Archive for December, 2009

A Thought on the Dollar Carry Trade…

Why is the stock market not plummeting while the US dollar index gets stronger?

Well, maybe it’s because the dollar carry trade is being replaced by the Yen carry trade?

Since November 30 the Yen rose from 86.28 to 89.86 to the dollar. At the same time, the US dollar index jumped from 74.50 to 77.09.

So the charts confirm my suspicion. It also means that the dollar can move higher without affecting the stock market much.

The move to the Yen is justified since Japan is suffering deflation and will keep interest rates low for a really, really long time. And by this time next year, US rates will probably be higher.

Is 10,500 STILL a No Go?

Last week I wrote about how the Dow Jones couldn’t stick at 10,500.

Well, nothing has changed this week.

This is what I think is going on…

This is a 3-year weekly chart of the Dow Jones. And it shows that since October of 2007, the Dow Jones has been in a pretty nasty bear market.

More importantly,  the Dow Jones is now at that bear market trend line. Will it break above it? That’s hard to say. But there are some other interesting things going on.

For example, the US Dollar Index is trending higher. I mentioned last week how the buck had broken above its 50-day moving average. Interestingly enough, even though the dollar is trending higher, the stock market has maintained its highs.

Sure, it’s not making new highs. But I expected to see more of a correction by now. Maybe a plunge under 10,000?

Of course, a strengthening dollar could actually lead a falling stock market. But why is it taking this long? After all, the dollar/stock relationship had been pretty tight over the last year.

It’s one of those questions I can only guess on. Maybe funds are moving to cash at the end of the year? (My main thought.) Or maybe the dollar carry trade isn’t as big as everyone thinks? Or possibly the dollar hasn’t strengthened enough to cause carry traders to sell?

It’s all just guesses at this point.

Taking a look at the US indexes on a shorter-term time frame, they are all pretty much overbought. I’d put my money on a reversal; with a tight stop set at around 10,550 on the Dow Jones.

This would strictly be a small money bet. None of the major indexes have broken under their 20 or 50-day moving averages. This would be more like insurance.

Fundamentally, there are still some things this recovery hasn’t proven yet. Like, will there be follow through? Consumers are up to their neck in debt. Credit lines are being shut. And a lot of money is spent on servicing debt.

I also think that people are beginning to shun debt. In a credit driven economy, debt is money. So less debt means less money. That’s deflation my friend.

I’m not sure how consumers could keep this economy humming along. If they do, it will be what John Mauldin likes to call a “statistical recovery” and nothing more.

With that in mind I think next year will be a flat year in the market. I mean, do you really expect this year’s momentum to continue? Stimulus is going to fade slowly. Tax credits are going to expire. And the government is going to tighten its budget.

That’s not exactly a good environment for growth.

Now you understand why I feel placing a little bit of insurance on the portfolio would be a good thing to do. Get into a put option, or short something. Just make sure it’s a small percentage of your overall portfolio.

Don’t go off and use 95% of your funds to insure your portfolio. That’s just stupid.

If the market falls, well, your portfolio is buffered somewhat until you can change things up. If the market doesn’t fall, just be glad you didn’t have to use your insurance.

Get it?

Good

The Trend is Your Friend

Listen, I don’t know how many times I have to repeat that the trend is your friend.

I mean seriously, have a beer with the trend. Talk with the trend. Don’t try and punch it in the face. The trend is stronger than you are. And it WILL smash your face in if you’re not careful.

While bears were out celebrating a stronger dollar and trying to spit in the trend’s face, the trend came back and hunted them down with a machine gun from a helicopter flying overhead.

If I recall correctly (and I do, because my blog tells me so) two days ago I told you to be careful about calling the recent 3-day rout another bear market.

And today, just like that, the Dow popped right back above its 20-day moving average.

Not only that, but the RSI is heading higher (forming an uptrend even) and the Slow Stochastic is nearly crossing over and heading higher as well.

That’s not all though. If you look at the dollar index, the buck is clearly overbought. And today, it was practically unchanged. I wouldn’t be shocked to see the dollar decline over the next few days.

If you’re bold, you might want to start buying.

If you’re a little more on the safe side, then wait for the dollar index to get back under its 50-day moving average before jumping into the market. At the very least, pay attention to the S&P 500 and make sure it gets above its 20-day moving average.

Oh what the hell. I’ll probably tell you as soon as it happens anyways.

