Market Keeps On Keepin' On

After a 10% rise in a straight line it is very tempting to try and call a top in the market. I am not interested in starting any new longs at this point. However, when I see  put buying and every other person trying to call a top in the market it makes me think that this move has more juice left in it. Have a good night.

A Long Way

We have come a long way and the market seems to be faltering.  A pullback would not be all that surprising but betting on the downside is far from a layup.

  • We are seeing put buying today signalling that participants are still fighting the rally.

  • The two days heading into Labor Day have positive seasonality.

  • We are not yet maximum overbought.

This afternoon pullback might be fueling us up for a further rally through the end of the week.

The Tell

Two weeks ago every sentiment indicator was giving off a buy signal, except for the Investors Intelligence survey. Yet, everybody decided to focus on the Investors Intelligence survey which was the only indicator of dozens not confirming the buy signal.

I wrote the following on August 22:
I find it telling that the most often quoted sentiment indicator of late has been the Investors Intelligence survey. I find that when the crowd focuses in on a single indicator it usually fails, even if it is a trusty indicator. I believe that will be the case again this time around.

This once again solidifies to me the notion that technical indicators that make the mainstream tend to fail, even if they are usually good indicators.

Closing In On Overbought

The market remains oversold on an intermediate term basis and sentiment remains bearish. It will likely take an intermediate term rally to turn all those newly minted bears back into bulls. However, on a shorter term basis we will be overbought at the end of this week.

If the market manages to rally through the end of this week than I would expect a pause at minimum and possibly a correction next week. All this analysis assumes that there are no game changing negative events out of Europe.

Normally, after a rally of the magnitude we just had I would call for a correction next week. However, in the past couple of years many of these overbought readings have only led to sideways pauses. There have been far fewer corrections during intermediate term moves be they up or down. Hence my call for a pause at minimum.

Good News and Bad News

The good news is that we are seeing put buying today and the market is hanging in. The bad news is that the situation in the Eurozone seems to be deteriorating. The rhetoric coming out of Germany is downright scary and Berlusconi's backtracking on his austerity plans is further angering the Germans.

We find ourselves in a very difficult investing environment. I believe the path of least resistance is higher but one must leave room for the possibility that Germany pulls the plug at some point.

Who Cares

Consumer confidence numbers have historically been good contrary indicators. Confidence numbers are highly correlated to the stock market so when the market falls, confidence falls. Consumer confidence is not a predictive indicator. I do not trade on consumer confidence numbers but if I did I would not freak out when there are bad numbers, I would buy.

Remaining Constructive

In the very short run it is not very surprising that the market is pausing after a 90 point run in the S&P 500. I believe the most likely outcome is that the market maintains an upward bias through the end of this week. Sentiment indicators have plenty of room before they are an issue for the market and we will not be overbought until the end of the week.

The biggest risk I see to my upward bias is more problems out of Europe. Italy has watered down its austerity plans and the bond market is not taking it kindly. Our markets have managed to decouple somewhat from European markets recently and have been outperforming. That can only go on for so long as further European woes will eventually weigh.

While I remain constructive and net long I have used this rally to take some precautions by putting on partial hedges last week and writing some covered calls yesterday. Additionally, my longs are businesses that I believe will hold up well in a slower economy. My style is to buy into weakness and sell into strength.

Monster Run

This has been a monster run off of the lows last week but I have always given more weight to time rather than price. From a time perspective the market will not be maximum overbought until the end of this week. While I have written some covered calls as a function of the higher prices I remain long and believe the bulls deserve the benefit of the doubt until we are overbought. Have a good night.

Wrote Covered Calls

I wrote some covered calls. This seems prudent after a 90 point run in the S&P 500.

Interesting Anecdote

One of the reasons I have been expecting a snapback in the market is because the market had gotten far ahead of the economy. Jeff Saut of Raymond James shares an interesting anecdote in his weekly missive:
Accordingly, I will leave you with this quip from our restaurant analyst, “Every casual dining company that has spoken to Wall Street has said they have seen no evidence of behavior change despite all the scary headlines of the past six weeks or so. If we have a recession, this would be the first one in my 25 years as an analyst that was not foreshadowed with weakness at full service (the most discretionary) restaurants.”


Massive Short Squeeze Possible

Last week I wrote how I do not like the short side. The recent short interest numbers add to my weariness of the short side. The following chart is from Zero Hedge showing that short interest numbers are at 2009 levels:

This would worry me if I were short

A Lot Of Call Buying

There is a lot of call buying today. This is not necessarily bearish as  a long string of call buying days are necessary to make this bearish. Today is only the first day. It is funny how they buy calls after the S&P 500 has rallied by 80 points in a  week. I remain constructive but  am a little more weary as well.

September Turn Of the Month

We are now entering the seasonally strong turn of the month. The seasonal strength should last through the end of the week, although September turn of the month is amongst the weakest. If we manage to rally through this week we will be short term overbought for the first time in a long time. If this occurs I will likely make some sales in the latter part of the week.

Market Wants To Go Higher

I believe the market wants to go higher as we have had bad news all week yet the market has still ended the week higher. Europe is an issue as it seemingly goes down 5% a day. If Europe can hold itself together than I believe the market will rally next week as we head into Labor Day. Have a great weekend.

