Just Ring The Bell Already

This market is exhausting. I am anxiously awaiting the closing bell. I believe we are making progress by dealing with some issues that are hanging over the market. Whether you like the Citigroup resolution or not, the subject can finally be laid to rest. GE has finally cut its dividend. The issue of AIG still lurks but I suspect we will see a resolution shortly.

It seems that many investors have completely given up hope or are in the process. The market is beginning to distinguish between good and bad stocks. While we might not be at the end of the Bear Market yet, it feels like we are making great progress. Have a great weekend.

Dividend Cut By GE Is A Positive

GE raised money by selling preferred shares to Warren Buffett paying him 10%. At the time I did not understand why they would continue to pay a dividend, while paying loan shark type prices to borrow money. The hard decisions are finally being made. I don't know what the short term reaction will be but these are necessary steps to get us out of this mess. This is good news for bondholders as was the Citigroup news.

Bill Gross Preferred Disaster

Bill Gross went on CNBC recommending buying preferred shares of banks. His logic was that since the TARP money was in the form of preferred shares, that the government would not allow the preferred shares to fail. He did not examine the balance sheet of the companies or their ability to pay. The position he pushed the hardest was AIG preferred shares. Today, the Citigroup plan was unveiled and his logic was proven faulty.

I have always admired Bill Gross but I have lost a lot of respect for him. I always thought that Pimco was too big, but I thought that the research was top notch. If that is the extent of the research he puts into a position I would rather take my money to Atlantic City and get some enjoyment out of losing it.

I Just Don't Know

This market continues to send out mixed signals. As such, I am staying put. I do have some long exposure via short puts that expire in three weeks. The strike prices are way out of the money so the market will need to go down a lot before the shares are put to me. These are companies I am happy to own at the prices where I sold the puts.

Call Buying Continues

I can't believe that the call buying is continuing and that this was not enough to get a spike in the VIX. Who are all these bullish people and why can't I find any of them?

One More Thing

I will only be buying shares of companies that I could live with no matter what happens. I am not betting on the "market".

Thoughts Before The Storm

  • Preferred shares are a form of debt, even though for accounting purposes they are considered equity. This solution wipes out a lot of debt and raises the amount of real equity. Debt destruction is a necessary evil in getting us out of this mess.There is no way all the existing debt out there can be serviced without destroying the currency.
  • The reason the stock market does not like it is because this increases the amount of common stock on the market. However, in the long run this increases the probability that these companies will be able to survive, as they will have much smaller debt burdens.
  • One glimmer of hope is that Dell is actually trading higher even though it "missed" estimates. Maybe some stocks are pricing in enough bad news.
  • While most PC companies saw demand decrease during the course of the quarter, Dell saw even demand throughout the quarter. When asked how this was possible by an analyst, they said that they sell directly to consumers, while other companies sell to wholesalers. It is possible that some of the deterioration seen by companies is a decrease in channel inventory. That is clearly better than slowing end user demand.
  • Dell also said that many customers are holding off on new purchases for the release of Windows 7. The release later in the year can be a catalyst for these depressed stocks.
  • Bottoms don't usually happen on Fridays. An ugly close with a lower open Monday and a reversal would be a more likely scenario. There are no hard and fast rules in the stock market though, so I will play it as I see it.

Where Does The Market Go From Here

Good Morning. Coming into the week, I was looking for a low on Tuesday or Wednesday. At the end of the day Tuesday, the market would have been maximum oversold. There were some ingredients missing for a rally to occur like a VIX that spiked signaling panic and put buying. At the end of the day Monday it seemed that all was on schedule and that the market was getting ready to put in a capitulation low. Instead, on Tuesday morning three market strategists came out with bullish calls. Instead of a panic low, we had a gap up and a big rally.

I was not thrilled by the manner in which we put in a low, but thought that we could still rally given how oversold we were. It appears that is not the case. In the pre-market the S&P 500 is trading at new 52 week lows. The panic that has so far eluded us looks to be arriving. I will be looking to deploy my money into this mess but will give it some time to unfold.

Citigroup Deal Fair

Mark this day on your calendar. I believe the deal the US government made with Citigroup is fair for the taxpayers. Citigroup has over 25 billion dollars worth of preferred shares outstanding, excluding the preferred shares the government owns. Citigroup pays over 2 billion dollars a year in preferred dividends on the shares not owned by the US government. I was against the idea of the government converting their preferred shares while the private preferred holders still get their dividends. After all, if the government did not step in the preferred shareholders would have been wiped out a long time ago.

The deal that Citigroup made with the government forces Citigroup to stop paying preferred dividends. Preferred shareholders will be offered to convert their shares to common stock. The government will convert an equal amount of their preferred shares that are converted from the private sector. The reason the stock of Citigroup is down is that the number of common shares of Citigroup on the market is going to grow (a.k.a. SUPPLY).

Not Looking Good

The Nasdaq 100 and the Russell 2000 have already made new lows for this move, while the S&P 500 still stands about 1% above Monday's lows. That is not a good sign. I was a little bothered by the fact that we made a bottom without a full fledged puke-a-thon, but it looks like there might be some projectile vomiting in our future. I have a list of individual names that I will be looking to buy. I just hope this is not the going out of business sale.

Microsoft Weakness

A few people asked me why I thought Microsoft was so weak the past few days. My best guess is that it is because Microsoft CEO Steve Ballmer said he would like to do a search deal with Yahoo. Yahoo is up by over 15% during the same time period so it seems the market believes it is a likely outcome.

A search deal between Yahoo and Microsoft makes sense as the two companies each spend billions on a search technology inferior to Google's. At a minimum they will be able to cut out the overlapping costs and there is a chance that two heads will prove better than one. There are clearly cost savings to be had and a deal could be beneficial to both companies. Like most deals, the wild card is the price that Microsoft is willing to pay for the deal.

As an aside, I am still looking for an entry point into Microsoft. If the market melts down again Microsoft will likely be on my shopping list.

Interest Rates Creeping Up

Don't look now but interest rates are slowly creeping up, with the ten year bond trading at 3%. There is a price to pay for a deficit nearing 2 trillion dollars. Higher interest rates is the last thing this economy needs. There is a crowding out effect when the government borrows so much money. Government spending is not the panacea it might seem.

Market Positives and Negatives

  • The biggest positive about this rally is that the banks are leading the way. They have led every market move and ignoring them has been a mistake.
  • It appears nationalization is off the table for now. The market is applauding, just like it did when Greenspan lowered rates to 1%.
  • The biggest negative is that call buying is getting more extreme.
  • I could just see everyone getting excited and calling this a double bottom right around the time we get overbought.
  • For some reason the full Dilbert cartoon below is not appearing on my blog. You will need to click through to see the whole thing.

The Truth About Politicans and Bank CEOs

From Dilbert.com:

Dilbert.com

Dell Is A Sign Of The Times

Dell is reporting earnings tonight. When I took a look at the company I was astonished to see how cheap the company was trading. Dell currently trades at about$8.50. They have about $3 in net cash per share. Trailing EPS are $1.32 and forward estimates are for $1.12. In other words, net of cash they trade at five times depressed forward estimates.

This is not an anomaly, as I have recently looked at a number of companies trading at similar multiples. While history suggests that this bear market has a little further to go and valuations can get more extreme, I have no interest in shorting the market when valuations are this cheap. Not with my money.

Market Sentiment

Good Morning. A major tool I use in trying to gauge where the market will go is sentiment. When sentiment gets extreme in one direction, it usually means we are close to the end of a move and the market is getting ready to move in the other direction.

The issue of sentiment has been troubling me recently. Anecdotally, I have never seen people so gloomy and the sentiment surveys seem to be telling the same story. However, judging by the put/call ratios one would think that people are bullish. If there is a discrepancy between the measures I usually err on the side of the put/call ratios because I am much more interested in what people are doing than what they are saying. This is the first time I can remember when the signals were so crossed.

People are criticizing every government plan before it even comes out. This is a far cry from when we rallied on every bailout package. When people have little hope it gets harder to disappoint them. While I normally would err on the side of the put/call ratios, I am inclined to give the bulls the benfit of the doubt as the market is still oversold and I don't believe that people are bullish.

Taxpayers Robbed

Whatever you may think of the new bank plan, the market remains oversold and we are entering the seasonally strong part of the month. While the past two days have made the market less oversold, I still believe the wind is at the market's back for now. In recent months the market has squandered opportunities to rally but its a little early to pass judgement.

In this morning's opener I said that I couldn't figure out why Barack Obama was on TV last night. I think I figured it out. It was to sweet talk the taxpayers before we got screwed. Have a good night.

A Bank On Every Corner

Clearly the model the US has been operating on for the past decade has not been working. An economy built on debt, where people do not save money. Currently, there is a bank on every corner and with lower demand for credit there is no way they can all make money. The bank plan unveiled today guarantees that all those banks stay open. Barack Obama talks about solving the problem and not kicking the can down the road. But he gave the can one hell of a kick today.

