Its All Good

As the year wraps up for 2012, markets continue to benefit from the Fed's ever corralling of investors to seek returns exceeding treasuries. Wall Street claims the US is only in need of a resolution to the fiscal cliff problem to resume an even greater growth trajectory.   Proof they say comes primarily from the recovering housing sector and in the never ending story of cash on the sidelines and strong corporate balance sheets. 

Regardless of the fiscal cliff, although certainly made more troubling if no agreement is ever reached, is an economy weighted by dismal job growth prospects as a result of demographic and structural productivity changes effecting future income potential for its citizens.  The US economy may be at the end of a powerful economic run starting after WWII which had tremendous spill over in job opportunities engined from investments in infrastructural, housing, and technology.  And while modest economic growth will continue, job and income upside may be capped for generations.

Equities are currently pre-priced for the next leg up and commodities correspondingly are  priced to accommodate growing demand.  The Fed has helped a recovering economy by keeping rates extraordinarily low.  But like all actions, there are multiple potential outcomes and not all of them are positive.  The Fed believes if they accommodate long enough the same economic mechanics which worked in the past will catch on again.   But the reality is equity and commodity markets sit atop a massive rally supported by pathetic annual growth rates and future expectations.  Playing the odds on that continuing is risky. 

Odds Increase of an Over the Cliff Event

In this game of Over the Cliff, the odds of going over the fiscal cliff now are 50/50, up from about a 33% chance earlier.  As a player, assume there are three potential choices; 

(1) Over the Cliff           (2) Good Compromise          (3) Bad Compromise (Boehner Plan B)

Given these three choices, in a game of chance you would have a 33% of picking the right one.  But now with the White House rejection of the Boehner Plan B proposal being representative of the Bad Compromise choice, it it would seem there are only two outcomes left;  Over the Cliff  or Good Compromise.  In this particular game you would then have a 50% change of choosing the right one.

Inside the game you have two choices while outside of this game, given these two choices, the path of least resistance for all parties is to do nothing or Over the Cliff. 

Bears may feel an Over the Cliff event is a win for them, but the event itself would lead to another set of possible outcomes.

Over the Cliff Rally                  Over the Cliff Break             Over the Cliff Nothing

Even knowing the outcome of the first set, you can be sure market players are positive they know the market direction given the particular outcome, but they really only have a 33% chance of being right here.

Political Tradeoff Matrix

The political deal tradeoff matrix gives you two most likely scenarios of action by the Washington participants.  Choices (in red) on any two leaves the probable required tradeoff (in black) for the particular strategy.   There seems to be no real difference between choosing to do the top matrix action and doing nothing in the bottom set.  So the political choices probably leave the same economic results; a declining economy. You can play the game by picking any two.  No winners here.

Market Participants Begin Move to Sidelines

Next week, with the fiscal cliff approaching, many market players will  begin to reduce daily exposure to trading in futures and equities leaving  the bulk of price action to professional traders to play thinning volume and the resulting increased volatility.  Decision strategies for Democrats and Republicans have begun to emerge with  both sides claiming they are restricted to an all or nothing outcome and unable to compromise.  Of course, the rule here is to never press the other side with what you think is a dominant strategy unless you absolutely know your own worse case outcome.   Many fools over the years have increased their own exposure by pressing a strategy they believe will absolutely motivate the other side.   More to come.....

Preparing For Cliff

Fed shifted the qualitative and quantitative asset rules a bit today when they decided to use an economic outcome as a benchmark for continued accommodation; 6.5% unemployment rate.   In a news conference later, Bernanke seem to be preparing for what the Fed sees as a long drawn out battle for economic recovery, one that is threatened by a likely over the fiscal cliff event.  Equities seem to be convinced of a just in time end of year positive outcome to negotiations which may confirm the contrary. 

The Bad News If There Is Good News

Regardless of the outcome of the fiscal cliff, lets look at where the equity markets are in terms of value.

Conventional wisdom apparently reasons any decent resolution to the fiscal cliff problem will send equity markets higher and interest rate markets lower (higher rates).  Various reasons are applied most notably is the uncertainty element shall be removed and thus release the upside horde in large part because of the forever anecdotal "cash on the sidelines".  

However, many are looking at the equity markets only in terms of its current price being as high as it can get  without more good news.  So it has a set point bias. The fiscal cliff has set up this line in the sand reference point where resolution is good and non resolution is bad.  But since the market sits at a price location much higher than its 2008 lows, it needs to rationalize the best possible outcome to maintain value.  Thus, to slightly modify the disposition effect, the market is less willing to recognize potentially downside market moves and more willing to accept positive upside moves. 