Long Lowes / Short Home Depot

I have gone long Lowes and short Home Depot. Home Depot is having a great week in anticipation of the hurricane but Lowes is less so. I put this trade on for the following reasons:

  • Lowes trades 20% cheaper based on 2013 estimates

  • Lowes is very slightly cheaper based on 2013 price to free cash flow. However, Lowes spends more on capex than Home Depot even though Home Depot is much larger. Shareholders of Sears can tell you that one can only neglect stores for so long.

  • Lowes just announced a large share repurchase for 20% of their shares.

  • Most of the gain from the hurricane has accrued to Home Depot. A hurricane is a one time event and I expect those gains to be reversed.

Waiting For The Crash

Ben Bernanke's speech was actually worse than expected. Most were expecting Bernanke to at least lay out his policy options and he did not even do that. So why is the market rallying? Because the bears were shorting in anticipation of today's event and the bulls were afraid as well. I heard numerous crash predictions for today. This is what happens when the crowd is lined up on one side of a trade.


Sold SPY Puts

I sold the 112 SPY Puts expiring today for 29 cents at an implied vol of over 100.

More European Woes

Our market turned lower yesterday when the German DAX suddenly dropped from flat to down 4% in a matter of minutes. The DAX is hitting new lows this morning and once again our futures are following. My sense is that Europe has gone too far and there has to be some value in European multi national companies at these levels. Unfortunately, I am not familiar enough with how Europe trades to make a short term market call.

I believe that Jackson Hole is a non event. Everybody already knows that Bernanke will not be making any earth shattering announcements. If anything I believe people are too pessimistic and getting Jackson Hole out of the way is bullish.


The Big Bad Event

The good news is that after tomorrow the Jackson Hole speech will be out of the way so there can be no more brooding over it. The bad news is that the European crisis will still be with us. I remain of the opinion that as long as the European crisis does not dramatically worsen we have yet to see the end of this rally. Have a good night.


The media and the bears are saying that the market has risen this week in anticipation of Jackson Hole and QE III. The bears are adamant that we will not see QE III and that the bulls will be disappointed. I agree that we are unlikely to see QE III or any prelude to QE III, but I don't agree that the bulls will be disappointed.

I have yet to see a single bull say they are buying in anticipation of QE III and all I see is put buying every day. If anything I believe people are worried about Jackson Hole. If the market sells off on Bernanke not announcing QE III I believe it is a buy. Europe is what keeps me up at night, not a lack of QE III.

I Don't Like The Short Side

While a pullback would not be surprising after the strong rally we have seen, I believe it is very dangerous to be short. Investors have de-risked and corporations are buying back shares at a torrid pace.

  • The ISI hedge fund survey shows hedge fund net exposure at the lowest level since 2009.

  • Individuals have been redeeming money from mutual funds, with $40 billion taken out in a single week.

  • Rydex traders are positioned bearishly.

  • The COT report shows speculators are net  short the indexes.

Market participants as a group have low exposure to the market. At the same time we are seeing numerous share repurchase announcements on a daily basis.  If corporate buying can goose the market we can see a performance chase develop. Barring a systemic collapse this market is likely headed higher. While an extremely unbalanced World makes a systemic collapse a possibility, it is a tough bet to make.


No Reason To Get Bearish

It is tempting to look for some downside after the two day run we just had, especially ahead of the big day on Friday. But there was once again heavy put buying today and it seems most market participants are caught on the wrong side of this move. While I did hedge a bit today, I remain constructive. Have a good night.

Closed ESRX/MHS Arb Trade

I closed out my Express Scripts/Medco arbitrage trade. The spread has come in to 22.75% from 27% when I put it on last week. I still think this spread is way too high, but I am not an arb and this deal does have some risk. I thought the closing of the Petrohawk deal would serve as a catalyst to close the spread and it did.

Heavy Put Buying

We are seeing heavy put buying once again today. Markets don't generally top out with everybody buying puts. My best guess is that the rally is not yet over although we are certainly taking a break.

Please Note

Please note that my longs are value stocks with businesses that I believe will hold up well in a recession.

Partial Hedges

I used the strength to put on some partial hedges. I shorted SPY and wrote out of money puts against it. I remain net long.

CVS Stepping Up The Buyback

CVS has already been repurchasing shares aggressively. They have stepped up the repurchase plan this morning. I am very happy with this.

From Marketwatch:
CVS Caremark Corp said Wednesday its board approved a $4 billion stock repurchase program and that it intends to complete an earlier $2 billion program before the end of this year. Under the new authorization, the retailer said it expects to repurchase about $1 billion in shares by the end of the year.

Betting On Mutually Assured Destruction

Walgreens is the largest drug store in America with 20% market share of prescriptions. Express Scripts and Medco are two of the three largest pharmacy benefit managers in America. Express Scripts and Walgreens could not come to an agreement on an extension of their contract that ends at the end of this year. Express Scripts is also trying to merge with Medco.

It is not in Walgreens or Express Scripts best interest to lose each other. For Walgreens it would mean a large loss in business when the contract runs out. For Express Scripts it would mean difficulty in attaining new business and renewing contracts. The PBM business is extremely competitive and not having access to the drugstores that 20% of Americans prefer to shop at would give their competitors a giant leg up in winning new business. As an insurance company, why do business with Express Scripts when for the same price or very close to it  one can do business with Caremark and give customers access to all pharmacies. Why piss off 1/5 of your customers?