The Details Of The Bank Plan Have Arrived

The details of the Capital Assistance Program for the banks have arrived. The terms of the capital are pretty tough. They are convertible preferred shares that carry a 9% dividend yield. Banks that accept the capital will not be allowed to pay "common" stock dividends and there will be a salary restriction. Healthy banks will clearly not want to take the money. That is the only positive

The problem is that giving capital to a struggling bank at 9% doesn't really help them. Its like giving someone deep in debt another credit card. It almost guarantees that the preferred shares will need to convert into common shares. The taxpayers will be the largest holders of bank equity in a few years. If I wanted to own the shares, I would buy them myself.

As an aside, this deal seems like a bonanza to the holders of preferred shares of banks. There are no dividend restrictions on existing preferred shares. Although with the government, the rules can change as we go along. I have a hard time buying preferred shares of banks that are probably insolvent on the idea that government will pay me, even though it is somewhat tempting.

Russell 2000 Getting Bludgeoned

While the S&P 500 and Nasdaq have given back about half their gains from yesterday, the Russell 2000 small cap index has given it all back. Some small cap stocks are absolutely getting bludgeoned. Hedge funds are large holders of small caps so there might be a liquidation going on.

Early Selling

The market is being sold in the early going. I would actually be more constructive if the S&P 500 broke below support at 741 and we saw some panic. That was the missing ingredient in yesterday's bottom. However, I don't believe that is in the cards for now. I am not adding to my longs on this dip even though I believe the market will hold. I am saving my firepower just in case we get the big dip.

Converting Preferred Shares Into Stock Is Premature

There are constant rumors about the government converting their preferred shares in AIG and Citigroup into common stock. I have a hard time understanding why they would not wait to see the results of the stress test before flushing tax payer money down the toilet.

What is the urgency? There are no bank runs. The only reason to do it is because the stock market and Jim Cramer are having a hissy fit. Alan Greenspan gave in to every one of the stock market's hissy fits and look where that led us. Why don't we see how bad the problem is and then try to solve it. This is akin to a doctor diagnosing a patient without first seeing the patient and running tests.

The Aftermath Of The Obama Speech

Good Morning. President Barack Obama got on the tube last night and spoke for an hour without saying much. I am still scratching my head trying to figure out what he was trying to accomplish other than blocking out my TV shows. I'm just happy he didn't speak on Monday during 24.

There were a lot of things not to like about the rally yesterday. Chief among them was all the bottom calling and call buying. However, now is not the time to focus on the negatives. The market is oversold and has the wind is at its back. That does not mean the market must go up but negative bets are better saved for when the oversold condition is worked off.

For my part, my long exposure is mostly via short puts. If I were long stock, I would take partial profits after catching a 4% move. However, because I am short puts my exposure becomes lower as time passes and the market rises, so essentially my position takes profits for me.

Market Stress Test

While this is not the best looking bottom I have seen (Jessica Biel wins that award), the market has managed to turn itself around. The wind is now at the market's back until the oversold condition is worked off. In addition, we are entering the turn of the month, which is the seasonally strongest part of the month. As a result the market should be given the benefit of the doubt for at least another week. Recently, the market has squandered opportunities to rally. Lets see if it can use this one.

I am very happy to see that traffic on the blog spiked today. I don't advertise so traffic is mostly a result of word of mouth. Thank you to all the readers who have spread the word. If you like the Capital Observer please tell a friend. Have a good night.

JPMorgan Makes Cutting Dividend Acceptable

JPMorgan Chase lowered its dividend yesterday and the stock has responded positively today. Companies with high debt levels have been fighting to maintain their dividends in order to keep up appearances. That is exactly the type of behavior that got us into this mess. This might open the door for other highly indebted companies to cut their dividend in order to pay down debt. In the long run this is a positive for stocks. In the short run it is a positive for the debt markets.

I have purchased a starter position in JFR, a closed end bank debt fund. Please note that bank debt does not mean loans to banks. It means bank loans to corporations, which are higher up in the capital structure than bonds.

The Golden Rule

Gold is sharply lower today. Positive sentiment towards gold has become extreme and I believe there is big downside potential. I am not saying that it will go lower, but saying that the trade seems crowded to me. If investors decide to exit in mass the door might be too tiny. This would probably be a positive for the equity market as investors have been moving assets from stocks into the precious metal.

Was That The Bottom

The question on everyone's mind is have we seem the bottom? While there are no hard and fast rules in the stock market on how a bottom should look these are the pros and cons I'm seeing.

Pros
  • The market is deeply oversold as I showed in my charts last night.
  • Sentiment is extremely pessimistic.
  • Stocks are trading at their cheapest in almost two decades
Cons
  • There have been 3 strategists to come out today and call this the bottom. If today is the bottom, this will be the first time I have ever seen so many people call a bottom and be right.
  • The market gapped up higher this morning without a test lower. I have not seen many major bottoms occur on gap ups with no test lower.
  • We never saw a jump on the VIX or heavy put buying.
I have some long positions on (mostly via short puts), but there are enough items in the Con column to stop me from pushing the rest of my stack into the middle of the table.

Two Long Time Bears Turn Bullish

I have seen two long time bears trying to call bottoms this morning. Super bear Robert Prechter of Elliot Wave fame has advised covering all shorts after being short for years. Long time bear and JPMorgan strategist Robert Lee is also bullish for a trade. I wish they waited another day with their bottom calls and allowed a better capitulation to happen. I have made a tiny purchase this morning but was not able to add to my positions as much as I would have liked to. Such is life.

Break Support

I would like to see the S&P 500 break support at 741. I believe that the plunge that would follow will be the climax of this decline.

Microsoft Sees More Weakness

In the past few weeks there have been clues that PC demand weakened further. Among them were HP's warning, industry monthly sales figures and weakness at contract manufacturers. The weakness extended to Apple's computers as well. This morning at an analyst meeting, Microsoft CEO, Steve Ballmer admitted to the weakness.

I was holding off on buying Microsoft because I saw all the clues but did not see a reaction from the stock. Now that the cat is out of the bag I will be looking for an entry point into Microsoft as I believe the value is still there.

Will This Gap Up Hold?

Good Morning. The chart I posted last night shows that the market was only more oversold twice in the past year. The two other readings led to rallies of over 10% in short time. However, this chart does have the potential to go lower today so we are not out of the woods yet. The end of the decline can be the fiercest part, but that is usually quickly recovered when the market finally does bounce.

I was planning to buy into the market this morning if we had a scary gap down opening. As I write the S&P futures are 10 points higher. One of these days a gap up will hold and catch everyone leaning the wrong way, but I don't want to bet on it. I wrote some puts on individual stocks last week, so I have some exposure. I would love to put more money to work if we could get one more scary plunge.

Anecdotally, I have never seen people this gloomy whether its people I talk to or when I turn on the TV. There is one thing I can say with certainty. This is not what a top looks like.

Market Deeply Oversold

I just updated my charts and wanted to show that the market was only more oversold twice in the past year. This chart has the potential to go lower tomorrow, but will have a really tough time going lower thereafter. We are getting closer to a rally.

Give Up Already

One of the most surprising aspects of this decline to me is that thus far there has not been a rush to buy puts. I believe this is why the VIX has not yet spiked. What will it take to make people buy puts? While every rally is different and we can rally without heavy put buying, I would feel much better buying if we did see a rush to puts and a spike in the VIX. Maybe a break of 741 will do it?

We are seeing a late day spike in the VIX now, so hopefully that will help. I suspect an ugly opening tomorrow would go a long way. Have a good night.

Technology Seasonality

Alpha Plus Advisors', Marvin Bolt, reminds us that this is a seasonally weak period for technology stocks. The seasonality lasts through April 10, with the worst stretch being the last twelve trading days ending on the tenth. This vibes with my sense that the technology trade has become too crowded, even though I still like technology longer term.

Signs Of A Trading Bottom and Obstacles

  • We are getting closer to the market being maximum oversold.
  • Technology stocks are being hit badly today. The hiding places are usually the last to go during a market decline. I believe technology has been a hiding place recently.
  • The put/call ratios are not yet showing extreme levels of put buying typically seen at bottoms. However, we have made some progress in recent days.
  • The VIX has not yet spiked, which is also typically seen close to bottoms.
  • I believe the last two will line up shortly if this decline continues.

Technology Versus Financials

  • The market often likes to confound the largest number of people. Recently, the Bulls favorite sector has been technology, while the Bears have been focusing on financial stocks. This morning both the Bulls and the Bears are being beat up with financial stocks up and technology stocks down.
  • Keep in mind that options expiration will be effecting the market until the afternoon.
  • I am still of the opinion that a shakeout now would lead to a better rally.
  • I would also prefer if the market rallied on its own, without a government announcement. Even better, if it rallied on bad news.