To understand the bulls; real estate, technology growth, and greater economic expansion will be positively influence by fiscal cliff resolution.  But the market may want to concern itself more with some of the least positive potential outcomes.  One of these is that large advances in equity prices over the last several years and certainly advances this year have led to a potential over subscribed market.  That does not mean there are not reasonable explanations to explain valuations, but there are simply fewer participants to take the markets higher.  And if the cash on the sidelines is the only hope, be aware most of investor reserves represent a generational cash stockpile reflecting loss aversion;  people would prefer avoiding losses than acquiring gains.   Thus the greatest potential outcome for the market may be down whether the fiscal cliff crisis is resolved or not.

QRiskValue Over/Under

Monthly QRiskValue Over/Under

AAPL   Over
BAC     Over
GOOG  Over
GS        Under
IBM     Under
MSFT  Over
F           Over
PFE      Over

Cliff or Not to Cliff

It is much easier to win an election than it is to redistribute wealth.   Since any deal before the Fiscal Cliff deadline is unlikely to be truly effective over much more than short term period, it is clear there is limited leverage in the deadline.  Though we are dealing with economic issues facing the country, the real story is about political gains and losses.  Thus there are two different dimensions here.  One economic; jobs and growth.  The other is political; using the Fiscal Cliff to get party control in Washington.

The Democrats have just emerged from a general election with a limited momentum they believe has some sort of mandate to drive a deal favorable to their agenda.  The Republicans, having been humbled by a changing political demographic, are trying to walk a fine line between looking reasonable without alienating their only real constituency, a sort of Ayn Rand meritocracy which blends fundamentalism with general accounting.

Now the Democrats may believe the last election gives them the upper hand but that trade is over.   And since Obama  had a  sort of non confrontational bargaining approach in his first administration, they are hard pressed to deliver before the deadline.

So the choice for both parties is clear.  Go over the cliff.  And indeed it may be the right decision for both.   But since this battle is a political one and not economic, the winner will ultimately be the party with the greatest ability to play the outcome and not have the outcome play them.  Going into that event the Democrats have Obama and the Republicans have nobody.    

Bear Side

Presenting the Bear Side, lets go to numbers. 

October marked the end of the attempt to test the highs made five years ago in 2007.  Market should decline for 60 months some 800 to 900 points in the S&P and then, if that is not bad enough, test those lows in 2022.  I guess that is another lost decade but at least interest rates will be low.  Refi at 0 with no points and the bank will throw in a vacant home in another state.

Looking back; October 1997 had a low 844 and 2.5 years later market made all time high of 1574 in 2000.  Market then declined to 767 in October of 2002 completing the 5 year cycle.  To speed this up, the market made a high of 1587 in October of 2007 and  made a low of 666 in March of 2009  and then we are right back up at the top of the previous paragraph.

But the Bears believe not just in cycle dirt, but in potential world class screw ups.  Bears believe any multiple combination of hits behind the four doors of the Apocalypse will send equities into a serious down.  Door one; Fiscal cliff.  Door two; Europe.  Door three; Middle East.  And door number four;  Chinese Recession.

 

Downside Hope vs Upside Cash

Markets are rarely obvious.  Apparently either are elections.  Though one might postulate the Wall Street brains may have been convinced Romney would win and sold off the market the days following the election, but that is too obvious.  The probable cause is more of a battle between those who truly believe we have higher prices on hope, and those who are sure the cost of carry is going continue to pay.   After all, in the search for returns,  its not whether one can find value, but where one can play the spread between the cost of money and the speculation on companies for modest returns over zero borrowing costs. 

But there is the fiscal cliff.  Everyone is talking about it so you know its over hyped and part of a self fulfilling temporary flagellation with an eventual hindsight view deserving an even greater upside narrative.    The markets are almost always wrong about the future but always right about the past. 

QRiskValue Over/Under Valued Eight

AAPL   Under
BAC     Under
GOOG  Over
GS        Under
IBM      Under
MSFT   Over
F           Under
PFE      Under

Electorate, Bettors, and Investors

Folks on the Romney side are upset with data coming from Nate Silver and his Fivethirtyeight blog.   Over the last few days Obama has ticked up in his chances to be re-elected according to the models Silver uses to predict the probable outcome.  Now there is now need to fully understand the make up of the methodology used to arrive at these projections but it is interesting how vitriolic the response has been to the blog's conclusions.  Republicans loved Silver when he was predicting their prior victories in various races but have attacked his conclusions of late due to the nature of their conservative bias. 

Silver is not a partisan but merely revealing the probability of Obama defeating Romney using the information he gleans from data mining certain criteria.  He is not telling you what is going to happen but what the models say is most likely to happen.  Vegas does not tell you if the Chicago Bears will win the Superbowl but only the chance of them winning; between 1/10  and 1/12 right now.   Silver says there is roughly an 8 in 10 chance Obama will win the electoral college and a 50/50 chance he will win the popular vote.

