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The trade of the decade?

The trade of the decade?

By Ray on July 31, 2010

The 2Q10 GDP report came out and it was an eye opener for many people as it showed that the recession, depression, was deeper than most believed and things are surely not as rosy as we are being told. Aside from the inventory rebuild there is not much else going on, final sales are dead as a door nail and some firms, like Samsung, are reporting good earnings, but warning of weaker times ahead. I take the Samsung warning pretty seriously as they are a large or the largest supplier of electronics which had shown signs of strength recently. So when they say things may not be rosy in the near future I suspect that will apply to more than just TV sales.

What made the news cycle this week was a report by Fed President Bullard about the threat of a Japanese style deflation here in America. I am kind of shocked that people were caught so of guard by this news, about 10 economic data points already indicated this to be if not already occurring a very real near-term threat. I suspect we are in for some really tough times ahead and worse yet I suspect we will see the Fed start moving towards quantitative easing, again. As I have said, repeatedly, this will not do anything to boost economic demand as we must wait for the deleveraging cycle to be completed by the consumer before demand will return. Zero Hedge just wrote a piece about this tonight which illustrates exactly what I have been saying for a month now, but no one is listening. Here is what they said:

“In other words, all those who say QE2.0 will do nothing to stimulate the economy are correct, as all such a greenlighted action would encourage is the warehousing of yet more cash by banks. And since banks have no incremental incentives to lend it out, it doesn’t matter if the Fed’s liabilities are $2.5 trillion or $2.5 quadrillion. Instead of stimulating inflation, which is the end goal, all such an action would do is to create further doubts about the stability of the dollar, which in turn, as Ambrose Evans-Pritchard discussed, is a sure way to go to hyperinflation without first passing either Go, or inflation.”

They also indicate my thoughts exactly, we bypass money velocity inflation and go straight to dollar devaluation, i.e. currency crisis, hyperinflation. The irony is that you would only feel this pain on imported goods and we do consume 87% of what we produce domestically so it may take some time before any real currency devaluation hits home. Regardless, Bullard indicated along with prior reports by Ben Bernanke himself that QE is on the table. The question is what kind of QE, treasury purchases or other asset purchases? Also, how much, I bet $3-5T in total purchases, but who knows.

What we do know, compliments of David Rosenberg, is that Ben Bernanke said IF we hit a Japanese style deflation that the target rate on the 30 year treasury would be 2.5%. Rosenberg says that if we hit that rate, down from the current 4% yield, one would receive about a 30% rate of return. I think he is right and if one followed his recommendations of treasuries and gold, along with high yield stocks, you would have avoided much volatility this year and had nice returns. I am happy to say I bought 2’s and 5’s when the yield was 1.10% and well over 2% so I am happy. I suspect the rally in treasuries will continue and if QE happens, wow.

The trade of the century, although risky, would be to leverage a long position into the 20+ year treasury market, UBT (2X bull) or TMF (3X bull). IF Rosenberg and I are right and this happens, QE, deflation or a major selloff in equities, those positions would do very well. However, they are risky, they are leveraged ETF’s, but if you time it right I believe that you could do very well. I also believe that the bull market in bonds is in full force again, very similarly to the summer of 2008 I might add which adds a bit of mystery to the rally in treasuries. The mystery is, what is going on and is the bond market telling you that something really bad is coming?

A look at the chart above looks like there is something going on in the bond market. We broke above the 123/4 mark on the 30 year futures and now that is support. I believe it goes higher because of, at least, of deflationary pressures and, at worst, because of QE. However, while I am short-term bullish on treasuries I hate them long-term since it will be impossible for the U.S. to meet its long-term debt obligations which means they will default somehow in the future, in my opinion. I also believe, as stated earlier, that QE will wreck our currency maybe not now, but at some point in the near future which makes gold very attractive as well. If QE is announced treasuries will go nuts and so will gold. If one is levered into treasuries you could do well, if you want the risk.

