The stealth rally as it has been called has continued, with every attempt of selling pressure being easily swatted away. Last week had some huge news, as V.P. Biden made us aware of, but little effect in the equity markets. We think this deserves a second look. Based on the laws, there will be an impact felt on corporate earnings and therefore valuations. Caterpillar and John Deere already announced non-cash charges of $100 and $150 million, respectively, for this year based upon the impact of this bill on forward retiree health care costs.
The law says you must account for such changes when you become aware of them, and that would be now. AT&T took a hit to their balance sheet announcing a $1 billion non-cash charge. Ouch!
On March 23, 2010, the President signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (HR 3590). Included among the major provisions of the law is a change in the tax treatment of the Medicare Part D subsidy. AT&T’s is taking non-cash charge in the first quarter of 2010 to reflect the impact of this change.
What is the bottom line?
AT&T had revenue of $123 billion and a reported profit margin of 10.19%, for a net profit of $12.54 billion - around 8% - for this quarter.
Caterpillar (NYSE: CAT) reported $32.4 billion in revenue and a 2.76% profit margin, with a net income attributed to common of $895 million. Their $100 million charge amounts to 11% of that income.
John Deere (NYSE: DE) reported $22.8 billion in revenue, a 4% profit margin and $912.80 million in net profit; their $150 million charge amounts to 16% of net income.
Based on the notion that most people value stocks based on Earnings Per Share, these charges would imply that stocks instantly became overvalued by somewhere between 10-15% when President Obama's signed this into law. Historically the market starts looking forward and discounting futures known facts.
On to the Treasury Bonds:
David Rosenberg, one of North America's leading economists at Gluskin Sheff + Associates Inc., a Toronto-based wealth management firm notes"¢ Last week's bond auctions did not go well. It seems that Japan and China did not show much interest. The lack of bids was no better underscored than in the 7-year Treasury note auction where the median yield was 3.29% versus 3.05% a month earlier. April is a cruel month for the U.S. Treasury market, with 10-year yields rising in each of the past 4 Aprils and in 6 of the past 7, and by an average of 25 basis points.
"That, in turn, could spook the equity market since another 25bps of upside pressure could then generate a fund-flow spiral as was the case in the summer of 2007 "” 3.85% (where we are now) ostensibly is a trigger point for selling of mortgage bonds. As rates rise, homeowners are less likely to pay their mortgages early, which extends the life of the mortgage and that in turn encourages mortgage investors to neutralize the duration of their portfolios by selling T-bonds and notes. We have seen this happen before and while it will likely provide a nice buying opportunity given the deflationary headwinds the economy now faces, the prospect of a spasm in the Treasury market is worth considering. Every equity market correction in the past "” 1987, 1994, 1998, 2000, and 2007 "” was preceded by what turned out to be a brief but significant run up in yields. See Stock Rally at Mercy of Rising Rates on page C1 of today's WSJ). And, the more overvalued the equity market is, the more the downside risks if bonds begin to provide greater yield competition in the near-term. Jeffery Hirsch over at the Stock Trader's Almanac is in today's NYT predicting a 20-30% correction ahead (see Stocks Soar, But Many Ask Why on page B1) "” he notes the modest number of stocks hitting new 52-week highs with every new interim peak being reached by the overall market.
At any rate, the march towards 1200 continues for the S&P, but it does appear that the bull has taken a breather and gotten a little tired.
Friday, March 26, 2010
Monday, March 22, 2010
Choppy Trading, New Highs and The VIX Part 2
I was in Austin, TX this weekend on Lake Austin. As I watched people drive their boats past and water ski, I also noticed that the waves that were coming towards the shore would run into the retaining walls and turn around and go the opposite direction immediately, only to run into the next rolling wave, then doing nothing - creating quite a chop. This was a perfect visual for the last three weeks of market trading.
The end of rollover week and futures/options expiration had the market closing near its highs. It was another week of choppy trading with the market grinding higher most of the time, except for Friday. The High Frequency Traders (HFT) were active again this week and there were many periods of the market going sideways in a very tight range for several hours.
