Sunday Nov 21, 2010
The weekly advance decline line for the NYSE has not turned down, but it has stopped going up. Casino stocks (VS, MGM) crashed two years ago, and now trade for a fraction of their former value. For profit colleges (CPLA, STRA) crashed 50% in a matter of weeks amid suspicions the Federal Government would not continue to provide carte blanche financing for all students. Now municipal bond funds have wiped out a year or more of dividends in the last few weeks. Pimco’s PMF is down 15% form its August high.
The bear market is under way in various sectors but not in all at the same time. This is how investors are like our friend Wiley Coyote chasing the Road Runner over the canyon cliff. QE II has done the opposite of its intended goal, bond prices have fallen and the dollar has firmed. We thought the Government would pressure underwriters to hold the market up until the GM IPO came off, they did so in spectacular fashion.
We also have a couple of qualitative events that should mark a market high. The US Government has a habit of attacking market success stories at stock market highs. In the 1920s it was RCA, in the 1960s it was IBM, in the 1990s, it was Microsoft. Notice how Microsoft stock has gone nowhere since, investors now call for the company to be broken up and or for Ballmer to resign. (Gates says teachers need incentive pay for results, I wonder why he does not apply that in reverse for Ballmer, oh well…. Now the WSJ and Zero Hedge report that expert networks are about to be exposed as insider trading. We do not doubt this to be true. Sounds like Mike Milken and Ivan Boesky and Dennis Levine all over again. But out point is that such scandals accompany market tops.
From a societal standpoint, the Beatles emerged in 1963-4 near the end of the 1949-1966 market bull run. Now they are back via iTunes. We suspect this retro nostalgic move will celebrate another market top, which as we say may well be under way already.
There are only about four real bull markets the last three years, long government bonds, the US Dollar, and gold and silver. Silver is near 50% above its 200 week moving average; gold is some 44% above its 200 week moving average. Those last two statistics explain why we are recommending government bonds and the Dollar., neither of which is that high above long term moving averages.
But first, here are a few headlines from our Thursday letter which did not run due to computer problems.
Municipal Downgrades
Philadelphia Downgraded, CA faces higher rates – Hamtramck, MI declares bankruptcy, how long before Miami, Houston, Los Angeles, Philly asks Mish
Buffet to Receive Medal of Freedom, Supports Bailout, Profits from Bailout
Wall Street Journal 11/18/2010
From Sacramento to Austin to Albany, the day of fiscal reckoning is here.
This past weekend we noted how quickly bond funds, not just in NY or CA were collapsing through major weekly moving averages but national funds were doing so as well. That news hit the papers this week. We also noted that this is occurring much faster than the 2008 meltdown. Suspicions that the Republican Congress will not go along with bailouts for CA, NY, IL are part of the problem but, let me sum this up for you.
Accounting Analysis
California and other states simply do not have enough revenue to meet the current obligations of payroll, services, pensions, and debt and interest payments. So they are selling long term commitments to meet short term obligations. For example, Chicago sold the revenue from its parking meters for the next 75 years. Mayor Daley has already spent that money, incredible! CA is trying to sell $10 B in revenue anticipation bonds. This is a euphemism for factoring. CA is tendering future tax revenues for cash today thereby incurring long term debt to meet short term obligations, like payroll. Firms in needs of cash will factor their accounts receivable. Banks used to do this for a substantial interest charge. The problem of course is that the firm factoring is then permanently behind in cash flow. Unless business somehow doubles, how will they ever be able to stop factoring? One recalls that Bear Stearns, Lehman et al were selling short term commercial paper to finance borrowing leveraged mortgages. When the mortgage payments slowed, the paper could not be paid, the entire commercial paper market locked up, ie, no one wanted anyone else’s promise to pay.
Municipalities are now doing the same thing. They are borrowing long term to pay short term commitments. The markets see this happening, sense a lack of insurance (read bailouts) on the part of the Federal Government, and realize it is only a matter of time. California and even Harvard have had to pay higher rates to sell bonds this past month. Higher interest rates make the time to default even sooner.
The inverse head and shoulders pattern for stocks projected another 100 points up. This would be from the break out point of the neckline at 1120. That target at 1220 has been achieved. We suspect 1250 or so is in the cards.
Specifically we are over bought, see MACD at bottom which may take out that uptrend from June. We expect stocks to correct into mid December. So in the mean time , we are initiating trades in TLT, the 20 year bond fun. As Dave Rosenberg it is risk on, stocks up, or risk off, stocks down. When stocks are down bonds are up. We will be employing conservative strategies to enhance the 3.7% annual dividend that TLT pays at these levels.