What QE means for stocks, I do not know. I would think QE would be bad for stocks as it signals things are not good and the economy is weak, but we are living in bizzaro world where good news is fantastic and bad news is even better.

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Too late to go short?

Too late to go short?

By Ray on July 19, 2010

The market has had a spectacular run lately, both up and down, which has been fantastic if you are a trader, but not if you are a long-term investor. Odds are that if you are a long-term investor you should be in bonds or cash anyhow at this stage of the game as the data clearly shows that equities are about to, or should be at least, take a rather large decline. The bulls have no data to stand on, zero, and the bears have all the evidence in the world including the Federal Reserve telling us that there is little to be excited about and what meager recovery we do have will take years to play out. How that could be interpreted as bullish is beyond me, but I am sure someone will read it that way. As for those waiting for quantitative easing part 2, keep waiting because it is not going to happen unless something different happens, like higher rates or a much stronger dollar.

What data am I pointing to? Pick a data series. The ECRI has been my favorite lately since it has never thrown off a head fake in the -10 range, we are at -9.8 now. Unemployment is also a favorite of mine, where is it getting better? Initial claims are stuck at 450,000+ per week, last week was a gift of seasonal adjustment, that will work itself out in the next couple of weeks. The employment reports are terrible and even the JOLT report was bad. I will say employment has stabilized kind of like how the Titanic stabilized when it finally hit the bottom of the ocean, but I fear there is a ravine close by and we are sitting very close to that edge, look for downside surprises in the employment reports. Housing is DOA and that is certainly not going to change, as I write this the Home Builder Confidence came in at a disheartening 14, need I remind you above 50 is considered positive? Tomorrow we are facing more housing data that is more than likely going to be worse than expected. Face it, there is little data in the bull’s camp except the data can’t get much worse or can it?

On the earnings front, well, we certainly had some great numbers last week, but what about this week? IBM missed on the revenue component and guided down by a couple of cents, no big deal, but big enough to emphasis a slowing in the second half. Texas Instruments met expectations, revenues were mildly light, but considering it is usually easy to beat estimates by a penny or two they couldn’t. Zions Bank, the fabled regional banks that were going to go gang busters this quarter, came in way below estimates, ($.84) vs. est. ($.54) and were light on the revenue side as well. Worse, on the top they said credit was improving, but they are setting aside more for credit losses and their charge offs increased between 1Q and 2Q10, how that is an improvement is beyond me, and we are talking about banks that get to carry loans at make believe values. Even Tupperware missed when people are spending less and eating leftovers! As I write many of these companies are trading lower off between 3 and 6%, not good news for the S&P futures.

Of course, we have a whole slew of earnings this week, a couple hundred companies, so why make big deal over these few firms. Oh, wait, they are IBM, Texas Instruments and Zions Bank, pretty big and respected companies that are leaders in their respective fields. Could earnings improve? Yes. Will they? I honestly do not know because, frankly and like it or not, earnings have been a mixed bag this quarter, but I also think earnings do not matter right now. The macro data is overwhelmingly bad and considering CEO’s do not want to repeat 2009 with negative warnings it is unlikely they will give negative guidance. I do not blame the CEO’s since they were punished relentlessly by the likes of Cramer in 2009 for not being positive enough and even today you only see CEO’s that give the most optimistic forecasts given air time on the TV. It is also or should be widely known that CEO’s are terrible at giving accurate forecasts, look at 2000 earnings releases and see what kind of guidance CEO’s gave back then. Clearly they did not see the slowdown coming when people like myself saw it a mile away, the same may hold true today.

