Monday, October 31, 2011

Halloween Scares - Greek Referendum.

In my last post I mentioned that risks are high and we will see a correction soon. Sure enough we got one. The market killed the bears and when the MOMO lemmings joined the bulls, they got killed as well. I think the corrections will continue for a while before we reach a tradable bottom.

Confusion should be the other name for Europe. Here we have an empty box full of magic money. The magic number of Euro 1 Trillion is a figure made out of imagination and half truths. Europeans never had that money to start with and it was just a figment of imagination of the EU politicians. Why otherwise travel to China and beg for money if they have it? The Italian bond rate continues to soar higher and that itself undermines all the efforts to stop the contagion. The pink elephant is well and truly in the room. There was nothing in the EU plan from last week that would make investing in European sovereign or European Banks attractive for investors. If 50% hair-cut was voluntary, can you imagine what the coming 90% hair-cut will be? The hair-saloon is now open - who is the next customer? This not going to end well for Greece or for Europe. And now G-Pap has come up with the bright idea of referendum for the freshly proposed bail-out package! Talk about brinkmanship!

Closer to home, MF Global has now gone bust and have taken customer’s money along with it.  Millions of dollars have gone missing. Will anyone go to jail for what appears to be a clear case of fraud. Will anyone be held responsible for this mess or they will reward the person in charge with a golden handshake of $12-13 millions? Judging by what has happened since the sub-prime crisis of 2008, where nobody has been held responsible for the massive losses and collapse of the financial system, chances of anyone going to jail this time around appears to be remote. But for the next few days at least it is all “Risk-Off”. At this point, S&P futures are down about 25 handles and European markets are down almost 4%. Euro has given up most of the gains from last Friday.  With the lack of clarity in Europe and absence of clear information with MF Global, there is bound to be some panic in the market place.

The prudent course of action is not to take any action at all at this point of time.  Too many factors are in play and it seems that no one is in complete control of the events.  Even precious metals are down and if gold closes below $1700, it will see more selling pressure. That is why I am still waiting for a better entry point for gold. So far as Us bonds are concerned, I do not think selling pressure is over yet and again, I have advised not to take any position yet.

We shall review the position by the end of the week and I expect the corrections to get over by then. If not, we can kiss the year-end rally good bye.
Till then, keep all your fire power dry.

Sunday, October 30, 2011

Why The Melt Up?

Last week I was travelling through parts of interior India and one thing lacking was decent internet connection. As a result I could not post my regular market comments for almost 10 days. I should have purchased and carried the portable internet connection from Mumbai but silly me.  Anyway, lessons learned.

Last week we saw melt up and SPX was almost touching 1300 level. Is this the beginning of a new Bull market?  I am waiting on the sideline for many months now, waiting to get a sense of direction. We were close to 1050 in SPX and while many were expecting a re-run of the 2008, I said many times that we are not going to fall though the crack as yet. We might see one more selling pressure next week before we can have a tradable bottom.

So what is the reason for this melt-up? Have Europe solved its problem for good? Are the PIIGS really flying?  We must be delusional to think so for even a moment. European Union faces a risk of tsunami of fiscal and banking crisis. EFSF cannot solve this problem.  The problem is of solvency of all Euro zone financial institutions and banks and ECB and the Governments are trying to cure it by injecting liquidity. Of course if you give free money to the insolvent banks, it might keep them alive for a longer period but in the process create some Zombie banks which will drag the economy down for ever. If you don’t believe me, ask Japan!
The Europeans agreed for 1Trillion Euro for EFSF but where this money will come from is not explained. And they will use leverage to reach this magic number. And even that number is not sufficient to shore up the fortunes of the PIIGS countries. We are told that the banks have agreed for a voluntary haircut of 50% on the Greek bond holding and yet there can never be a greater lie. Because team Merkozy told them that the other alternative is 100% haircut. There is nothing voluntary about this agreement. The banks have been forced to accept this 50% write down with great deal of arm twisting and the next question is whether they will get the protection from the CDS they purchased. If it is voluntary, then there is no compensation from the CDS they purchased and that will effectively kill the CDS market.  So what happens when Ireland comes calling next about its due 50% write down or when Portugal comes with its share of write down? Will it be a voluntary event as well? What happens when Spain or Italy goes down? Already the yield of Italian Bonds are close to 6 % vs 2.5% of German bond yields.

"Data released by the European Central Bank show that real M1 deposits in Portugal have fallen at an annualized rate of 21pc over the past six months, buckling violently in September.
" ‘Portugal appears to have entered a Grecian vortex and monetary trends have deteriorated sharply in Spain, with a decline of 8.4pc,' said Simon Ward, from Henderson Global Investors.