George Soros Is Wrong About Lehman Brothers

George Soros is quoted in the press almost every week as saying that we would not be in this mess if the US saved Lehman Brothers. If this were a liquidity crisis he would be correct. The Lehman Brothers incident did have an effect on market liquidity. However, this is a solvency crisis. The reason the toxic assets are toxic is that the ability of the assets to pay has been severely impaired. Soros' is implying that the problem is not the toxic assets, but that people don't want to pay for the assets.

George Soros was always a great trader. He was wrong more often than he was right. When he was wrong he quickly cut his losses but when he was right he made a killing. However, if Soros would have stuck with all his big picture views he would be in the poor house. That is why I am confounded when his big picture views are treated like the words of a prophet by the media. I aspire to be half as good as Soros was, but I must respectfully disagree with him on this.

Pandit's Proposal

Good Morning. The futures are higher on Vikram Pandit's proposal that the government convert their Citigroup preferred shares into common stock. The government is about to begin its stress test of Citigroup this week. It would seem to be an irresponsible use of taxpayer money to further bailout Citigroup without first finishing the stress test. The government should at a minimum give the appearance of due diligence before throwing away more taxpayer money.

When the market is oversold, it looks for excuses to rally. It appears that Mr. Pandit's proposal will do. While I believe that one more scary move down would lead to a better rally, we are sufficiently oversold to rally. A market rally starting now should last through the seasonally strong turn of the month, which is the middle of next week.

Weekly Strategy

The most vital part of the bottoming process is the realization by market participants that we are headed for a protracted period of little to no growth. There is no magic plan that will put everything back to the way it was. Once participants accept this there will be be little in the way of disappointments. I believe that we are making great progress in that process. The public has mostly given up on stocks, but some market professionals still seem to be more fearful of missing the bottom than of losing money.

In the shorter term, the market will be maximum oversold by Tuesday (I have posted the chart below). This does not mean that the market must decline until Tuesday, only that it would make for a lower risk entry point if it did and that the rally would likely be better. Additionally, a spike in the VIX has preceded most good rallies in the past few months. While the VIX is high, it has not spiked up, but climbed steadily. If we saw a decline early in the week that coincided with a spike in the VIX, I would be much more constructive.



I have made a conscience effort in the past few months to find individual stocks to buy, rather than buying ETFs (Exchange Traded Funds). ETFs have grown in popularity as study after study showed that most active strategies failed to beat the indices. However, the popularity of ETFs has grown so much that many individual stocks are now being moved by the ETFs, instead of vice versa. The tail is now wagging the dog. I believe this is leading to opportunities in individual stocks.

For instance, Annaly Capital Management is the largest component in the REIT (Real Estate Investment Trust) ETF, IYR, making up almost 5% of the index. Most participants who are shorting IYR are probably making a bet against real estate and don't even realize that they are shorting Annaly. Annaly is only a REIT in name, as it does not own any real estate. They hold Fannie Mae and Freddie Mac bonds. An argument could be made that Annaly should trade inversely with IYR as bonds are a safe bet when the indexes are falling. But every time IYR plunges, it drags down Annaly.

I believe that similar distortions caused by ETFs are widespread. I have done well this year, even though I have traded predominantly from the long side as stock selection is once again being rewarded. If one does not have the time than indexing is probably the best choice, but for those that do I believe individual stock selection is better in the current environment.

Draw

The fact that today was an options expiration probably skewed the market a bit. I made some purchases this week as we have finally seen the return of fear. I think it would make for a better rally if we declined early next week and got one more good scare. I would get heavily invested in such a scenario. I have some inventory in case we don't. Have a great weekend.

Maturity

I made some initial purchases two days ago, which are doing fine even though the market has gotten beat up. My plan was to add to my positions when the market was maximum oversold. The market should be maximum oversold by Tuesday. When the S&P 500 was down over 20 handles today I was itching to buy, but stopped myself. I told myself to save my powder in case we get maximum oversold. We have since rallied almost 20 points on the S&P 500. In the past I would have been kicking myself for not buying. But I really could not care less. That is the price of discipline and its well worth it. If the market rallies I have some positions.

The Problem With Retail

Aside from the obvious secular issues that retailers are facing like increasing shopping on the internet and an increase of saving by Americans, there is a much more fundamental problem I have with owning a retailer.

I will use Lowes as an example. Let's assume that at some point we will get out of this recession and that Lowes' profits will return to their old highs as they are a well managed company gaining market share. Let's even assume that they continue to grow profits for a few years after that.

Inevitably, every retailer hits hard times as it is a very competetive business. The retailers that were around 50 years ago are not the ones that are around today. If we look back in fifty years, I am sure we will see the same thing. I will assume that some time in the far off future Lowes will hit hard times (not the cyclical type from the economic environment but the secular type, similar to the one that The Gap has been facing).

During the good times Lowes will spend almost every dollar of profit on opening new stores, returning very little cash to shareholders. Only after Lowes is in decline will they consider returning money to shareholders. However, a retailer in decline is a value trap as it is a high leverage business.

It is probable that during the next expansion, when Lowes is earning record profits you will be able to sell Lowes at much higher prices than those prevailing today. But when we look back in fifty years, chances are that little will have been returned to shareholders.

The Bright Side

  • The bright side of the carnage in the banks is that they can only go down in this manner for a few more days before there is nothing left of them. At that point they can't effect the stock market anymore.
  • Last month I sold some 13 strike price Annaly puts for 80 cents. I left them for dead, but it seems there is a chance I will be the proud owner at the close today. It should make for an exciting day.
  • Normally, I would not leave short cheap out of the money puts hanging out in my portfolio. But the bid/ask spread was so wide that it did not make sense to buy them back. Or maybe it did?
  • I have never seen people as gloomy as they are now. Now we know why it is called a depression.
  • I prefer gap down openings to up openings. They tend to happen closer to the end of a decline. Additionally, if the market starts to rebound it really puts the bears that short into this opening behind the eight ball.
  • I was as bearish as everyone is today two years ago. I felt silly telling people my opinion back then. I feel the same way today.

Healthy Fear

Good Morning. Coming into the New Year there was a renewal of hope in the stock market. That hope has been squashed as the S&P 500 is sitting almost 20% below its January highs. The hope has been replaced by widespread fear. Talk of a second half recovery has been replaced with talk of the Great Depression II. In truth, not much has changed in the past six weeks. The outlook was grim back then and it remains so today. It is much more advantageous to make purchase in this environment, than the one that prevailed in early January.

I made some purchases in the current environment but I did not just go out and buy the indices. I bought value stocks with a margin of safety. I sold puts, that would put me in Annaly Capital Management at below book value. The vast majority of Annaly's book value is made up of agency securities that have implicit government backing. The securities they hold are easily convertible into cash. When I can buy a dollar for ninety cents, I will do it any day of the week. Additionally, I sold puts that would put me in Avalon Bay Communities at a 12% cap rate. A 12% a year return in high quality real estate, like Avalon Bay owns is simply not available in the real world, only in the stock market. I understand that rents could fall, but there is enough protection in the price I am paying to allow for a decline in rents.

I understand that times are bad and I believe it will take a long time to get out of this mess. But the type of bargains we are seeing don't occur when times are good. The news is always worst at the lows and best at the top. I don't believe that we have seen the ultimate low for this bear market but I could live with my purchases regardless.

Bailing Out

  • Many aspects of the stock market are counter intuitive. For instance a decline into early next week would actually make for a better rally than if we took off now. The market would be maximum oversold and rallies that start from a maximum oversold condition tend to be better rallies. Additionally, we would probably get a buildup in put buying.
  • Why didn't I wait until next week before buying? The perfect setup does not always come along. Additionally, I gave myself some room for error by a) only making a few purchases so I have money to deploy next week and b) selling puts instead of buying stock outright.
  • Once again the weakness in the banks told the story this morning. Their refusal to rally when the market was higher was the proverbial canary in the coal mine.
  • Bank stocks are getting hammered on nationalization fears. The fact that the Obama administration has not come out denying the allegation means they probably have some merit.
  • Could the nationalization of the banks mark "THE BOTTOM"?

Clown Car

Long only managers, such as mutual fund managers, have to be in the market, as going to cash is not an option. A few months ago long only managers were piling in to consumer staple stocks. The idea was that during a recession people will still need to eat, clean their house and brush their teeth. The idea was valid but it came to a point where everyone was "hiding" in these stocks. The stocks traded at high teen P/E ratios, while cash rich tech companies traded at single digit PE ratios. The valuation difference was excessive.

All was well until Procter & Gamble and Kraft warned on earnings, as Americans started cutting back on everything. Recently, consumer staples have been beaten mercilessly while tech has outperformed as everyone piles into the technology sector. Every day analysts and reporters are pointing to how much cash tech companies have. Of course this was true for the past few months (just as the logic for consumer staples was true) but no one took notice until after technology was outperforming.