So, is it too late to get short this market? Maybe, it depends on what happens tomorrow. My forecast is for the S&P 500 to initially drop to the 960-980 area where it will rebound, I obviously have no idea when it will happen or how long it will take. After it rebounds I believe it will drop to 860 so there is plenty of time to get short, depending how you plan on shorting it. If you are using options you have to be careful and trade them. If you are using leveraged ETF’s I think there is a lot of danger in holding them, but unleveraged ETF’s, like SH (I own SH), is safer to hold. I believe the best time to get short was 100 points ago, obviously, but last week was a great opportunity as well. Tomorrow, Tuesday, everyone is going to be looking to get short so you will pay a premium to jump on the bandwagon and will be assuming more risk than reward in the short-term.

What is interesting is that the rally, the whippy 7% gain, was a 61.8% retracement from the lowest closing low, 101ish on the SPY. It goes to show that the rally in itself was nothing more than a technical bounce and was rejected when it tried to go higher. That, to me, confirms that there is much more room on the downside than there is on the upside right now. Yes, stocks can move higher depending if ‘something’ happens like a stress test that was designed to not fail actually impresses people, but I actually believe that is irrelevant at this point. Europe is not the cause of our problems, we are as the data is all U.S. data that shows we are if not in another recession/depression certainly going to slow down significantly. I am short so I do not have to worry about working in new positions, I hope you were short as well. (I own various SPY put options, SDS, SH, TZA, BGZ, TYP)

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I was wrong on the employment report, but right

By Ray on July 5, 2010

I was wrong on the numbers on the employment report, kind of, take out the temporary hires and birth/death adjustments and I was very much right. Contrary to popular belief, the birth/death adjustments do matter as those adjustments are responsible for underestimating unemployment by 880,000 people last year and, in my opinion, that rate is probably way underestimated at that. Even Dave Rosenberg lambasted the birth/death adjustment as “fantasy” which means I am not alone in my thinking. Regardless, that employment report was clearly not priced into the market and was very bad news.

We had wages drop and the work week shrink which is very deflationary to say the least. I also believe that the full impact of the Gulf oil leak has not made the rolls either yet which means more bad news ahead. There is also the ban on offshore drilling making its way through the court system which could have some profound implications in the Gulf region adding thousands to the if not temporary unemployed at least the medium term unemployed area of the report. The icing on the cake was the initial claims report of Thursday which came in much higher than anticipated at 472,000 which is not good at all.

Mix that in with the ECRI slipping further and I am comfortable with the double dip scenario, if we were ever really out of the recession to begin with. I am hard pressed to believe any of this is priced into the market even after this massive slide we have seen in equity prices. From my point of view the equity markets had some 4% GDP priced in and flawless earnings with endless positive guidance. So far we have seen some firms pre-warn about a slowdown in the economy and their earnings. This means some of this is priced into equities, but not a 1% GDP print or a negative print which is possible at this rate. Housing is telling us that we have serious problems and the slide in all the housing data means that a full fifth of the economy is in negative territory. We also see that hiring in the manufacturing area, which was giving economists a sense of comfort, is slowing down dramatically. Can we all say this together please, inventory rebuild, but that is now over.

There is simply no end demand for products at this point which is not good. I had called this a depression last fall and received tremendous heat for using that term, but make no mistake about it, this is a depression. Unemployment is telling us that it is a depression and we are, as history seems to be repeating itself, looking at acts that mimic what we did pre-1929 crash, Smoot-Hawley, now called Schumer-Graham for the currency manipulator tariff act. None of this is priced into the equity markets which mean we will have much to worry about on the downside. Be sure, there will be sharp rallies, but you should not buy the dips on this one. I sold everything except for biotech, high yielding stocks with strong balance sheets, high grade bonds, treasuries and I own a tiny position in high yield bonds, I sold 80% at the end of 1Q after the stellar performance. I hold large short positions, which is relatively unchanged from the end of 1Q except I rolled put options out until September and began building a position in some leveraged and unleveraged short ETF’s, TZA, SH, SDS, BGZ to name a few, some I will hold and some I trade.