As in all negotiations both sides must behave as if they are willing to walk away. And obviously the analyst at Barclays believes the bluff. He assigned a 2/3 probability to the possibility that Walgreens and Express Scripts don't come to an agreement. Within that probability he assigned a 50% probability that Walgreens loses Medco as well once the takeover is completed.

Since it is in both companies best interest to come to an agreement I have to believe an agreement will eventually be reached. I think the worst case is that there is no agreement for a few months into next year. Assigning a 2/3 probability to no agreement with no room for reconciliation further out is absolutely ludicrous. It reminds me of the people who believed the debt ceiling would not be raised.

I believe Walgreens is a bargain at current prices. The business is recession resistant, will benefit from baby boomers filling more prescription, the multiple is attractive and management has  a good record of returning cash to shareholders. I believe we are simply witnessing a negotiation, which is creating an opportunity.

Media Ramblings

A theme I have heard in the media over and over is that the market is rising in anticipation of Ben Bernanke's Jackson Hole speech on Friday. I have yet to hear from a single bull that the reason they are buying is Bernanke's speech. I am hearing bears pointing to Friday as a bearish catalyst because everybody will surely be disappointed.

Investors continued to buy puts yesterday despite the steep rise in the market. Rydex traders reversed the previous days bearish bets but are still positioned very bearishly. Investors Intelligence bulls have pulled back to 40%, which is normally slightly bullish,  but is still far above the 30% level seen last Summer. Given the decline in the market Investors Intelligence bulls should be a lot lower, but this data point seems to be an outlier versus dozens of other sentiment indicators I look at. Overall, the weight of the evidence points to very bearish market participants.

If we rally into Friday's Jackson Hole speech I will likely use the strength to hedge somewhat. However, if we decline into Friday's speech I will be inclined to remain unhedged.

Bear Market Geniuses

The bear market geniuses were getting a little too certain of themselves of late. There has been a lot of chest thumping and back patting. I don't believe the market will let these brazen bears off so easy with a one and done up day. Have a good night.

Was That The Bottom

There were a lot of scary rumors flying around this morning and the negativity was thick. Yet, here we are rallying strongly. Is this market sold out? Sure feels like it to me.

Stupid Fear

There is a lot of fear out there that seems absolutely ridiculous to me:

  • Henry Blodgett said that Bank of America might need $200 billion of capital. Last I checked he was an internet analyst and not a good one at that. While I recognize that I am not a banking analyst either, this eerily reminds me of the $1,000 price targets that made him so famous. And lost everybody who listened to him money. I can't wait for the $1 trillion loss estimate from the analyst that wants to top him.

  • People are freaking out that Lloyd Blankfein hired a lawyer. What would you do if you were being investigated by Congress. I would hire two.

  • An analyst at Barclays put out a note saying Walgreens will commit suicide by losing both its Medco and Express Scripts business. Yet, I'm certain they will sell down CVS as well because nobody will gain that business. I am long both CVS and Walgreens.

  • I have heard price targets of down 10% by Friday numerous times.

Investors Gloomy

If  it felt like investors were gloomy yesterday, it was because they were. Rydex traders greatly increased their short positions yesterday. They are now positioned about as negatively as they were last Summer. put out a study yesterday, using the COT report, showing that small speculators have their lowest long position in the indices ever. Add to that days upon days of put buying and a very bleak picture  of investor sentiment emerges. The good news is that it cannot get much worse.

It looks like we will get a large gap up at the opening as Europe is doing well for a second day in a row. While I did not see yesterday's fade coming I do not expect a repeat performance today. That does not mean the bears will not  try at some point. The reason I expect today's gap to hold  is that market participants are already positioned so negatively that its hard to see where the selling comes from. We could see more liquidations but that is a catalyst that is difficult to predict.

Could Be Worse

While the fade away was certainly disappointing there were some positives today. There was some differentiation between stocks and sectors as not all stocks were correlated. Europe has outperformed by over 2% since Friday's European close, which is certainly a welcome change.Thirdly the mood cannot get a lot worse than it currently is. Have a good night.

Stateside Liquidations

It seems like Europe wanted to go higher but there has been heavy selling since the US open. My best guess is that funds with large allocations to financials are seeing redemptions as they are the weakest group. Energy shares are also weak but that is likely related to the news from Libya. Sometimes expiration effects the market the Monday after but that does not explain the move in financials. I have not made a trade today yet.

Doom & Gloom

The doom and gloom talk this weekend was at a fever pitch. It is very difficult not to get sucked in as all the arguments make perfect sense. It is often the case at bottoms that there are few reasons to buy and at tops there are often few reasons to sell.

Every sentiment indicator I look at except for the Investors Intelligence survey is showing extreme pessimism that typically leads to favorable returns. At almost every bottom and top there will be at least a single indicator that does not confirm it. That is why I believe one must look at the weight of the evidence.  There are dozens of sentiment indicators I look and they all clearly support the upside save for the II survey.

I find it telling that the most often quoted sentiment indicator of late has been the Investors Intelligence survey. I find that when the crowd focuses in on a single indicator it usually fails, even if it is a trusty indicator. I believe that will be the case again this time around.

