11:50pmCT, Saturday, January 17, 2015 “Currencies Gone Wild!”

PRAESENT ABIIT FERAE!

“CURRENCIES GONE WILD!”

As you may have noticed there’s been significant percentage moves in many currencies lately in the FOREX markets.  The strength in the U.S. dollar lately versus the cross rates against the Euro and the Ruble are particularly remarkable.  Also Thursday night the Swiss Central Bank decided to lift its peg against the Euro after having it for just a few years (in an effort to increase their exports to all of Europe).  They decided to do this when the Franc was at the top end ceiling range of trading set by the Swiss Central bank, which explains why so many traders and investors were caught on the wrong side of the trade.  When the Swiss Central Bank issued the news, they effectively pulled the rug, perhaps the magic carpet, out from under the Euro.  Consequently, instantaneously the Swiss Franc appreciated against the Euro in the magnitude of approximately 30%, and against the cross rate to the U.S. Dollar, the Swiss Frank rose roughly 16 to 17 percent in just seconds (closing up these figures for the day).  Obviously, this caught a lot of traders by surprise!

As you may or may not know, the SEC does not enforce its rules and regulations on commodities (including currencies) traders, so there’s no “Reg T” to deal with.  Consequently, the traders and investors, regulated by the Commodity Futures Trading Commission (the CFTC), are actually allowed to use 50:1, or 100:1.  In foreign countries abroad investors can legally employ the use of leverage (meaning to borrow funds to seek excess returns) in currency trading at 400:1.  Consequently when a 30% move occurs, investors with 400:1 leverage (and borrowing) can have unrealized gains or losses of 12,000% (derived by 30×400).  Such excessive and intense borrowing is allowed because many currencies are widely believed to trade with minimal volatility and in tiny daily percentage moves.  Currency and Commodity trading firms believe they can issue margin calls, and traders and investors believe they can self protect themselves from “big” moves by using stop-losses.  Obviously, this time, these precautions didn’t really help to mitigate losses.  I wouldn’t necessarily even agree that currencies don’t appreciate or depreciate much over e.g. the course of a day, and as you can see below in the charts, currencies have been on the move!  The Swiss Franc moved instantaneously (from roughly 0.98 to 1.165) so strongly that those caught on the wrong side of the trade will, or may, pass on their losses to the brokerage firm, who has to make the other side’s trader whole, at once.  Consequently, these currency and commodity brokerage trading firms may “go bust!” and file for bankruptcy (due to the excessive leverage, hence borrowing that’s so common for commodities traders).  This is what makes borrowing money for investing so dangerous, in securities trading it’s referred to as “margin,” in commodities trading it’s referred to as acceptable leverage.  If I had to guess the CFTC’s leverage and margin requirements will be examined by some regulatory agency.

Despite what the media has been reporting, there have been some HUGE winners in the currency markets, in addition to HUGE losers as of late, regarding the currency cross rate of the Swiss Franc to the Euro.  By definition there must be someone on the opposite side of the futures transaction.

Also lately on the move has been the Russian Ruble, which due to oil’s great depreciation since late June of 2014, has depreciated substantially versus the U.S. Dollar.

The Euro has also been experiencing a major slump, and has depreciated substantially against the U.S. Dollar, and other major currencies.  The U.S. Dollar has reached an 11 year high versus the Euro, now at (a cost of U.S. dollars at) 1.1561.  I believe the Euro will continue to have further future losses against all major currency cross rates, and I think the Ruble is also headed for further turmoil, despite oil having reached a potential bottom or trough on Wednesday, January 14, 2015.  I’d say Europe is in dire straights because of nearly no growth, no consumer spending, no savings & investment, nearly zero interest rates, and because of poor education, ridiculous job security, corruption, zero inflation (they forgot how to print money at the ECB, which could be spent, immediately assisting jobs and GDP growth, etc.), deflation scares (which halts spending further by the people, who wait for lower and lower prices, causing zero growth, if not a contraction of the economy, and layoffs), and their taxes are too high.  Another looming problem worldwide (especially in Japan) is the coming generational storm of demographics, due to birth control pills.  Additionally, perhaps socialism really isn’t conducive to economic growth, economic development, or to progress.