I expect a rally up to the 104-105 area in the SPY which should prove to be a nice entry point into a short position, if you are aggressive and believe growth will be weak as I do. However, I believe tomorrow we open lower since we could not hold $102.50 on Friday in the SPY, but we should reverse up since everyone is so negative. Depending on what happens, everything always depends, I will more than likely cover my shorts tomorrow and play the long side for that rally and reenter my short positions at higher levels. Volatility is your friend, but we are dominated by certain carry trades, news events and other macro items that one needs to monitor so be careful and don’t just trust the charts, look at everything to make your decisions. My target for the S&P is still at least 900, but it can go as low as 860 and retest the March 2009 lows without any problem whatsoever. I am not even sure quantitative easing can fix this problem since treasury yields are heading lower already. We are in a very bad position and there are no more bullets left from the government. This could get very, very bad.

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Well, what do you know?

By Ray on June 30, 2010

Apparently it is now fashionable to be bearish since the S&P’s smashing, as in breaking below the 1040 level and 1035 for that matter, performance over the past few days. I hate to break it to everyone, but the time to be bearish was at 1120 and when the VIX was at 15, now, well, be bearish, but be careful. Those looking to jump on the short wagon might find themselves over paying for their positions and they might get squeezed out in the next few days. Don’t get me wrong, my S&P 500 target price is still 900, but I fully expect a retest of the 1040 mark in the very near term.

How bad is the economy?

Anyone even questioning how bad the economy is has their eyes closed and their head stuck in the sand. All the data is rolling over, look at the Chicago PMI today which came in at 59.1, sure, it met expectations, but it is down from where it was and is establishing a declining trend. The leading indicators are down and probably going to look horrible in the near future. I am sure initial claims will still be well over 450K tomorrow, oh, the ADP data stank to high heaven today as well so forget about an upside surprise on Friday. There is some housing data out tomorrow morning and I am sure it will not be good, it is May contract data, but never fear because Congress is attaching an extension of the home buyers tax credit to the unemployment extension, fantastic!

In short, things are much better than, say, September 2008, but things are not good and we are heading for either a double dip or very slow growth in the second half of this year. Treasury yields are telling us we got serious problems ahead and deflation, sound familiar yet, is an immediate threat. However, remember that inflation will come on very fast at some point in the future, you will never see it coming. The good news was that the ECB lending news was not as bad as I was expecting, but let’s face it, the news is still not good in Europe and the risks are very high. Spain may be downgraded, it will be very soon, which I am sure is surprising and people are wondering why such a fiscally sound country be downgraded?

The only thing I am surprised about is the U.S. and the U.K. still have the ‘AAA’ ratings after their drunken stupor of a spending spree, with much more to come before the majority is kicked out in November. After all, once your vote is cast and they lose their jobs what do they care if you dislike them or not? Expect another stimulus which is sure to extend our pain well into 2011. In the end all we will have found is that we have spent a lot of money with very poor results, just like the 1930’s. Let’s just hope this time it does not end like it did in 1941, there seems to be a correlation between poor economic stretches and wars.

What should give bulls some fuel is that everyone is so bearish it is bound to be a contrarian indicator. Am I going to bet on that? No, not yet at least. I spent the majority of this morning dumping everything I absolutely did not love to own building cash and some short positions, the markets were up this AM. While I am sure we will get a bounce in equities I am not so sure we will get it this week, a notable bounce at least. There will be short covering before the 3 day weekend, but at the same time I do not believe any one wants to be long either. What does that mean? We go lower, in my opinion at this very moment, but we could very well get a sharp bounce tomorrow before we go lower. If we break above 1040 we might go higher, but we are certainly not going to make new highs again this year, from what I see right here and now. Things are much worse than they appear unless you are 100% treasuries, suddenly that call I made back in April doesn’t look so crazy anymore either.

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Double Dip Surprise

By Ray on June 27, 2010

How anyone is really surprised by the possibility of a further decline in economic activity is puzzling to me. Perhaps it is all the distortions in the data that is coming from the government supporting the economy. Maybe it is because their vested interest is to have you invest in their funds. Perhaps they just drank the Kool-Aid. No matter what it is almost a certainty, in terms of forecasting, that the economy will either stagnant here or decline.

