Merry Monday Markets

Are we going to just drift into the holidays?

On Friday in our Phil’s Favorites section, Ilene posted an article from Corey at Afraid to Trade in which he put up an S&P chart based on Elliot Waves.  In chart 1 (below), we have finished wave 3 and should be heading for a nice rebound in early 2009 and in chart 2, we are still in wave 3 and we are going to make new lows right after the holidays.  Even the pictured wave 4 has a very unhappy ending and, although I’m not a big Elliot Wave fan myself, I think that this is a pretty good summary of investor expectations for 2009 – if there’s going to be a rally, it won’t last…

In our Weak Weekly Wrap-Up, I quoted Adam from Daily Options Report, who said: "The single most dangerous thing I hear on TV is the constant desire to ascribe causality to EVERY SINGLE MARKET TWEAK. OK, maybe that’s the second most dangerous thing after "anything you hear on Power Lunch"  and on Friday I pointed out to Dalef that you couldn’t read into the nonsense of STP’s trading on Friday as the stock was jammed down into options expiration to $10.10 before being rebought back to Thursday’s on a spike at 3:50 that continued into after hours trading.  While this kind of nonsense goes on all the time around options expirations, what’s really frightening (or should be to the casual investor) is that about $5M worth of shares were able to drive a $2Bn company up and down 10% in a thinly traded market. 

What happened is the stock was "pinned" down to a strike that allowed the seller of the call contracts to cancel those contracts (the December $10s) for .25 or less, rather than $1 he would have owed had the stock closed at $11.  Once all the contracts were cancelled out, just before the close.  That "seller" bought his position back, ready to sell to the next round of suckers.  That’s why we like to SELL options – As I often say to members, we don’t care if the game is rigged, as long as we understand how it’s rigged.  Thanks to Madoff, the oil scam and the bank crisis I no longer have to explain to people how the SEC can be asleep at the wheel while this stuff goes on in the markets every day.

BusinessWeek had a great article this weekend about bubbles, citing Charles Mackay’s 1841 book "Extraordinary Popular Delusions and the Madness of Crowds."  if you are not going to read the book, at least read this article as it was a great summary of how everything old is new again (as usual) and people simply go from bubble to bubble and, this too, shall pass.  You may be hearing that the hedge fund bubble is bursting with almost 900 funds closing in 2008 but what they don’t tell you is 848 closed in 2005, when there were far fewer than the 9,700 funds that are estimated to remain.  Just like any small business, hedge funds have a failure rate if they don’t get off to a good start as the costs of running a fund are prohibitive if they are not turning a good profit and, of course, since they work on commissions, there really is no point in keeping open a fund that is losing money. 

We stayed, not bullish, but bottomish on the markets last week as I felt the hysteria over the Madoff scandal kept the markets down despite the massive Fed cut and the auto bailout.  I had a long talk with Option Sage over the weekend and it served to sharpen my resolve that the world is NOT going to implode over a few Trillion in paper losses.  No property was destroyed and no lives were lost and 6.6Bn people will wake up this morning and will want to eat something and they will put on a pair of Nikes and go about their day, either working or not with the vast majority of them producing something concrete (not you Mr. Paper Pusher!).  If just 3Bn of those people create $27.40 worth of value per day, that’s a $30Tn global economy – HAVE YOU DONE YOUR $27.40 WORTH TODAY?

$27.40 x 3,000,000,000,000 x 365 days is $30Tn and that, my friends is 60% what the global economy was in 2007.  That’s what we can produce with more than half the global population "unemployed."  It is beyond ridiculous for the markets to trade as if all global commerce has ground to an absolute halt and will never recover.  I said last week that putting money in a 10-year note for 2% is utter madness.  The Great Depression was bought on by a financial crisis but also by Famine, a market bubble and a lot of unpaid WWI debt that was defaulted on.  While we’ve repeated many of the same mistakes, 80 years of scientific progress and globalization make it far less likely that mass starvation will force migrations that further unsettle the global economy.

Also, in 1929, almost all of the companies in the market were "speculative" with very little track history and most had never weathered financial difficulties before and were unprepared to get through hard times.  What should be surprising to current Fear Bubble investors is how FEW companies have gone bankrupt, how FEW banks have failed, how FEW people are unemployed by the worst economic downturn in eight decades.  The Big 3 have been going out of business since the 80s so this is not news and the financials and commodities never should have bubbled up like they did in the first place so they are simply coming back to reality – the world will not end if GS doesn’t make $20Bn moving bits of paper around and creating nothing. 

