What I'm Reading

Greenspan: Repel the Calls to Contain Competitive Markets

European House Price Guide

Hussman Weekly Market Comment (Last Week)

M&A and the Dollar

Global Economy Remains Solid

Slim Pickings at ML

Roubini Interview with Barrons

Fergusson: How a Local Squall Might Become a Global Tempest

Short View: European Economy

European vs US Banks

The Four Part Series: The Big Freeze

Part 1

Part 2

Part 3

Part 4

What I'm Reading

The Woman Who Called Wall Street's Crisis

Risk for Spain's Banks

Efforts to De-Risk Bank's Balance Sheets Raise Questions

UK Inflation

Authers: Deflation

Subprime & Alt-A: End of One Crisis, Beginning of Another

What I'm Reading

Judging by the US, the worst might be yet to come

The wrong tools to tackle inflation

JPM: Economy "Weak, likely to get weaker"

Welcome to the vacuum market

Edwards: Jail Eddie George and mervyn King. And Bernanke!

June Housing Starts

Cold-Eyed Review of a Red-Hot Rally

The Psychology of Selling

Merrill's Q2 - Worse than Expected

What I'm Reading

Thoughts on Employment

Ballooning Commodities

Fannie and Freddie: Another bust for Shareholders

Are the Hunters Low on Magic Bullets?

El-Erian: Crisis and Coherence

US inflation is not going away anytime soon

Rogers: Fannie Plan a Disaster

Fed Holds its Breath on Inflation

Treasury Default Swaps: New Record

A trillion dollar mean reversion

What I'm Reading

Sesit: Dollar Peg Should Be Buried to Beat Inflation

Oil Spike

Sharpe Ratios of Managers

Rate Rise Expectation Overplayed, believe Fed Officials

More on Oil

Oil Marches On?

Cement Usage: Wow!

Scientists find bugs that eat waste and excrete gasoline

Watch those Yields

Yahoo must call time on Jerry Yang

What I'm Thinking

My holiday is coming to an end. I should be back to the normal routine starting Tuesday after the long weekend.

I'm a bit frustrated at my recent trading. I was stopped out of my EUR/USD short as well as my long SLV trade. Both have since retraced a bit. At this point I'm looking forward to getting back to the old routine and finding some compelling opportunities. I have been poor thus far at waiting for a good entry price on my trades. I'll have to keep this in mind in the future.

What I'm Thinking

As I previously mentioned, I put on a short EUR/USD trade. This is of moderate size relative to my portfolio value, but I'm fairly optimistic about its potential to add to my P/L.

The preceding chart of spot EUR/USD for the last 10 days is not much to write home about, but when you consider this recent item of news, I'm fairly optimistic. I entered the trade mid-day on May 7th at basically the same level we are currently trading. Initial resistance is at 1.53 with support at 1.5530. I suspect that if negative news in the U.S. propels EUR/USD back to the 1.60 level, it's very possible that there will be a coordinated central bank intervention. I see this is a reasonable floor on my downside. If we can break through the initial resistance of 1.53, sub 1.50 would not be out of the question. I'd likely take profits in the 1.48-49 area. The chart looks a little better when you zoom out:

I'm not expecting EUR/USD to be trading sub 1.40 anytime soon. I'm still a dollar bear. But I feel like the following are coming together to make a short EUR/USD trade compelling:

1. Tacit central bank support, if not active in the future
2. Asian central banks (China) that were former sellers are now buyers at these levels
3. Declining economic picture in Europe (although I don't see any ECB rate cuts anytime soon)
   

The longer we are able to stay below this 1.5530 level the more likely I feel we'll be able to take out the 1.53 lows. I am going to Greece tomorrow for 2 weeks so I won't be able to actively watch (this might be a good thing), but even so I have not put any stops in. This move has largely been motivated to put a lid on oil's recent surge. I'm not putting any money into play but I think it's possible oil could be the next trade that has solid investor support to capitulate and pull back. We saw that with the front end of the curve across the world recently. If oil actually does have a pullback this would be extremely USD bullish.

On a different note, I put in some limit sell-short orders on SPY, pyramiding up from 141 to 144. I'm not ready to say that this little counter-trend rally is over but I'm not intent on selling at current levels, especially after the trading of the past couple days. So that's the reason for the pyramiding up. Frankly, I'm hoping they all get triggered because I think it would mean more upside in the long run.

Some other ideas have continued to nag at me. I think the large-cap small cap trade is still looking good, and a consumer cyclical / S&P spread trade seems about right too. If the bulls can take us up past 1420 again I'd be much more likely to put those ideas to work. I'm also assuming any increase to those levels would be driven by discretionary and financials. If that were the case buying a small amount of puts on some of the more unsavory financial names wouldn't be a bad idea.

In the meantime, my risk level is relatively small. I still have my long term rate trades, and those are showing nice gains. This past week was quite a good one for the ol' P/L. But I can't concentrate too much on that in the short term. What matters is that I hold conviction in my ideas and I don't overtrade.

What I'm Reading

Is the Commodities Boom Driven by Speculation?

U.S. Leads Effort to Prop Up Dollar

Global Imbalances

Asian Bond Markets



That's about it for today. Did a lot of reading but nothing much that piqued my interest.

What I'm Reading

All about the dollar

Recession Probabilities for the U.S.

All of Inflation's Little Charts

Worldwide Growth in Fertilizer Usage

Misleading Growth Statistics Give False Comfort

No silver lining as prices take a tumble

Global Long Term Interest Rates

Desperate Measures: India Closes Soybean Oil, Potatoes Exchanges to Fight Inflation

Sucker's Rally? - I think so..

Scale-up sells in the 1420-1440 range - I like this approach

A Rally with Serious Muscle

What I'm Thinking

Well now. It appears many things are coming together for my EUR/USD short. I check out FT for one last bit of reading before I call it a day and I come across this.

Now that is certainly something. The highlights:

"Senior eurozone officials believe that the dollar-euro rate had reached levels unhelpful to both the US and Europe."