Given this situation, when things are far from normal why this massive stock market melt up? What gives?  Because they changed the rules of the game. As simple as that. Because the haircut was voluntary, it did not trigger the CDS payouts. That took away the risk factor the financials who wrote the CDS.  As there is no risk, it is time to cover for those who were short the markets.  The HFT algos saw the short covering and they joined the trade. So did the momentum traders. And the run up continues. This is a very simplified version or explanation of the run up.

Just remember nothing has changed and when other PIIGS come calling, there would not be enough money in the world for voluntary haircut. Not even China can save Europe.

Coming back to the stock market, what can we expect next? Because everything is so overbought for now, we can expect a pullback next week. For traders that will be an opportunity to go long. I think it will be safer now to buy the dip till December. For investors, it will be another opportunity to liquidate and go out of equities.

For precious metals, the Bull Run will continue for the next six to eight months. I plan to go long gold in the next two weeks time. But I am hoping for a lower entry point. If we close below $1700 in gold that would mean that the corrections in gold is not over yet.

The year 2011 will possibly end in positive territory but I am very skeptical about 2012. Combined with the solvency problem in the Euro Zone, we shall be facing a very nasty Presidential election in the USA. The end of the debt super cycle is upon us. We are just missing the woods for the trees. The risk is actually increasing.   

Wednesday, October 12, 2011

Not Out Of The Woods Yet.

The Futures are up. European markets are up and yet it does not feel like we have reached the bottom.
let us consider the following news items;
Aluminium company Alcoa opened the US corporate earnings season with disappointing results for the third quarter, reporting profits below consensus expectations, the FT reports. Earnings per share were 15 cents for the third quarter,

European authorities plan to set a higher than expected capital threshold for the region’s banks and give them six to nine months to achieve that level or face government recapitalisations under the auspices of the eurozone’s €440bn rescue fund,

A bill that aims to punish Beijing for holding down its currency passed the Senate on Tuesday despite a warning from China that the legislation could plunge the global economy into a 1930s-like depression,

Slovakia’s government became the first in the eurozone to fall over opposition to expanding the European financial stability fund when just 55 of the parliament’s 150 MPs voted in favour of the measure,

Paulson & Co, the giant US hedge fund run by billionaire investor John Paulson, has warned that in a “worst case” scenario, it could suffer redemptions equivalent to between a fifth and a quarter of its assets by the end of the year,

I think till uncle Ben comes up with QE 3 or whatever number, we shall see renewed weakness. Time is not right to invest. I think the rally is just a bounce and the bears are not done yet.

Monday, October 10, 2011

Columbus Day Short Squeeze

That was a jolly good show. But what the pundits are forgetting to mention is that economic fundamentals did not change from last week. Team Markozy or Sarkel (your take) just agreed to agree without a detail plan yet and the entire song and dance is being played by HFTs without a shade of retail participation. The TBTF banks and the likes of GS or  MS really need to generate profit to cover their zero value assets. By the way the biggest gain was made in stocks which had the highest short interest.
 The bond markets are not impressed yet with Greek one year yield around 150% ! I have never seen anything like this before. That market is more than convinced about a Greek default and yet everything seems to rosy. What am I missing?
The only silver lining I can think of is the coming earning season. A good earning season will justify a short year end rally but most likely it will be the last of the bull rally when it comes.
For now I am happy to sit outside till I am convinced that we have a bottom. This week was the week of killing the bears, next will week will be the season of hunting the bulls. 

Sunday, October 9, 2011

Is it time to go long?

Is it time to go long equities again? While it is possible that some kind of low was in, I am not ready to dip the toe in the water yet, let alone jump in it. There are chances that while dipping the toe to test the water, we might lose the foot altogether. The European drama is far from over and unless a definitive course of action is implemented, we might see more violent market actions. Moreover, the Fed has not yet come out with more free money for the TBTF banks.  So no sustainable rally can be expected yet.