The world will not end if oil companies get paid thin margins for transporting commodities or if copper miners make thin margins for pulling stuff out of the ground and shipping it to people who are actually going to build something – that’s how it’s supposed to work – it’s the past 10 years when things have been upside down.  Money is also a commodity – something that is supposedly a finite resource that is traded for other commodities and exchanged for services.  What happened to the markets this decade is the people who trade the money seized an opportunity to overvalue their niche and, in turn, drove up the price of other commodities (including homes) into a massive, unsustainable bubble that very simply popped. 

While this may be devastating to you (and by you I mean most people who are able to wake up and have time to read about finance on the internet in the mornings), I can assure you that the impact on the 4.5Bn people who are very likely to have a bowl of rice for lunch today is almost infintesimal.  The vast bulk of the population of this planet will get up and do what it takes to survive for the day much as they did in 2001, 1999, 1987,1973, 1944, 1929, 1776 and pretty much every other year in human history.  They will do something that is worth trading for something else and that is how they will eat and clothe their children and find shelter and, at $27.40 worth of "something" a day, those people make up 60% of the global economy. 

About 3Bn of those people live in Asia and those markets were mixed this morning with the Hang Seng, as we expected with our FXP bets, falling 3.3% despite the expected 0.27% PBOC rate cut officially announced to take effect tomorrow along with a half-point cut in reserve requirements.  "[The] market may be disappointed by the small scale of China rate cuts," said Standard Chartered economist Stephen Green. "They want to save some ammunition up for next year," he said. Mr. Green said he expects China to cut interest rates five times in the first quarter, by 0.27 percentage point each. He added that while monetary policy is useful, fiscal policy will be Beijing’s main tool to stimulate the domestic economy.

The Nikkei shook of more bad news from TM along with some terrible export numbers to post a 1.5% gain on the day  and the rest of Asia was down about 1.5%.  Over in Europe (only about 750M people), the markets are much improved off a poor open as Ireland stepped in to support 3 banks with a $7.66Bn investment injection.  Trading is generally flat to down ahead of our open but that is off 2% losses at the open so an improvement of sorts.

It would be irrational for our markets to do much ahead of the holiday (Wednesday is a half day, Thursday we’re closed, Friday only the people who have to will show up).  Appropriately for the season, investors must regain their faith in the markets and today we get a chance to test investors’ faith in the US dollar as a $66Bn Treasury auction begins today and closes at 2pm tomorrow.  Current yeilds on the 10-year are 2.132% and rates much closer to zero will not be surprising for the 2 and 5-year notes.  "As the credit markets remain frozen, there will be no sustained economic recovery and the Treasury market will benefit from investment behavior that is dominated by safe-haven activity," said Ward McCarthy, managing director at Stone & McCarthy Research Associates.

We’re trying to stay balanced into the holidays and erroring on the side of being well covered for now.  Our opportunities will come through some short-term trends we are following and there are still plenty of great bargains out the for our "maybe the world won’t end" trades.  Still, our overall strategy, with the VIX still in the 40s, is to sell premiums and let someone else take the risks – we can be the patient ones in this market.  Speaking of patience, oil of course jumped up today as we rolled over to the February markets but it will be no help to USO, which trades off the blended front-months.  I noted last week that oil had flatlined against the dollar moves (or as flat as oil can get) and $42.50 will go back to being our line in the sand to watch.

On the whole, there is nothing for oil to get excited about as Russia is going to pump every barrel they have to balance the budget and the Ruble, Yen and Yuan are falling against the dollar this morning.  The Yen has the most influence and can push the dollar right back over 85 all by itself if we can go back to 100 Yen to the dollar and the BOJ’s target is closer to 110 at minimum.  Tomorrow we get the negative Q3 GDP final number (-0.5%) along with Home Sales and Michigan Sentiment.  Wednesday we have Jobless Claims along with Personal Income and Spending and possibly crude inventories but you can never be sure on a holiday. 

Overall there is little to move the markets and it would be nice to relax for a few days but let’s continue to be careful out there as "they" certainly took advantage of the thin trading on Friday to yank a lot of stocks around.