"The US is still a long way from agreeing to intervene in currency markets or identifying desired exchange rates. But both sides believe fundamentals and central bank policies are turning in the direction of relative dollar strength. After cutting interest rates aggressively, the Federal Reserve has indicated its desire to pause. Meanwhile, the ECB is softening its hawkish tone, and could shift further if weaker growth reduced inflation risk."

"The central banks have not ­co-ordinated their policies to manage the exchange rate. But policymakers feel communicating the change in relative fundamentals and monetary policies may be effective"

I'm curious if officials agreed to come out like this in hopes of sidetracking oil. Macro Man and Brad Setser both have been writing about how central banks that were dollar sellers have turned dollar buyers in the past couple of weeks. And we also have a recent string of negative economic data coming out of the Eurozone. I'm thinking EUR/USD can see sub 1.50 in the next month. And I'm positioned accordingly to take advantage of that.

What I'm Reading & Thinking

Bond Investors Play a Waiting Game

Hoenig Says Inflation 'Serious' and may prompt rate rise

Vallejo, CA officials vote to file for bankruptcy

The short view: Crunchy Credit

Yield of 4% Beckons in Treasurys

Seeing Inflation Only in the Prices that Go Up

Some Inflation Charts

Win Some, Lose Some - How to Come Out On Top

Cyclicals are Still Overpriced

Soros Says Impact of Crisis on Economy Just Starting

Home Improvement Investment has a Significant Downside Potential (Short HD?)

U.S. Consumer Debt Surges in March

Silver: Still dependent on gold for upside

Peruvian Miners set to strike May 12th. Silver should see benefits

World Silver Survey authors say silver outlook is still positive

Current Thoughts:

*Home Improvement Stocks look like good short candidates

* I really like how I'm positioned right now (short EUR/USD, long my FF future spread trade, and long Dec ED futures). I'm feeling a little less bullish on my SLV holding. Gold is tracking pretty closely to USD movements, especially EUR/USD.

What I'm Reading

Medvedev Boxed In by Oil as Putin Bequeaths Economic "Dead End"

Fed Survey Shows More U.S. Banks Tighten Loan Terms

Updated Year-End S&P 500 Price Targets

Sales Tax Collections Decline in Most States

Jitters in the Eurozone

Will BofA-Countrywide Deal Get Done?

Economists Look for ECB Signal on Rates - I'm short EUR/USD but I doubt anything new will come out of this meeting

Shorting Puts - Interesting...

Commodity Prices in Historical Perspective

A little Yield Analysis

YoY NFP - A little different take

More on Earnings Expectations

Bulltrap: ABCP and Level 3 Bombs

Time for money market funds to help - Good article from FT that explains why "banks afraid to lend to other banks" is wrong

NYSE April Month End Short Interest

Some Signs of an Upturn for the Dollar

Disconnect

TED Spread is Improving

Housing Burst Duration

What's behind the Slide in Gold and Silver?

May 4th Got Gold Report - Money flows are increasing into SLV (current holding) as the price has declined

Dollar Demand is Strong Among European Banks

Brics offer investors a varied harvest

Wrong time to enter vulture business

What I'm Reading

Hussman Weekly Market Comment

NYFR

Indicator Review for May 5th

Mark Kiesel: Slimming Down - I strongly agree with what this article has to say

What Uncle Sam Gives in Rebates, OPEC Takes

Economy May Face Prolonged Pain, History Suggests

Departures May Change More Than the Look of ECB

Economists React: Jobs Report

Economists React: Fed Statement

Economists React: GDP

Non-Residential Investment: Still the Key

Q1 Sector EPS Growth vs. Estimates - Estimates were right on for the S&P according to BIG, but I'm not sure the date they used for the start of earnings season. Their figure is different from the one I cited in my inital post on earnings.

Caroline Baum: Wall Street CEO Chorus is Singing Out of Tune

What are corporate bonds worth in a recession? (Spreads Have Further to Tighten)

Slow German Growth Sounds Poverty Alert

Weyerhaeuser's Loss - WY is on my value watch list

Tentacles of Recession and the Great Unwind

John Authers: Uncertainty in markets

What I'm Thinking

CFC is down about 15% today on an FBR analyst call that BofA will renegotiate their deal. He has a price target of $0 to $2 and cites BofA's May 1st filing that states there is no assurance that any of CFC's debt will be assumed. I agree with the analyst's call that this is a first step in a renegotiation process over the acquisition of Countrywide. I actually think there is a strong possibility that CFC will just go bankrupt. A quote from the report:


"Countrywide's loan portfolio has deteriorated so rapidly that it currently has negative equity and the proposed takeover of the company will be a drag on Bank of America's earnings due to the elevated credit expenses at Countrywide, analyst Paul Miller wrote in a note to clients...
If mark-downs on Countrywide's loan portfolio are less than $22 billion, then Bank of America can likely offset the adjustments with fair value debt adjustments and the difference between tangible equity and its purchase price of Countrywide, he estimated."

It's really tough to estimate book value for these financial companies now, but I certainly am in the camp that believes mortgage resets will lead to greater financial losses than the market currently expects. I think what we have going on here is a case of BofA looking under the hood of CFC and finding that they don't really like what they see. I think that CFC doesn't go any higher than $6.20, which was the high of its recent trading range. The original BofA acquisition price was for $7.16 a share. So with an upside of $3-5 and a downside of $1, I think we have a pretty good case here for a short of CFC. I'll be looking to get in at a better price later in the week.

What I'm Thinking

A quick update:

Since we broke through the psychological barriers of 13,000 for the DOW and 1400-06 for the S&P 500 along with breaking through and closing above 200 dma's, I have closed out all of my short positions in U.S. equities.

I have kept my long Silver position. It is close to my review point and this time of the year is considered seasonally weak so I may close out this position as well. I haven't put down my thoughts yet on silver but long term I am extremely bullish on this play. I'll get to it in time.

Last week I put on a Fed Funds spread trade that basically makes money as long as the Fed doesn't raise rates by November. More on it later...

Tech stocks have been extremely strong lately. The chart looks bullish, money managers are optimistic, etc. etc. I have added some low-delta calls on the QQQQ. Will probably sell during this week.

