11:50pmCT, Monday, January 19, 2015 “Big Trouble In Little China”

In parva molestia Sina!

“Big Trouble In Little China!”

Hang Sang Ain’t Hangin’ Today… It’s a Fallin’

The fallout of the Swiss Central Bank’s action to lift its currency peg (or allowable trading range) against the cross rate of the Swiss Franc to the Euro has made the Chinese quite worried.  In the last 24 hours, during early Monday morning in the China (Sunday night in the USA) when the U.S. markets were shut, China’s Shanghai Composite Index (SSEC) fell from approximately from 3,400 to roughly 3,100 before it closed around 3,115, a drop of approximately 8 to 10 percent on one trading session.

Monday, the U.S. stock and bond trading was on Federal Holiday, for Rev. Martin Luther King Day, the markets were shut.  Meanwhile, investors in China were worried about their own hasty lawmakers and their actions in response to losses of currency and commodity trading firms, and of their clients, in the aftermath of the Swiss Franc surging after it lifted its peg to the Euro.

Chinese investors were worried about future regulatory changes associated with currency and commodity trading and the use of leverage and borrowing to do such trading and investing.  Foreigners can currently employ about 100:1 to 400:1 leverage, by borrowing, to increase their exposure to currency and commodity trades.  This isn’t the case in the USA where the CFTC regulates margin on currency and commodities and futures trading and investing.  In the USA we also have Reg T for securities trading (which includes the regulation of stocks, bonds, and options) and as investors of these actual securities (very different from futures and commodities) we’re not allowed to have 400:1 leverage and borrowing.

If regulatory action is taken by legislatures worldwide in the fallout and aftermath of the Swiss Franc surging by lifting its peg, then I’m sure you can imagine what’s going to happen to commodities prices which may be supported by, in my mind, extreme leverage (aka extreme borrowing).  If the magic carpet of margin, of 400:1 lending is pulled out from underneath commodity prices, then their prices will (or may) collapse!!!  Everything from cattle, to corn, to soybeans, to coffee, sugar, orange juice, milk, rice, cattle, hogs, to even lumber, and precious metals (gold, silver, platinum, and palladium, and copper) could all plummet in prices!  [Click here for current commodities prices]

In my mind, the world would then experience an environment of disflation (lower and lower inflation rates), leading to outright deflation (actual lower and lower prices).

Deflation is when price levels decline, or even plummet (perhaps that would be “hyper deflation”).  At first glance this seems great; I mean who doesn’t want a cheap Starbucks coffee right?!  But it’s actually a total disaster!  Deflation is paralyzing, if not total paralysis, and is crippling to the people and to their economies and society.  If prices are falling what would or may you or people do?  You might wait for lower prices later right?  Well, if everyone waits for lower prices, then people aren’t buying things, if they’re not buying, no one is earning money, if no one is earning money there are layoffs, lower demand, lower wages, lower productivity, and layoffs which exacerbates the entire issue, of people being less willing to purchase anything.  The whole deflationary spiral would get alarmingly out of hand!  Prices would or could plummet, through regulation of margin.  When margin regulations on the stock market were put into place after the Great Depression, surely that took some “hot air” out of the stock market, leading to lower stock prices.  In a deflationary environment growth would slow, the economy could contract and shrink, spending would or could cease, savings and investment would dwindle, layoffs would increase, and prices would continue to plummet. Sounds like economic Armageddon… It’s because it is, or would be!

I hope the CFTC in the USA doesn’t even look into or examine the regulatory structure of excessive leverage of currencies and commodities investors and traders.  It would probably prove to be enough to cause a stir and incite a panic, before you know it, deflation would materialize, along with a recession.

Don’t worry, it doesn’t seem to be affecting the market psychology and behavioral finance of American and U.S. investors.  Currently as of 11:50pmCT stocks are mostly trading higher in Asia, and S&P Futures vs. Fair value are indicating an implied open of +27 points on the DJIA for Tuesday trading.

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

2:15amCT, Friday, February 16, 2015

Thursday sure was a wild day!  USO the etf which tracks West Texas Intermediate Oil was down nearly 4.49% in one trading session.  USO is a good candidate for a two week straddle of ATM options.  Oil’s spectacular demise and fall since late June 2014 has been very stunning.  I’m still bullish on equities for 2015 despite the last several days of selling.  I believe they will end 2015 up 5 to 15 percent, with the DJIA leading the way, since its PE Multiple is lowest among the U.S. major stock market indices.  Most major U.S. stock indices are currently off their highs by about 4.0 to 5.5%, which I think represents a buying opportunity.  I’m most bullish on financials (see etf XLF, and some of my favourite financials are BAC, AIG, C, MS, CS, RF, USB, JNS, HRB, FITB, HIG, DB, BOH, BK, MMC, and STI) and the DJIA (Dow Jones Industrial Average) for 2015, I also like the S&PMidCap400 (see etf MDY); of course I like large caps as well, and ticker SPY (an etf which matches the performance of the S&P500) is a favourite among many investors.  Due to SPY’s very heavy trading, and high volume and open interest, the option chains for SPY are in strike price increments of $0.50 and have bid-ask spreads of just three to five cents(!!!), which is a major advantage for traders relative to other ETF options (no one likes wide spreads).