The main indicator that has been telling us there were problems for some time now is the initial claims data and the lack of private payroll growth. Sure, we saw a bump up in payrolls with the 5%+ GDP print, thanks to inventory restocking, but 1Q10 GDP shows signs of significant weakness. What has held true is initial claims, first they got better with the big GDP print, but now they are soft with the constant downward revisions to 1Q10 GDP. The ECRI data also points to weakness in the economy as well which correlates with initial claims data. From my lens, employment is not a lagging indicator, I have been pounding the table on this for a year now, it is a leading indicator in a post credit collapse scenario.

Friday’s employment report is now being telegraphed by Bloomberg to be weak, -110K is the forecast, especially since the Census hiring is done and they are now laying off workers. All of this is not surprising if you track initial claims and use it as a leading indicator. To put the monthly initial claims data into perspective 1,850,000 are filing claims for the first time and that means there needs to be about 2M jobs created every month to offset the ones just lost and we also have to contend with population growth as well. To be blunt, full employment is a figment of one’s imagination at this point for at least the next 5-8 years. Unemployment will be our greatest problem for a long, long time and there is little the government can do since end demand is the issue.

There is simply no way the Fed can raise rates for the foreseeable future either since one of their mandates is full employment. Yes, I know they said they would raise rates before employment recovered, but they won’t for political reasons. Obviously, that might change depending on what happens in the future, but for right now there simply is no reason to raise interest rates, at all, from their perspective. Worse is the fact that the Senate did not extend unemployment insurance last week which means a million plus people will lose benefits very soon. After their drunken spending binge to bailout the banks after they created this it is beyond me how they would let a million people just wither and die. There are 6 people for every job opening out there so it is not like these people are actively NOT trying to find work, so enough with that whole theatrical display of utter idiocy. Keep in mind I am a deficit hawk, but there is a difference between government wasting money and government helping those who cannot find work.

The loss of those benefits will have a huge impact on the economy as a whole since that money will not be spent. Retail sales will continue to slide and foreclosures will continue to rise, how many of those million plus people are barely hanging on? I am not sure how so many people can claim that the unemployed are simply freeloaders looking to live the highlife on such a meager government stipend which is what you hear often on other blogs or by the ultra rightwing. Considering that there are so many people looking for work the competition for a job, any job, is extremely high which reduces the odds of a person actually getting a new job anytime soon. Not to mention that unemployment benefits are usually around $300 – $500 a week I find it hard to believe that anyone is living the highlife on such a low amount, but that is the case. I am sure that there are abuses, but this is one of those give me a break moments and I am definitely right of center.

The other reason many believe a double dip is out of the question is that companies have extraordinary amount f cash on their balance sheets. Well, all I have to say is how long has that cash been on their balance sheet and it has not gone to work yet? This is like the temporary employment is a bullish indicator, if it is not happened yet the odds of it happening anytime soon are dwindling. The cash on the balance sheet is also part of the deleveraging cycle as companies pay down debt and hoard cash. Perhaps the main reason that companies have so much cash on hand is they think that business is going to get very tough in the near future. After all, many of our best companies have roots going back beyond the Depression and they know the value of having cash on hand to make it through the storms. Of course, they could spend it all tomorrow, but I ask again, what are they waiting for and why hasn’t it happened yet?

The bottom line is that it is really shocking to see so many smart people caught off guard about a potential double dip recession. All of the signs have been around for a longtime that the thought should have entered their mind at some point in time in recent months. There is a chance that we could avoid it, but I do not see how. I should point out the fact that I never bought the idea that we actually made it out of the first one, other than a statistical recovery that is. Time will tell on this one, but if Friday’s report is worse than expectations we will be well on our way to S&P 900.

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