I remain of the opinion that this is a sucker's rally. The VIX is signaling extreme complacency and I'm looking to setup a VIX trade in the near future to go long vol.

What I'm Reading

Hussman's Weekly Market Comment

The Fertilizer Commodity Bubble

Silver Prices to Resume Rally in Late 2008, early 2009
And More Here

The Real Impact of De-Leveraging

Is the Credit Crisis Really Over? Minsky Would Say No

Accelerating Housing Declines

The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus

Brazilian Stocks on Fire

Low Spending is Taking Toll on Economy

How Long Can the Rally Run?

Ten Things Everyone Should Know about the VIX

What I'm Reading & Thinking

Europe's economic slowdown to continue - I can't imagine trying to predict the growth rate for 27 countries. Just 1 is hard enough.

Fed set for further cut in rates

View of the Day - Ian Scott, Lehman Brothers

Safety dash into bonds brought to abrupt end

Wrigley Mars Deal in Depth - 32 x forward earnings and 20 x ebitda seems darn pricey to me

Soaring Rice Prices Send Asian Nations Scrambling

Is the Work of Fed Bankers Really Done?

DB Chief Energy Economist: Oil to $250, then demand collapse

Barron's Big Money institutional survey - Quite telling. I find myself in disagreement with many of these big time money managers. As one commentator put it, "many of these guys appear to be trading the rally before we've experienced the recession." I agree.

Bill Gross' May Investment Outlook - "Home prices and their real economic fallout are the financial markets – and PIMCO’s – vulnerable flank." I'm glad I'm on similar terms. I have taken a side on this issue and feel that falling home prices will lead to economic fallout in consumer spending and corporate profits. Indeed, these two indicators have already topped out. This is basically the core of my domestic outlook for equities. And to continue, I think that this is our endgame:

"To be brief and blunt, the reason that home prices are so critical, he would claim, is that they are at the forefront of potential asset deflation. Because the U.S. and selected other economies are now substantially asset-based and dependent on stable and upward tilting prices, a deflation of an economy’s primary financial asset can be ruinous. Its deflationary thrust must be countered, wrote Minsky, or else the battle might be lost. If so, the real economy as Mohamed El-Erian suggests, might become so shell-shocked that financial markets once again turn down instead of up."

I don't necessarily think that we will have a long-term deflationary problem like Japan. But I think it's likely declining home prices will lead to slower consumer spending, the great "muddle-through" economy combined with the great unwind in leverage, and lower financial asset prices as a result. My short equity bias remains as long as I view earnings expectations to be overly optimistic. Currently I view Q3-Q4 as wildly optimistic. I'm less inclined to believe Q2 will be greatly below expectations because of the effects of the stimulus checks. Even that argument contains less merit as oil continues to hover around $120 and gas remains around $3.60/gallon.

The chart above is Corporate Profits as a % of GDP. When I mentioned above that corporate profits have topped out this is some of the data that helped me come that decision. And this is one of my strongest arguments for why earnings expectations are too high for the latter half of this year. In the Barron's Big Money institutional poll all the bulls were pointing to low P/E's. 55% thought stocks were undervalued. I come to the conclusion that with normalized corporate profits stocks are overvalued. The chart says it all. We are at the highest level of corporate profits since the 60's. And with consumer spending (and leverage in recent years) being the primary driver of corporate profits, do I think these elevated levels are likely to stabilize and continue?

I find this unlikely. The chart above (via John Mauldin) makes me think that we have probably topped out in consumer spending as well. The negative wealth effect, stagnant wages, and higher commodity costs all add to the consumer's pain. The economy was essentially fueled in 2002 to 2007 by leverage and HEW's as consumer's thought housing prices would increase forever. HEW's have dried up and as BofA noted in the earning's calls, we have seen rising credit card delinquencies (especially in housing bubble areas). As Bud Fox said, "I'm tapped out Marv. American Express has got a hitman looking for me."

I have to be wary here about confusing my economic outlook with my market outlook. While ultimately the economics are the underlying factor, the great bull party may continue for a little while longer. I am prepared and will position the portfolio accordingly. Opportunities abound in this market and I am confident I'll be able to take advantage of them.

What I'm Reading

Waiting Game Begins on Rebates

Global Adjustment Will be Long and Painful

The State of Credit

U.S. Home Vacancies Rise to Record on Foreclosures

Tech Tonic

Small Banks Under Threat in US

Steel price nearly doubles in a year - I'm tempted to say that this bull has not yet run its course but I'm entirely uninformed about the market

Jim Rogers is Buying China Again

Morgan Stanley: US Banks Earnings to Fall 26% in '08 and 15% in '09

USD Hits 2-month High Against Yen

Silver fundamentals seen as poor which makes price vulnerable

Rise of Nationalism Frays Global Ties

South Korea's Growth is Likely to Slow More

Japan's Inflation: Bad Timing

The Dollar Rebound: Is It for Real?

No bubbles, Just fundamentals

What I'm Reading

Even the great investors get the right bets wrong

Massive JGB Selloff

El-Erian: Why this crisis is still far from finished

Japanese Stocks Cheap?

Learning from Amex

Counterparty Risk in the Commodity Market

If Tech Companies Are Beating Earnings, Why Isn't NASDAQ Breadth Improving?

This Bear Growls On

Jeremy Grantham Q1 Letter

Why Haven't Existing Home Sales Fallen Further?

Pimco's European Perspectives: Haven't We Been Here Before?

What I'm Reading

U.K. Economy Expands at Slowest Pace in Three Years

Ukraine had 26% YoY inflation last month

China Price to Drive - As oil has been hovering around 120 I have seen several articles or research reports that talk about the effects of price controls in many oil producing and asian economies. In places like China, Saudi Arabia, Russia, and Venezuela governments subsidize gas prices. This allows fuel consumers in these nations to not pare back consumption, an upward pressure on global market price.

Commercial and Industrial Loans Near Record Levels

US Regulator Fears Wave of Bank Failures

The Good News About the Housing Bust

Expectations for the Fed Meeting

Business Bankruptcies Rose 43% in 2007

Value in the Front End of the Yield Curve?