Punch Drunk

I was short some naked calls and covered calls that expired today. They acted as partial hedges to my longs(very partial). I was hoping to roll these positions into next month but I did not want to sell into weakness today. I hope to be able to re-hedge next week. What a day, what a week, what a month. Have a great weekend.

My Biggest Loss Was My Best Decision

Earlier in the year I took a loss on Hewlett Packard which I bought close to $41 and sold at $36.50. It was the worst single stock loss I had to take in years because the position was big and the loss was large. It was difficult as  a value investor to sell the stock at seven times earnings as usually when a stock becomes cheaper I buy more. The loss is still very fresh in my memory.

At the time I bought Hewlett Packard I overlooked some blemishes because it was getting hard to find any stocks that met my criteria. My general thesis was that even if one removed all the earnings from the consumer PC division the stock still traded cheap.

When HP reported earnings the CEO reported problems in the consulting division, which I assumed until that point was the most solid part of the business. He blamed the previous CEO for starving the business in order to make earnings numbers. As the preceding CEO was a former GE guy who always beat the number it was not hard to believe. At that point I was not sure what I could trust as it took the new CEO six months to figure this out.

I have a general rule that I don't own what I don't understand. At that point I realized that I did not have  a full understanding of what I owned and it was possible that the new CEO did not know either. Taking a large loss is one of the most painful things for me in investing but I knew I had to do it. My principal of needing to understand what I own has kept me from losing money in financials the past few years as well as saved me from an even larger loss in HP. I feel slightly better about my HP loss today.

An Interesting Tidbit

I picked up this interesting tidbit from Doug Kass at RealMoneyPro
Derisked hedge funds (ISI Hedge Fund Survey reports net exposure down to 45.8%, the lowest level in two years).

It seems that mom and pops have not been the only ones selling. There is room for upside in this market if less than a disaster occurs as market participants have de-risked.

Risk Aversion

There is no better measure of the risk aversion out there than the Petrohawk deal which closes today. Even after receiving final regulatory clearance two days ago it closed yesterday at a 13 bps spread(or well into a double digit yield annualized). Six month treasuries are yielding 2 bps. At that rate it would take years to earn the same 13 bps that one can earn in a single day holding Petrohawk. Yet financial institutions are shunning Petrohawk and buying treasuries.

I am very worried about the possibility of a depression as many chickens are coming home to roost at once. But given the current level of risk aversion there is room for improvement in markets if something short of a disaster occurs. Even if we are headed for a depression the path there will likely not be straight down.

Sticking To My Guns

Its hard to say anything with confidence these days because I'm not even certain why we were down so much today. That said, I remain long and believe there will be better opportunities to sell at. Have a good night.

Sell To The Point Of Sleep

There is an old Wall Street adage that says "sell to the point of sleep". I have found that a variation of that statement works a lot better for me. Often when I cannot sleep, the market is in turmoil and it is not a good time to sell. I find that the best thing to do is to suck it up and take the pain and sell at the next opportunity.

Last week when we were crashing I felt like I was losing my mind. When we rallied back I took some positions off and added some hedges even though I was still bullish. As a result I am in  much better shape today than I was last week at these levels both from an account value and sanity perspective. Don't get me wrong , I am having a painful day but not nearly as painful as it would have been if I did nothing.

Long Medco/Express Scripts Arb

Last week I was able to purchase Petrohawk at a 2.5% gross spread on a deal that was as close to a sure thing as one could get (I bought at $37.85 and the deal is closing tomorrow at $38.75). I never wrote about it because I was only filled on about 15% of my desired position. Quibbling about a few pennies sure seems silly now but when the deal was available a week ago when the market was tanking it felt scarier.

The point of this anecdote is to point out that there are some good deals available in the merger arb world. Wall Street prop desks and European banks are the major players in merger arbitrage. Wall Street has scaled back proprietary trading and European banks are in risk off mode. There is simply not enough capital to close these spreads as many hedge funds do not have this expertise.

Today, I entered the Medco/ Express Scripts merger arbitrage play. This is not nearly as low risk as the Petrohawk deal but there is a 27% gross spread available. The  downside seems protected as Medco is trading lower today than where it was before the deal was announced. I believe the risk/reward is very favorable in this spread and have taken a position. However, because there is some risk in this trade it is smaller than the position I wanted to take in Petrohawk.

My Positioning

I am of the belief that this decline could be bought into. As the market rose I trimmed some positions and wrote covered calls and naked calls as hedges. As we decline those calls I wrote act less as hedges and my long exposure increases automatically even if I don't do any buying.

I will give an example of what I mean. Yesterday, I wrote the SPY 120 Calls expiring tomorrow for $1.75 naked. When the market opens today those Calls will likely be nearly worthless, so I will already have recognized the vast majority of the benefit of my hedge. This makes me longer because I no longer have that hedge or very little of it.

I also want to emphasize to readers that my longs are very conservative companies that should do relatively well in a weak economy with rock solid balance sheets.

