Random thoughts

As the news starts to trickle, and volumes dissipate, here are a couple of things to share:

• There’s a big trader hoarding copper. What does it mean and where does it end? Is it a big squeeze for the shorts or does it signal an opportunity to get out and maybe even go short as markets will move to squeeze the large player?
• Oil is above $90, but so what? The real interesting move is in COW.
• Franc-Euro? No end in sight yet. Pity the Swiss. Their economy is going to come to a standstill because their neighbors borrowed too much. Oh wait! That sounds like the entire world.

• Anybody still looking at this Baltic Dry Index? It ain’t looking good for trans-ocean trade.

• In happier news, I keep getting updates from people more bullish than I such as “Architect Billings Continue To Improve”. OK. I hope it’s a good sign. Although, maybe it’s also a sign that people aren’t moving. Maybe that’s why the inventory levels are at 9.5 months with no sign of increased household formation and mortgage rates increasing, which in turn will lead to continued real estate declines. Heck, but that’s just me.
• Strikes all over Europe. I can’t even keep track what the people are striking about. They probably want what everyone wants: to get paid more for less work. So in Europe that’s cause for a strike. Staying short the euro.
• Net neutrality passed: it’s complicated.
• Don’t ask, Don’t tell was repealed: not complicated at all. Overdue in a democracy that values its citizens, the Constitution, and the rule of law.
• IMF completes its gold sales, along with most major CB’s. Any net sellers left?

Franc-Euro

Have to share this chart, as Swiss Franc is taking out all stops and heading to fresh highs against the Euro.

This is a weekly chart, so it mutes a lot of intraday vol. What’s quite surprising is that the USD isn’t even stronger. There might be a lot of explanations, but a simple one is that European investors are flocking to the Franc rather than the USD.

As a side-note (although it’s the real story here), Spain and Portugal continue to be in the cross-hairs and Chinese statements that they’ll help the Euro are nice, but even the Chinese war chest isn’t bigger than the market. It will buy some time, but the end game is becoming ever clearer.

Adobe (ADBE)

I don’t usually write about individual company earning reports, but this one was special for me. Before we begin, let me mention that I don’t have any position in the stock, and am not discussing its investment potential per se.

What I am interested in is whether this is actually a sign of the times. Is the web making everyone a publisher and if so, what does that mean for the publishing industry as a whole? Is ADBE just one of the beneficiaries in a publishing-obsessed culture?

Twitter and Facebook, WordPress (and blogs in general) and Youtube, etc. have made everyone a publisher. Individuals, hobbyists, professionals, households, and corporations are all putting thoughts, information, CONTENT online and spreading it to the world. Google adwords is helping some monetize their publishing efforts, but overall, money doesn’t equal time any longer. As people spend more time creating information for free, the supply side of the information dynamic has blown away traditional publishing houses by driving down top line growth. Content used to be king. Then distribution. Now, just the tools for publishing.

I’ not really sure what the implications are going forward, and I have my own opinion on what happens when there is no privacy and room for foibles (WikiLeaks is a perfect example, namely, in the name of transparency, the day-to-day gossip and minutia will become threatening and force people to close-up, either through intuition or policy), but the business case is just as interesting. What happens to companies that do not publish? Can individuals afford to NOT control their on-line persona? Is the next step for individuals to spend ever greater efforts in marketing and controlling their publications? It should therefore not be that surprising to us that about.me just got bought out. The real question is who’s next.

Treasury Yields – Interview On The Wall Street Shuffle

A bit late, but here’s the link to my interview on The Wall Street Shuffle last week discussing treasury yields.

Geopolitics for breakfast

Asian markets are open already, but European and later US investors, will get some more geopolitics for breakfast.