An Endgame for the Euro?

Goldman: More Pain for Monolines

Odd Numbers

What I'm Thinking

Equities are rallying. The "consensus" resistance levels are 720 for Russell 2,000, 1400 - 1406 for the S&P 500, and 13k for the Dow. If they are able to break those, rally a little bit more to close above their 200 day MA's I must admit that this is a true rally. Until then I still deem it a counter-trend rally.

What I'm Reading

Bondholders Lucky to Get 10 Cents in Looming Defaults

Recession? It Doesn't Add Up

Target March Creit-Card Charge-offs Annualized 8.1% - There is a picture here getting clearer and clearer with each earnings report that credit card delinquences are rising and consumers are getting tapped out. The BofA earnings call detailed how credit card losses were up sharply in areas affected by declining housing prices. It's a consumer-led recession (something we have not seen in 25 years).

Tracking NAR Spin

Anemic Global CDO Issuance in 2008-Q1

Disastrous New Home Sales

U.S. Sector P/E Ratios (High)

The 800 Pound Gorilla on Consumer's Backs

Economic Releases (Not too shabby)

EUR/USD has fallen 3 big figures in the past 2 days (Just in time for my long EUR/USD post)

What I'm Thinking

In the early stages of a reflexive process of credit expansion the amount of credit involved is relatively small so that its impact on collateral values is negligible. That is why the expansionary phase is slow to start with and credit remains soundly based at first. But as the amount of debt accumulates, total lending increases in importance and begins to have an appreciable effect on collateral values. The process continues until a point is reached where total credit cannot increase fast enough to continue stimulating the economy. By that time, collateral values have become greatly dependent on the stimulative effect of new lending and, as new lending fails to accelerate, collateral values begin to decline. The erosion of collateral values has a depressing effect on economic activity, which in turn reinforces the erosion of collateral values. Since the collateral has been pretty fully utilized at that point, a decline may precipitate the liquidation of loans, which in turn may make the decline more precipitous. That is the anatomy of a typical boom and bust. ~ George Soros, 1985 (The Alchemy of Finance)

A very topical quote for the current situation. Written over 20 years ago when we had nowhere near the level of sophistication in credit creation. This summary is a good reason why I think the longer-term outlook is deflation. But I'm beginning to think that won't happen until we have our current little run with price inflation.

And since EUR/USD broke through the psychologically significant 1.60 today, I think it's very likely we could see a run-up to 1.63 and eventually 1.65 in the next 3 weeks. The economic situation in the U.S. is deteriorating, price inflation through oil and food remain, but above all long EUR/USD has remained a very profitable trade since November of 2006. This has been a self reinforcing process (here I go with the Soros reflexivity stuff). The longer it remains profitable the more it will attract speculators. And we have recent hawkish commentary from the ECB and China sitting on over $1 Trillion USD to boot. The ECB is dying to raise rates it seems. The updated statements from various officials made it clear that it's not really relative currency values that are concerning them but currency volatility. And it's essential to remember that the ECB is much more of a hawkish organization than the Fed is. The ECB is actually mandated to prick bubbles whereas the Fed claims that bubbles can only be truly known until after they burst. Basically ECB will control asset prices while the U.S. will not. If anything I think the argument can be made that the market considers the Fed as a supporter of asset prices. Soo all and all I really just won't fight this trend. I want to trade this trend. I think 1.65 is very likely, 1.75 a definite possibility. As I've mentioned previously the endgame here is coordinated central bank intervention. We're not there yet.

Eventually... I won't try to put a date on it.. but eventually, we'll see the slowdown in the U.S. spill over to the Eurozone in a material way. Spain, the U.K., and Ireland all have/had housing bubbles of their own that are popping. This will cause deflationary pressures and a de-emphasis on the hawkish stance of the ECB. When the slowdown becomes apparent in the eyes of the market, THAT's when we'll see EUR/USD fade. But as I said, I'm not looking for that to happen anytime in the immediate future. Long EUR/USD seems like the best option. But....

If and when the EUR/USD retracement comes, I see the potential to make a boatload. I'd look for a period of low vol where you could get a really nice risk/reward ratio. We're not there yet, but we're certainly getting closer. I'm thinking you'll be able to get a 10/1+ ratio on some bearish EUR/USD options.

On an equities note, I'm adding UNH to my equity value watchlist. They reported earnings today that were not to investors' liking. They're trading at a 3-year low with a trailing of P/E of 10. Won't go into any depth here but I'll keep my eye on them. They join Weyerhaeuser as the second equity on my value watch list.

What I'm Reading

In the Eye of the Housing Hurricane

Bonds are Back in the Game

Earnings Beat Rates

From the Energy Desk

March Existing Home Sales

Is Buying Drying Up?

A Nice Quick Update on Housing - Peak to trough I think housing prices will fall 25% - 30%

More on March Existing Home Inventory

Japanese Banks Step up their Lending

Banks to Pay Steep Cost in BOE Plan

Beijing Unveils Stock Plan

New Threat: Loan Losses

Economic Recovery Already Underway - I think I may just have to come back to this post in a year or so for humor

Some Thoughts on Earnings & Equities

No changes to the portfolio recently. I won't be making any trades until my funds are moved to the margin account. Once there though I have a couple good ideas I want to put into action. But I wanted to put some of my thoughts down in the meantime.

I think I'm going about my trade in the wrong way, and a lot of this has to do with the fact that my options have been limited as to what I can trade. But shorting indeces outright doesn't seem to be the best play at this time. Financials and consumers are tanking while energy and materials are ripping, so we're seeing some offsetting action here. And this is also why the current bear-market rally isn't all it's cracked up to be. We don't have broad rallying across all sectors, and for me to start changing my mind and thinking about putting on some sort of short-term long index trade I'd have to see broad based support on strong volume.