It’s amazing to me how resilient REITs have been since 2009 and over the past year, also the strength of the health care sector has been quite remarkable over the same periods.  Some of my favourite REITs are HCN, HCP, OHI, NHI, SBRA, SNH, DOC, MPW, DOC, HCT, GOV, GEO, and CXW.  In “Big Pharma” I’d play an etf like XLV, or really I’d likely buy deep in the money calls, to amplify the etf’s performance.

If you like index options however, I would recommend (free advice here!), I would recommend using the CBOE root index options SPX, and DJX for example (or e.g. RUT or NDX), due to their preferential tax status as 1256 contracts, which are taxed 60% long term and 40% short term capital gains tax, regardless of the holding period potentially or hypothetically being short term, versus ETF options which do not get the preferential 1256 contracts tax status.  I also like the cash settlement and euro style assignment of 1256 contracts, versus the physical settlement and american style  assignment of non-index options at the CBOE.

I am getting worried about oil’s decline though, despite economists believing it’s decline is “like a tax cut,” (in 2007 oil fell of $140 per barrel to rock bottom around $30 a barrel, that “tax cut” sure didn’t really help(!!!), it nearly indicated (what I describe as) the greater depression was coming) I think the energy sector (and high yield fixed income, including sovereigns and corporate, I like EMB, PCY, HYG, JNK, and QLTC all the most— I believe anyone that buys Treasury Securities is “ripping themselves off,” I usually like to say… so anyway, the energy sector’s stocks, and Russian equities, see etf RSX… ) is going to continue to be very volatile until light sweet crude oil can find a bottom, which I believe is coming soon (“to a theater near you”… just joking).  At that point there could be major opportunities in the energy sector, in all high yield bonds (see the etfs mentioned above), and in Russian equities (see RSX), and in the Russian Ruble currency, and  a lot of U.S. company’s equities, e.g. tickers XOM, BP, BPT, CVX, and RIG, etc. are all well off of their highs, 30 to 50 percent or more, and consequently have some very strong dividends; etf XLE matches the performance of a lot of securities in the energy sector.  I do believe that there will be energy sector related layoffs, drilling and other oil related projects may be stopped or closed or delayed, since oil has depreciated quite strongly.  I also believe the energy sector’s big names will have weak revenue & weak EPS, as oil is more than 50% off it’s June 2014 highs; additionally, I think there could be dividend cuts.  Will this be the catalyst for a market panic and sell off, or correction?  Lower oil should be a net positive for the vast majority of people and companies!  I wonder how XOM and BP and CVX will fair after their EPS reports due at the end of January?  The rest of the market I’m expecting to do quite well in 2015 (perhaps even the energy sector starting very soon).  Thursday also saw the Swiss Central Bank lift a currency peg it had established a few years ago versus the Euro currency, and consequently the Swiss Franc appreciated over 17% as measured by etf FXF (which matches the cross exchange rate of the Swiss Franc to the U.S. Dollar, the franc rose even stronger versus the weak euro).  The Euro currency has been weak over lower and lower GDP growth forecasts (if not recession worries), and ZIRP aka nearly zero interest rates, and no indication on the ECB of raising interest rates anytime soon, despite an eager USA wanting to raise rates.  I believe, the Euro will continue to slide downward.  There are also difficulties with Greece being a Euro Union or Euro Zone member, and speculation that it may leave the EU (then there will or could be worries of other nations exiting the euro).  One economist dubbed this risk as “Lehman Brothers Squared”, which I think is fear mongering.  I could care less if corrupt Greece left the Eurozone or Euro Union, it would likely in my mind be a net positive for Europe!  How Italy, Portugal, and Spain (and Greece) ever got membership into the Euro Zone boggles my mind.

S&P Futures vs. Fair Value are indicating as of 2:15amCT that the DJIA is poised for an implied opening change of just -0.71 points, and the S&P500 is going to open down just 1.32 points.  In my mind, the VIX (S&P Volatility) is very high, and when it implodes, which I think it will soon, I believe that the major stock markets will take off like a rocket, potentially to new highs.  I find it bizarre that the new mortgage applications data released earlier this week, as well as a remarkable jobs (and unemployment) report, was not reason for equities to rally strongly upwards.

Friday before the bell, the CPI and Goldman Sachs (GS) EPS are due… Later Friday, Capacity Utilization is due, and Consumer Sentiment.  Generally, I feel as though all U.S. economic data will meet or exceed census estimates & forecasts.  If I had to guess, Friday will prove to be a positive day for equities on Wall Street, as we’ve had now five days in a row of selling.

I like to use CNBC.com, Bloomberg.com, Yahoo Finance (www.finance.yahoo.com), and on Android I like Bloomberg Radio, the CNBC app, and the Bloomberg+ App (which gets a live video feed to their cable TV broadcast), and the Wall Street Journal (WSJ) app.

I also read The Economist Magazine, Foreign Affairs, Harvard Business Review, GPO’s The Economic Indicators, Fed. Minutes, the BLS’s CPI Reports, and the Commerce Department’s GDP Reports. I will be more than happy to share my insights with my readers, and I look forward to any questions or comments you may have.  I intend on having a great time with this blog.

Andrew G. Bernhardt