Entering the market in this environment can be very tricky and require tremendous patience. The reason being is that as the market goes higher, ideally we would like to enter a long position on a pullback. However, when we have these slowly grinding higher markets, what tends to happen is the market makes a new high by a tick or two, then comes down three ticks or so, and then repeats this pattern for hours. Thus, we will watch as the market goes away very slowly and do not get filled, or in the market many times.
At any rate, although the market is overbought in the short term according to a couple of our models, markets can stay that way for quite awhile. Remember the internet stocks? While we believe the market will have volatility return and we will eventually exit this abnormal time frame & market that seems to slowly just move up, we realize that this environment may continue and we have to be prepared.
The volatility in the market often referred to as the VIX or The Chicago Board Options Exchange’s Market Volatility Index is near two year lows, and many folks believe this under prices the risk in the marketplace, as discussed last week. But there may be more to the story. From Barron’s http://online.barrons.com/article/SB126903911394364763.html.
The Volatility Paradox
The reason volatility is trending lower has more to do with complicated forces converging on the options market, rather than the oft-cited investor complacency. When stock prices “melt up,” options pricing models can get cloudy. Because recent stock action wasn’t tumultuous, as recorded by realized volatility, pricing models reflexively lowered implied volatility – the view of the future – based on what happened in the past.
The models can be overpowered by widespread options buying, but buying options to bet on rising volatility has been a losing strategy since VIX declined from an October 2008 high of about 90 to its recent level around 16.
Meanwhile, hedge funds, top options-market customers in recent years, have pulled back from the markets. Trading volatility is complicated and sometimes capital intensive, which is the opposite of where many hedge fund managers want to be after the drama of the credit crisis. This further depresses volatility and stock-trading volumes.
In a telling insight into the secretive hedge-fund community, an options trader who counts many of them as clients said he increasingly hears fund managers recite this 2010 market mantra – 80% of the money will be made in 20% of the time. These aggressive traders are watching the stock market like everyone else, waiting for a big dislocation to tip the odds in their favor.
Conversations with people active in all areas of the options market reveal a loose consensus that the stock market could quickly rise or fall by 10%. Some senior options traders say this scares institutional investors away from options because they are afraid of getting trapped – something Wall Street banks are intimately familiar with, thanks to the credit crisis.
Many major investors rely on trading desks to facilitate options trades, but the banks’ ability to assemble these trades is thought to be hampered by internal risk-management systems that are restraining trading. VaR, or value at risk, datasets still include second-half 2008 volatility levels, which predicted another Great Depression.
“You can’t sell many 15 vol[atility] options without blowing through risk limits,” the top options trader at a major bank said.
And so it remains that the return of capital, rather than the return on it, rests paramount in many minds, even when viewing options
The end of rollover week and futures/options expiration had the market closing near its highs. It was another week of choppy trading with the market grinding higher most of the time, except for Friday. The High Frequency Traders (HFT) were active again this week and there were many periods of the market going sideways in a very tight range for several hours.
Entering the market in this environment can be very tricky and require tremendous patience. The reason being is that as the market goes higher, ideally we would like to enter a long position on a pullback. However, when we have these slowly grinding higher markets, what tends to happen is the market makes a new high by a tick or two, then comes down three ticks or so, and then repeats this pattern for hours. Thus, we will watch as the market goes away very slowly and do not get filled, or in the market many times.
At any rate, although the market is overbought in the short term according to a couple of our models, markets can stay that way for quite awhile. Remember the internet stocks? While we believe the market will have volatility return and we will eventually exit this abnormal time frame & market that seems to slowly just move up, we realize that this environment may continue and we have to be prepared.
The volatility in the market often referred to as the VIX or The Chicago Board Options Exchange’s Market Volatility Index is near two year lows, and many folks believe this under prices the risk in the marketplace, as discussed last week. But there may be more to the story. From Barron’s http://online.barrons.com/article/SB126903911394364763.html.
The Volatility Paradox
The reason volatility is trending lower has more to do with complicated forces converging on the options market, rather than the oft-cited investor complacency. When stock prices “melt up,” options pricing models can get cloudy. Because recent stock action wasn’t tumultuous, as recorded by realized volatility, pricing models reflexively lowered implied volatility – the view of the future – based on what happened in the past.