80% of S&P 500 profits still come from the domestic economy, but the DOW components take much less than that from the U.S. I'm looking for where I can find this data (I don't want to have to go through each individual component of the DOW), but it's safe to say that as far as being tied to the U.S., it would go Russell, S&P, and then DOW. And now is time to bring in a topical chart via MacroMan:

Quite a disparity between domestic and foreign YoY profit growth. Makes a very compelling case for my short Russell trade and less of a case for my short DOW trade. Macro Man recommends a large cap/small cap spread trade. Now that might work for me If I had a big capitalization but I have a pretty small account. I'm more likely to just cut my short DOW trade and keep my Russell 2,000 short on.

I'm feeling pretty comfortable right now with my short equities position. Falling domestic profits, elevated valuations, and what will likely be slower consumer spending all lend support to my trade.

What I'm Reading

Mortgage Rates on the Rise

Trading Radar for this Upcoming Week

Israel seeks to become finance hub

Q1 Earnings Growth Results With 20% Reported - It appears I am very right so far about worse than expected earnings but I've been wrong on the market's reaction

BofA Fails to Meet Expectations - ``We remain concerned about the health of the consumer given the prolonged housing slump, subprime issues, employment levels and higher fuel and food prices,'' - CEO Ken Lewis

Historical S&P Performance after Strong Breadth - A Study done in Tradestation. I'm curious how people do studies like this. I'd enjoy adding it to my repetoir

Delinquencies Rise on HEL

BofE Announces their version of the TSLF

Thoughts on U.S. Equities & Earnings

It appears that U.S. equities are intent on rallying. Bottom callers are out in full force. As mentioned in the last post, I thought that Friday could be a big up day if Citigroup, Honeywell, and Caterpillar had good earnings. All three companies seemed to please investors judging by their performance. Last week for equities was actually better than any week in all of 2007. Recall that I thought the initial impetus for a resumed downtrend would be earnings significantly worse than what was expected. Lo and behold we have this article in Friday's WSJ.

"Thus far, roughly 20% of the companies in the S&P 500 have reported, and overall first-quarter earnings are down 22.1%, according to Brown Brothers Harriman. But excluding financials, earnings are up by 8.2%. If the actual reported earnings are combined with estimates for the remaining companies, earnings are coming in slightly above expectations, at a 12.9% decline. Excluding financials, they're up a healthy 9.5% Brown Brothers says."

Reading that and many other bullish pieces in the news (especially on Friday), it appears the market really wants to rally. For the companies that have reported thus far (granted only 20%), actual results have been almost twice as bad as expectations. But the indices are climbing. We're in this mode of "Well if only we don't look at these numbers, it seems we're in pretty good shape!" And we still have what I believe to be wildly optimistic 2H 08 earnings. Consider again:

"Despite the first-half losses, some analysts predict a big rebound in third- and fourth-quarter earnings. The wave, they believe, will be led by financials and companies that make and sell so-called consumer cyclicals -- such as cars or home furnishings. Such an uptick is expected to lead to an 18% rebound in third-quarter earnings and a full-year gain for S&P 500 earnings of 14.7%, according to Thomson Reuters."

And remember this rally took place under the backdrop of very bad housing data, $116 oil, better than expected industrial production, and elevated inflation numbers. It's safe to say that the economic data was more negative than positive.

Now I don't want to fall into the trap of only only looking at economic indicators and not listening to what the market is telling me. But I do feel that I'm coming to the logical, objective choice here by having a negative longer-term bias towards U.S. equities. My solution to this will be shorter term trading on margin trying to take advantage of the current rally.

What I'm Reading

The Worst May Be Over, but...

Beige Book: Economy Slowing, Prices Rising - I'm pretty much in the camp now that the Fed's actions to abate the credit crisis were extremely inflationary. My current outlook is inflationary, but my long-term outlook remains that the bursting of the housing buble is a largely deflationary phenomenon.

Simply.. a MUST Read

Where the Smart Money is

Value Maybe?

And so it goes...

First things first ... Google murdered it this past quarter as far as expectations were concerned. They are currently up 16% after hours with a last sale at $528. This should give bulls something to get excited about. GOOG is not only a tech bell weather, but a bell weather for the broader market. Consider the following: "We have not yet seen any impact from the rumors of a future recession." ~ CEO Eric Schmidt

If we see some big upward surprises tomorrow before the market opens for Caterpillar, Citigroup, and Honeywell we could have a pretty big up day for U.S. equities.

On the international front, Iceland's credit rating was cut again by S&P and Israel's rating was raised by Moody's. Now I don't necessarily care too much about what the soon-to-be-defunct-in-current-form rating agencies are doing, but I was planning on taking this weekend to read up on Israel and their market. My initial thoughts were that Israeli equities were pretty darn cheap. Along with Israel, South Korea and Turkey are on my agenda. South Korea is dirt cheap, but they are also closely tied to the fortunes of Samsung. I plan on checking out the macro picture in addition to looking at equities, currencies, etc. etc. for those three countries. I'm hoping to make this a weekend ritual actually.

In currencies, Luxembourg Finance Minister Jean-Claude Juncker helped lift USD by saying financial markets misunderstood the recent G-7 statement about currency volatility. I've believed for some time that the endgame for the slide of USD is cooperative action by the world's central banks. This would certainly make that statement by Juncker pretty important. But we're not quite there yet. Macro Man has a good post on the wording of past statements preceding currency interventions. I mentioned this idea to a friend who works in currencies and he brought up an essential point that even if their was collective action to boost USD, China is sitting on over $1 Trillion and will buy EUR/USD out to yazoo. This makes collective action extremely difficult.

So that's the portfolio right now. Won't be doing any other moves in the near future. I am moving the portfolio to MB Trading over the course of the next two weeks. As I've mentioned before, I'm approved for margin trading, futures, options, and international markets over there. This is the initial setup for the portfolio during the ACAT transfer process. As with any shorts, I'll be keeping a close eye to make sure things don't get out of hand. Since these are all long/medium term holdings, my plan is to do a thorough review of a position if I it's at a 10% unrealized loss.

And in closing I'll add a few links to what I've been reading. I like posting links so I can go back later and read again.

To VIX or Not?