Now Vegas is a bit different in the fact that it does not try to predict the winner as much as putting up a line which will encourage the most betting on both sides.   Predicting the path of where the electorate, bettors, and investors with travel are correspondingly determined by votes, bets, and price movement.  Building models on how to capture a probable path is what many of us have successfully done.  But everyday is different and probabilities are not realities.  

Free Market Carny

The last of the political spin cycles will be going on over the next few days as the talking heads move to elect their man.  Business channels such as CNBC are trying to move Romney cheering to a new level as evening hosts  Kudlow and his sidekick, Lisa Something,  try to connect concepts of a fee market America with own ability to reason.  It might be interesting if it were not so pathetically shilled.  But I like watching Kudlow because its like watching a carny trying so sell you a product based on sincere nonsense.   You'd never by the crap but its fun to watch.

So markets have two more months to make everyone happy.  The moves have been anything but exciting and the bulls still dominate.  Fed forced feeding keeps rates down and balloons asset prices while sellers standing in front of the Bernanke equity train are thinning.  Bears know the action requires quick feet and if there are any downside victories ahead they will come out of nowhere.  

Giddy Up

Men sobbing as falling trading volumes for  equities and derivatives are having negative impact on hedge funds, high frequency operations, and exchanges.  But in a world where "up" does not necessarily mean you get a bonus, the performance of the underlying equity prices have had their best year since 2009.   The DJIA sits today just 6% off its all time high while volume for the benchmark average is down around 63% since mid 2009.   Rising equity prices and falling volume have been a feature as a result of a Fed policy directed at supporting financial assets.  It is only fitting that the best place to have been up to this point are the popular indexes which represent an area the general public and many managers has so rejected.

Tops and bottoms are made on huge volume and so the bears may have a particular problem since the S&P500 sits just under 10% off its all time highs.   There is a greater chance to test  those highs given their close proximity and any modest pickup in stock participation would spike values.

But this is an election year and there will be lots of opportunities to screw up the last quarter.   Expect a severe increase in volatility with a Romney victory as Fed leadership uncertainty along with a greater probability of an EU breakdown would create wild swings.  Add in the fiscal cliff impasse mixed in with a giddy Wall Street thinking Mitt means higher.  An Obama win would still have fiscal cliff problems but there would be no Fed issues and the EU would be less likely to implode.

Now imagine on election night in this too close to call election, the glowing lights from the towers of Wall Street as the collective Ivy League intellectual thunder have there hands hovering over the red and green market buttons.  For them, it is all good if Mitt wins although they would just as willing vote for Palin's second cousin if it meant more volatility and a good chance at a bonus. 
  

QRV Over/Under

The QRiskValue Over/Under Valued  Eight

AAPL    Over
BAC      Over
GOOG   Over
GS         Under
IBM       Over
MSFT    Under
F            Under
PFE        Over

Fastdown Or Grind Up

Clean sharp lights shining on an undisturbed baseball diamond is one of the most calming images to behold.   There is no moment in trading ever so calming with the exception of a quiet trading floor hours after the close. Today's markets have no refuge, they just grind endlessly over hills and down valleys.  They are supported by serious explanations of value and derided by suspicious inquisitors.

Bulls have had no lifting problems in 2012, while the bears have repeatedly been trapped by pull backs believed to be so globally dire but only to become rally points.  Certainly the value of the great bailout promise from the EU has risen to new highs.  Nothing has been accomplished but the rewording of tired declarations.

This is a powerful time period for all markets as I so remember back in 1982 with the bottom of commodity markets and the month earlier bottom is equities.  All had be falling for a time and the slow upward march began in the second week of October.  But there is no indication to the direction here under these extraordinary economic times of deliberate intervention and almost constant upside bias.

If this is a top, it will fall rapidly. If it is a pullback, the grind higher will be at the bear's throat before he can cover cleanly.

Fed Picks Theme Song

Ben Bernanke was seen driving away from the Federal Reserve's Open Market Committee Meeting  this week with his head bouncing to Def Leppard's " Pour Some Sugar On Me" which he has personally picked as the Fed's theme song for 2012.  He has also privately predicted the DJIA to hit 20,000 shortly but only if there is world wide economic collapse.  If things get much worse the no telling how high the market can go.  But just in case, Bernanke believes increasing the value of expressionists paintings may be the boost the job market needs. 

Economic Fuel Gauge

Here is the Civilian Employment Population Ratio chart published by the Federal Reserve.
Generational employment as a percentage of the population have been declining since the dot.com bubble in 2000. Then the unprecedented downward momentum caused by the financial crash in 2007 left the chart hanging just over the gains forty years ago.  The chart is sort of an economic fuel gauge which illustrates the dilemma the Fed is in.  Their accommodations cannot seem to find the economic gas tank for the broad middle class and one can sense Bernanke is nervous.  He does not want the current consolidation turning into a ledge for further declines.  "Do something" is now the policy impetus.  Yet all accommodative QE programs have come from what has been called "the double down on trickle down" method.  Feeding the top so they might feed the rest is leaving the chart hanging.    