The Ruble, the Russian stock market, and oil seem to correlate as of late.  Many are wondering and are worried about a possible default of the Russian Ruble this year, and of Russian’s sovereign bonds, notes, and bills (additionally, after a couple weeks passed, Moody’s and/or S&P have finally gotten around to downgrading their Russian outlook, and their currency, and their sovereign fixed income… I think Russia’s 17% interest rates readily let investors know of the risks involved in the Russian debt markets, as does their rapidly depreciating currency.  BEWARE:  The Russians are having a currency crisis, and interest rate surge).

Next week traders may be looking for signs the ECB will provide some kind of stimulus program.  Europe has experienced and endured elevated unemployment, weakening GDP growth, recent disflation and deflation.  Their nearly zero interest rate policy also is not conducive to savings & investment.  The ECB also seems to be broadcasting that they have no intention to raise interest rates anytime soon.

What currency traders analyze, or really what I would analyze before trading any particular currency cross rate would include a broad base and range of economic data of one nation versus another. Most traders would choose their home country versus a foreign country, but anyone could trade any particular cross rate they’d like. Before trading a currency I would suggest these investors and traders examine interest rates (and if they’re rising or falling), inflation rates (and if they’re increasing aka reflation, or decreasing aka disflation), and GDP (is it falling or rising, and at what rate, and is this rate gaining strength or slowing down), the labor markets (employment, unemployment, and labor force participation rates), deficits or surpluses (and is it getting more or less obscene), and total government debt outstanding (how fast is this figure increasing per year?), as well as the deficits as a percentage of GDP, and the total debt as a percentage of GDP. They then have to develop a hypothesis or forecast or estimate of which way these figures are going to go, either improving or deteriorating. Only at this point would I, or these hypothetical currency traders be either bullish or bearish on their home country’s currency vs. some foreign currency. Again, this is what I’d do, and what others do, is their choice. Some may just examine which way has the currency cross rate moved in the last 1 minute, 5 minutes, 30 minutes, or 60 minutes, and decide to then either buck that trend or go with the flow… they could also examine the exchange rate for 1 day, 5 days, 30 days, 90 days, 180 days, or 365 days, and decide to either buck that trend, or go with the flow. There are many ways (and no right way) to eat a reese’s pieces.

I believe the Swiss Central Bank simply didn’t want to support the Euro any longer, by purchasing it in the open market to support it’s price, versus their Swiss Franc.  They felt as though they had accumulated enough Euros, and they decided to dump them on the open market.  They had wanted to artificially lower their cost of a Franc to Euro holders, to artificially increase their exports to Europe.  After that experiment, they decided to stop it.  The Swiss Central Bank also had tried to weaken its own currency by introducing negative interest rates of -0.25% for its Government Securities, but that couldn’t even support the Euro, and weaken the Swiss Franc.  Negative interest rates are nuts to me!  Who in the hell would pay a Government for the privilege of holding and owning their fixed income!?  It sure doesn’t stimulate savings & investment.

Ponder this, if margin interest rates were zero (and they never are… but this is funny!) if margin interest rates were zero, what would happen if you shorted a Swiss Franc Denominated Government bill at -0.25%!?  Would they then owe you money, aka interest?!

Below, behold… CURRENCIES GONE WILD!!!

Press here for all major currency cross rates… http://www.cnbc.com/id/15839178 or here…  http://finance.yahoo.com/currency-investing.

Press here for the cost of the Euro in U.S. Dollars, and a one year chart.  As you can see the price of a Euro in Dollars has been trending lower and lower.