Trim Tabs Liquidity Theory

I want to make a correction to my final post last night regarding the $12 billion cash Petrohawk deal that is expected to close this week. I wrote that according to Trim Tabs 1/2 of a cash deals value acts as an inflow into the market upon closing. I was mistaken in that according to Trim Tabs 1/3 of a deals value acts as an inflow upon closing. 2/3 of the value is recognized at announcement of the deal as arbs take the shares from fundamental investors and fundamental investors reinvest that cash . I would note that we had the $12 billion cash Motorola deal announced this week as well. Combining the Motorola and Petrohawk deal, they acted as a $12 billion cash inflow.

In the nineties Trim Tabs had the novel idea of tracking what corporations were doing as a way of predicting market direction. They looked at corporate buying which included cash takeovers, share repurchases and insider buying. They compared this to corporate selling which included IPOs, secondaries and insider selling. They came up with a formula that figured out on net if corporations were buyers or sellers. They ignored the public and thought of their behavior as erratic and unpredictable.

This formula worked fabulously for over a decade as it absolutely trounced the market. However, it missed the top in 2007 and then missed the bottom in 2009 and they stayed short for a long way off the bottom. Trim Tabs than veered from their formula and started blaming the Fed for manipulating the market. I believe they should have simply added a factor to their model to account for the public. At the 2009 lows the public was underinvested and short and therefore had a lot of buying power. The opposite was true at the 2007 top.

I have used their formula as a factor in my trading and it has helped a lot. My best trade of this year was to be long biotech during the closing of the Genzyme deal as the sector absolutely exploded higher. I believe that closings of deals might have larger effects than they used to when the formula was originally conceived. The reason being that so much more money is indexed these days and the indexes don't reinvest the money until closing.


Still Long Biased

I don't believe the market has a lot of downside potential this week. The $12.5 billion cash  Petrohawk deal is expected to close this Friday. According to TrimTabs the closing of a deal is the equivalent of an inflow of 50% of the value of the deal. That equates to a $6.25 billion inflow. The reason this theoretically works is that managers put cash to work received from the closing of the deal. Have a good night.

Mom And Pops Said See Ya

Investors pulled $23.5 billion from equity mutual funds during the week of the S&P downgrade. As others blamed high frequency trading the Monday following  the S&P downgrade I wrote:
My best guess as to what is occurring today is that retail investors are just getting out. The media got everybody worked up about the S&P downgrade and combined with the recent decline it put mom and pops over the top. They simply don’t want to go through another 2008.

The fact that mutual fund investors pulled that much money while insiders and billionaires were buying has bullish medium term implications but little short term implications.

Started To Hedge

I have started to hedge by selling the SPY 120 calls expiring this Friday naked. I am not bearish, I just don't want to be a pig.

The End Of The World Has Been Delayed : Part Two

"We do not see retests when everyone is still on the edge of their trading seat, anticipating the next shoe to drop."

- Helene Meisler of

For weeks, every press conference and every utterance from a politician has led to severe losses. This has conditioned market participants to expect the same thing going forward. Market participants were very eager to sell the news coming out of the Merkel/Sarkozy press conference even though it was largely a non-event. Those declines are now in the process of being reversed as European markets have pared losses from a weak opening.

As long as investors continue to look for a retest I believe the odds favor the upside. The market is still not overbought and put/call ratios continue to show heavy put activity. I believe that options expiration will exert upside pressure on the market as all those puts recently purchased go up in smoke.

While I continue to favor the upside I am quite long and would likely use a strong day to add some hedges to my portfolio.


The End Of the World Has Been Delayed

The bears have been licking their chops waiting for this Sarkozy/Merkel meeting. I thought it was a nonevent and believe the bears are now out of catalysts. Let's see if the Europeans agree with me tomorrow. Have a good night.


I believe we are witnessing a shakeout. Did anybody really expect Merkel to agree to a Eurobond? One would have had to be born yesterday to expect that. I believe we will end the week significantly higher than current levels.

Summer Trading

It is finally starting to feel like Summer trading. Here is some entertaining viewing.


The Daily Show With Jon StewartMon - Thurs 11p / 10c
Indecision 2012 - Corn Polled Edition - Ron Paul & the Top Tier

Daily Show Full EpisodesPolitical Humor & Satire BlogThe Daily Show on Facebook


And here is the Charlie Rose Warren Buffet interview.

Volume Blah Blah Blah ...

All I heard yesterday was complaining about the volume of the rally. Almost the entire rally since the March 2009 low has come on low volume but suddenly everybody is a volume expert. I believe this speaks to the mood of market participants as they are very gloomy. I will be a lot more worried when everybody loves the “fabulous action”, which will likely occur at higher prices.

We are opening lower on declining European markets. While I believe EU officials have done enough to hold things together for now, I still am monitoring developments very closely over there. If another shoe drops in Europe than the negative sentiment will be meaningless. That said, after the sharp rally of the past week a pullback is not all that surprising and there is no need for alarm yet.

Small Sales

I made some sales at the end of the day but remain quite long. I believe there is a strong likelihood this rally reaches expiration in order to burn out the recently purchased puts.  Have a good night.

Recession Resistant Stocks

There is a good chance we are headed into a recession, yet there are stocks worth owning. I believe that there are opportunities available where one can do well in a bull or bear market. Drugstore chains CVS and Walgreens both trade at a little over ten times next years earnings estimates. While a  recession will hurt business, earnings are unlikely to fall off a cliff. They have secular tailwinds in that aging baby boomers will be filling more prescriptions and a move to generics benefits them. Both companies are aggressively returning cash to shareholders via share repurchases and dividends.  I own both names.