Market Good News Bad News

Conditional unlimited bond buying is the new spin to calm the markets being put forth by ECB President Mario "whatever it takes" Draghi and German President "not so fast" Merkel.  So far the EU participants have been in lip sync to show solidarity as they conjure a bond buying program which may ultimately be so conditional as to be worthless. Besides the directional talk to date, nothing has actually ever been implemented by the ECB. 

The U.S. has a stagnant work force producing marginal GDP and a Fed policy to promote cheap credit to a financial institutional structure which has proven to be incapable of financing commerce but excellent at blowing up any investments their trading operations pick.  The EU has not only a slowing economy but the added stress of solving cross country bailouts without the political ability to craft long term solutions.

Stock markets tend to be in front of good news and behind in bad news. The good news is of coarse the coordinated sensitivity to market direction by world finance leaders.  The bad news is the coordinated sensitivity to market direction by world finance leaders.  

Economic growth and the resulting race of asset price value to catch future value is a product of expanding participation by a broad base economy.  Inflating asset value as a replacement for growth is dangerous in that it is an "all in" strategy based the past performance old growth economic models. 

The markets are "all in" in front of the good news but are behind the bad news.

Financial Over Steering

Looks like Greece is odd country out.  German conditions will not allow it to constantly rework the previous workouts which will be required for it to stay in the EU since it has no viable way to accomplish the austerity measures as currently constructed.  Equity and bond markets are already bloated from the new normal trading strategy; i.e. place monster bets on the Fed/EU put protecting all assets.  The EU portion of the put has about as much behind it as a tooth under a pillow; you will get paid, but will be disappointing on how little.

Common thought now is that any crisis can be avoided by following a few simple steps worked out through a recipe concocted by the Fed during the 2008 financial crisis.  The buy math formula for all sorts of bond instruments is the patch solution.  But like all solutions of grand scale but limited to the best last strategy, a mutation of problems will appear and multiply into a panic of some unpredictable degree.   Over steering leads to dramatic spin.

Notions of Value

No one would argue that the greatest marginal advantage for the bulls this year is being provided once again by the US Federal Reserve.  Reports of outflows from Europe into the US has helped the upside lately but may create an unwanted technical burden to equities.  While the Fed promotes equities via the bond market where it has a direct hand intervening on the cost of money, the door always swings both ways in stocks.  Notions of value and safety are always the last criteria met before a decline.

Some interesting numbers from QRiskValue.  Despite all the claims of market volatility, this year has been the least volatile of the last five and a half years when measured by total range.  From the beginning of the year until last Friday, the S&P 500 total range has been just 160 points compared to last year at this time of just over 300 points.  The last time it was this skinny over same time period was 2007 at just under 200 points.

Market May Have Weak Timbers

Some overbought indicators produced at QRiskValue show only a few times when the market construct was this poor for the S&P500 futures.  October 9th of 2007 (futures 1576), January 24th of 2008,  (1352), July 7th 2011 (1318),  July 27 2012 (1368).

The 2007, 2008  break in the market went to 665.75 in the spot futures, 2011 break to 1068. 

Construct weighs upside potential and current market strength.

More Despair, More Worry, More Buying

The markets never move without the some confusion and important miscalculations but they are always convinced whatever the current direction must be the right direction, at the moment.  EU failure to produce any real substantive economic intervention has put the world markets into end of world mode. But looking at the map, the DJIA and the S&P500 are not far from all time highs and bearish sentiment is on every sign post. We must be at that place they call Going Higher Right Now, Down Later.

Now maybe there will be an event triggered from economic twists no markets can withstand.  But the game being played here is to placate the markets.

Fed intervention to stabilize asset prices has worked in so far as it has inflated financial indexes prices.  This is in part to cover the Fed's inability to stem the downward spiral of new job creation and its ineffectiveness to produce any reasonable economic recovery.

But there are real dangers.  Affecting the balance sheets of banks and providing massive liquidity for lending is much easier than ultimately controlling stock markets which have at their core random movements kicked around by price discovery.  Added volatility resulting from a policy of asset stock inflation works both positively and negatively and up cannot be guaranteed just because a Fed points its finger higher.  Markets are now faced with having to defend speculation in stocks promoted by lower interest rates without the benefit of economic growth.  No jobs, just higher stock prices. 

The Fed and now the EU have created a cloud upon which all financial markets now sit.  With whatever the EU comes up with being probably too thin to save massive red balance sheets, the Fed is locked in.  The Fed believes it has the dominant strategy so that no matter what any of the other players do, it has implemented the correct action.  Clearly the Fed believed things would be improving much more rapidly when it undertook its strategy.  As in any other game, if you are wrong about having the dominate strategy, you lose your defense, and for the Fed that would be asset price protection.