Press here for the amount of Rubles you’d get per U.S. Dollar, and a one year chart.  As you can see the amount of Rubles you’d get for a U.S. Dollar has been nearly going parabolic lately.  The Russians are having, in my mind, a major currency crisis, as the Ruble has lost roughly now half it’s value, over the past year.  It’s from the Sanctions imposed due to their War against the former U.S.S.R. states.  This will cost the Russians an “arm and a leg” to import things compared to just a few months ago.  Also, to foreigners, Russian goods will be looking awfully cheap.

Press here for the cost of the Swiss Franc in U.S. Dollars, and a 5 day chart.  As you can see the price of a Swiss Franc surged versus the Euro, when the Swiss Central Bank no longer bolstered the value of the Euro, in an effort to artificially increase Swiss exports.  An immediate nearly 30% surge, wound up closing up around 17% for the day.

Here is a 6 month chart of the exchange rate between the Swiss Franc and the U.S. dollar, it is plotting the cost of 1 Swiss Franc.  As you can see, currencies don’t really make tiny moves, sometimes they gap up or down rather quickly.

Here is the price of a Swiss franc quoted in the Euro currency.  Here you can see the cost of a Swiss Franc quoted in the Euro currency.

Hence, for all these reasons, it is now officially… “CURRENCIES GONE WILD!”

By Andrew G. Bernhardt

8:45pmCT, Friday, January 16, 2015

Here’s the current PE Multiple and Dividend yields of major U.S. stock indices.

In this post I discuss Index Dividend Yields, Index PE Multiples, Annualized Past Performance, Asset Allocation, Options & Derivative Securities.

As you can see the DJIA is quite reasonable in terms of  PE Multiple, at just 16.19, with forward looking estimates placing its PE Multiple at 15.33 in twelve months time; while the DJIA’s dividend yield has actually increased over the past 12 months to 2.51% from 2.08 a year ago.  This makes me most bullish on the DJIA, and I believe it will outperform the rest of the major U.S. stock indices in 2015 for this reason (the lower pe multiple, relative to other indices, and the strengthening dividend yield on this index).  DIA is an etf that matches the performance of the DJIA, which is a basket of 30 large super capitalization stocks representative of the U.S. economy.  Of course there are options on DIA, and also the CBOE has root symbol DJX and index options on the DJIA with 1256 contract status, which have preferential tax treatment, and cash settlement and European style assignment.

For educational and informational purposes, using options, one could hypothetically construct a portfolio with e.g. 20% allocation to index options achieving 5:1 enhancement, and then he/she could allocate the remainder, the 80% into e.g. high yield fixed income via etfs QLTC, EMB, PCY, JNK, and HYG (alternatively they could use Treasury etfs, e.g. AGG, IEF or TIP, or high quality corporate fixed income etfs e.g. LQD and many others).  This would likely produce awesome gains annually, if rebalanced annually.  This type of strategy is suitable for institutional trading, and it achieves the “best of both worlds” in terms of a large fixed income portfolio, for safety, and then an index option which would effectively capture the gains of the stock market over e.g. the course of a year or two.  A lot of investors, including institutional investors, “dilute” their equity portfolio’s potential gains with fixed income, which over time can produce returns less than the stock market (assuming high yield bonds are not employed).

What most people don’t know is that e.g. the JPM EMBI [which stands for the J.P. Morgan Emerging Market Bond Index] (matched by etf EMB, and many other higher cost mutual funds, like FNMIX, PEMDX, and GSDAX) has produced annualized gains over the past which are awesome, sometimes beating stock indices.  Over the past 12 months (according to https://fundresearch.fidelity.com/mutual-funds/performance-and-risk/315910836 the JPM EMBI has returned (through December 2014) +5.53%, and over the past 3 years the annualized return was +5.33%, over the past 5 years the annualized return was +7.21%, and over the past 10 years has produced annualized gains of +7.68%.  The high yield bond markets and high yield fixed income indices (rated BB or better, and the etf EMB meets that requirement) have never returned a negative return over any rolling 18 month period of time. This means that if there ever is a selloff in these fixed income indices it’s most likely a major buying opportunity, and based on past performance since the stone age, that the index will strike a new all time high within 18 months.  This is not the case for equity indices, which e.g. took 25 years from 1929 to 1954 to break even, even before inflation adjustments; also the Nasdaq Composite hasn’t reached it’s March 2000 levels of roughly 5,134, also before inflation adjustments, and it has been 15 years!  The etf PCY is very similar to etf EMB and has a slightly longer average weighted maturity, compared to EMB; It was designed by Deutsche Bank to outperform the EMB by 200 bp per year. Other corporate U.S. high yield bond funds rated BB or better include JNK, and HYG; of course there are many others.  There are also higher risk CCC rated fixed income mutual funds and etfs, including QLTC.