Yesterday, Hewlett Packard warned and we see tech stocks like Apple and Google getting beat up. It feels like watching the circus where clowns pile into one car and then they realize that the car is full and all get out and pile into the next one. I will continue to look for cars where there are no clowns.

Positive Signs In Currencies

  • The Euro is rebounding sharply today versus the Yen. The Euro/Yen relationship has been the best gauge of stress in the financial system for the past year. This is a positive.
  • The banks stocks are mixed today. It would be nice if they were stronger with the market higher.
  • Breadth is positive but there is more call buying than I would like to see
  • All in all its a tough call for today, but the odds slightly favor a higher market.

Charles Schwab

Charles Schwab was a stock that I was hoping would come in during the recent selloff but thus far has not. Less than 20% of Schwab's revenues actually comes from trading commissions. They make the majority of their money from net interest margins. In other words they make money from holding your money and investing it at a higher rate.

Recently treasury yields have been so low that they have not been able to make this margin and earnings have taken a hit. Earnings expectations for 2009 are 80 cents a share. The earnings should explode higher when treasury yields rise and they have been creeping up in the past few weeks. Its hard to believe treasury yields will stay this low with the government spending money like a drunken sailor. However, I was hoping to pay under $10 for the stock. That way the stock would be cheap even under the current environment and the explosion higher in earnings would be my bonus. Currently, the stock is pricing in some rebound in earnings.

I spend the majority of my time researching situations like this. Most of the time the research is for nothing. However, when a nasty selloff does occur there is rarely time to do research, so one must be prepared before hand with a shopping list.

Eastern Promises

Good Morning. There have been negative rumblings in the past week about problems in Eastern European countries. My main fear over night was that some bad news might emerge and I believe it was the market's fear as well. There was no news overnight, which is why I believe the S&P futures are rallying. I believe that a lot of traders are poorly positioned for a rally right now. That would exacerbate a move to the upside if one developed.

As I keep mentioning, my issues with a rally now is that the market is not yet maximum oversold and we have not had the type of build up in put buying that we have had before previous rallies. However, I did some buying yesterday because we started to see some panic, the market is somewhat oversold and there was some put buying. The market does not always give you a perfect setup. The better the setup, the more money I am willing to commit.

Baby Steps

  • I came into the day practically void of common stock exposure and I am leaving with a few positions, but with plenty of room to add.
  • If the market continues its decline I will add early next week when the market is maximum oversold.
  • The best time to buy is also the hardest time to buy. Buying now is not easy.
  • I would say the lack of downside follow through could be considered a positive for the bulls. But its hardly something to do victory laps over.
  • This is the first time we did not sell of after the actual bailout announcement. Baby steps.
  • My view that the mortgage bailout is a poor use of taxpayer money is unchanged. Why am I punished for being responsible?
  • Have a good night.

Risk Taker

  • If the S&P 500 managed to close above 800 today everyone who sold or shorted because we broke below 800 would be caught leaning the wrong way. I'm not saying its going to happen but it would make for some interesting viewing.
  • I was told that if you try to pick the bottom you end up with a handful of shit. What can I say, I was itching.
  • The only way I can make money is by taking risk as I don't have a salary. I would much rather take risks at times when I am getting paid to do so.
  • It is interesting that the Yen has been declining. During times of uncertainty the Yen usually advances. A positive divergence?
  • Real estate is not a bad thing. The price people were paying 2 years ago to own real estate was bad.
  • I don't believe real estate prices have bottomed but most REITs trade at significant discounts to the current market value of their assets.
  • I see no reason to buy physical real estate when you can buy REITs for much cheaper.

Some Explanation

I don't deny that the picture is not pretty. But there are some stocks that are selling at attractive prices. Over the years I have found it advantageous to buy when everyone is panicking and sell when everyone is rejoicing. It is hard to make a case that the latter is occurring right now. I am leaving plenty of room to add to my positions as I understand that ugly could get uglier.

I sold the April 13 Puts in Annaly Capital Management for 90 cents (although I only got a partial fill on my order). That means I would own the stock at 12.10 if it were put to me. At 10% below book I am happy to own the stock any day. My return is 7.5% on my investment in 8 weeks if the stock is not put to me, which I can live with as well.

I sold the March 35 Puts on Avalon Bay Communities for $1.50. That would put me in the stock at $33.50. At that price I am buying apartment buildings at a cap rate of 12% (cap rate is just the yearly return of the real estate investment after expenses). A year ago people were clamoring to buy real estate at cap rates of 3-4%. Now, no one wants 12%. Even if there were a significant decline in rents, the cap rate would still be attractive. I chose Avalon Bay because they are the least leveraged of the residential REITs. Additionally, they do not have to roll over a significant amount of debt in the next few years.

Busy Buying

I have been building some positions this morning through the selling of puts. I sold puts on Avalon Bay Communities and Annaly Capital Management. I want to use weakness as a buying opportunity. I am leaving room in case we go lower. I will explain my purchases a little later.

Renters Evicted

Good Morning. The S&P 500 broke below its recent range and closed below support at the 790 and 800 levels. Those were widely watched technical levels that I have been hearing about for weeks now. By breaching them we probably flushed out some renters from the market.

I am starting to see anecdotal signs of a bottom in the stock market. People I speak to want nothing to do with the stock market. They don't care how cheap it is. Its not buyable at any price. When that is the prevailing attitude, there are bound to be bargains. People are selling out of revulsion, rather than out of reason. Additionally, we have gone down 10% in a straight line from the Geithner announcement. A bounce should not be too far in the offing.

However, there are some obstacles to a sustainable rally. The market is not yet oversold and I am not seeing the type of put buying that was present at previous bottoms. As a result, I respect the possibility of further downside. My plan is to buy into weakness today, but I will leave plenty of room in case we have further to go. The Obama mortgage plan will be announced today. If the knee jerk response is to sell the news, that might be my entry point.

Closing Time

  • It is rare to get a turnaround so late in the day. I don't see it, but the caveat is that the mortgage plan will be announced tomorrow so there might be some repositioning ahead of the announcement.
  • It feels like we are getting late in the decline in oil. The caveat is that a lot of damage can be done at the end of a move.
  • Annaly Capital Management has been my "go to" on market sell offs. The problem is that it is not selling off with the market this time. At 15% above book value I believe its fairly valued and I am not interested in buying it.
  • Technology, another one of my hunting grounds is holding up well.
  • I am expanding my hunting grounds but haven't had much luck finding stocks that meet my criteria.
  • If the selloff in the REIT sector continues, I believe there will be some babies thrown out with the bathwater. Problem is that there is an awful lot of bathwater to sift through.
  • I am headed out early for a doctor's appointment. Have a good night.

Another Ponzi Scheme

It appears the FBI has uncovered another Ponzi scheme. This one involves bank CDs and appears to be 8 billion dollars in size or possibly larger. This will not help confidence. From the Wall Street Journal:

The Securities and Exchange Commission on Tuesday filed civil charges against financier R. Allen Stanford, alleging he orchestrated a multibillion dollar scheme centering on an $8 billion certificate of deposit program.
...

Stanford International Bank Ltd. and related firms controlled by Mr. Stanford have fallen under scrutiny by the Federal Bureau of Investigation, the SEC and other regulatory bodies. The bank has said it has more than 30,000 investors and $8.5 billion in assets; it says the larger group of which it is a part manages over $51 billion in assets.

Federal regulators said the wealthy financier promised improbable and unsubstantiated high interest rates that were supposedly earned through a unique investment strategy that purportedly allowed the bank to achieve double-digit returns on its investments for the past 15 years.

My Two Cents On Nationalization/Preprivitization

The case for nationalization has been gaining steam in recent weeks. Nationalization means that instead of saving weak banks, the government would take over the banks. The shareholders and bondholders would be wiped out. However, the depositors and counterparties would be made whole. The government would then remove the toxic assets from the banks and sell the healthy bank to the private sector. The healthy banks would then be in a position to lend.

I believe that nationalization is the best course of action. There is too much debt in the economy. This deals head on with the problem by destroying much of the debt. I would not be surprised if the stock market reacted negatively at first. After all, if a bunch of stocks and bonds you owned got wiped out, would you be comforted that its the best long term decision? However, the stock market is not a good judge of policy. The stock market applauded when Greenspan lowered rates to 1% in 2003. Look where that got us.

Waiting Game

  • Warren Buffet has been maligned in the media recently for buying GE and GS at much higher prices. However, one must remember that Buffet received preferred shares with a 10% dividend. The kicker is that they can convert into common shares. Last I checked publicly traded GE and GS preferred shares were yielding less than 10%. By my calculations that means Buffet is still up, even when ignoring the option to convert.
  • Am I being penny wise, pound foolish by not putting some money to work here?
  • Stocks that I am interested in owning are still holding in much better than the market. This makes it hard for me to find anything to buy.
  • The fear of missing out on rallies has cost investors a lot more than any other emotion.
  • Believe it or not, investors are buying calls at the ISE.