Fed's Asset Stabilization Strategy

In the past, Fed accommodations have helped to stimulate economic growth after a brief cyclical downturn.  This time a structural downturn is necessitating greater demand for relief through massive injections of liquidity to support a strategic plan to protect asset prices via the great buy hedge. Now, the EU's cheap euro strategy which is needed to facilitate repair of the economic conditions brought about by a de-leveraging world, is challenging the Fed's asset stabilization policy.  While the Fed has provided a covered hedge for assets such as stock prices, a cheap euro policy may ultimately force the hedge to be cashed-in as world pricing power wains, profits fall, and job growth remains weak. 

The world seems to heading towards a new standard of living set point.  The Fed's policy of asset stabilization may in the end be the difference between deflation and just a bit better than deflation.  Either way, the great buy hedge will see some pressure as some may take the opportunity to raise cash by liquidating against the hedge.

The Big Wean

Bernanke testimony this week clearly shows a Fed which would love to prepare the US economy for the beginning of the end of stimulus.  Without committing to further stimulus yesterday before the Senate and in his testimony before the House today, the Fed Chairman stated he did not see a double dip recession.  His message. The beginning of the big wean or the end stimulus is being cautiously prepared. 

The problem of course is if it were not for the European economic problems, Bernanke would be more confident in the initiation of the end plan. If Europe can repair itself even ever so slightly, then the markets will not need much more help.

Now the markets may not like the thought of growing ever so slowly all by themselves which is probably not good for owning equities right now.  In fact, it is the first time since 2008 the Fed has indicated it may not be the great asset enabler in the next investment cycle.  Thus the buy for equities was between March and September of 2009 and the potential end of that Fed enabling run may be March to September of 2012.

Up To Sideways

Collective maneuvering by sovereigns is making it tough on the bear's vision of economic disaster and effectively putting a range bottom in the equity markets for the balance of the year.  Only a significant impediment to the EU's ability to cover shared subsidization of EU debt problems will turn the market south. Extended upside action and the ultimate test of all time highs will be difficult however since generational choices on spending will limit job creation and the huge government stimulus tab of the last few years will be a drag on economic growth. 

Yesterday's Supreme Court ruling on Obama Care may ultimately be the driver re-electing Obama since it will place in contrast a Republican endeavoring to take away future benefits during a recovering market from a general population who have lost twenty years of wealth in the last seven years. People may complain about big government, but when it comes to their own benefits such as Social Security, and now health care, it is not big government, its mine.   

Sovereigns Enter The Markets

Sovereigns have been collectively fighting the battle of market confidence and are hoping to ultimately win the greater war threatening world economic growth.  They have been engaged in direct intervention as we know in the credit and currency markets for some time but now appear to have entered into direct intervention into equity markets around the world where needed.  Having clearly created an economic environment which Adam Smith did not envision, i.e, where the main economic market drivers come from a circle countries printing money because their own economies cannot support economic growth. This strategy of  asset subsidization based on injecting massive liquidity into the markets in the hope that future growth will be able to pay for the radical costs is certainly dangerous. 

The problem if this particular strategy fails to deliver the broad economic growth needed to eventually pay back the gambit is not clear but probably not good. Supporting assets may lead to a greater economic divide between those whose assets are being protected and those of the much broader population whose assets really are not.  Social unrest could enlist a larger segment of the world seeking to reject current approaches.  If Europe delivers on its propensity to cycle into world disasters, they will ultimately fail at  pandering to the markets and panic would prevail.

One of the lessons learned in trading early on is that spreading into an additional position when the original positions is a loser almost always results in a greater loss than if one had just taken the loss in the first place.  Unfortunately, real fixes could come from a rather unpleasant round of economic panics and a debt jubilee a gigantic proportions.  But right now, sovereigns in the thick of a defensive battle whose end is not clear.

European Fail Safe

Stocks continuing to sort out a range bottom as Wednesday's action traversed but did not confirm a bottom.  After last Friday, many had worried that some of the broader indexes closing around the 200 day moving average meant something, let all concerned know ; i.e.  the 200 day average never means anything in any market.

The fact the Fed is jawboning the upside along with a Walker victory in Wisconsin led to some kind of mutant Stimulus/Romney rally event.  Bears got squeezed and there has been a thrashing to establish a range bottom.  

Traders have learned each economic disaster since 2008 has also been a buying opportunity and the current European economic disaster seems at least to be following the same pattern of rewarding bad behavior.   An important difference is  European problems are largely out of U.S. control despite all the stimulus if needed winking professed over the last couple of days. 