American Credit Crisis Returns January 1, 2010

Ever heard of FAS 167?

Most investor’s haven’t. Which means they aren’t aware that it could cause another credit collapse come January 1, 2010.

FAS 167 is a rule from the Financial Standards Accounting Board (FASB) that forces banks to put securitized off-balance assets back onto the balance sheet.

In other words, all of those failing mortgages and credit card assets that banks hold will be out in the open, for everyone to see the true value of. And banks will have to put more cash in loss reserves for these assets (some of which are deteriorating rapidly in value).

As you can imagine, banks are scared shitless.

From Fincriadvisor.com…

The American Bankers Association declared the NPR a disaster-in-the-making, noting that the effect of the proposal would be to require higher levels of risk-based capital against assets that pose minimal risk, diminishing the “resurgence of bank lending that is so critical to the restoration of a vital U.S. economy.” The ABA also noted that FAS 167 could force banks to account for billions in assets in investment funds managed for third parties.

Here’s what Freddie Mac had to say about it…

“Under these accounting standards [SFAS 166 & 167], the company will record the underlying mortgage loans in these single-family PC trusts and some of its Structured Transactions on its balance sheet. These mortgage loans have an outstanding unpaid principal balance of approximately $1.8 trillion as of Sept. 30, 2009… While Freddie Mac continues to evaluate the impacts of adoption, the company expects that the adoption could have a significant negative impact on its net worth.”

Wells Fargo isn’t happy either…

“I want to update you on our most recent analysis of the impact of the application of FAS 166 and 167, which is expected to result in the consolidation of certain off-balance sheet assets currently not included in our financial statements. We provided a preliminary analysis in our second-quarter 10-Q. Based on our continued refinement of this analysis, we now expect approximately $55 billion in incremental GAAP assets to be brought on balance sheet, representing approximately $28 billion in incremental risk-weighted assets… we continue to explore the sale of certain interests we hold in securitized residential mortgage loans, which would further reduce the amount of incremental GAAP assets and incremental risk-weighted assets.”

Up until now, banks have kept these assets off balance in special investment vehicles. As long as the assets were off balance, the banks could essentially make up a value for them, resulting in less cash going into loss reserves.

But you and I know better.

Banks in America are practically insolvent.

The only reason this hasn’t come out in the open is collusion between the banks and the government. Hell, the government even forced the FASB to lighten up on mark-to-market rules earlier this year in order to keep the banks solvent.

This collusion isn’t over, either.

From 12^th street capital…

A bit of good news for banks today. In a Bloomberg interview, FDIC Chairman Sheila Bair said that she is in favor of giving banks “some breathing room” to raise the additional capital that will be required to support the hundreds of billions of dollars of securitized assets that will be consolidated onto their balance sheets as as result of the implementation of FASB Statements 166 and 167. Bair said she hopes to have the matter voted on at the December 15 meeting of the FDIC’s board.

It’s obvious the FDIC is worried about this. And the reason is very simple: The FDIC is in charge of taking over any other banks that fail. So this rule could have a disastrous effect on the FDIC. They’d be inundated with failed banks and have too few resources to take care of them effectively.

At this point, the banks all know that FAS 167 is in the works. And to compensate for the insane amount of capital they’ll need to build to cover the losses on these new assets, banks have hoarded cash, slashed credit, and increased fees like crazy.

Banks are in survival mode. And FAS 167 is one big reason why consumer credit has dropped for 9 straight months.

We’ll find out on December 15 whether the banks will have more time or not before FAS 167 takes effect. In the meantime, it’s adding a lot of uncertainty. And even if the rule is pushed off by six months, all it does is buy the banks time – time to slash more credit and increase more fees in a vain attempt to raise more cash.

What does the dollar rally mean to investors?

When I used to date (before I got engaged), I never tried to kiss a girl unless she confirmed her interest in me.

A first date was never enough. People date all the time and it leads nowhere.

But if the girl was fiddling with her hair, touching my arms and telling me how I was a “strong and powerful Puerto Rican”, well, I would definitely kiss her by the end of the date.

Other guys I know aren’t as conservative. They try and kiss a girl whether she shows interest or not.

These are the same guys that spend money that they don’t yet have. Or that put all of their money on one big bet. And the same ones that try and predict tops and bottoms before they ever happen.

Their success in the stock market – as with the ladies – was limited.

