Thursday, December 18, 2008

Something's Got to Give

I think the markets are at a crossroads and need to make a decision very soon. That would mean volatility and the opportunity to make some money. I think it is a trading opportunity. If it is a rally, then I expect a really good shorting opportunity in the next few weeks. If it is a breakdown, then I expect the opportunity to buy a retest of the 11/21 lows.

I don’t even know what I am having for dinner tonight. That is how short term my expectations are on this set up. I have already closed out purchases of the last 2 days – XHB, XLK, JNK and MYC. My trading positions have been small and I have been quick to take profits.

I Like Exchange Traded Funds
This removes company-specific events which may compromise an individual stock, even though the group may work. When really leaders with high growth show up again, then I will look at stocks again.

I see two very good potential trades. These aren’t recommendations! I’m just showing you what I am seeing. Most of you will look at all the lines, roll your eyes and go back to ESPN or CNN… I want my thoughts archived for future analysis of what worked and what didn't.

The NASDAQ 100 Index (QQQQ)
QQQQ has been trading in a narrow range between $28.5 and $30.5 for the last 9 trading days. Hourly volatility is now at extremely low readings, so a new trend may not be far away.

The trading range is capped by the Blue Line. See how this line has proven to be support (Blue Arrows) and resistance (Red Arrows) since the 10/10 low? It is a critical price level and traders have been keying off of it. Since mid-November, all rallies into it have been sold.

The trendline off the 11/21 low (Citibank bailout) has proven to be substantial support (Green Line and Arrows). It has held on all attempted selloffs.

Something has to give. Either resistance is taken out and the markets rally sharply, or support is taken out and we fall sharply. I think we are still in a Bear Market, so I am not invested in stocks and don’t care which way we go. I can make money in either direction. I just want a strong trend!

If resistance is taken out, then I want to own QQQQ. I will put in Stop Orders to Buy above $30.50.
I expect the first move out of this range to be a headfake and would not be surprised to see the market start in one direction to trigger a bunch of trades and then reverse sharply to trigger a bunch of stop losses to accelerate the real move. Yes, Market Makers do such things.

The inverse of the NASDAQ 100 Index is PSQ. If the uptrend from the lows is broken on QQQQ, then I want to buy PSQ. I will have stop orders in above the PSQ Green Line.

One thing to watch out for is that if support is broken, then I would expect CNBC to float a rumor that the government is going to announce a bailout after the close on Friday. Gasparino will be the guy who does it, if it happens – “My sources are telling me (blah), (blah), blah)…”

Here is the hourly on QQQQ. QQQQ was extremely oversold on 11/21 (Pink Circle). It was 2.5 Standard Deviations from its hourly norm. This is a rare occurrence and a normal place at which to look for a reversal. QQQQ closed right on the norm today (Black Arrow).

QQQQ is actually pretty oversold on the hourly chart (Blue Box and Arrow) and could just sit around here for a few hours on Friday before breaking down. It could also just ramp and be at $32 before you can blink. We’ll see how it goes. In a week, I could be telling you that we are still stuck in the $29.5 range... I need to take what the markets give me.

Crude Oil (USO)
The other potential set up is a reversal in the price of Crude Oil. I use the ETF USO for investing in Crude Oil.

USO has traded from $119.17 to $32.10 in 5 months. The last 2 days have seen MASSIVE volume (Arrows). I always get interested when volume explodes, because it often occurs at the end of a move. So, I am looking for a potential reversal.

Here is the hourly chart on USO. The setup is there for a panic bottom. See how Momentum (bottom of chart) is putting in a higher low (Blue Line and Arrows), while price is putting in a lower low (Green Line).

On a panic bottom, big money stops selling on the first bottom (Green Arrow) and the little guy gets shaken out on the final panic bottom (potentially today’s bottom).

The setup I will be looking for is a reversal in price back above $33.25. That would give USO a chance to start a major short squeeze, where all the people who went short on the break of $33 are forced to cover, while others are buying USO.