Europe has a long history of epic events spinning out of control right after reassurances from the most high.  The partial collapse of the European economic system is about the only thing which would have the magnitude to wreck  global interconnected banking. It would capsize not only the current weak recovery, but impact Federal Reserve efforts past, present, and future.  A kink in economic activity would require the rest of corporate growth to recalibrate at a lower level.  One more representative of the actual economic conditions reflected in the U.S.'s biggest industry, housing.

The usual three ground forces engaging the economic battle of the last five years has been spin, cash, and hope.  Europe will deploy all of them.   If it works, financial assets will outpace broader economic growth.  If it fails and Europe blows it, financial assets will not be able to provide a fail safe any longer.

Three Phases of Investing

Wondering whether it is possible to safely invest in stocks, commodities, or whatever asset class one may be examining is tough for pro and amateur alike.  Facebook is a classic example of investors so desperately wanting to believe they had an opportunity to enter an almost riskless trade because they were certain of " This Equals That" or what I call the TET reflex. 

One could say TET is what we rely on every day to assess problems, observations, and opportunities.  Facebook's automatic TET reflex glided through home, office, and financial industry circles with an absolute impatience for the normal processes involved in IPOs.  But alas, the Facebook IPO bombed for everyone except the dweebs who were already made.

Here were the three normal phases of the TET reflexes for Facebook investors and all investors for that matter.

Phase 1.  This is the big one. 

Wealth now or die.

Phase 2.  Why isn't this working. 

This starts when you realize maybe you've been hosed and red marks start appearing on your face, reflecting from the computer screen as you watch your investment go negative.   

Phase 3.  It's someone else's  fault.

This final phase occurs when all hope is lost for the quick score and you begin to organize lists of the responsible.  You are not on that list.

There is a reason you are stupid.  It is is rooted in the belief there are growing opportunities in a de-leveraging world.  There are not. 

Key lesson here. 

You better already own it early and be prepared to wait a long time to be successful.

Range Bottom Forming

Range bottom in equities is being established today as negative market chatter gets ahead of itself in Europe and banking fears from JPMorgan trading.  Greece does not really matter because there really is nothing new here.  When debt holders had to take 90% hit months back, it was over.   EU will create some trash solutions but in the end it will accommodate survival but lead to slow growth.   Same for Spain.  Solutions which lead to sluggish economic gains.

JP Morgan is a non event as far a scale of loss.  It will add to a extremely modest uptick in regulation.

Interest rate swings within the lower range will be great in percentage terms but modest in terms of significant impact on higher rates. 

Surprise Index

(From Bloomberg).  The Citigroup Economic Surprise Index for the U.S., a gauge of how much reports differ from economists’ estimates in Bloomberg surveys, turned negative on April 25 and fell May 3 to the lowest level since September. Last year, the gauge sank below zero for the first time in five months on May 2, the day when the S&P 500 began a 19 percent drop.

It Hurts When He Thinks

Alan Greenspan thinks stocks are cheap and likely to rise.  This from a guy that help create one of the worst economic downturns in the history of the United States.  Now except for his only lucid moment when as Chairman of the Fed he characterized market behavior as "irrational exuberance" in his testimony before Congress, he has always been a shill for Wall Street.   A tradition not lost with Bernanke.

Kudlow Effect

Fed this week indicated they were holding off on QE3 just in case their real Constant Quantitative Easing All The Time Every Day Forever shows some stalling.  Buying time for corporate America to get their balance sheets in order by cutting jobs and gaming earnings has about run its course and now the Fed is bracing for the double secret elevation market move.  This is not widely known about but has been confirmed by three researchers studying the cause and effect that bullshit has on calming the nerves of people following business news programs.  Often referred to as the Kudlow Effect, it is an phenomenon observed when select pro business individuals or defrocked evangelists try to levitate a dollar bill by concentrating on the first time they were completely honest with themselves.  Needless to say the dollar has yet to be moved.  But, for the vast numbers of Americans, economic elevation is just as hopeless but has fools believing.

Duped

Markets set up participants by producing apparently recognizable patterns only to then present a completely different form and outcome.  The ability to fool investors and traders into profound directional gaffs is repeated without fail with slightly altered timing.  Dupes are always being created by chance and necessity.  

Corporations need dupes such as analysts in order to game earnings reports. The analyst's motto should be, "never have so many been so surprised."  

Business news programs with their constant blabbing help shape amateurish perceptions of cause and effect. Notions of market prowess are always be attributed to market participants in hedge and high frequency trading communities contrary to their less than stellar performances. The reality is high frequency trading is not driven by a sophistication of analysis but by an abject fear of risk.  In the end, the capacity for both speed and returns is finite.

Bernanke Company Store

Article in the New York Times about the purchases of large amounts of distressed homes by private equity folks looking to turn profits by making these homes rental units. Seen as an alternative to other current returns in the market place, these ambitious folks are buying blocks of homes at supposed deep discounts.