The models can be overpowered by widespread options buying, but buying options to bet on rising volatility has been a losing strategy since VIX declined from an October 2008 high of about 90 to its recent level around 16.
Meanwhile, hedge funds, top options-market customers in recent years, have pulled back from the markets. Trading volatility is complicated and sometimes capital intensive, which is the opposite of where many hedge fund managers want to be after the drama of the credit crisis. This further depresses volatility and stock-trading volumes.
In a telling insight into the secretive hedge-fund community, an options trader who counts many of them as clients said he increasingly hears fund managers recite this 2010 market mantra – 80% of the money will be made in 20% of the time. These aggressive traders are watching the stock market like everyone else, waiting for a big dislocation to tip the odds in their favor.
Conversations with people active in all areas of the options market reveal a loose consensus that the stock market could quickly rise or fall by 10%. Some senior options traders say this scares institutional investors away from options because they are afraid of getting trapped – something Wall Street banks are intimately familiar with, thanks to the credit crisis.
Many major investors rely on trading desks to facilitate options trades, but the banks’ ability to assemble these trades is thought to be hampered by internal risk-management systems that are restraining trading. VaR, or value at risk, datasets still include second-half 2008 volatility levels, which predicted another Great Depression.
“You can’t sell many 15 vol[atility] options without blowing through risk limits,” the top options trader at a major bank said.
And so it remains that the return of capital, rather than the return on it, rests paramount in many minds, even when viewing options
Friday, March 12, 2010
Rollover week and slow days
This was the beginning of rollover week when the June S&P contract becomes the front month and traders are moving from the March contracts to the June contracts. The effect of this is usually reduced volume, due to the trading being split between two contracts combined with choppy trading. Well the rollover week lived up to its reputation as this week was extremely choppy, with light to anemic volume during the middle of the day – one of the worst we have seen in a long time.
The market grinded higher most of the time, except on Tuesday and Wednesday where it was clear that the Buy Programs were in place. Tuesday and Wednesday were straight up form open and looked like carbon copies of each other. After the initial big pops, the High Frequency Traders (HFT) created a choppy environment with sleepy trading & little movement, then bam out of nowhere a big move/break out, no wait, a fake out. So, this made for very frustrating trading. During the day Tuesday and Wednesday it was evident that these HFT programs were running as orders to sell 3000 contracts on the books were being overtaken by 50 or even 0 buyers. The S&P e-mini’s would hardly go down one tick! The buyers bought everything and the orders were obviously off the books.
Short term – over the last several weeks - we continue to be overbought with very little block selling and 9 up days in a row through Thursday. Friday hardly being a down day at all. VIX continues to be very low. Some people think the VIX continues to under price the risk in the markets and I ran across an interesting article that describes this nicely. From EWI.
http://www.elliottwave.com/freeupdates/archives/2010/03/11/All-Is-Quiet-On-The-Global-Front----For-Now.aspx
All Is Quiet On The Global Front -- For Now
Volatility index VIX may be telling us something important.
The financial news these days makes it clear that the world economy is on shaky ground. "China's bubble"; "high U.S. unemployment"; "uncertainty about interest rates"; "sovereign debt problems in Greece"... You'd think that in this environment, the financial markets would be as jittery as some of the commentators are. But they aren't.
The DJIA, the world's benchmark stock index, has rallied since a February 5 low. The Chicago Board Options Exchange’s VIX index (the "fear" index) also shows that the markets are not nervous. The British Financial Times picked up on this on March 8 (italics added):
The Vix index, a measure of expected market volatility, hovered around its lowest levels for the year at 17.63... The Vix has closed down 16 out of the last 18 sessions -- we haven’t seen it do that in such a consistent manner since 1997. [The low level] suggests that the Vix is not fully reflecting the amount of risk in the market right now...
We've been here before. In May 2008, three months before the AIG and Lehman troubles shook Wall Street, our monthly Elliott Wave Financial Forecast (EWFF) reported:
High volatility tends to follow low volatility, and volatility is always greater on the downside. The "impending ‘heart attack'" should generate some of the most pronounced volatility in history.