Holding Off

While I said I wanted to buy a break of 800 on the S&P 500, I have not yet done so. The decline so far has been too orderly. I prefer to see more panic. Additionally, I did not envision us breaking 800 so quickly. That leaves an awful long time before the market gets maximum oversold. That said, my finger is on the trigger.

Perspective

It is very important not to get sucked into the emotion of the day. The news is miserable. The state of the economy is miserable. The state of the country is miserable. But, the prices are getting cheap. In investing, the most important factor is the price you pay for something. The economy was as strong as ever in 1999 but the prices were expensive. Just as we went too high back then we can go too low today, but that does not change the fact that one should get more bullish as prices get cheaper.

Futures Down

Good Morning. They say that distance makes the heart grow fonder. After three days away from the market I must admit to being excited for a new week, although I will probably be singing a different tune by Friday. The S&P futures are currently sitting 20 points below fair value and are within spitting distance of support at the 800 level. I would be surprised if 800 gave way on the first try.

The market is in close proximity to its November lows. The difference was that in November we were deeply oversold and at the current juncture we are not even slightly oversold. That means that a decline has the potential to go further and last for quite a while. I will likely do some buying if we get panic selling off the break of the 800 level. However, I will leave plenty of room in case this market does not want to stop at the November lows.

Weekly Strategy

I continue to operate under the assumption that we are in a bear market. I will likely reverse my stance when the S&P 500 reaches the 600 level. 600 on the S&P 500 represents the level at which the S&P 500 is 40% below fair value (using normalized profit margins and normalized P/Es). That is the valuation level where previous bear markets ended.

Even though I believe we are in a bear market, I am not willing to take short positions. With the S&P 500 15% below fair value, the price for being wrong is too high for me. That means waiting for opportunities on the long side. In order to go long during a bear market, everything must line up. The market should be oversold, sentiment should be despondent and there should be some panic.

While the current conditions don't meet my criteria for going long in a bear market, I believe that a break of the 800 level on the S&P 500 would go a long way in getting us there. I believe a lot of traders are playing the range in the S&P 500. A break below 800 on the S&P 500 should scare those people out. Additionally, many technicians are looking at 790-800 as a major support level. If that level is broken we should start to see some despondency and panic. If the market declined, we would be maximum oversold by the middle of next week. That would sew the seeds for the next rally.

I am not predicting a decline this week. Only saying that a decline would put us in a better position to rally. There should be a lot of movement this coming week, surrounding news leaks and announcements of the mortgage plan. I have no edge in that game so I will stand aside until my criteria are met. As Warren Buffet says "There are no called strikes in the stock market".

New Issuance

This morning, I mentioned that Freeport McMoRan and Geron issued new stock. Add hotel operator, Wyndham Worldwide to the list of companies issuing new stock. They are looking to raise 200 million dollars. In isolation these small issuances do not matter but after a while it starts to add up. From Bloomberg:
Wyndham Worldwide Corp. dropped as much as 32 percent in New York trading after announcing plans to raise $200 million in a new stock sale and reporting a fourth- quarter loss on a writedown at its time-share unit.

Swimming With The Sharks

For the first few weeks of 2009 I was finding pockets of value in the market to trade. While I wasn't hitting it out of the park, I managed to make a living. However, in the past two weeks despite doubling my efforts on research I am coming up empty on ideas. While the market as a whole is not going anywhere it is starting to put a premium on the type of companies I am interested in. Namely, companies with solid balance sheets and solid cash flow. Meanwhile the fluff is being taken out of consumer staples, which was the only remaining high priced sector. I am not interested in leveraged companies, which are abundant and all look cheap. It has become a lot harder to do my job.

Today, I noticed a headline that daily trading volume was down over 30% at Schwab from October to January. The retail investor is dropping out of the market, leaving the pros shooting at each other. It is no coincidence that I am having a much harder time finding mispricings. Have a great weekend.

The Slippery Slope Of Hope

  • On cue the market rallied on the announcement that Obama will unveil his mortgage plan on Wednesday.
  • Many traders have probably already left for the long weekend so the market is probably very thin. We could see big moves in either direction.
  • Two rallies on this cockamamie mortgage plan two days in a row seems a little too cute for me. No skin in the game though.
  • There are persistent rumors about secondaries in Goldman Sachs and Morgan Stanley. If they are true that is not a short term positive, as it means more supply.
  • Any rally would likely result in more companies issuing stock. I believe the upside is limited.

The Nobel

  • Microsoft is planning to open retail stores to compete with Apple's. I believe the Zune will look like a Nobel prize winning idea compared to this. Luckily, Microsoft makes so much money that squandering a few dollars on this does not change the story.
  • Isn't it an amazing coincidence how the government releases information about bailout packages every time the market reaches a critical point?
  • Yes, I'm bitter because we were getting close to a good entry point and now I have to wait again. But so what?
  • We are seeing some put buying at the ISE in the early going, but not at the CBOE.
  • Market Breadth is flat.
  • The financial stocks are lower but Goldman Sachs is higher. The stock has been the strongest stock recently and is an excellent market tell.
  • I have no edge in this market so I continue to be on hold.

Dividend Cuts

My previous post talked about companies issuing new shares. In addition, there are new announcements of companies cutting dividends on a daily basis. At the same time that companies are looking to raise cash from investors, they are paying out less. This is not a good combination and part of the reason I believe we have yet to see the bottom.

Increasing Supply of Stock

Increasing supply of stock is a negative for the stock market. Just today, I noticed two companies issuing new shares. Freeport McMoRan Copper & Gold issued 750 million in new shares. From Yahoo:
Freeport-McMoRan Copper & Gold Inc. announced today that it has completed its at-the-market offering of common stock. FCX raised $750 million in gross proceeds through the sale of 26.8 million shares of FCX common stock in open market transactions at an average price of $28.00 per share.
In addition, stem cell stock Geron did a spot secondary last night. While secondary offerings are normal, they are somewhat unusual with the stock market so close to its lows. If this trend grows it will be yet another obstacle for this market.

Bear Market Survival Guide

Good Morning. The best course of action for most in a Bear Market is to be positioned conservatively and to hunker down. However, if one must trade from the long side everything should be lining up for a rally, before putting money to work.

1. The market should be oversold. In the current Bear Market all rallies that were of any significance came from deeply oversold readings. The large decline in early January and this week after the Geithner speech both came from overbought readings. Following this simple rule would have kept you safe from both declines. At the present time the market is not overbought nor oversold. NEUTRAL

2. Market participants should be in a grim mood. When everyone is hopeful that the bad news is priced in and that we have turned the corner it is very dangerous to be long. Most rallies have started from a mood of despair. While sentiment surveys are showing negativity, the put/call ratios are showing that people are trying to catch the bottom. I prefer the put/call ratio to sentiment surveys because it shows what people are doing as opposed to what they are saying. Additionally, it seems that everyone is now a trader trying to buy the dips. NEUTRAL/NEGATIVE

3. Panic should be in the air. Panic has always preceded a bottom. People should be just selling everything to stop the pain. I have a sixth sense for when this is occurring but that is not necessary. One just needs to look at the VIX and see if it is spiking up. There was a whiff of panic yesterday but the market was saved by the "new mortgage plan". NEUTRAL/NEGATIVE

At the current juncture we are not set up for a strong rally. That does not mean one cannot occur. Just that the risks are too high for me to participate in one. If we got a decline next week that breaks below 800 on the S&P 500, I believe the stars would begin to align for the next rally.

Rewarding Recklessness

This latest plan to lower interest rates and modify loans for people who can't pay their mortgages is a disaster. Those who got in over their heads will be rewarded while those who were prudent will need to pay for this plan. Whether it be through higher taxes or because the currency will be debased. Homeowners on the edge are now incentivized to default. This country is headed in the wrong direction.

Hope Is Renewed

Announcement of yet another bailout plan has renewed hope in the market. The market rallied strongly and ended the day up. I continue to be of the opinion that there is no silver bullet that will cure the economy. We need to move from an economy based on debt and borrowing to an economy based on living within ones means. Cheaper debt is not the cure. Unfortunately, this brings us a step further from a good bottom. Have a good night.

Follow the Banks

  • The banks have been the best short term compass. Yesterday the banks were strong all day and at the end the market finished higher. We are seeing weakness from the banks today.
  • Market breadth is ugly and there is too much call buying.
  • Those three things combined are tempering my desire to buy.
  • What is the bull case?
  • We are oversold on the shortest of time frames.
  • The high beta stocks like AAPL, RIMM and GOOG are all higher.
  • Oil is up on the day

Why I'm Not Buying It

There are two reasons I am not ready to buy into this market quite yet:
  1. The futures traded sharply lower this morning, for no apparent reason. Often when the market sells off like this for no reason, it means a reason is forthcoming. I want to wait to find out that reason.
  2. The call buyers have once again crawled out of their holes.