I have personally annualized the S&P500, and it has returned over the past ten years +5.238%, going from a December 31, 2004 value of 1,211.92 to the current 2,019.42 (derived from [2019.42/1211.92]^[1/10]).  Yes, you’re reading this correctly, high yield fixed income (as measured by the JPM EMBI) has outperformed the S&P500 over the past 10 years, each and every year (on average) by nearly +2.44%, and an extra 244 bp adds up quick over long periods of time.  It is said there’s nothing more powerful than compound returns.  Over the past 20 years the S&P500 has risen from 459.27 to the current 2,019.42, which annualizes to +7.6857% over the past 20 years through today (derived from [2019.41/459]^[1/20]).  I’d rather have bond market (aka fixed income) risk(s) than stock market risks.

Speaking of fixed income risk, here they are: Fixed Income Securities (including U.S. Treasury Securities) have default risk, interest rate risk, inflationary risk, liquidity risk, currency risk, credit quality risk, repayment or principal risk, streaming income risk, reinvestment risk, duration risk, convexity risk, maturity risk, market risk, political risk, and taxation adjustment risk, despite the caveat of “full faith and credit of the US Government” for US Treasuries.  Makes you wonder doesn’t it!  Just joking, obviously, fixed income is safer than equities, even when analyzing high yield fixed income indices.

Here’s the annualized data on the DJIA, which I have just personally calculated for you.  It closed today at 17,511.57, and in December of 1994, the last trading day of the year it closed at 3,834.44. So for 20 years the annualized DJIA return has been +7.890% (calculated from [17511.57/3834.44]^[1/20]).  For ten years the annualized return for the DJIA  has been +4.968%, going from 10,783.01, on the last trading day of 2004, to the current 17,511.57  (calculated from [17511.57/10783.01]^[1/10]).

In December of 2004, on the last trading day of the year, the S&PMidCap400 closed at 663.31, today it closed at 1,430.89; This annualizes to +7.991%, derived from [1430.89/663.31]^[1/10].

This is why my main “master strategy” (which after trading options for ten years I believe to be the best) has been to amplify the stock indices (rebalanced annually) using stock index options (which for safety have an expiration date going out more than two years), with 10 to 25 percent allocations, and enhancement ratios of 5:1 to 7:1 (this would require a level II purchase of a deep in the money call index option, and perhaps the selling or writing of an out of the money call, to mitigate extrinsic value decay, by turning the trade into a level III e.g. vertical bull call debit spread— potentially making the options positions theta positive); while placing the remainder, the 75 to 90 percent, into high yield fixed income.  I’m sure you can do the math, to discover what that hypothetical portfolio construction strategy annualizes, based on long term past performance figures.  Amazing isn’t it?!  Who can beat that?!

By Andrew G. Bernhardt

6:30pmCT, Friday, January 16, 2015

Pecunia non est radix omnium malorum. 

“Money is not the root of all evil.”