But first a preview of what more and more markets will look like as the bear market progresses. We have seen casinos, then for profit colleges collapse, now municipal bonds have joined the fray.
This is the closing graph Thursday, Friday closed at 12.56. Yes we expect a rebound from this oversold condition, but that will be the case for most investments, the frog is slowly boiling in the pot of water. And so we highlighted the stair steps down just since August for this major bond fund. 15 to 12.75 is an 18% loss in just three plus months or the equivalent of three years of dividends!
One can almost hear the retirees calling their brokers for re assurance, or at AARP, hey you can do this yourself, is there a broker? At any rate, yes there will be a rebound but not to 15.00.
We bought 250 shares of TLT at an average price of 95.60 the last couple of days by placing limit orders below the market. We are up a buck. In an ideal world we would have sold puts under our existing positions. We will attempt to do that Monday. The Dec 10 94 puts are about $100. We believe stocks will experience a ragged sideways movement between now and option expiration Dec 10. So we expect bonds to advance, note the reverse head and shoulders patterns in TLT and in On Balance Volume. And at bottom MACD is turning up. As the price increases we will sell calls above the position hoping to be called by expiration Dec 10.
The strategy here is to sell puts when we believe TLT is near a bottom. We are not adverse to buying more TLT should we be exercised but want to take in the premium to enhance the overall return. We believe this will be a successful strategy for the next year during the expected bear market. We expect that selling puts and calls should enhance our overall return to well past 10%. The ideal strategy is to use December 10 expiration date to
Buy TLT at 95.60. (9800 – 9560 would be about 250)
Sell 94 puts for 100
Sell 98 calls for 100
Collect the monthly $30 dividend at the first of the month.
Sell TLT at 98 on December 10 for a total gain of
100 Put + 100 Call + 30 Div + 250 Cap Gain = 480/9560 = 5% in about one month or 60% annualized, not bad for a low risk trade Stay tuned to see how we do (yes the author has been a Registered Options Principal and a Securities Principal with considerable experience in this area). We are ignoring commissions and will account for that in our final tally.
The Thailand ETF is at top. We used green underscore to emphasize its increase. Note this occurs when the US Dollar is falling. This same scenario exists for most emerging markets. Such markets have become the New Frontier for speculation fueled by cheap dollars at zero interest rates courtesy of the FED. This will soon reverse with emerging markets crashing back to reality.
The US Dollar appears to have made another annual low and rebounded. It is doing the opposite of what Bernanke claims QE II will do. Most of the press and Congress still seem to think the Dollar is falling. It is not. Now another stock market also moves inverse with the Dollar, ours.
We remind you that the stock market collapse in 2008, was accompanied by a sharp dollar rise, the genuine flight to safety. Since then the market rallied in 2009 on a falling Dollar. The FED beat the Dollar back this year, but the results have been marginal at best, the market has mostly moved sideways on money sloshing through the FED to broker dealers who use it to support the market. With the latest Dollar bottom the stock market is probably on
borrowed time.
QQQQ
As various sectors like for profit colleges fail, the money is forced into the fewer risk assets left that are still rising. Consider that the top ten holdings of QQQQ comprise 46% of total assets. Apple AAPL alone is 19%. And so as more groups buy QQQQ, Apple goes ever higher, one move begets the other. Google and Amazon are also represented, and of course have been going up. This same sort of crowding by the herd into fewer and fewer stocks typically happens at most market tops. In 1929 it was RCA, in 1970 the nifty fifty, in the 1999 the dot.coms and DELL. Now it is Apple. If the 4% of QQQQ that is MSFT were that much more of Apple, QQQQ would be even higher now.
Now about that Chinese Growth Engine…There are continued reports of massive over building in Chinese real estate. Here Shanghai has failed on its attempt to get through the red 200 week MA. Note that the blue 50 week MA never penetrated the 200 week MA. The trend is down. Shanghai usually leads the US stock markets, as it is a derivative of US trade, this makes perfect sense.
Bottom Line Stocks are consolidating and should do so until mid December. Government bonds are bottoming and we bought them. There are examples that the bear market is well underway in various sectors such as colleges, casinos, and now municipal bonds. The US Dollar appears to have made another annual bottom which further confirms that the bull market in stocks is on borrowed time. We are buyers of UUP the Dollar, at 22.55 and below.
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