Money Market Morass

Lenders examine Libor alternatives

Libor, the TSLF, and the TAF

What I'm Reading

Yellen: House Price Declines Best Predictor of Delinquency Rates

Single Family Housing Starts Lowest Since Jan '91

CPI Meets Expectations

EUR/USD at Record High

NAHB: Builder Confidence Unchanged at Near Record Lows

The Clock is Ticking

Home Forclosures Jump 57% YoY in March

WSJ MarketBeat Credit Report

Credit Card Charge-Offs & Delinquency Rates

Goldman: Expect Awful Profits (The main reason I've been short)

US vs. Europe EPS Growth Rate Estimates

Housing Woes Around the Globe

Industrial Production Not too Shabby

Oil and the Great Moderation

10 Reasons to Like U.S. Equities

12 Wall Street Classics for 2008

Macro Man: A funny thing happened on the way to the rally

Banks That Misquote Libor will be Banned

JPMorgan: Conference Call Comments

What I'm Reading

12% After-Tax Return

An Interview with Jim Rogers

The Future of FX

John Thain and the Taming of Merrill Lynch

HSBC on Latest Housing Starts

What a Real Bear Market Looks Like: China

What I'm Reading

The Consumer Spending Mirage

Eurozone's Imbalances

Fitch Warns on Homebuilders

Lots of Cash on the Sidelines

A Top in Rice?

Munis are Yielding More than Treasuries

UK Housing Bust Begins?

Euro Under Attack

Britain Hardest Hit by Financial Crisis?

Gold...

Bond Spread & The Portfolio

The chart above (updated as of Wednesday) is one of many indicators which I believe show that the credit crunch is not over yet. I won't start thinking about the credit crunch being over (or on its way to being over) until this spread declines. I'd consider getting bullish if that spread drops to around 2.5.

The yellow vertical bands mark recessions. Other than the 1998 spike (LTCM) and the 1965 spike, most spikes in this spread coincide with a recession. And I think the current spike coincides with the recession that began in December/January.

Considering that we remain at elevated valuation levels coming into this earnings season, I feel comfortable having a medium to long-term short bias.

This of course does not mean that we can't see higher equity markets and U.S. equities in particular become more overvalued. I have prepared myself mentally for such a move. If you look at any secular bear market there are cyclical bull markets on the way down. My belief right now is that we have been in a secular bear market since equities topped in the tech bubble of 2000. 2003 to 2007 was a cyclical bull market. We're just about ripe for a subsequent cyclical bear market.

I'm currently running two positions. 25% of the portfolio is in RWM, an inverse Russell 2,000 ETF, and roughly 10% of the portfolio is in SH, an inverse S&P 500 ETF. Still currently working on getting a margin account (approved at MB Trading, pending at Interactive Brokers), so this is why I'm using inverse ETF's rather than shorting indeces outright.

Once I am able to trade/invest on margin, I'll look to add international, credit, commodity, and currency exposures. Because of my small capital base I'll probably end up exercising these views through ETF's. And I'll use 15% to 25% of the portfolio for a more active approach which would include shorting and going long individual stocks and utilizing options for trades with a shorter time horizon. I might implement more technical analysis for that part of the portfolio. I'll probably hold 7 to 8 positions when I get fully invested, but I'm not against bringing that down to 3 or 4 positions I feel strongly about.

"You have to recognize that every 'out-front' maneuver is going to be lonely. But if you feel entirely comfortable, then you're not far enough ahead to do any good. That warm sense of everything going well is usually the body temperature at the center of the herd. Only if you're far enough ahead to be at risk do you have a chance for large rewards." ~ John Masters

To Do List

I am trying to create a lot of different charts and data sets that will help me keep track of the economy, sentiment, spreads, indicators, etc. etc. Many of the charts are available online (Bloomberg has everything, of course) but I want to track back the charts as far as possible.

On my list so far are:

* Consumer spending
* Industrial Production
* CPI, PPI, and inflation in all of its forms
* Real hourly earnings
* Debt levels
* Debt to earnings levels
* Savings Rates
* Unemployment
* 10-year Swap spread
* Fed Funds/Discount Rate
* Baa corporate spread
* Junk-bond yield spread
* Consumer Confidence Index
* Jumbo mortgage rate minus conventional 30-year mortgage rate
* 3 month TED spread


That's all I can really think of right now. I'm sure I will add many more to my list as I come across them while reading. I certainly have my work cut out for me but I am in no rush. It's a process for the long haul and I hope to keep the data sets in perpetuity.

What I'm Reading

Can Stocks Push Higher?

Don't Buy this IPO

IMF Jumps on the Bandwagon

Seriously????

Cramer Gettin' Paid

I'm Glad I Flew AA Last Week and Not This Week

A Substantial Move IS Coming!

Lower Lows & Broken Trendlines

I Tend to Think Private Equity is Dead for the Next Couple Years

Links

More Thoughts on Decoupling

Shorting ETFs and Alpha

2007: The Year of the Buyback

Here Come China's Banks

Funny Anecdotal Retail Fearmongering

How to Get Into Harvard

WaMu Raises Cash and Skeptical Eyebrows

Incubation and Angel Investing

Small Business Sentiment at 20-Year Low

The Start of Earnings Season

A nice little post with video from TBP on Q1 earnings.

Q1 Expected Earnings: -10.9%
2007 Q4 Earnings: -25.1%

Now expectations are generally that financials and retail will lead on the downside while tech, oil, and agriculture/materials will lead on the upside. But I thought this would be a good time to mention the disparity between analyst estimates and actual earnings. Check out the chart that was included in the latest Outside the Box from John Mauldin:

Earnings estimates clearly lag actual earnings by about a year. And this becomes pivotal in tops and bottoms. As you can see from the chart it's clear that sentiment hasn't really caught up with the decline in earnings. Read the entire piece via John Mauldin and you can see some reasons for this. It's pretty interesting stuff.


When you add this factor to the fact that we are overbought (see my previous post), it makes for a pretty enticing reason to be short if you are a longer term investor.