See how the norm is at $44? There is not a lot of resistance until $40. I’d be happy with $35…

Friday and Monday could have some serious fireworks!
Now, off to yet another Holiday Party or recital or something festive...

Wednesday, December 17, 2008

Why Isn't Energy Rallying?

After a sharp, 6-day rally, Crude Oil fell 7% today. The excuse is that OPEC cuts to Oil production were below expectations. I wanted to take a look at Commodities and Commodity-related sectors. I wanted to do so, because I keep hearing people on TV talk about how great the likes of Dry Ships (DRYS) and Chesapeke Energy (CHK) look.

I keep hearing the same words they were throwing around when they talked about Financial stocks – “Value”, “Cheap”, “Oversold”, “Bottom”… Bottoms will form over time and there is no need to jump in until institutions prove that they are looking to buy as well.

Bubbles Cause Mal-Investment
My thesis is that there is a massive supply of Oil now sitting in Oil Storage Facilities and parked in Super Tankers off many major ports. This supply is now competing directly with OPEC for a presently-diminishing number of consumers. So it doesn't really matter how much OPEC cuts supply in the near term, because there is ample supply available, without having to take any more oil out of the ground. At some point, this dynamic will change and I will be interested in OIl when it does.

The last phase of the 2002-2007 Bull Market was the bubble in Commodities and Energy. This bubble popped in early- to mid-2008. Here is a chart of the Energy Stock ETF (IYE). Look at how many shares of IYE were traded in the 1st half of 2008 (Green Box).

That was massive speculation, with buyers stepping all over each other to load up on Energy holdings. I think a lot of this was the result of Hedge Funds being allowed to lever up 6:1 or 10:1 and ramp up energy prices. West Texas Crude Oil ($WTIC) and Natural Gas ($NATGAS) went straight up.

So did Agricultural Commodities ($DJAAGT).

This was a classic bubble, where people all tried to chase returns and in the end, there was nobody left to buy. Then, the inevitable Crash soon followed.

Futures Deliveries
Because Futures Contracts ultimately end in the delivery of the underlying commodity to the owner of the contract, somebody has to figure out how to store the commodities they buy. What ended up occurring in the Commodity Bubble, was that Hedge Funds and large Investment Banks bought storage facilities and oil tankers to store their oil.

This stuff never made it into the economy – it was sitting in the SS Harvard Endowment Supertanker in the South China Sea, waiting to be sold at some future date, at some higher price.
When the bubble popped, there were no more speculators to sell to and now massive excess supply existed. The owners then started selling to consumers. So you now had this fleet of Oil Tankers and Cargo Ships full of Raw Materials, sitting in the harbors of the World’s major cities.

This excess supply led to price implosions and also led to implosions in the business of companies who make their money shipping raw materials – Shippers ($BDI), Pipelines ($DJUSPL) and Railroads ($DJUSRR).

The moral to the story is this – don’t go buying these sectors because some guy on TV is telling you that they are cheap. Be patient. The bottoms will take time. But they will eventually bottom and may become leaders again.

Remember how they looked at the top, because the cheap money now being printed by Central Banks is going to set up a new series of bubbles. There will come a time to buy these and then another time to sell these. I will let you know when these times arrive.

For now, here is the Energy Index (IYE). It has been consolidating for 11 weeks on contracting volume. Remember, consolidations are followed by violent moves. I expect a big move soon. I am not sure in which direction it will move, but I think I can make money on it when it arrives.

Huge Losses at CalPERS

CalPERS (California Public Employees Retirement System)
I didn't plan on posting this morning, but I came across this and had to get the word out.

The pensions money managed by CalPRES has lost 25% of its value since July 1, 2008.
According to the Wall St Journal, CalPERS bought lots of residential real estate and raw land at the top of the bubble. Even worse, they levered up to by the land (20% down and 80% borrowed). CalPERS is now admitting to losing 103% on at least one of these investments.