This Is What I Like To See

This is the type of action I like to see. Panicky traders hitting the eject button and some put buying. Ideally I would like to see the stop loss orders between 790-800 on the S&p 500 get triggered. I would definitely do some buying if that occurred. That might be too much to ask as the market already down more than 7% since Tuesday. Stay tuned.

Patience

Good Morning. I read everything I could get my hands on written by or about successful investors. There are two traits I notice most often in successful investors. The ability to think differently than the crowd and patience. Thinking differently than the crowd comes naturally to me. However, patience is a constant struggle. My best trades come when I feel strongly about something. Right now I don't have a strong feeling about the market. While it is very difficult for me to sit in mostly cash, I know that this is the best course of action. Right now it seems like there are no good ideas out there, but I know an idea will come. It always does.
  • I can never understand why people trade on the retail sales number. All the retailers already reported sales for the month of January.
  • When do we get to grill the politicians on their deficit spending, lack of oversight and campaign contributions from financial firms for the past twenty years?
  • Is there anything more sickening than watching a self righteous politician?
  • Answer: watching a self righteous politician talking to a self righteous bank CEO.

Frustration: Part Two

  • Obama used the words "tough love" in the interview I posted earlier. Reading between the lines, does that mean he is not planning on bailing out the banks?
  • Is it bullish that everyone is so mad at Geithner, yet the banks are holding up well?
  • My gut keeps telling me that this market wants to go up. Unfortunately, the indicators I look at are not giving me the green light.
  • I spent the majority of the past few weeks researching individual stocks. I came up with a decent sized list of stocks that I wanted to buy on weakness. Even though the S&P 500 is trading close to its recent lows, every stock I was planning on buying has rallied significantly and not pulled back.
  • I keep reminding myself that it could be much worse. Have a good night.

Frustrating Market

We finally saw a cessation in call buying during that last probe and the banks remained strong. However, the market has zoomed ahead quickly and did not give me a chance to get involved. The markets refusal to go to extremes is very frustrating for me. Of the rallies we have seen today this one looks the best. Unfortunately, I am a spectator.

Divergent Signals

The best short term compass for the market has been the banks and they have been strong all day. Market breadth has been strong all day as well. The combination of the two have been making me want to buy every dip, but the put call ratios are showing too much bullishness. So I continue to sit on my hands.

Obama Gets It

President Barack Obama did an interview with ABC News discussing the financial crisis. He is the first person from either administration to show some semblance of understanding of the problems we are facing. From ABC News:

Obama: Well, you know, it's interesting. There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what's called "The Lost Decade." They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn't see any growth whatsoever.

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country.

And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again.

President Obama understands that the better course of action is to own up to our problems (the Sweden example) and let the market sort things out. However, he fears that owning up to our problems might cause a complete catastrophe. In other words we are in a pickle and Obama understands it. Recognizing the problem is the first step to recovery. I don't know if other officials don't get it or are just playing stupid but it is good to know that the President's brain works.

How Do You Say "Good Morning" In Chinese

A former adviser to the Chinese central bank expressed concerns about all the treasuries that China is holding. He is worried that the US will just print money, which will erode the value of the obligations China is holding. From Bloomberg:
China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by “reckless policies,” said Yu Yongding, a former adviser to the central bank.

The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,” Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing. He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.

I had three reactions when I read this article.

  1. Good Morning China. You just now realized that it was imprudent to lend so much money to a debtor nation.
  2. Ben Bernanke believes he could just print his way out of this mess. If our foreign creditors start waking up, between their selling and his printing the dollar would make for nice wall paper.
  3. Are we over estimating the appetite for all the US debt it will take to fund the bailout packages?

Are We There Yet

  • Once again calls are being bought. Yesterday's drop does not seem to have spooked traders.
  • Is it me or does it feel like everyone is very eager to buy every dip?
  • I can't figure out of that is good or bad?
  • This type of trading does not fit my style as I like to buy when stocks are taken to an extreme. Dip buyers are not allowing the selling to get extreme.
  • Rather than change my style, which has served me well over the years, I will wait patiently. Although, I feel like a child on a really long car ride saying, "Are we there yet"?

Tech Outperformance

I believe we are getting very late in the game of technology stocks outperforming. They have been outperforming for a long time but it seems that the masses are suddenly catching on. RIMM is down over 10% in the pre market as investors did not like their mid quarter update. This should put technology bulls to the test today.

The fundamental argument for owning technology is still in tact. They have little debt, easy to understand balance sheets and solid free cash flow. However, valuations versus the rest of the market have become somewhat less attractive as a result of the outperformance.

This is more of a sentiment call than a fundamental call. I would likely be a buyer if tech corrected but right now I believe the trade is getting crowded.

Back To Reality

Good Morning. Fantasies about a silver bullet saving the economy can be put to rest now as we focus on the long, hard road ahead. Expectations for a bailout that would be a panacea to banks were clearly dashed as Secretary Geithner offered more of the same. More TARP money but with tougher conditions than the Bush administration attached to it. The "bad bank" plan was replaced with a plan to finance private investors. Incidentally, a "bad bank" plan that would be enough to bailout the banks would have cost taxpayers trillions of dollars. All to keep the same people and systems in place that got us into this mess.
  • For the shortest term traders, weakness could probably be bought today. However, it will take until after options expiration to get a better oversold reading.
  • There are a lot of stop losses residing in the 790-800 level on the S&P 500. If the market wanted to frustrate the most people it would take out those stop losses and then rally.
  • How do I know that is where the stop losses are? Almost every technician has mentioned those levels as important.
  • I don't trade based on support and resistance levels. But I try to pay attention to what everyone else is doing.

Werewolves Of The White House

There was actually a study that showed that market turning points tended to happen when the moon was full. While this may sound silly, there is a reason why it might work. Full moons have a gravitational pull that changes tides, changes a women's menstrual cycle and effect some Alzheimers patients. The gravitational pull of the moon has an effect on our psyche whether we realize it or not.

I don't trade on this but it is interesting to note that I remember seeing a full moon last night. Have a good night.

Geithner Bashing

Yesterday Treasury Secretary Geithner was a hero and today he is a villain, according to some of the things I am reading. Geithner did not create this mess on his own and he does not have a magic wand that will get us out of this mess. The incessant hope that there is an easy way out is the culprit that does not allow this market to bottom. The crushing of that hope actually brings us a step closer to a real bottom. Have a good night.

Hot and Bothered

  • Last week's 5% rally in the S&P 500 that got everyone so hot and bothered has been completely erased. While I was expecting the news to be sold I was not expecting this.
  • There are not many things more dangerous than buying into an overbought reading during a Bear Market.
  • It will be a while before the market is oversold again (right after options expiration). That does not mean we can't rally. It just means that there will not be a low risk setup between now and then.
  • It is very hard for me to analyze commodities as there are no cash flows associated with a barrel of oil or ounce of gold.
  • Oil is getting interesting. My understanding is that under $35 a barrel, a lot of oil projects become uneconomic.
  • On the other hand gold costs about $400 to mine and the price is more than double that.
  • On that simple analysis I would rather own oil. Additionally, if inflation will be as bad as Gold bulls believe oil should do ok.

Bye Bye Banks

Geithner was vague about the details of his plan. If Geithner's comments are to be taken at face value there will be a lot of banks failing in the next year. This is not Geithner's fault as the banks have put themselves in a pickle. It just seems that the bailout plan is not big enough of a handout to save them.

That said, bank failures will take time to play out. On Friday, I said I would hold back on buying. Despite most of last week's gains being given back, if I were bullish this would be the time to buy. For now I am still in watch mode.

Sell The News

It should come as no surprise that the news of the highly anticipated bank bailout package is being sold. One would have to have been in a coma for the past week for this to be news and there do not seem to be any positive surprises in the details. The market has been a buy on dips for the past few weeks. Like Pavlov's dogs traders will probably try to buy this dip but I don't think that the market will be able to turn today.

Even though the S&P 500 is not far above levels where I have made purchases in the past month, it is getting increasingly difficult for me to find anything I am interested in buying. While the S&P has only rallied a few percent stocks that I want to own like Microsoft, Annaly and Schwab have rallied by much greater amounts off their lows. Consumer staples have declined but the stocks are still overvalued as managers have been using them as hiding spots.

GE's Awakening

For the past year GE has gone down precipitously, while the entire time the CEO, Jeff Immelt, denied that there were any problems and said the dividend would not be cut. On Friday, he finally admitted that there was a problem and that the dividend will likely be cut. Yesterday, the stock rallied by 13%. While this might seem counter intuitive this is a fairly normal reaction to a dividend cut. Most of the time everyone knows a dividend cut is coming. So when the announcement finally comes short sellers cover because they no longer have a reason for being short. In addition, people who are interested in buying want the dividend cut out of the way before buying.