And now let's take a look at global P/E ratios courtesy of Bespoke Investment Group:

Does the U.S., especially the NASDAQ, deserve a higher P/E than China? As far as I am aware China's economy is growing at double digits while our economy has negligible growth. Remember my previous post about market returns YTD. This entire situation doesn't make a lot of sense to me. Yes, a lower dollar is helping exports and U.S. companies are not nearly as tied to the domestic economy as they used to be, but still....

Across the board the street is still expecting higher equity markets by the end of the year. Merrill's Thain recently said that the worst of the credit crisis is behind us, but I think we're probably only about half way through. Housing prices still have not stabilized. Today's pending home sales numbers fell more than expected. This is just one of countless examples of a housing market that is in the early to mid stages of a depression.

I think there will be a string of disappointments over the next 3 quarters. Volatility will come back in the market, risk premiums will increase, and valuations will decrease. Don't be surprised if you see the VIX hit 30 again the next three months. I'd like to setup a trade to take advantage of that but I still don't have that damn margin account.

Go Short?

Momentum was positive in the first half of today's trading and negative in the second half:

Potential reasons to short:

* We are very overbought, conditions that could lead to a severe snap back

* Two big retail names report Wednesday. Circuit City (CC) and Bed Bath & Beyond (BBBY) report before the market opens and after the close, respectively. I think this could be the spark that renews our downtrend.

* S&P 500 futures show us down 6 points from today's close currently

But posts like this make you think.

A note on my position size:

Today's trades were exactly that, trades. Considering that I should keep them a relatively low level of my capital base. 2% is a common number you see for how much of your equity you should use on each individual trade. I went 80% net long today. That would be OK if it were a longer term trade or an investment, but i think risking 80% of my capital on something I don't feel VERY strong about is needlessly piggish.

VIX and Trades

Apr 08 25 calls going for .70 today. Might have made a nice little profit . I failed to mention lat post that a strategy of selling OTM calls like that puts you in the way of potential black swans. Selling OTM calls is what made Victor Niederhoffer blow up (twice!).


A multi-leg strategy is probably much safer and less piggish.


12:24 PM Update: Apr 25 calls last sale at .50. I would take gains right now from initial 1.00 sale. Also made the following two trades today:

BOT 120 SPY at 138.11 (Stop-loss at 132.58, Target of 139.00, If SPY breaks through 140.00 I think next stop is 143 - 145)

BOT 100 QQQQ at 46.19 (Stop-loss at 44.34, Target of 47.50)

Trying to take advantage of what I believe to be the counter-trend rally that is currently going on. Will take profits very quickly if I feel sentiment gets skiddish when banks report in the upcoming weeks.

Also, I am fully aware that there is not much upside potential relative to where I have placed my stops for these trades. Although I have potential near-term targets I won't necessarily take profits if we reach those levels. That's why I have a relatively large move of 4% for my stop and near-term price targets.

Off the Top of My Head

* We're in a 1 - 6 month uptrend/bounce

* The market shrugged off very recessionary job numbers. Don't fight the market.

* The homebuilders still have a LONG, LONG way to fall when all is said and done. The bounce increases our profit potential.

* We are in a recession as I type this.

* I need to get caught up in my research on currencies and commodities.

* It is still not time to talk my Dad into buying an upscale condo in Florida. We are 1 to 2 years away from that. Eventually, though, the potential is there for a multi million dollar gain by the time it's all said and done with my parents.

* Declining consumer spending will be a buzz topic by the end of 2008

* Earnings will disappoint in Q2 and Q3. 15% earnings projection by S&P analysts for Q3 is madness.

* Is the 1 to 3 year outlook for oil higher or lower? I don't have a definitive answer and cannot make a longer term investment until I have taken a side on this.

* VIX options seem pretty enticing to me, but after doing a little reading and learning that VIX futures options don't track VIX spot very well, I'm determined over the next couple of weeks to learn how to capitalize on what I feel will be another shot up in the VIX to 30 over the next 3 to 6 months. I may have to give a call to my friend to trades options on the street. For the time being, however, as I mentioned in the first bullet I think we are in for a 1 month bounce at the least. So, if I had to put the dough on the line right now! (too bad I can't). I say:

Sell the 08 Apr 25.00 calls at the current ask of 1.00. We will come back to this over the next week. The contract expires on the 16th of April and my prediction is they expire worthless. (This is the first specific investment recommendation I have made so I'm a little interested to how it pans out.)

And that's all for now...

Weekend Linkfest

* Posner and Becker on Intelligence Doping

* S&P/Case-Shiller Home Price Index Falls Record 10.7% ~~ Interesting point in this article. Lehman predicts another 10% slide in home prices, predicts new home sales bottom in the middle of this year, existing home sales and housing starts bottom in the third quarter

* Peter Bernstein on The Shape of the Future (via John Mauldin) ~~ This is the same Bernstein that wrote Against the Gods

* Some Cruel Context on the US Housing Market - FT Alphaville

* Walmart and Chicago - Chicago Tribune

* Obama and Big Oil - QandO Blog

I am in Chicago for the time being. After a stop at Notre Dame on Monday I should be back Tuesday. Then I'm off to Dallas for 4 days. I should have an update post on my online brokerage situation very soon.

Is this a Bear Market?

I find this chart striking considering the tremendous negative sentiment coming from all angles. Wouldn't most people argue that the U.S economic condition is worse than abroad? Why is the Fed lowering interest rates at the fastest pace in its history while the ECB has kept rates at current levels? What does the bond market know that the stock market doesn't? These are all extremely interesting questions.

The graph comes courtesy of Bespoke Investment Group and they make the interesting comment that decoupling indeed seems to be playing out but in reverse.

Here are my thoughts:

1. We are in a consolidation/bounce phase of a longer-term downtrend in U.S. equities

2. The ECB will be forced to lower interest rates as recoupling with the U.S. becomes apparent. This is USD positive. Add that to the fact that inflation concerns (one of the main drivers of the USD slide) are overblown. Deflation is a bigger issue in the next 2 to 3 years as housing prices fall 25% from their highs. I haven't double checked but I believe we have seen housing prices fall 11% thus far.