The "heart attack" that stocks suffered in 2008-2009 pushed the VIX to an all-time high of 89.53 (October 2008). Our June 2009 EWFF picked up the volatility theme:
After surging to an all-time high of 89.53 in conjunction with the end of wave (3) of 1 in October, the VIX fell to below 30 last week... reflecting a lessening fear of falling stock prices. Odds are that the VIX will fall into the low 20s or possibly even into the teens prior to the end of the current bear market rally.
That brings us to the recent 17.63 VIX reading -- "the teens," just as the EWFF expected. By itself it's no guarantee of anything; no indicator is. But when you see the DJIA's latest Elliott wave count and other technical evidence, the picture gets clearer.
We had a tough trading week with the choppy environment and apathy in the markets. This environment made it very difficult to gain any edge when placing a high probability trades, as this became irrelevant.
On the Treasury bond side, looks like all is well again with a strong auction and an A+ rating from Rick on CNBC. A big change from the last auction that I think got an F and had a high bid to cover.
The market grinded higher most of the time, except on Tuesday and Wednesday where it was clear that the Buy Programs were in place. Tuesday and Wednesday were straight up form open and looked like carbon copies of each other. After the initial big pops, the High Frequency Traders (HFT) created a choppy environment with sleepy trading & little movement, then bam out of nowhere a big move/break out, no wait, a fake out. So, this made for very frustrating trading. During the day Tuesday and Wednesday it was evident that these HFT programs were running as orders to sell 3000 contracts on the books were being overtaken by 50 or even 0 buyers. The S&P e-mini’s would hardly go down one tick! The buyers bought everything and the orders were obviously off the books.
Short term – over the last several weeks - we continue to be overbought with very little block selling and 9 up days in a row through Thursday. Friday hardly being a down day at all. VIX continues to be very low. Some people think the VIX continues to under price the risk in the markets and I ran across an interesting article that describes this nicely. From EWI.
http://www.elliottwave.com/freeupdates/archives/2010/03/11/All-Is-Quiet-On-The-Global-Front----For-Now.aspx
All Is Quiet On The Global Front -- For Now
Volatility index VIX may be telling us something important.
The financial news these days makes it clear that the world economy is on shaky ground. "China's bubble"; "high U.S. unemployment"; "uncertainty about interest rates"; "sovereign debt problems in Greece"... You'd think that in this environment, the financial markets would be as jittery as some of the commentators are. But they aren't.
The DJIA, the world's benchmark stock index, has rallied since a February 5 low. The Chicago Board Options Exchange’s VIX index (the "fear" index) also shows that the markets are not nervous. The British Financial Times picked up on this on March 8 (italics added):
The Vix index, a measure of expected market volatility, hovered around its lowest levels for the year at 17.63... The Vix has closed down 16 out of the last 18 sessions -- we haven’t seen it do that in such a consistent manner since 1997. [The low level] suggests that the Vix is not fully reflecting the amount of risk in the market right now...
We've been here before. In May 2008, three months before the AIG and Lehman troubles shook Wall Street, our monthly Elliott Wave Financial Forecast (EWFF) reported:
High volatility tends to follow low volatility, and volatility is always greater on the downside. The "impending ‘heart attack'" should generate some of the most pronounced volatility in history.
The "heart attack" that stocks suffered in 2008-2009 pushed the VIX to an all-time high of 89.53 (October 2008). Our June 2009 EWFF picked up the volatility theme:
After surging to an all-time high of 89.53 in conjunction with the end of wave (3) of 1 in October, the VIX fell to below 30 last week... reflecting a lessening fear of falling stock prices. Odds are that the VIX will fall into the low 20s or possibly even into the teens prior to the end of the current bear market rally.
That brings us to the recent 17.63 VIX reading -- "the teens," just as the EWFF expected. By itself it's no guarantee of anything; no indicator is. But when you see the DJIA's latest Elliott wave count and other technical evidence, the picture gets clearer.