So far as the Greek drama is concerned, Greece has been in default for 140 years out of last 200 years. So what makes you think that they will not default again? The following are from John Mauldin;

“Greece used its access to low rates that came along with the euro to borrow and increase the wages of government workers, until the Greek train system, for instance, had €100 million in revenue and €400 million in salaries, with another €300 million in expenses. A government-sponsored retirement plan for some 600 different "hazardous" jobs (like hairdressing and radio work) was available at 50 years of age”

And now the Greeks are rioting on the street because their privileged lifestyle is being threatened? How long before Germany either throws Greece out of Euro or quits itself? I think till they figure out how much they need to recapitalize their banks. That may well be within the next six to eight months. And if and when Greece gets a haircut or restructuring of its lazy bum loans, Ireland will ask for its fair share and so will Spain, Portugal and yes, Italy. Euro zone will need between two trillion to six trillion euro to re capitalize its banks and tide over the bad loans. Do they have that kind of money? I doubt it very much. So my views of the long term prospect of the Euro zone and the world economy is pretty much certain.

But that does not mean we will roll over tomorrow. The central bankers and governments of the western world, including the US government, will do their best to prevent a Lehman type situation by pumping more and more liquidity. That is the only solution they know and that effort is already underway. We can see that happening with ECB agreeing to buy bonds of Spain and Italy, BOE injecting more money in the system and BOJ also joining the liquidity pumping operation. We are just waiting for the FED to join the party and we may not have to wait for long. With so much liquidity being thrown in the system, we might see short term ISM turning up and economy showing some life again. The net result, we should be seeing a yearend rally starting possibly by late October.

 I am monitoring various indicators to decide if that rally is going to have any traction at all and if it is worth going long equities by end of October. For now though, it is better to wait outside and not join the game even on the short side.

Friday, October 7, 2011

More Of The Same.

Another weekend. This week Bulls got excited hoping for a bottom and a rally. But my target of 1150 in SPX which I mentioned on 26th September is still holding. I do not think we should be excited yet. The rally was just a short squeeze and nothing else.

While there is some hope of a resolution in Euro land, we are not there yet.  In the meantime, rating agencies have downgraded Italy and Spain. One has to marvel at the intelligence level of these rating agencies! What purpose they serve is anybody’s guess.Germany is pushing for larger haircut from the Banksters over and above the 21% voluntary hit they discussed before and the Banksters there are obviously not very happy. Dixia, the famous Belgian bank is about to roll over. This is the same bank which passed the last European stress test with flying colours! While ECB has said that it will purchase bonds of Italy and Spain and thus planning to start its own QE and BOE has agreed for further liquidity injection, there is no direct monetary intervention from our Fed yet. While Uncle Ben said that the Fed will intervene if needed, the TBTF banks in the USA cannot expect free money if the stock markets go up. So logically we should see more weakness and volatility.

Last Sunday I said that I expect Apple share price to fall. Apple was around $ 382 at the time of my writing. Apple came out with their new Iphone which disappointed the market. As of today the share is trading around $370, and further fall can be expected till end of October.

Gold is going back and forth in a $ 50 dollar range and I still think we should see a further drop in price.

Interesting news is coming out of China and the giant ponzi scheme of Chinese economy will soon come undone. By soon I mean in the next one year. The accounting fraud that the Chinese companies practice in NYSE is magnified many hundred times by the Chinese Government while reporting its growth and GDP. Investors and companies who have invested money in opening up factories in mainland China will lose all their investment. This is a country which does not follow the rule of law as we know it. Overnight there will be ban on withdrawal and exit of money. The trade relation between USA and China is going to get difficult when the next depression hits.

For the coming week, we should see more of the same.  I am not ready to go long yet and happy to enjoy the show sitting on the sideline.

Enjoy your weekend. A very happy Thanksgiving Holiday to our Canadian readers.

Hokey Pokey Plan

The Fed announced its upcoming schedule for “Operation Twist.” The Fed plans to buy approximately $44 billion long-term treasuries funded by its sale of approximately $44 billion short-term bonds in October. While this program was named after the dance craze of the early 60’s, a more appropriate name might be “Operation Hokey Pokey,” since it is a simple program of exchanging short bonds for long bonds, or in other words “you put your short bonds in, you pull your long bonds out, you put your short bonds in and you shake them all about.”

One of the purported beneficiaries of the Fed’s policy is the housing market because “Operation Twist” is expected to push interest rates down for home mortgages, which will (hopefully) put more money in homeowners’ pockets, and ultimately the economy at large.

The housing market can use the help. A recent survey of economists, analysts and real estate professionals concluded that the “housing market remains shaky and is unlikely to deliver significant growth in prices over the next five years.” On the other hand, many question the wisdom of the Fed’s intervention. Robert Shiller, cofounder of MacroMarkets, opined “markets and government institutions are visibly struggling to respond consistently to an unprecedented rash of crises and conflicts. These struggles diminish confidence, which compounds the underlying economic stresses and lowers expectations.” (Five more years of housing problems, with some stability in local markets)

Paul Craig Roberts questioned the potential efficacy of the Fed’s Hokey Pokey program. In Saving the Rich, Losing the Economy, he wrote, “The Federal Reserve announced that the bank would purchase $400 billion of long-term Treasury bonds over the next nine months in an effort to drive long-term US interest rates even further below the rate of inflation, thus maximizing the negative rate of return on the purchase of long-term Treasury bonds. The Federal Reserve officials say that this will lower mortgage rates by a few basis points and renew the housing market.