GE's dividend cut was no secret. The options were pricing in a hefty dividend cut for months now. It was a classic sell the news reaction. I don't know if this will be the low for GE but it does buy GE some time as the stock will not likely make a new low any time soon. If the news does not deteriorate from here than it probably is the low. Unfortunately, GE is too complicated for me to analyze. They have so many businesses and a finacial unit that I have no idea how to value so I will take a pass.

Back In Business

Good Morning. While the full details of the bank plan have not been released, it appears that the government will provide financing to private investors to buy assets from banks. Private investors are unlikely to overpay for assets, so the plan is unlikely to be much help to the banks. The remaining TARP money will be used to inject capital in to banks, much like the original TARP money.

The question on everyone's mind is, "Will this rally hold or will it fail like the others"? I suspect that we will get a pullback today, as the bank plan is less than what it was built up to be and the market is overbought and in need of a rest. What happens after that is a lot trickier. While I don't believe this Bear Market is over, there is the possibility of a Bear Market rally. Hedge fund managers and advisors have record low stock allocations. It seems too many people have become comfortable being "out of the market". The market may want to suck that money back in before resuming its downward march. I am still getting my sea legs back as I return from vacation. I hope to develop a better sense of the staying power of this rally.

What A Difference A Week Makes

Please note: I am on vacation until Tuesday. I will try to post, but posts will be sparse.

Good Morning. Stock market players are infamous for alternating between fear and greed. The past week was an excellent example of this. Last Friday, when the GDP report came out the mood was downright dreary, while the Bears were rejoicing. One week later, with the market awaiting the new new bailout plan, the Bulls were rejoicing. From fear to greed in one short week.

The market certainly has room to rally. As I outlined last week, both hedge funds and individuals are positioned very conservatively. If they could be convinced to move some money back into the market we could see a large multi-week rally.

While I see the potential for a multi-week rally, I am not betting on one. The bank plan can have a tremendous effect on the market, which I have no insight on. Additionally, the market is now overbought. I would rather buy into the market the next time it gets oversold, than chase it when it is overbought. I will be returning tomorrow bright and early.

Thoughts From The Beach

Please note: I am on vacation until Tuesday. I will try to post, but posts will be sparse.

It seems that investors are getting a little too excited about the mark to market change. Call buying has been intense for the past two days. Not marking positions to market is the equivalent of making believe nothing is wrong when indeed something is. Ignoring the sickness does not get rid of it. That is what Japan did.

While I would be hesitant to short this market as the bank plan is going to be announced next week, I would definitely not be buying here. Back to the beach.

More From Annaly Conference Call

Please note: I am on vacation until Tuesday. I will try to post, but posts will be sparse.

On the Annaly conference call analysts are questioning Annaly's conservatism. One analyst just asked why they are spending so much money to hedge out their interest rate exposure when everyone knows rates are staying low for a long time. I almost spit my cofee out. How does this analyst "know" rates will stay low? Annaly's response was that governments around the world are printing money like crazy and it is impossible to know the consequences. The cost of the hedge is well worth the price. I am very happy that this analyst is not running the company.

Annaly Misses Earnings

Annaly Capital Management missed analyst estimates. Annaly is a REIT but does not invest in real estate. They invest in agency (Fannie, Freddie) bonds, which have an implicit government backing. The reason for the earnings miss appears to be their conservatism as they reduced leverage further. That is perfectly fine with me. I have been buying the stock when it trades below book value or selling puts that would put me in the stock below book value. The reduced leverage makes Annaly an even better buy when it trades below book. My strategy remains unchanged and I remain short Puts (bullish strategy via options).

Departing View

Good Morning. I will be be leaving for vacation today and will return Tuesday morning. The market continues to give mixed signals and I don't see a low risk setup. Event risk is extremely high as the bank plan is expected to be revealed in the coming week. The reason this plan is so important is that the majority of the banks in the country are likely insolvent. This rescue plan (hand out, corporate welfare) will determine if there will be anything left for shareholders. Insiders are likely to be leaked the details first, so know that you are trading with a disadvantage if you are not an insider.

On a side note, I am extremely disappointed with Barack Obama. I was very impressed that he appointed Paul Volcker as one his top economic advisers. He is the only one in the Obama administration that warned of the stock market, real estate and debt bubble years ago. He is the only one that has had the guts to make unpopular decisions. In the meanwhile, Larry Summers and Timothy Geithner oversaw these bubbles and never said a word. Even worse, they defended it and nurtured it. According to a Bloomberg article, Paul Volcker is being pushed aside. It appears that Obama used him to gain credibilty. I wanted to believe in change but I am starting to believe it was just a great marketing term by a politician.

Heavy Rotation

The rotation into large cap tech continues. Portfolio managers were hiding in consumer staples like Kraft and Procter & Gamble. This week those "recession proof" stocks proved that in this recession-depression nothing is safe as consumers reconsider all their spending habits. It seems like the new hiding place is large cap tech. While I have long favored large cap tech, I believe the outperformance is in the very late stages.This market remains too tough to call. I am going on vacation tomorrow but will be posting some of my departing thoughts in the morning. Have a good night.

Be Humble

On Friday I wrote, "My antennas have been perking up today as there seems to be a little too much high fiving by the bears". The Bears were downright cocky after the GDP report on Friday. Hubris is punished in the stock market and the Bears have received a fair share of punishment in the past few days as a result. One of the best contrary indicators is when either the Bulls or Bears get too cocky. While there is no way to measure hubris other than anecdotally, if one pays attention it is not too hard to notice.

Out Of Microsoft

I have flattened out my Microsoft position for a number of reasons
  1. I am going on vacation tomorrow. After waking up every night on my Honeymoon to trade at 3 AM, I am trying to take it easy on this vacation.
  2. The market is getting overbought.
  3. In this market you need to take profits before they disappear.

Two Types Of Companies

In the past few days there are a laundry list of high profile companies that have warned on earnings including UPS, Procter & Gamble, Kraft, Disney, Costco ... . Earnings estimates for individual companies remain way too high. In my opinion there are two types of companies. Companies that have lowered expectations and companies that will lower expectations. I prefer to own companies that have already lowered expectations. And if the new expectations involve a second half recovery, forget about it. I'm not saying it won't happen but I don't want to pay for it.

Many will snicker at Warren Buffett for getting killed in Kraft. I am in the very early stages of researching the company. He is still the best investor in history and I might be able to get in a lot cheaper than he did. My very early judgment is that Kraft is a buy in the low 20's. I'm not saying it will get there but one has to be prepared ahead of time.

How Do I Get That Job

Good Morning. The stock market remains too tough of a call for me in the short term as there are more mixed signals than a first date. The overbought indicator I use is starting to lean bearish but not by too much. The CBOE is showing too much volume in calls, while the ISE is showing put buying. Anecdotal sentiment and surveys are showing people are bearish but not to an extreme. The market feels like it wants to go up but the financial stocks don't seem to want to go for the ride. This remains a short term traders market.
  • I prefer when the markets are at an extreme. In the past year we have had many extremes but that time may be passing and I might have to adjust.
  • I am building a shopping list of stocks in case the market gets hit again over the next few weeks. There are great comapnies trading at very reasonable valuations.
  • I am only interested in companies with pristine balance sheets. I want to make sure they can ride out this crisis in case I am early in my buying.
  • I was shocked to find out that the CEO of GM was payed 17 million dollars last year. GM's problems have been going on for a few years so this was not a mistake. Combine that with the fact that he flew into Congress on a private jet asking for bailout money and its no wonder that the masses want to lynch CEOs and Wall Street.
  • Sandy Weill generously gave up his privileges for the Citigroup private jet to help out. Why is it that we are bailing out companies with private jets? Why do they still have them?

Microsoft On Fire

  • The market did not take kindly to my saying that it wasted its oversold reading and reminded everyone that there is still time on the clock.
  • Given all the cash on the sidelines a large multi-week rally is not out of the question. I would prefer if the rally came off of a lower risk setup so I could participate but the market doesn't care what I would prefer.
  • The financial stocks are lagging today. They have been leading the market so they are worth keeping an eye on.
  • Microsoft has now rallied almost 10% since the day they "missed" earnings. That is why I prefer the valuation game to the earnings game.
  • I am still involved in the long side of Microsoft via short puts. I would have done better by just buying the stock but my downside was also smaller. That is a trade off I am willing to make in this market

Oversold Reading Wasted

While I am too scared to short this market for the reasons outlined in earlier posts, I am not yet interested in buying it either. If the market rallies it will become overbought in relatively short order. Why will the market become overbought even though it has gone nowhere? The Overbought indicator I use looks at time as well as price. Two weeks ago, when Obama was inaugurated, the market was maximum oversold. Since then the market has just milled around and wasted the oversold reading as a function of time. Using a football analogy, the market was on offense and wasn't able to score any points. The time is soon coming for the market to go on defense.