We had a tough trading week with the choppy environment and apathy in the markets. This environment made it very difficult to gain any edge when placing a high probability trades, as this became irrelevant.
On the Treasury bond side, looks like all is well again with a strong auction and an A+ rating from Rick on CNBC. A big change from the last auction that I think got an F and had a high bid to cover.
Friday, March 5, 2010
The Two and a half hour Market
Over the last week the market has gotten into the routine of having some volume for the first hour, then flat lining until 60 to 90 minutes before the cash close. Amazingly the overnight or globex sessions are having wider ranges. The range of the market after being open for an hour has become incredibly narrow. In fact on Friday we had basically a 2 point range from 9:30 CST to 1:30. Talk about putting someone to sleep! The volume continues to be light and the market grinds higher. Normally this would be a very negative development. A market moving higher on weak volume is seen as having a chink in the armor. But, the bulls scored a victory on Friday closing the S&P e-mini’s above 1125 and it looks like it can test new highs again.
Interestingly, earlier in the week, the market tried to make a new high over 1115 and JP Morgan offered to sell 1000 big S&P’s in the pit. This is the first time they have tried to sell this size in months. Our indicators are flashing warning signs again, with the market getting overbought and into a position where the excess will need to be worked off. Both the Treasury bonds and the S&P had moved into an overbought position last week, which is very unusual. Once the employment report was released, all was well, as the Fed and media had the weather and snow to blame for any increases in unemployment. The Treasuries showed that some normalcy still exists in the markets and had a quick correction.
These tight ranges have made for a difficult trading environment and many false moves being influenced by one big buyer or seller for a few minutes.
Regarding the appetite for risk and complacency, it has appeared to return. As long as the Fed remains easy and provides liquidity to the system, this environment will most likely persist. The VIX has moved into the 17.50 range and it does not look like too many investors are concerned about a pullback. At any rate, the market is building energy for a move one way or the other, once it resolves the tug of war between the bulls and bears.
When and not if the liquidity is removed from the market, beware. The Fed did it before in 1999 & 2000 and the consequences in equities were not pretty. Has the Fed learned anything from that past experience? Granted they have different leadership, but we think they are caught in a precarious situation. Leave things alone and things heat up and we see inflation. Raise rates and stymie the growth.
With the market being so choppy, we had a difficult time profiting in the S&P for the week. However, we kept a close eye on the risk management and were able to have a nice profit on a Treasury bond short position, ultimately finishing the week with a -.38% or so loss. We will continue to be patient and wait for opportunities that Mr. Market will offer, rather than trying to force the issue.
Interestingly, earlier in the week, the market tried to make a new high over 1115 and JP Morgan offered to sell 1000 big S&P’s in the pit. This is the first time they have tried to sell this size in months. Our indicators are flashing warning signs again, with the market getting overbought and into a position where the excess will need to be worked off. Both the Treasury bonds and the S&P had moved into an overbought position last week, which is very unusual. Once the employment report was released, all was well, as the Fed and media had the weather and snow to blame for any increases in unemployment. The Treasuries showed that some normalcy still exists in the markets and had a quick correction.
These tight ranges have made for a difficult trading environment and many false moves being influenced by one big buyer or seller for a few minutes.
Regarding the appetite for risk and complacency, it has appeared to return. As long as the Fed remains easy and provides liquidity to the system, this environment will most likely persist. The VIX has moved into the 17.50 range and it does not look like too many investors are concerned about a pullback. At any rate, the market is building energy for a move one way or the other, once it resolves the tug of war between the bulls and bears.
When and not if the liquidity is removed from the market, beware. The Fed did it before in 1999 & 2000 and the consequences in equities were not pretty. Has the Fed learned anything from that past experience? Granted they have different leadership, but we think they are caught in a precarious situation. Leave things alone and things heat up and we see inflation. Raise rates and stymie the growth.
With the market being so choppy, we had a difficult time profiting in the S&P for the week. However, we kept a close eye on the risk management and were able to have a nice profit on a Treasury bond short position, ultimately finishing the week with a -.38% or so loss. We will continue to be patient and wait for opportunities that Mr. Market will offer, rather than trying to force the issue.
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