“The officials say that QE 3, unlike its predecessors, will not result in the Federal Reserve printing more dollars in order to monetize US debt. Instead, the central bank will raise money for the bond purchases by selling holdings of short-term debt. Apparently, the Federal Reserve believes it can do this without raising short-term interest rates, because back during the recent debt-ceiling-government-shutdown-crisis, the Federal Reserve promised banks that it would keep the short-term interest rate (essentially zero) constant for two years.

“The Fed’s new policy will do far more harm than good. Interest rates are already negative. To make them more so will have no positive effect. People aren’t buying houses because interest rates are too high, but because they are either unemployed or worried about their jobs and do not see a recovering economy.

“Already insurance companies can make no money on their investments. Consequently, they are unable to build their reserves against claims. Their only alternative is to raise their premiums. The cost of a homeowner’s policy will go up by more than the cost of a mortgage will decline. The cost of health insurance will go up. The cost of car insurance will rise. The Federal Reserve’s newly announced policy will impose more costs on the economy than it will reduce.

“In addition, in America today savings earn nothing. Indeed, they produce an ongoing loss as the interest rate is below the inflation rate. The Federal Reserve has interest rates so low that only professionals who are playing arbitrage with algorithm-programmed computer models can make money. The typical saver and investor can get nothing on bank CDs, money market funds, municipal and government bonds. Only high risk debt, such as Greek and Spanish bonds, pay an interest rate that is higher than inflation.

“For four years interest rates, when properly measured, have been negative. Americans are getting by, maintaining living standards, by consuming their capital. Even those with a cushion are eating their seed corn. The path that the US economy is on means that the number of Americans without resources to sustain them will be rising.”

Lee Adler of the Wall Street Examiner reported on unusual activity in the Treasuries markets recently. He wrote,“Foreign central bank dumping of Treasuries and Agencies reached record levels this week, far beyond anything seen in the 9 years since I started tracking this data. The last time anything remotely similar happened was at the top of the bull market in the summer of 2007, and those levels pale by comparison with what is going on today. Furthermore, this is no flash in the pan. This has been going on for 4 weeks, and has been growing for the past 3. Over the past 9 years, there has never been a time when FCBs were sellers of their Treasury and Agency debt for 4 weeks in a row. I do not believe that the bull market in bonds can survive under these conditions, regardless of what the Fed does. If the runs on European banks, bank paper, and sovereign debt subside, by even a little, it’s over.

“Furthermore, this withdrawal of FCB liquidity from the US market, combined with no net new liquidity from the Fed, should keep stock prices under pressure. For months falling stock prices have gone hand in hand with rising bond prices and falling yields. Any reversal in the trend of bond yields may not be accompanied by a similar reversal in stock prices, or at least not to the same degree. We need to be alert for any signs of a shift in these correlations in the weeks ahead.” (Foreign Central Banks Massively Dump Treasuries)

We will also be keeping an eye on the U.S. Dollar, which had been running in a channel between 73 and 76 from April through early September. More recently, it broke higher into the 76 to 79 range. Phil wrote, “We anticipate the rising Dollar to adversely effect the earnings of companies that earn a lot of revenues overseas. Clearly in this environment, it is very difficult to push through price increases and, if revenues are the same in Euros, then they will be lower when the company reports them in Dollars – a simple enough premise.”

The big question of the day is, are we going to see a strengthening economy, or are we going to backslide into recession? Many are thinking the latter. EconMatters sees multiple reasons that the economy is already contracting, including the falling prices of oil, cotton, copper and the S&P 500.(4 Market Signs Signaling a Recession)

And what about the stock market? Phil wrote, “Keep in mind, we are still around 2/3 cash in our (virtual) allocations. That keeps us flexible but it’s no reason to be careless. Our main job, as we retest the bottom of our range for the forth time since early August, is to decide if "this time is different." Is this case the same as 2008 when the Global Economy is going off a cliff and we can just throw VALUE out the window as panicked traders sell their stocks at any PRICE? Or is this another opportunity for us to be greedy when others are fearful, and pick up some great VALUES at low PRICES?