Vodafone owns wireless communication businesses around the World. They trade at a double digit forward free cash flow yield and an 8% dividend yield. I don't believe many people will give up their cell phones, even in a recession. Impoverished people in third world countries have cell phones. I don't see consumers giving up cell phones en masse, even in a recession. I own Vodafone as well.

When you read that I am long stocks, do not think that means I am an economic bull. I am very worried about the economy and uncertain about the future. However, there are businesses that should be fine in a recession and that are trading at very attractive prices.


What Would A Recession Look Like

A recession is looking more likely by the day as the economy slows and the mood turns sour. Assuming that there is a recession in the US, what would it look like and what would the effect on the stock market be? I suspect it would look different than the past two recessions as there are far fewer excesses heading into this recession than the previous two.

Heading into the recession in 2000, we had the biggest stock market bubble in history and the highest valuations in history.   Heading into the 2007 recession we had the biggest real estate and credit bubble in history and stock valuations were high. Heading into this recession there are far fewer excesses and valuations are a lot tamer. One would expect that this recession would be milder and that the effect on stock prices would be as well. At last week's low the S&P 500 was already down nearly 20%.

We would likely need to see a depression in order to match the type of bear market that we saw  the last two times around. That is certainly not out of the question but its a tough outcome to be betting on. I am expecting a weak economy and likely a recession but am positioned in recession resistant stocks at low valuations. I will speak about some of them in a later post.

Google Spending Cash

Google is buying Motorola Mobility for $12.5 billion in cash. Cash takeovers are bullish for the overall market as the cash is put to work in other stocks. Less so for Google shareholders. That is the danger of investing in companies that do not return cash to shareholders.

Not A Wild Eyed Optimist But Optimistic

I am very worried about the economy. Many of the imbalances that have not mattered are starting to matter. The Eurozone is on the brink of collapse, while the US economy is slowing and the government is handcuffed as their is little political will for stimulus. Not to mention the negative feedback loop that negative sentiment can cause.

Now that readers understand that I am not a wild eyed optimist I want to explain why I believe that in the short run the bull case is more attractive to me. Some of the biggest, most powerful rallies occur in the context of bear markets. Rarely does the market go down in a straight line, especially when so many people are betting that way.

The chart below from shows how aggressive traders at Rydex are positioned. They have not been positioned so negatively since last Summer, which turned out to be an excellent buying opportunity. Options ratios and investor redemptions from mutual funds are showing similar extremes that typically lead to rallies.

If the financial system falls apart than all bets are off. However, Eurozone and Fed officials have put in place some extreme measures to keep that from happening. If the system can hold itself together than I believe that the market will squeeze out the newbie shorts and give us better levels at which to sell.


I Survived The August 2011 Crash

I rely on mean reversion both in my value investing strategy and for my trading strategy. A 20% move in a straight line is a mean reversion traders worst nightmare. Many records were broken over the course of the past two weeks and not good ones.

While I have had a bit of a drawdown, it could have been a lot worse. I was patient with my adds, did not get too large and did not panic even though I was close. I used the rally of the past two days to take off some positions put on Monday and Friday. On net I took slight gains on those position. I was originally looking for more from those position but right now I'm just happy to have survived and wanted to take some risk off. Have a great weekend.

Encouraging Signs

I am seeing some encouraging signs in the market and expect this rally to continue barring further systemic shocks. After staying stubbornly bullish for months Rydex traders have been increasing their short positions all week and are now at an extreme. Anecdotally, there was a lot of scoffing yesterday at the short ban and the ensuing rally. That tells me that not many are looking for a continued rally, which means the bullish bandwagon has plenty of room to grow.

Many of the positives I discussed earlier in the week are still in place. The market remains oversold and  the put/call ratio is deeply oversold. Many EU countries put in a short ban that will last 15 days. Coincidentally that is just enough time to allow EU officials to finish their Summer holiday. I believe that should be enough to hold things together for a few weeks. As long as the crisis does not flare up again I believe the path of least resistance is higher.

Wrote Covered Calls

I wrote some covered calls and wrote naked SPY calls as a means of putting some hedges back on. I cannot believe the week is not over yet. Have a good night.

Come To God

I took profits on my UPS position. It was meant to be a long term hold but after numerous "Come To God" moments this week I needed to reduce stress.

Short Ban

I am hearing that shorting financial stocks and naked CDS will be banned in Italy and France. Its about time. It will be interesting between now and the European close at 11:30 to say the least.


I wrote earlier we are at the edge of the abyss and that I suspect the Europeans will be forced to act. There are rumors swirling of a ban on short selling in Europe. They should include CDS as well. Hopefully, we will get an official announcement soon.


Every indicator I look at is pointing to a rally but those indicators are useless if  there are systemic issues. There is a classic run on the bank occurring in Europe. It has been reported that some Asian lenders cut off funding to French banks. It is snowballing and becoming worse but the European authorities have not responded. I find it absolutely astonishing that they cannot be bothered to be disturbed during their Summer holiday and are allowing this to occur. My suspicion is that they will do something because they have no choice. We are at the edge of the abyss.