3. China, India, and Hong Kong clearly have had hot, fast money that left. What about Germany, France, Japan, and the U.K.? Why are their markets down significantly more than ours when they are in a comparitively better economic situation?

Interesting questions...Interesting times...

Capital Acquired!

I spent the morning doing administrative work for the newly acquired $25k I will be investing for my father. I also decided today to rollover my Roth IRA from PNC Investments into my own actively managed account. Those savings amount to about $9k.

My Roth IRA rollover has been approved and as of now I'll have to wait a couple days for the transfer of funds to take place. I had to go to PNC Bank today and liquidate the three mutual funds I had my savings invested in. I then sent an authorization form to my new discount broker allowing them to acquire my PNC funds. The remainder of the process should take 3 or 4 days.

My account for the Roth IRA will be a vanilla cash account. Regulations do not allow shorting so I plan on rarely making trades for this account. I'll mostly utilize ETF's and have a very value, long-term oriented approach.


And then there is the $25k investment account. I finished my application today with the same online broker I chose for my Roth IRA. I discussed the possibility of opening this account up with a separate online broker but decided against it after reading online reviews and talking to friends to actively manage money. This account is a margin account with leverage power of 4 to 1 for common stocks and 50 to 1 for foreign exchange. While I feel it is unlikely I utilize margin often I can forsee some potential uses, especially in foreign exchange. You also need a margin account to short stocks and buy puts.


I am excited to start trading. I waited for what seemed like forever telling the CEO of my former investment fund that stocks were expensive and I'd rather short than go long. I waited patiently. Now my worry is that opportunities are passing me by. Take for instance the following:

Last spring I mentioned to a friend of mine who trades equity options for a major Wall Street bank that buying VIX futures might make a good trade. Volatility was at historical lows; the VIX was trading at 12. While he agreed that it might make a good trade he said that VIX futures weren't actively traded enough for it be feasible for him. He had some liquidity issues that prevented it. Those would not have been the case for me. Well, what happened since then? The credit crisis. The VIX has since shot up and stands at 25. And I would not have had those liquidity issues.

That's just one example. Are there still a myriad of opportunities? Certainly. But do I think it's the kind of market where we can have another incident like John Paulson shorting subprime debt and making $2Billion dollars? Probably not. I read in Barrons today that consumer confidence in the economy is at 17 year lows. Even if the broader market is wrong about the extent of how much worse the economy will get there is massive psychological bearish sentiment. You can't bet against something like that and make serious dough.

Rosenberg: Deep Recession

David Rosenberg from Merrill Lynch. Considered to be very bearish by the Street. I read him every day this summer and can't wait until I have access to him again starting in July.

LEH Update

I wrote my last post on Lehman Brothers on Sunday and as of Tuesday we are right around the same level. What a wild ride, though. Gapping lower on Monday and higher on Tuesday. Lehman reported earnings today, beating estimates. They are up about 31% on the day.

I'm not sure whether I would have kept any trade on overnight. I'll be honest and say I probably would have. I still think shorting the financials is a good play.

LEH: Potential Near-Term Short

With news of Bear Stearns being sold to JPMorgan for $2/share, the street will be looking to see which bank is next in line for collapse. The figure of $2/share is pretty stunning considering Bear closed the trading day Friday at $30, albeit down close to 50%. It also means that Bear Stearns was essentially insolvent, not just illiquid.

This brings me to Lehman Brothers (LEH). Lehman Brothers had the second highest levels of toxic ABS/MBS securities on their books after Bear, each bank having twice as much relative to total assets as Goldman and Merrill. They were down 14% Friday as Bear collapsed. I think it's likely that the street will now turn their attention toward LEH as the next pin to possibly fall. In addition, although Bear went donuts over the weekend they closed Friday with a price/book of 0.7. LEH closed with a price to book of 1.15. If the market truly panics over LEH it could have a serious fall.

I have been extremely bearish on the financials for some time now, but I think this Bear situation creates a short-term opportunity to take advantage of the current fears in the market .



Since we are on the topic I thought it would be interesting to note that in January of 2007 Bear's stock was trading close to $170/share. That valued now ex- CEO and chairman Jimmy Cayne's holdings of Bear Stock at right around $1Billion. In a year and two months Cayne's position has been wiped out. Don't feel too sorry for him though. He played bridge and golf throughout this summer as two hedge funds blew up and the market began to panic. He also just closed on a $26 million condo in Manhattan, paying in cash.



1:00AM - 3/17/08 - Update - From the RGE Monitor on Lehman:

• WSJ: Lehman's liqudity position stronger than BS was but weaker than other peers. Lehman learned lesson from 1998 liquidity crunch: less reliance on short-term funding.
  
• Cumberland: Main difference to BS: Lehman generated over 60% of their revenues outside the U.S. in Q4 2007.
• Bloomberg: March 14: Lehman Brothers, largest mortgage underwriter in U.S., obtained a $2 billion, unsecured, three-year credit line from 40 banks. "The unsecured facility replaces an existing credit line"; JPMorgan and Citigroup led the effort.
• Reuters: CDS spreads spiked to 465bp after Bear announcement, most among investment banks.
• Fitch (via RGE): At the beginning of the turmoil Bear Stearns had the highest toxic waste ("residual balance") exposure as percent of adjusted equity on balance sheet: BSC = 54.5%; LEH = 53.3%; GS = 21%; MER = 17.8%; MS = 8.3%.
• Fahey (Fitch): Lehman Brothers reported Level 3 assets-to-equity of 1.68x in 3Q07 (BSC 1.56; GS 1.84; MER 0.70; MS 2.74: gross notional Level 3 asset value, not netted with derivatives hedges in Level 1 or 2 as reported by other banks)
• Hedges on Level 3 assets (i.e. "short their own instruments") produced book gains of $750m at Lehman (largest amount among 5 brokers) but Fitch decided that gains from credit spread widening will not be considered in evaluating operating performance
  --> Gains from structured notes spread widening as percentage of pre tax earnings was 62% at Lehman in Q3; 129% at BS; 7% at GS; -17% at ML; 17% at MS.