South Korea is down just over 1% as I write this, mostly over tensions with North Korea, military exercises, etc. When money gets tight, tensions run high. I think this is only the beginning of world flare-ups. Shanghai, is down 3%, with property and bank shares leading the charge. How many times can I write about property and finance companies being a sham in China before investors realize they will not get paid for the risk of Chinese investments. If you’re not local and tapped into the bureaucracy, stay away at these valuations!

In the meantime, the euro is ticking lower and I am guessing that it breaks the 1.30 handle before everyone goes away for Christmas. Which brings me to another thought of the evening…

Everyone is expecting a slow, boring week, and the volumes will probably reflect that. But what if they’re wrong? For those who fly, you’ll understand the following analogy: the most dangerous times in a flight are the take-off and landing. The next two weeks are the landing for 2010. Thinner volume, ridiculously low-priced VIX, 6-sigma currency vol, rising bond yields, etc. all lead me to want to buy insurance. I’m already so underweight equities, and short so many asset classes, that I’m not adding to anything, but new funds would definitely be searching for insurance at these levels.

Jesse Livermore, Stock Operator

So many articles have been written on Reminiscences of a Stock Operator that it seems there’s nothing new to add: except that they’re all positive, immortalizing The Boy Plunger and his trading acumen, and the book itself is often given as a holiday gift or as part of training programs of some big houses, that I had to put in my two cents. There are numerous blogs, and writers dedicated to Livermore, seeming to think that he was the ultimate trader and that just by following his sage advice, one could make millions.

I have read Reminiscences multiple times, and each time I think I get a little nugget of new insight into the trading mind. So it is with the utmost respect and reverence that I caution readers not to take it too far and try to emulate the man himself.

In 1923, seven men who had made it to the top of the financial success pyramid met together at the Edgewater Hotel in Chicago. Collectively, they controlled more wealth than the entire Untied States Treasury, and for years the media had held them up as examples of success.

Who were they? Charles Schwab, president of the world’s largest steel company; Arthur Cutten, the greatest wheat speculator of his day; Richard Whitney, president of the New York Stock Exchange; Albert Fall, a member of the President’s Cabinet; Jesse Livermore, the greatest bear on Wall Street; Leon Fraser, president of the International Bank of Settlement; and Ivan Kruegger, the head of the world’s largest monopoly.

What happened to them? Schwab and Cutten both died broke; Whitney spent years of his life in Sing Sing penitentiary; Fall also spent years in prison, but was released so he could die at home; and the others- Livermore, Fraser, and Kruegger, committed suicide.
–Donald McCullogh, Waking From The American Dream (From Jesse Livermore: World’s Greatest Stock Trader, by Richard Smitten)

So how does it come about that a man who went bankrupt at least 3 times, become an emblem for trading success? My goal is not to go through and show the nuggets that I’ve picked up from learning about Livermore, which I have. Nor is it to suggest that just because he died bankrupt, by suicide, alone, etc. that there aren’t lessons to be learned. I just think that it’s worthwhile noting that holding him up as the ideal might be a stretch.

Also, without knowing his blotters or daily PNL, I would assume his equity curve is pretty standard for the type of trading he did: relatively small gains, repeated for a period of time, bigger positions lead to increased vol, and finally, a big blow-up. Sound familiar? Sure. The names associated with similar curves are so ubiquitous that it’s cliche. The opposite, or the guys who grind it out, aren’t battling demons, but rather appreciating the bounty of the sea, etc. tend to end up with longer lives and get to keep more of their wealth for longer periods of time.

All of that being said, Reminiscences is a great read, very accessible, with the most important line in investing/trading ever:

It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine–that is, they made no real money out of it. Men who can both be right and sit tight are uncommon.

The beginning of the end

The end of the year is almost upon us, and with it, a certain sense of complacency. I’ll admit it, I’m guilty of it just as much as the next guy. But it ain’t right. There’s nothing inherently more or less risky about a given day or period, so why should the next two weeks be any different? But they are. Liquidity starts to whither away. The fund managers take their families away. And smaller players suddenly feel powerful because they think they can move the markets. So I’m not putting on major positions, but I’m watching and waiting.