Turning the fragmented real estate market into a private equity liquidity block trade seems only natural given the too big to fail environment Bernanke has underwritten. These type of investment strategies come directly out of the Fed stimulus initiatives of pushing liquidity into privileged hands and while in effect restricting capital and rousting many Americans from their homes. The old saying goes that God must love poor people because he made so many so that He and his rich friends can have a good laugh. Real estate has definitely turned and much like the impetus which is driving over valuations in stocks, there is an investment frenzy currently underway spawned from tech stocks and now into the broader S&P 500. Gains in 2012 rival the bull rush in 1998 which of coarse was the beginning of the end.

HF Trading

High frequency trading is going to be getting the once over by SEC and other oversight authorities with ultimately the volume kick backs probably being eliminated. The broader issue of high volume day trading is completely within market making rules and will be here forever. Whether or not they put some type of time throttle on price view is another question whereby no one trading group can see price data faster than a set point of origination from a server.

Many of the HF programs rely on location proximity there by reducing latency and thus by their nature rely on modified front running to make profits because consistent trading program success which depends on unique market insight is rare. Since fundamental market information is practically useless beyond normal bias reinforcement, any edge similar to the old wink wink nod nod is pursued.

What works works. What doesn't is almost everything talked about every day on every business news station. Adaptive programs with alpha producing strategies year in and year out provide a better market view than any earnings, share demand, and growth scenarios.

Correction Time

Systemic price correction is in the offing for almost every market. As with all serious corrections, it is never about the reasons given by market pundits but primarily a structural price recalibration and as such always deeper than the even the bearish forecasts. While it is believed the greatest upside offenders will correct the most, there is really no evidence of any punishment for particular performance. Rather it is more of a random collection of price declines where sectors become the focus of wrath because managers work as a connected organism with limited insight.

All In or All Out

If changing perceptions about values is the main goal of the Fed, it seems to be succeeding. Stocks and treasuries have certainly switched positions on the comfort scale recently with equities now being repeatedly called an "all in " and owning treasuries now being claimed by managers to be the worst investment possible. The bull cheer in stocks comes after a two and a half year bull run along and with a Fed as recently as last month declaring yields would remain at historic lows for several more years.

If the Fed has helped to alter value perceptions then it comes from a lot of work as the great liquidator. Not to be confused with liquifier, rather a proxy liquidator. Banks unable to retrieve debts owned them, Fed in effect liquidates the trade by providing zero cost money to the lender and lets them hold the diminished asset as if to say, go ahead and get whatever you can for it. The same thing is going on by European central banks although not nearly as effectively. Just in case the CDS claims are made, flood the system with cash, though probably no where near the money needed if necessary.

There is a natural bias at work here of coarse. The world is long stock despite what "cash on the sidelines" rant one might believe. The perception of a recovering economy then leads to a bias toward higher rates or bearish bond recommendations.

The Fed has consistently seen a much darker side to the economy. A potential storm's impending arrival seemingly as hard to peg as typical forecasts as to weather to call it a storm watch or a storm warning. Regardless, the Feds actions to prepare for any bad weather has had the effect of herding returns into assets outside the comfort zone of virtually zero risk treasuries. Now these dollars are corralled into a smaller and smaller fenced area as prices for assets such as stock are significantly higher.

If the Feds accommodation is an accurate perception into storm forecasting, then bullish sentiment of stocks and bearish sentiment on bonds probably mark a top for each.

AAPL GOOG Match Up

The battle between these two monsters will be interesting to watch. Here are the number comparisons supplied by Wolfram Alpha

This Time For Sure Again

Waiting for the next leg up in stocks seems to be a given if you listen and read the vested interests, which is just about anyone providing market information these days. Never have so many wanted so much for things to break out on the upside. I have heard endless price forecasts based on the "golden cross" where the 50 day average crosses the 200 day average. It is hard to believe people actually rely on these tools but given the weak state of hedge fund mechanics it is not a surprise. Having looked at enough data for 20 lifetimes it is clear this trick of the trade comes from the secular bull markets developed from the great run originating from the Great Depression. What they don't tell you is the cost against any future gains incurred when the two averages cross back and forth, over and over again before breaking out. I guess they call that the "golden shower".

Anyway, golden cross, money on the sidelines, and describing losses of more than 50% by Greek bond holders as concessions and not defaults are all part of the kool-aid being sucked down. It's a default and CDSs will be exercised in one fashion or another.

Markets have a great habit of using the formula, " this equals that," and as a result, repeatedly makes great errors in pricing.

Facebook Saves Economy

Facebook is now hiring thousands of people to create their own Facebook site. Imagine being paid to put nothing but information about yourself and fellow Facebookians so that millions can experience you and any fascinating facts or not so factual facts. Financial amounts have not been disclosed because negotiations between those who wish to provide important personal information are being interfered with by those who are boring. Just putting a picture of you and your dog is not going to make you rich. You need to put a picture of you and your dog eating together at a table with party hats and T shirts that say Eat Me. And that is only a start.

