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 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 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 & 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 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 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.