I guess you can say I’m on the safer side of things. I like to wait for confirmation before I act. With the girls, as I explained above, I like them to show an interest in me. I don’t like to spend money I’m not holding in my hand. And I definitely don’t try and pick tops and bottoms in the market before they happen.

Rather, I ride out the trends and look for predictable buying or selling opportunities to take advantage.

In yesterday’s issue, I told you that I wouldn’t become a bear until the 50-day moving average was breached on the major indexes.

One thing I didn’t cover though was the dollar.

Careful observers have noted that the buck is now above its 50-day moving average. On Friday, I explained the relationship between the dollar and the stock market. Suffice it to say, a rallying dollar is bearish for the stock market.

But just because the buck is above its 50-day doesn’t mean I’ve become a bear. As I said before, I like to see confirmation first. In this case, confirmation would only happen if the major indexes drop under their 50-day moving averages (10,076 on the Dow Jones).

In the end, you have to stay realistic. Don’t let ideology drive your actions in the stock market. Instead let the market guide you.

Even though the dollar broke through a major resistance point, the trend is still up for the stock market.

Act accordingly.

The Bear Market We’ve All Been Waiting For?

Bears are dancing in the streets, biting the heads off of random bulls they see.

The Dow Jones, Nasdaq, and S&P all broke under the 20-day moving average. The 50-day is in the line of sight. Will all three indexes plunge below the 50-day? I may not have a crystal ball, but I do have technical analysis.

Dow Jones Industrial Average

This is what the chart is telling me right now

• The Dow Jones saw significant resistance at 10,500. It even tried six times to break above 10,500 with no success.
• Huge spike in buying volume followed by selling might indicate a blow-off top.
• The RSI and Slow Stochastic are both in neutral territory. This signals more downside left (I’d like to see these two oversold before buying).
• The Dow broke under its 20-day average but is still above its 50-day.

It looks like we might have a few more days of selling. But I expect buyers to come back in as soon as the major averages hit their 50-day moving averages. If we see a decisive break UNDER this average, it could signal a change in trend.

In other words, buying now might be a bit silly. But getting heavily short right now is equally as silly. It’s kind of like betting against the Yankee’s in the first inning because the Red Sox barely hit a home run. It’s just too soon to make that bet.

In times like these, you want to use these small downturns to hedge your portfolio.

Yesterday I recommended you get into January VIX out of the money call options to hedge your portfolio. If you had done what I said, you would probably be in the green (the VIX is up over 6% today!).

Until the trend becomes bearish, I simply won’t get heavily short this market. And that won’t happen until the 50-day is breached on all three indexes.

Another day… another failed rally

Let’s give a warm round of applause to Ben Bernanke for opening his big fat mouth (hey, this reminds me of when he first became Fed chairman!) and killing the market rally today!

In a speech Ben gave today, he told us what we already knew: that the US expansion would be slow and that there were significant headwinds ahead. Why this shocked the market into a decline is anyone’s guess. After all, the market is supposed to be efficient. And it should have priced this in already.

It obviously didn’t (another loss for the efficient market corner).

You can get a transcript of Ben’s talk here: http://www.ritholtz.com/blog/2009/12/chairman-ben-s-bernankes-frequently-asked-questions/

In the meantime, we have to determine what this means to the stock market and most importantly, to our own portfolio.

With Ben saying that inflation will drop, investors got out of risk (commodities, emerging markets, and US stocks) and into treasuries and the dollar. The yield on two-year treasuries alone dropped 7 basis points today (0.07%) and the buck rose 0.3% against the Euro.

This, of course, is the second straight day of dollar gains (Read Friday’s post to see what I said about it then). And if you’ve followed my writing for some time, you know that I’m expecting a dollar rally in the next few months. But whether what we’re seeing today will transpire into the dollar rally I’m looking for isn’t clear.

The Dow, S&P, and Nasdaq are all above the 20-day moving average. If that support line fails, I expect to see support at the 50-day averages. If we see the markets penetrate the 50-day, then i’ll take my ramming bull horns off and put on a stinky bear outfit and go hibernate.

If you’re heavily long, you should probably put on a little hedge by buying an out of the money January call option on the VIX.

Is 10,500 a no go?

10,500 is like the land the Dow dare not close above.