“With 500-point weekly swings and 1,000 point monthly swings since July – it’s a fantastic market to trade in but you have to have that balance and, if we do begin to fail our major supports – we also have to have restraint because what looks like a bargain today may not seem like one after Greece defaults or a major bank fails or AAPL misses earnings or some other kind of major catastrophe.” (Weekend Update - Are We Bear Yet?)

As always, determining the difference between “price” and “value” is critical for making good trading decisions in the markets. For now, we’re not quite bearish yet, and since our current strategy of “cashy and cautious” has been working for us, we’ll continue to stick with it until it makes sense to change our stance.

Sunday, October 2, 2011

Apple Sell-Off Next.

Several Mutual Funds and Hedge Funds are in negative territory for the month of September. And most have gone negative YTD.  The redemption calls came in fast and furious and forced the funds to liquidate their profitable positions first. Thus we saw gold being sold off and gold bugs a bit shaken. I think the sell-off of precious metals is not over yet.
The situation in Euro land is not stable yet for any sustainable rally in the world stock markets. The TBTF banks will use this weakness to create further panic in the US stock markets to force the Feds hand with QE3.  

I expect that the stock markets will continue to show high volatility in October and S&P may well go below the August lows. Which means the fund will sell their most profitable positions to keep up the illusion of profitability and meet the redemption calls. We can expect precious metals to go below the current level. Silver in range of $20s and gold somewhere in the range of $ 1400 or below is well within the realm of possibilities.

One of the next sell-off will be the stock most widely held by the hedge funds. That one stock is Apple. Notwithstanding the new high, it is logical to expect that Apple, the darling of the stock markets, will see a huge drop in price in the coming weeks. That will be induced by technical selling and redemption calls. From the enclosed table of GS, you can see that Apple has the highest return YTD and it will be the next on the sell list to generate cash and show profit.

I have written about “Balance Sheet” contraction and many readers have difficulty understanding it.  Basically the current and impending deflation is and will be caused by credit contraction and destruction of the asset value. The TBTF banks have assets in their balance sheet which are worth much less than being shown. At best they are worth 50% of the book value and at worst 10%. This is the sole reason of the QE1 and QE2 and incessant speculation by these banks to generate profit from other sources to cover the losses.  The banks have sat on trillions of dollars of reserves and are either unable or unwilling to give loans and advances to business. Some banks are charging fees for accepting deposits.  Thus there is credit contraction in one hand and asset value erosion on the other hand.  There is no growth in real income of the consumers and the businesses are not investing either.  US products are not globally competitive and the next export by USA is negative as a result. So the only part of GDP that is growing is the government spending and that is coming through borrowing.

The whole equation is unsustainable both mathematically and fundamentally and it has to burst to balance the equation. TPTB are trying their best to keep the Goldilocks economy going for ever by injecting more and more liquidity but their ability to get results is getting reduced with every crisis. We are seeing social unrest developing now close to home with people protesting in Wall St.

It is sure going to be an interesting time. In the mean time, let us see if my bold call of Apple sell-off materialize in October. 

Saturday, October 1, 2011

No Man's Land

On 26th September morning I wrote that SPX will have trouble going past 1150. But when on 27th September, it closed above 1190 readers questioned my calls and there were talks of 1200 or bust. Sure enough we closed the week and 3rd quarter at 1131. So I can say that I have been vindicated.  

My theme has been consistent in this respect. That we shall be seeing continued weakness in the stock markets well in October and we might re-visit the lows of August. But at the same time, the bottom is not going to fall off yet.  I also expect weakness to continue in precious metals, at least till October. Those who are short on gold and silver might want to get out and close their position in the next two weeks or so.
Things are kind of messy all around and it is not a market for investors. On one hand ECRI is taking of imminent recession and there is enough doom and gloom to sink a battle ship. On the other hand, all the Central Bankers and governments of the western world are trying their best to re-inflate the stock markets. I think in the short term, the CBs and TPTB will win and they would be able to paint the rosy picture. But not before we have tested the lows of August and a new round of liquidity is injected in the stock markets.

I have been travelling and have reached India. Every time I come here, I cannot but marvel at the perfect example of chaos theory in operation. The roads are crowded as ever. The airports are teeming with travelers, things are noisy and chaotic. How anything works is anybody’s guess. But they work and India is making good progress despite the odds.

I plan to write a comparative analysis between India China and Brazil in the coming days. I think for the coming decade India offers the best growth opportunity and Investors would be wise to realize the potential of growth of Indian stock markets.

For now, let me try to shake off the jet lag with some more sleep.