Separating the noise from the louder noise

There’s obviously been a lot of news since last night and I’ve been trying to wrap my head around it, but for starters let’s mention some of the big items:

Belgium and Spain are only the latest, but not the only(!), reasons for the euro to fall…and fall it did. We’re back to a 1.32 handle. Why do I say that they’re not the only reasons? Well, for starters, I thought the euro was structurally flawed before any downgrade, and continue to think so. The euro is now trading by default since there’s no alternative in Europe. Imagine for a moment if Germany came out tomorrow and said that it would start issuing Marks. The euro would be DOA.

On our side of the pond, we have treasury yields continuing to move up. 10 year yield is now above 3.5%! We’ve discussed the phenomenon before where we can have deflation AND rising yields at the same time. Locking in 3.5% for 10 years isn’t that attractive afterall. We’ve been calling it biflation, but I’ve been researching some underlying elements to help explain the phenomenon. Each time I come to the same issue: What cause yields to rise?

• If yields are REACTING to inflation and inflation expectations, then they are lagging commodities, but still part of the same message we’re getting from other asset classes. This could be bullish for equities and real estate, as well as supporting the runup of commodities in general (such as copper, industrial commodities, etc).
• If they are LEADING and are a result of fear over solvency, or frontrunning the pack (e.g. fear China will sell their holdings), then the recent run-up could be part of a debt-deflation cycle which is very negative and could be a harbinger of increased real costs of borrowing, economic slowdown, deflation across asset classes, etc. This would be very bearish for industrial commodities such as copper, but still supportive of precious metals as stores of value.

This dichotomy is the debate being had across the street. The first case is easier to deal with – we have the fiscal and monetary tools to stop inflation, and while painful down the road, we know it. The second case is similar to what happened during the Great Depression (and I don’t use that comparison lightly). It’s a world where fiscal and monetary policies are powerless, and it’s the scenario Bernanke fears most. Unfortunately, increased government spending does not and will not stop scenario two from occurring, so it just leaves us more vulnerable. We are maintaining our short treasury exposure.

Gold down. Oil up. Noise for me, since these are long term positions.

Muni bonds have gotten hit recently (as we predicted a few months ago). Noise for me at this point since we cut all exposure. At some point, yields will become attractive enough to take long term positions, but for me, not yet.

Tax bills, healthcare constitutionality, and WikiLeaks – all noise.

David Rosenberg (Rosie) discussing the rise of inputs versus no retail pricing power causing the mother of all margin squeezes?

The U.S. PPI, at +0.8% MoM in November and the core (which removes the effects of food and energy) at +0.3%, were both above expected but skewed by a seasonal rebound in auto pricing. Outside of that, core would have been as expected at +0.2%.

What is striking, however, is how cost trends are accelerating at the early stages of production in lagged response to the recent leg of the commodity boom. The “core crude” PPI jumped 3.1% MoM and is now up 30.2% on a year-over-year basis. This is the very early pipeline stage.

At the same time, core intermediate PPI leapt 0.7% and is up 4.7% from a year ago. When we get to final core goods PPI, the YoY trend is running at a mere 1.2% (and -0.7% on a three-month annualized basis).

In other words, the closer you are to the commodity complex, businesses have greater pricing power. And, the closer you are to the consumer at the final stages of production, the less pricing power you have. (emphasis mine)

That’s not noise. It’s just further confirmation that equity valuations are too high.

OK, there are other things to look at

There are some funky moves happening in commodities and it will take time, perhaps even years, for all the dirty laundry to be aired and balance sheets to be cleared. At the center, of course, is JP Morgan (JPM) which has been rumored as getting squeezed in silver, while at the same time holding a dominant position in copper. One thing is for sure, there are big players afraid of revealing their hands.