Do you have a pension? Do any family members? Yikes! Clients who worked for General Motors have seen their benefits decline the last few years. I hope that the same does not happened to potential CalPERS pensioners. CalPERS covers 1.6 million people. I hope that CalSTRS did not do similar things with the money they oversee.
In 2006 and 2007, everybody was trying to mirror the investment strategies of the endowments run by Harvard and Stanford. They both had enormous holdings in "Private Equity". They owned a lot of individual investments and Hedge Funds. These investments worked great on the way up, but have proven to be illiquid (you can't sell them) on the way down.
The moral to this story is that YOU are responsible for financing your own lifestyle. Pensions may be there and Social Security may be there, but you need to know that a certain amount of money WILL be there - no matter what. That means avoid Limited Partnerships, Fund of Funds, Managed Futures and "Alternate Asset Classes". Only own holdings where you can put in a "Stop Order" to protect yourself if you are wrong and the market turns against you.
CalPERS is by no means a Ponzi Scheme like the one run by Mr Madoff. CalPERS has a big pile of money. But CalPERS may now be "under funded" - meaning they will have to go to the entities that employ the current workers who are paying into CalPERS each money (Municipalities) and force them to pony up some additional money to make up for the investment losses. Municipalities are in no shape to fork over a couple Billion Dollars to CalPERS right now.
Compare these two links and see which one you believe.
CalPERS is Resilient in Market Downturns
State public worker pension fund takes big hit

Tuesday, December 16, 2008

Today's Rate Cut

Did anybody really not see this Fed announcement coming today? Really?

Quantitative Easing started on November 21st, when the Fed bailed out Citigroup, not today at 11:20 am. The markets have been rallying since and may soon sell on the “news” announced today by the Fed.

Recap of the Keys of Quantitative Easing (QE) - per Ben Bernanke
I broke down Bernanke’s beliefs about QE in the following post (that post will end up being one of many on the topic of QE) –

“When your target interest rate approaches zero, you are forced to use other policy tools to impact economic activity. Bernanke sites three –

- Provide assurances to the financial system that short term rates will be lower in the future than is expected
- Shift the asset mix of the holdings on the Balance Sheet of the Federal Reserve
- Increase the size of the Federal Reserve’s Balance Sheet beyond the level needed to get short term interest rates to zero. This is Quantitative Easing.”

With that in mind, I want to review today’s rate cut press release from the Fed –

“(T)he committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the Federal Funds Rate for some time.” - Point #1 from above

“(O)ver the next few quarters the Federal Reserve will purchase large quantities of agency (Fannie Mae and Freddie Mac) debt and mortgage-backed securities ... it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.”

“Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.” - Point #2 from above

“(S)ustain the size of the Federal Reserve’s balance sheet at a high level.” – Point #3 from above

The Fed really didn’t announce anything new today. Moreover, the markets have been pricing in this new reality for almost a month.

Buy Mortgage Backed Securities
On 11/25, the Fed announced a $500 billion program to buy Mortgage-Backed Securities issued by the US Government Agencies, Freddie Mac and Fannie Mae. The Fed already started buying these securities, weeks before today’s announcement.

The purchase program has brought up a couple of concerns. The primary concern is that if these mortgages are written by US Agencies and carry the “implicit guarantee” of the US Government, then why does the Fed have to print $500 billion in new money to buy some of them?

The answer is two fold. First, if the government completely takes over Freddie and Fannie and issues an “explicit guarantee” for their paper, then the US Government has to move the debt of Freddie and Fannie onto the Balance Sheet of the US Treasury, forcing the US Government to add over $5 trillion to that year’s deficit and over $5 trillion to the US Government Debt total (off balance sheet accounting).

The other concern is that the move is designed to raise the prices on all $5 trillion of the bonds, while they are only threatening to buy $500 billion of them. This is the old “Fractional Banking System Game”, where you act like you have enough money to cover anybody who wants to sell today, but in fact you only have a fraction of the total amount on hand and are really just bluffing.

The concern is then what happens to the prices of mortgages when the Fed spends the $500 billion? About 80% of PIMCO’s flagship mutual fund is invested in US Agency mortgages. Don’t you think they will want to sell a bunch of that junk at a fat premium to the Fed? I know that Foreign Governments are unloading that stuff at a rate of over $20 billion a month. China alone has well in excess of $500 billion in Agency paper.