It didn’t even matter that the unemployment count for November was far better then expected (a 11,000 drop). After starting the day up over 1%, the Dow Jones and the other two indexes both ended the day barely in the green.

The funny thing is that the good economic news actually contributed to the markets rough going. It all has to do with the complex and far reaching implications of an improving labor market and its effect on the dollar.

You see, most currency traders like to see an economy producing jobs. It makes them want to buy more of that currency, pushing the price higher.

The problem is, the dollar is being used to fuel a huge carry trade. If the value of the dollar  increases,  the carry trade becomes more expensive. Eventually any fund that is short dollars (borrowing) will have to unwind its carry trade (close out the loan and take a loss). And the dollar moves up, up, up.

This scenario is pretty much what happened today, albeit on a small scale. The November unemployment report came in strong, and some currency traders took that as a sign of strength for the buck. At the same time, the increase in the dollars value spooked carry traders into closing out their positions.

This drained liquidity from the global markets and resulted in all three major indexes closing at the lows of the day. Frankly, i’m shocked we didn’t close out deeply in the red.

Here’s the kicker…

If the market is weakening over employment numbers, how badly will it weaken once the Fed announces an end to its MBS purchases in the first quarter of 2010? How will the market react if the Fed raises rates by June 2010?Or the passage of FAS 167 in January 2010? All of these things are dollar bullish and should add downside pressure to the stock market throughout the year.

And on a finally note, let me show you a chat of the Dow Jones. It shows the important inflection point we now sit at.

Want to Bet Against Wall Street?

If you’re a boxer, the first thing you have to learn is how to bob and weave. You have to avoid punches and punch back at the right times if you want to survive out in the ring.

Other forms of martial arts fighting, like tai chi, focuses on using your opponents energy against himself. A person who fights tai chi doesn’t just swing like a drunk Puerto Rican in the Bronx. He sits back and actually waits for the drunk Puerto Rican to rush him… then he quickly gets out of the way and pushes the drunk bastard down to the ground… kicking him while he’s down.

So if you want to make money on Wall Street, I propose you use the crowd to your advantage by betting against them. Some people call it being a contrarian. Others call it having balls. Whatever you want to call it, I’m going to show you one way to be a contrarian right now.

Check out this news clip from Bloomberg…

Trading of options on the benchmark index for U.S. equity derivatives surged to a record in a bet that the so-called VIX may decline in the next two months.

“It looks like they’re trying to short the VIX in January and February,” said Dan Deming, a VIX options trader at Stutland Equities LLC in Chicago. “They’re selling the call spreads so that would indicate they think it’s going to be under pressure.”

More than 634,000 calls to buy futures on the VIX, as the Chicago Board Options Exchange Volatility Index is known, traded today, six times the four-week average. Eighty-seven percent of those contracts changed hands as part of two spread trades, according to data compiled by Bloomberg. The calls were probably sold, meaning traders were betting the VIX would decline, Deming said.

Now, over the longer-term I think the VIX is going down. So these smart asses selling calls are probably going to make some cash doing so. But there is a risk that the VIX pops up to 30 in the next 3-5 day sell-off which could happen at any time.

In fact, I’m pretty sure it’s going to happen either late this month or in early January.

Early January is more suspect because banks will be forced to put some junk assets back on the balance sheets as FAS 167 comes into effect. In other words, banks will have to use market value to price these assets and may lose a few billion in the process.

Plus, we should see lower consumer spending in January as jobless, cash-strapped individuals with maxed out credit cards try and pay off their newly acquired debt.

That’s going to act as a drag on retailers and probably spike the number of layoffs that happen after the holidays.

In the end, it’s likely that we see a big sell-off in the next few weeks. And when it happens, these VIX call sellers will turn into buyers and push the value of VIX calls through the roof.

I know what side I’d rather be on.

Want to Pick a Value Stock?

This is  one of the first things I learned as a financial analyst.

The style is very buffet-esque.  Basically just looking for really cheap stocks.

Here’s what you do…

Go here: Yahoo! Finance Stock Screener

Now input the following…

Operating Margins <= 20%

Return on Equity <= 15%

P/E <=15

Book Value <=2

When you find some stuff, make sure it has a EV/EBITDA ranking of under 10. Revenue and Earnings growth is always nice too. And Never discount a healthy dividend.

Of course, make sure to research the companies this screener pulls up. A lot of times companies are in value territory because they are doing horribly. So make sure you can tell the difference.