Good golly, what a mess!
And to think I was worried I was being too bearish about that Fed statement… Being short was like shooting fish in a barrel today as no sector was spared from what was mainly a massive commodity sell-off that I am, on the whole, very pleased with. Another commodity that is selling off is the Japanese Yen, this is not to be taken lightly as the yen is up 25% to the dollar since last summer and the Yen carry trade, in which investors borrow low interest Yen to buy commodities (including stocks) has been the fuel that has driven this speculative rally.
If commodities start going down, then carry traders are forced to quickly unwind their positions as rising commodity prices have barely kept up with rising Yen prices so they have a tremendous risk (and these are highly leveraged risks) of losing money on the exchange. You can see the Yen being repatriated as demand for the Yen is dropping fast, causing a 3% drop in 3 days even though the headless BOJ has held rates steady while the Fed tanked the dollar. Of course investing in dollar denominated assets when the dollar is declining against the Yen you have to pay back to the bank is another problem that has been crushing carry traders so let’s keep our eyes open for signs of trading houses in crisis across the globe.
Of course that’s also the problem. US markets were taken down today on rumors that MER was in trouble and 290,000 put contracts crossed the wire yesterday with the implied volatility of MER contracts rising 66% in afternoon trading and the stock fell 11% on triple volume. At the same time the MER was under attack, British hyenas were trying to take down HBOS, causing the BOE to take the unprecedented step of issuing a formal denial that the bank was in trouble. The bank dropped 17% and still finished the day down 7%, even after the denial.
The Financial Services Authority (FSA) said that it would pursue traders guilty of “market abuse” by spreading untrue claims that banks were on the brink of collapse. "The authorities believe that the fear and uncertainty in financial markets are allowing unscrupulous traders to make multimillion-pound profits by whipping up hysteria about the stability of big banks." Finally someone in authority is catching on – I’ve only been pointing this out for 3 months!
BOE minutes yesterday showed the CB was confident enough to vote 7-2 to hold rates at 5.25% as inflation concerns trump liquidity concerns in the UK by a wide margin. This was another factor in unwinding commodities yesterday. Add that to the Chinese crackdown on inflation and what else would we expect to happen to commodities?
So after 24 hours of saying cover, cover, cover I decided (a little early) to take off the March covers we were well ahead on at 3:06 as this was exactly the correction we’d been looking for. Our DIA index puts are massively profitable because the puts we sold against them dropped 70% at the open and we got really cheap rolls ahead of the 350-point drop so we can afford to take a chance with the calls and the naked puts. I wasn’t willing to commit fresh capital but buying out callers that expire tomorrow didn’t seem too risky and I was really liking the way Apple and IBM were holding our levels during the afternoon.
We’ll see what happens in the morning but between the hyena attacks, the commodity meltdown and Bush’s celebration of Iraq ($3Tn is now the working number for total costs including economic costs) along with McCain taking a lead in the polls, giving us the promise of a never-ending war, it’s surprising we "only" fell 300 points. I was also encouraged by the fact that we held the 2.5% rule pretty much across the board:
- Dow -2.52%
- S&P -2.34%
- Nasdaq -2.57%
- NYSE -3.14% (lots of commodities and oil)
- Russell -2.61%
- Wilshire -2.38%
Health care held up and consumer staples was actually up half a point but energy was off 6.11% and Materials were off 6.77% so there was little chance for the markets when two major sectors tank like that. Airlines, as we expected, did well and REIT’s also held up so our VNO and CAL plays from Monday were right on the money. While closing AT the 2.5% line is generally not a great signal, I had to go with my gut as I feel we are in much better shape than we were last week.
As I said yesterday, we still need some Federal assistance in the housing market to really pull us out of this slump but if we can get oil back under $100 that should perk up the transports and pull the industrials along for the ride. Let’s keep in mind that the Dow, with the addition of BAC (down 1%) and CVX (down 5%) is now much more sensitive to sell-offs in energy and financials than it used to be so we have to accept a little pain as we rotate out of these sectors.