Buy Credit Card, Automobile and Student Loans
On 11/25, the Fed also pledged $200 billion to buy these loans.

There are two goals to these debt purchase programs of the Fed. The first goal is to take toxic debt off the books of banks at better prices than they would get if they had to sell them at market to decrease their leverage. The second goal is to get lending going again by either getting the banks healthy enough to make new loans, or by having the Fed actually make the loans. The Fed would do so by buying the loans as securities, created by the original lenders – example - General Motors writes a loan to sell a car and sells the loan to the Fed, because these days, nobody else can or wants to buy that loan.

Paul Volcker
Volcker is a former Fed Chairman, who once uttered something to the effect of – eventually you get to a point where you have to make the decision to either crater the currency or crater the economy. Volcker was forced to crater the economy to kill inflation. He did this by raising short to interest rates in excess of 22%. This will occur again in the next 10 years - mark my words.

Now, Bernanke is faces with “curing deflation”. To do so, he will print infinite money and “crater the currency”.

When the Fed’s rate cut was announced today, I heard one of the CNBC guys say “Oh my God, look at the Euro”. The Dollar got killed today (-2.75%). The Euro rallied +3.07% today. The Dollar topped on 11/21 (think Citigroup bailout) and is down -12.5% since. The Euro has rallied 16% over the same period. Silver is up +26.6%.

Remember, asset price appreciation is the primary economic goal of the Fed/Wall Street/US Government crowd, which now controls our country (you can debate me on this if you would like, but my intention is to remain apolitical). So if you have assets, then you should be able to survive the inevitable, massive future inflation wave and interest rate spike.

You will need to get comfortable owning assets like commodities and inflation-adjusted bonds, in addition to stocks. You will also need to be able to own short-term bonds and avoid long-term bonds, because long-term bonds will get trashed when inflation goes up.

So, today’s Fed announcement was more of a confession about the obvious, rather than the announcement of a new policy. The dramatic moves in stocks, commodities and currencies since 11/21 should be retested in the not-so-distant future. I had stops in to buy a few small holdings in Technology (XLK) and Real Estate (XHB) today and my sell them tomorrow. I want to keep my mind fresh for shorting whatever topping process starts to form on this rally from the 11/21 low.

Sunday, December 14, 2008

Hedge Fund Nation

No doubt, by now you have come across the news of the arrest of Bernard Madoff. Madoff’s Hedge Fund managed to lose $50 billion (effectively all) of the money people entrusted with him to invest. That number is staggering! Many people have lost literally everything and their lives are forever changed.

Where Were the Regulators?
Bernard Madoff was the former Vice Chairman of the National Association of Securities Dealers (NASD).
Let me describe for you what the NASD is and what its functions are –The NASD (now FINRA – Financial Industry Regulatory Agency) was established under the Securities Act of 1934 to oversee all securities firms and licensed individuals who do business with the public. The goal was to set up a regulatory system to protect the public from crooks.
“NASD regulates trading in equities, corporate bonds, securities futures, and options, with authority over the activities of more than 5,100 brokerage firms, approximately 173,000 branch offices, and more than 676,000 registered securities representatives. All firms dealing in securities that are not regulated by another SRO are required to be member firms of the NASD.
NASD licenses individuals and admits firms to the industry, writes rules to govern their behavior, examines them for regulatory compliance, and is sanctioned by the U.S. Securities and Exchange Commission ("SEC") to discipline registered representatives and member firms that fail to comply with federal securities laws and NASD's rules and regulations.”
At FINRA, Madoff or his company now sit or sat on at least the following “FINRA Advisory Committees –

Compliance Advisory Group
National Adjudicatory Council
NASD Mutual Fund Task Force
NASD Nominating Committee

So it turns out that Madoff was one of the regulators responsible for protecting the public from the criminals.

What Happened?
Madoff set up a classic “Ponzi Scheme” - which involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business.