The major stock markets in the U.S. began the day selling off for nearly 45 minutes, before strengthening for nearly the rest of the trading day, particularly in the last 45 to 60 minutes of trading. The VIX dropped -6.43% or 1.44 points to 20.95, the S&P500 gained +1.34% or +26.75 points to 2,019.42, the DJIA gained +1.1% or +190.86 points to 17,511.57, the S&PMidCap400 gained +19.98 points or 1.42% to 1,430.89, the Nasdaq Composite rose +64.56 points or 1.39% to 4,634.38, the Russell 2000 rose 1.90% or +21.95 points to 1,176.65, and the Wilshire 5000 rose +1.39% to 21, 244.68. Nearly all these major U.S. stock indices are roughly 3 to 3.5 percent off their all time highs, with the exception of the Nasdaq Composite which is no where near it’s March 2000 all time high of roughly 5,134, (even before inflation adjustments) and it’s been just barely under 15 years!

XLF (an etf of financials) rose +1.21% or 0.28 to 23.49, XLE (an etf of energy sector securities) rose +3.25% or 2.37 to 75.23. USO (and etf matching the performance of West Texas Intermediate) rose +5.04% or 0.88 points to 18.33. The etf USO is so volatile that I think it’s ripe for a straddle or strangle options strategy.

For educational & informational purposes, a straddle is where you choose the same expiration date, and you go long the at-the-money call and the at-the-money put; a strangle is slightly more dangerous and you go long one strike price away from at-the-money, basically you go long a slightly out-of-the-money call, and a slightly out of the money put. Strangles can have a higher return if the underlying security really moves one way or the other strongly, versus the straddle strategy. It seems nuts to novice options, to be long a call and put simultaneously, but if you believe the underlying security is going to “go up” or “go down” quite a bit before expiration, then this is the trade for you. I’d probably say to use expiration dates two weeks away, I think that’s where the best returns could potentially be had. The underlying security basically needs to appreciate MORE than the sum of the cost of the call and put, together in total. I used to trade this strategy, straddles mostly, but some strangles too, on “hype stocks” e.g. GOOG, GOOGL, PCLN, TSLA, FB, AMZN, AAPL, etc. Straddles work well on volatile securities. Some brokers like to trade straddles just before EPS reports, or one day before expiration on a volatile security, because the extrinsic value of the options is then mitigated and the potential for a quick and lucrative trade is possible. Of course trading ATM (at-the-money, or worse, out-of-the-money) options carry a substantial and high level of risk, if the underlying security doesn’t budge, and is relatively flat, you could literally, “lose everything,” and have a 100% loss. So this is not a feasible or viable long term strategy, or something practiced very often in institutional trading or asset management; Of course there are many options strategies that institutional clientele may really benefit from involving options and derivative securities, this (“this,” being straddles and strangles) however, in my mind, is not one of them.

Light Sweet Crude oil closed at 48.69 and finished up +5.28% or 2.44 per barrel, Brent finished up + 3.38% to 49.90 per barrel. Gold finished up +12.10 or +0.96% to 1,276.90 per ounce.

The Euro cross rate to the U.S. Dollar dropped -0.52%, indicating further Dollar strength, closing at 1.1567.  This is the weakest the Euro has been since November of 2003.  I believe the Euro has further to fall before stabilizing.

Treasury Securities were mostly down, after reaching record low yields yesterday. 30 Year Zeroes (as measured by etf ZROZ) were down roughly -1.49%, while conventional 30 year Treasuries (as measured by etf TLT) were down -1.27%, TIPS (Treasury Inflation Protected Securities, as measured by etf TIP) were down -0.56%. The conventional 30 year Treasury bond yield finished at 2.4462%, and the 10 year Treasury Note yield finished at 1.8308%.

The JPM EMBI was (as measured by etf EMB) +0.07% and is now just 4.74% off its all time high, the etf PCY was+0.04% and is now 3.83% off its all time high, etf JNK was +0.29% and is now 7.63% off its all time high, HYG was +0.38% and is now 6.14% off its all time high, and etf QLTC was +0.10% and is now 12.22% of its all time high.

I believe the high yield sectors of the fixed income markets are rallying along with oil, because there is representation of energy related companys’ bonds in those funds and bond indices, including the sovereign high yield. Sovereign high yield bonds are rallying due to some foreign governments who nearly own and fully control their energy sectors, e.g. in Russia and in Brazil.

By Andrew G. Bernhardt