Quashed Hopes

European markets were higher early this morning and our market was actually set to open higher at one point. Then rumors started spreading about S&P downgrading France. These rumors were unfounded as S&P affirmed France's rating later in the day but the damage was already done. This was only one of many rumors floating today about European countries and banks. Investors are buying cheapie CDS and then doing what they are being incentivized to do, cause a run on banks and sovereign countries. Hopefully European officials will act to stop this tomorrow but given their track record I am not holding my breathe. Have a good night.

Ban Naked CDS

John Paulson made CDS famous as he built a fortune buying CDS on subprime bonds. CDS are essentially a side bet that a certain bond will fail. Investors are buying cheap CDS in a similar fashion to the way they buy lottery tickets.  Everybody wants to make the next Greatest Trade Ever. And they are doing so on European sovereign debt and banks.

This is all well and good except that these CDS can effect the markets that are being bet on. For instance, as investors buy CDS on Societe Generale the banks that sell them have to hedge by either shorting SocGen's bonds or their stock. This causes the price to go down and can lead to a vicious spiral. Not to mention it creates incentives to spread rumors and cause a run on the bank.

There is no economic need for these instruments, when they are not being used a s a hedge on a long position in the corresponding bond. Quite frankly, I don't even understand why they are needed as a hedge. Just sell the bond if you don't want the risk.

The EU put out the fire in Spain and Italy but it seems that new fires will arise everyday as long as naked CDS are allowed. I say ban them.

Under Attack

So many rumors are circulating in Europe that it is difficult to keep up with all of them. This wreaks of a speculative attack. I believe European shares are ripe for a short covering rally as their markets make ours look overbought and sentiment there is far worse. The problem is that the authorities there are so slow to act. Even after they finally do act other officials make comments that undermines the actions. I don't believe it will require much to get the shorts running right now as long as they do something.


The market finally rallied yesterday proving the axiom that a broken clock is still right twice a day. In the current market I don't rule out anything but the majority of the evidence supports a continued rally:

  • The market is oversold and will remain that way for a while. It will not be overbought until after options expiration.

  • The put/call ratios will be maximum oversold at the end of the day today. The reason they are only becoming oversold today is that for the first few days of the decline investors were still buying calls.

  • Rydex traders are now positioned negatively and they actually increased their bearish bets yesterday.

  • A sharp reversal from such a high level in the VIX tends to lead to further upside.

  • The AAII, NAIIM and DSI surveys all show extreme bearishness. It is disconcerting that the Investors Intelligence survey is still showing excess bullishness. However, it seems to be an outlier as it is the only sentiment indicator doing so.

  • The vicious cycle of selling begetting selling seems to have been broken, although there is still the  danger of margin calls for the next couple of days.

Signing Off

“Has the world really gotten 10, 12, 15 percent worse in the last 48 hours? I don’t think so, Buying stocks at today’s prices over a couple of years’ time period will prove to be a uniquely rewarding experience.

-Billionaire Wilbur Ross

Hopefully Wilbur Ross will be proven correct. I am off to a funeral. Good luck. I will be back in tomorrow morning.

Why I Purchased UPS

UPS is a stock I have been wanting to own for years. Except for a brief period during the financial crisis it has traded too richly for a value investor like myself. Yesterday I was finally able to purchase the shares of of UPS, a first rate company, for a value price. Here is why I believe UPS deserves to trade at a premium:

  • UPS and Fedex are a duopoly. The barriers to entry are enormous and its almost inconceivable that a third shipper would ever be able to challenge them.

  • UPS has the secular tailwind of e-commerce that should benefit them for years to come.

  • UPS trades at 12.5 times 2012 earnings estimates.

  • The drop in oil prices might help UPS exceed estimates

  • UPS has a solid history of returning cash to shareholders via dividends and share repurchases. The shares have  a dividend yield of 3.2%

Many might be wondering why I did not purchase Fedex. Historically UPS has had better free cash flow and returns more cash to shareholders.

How To Stem The Panic

Many are clamoring for QE but I believe the most effective way to stop the panic would be to orchestrate massive share repurchases today. The exchanges should suspend all share repurchase rules allowing companies to repurchase as many shares as they want for the day. An official from the government should make a request of corporations to repurchase as many shares as they could today. Corporations are sitting on mountains of cash and they are in a unique position to stop this negative feedback loop. This is a much more direct solution to the problem than QE hocus pocus.

Why I Believe This Is Different Than 2008

Here are a list of reasons that I believe the current situation is different from 2008:

  • Credit spreads for corporations are relatively tight now. In 2008 spreads blew out to historic levels.

  • In 2008 companies were raising capital every chance they had. Today corporations are buying back stock.

  • In 2008 there were systemic issues after Lehman Brothers collapsed. The ECB seems to have Europe under control for the time being. There has yet to be  a Lehman Brothers.

  • Corporations are wildly profitable right now. In late 2008, when the collapse occurred profits had already imploded.

  • There are far fewer over leveraged corporations today.

  • While it certainly feels like there are forced liquidations occurring it does not seem like it is on the same scale as 2008.

I don't rule out that we could be headed for the Great Depression II, but we are not there yet. As such, I believe this is likely a liquidation that will pass rather than something more sinister. This too shall pass. Have a good night.