Look at copper:

And now at silver:

And here’s just one of dozens of articles on JPM: this one from ZeroHedge.

Now if silver is going to squeeze higher, would that make copper the easier position to unload to cover any margin calls? Is JPM actually short, or just short against forwards from clients? In other words, is JPM getting squeezed on a timing issue or is it taking a prop directional position?

I have a long position in the precious metals and continue to see opportunity for them to be stores of value in a volatile time, but I’m not a big fan of the industrial inputs as I see a major slowdown coming. This might would put fundamental pressure on copper, which could result in a magnified move if indeed JPM gets squeezed as (if?) their silver:copper spread goes crazy.

If you look at nothing else today

If you look at nothing else today, you must look at bonds.

Let’s go from shortest:

All the charts are weekly to give you a sense both of the magnitude of the current move and the potential for a continuation in the rise in yields. The short end has the most to catch up and we can see the historic steepness starting to come in:

Equities, in the meantime, are either blind to the turmoil in bondland or else have become the safe-haven trade. Really? Equities as the safe haven? BBY should at least give us a clue that valuations are priced for growth, increased leverage, etc. which probably will not happen. Any miss will be punished brutally at these levels. This is a set up. Even if we break through upside resistance, my estimation is that we are extended and overvalued, and that any rally is an opportunity to lighten up exposure.

It’s a fine line

There’s a fine line between bravery and sheer stupidity. Belgium can’t form a government and their outlook was just cut to negative. Spain yields on 12 and 18 month paper continues to show strain. So here’s the fine line:

Who’s buying the euro?

Investors buying the euro at 1.33 levels must believe that other buyers will step in after them. But who wants to hold the currency long term as political instability rises? No new members will be added to aid in growth and the next bailouts. Existing member countries are running out of time, and the previous bailouts only postponed (for a short period) the inevitable calling of bad debts.

Am I missing something? Maybe the investors at this level are just making a logical investment based on their risk analysis, but I think in the next 6 months, the news will read “No one saw the currency crunch coming” – but you’ll know that it’s not true.

Tech, PPI, and retail sales – do the numbers add up?

From Marketwatch:

NEW YORK (MarketWatch) — Treasury prices fell further Tuesday, pushing yields up again, after a pair of reports showed U.S. retail sales and wholesale prices last month were stronger than economists had anticipated.

The data should comfort the Federal Reserve that the economy is indeed improving, though analysts expect policy makers to maintain the central bank’s bond-buying program and target lending rate. Their rate decision and monetary-policy statement are due at 2:15 p.m. Eastern time.

Retail sales rose 0.8% in November and the PPI rose 0.8% and yet…BBY is down 14% on a huge top line revenue miss, coupled with a bad outlook. So consumers were either buying everywhere EXCEPT Best Buy, which is pretty unlikely given its dominance in the electronic space, or something in the numbers doesn’t add up. Nasdaq has been underperforming the S&P recently, and the question is which is the tail doing the wagging?

Natural gas/Energy

For the past few months, I’ve been discussing energy as a long term position on the following grounds:

1. Supply constraints in conventional oil will put a bid in the energy complex.
2. Geopolitical risks remain underpriced.
3. Global currency debasement will provide a bid in the energy space, even if global slowdown accelerates.
4. Potential hedge in case global activity actually picks up.

Once we understand the thematic reasons to be long energy, the question remains on how to best implement it and gain exposure.

Starting with the direct exposure to oil and energy futures – I’m very hesitant. Contango in the space means that rolling over futures is expensive, the ETF’s/ETN’s that are in the space are going to face structural problems with rolling over positions, and the inherent leverage in the futures markets make them a difficult long term position.

A few months ago I mentioned NLR, and I continue to view nuclear as a clear beneficiary on multiple levels. It’s cleaner, it’s more efficient after the plants are up, and the political environment is getting more comfortable with building new plants. Additionally, the US has access to the raw materials needed to power the plants, so it would be strategically in our best interests. Coal is similar, except for the whole environment thing, but reading this months Atlantic gave me renewed insight that coal is catching on as a viable alternative. To that end, I’ve been waiting for the right opportunity to gain exposure to KOL.