His Hedge Fund had an exceptional track record of historical returns. Money goes where it is treated best, so investors plowed their money into Madoff’s fund. At some point you need to figure out that the definition of greed is chasing large returns after they already occurred.

It turns out that the scam was uncovered when a client wanted their $7 billion investment back and Madoff was unable to come up with the money. Even better, knowing he was under the gun, Madoff tried to pay bonuses early to employees such as his sons. The bonuses would have been from the excellent performance returns the fund had generated for clients. Un-freakin-believable. The criminals are unconscionable!

My Big Concern
There have been a lot of instances over the past two years where Hedge Funds and Money Market Funds have had to freeze their accounts and no allow investors to get access to their money.

My fear is that there are a lot of crooks cooking the books at Hedge Funds. What I am afraid of is that the Fund Managers have held assets that are difficult to price, and have been generously setting their values too high. This makes the price of the portfolio artificially high and allows those selling to get out at artificially inflated values. It also leaves the late sellers with the losses, amounting to the difference between the invented price and the actual price of the securities.

This occurred in Florida about a year ago. A Money Market Fund was set up to manage the cash of Florida Municipalities and Charities. Its returns were in excess of those of other funds. Some investors got spooked and wanted to cash out. When investors want their money, the fund has to sell holdings to cover the redemptions. They tried to prop up the price of the fund and paid out artificially high prices to the first group of redemptions.

Eventually, they stopped honoring all sell orders. It then became clear that they had bad investments and they were over pricing their holdings. Good people got hurt.

Money Market Funds
I think the Money Market Fund managers got bailed out when the Fed instituted the $540 billion Money Market Fund backstop on 10/21/2008 and the $1.3 trillion Commercial Paper backstop on 10/07/2008. So at least the vast majority of the investing public was spared harm and an effective run on the Money Market Industry was prevented.

When Bear Stearns went under (sorry, was married at gunpoint with JPMorgan), I read Prospectuses and Position Statements on 34 Money Market Funds. I wanted to make sure that the money I managed was not exposed to bad investments.

When Lehman went under, a $25 billion Money Market Fund lost money and investors saw their money market accounts trading at 97 Cents on the Dollar. That was the death of the Money Market Industry. I was positioned to avoid it, because I did my homework. Clearly others weren’t because 4 days later, the Fed set up FDIC style Insurance for the Money Market Industry.

People didn’t do their homework and could have lost everything. I was sitting in 1-month US Treasuries at 0% yields. I got berated for the poor yields, but we eventually proven right when it all hit the fan.

Hedge Fund Nation
Now the US Government is a $7 trillion Hedge Fund. The Government is printing money, leveraging up and hiding price discovery. They won’t tell us what they are buying, who they are buying it from and what these holdings are worth. You know that they will keep buying stuff on any future market weakness. Do you see how the only people getting screwed in this are the Taxpayers? We keep having to pay to clean up everybody else’s mess.

It’s your money. YOU are responsible for knowing what you own, or you are responsible for finding an advisor you trust who does the homework for you and is proactive in getting the information into your hands.

The regulators are nowhere to be found. The crooks are everywhere, and they are trying to steal your money each and every day. Be careful, and either work with a pro or hide your money under your mattress.

Auto Bailout

I was going to bed on Thursday night and the Senate had stated there were not enough votes to allow them to give $15 billion to the automobile makers to keep them in business for another month. The Dow was down 350 points (at about 8,250). I had two thoughts –

This was the single biggest policy blunder in my lifetime
The Whitehouse would use the TARP over the weekend to bail out the auto makers

I turned on the TV Friday morning and the Dow was down -25 points, and I knew that Paulson had at the least hinted that he would open his proprietary Hedge Fund (the TARP) and write a check to save Detroit. I assumed that he would have waited until the markets closed on Friday, but he could not wait and had to prop up the equities markets ahead of the weekend.

By now you know my belief that until somebody other than the US Government is willing to buy an investment for longer than a few days, I am not willing to buy anything. Until the US Government gets out of the stock market manipulation business, I am reluctant to short anything. So I took most of this week and spent it with my family and some clients and turned off the computer and the Blackberry.