Now remember, if you cannot get paid for providing personal information you will have to do it for nothing. That means just having a Facebook site and adding pictures of yourself and friends for no particular reason.

Over/Under

Let's look at our basket of stocks and indexes from QRiskValue.com and see how they are ranked by the over/under based on QRV ranking. An increasing positive correlates to overvalue and a increasing negative to a undervalue. Range (+100 to -100)
AAPL +101
F +75
IBM +64
NQ100 +33
DJIA +28
S&P500 +16
GOOG +9
MSFT +9
PFE +6
GS -29
BAC -67

Be Happy and Beware

Bears in stocks and interest rates getting slapped repeatedly as the Fed leaves no doubt it will punish anyone getting in the way of their drive to preserve a recovery being threatened by a Europe known for creating world class events which affect the world badly. Fed clearly does not believe the ECU will be able to work out of this mess without some type disaster. Thus they have to create a fall back position where the world can seek refuge. The action is really just a redo of last year for stocks and, had it not been for the ECU then, indexes such as the S&P 500 would have had a great year.

What could screw up the Fed's intent? All of us participating in the markets daily know the monster never sleeps and market direction and volatility live with randomness. Just as the Fed was sure of the health of the housing market in 2006, it is sure of its ability to corner investments into selected alternatives with more risk than the 10 year. Structural price events, flash crashes, panics, and rolling downside momentum are the unpredictable side of a sure thing intervention.

For bulls, be happy and beware.

Say Anything

Got to love the Gingrich candidacy. In motions of body type and style, he looks like a caricature of an 'old pol' but without the discretion. His interesting domestic policy of asking his then now xwife to have an open marriage is one way to have it two ways in a three way. But just in case he needs a defense, he is using one reminiscent of a fallen television evangelical; do anything just ask for forgiveness. Just like the recent luxury liner captain explaining why he did not stay with his ship and instead found himself in a life boat with fleeing passengers. He tripped, and found himself in the life boat. Like Gingrich, the captain found himself in a dilemma. How do you make a "this may look odd" moment of life into a ready to apply response? You know. Say anything, and if you have to, just ask for forgiveness.

Markets say anything all the time. Remember the New Economy of the tech nineties. Old rules did not apply to speculation and capital formation. How about real estate inflation forever. Or the financial deregulation is better for everyone. Or the efficient market theory. Or gold is a currency. Or in 2012, the worst of the financial crisis is over.

Pawn Your Stocks and Indexes

Lots of talk about an upside break out in equities and that is fine. Up, down, whatever but maybe a few comments about where we sit and what things may be worth in turns of premium or discount. Now the things that have been going up for the last 4 years will get even more interest because they are proven movers. Brand name movers AAPL, IBM, and F are darlings of the risk averse. But lets look at several stocks and play pawn shop or let's find the riskvalue, the QRV, what will they be worth if things become not so bright and beautiful. Let's throw in a few of the indexes. So here is what the pawn shop will give for the list. (Data from QRiskValue.com)

AAPL 220
IBM 113
F 7
GOOG 528
PFE 20
MSFT 26
S&P 500 1140
NQ 100 1840
DJIA 9800

Oddly, only two pigs of the last 4 years have big upside, GS 152, BAC 20

Losing Wins

Lots of bad news about sovereign debt and the years it will take to resolve decades of accrued red. Interest rates still pushing ever so quietly lower. Reported hedge fund and mutual fund problems due to under performance in 2011.

Back in the early 00s I was a founding principal in a firm which looked to develop trading strategies to keep one step ahead of the market. Along with applying strategies to various markets ,we were also a market maker approved by the exchange to provide liquidity in a new contract. We were compensated in two ways ; any trading profits and payment for volume provided. We had a simple formula. Quickly pick off mispriced bids and offers. This was of coarse just as the latency arms race was picking up speed.

Now my point of telling this story is about the confusion individuals and markets make when they believe they are in control of all the important information which determines value and direction. In our trading operation, the market making desk was run primarily by a guy believed the particular market making strategy could be enhanced by his gaming the program. While the program was fully automated, he would override the system and hit bids or grab offers, anticipating the next move. When there is a larger latency spread, this works. When it closes, it does not.

His real ultimate problem however was his absolute aversion to losses. In fact, the first year there were only two or three losing days. But as the window closed on speed and other market makers step up their strategies, the firms strategy became less competitive.

Any strategy which requires less than normal distribution of losses is an eventual disaster. That goes for sovereign debt, hedge funds, and brand name stocks. Keeping things floating will eventually bring larger problems.

There is a saying which is the key to creating successful strategies and solutions. If it wasn't for the losses, you would never make any money.