My Best Guess

My best guess as to what is occurring today is that retail investors are just getting out. The media got everybody worked up about the S&P downgrade and combined with the recent decline it put mom and pops over the top. They simply don't want to go through another 2008. Never mind that the folks at S&P are about as prescient as yesterday's newspaper or that Treasuries, the object of the downgrade, are screaming higher. I would actually bet that many of these mom and pops investors are fleeing into treasuries, which is what was actually downgraded.

Add to that all the momentum strategies practiced by technicians and quants. Hedge funds tend to reduce risk as well when the markets decline further adding to the negative momentum.

My sense is that the S&P downgrade is the height of the panic and that the liquidations just need to work their way through the system. I believe we will be much higher by the end of the week.

My Experience

The only time I can recall seeing this much panic without a bounceback was in November 2008, when we just kept going lower and lower. That followed Lehman Brothers. I don't think we are in a similar situation as the ECB has stepped into the market. I was not trading in 1987 but my understanding is that portfolio insurance was widespread and is what exacerbated the decline. I don't see anything similar today.


This sure looks like capitulation to me.

Added To Longs

I have started anew position in UPS and bought back the Walgreens covered calls that I sold.

Blood in The Streets

Italian and Spanish bond yields are trading at their lowest levels in weeks as the ECB has intervened. US treasuries, which were downgraded by S&P, are  bucking the downgrade and  trading higher on the day.  From a fundamental standpoint this is the best outcome one could have hoped for. The risk of contagion is now at a far lower level than it was last week.

So why are equity markets trading sharply lower? A lot of fear was stirred up this weekend and many scared retail investors are likely to hit the panic button (and professional investors who act like retail investors). I believe that this provides an excellent opportunity for level headed investors. The market is at all sorts of extremes that typically leads to a rally and the risk of contagion is largely gone.

Historically, the best time to buy has been when the stock market makes the front page of the mainstream newspapers and that is precisely what is happening. Everybody says they want to buy when there is blood in the streets but instead they wring their hands about a meaningless S&P downgrade.

Keep Your Eye On The Ball

When S&P initially announced they were reviewing the credit rating of the US Government, the stock market swooned but treasuries climbed. Treasuries are the obligations of the US government and those are the instruments directly effected by a downgrade. Yet, as the threats of defaults and downgrades have gained steam treasuries continued to climb. They have been one of the best performing asset classes since the downgrade threats started.

If the instruments that are being downgraded by S&P are not being effected, than why should equities be effected? The S&P downgrade is a non event. It is a  possibility that equity investors will freak out Monday morning but that would only be an opportunity as long as the EU doesn't spiral out of control.

In my opinion the events in the EU are of paramount importance and the rest is  a sideshow. If the ECB follows through and buys Italian bonds than I believe we will rally next week. If not, all bets are off.

I'm Incoherent and Long

I am so exhausted from this week I don't think I could put out a coherent post, so I will leave you with this. I am quite long. Have a great weekend.

Position Squaring

I sold 1/4 of the Walgreens positions I bought today and wrote covered calls on the remainder. I am short the SPY 121 puts expiring today and it looks like I will take delivery.

Random Thoughts

  • The VIX spiked to over 38

  • The ECB and Italy came to an agreement that should kick the can further down the road at worst and solve the crisis at best.

  • Yet this market still cannot run.

  • I still think we see a rally. If not today than next week.

  • I am dying to hedge my portfolio so I can rest but I cannot allow myself to do it under these conditions.

  • If I sleep until 4 AM these days I feel lucky.

  • It is really annoying to be short 121 SPY Puts that expire in an hour and a half with the market oscillating at that level for the past 2 hours.

  • I wanted to just buy them back a few times but there is still a ton of premium in them.

Bought Walgreens

I bought a position in Walgreens. They are trading at a low multiple, recession resistant and are buying back shares.

Employment Report A Sideshow

The employment report is a sideshow. We are here because of the European crisis. All that matters is Italian and Spanish bonds. So far, so good. Keep your eye on the ball.

Improvements To Report

More ducks are starting to line up for a rally. In the past day we have seen the following positive developments:

  • The NAAIM Survey of Manager Sentiment finally showed active advisers turning negative. This was before yesterday's rout so its likely sentiment has become worse. This also comes on the heels of individuals getting as negative as they have been in a year, according to the AAII survey.

  • Rydex traders abandoned the long side en masse yesterday. They have been stubbornly bullish this entire time. The only difference between this Summer and last Summer is that last Summer they were aggressively short. They are not aggressively short now.

  • The VIX has spiked.

  • The market is maximum oversold.

  • Italian 10 year bonds are actually higher on the day. They were the original cause for the sell off. Now people can't even remember why they are selling. They just want the pain to stop.

The ECB's Blunder

The ECB made a giant blunder yesterday by only buying Portugese and Irish bonds. Ireland and Portugal already have rescue funds in place for them, which they are borrowing from. The money was wasted for what is largely a symbolic gesture. Additionally, it caused a rout in Italian and Spanish bonds that has likely scared many investors into selling. It will now take a lot more money than it would have yesterday to stabilize those markets.

It looks like the ECB may have backpedaled and decided to buy Italian bonds today. Italian bonds are actually higher on the day after a nasty open, as seen in the chart below of the intra-day 10 year Italian bond yield from Bloomberg (lower yields equal higher bond prices)