Rummaging Through Earnings

I go through a number of earnings reports and conference calls every day in searching for investment opportunities. Often I find information about the general economic environment that I was not searching for. In going through Charles Schwab's earnings report I noticed that margin loans outstanding at the end of the 4th quarter were down 47% year over year. That number probably understates the severity of the decline because Charles Schwab has been stealing clients from just about everyone and there are a lot more clients than a year ago. In addition, they revealed that adviser cash levels are at 20% on average when historically they have been at 10%.

It seems that individuals and hedge funds are sitting on very high levels of cash. This is the reason that I would be very hesitant to short this market.

Hedge Fund Positioning

Hedge fund performance figures for January are starting to trickle out. For the most part, they are positive to slightly down. With the S&P 500 down 8% in January it is not a leap to assume that most hedge funds are under invested or short. While there is no rush to invest now, when the market and psychology turns (as it always does) there will be a lot of fuel chasing the rally.

Mr. Retail

I have a friend who we will call Mr. Retail to protect the innocent. Mr. Retail worked both in the retailing industry and as a retail analyst on the sell side. Mr. Retail was willing to tell anyone that would listen that most of retail was a short sale at a time when retail stocks sold at multiples of today's prices. While everyone is bearish on retail now, at the time he was in a lonely minority. His sell side bosses did not appreciate his insights so he moved to the buy side.

A few weeks ago I checked in with Mr. Retail. He told me that it was likely that Macy's would go bankrupt. While I have learned that it does not pay to bet against Mr. Retail, I was struck by his pronouncement. After all Macy's had just had better than expected holiday sales and profits. Certainly there were better candidates in this recession-depression. Then yesterday we found out that Macy's is going to earn half of what analysts estimated and is restructuring. They are one page closer to Chapter 11. Naturally, I checked in again with Mr. Retail on the state of the retailing industry. This was his response to me:

I'm going to call this analogy the Indian Buffalo Run. Banks, auto makers, and retail companies all knew the outcome of running their business the way they ran them. Full tilt and without restraint. It's like the buffalo, they knew they were being driven off a cliff, but they couldn't stop running or they would be trampled. So they charged ahead.

Retailers have no choice but to keep pushing ahead…they'll pretend to have some flexiblility in inventory and salary expense (BS) … the street might believe them because very few people know what it's like to run a company. Nevertheless if you are Macy's and you have private label and you say I'm going to order 25% less…you know what that means…first of all you are probably going to have to shut down 40% of your manufacturers –no half's in manufacturing or shipping. For the most part you either run all your machines or none. Not to mention containers don't set sail half empty.

So you cancel tons of merchandise and your store starts to look crappy (that's why ANF doesn't want to go there but will have to). It costs you more per item and you need to charge less, so margins stink. On top of that your wholesalers are getting crushed (because of you and everyone else) so the same problems exists in all your inventory. And you know what? While sales/sq.ft dries up…rent/sq.ft doesn't. Models starts to break.

So why not work out the leases? They'll try but landlords only have so much room because they've got their own debt covenants to think about and lots of debt too. So they give you a break, but it's not enough for the little mom and pops that fill in all the holes in the floor plan. They are going tapioca because who cares about fancy candy and candles and whatever other junk they are pushing. Now you've got some dark spots in the mall…uh oh. Dark mall not good. Traffic down more, sales/sq.ft down more, rent expense…still there baby.

Buffalo run…cliff ahead.I say we wait at the bottom and eat the carcasses and wear their hides for warmth!

Jeremy Grantham's Q4 Letter

"During the market’s rise, I wrote about the fallacy of paper wealth, particularly as it applied to houses. At three times the price, they were obviously still the very same houses. How could we kid ourselves that we were suddenly rich and didn’t need to save for our pensions when we were sitting in the very same buildings we bought in 1974? With “wealth” built on such false premises, it is not surprising that we come to grief from time to time. But the good news is that, as we move back down to earlier prices, they are still the same houses. We have not lost wealth, but just the illusion of wealth."

- Jeremy Grantham in his Q4 letter to investors


If you did not read Jeremy Grantham's Q4 letter it is a must read as usual.

Capital Observations

  • I have been writing for months that I favor large cap tech because of low debt levels, easy to understand balance sheets and strong cash generation. Throughout that period large cap tech has outperformed. Recently, the mainstream media has begun to pick up on this outperformance. That means we are probably closer to the end than the beginning of this trend.
  • I pointed out the low put/call ratio as the fly in the ointment when the market was up. The market is now significantly lower.
  • I have been reading through conference calls for the past few weeks. The recurring theme is that everyone is cutting costs. I believe premium real estate locations such as New York and San Francisco will suffer mightily.
  • How can we get out of this mess when the authorities don't understand the problem? The problem is that we borrow too much. How does lending more cure that?

A Thorn In Market's Side

  • The "bad bank" plan is only good for banks if the government overpays for the assets. If they wanted prevailing prices they could just sell into the market.
  • With public sentiment against the banks, how favorable could any "bad bank" plan be for the banks? Wouldn't a plan heavily favoring the banks be the equivalent of political suicide for Obama?
  • The low put/call ratio on the CBOE continues to bother me. While a single indicator is just that, it is enough to stop me from making any incremental purchases.
  • Every indicator I follow has failed at one point or another. However, when they are all lining up the odds favor listening to them. Right now they are all singing different songs.

The Right Side

The only side of the market I would currently consider is the long side. With the market 15% below fair value it would be hard for me to have conviction on the short side. The downside to being wrong is tremendous. In addition, everyone is talking about how bad things are. If everyone already knows that it is bad, what do I know that is not already known?
  • While I would have a hard time going short, the long side is not that tempting.
  • Microsoft is up 4% in a down market, which is a big change of character for the stock. I picked up some long exposure late Friday in the name (via short Puts).
  • The spread in the Pfizer-Wyeth deal is tightening today. Unfortunately, I unwound that trade to make room for Microsoft.
  • The first two days of the month are statistically the strongest.

Groundhog Day

Good Morning. Today is Groundhog Day, and it sure feels like it with the futures once again pointing to a lower open. The week will likely be dominated by rumors about the "bad bank" and stimulus package. I try to avoid trading in these types of environments because news tends to leak first to those who are politically connected and I am not one of those people.
  • I have been hearing a lot of talk about the 790-800 level on the S&P 500. Many are using it as a stop loss level. If the market wanted to stymie everyone it would break that level and then regain it.
  • Popular opinion about CEOs and Wall Street is very negative. The people want blood. Who will get tossed to the dogs?
  • Is it possible that we are stuck in a trading range which will continue to frustrate both Bulls and Bears?
  • Why does it seem like everyone is bearish, yet there is little put buying?
  • The new lows list is filled with regional bank stocks. Their problems will likely be the next chapter in this bank saga.

Weekly Strategy

Nobody knows where the stock market will go because the stock market's destiny is not set in stone. It is dependent on the action of millions of people, which is unpredictable. The question that comes to mind is, "If nobody knows where the stock market will go, isn't investing just a pure game of chance?"

While I don't believe it is possible to know where the market will go, I believe it is possible to identify high probability situations. If one invests when the probabilities are in their favor they might lose sometimes, but in the long run they should come out ahead. A casino has the odds in their favor, yet every day there are "winners" that walk away with the casinos money. However, in the long run the "losers" outnumber the "winners" and the casino comes out ahead. I attempt to become the casino and only participate when the odds are in my favor.

The purpose of my weekly strategy is to try to identify which way the wind is blowing. Is the environment a tailwind to stocks and the probability high that stocks will rise? Or is the environment a headwind and the probability favoring a decrease?

From a valuation standpoint, the S&P 500 is 15% below its long term fair value (using normalized profit margins and normalized P/E). However, in past secular Bear Markets the trough did not come until the market was 40% below fair value.

From a fundamental standpoint it will take years to overcome the imbalances that have built up as bubble after bubble permeated the economy. Periods of adjustment have not been kind to the stock market. However, we are seeing unprecedented fiscal and monetary stimulus. Even if the "drugs" will eventually fail, they might work in the short term.

The market is neither overbought nor oversold, but somewhere in between. From an anecdotal standpoint and from looking at sentiment surveys it seems that the crowd is bearish, but not to an extreme. However, when looking at the option markets one might conclude that investors are too bullish, especially given the fact that the market has been declining.

I don't believe this is an environment for big bets as the winds are currently swirling aimlessly. The Bulls might press their luck at the beginning of the week as the first two days of the month are seasonally strong and the market will not be overbought. Bears might want to press theirs towards the end of the week if the market becomes overbought. I am keeping my chips in my pocket for now.