Moving on in the complex, I’ve been researching natural gas, mostly because everyone else hates it. Natural gas is down 30% YTD, while the rest of the complex is up. More new natural gas deposits seem to be found each passing day, and the current price could easily go down by 40-50% if the combination of new finds and global slowdown materializes. That being said, valuations look pretty attractive with single-digit P/E’s and a lot of producers shutting down operations with the decrease in price. Also, since the direct exposure through UNG has proven such a fatal mistake, many retail traders are starting to stay away. Lastly, natural gas is plentiful, cleaner burning, and already has a viable infrastructure for distribution.

Last year, Exxon went after XTO seeing the potential in the space. Today, GE is buying Wellstream a pipeline producer, realizing that maybe there’s room beyond wind. I have been looking at buying some individual names, but FCG seems to offer a pretty diversified exposure to the space and might be worth a look.

Slow news day, except this release (Q-ratio update)

Every quarter, I eagerly await the flow of funds report, so I can play around with the numbers on the back of an envelope – yup, I still use a pencil and scrap paper for quick calculations; call me old fashioned. Of course, long time readers will know that the Flow of Funds report contains 2 pieces of information that we use to calculate the q-ratio. A quick word on q-ratio for the un-initiated:

Q is a method of estimating the fair value of the stock market. It’s defined as the total price of the market divided by the replacement cost of all its companies.

The concept was originally developed by economist James Tobin. More recently, it’s been advocated by Andrew Smithers and Stephen Wright in their prescient book Valuing Wall Street.

…The data from which q is calculated are published in the “Flow of Funds Accounts of the United States Z1″, which is published quarterly by the Federal Reserve. This data source is available from 1952 onwards.

Smithers & Co.
http://www.smithers.co.uk/faqs.php

So many “theme” lists, so little value

It’s that time of year again, where we all take stock, review the previous year, make predictions for the upcoming year, and hope that the random cutoff of December 31st is in our favor. I’ve been getting emails and reading on different sites multiple “theme” lists for the next year. Some are probable improbables, some are pure predictions, etc. and I’m sure you’ve seen them too.

Recently, I came across a list that caught my eye. I won’t name it specifically, but just note that it listed multiple themes that built on each other, and I wanted to tell the writer that if he composed a portfolio to implement his themes he’d be doubling, tripling and in some cases quadrupling the exposure to the same underlying theme. That might be OK, as long as he was aware of it, but he made no mention in his list of the overlap in exposure.

Something else caught my eye – one theme stated that gold would go down in 2011 and produce a negative return; another, stated that energy and materials would outperform. Now, it’s definitely possible, and I don’t even disagree that those scenarios can happen simultaneously. What caught my eye was that the author believes that stocks will do well, and the dollar will strengthen. So let’s walk through his ideas:

• Stocks go up as economy expands. (How? Nominal or real returns?)
• Dollar strengthens. (Implies deflationary pressure, so growth in stocks is real, but would put pressure on dollar based commodities.)
• Energy and Materials outperform. (How? Do they outperform with a stronger dollar? Outperform companies with international exposure that are also benefiting from stronger dollar?)
• Gold is negative. (Again, why would gold and materials be SO divergent? Check out their chart together below. How does the author think they delink?)

If nothing else, the chart implies that gold and materials are closely linked. I also sometimes write about things that others seem to think have limited probability, so my issue is not with this prediction nor any of the lists I come across. My main issue stems from the fact that the authors rarely reconcile the discrepancies inherent in their own lists. So, I read them, and enjoy them for what they are, and periodically I’ll even get a nugget that will trigger further research; however, overall they don’t give me the necessary tools to make investment decisions.