Perspectives on the Market?

Being friends with your broker can have a unique set of perks. Flying wingman to an economic round table turned out to be just that, a fantastic perk. I wound up in the audience for a Morgan Stanley Smith Barney market discussion moderated by Consuelo Mack that included the following:

*Jeff Applegate {CIO MSSB}

*Bob Dole {Sr. Managing Director at BlackRock}

*Dr. David Kelly {Chief Market Strategist at JP Morgan}

*Christopher C. Davis {Chairman of Davis Advisors}

Below are my notes, a few quotations, and a comment or two

All four men stated, unashamedly, that they expect to see the next ten years produce 8-10% inflation adjusted returns from equity holdings. In order to achieve this rate of return in an individuals portfolio they suggested being overweight equities, underweight bonds, and an acute focus on Emerging Markets {BRIC}

Davis argued that we're doing ourselves a huge disservice by staying in Money Market Accounts. He noted that the Perils of Passivity {being in a safe haven like cash} are essentially backward thinking. He equates cash to "The Returnless Risk", citing that in the lifespan of his father, the dollar has lost 92% of its purchasing power.

Kelly proposed that the idea of current massive volatility in the market becomes much more muted when you change the time period to a 10 year moving average. He said that historically speaking, current volatility is very average when viewed through this lens. His recommendation was, "have a plan, stick to it." I found it rather cliche and dull. Remember that the further out you take your volatility lens, the less muted weekly, monthly, even yearly events become. I expected deeper wisdom from a Ph. D in economics.

10 year moving average of the S&P yearly volatility. We're average right now, huh?

Applegate had a unique outlook for the near term. He mentioned the date December 1st. No one in the media has said a thing about this to my knowledge and he made a compelling argument. Obama's Committee on Deficits makes it official recommendation about how to fix our current situation. The only other time this type of committee has been around was during the Reagan years. The outcome of that committee was a change in the retiring entitlement age from 65 to 67. Applegate said that this will happen again and the result will result in pushing our debt further out the curve. The 'media' effect will say that our budget is looking much better and the stocks will continue to head higher. I don't have an opinion on whether this will happen or not, but it was interesting.

Here are a couple of  one-liners and some of the interesting correlations they cited though providing no actual data were:

*14% of disposable income went to debt servicing in 2000, now we only use 12.1%

*The largest component of Consumer Confidence is the Unemployment Rate

*Attractive P/E ratios are the precursor for gains in Consumer Confidence

*High Unemployment is the precursor of gains in future equity valuations

*QE2 is coming

*The Bush Administration Tax Cuts will be extended for at least 2 or 3 years

On the whole, it was an interesting night with some people that I would dub "perma-bulls." I was a touch disappointed that there were no contrarian viewpoints to their arguments, though I am sure that bearish comments where NOT what they were hired to talk about. I'll finish with a quote from Sir John Templeton that I'm sure they would have engraved on their desks. {especially knowing where we've just come from and where they believe we're headed}

"Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria."

What does everyone else know...

I noticed this headline today on ZeroHedge.com

NYSE Short Interest Surges To Second Highest In A Year In Advance Of September Short-Covering Rally

Here's the accompanying graph that can be found here.

I don't really have much to say about this with one exception. IF we do get some type of hint at QE2 AND we have a broad market rally, it will be greatly exacerbated by the rush to cover these shorts.Oh and good luck getting real volume done when the HFT turn off their algorithms.

Sizing up my opponent

Mid-September and I have plenty of irons in the fire. Yet the daily grind in the Fed Funds is slow and sometimes arduous.  The idea of growing our single accounts into a larger, more macro-focused trading vehicle has begun to effect my thoughts and the process by which I believe trade creation occurs. The Greek philosopher Heraclitus wrote, "Nothing endures but change." {We often hear it translated just a bit differently as, "Change is the only constant."} My newer approach is to pull back from the one tree from which I'm picking apples and take a look around me to see if there is any low-hanging fruit on another trees nearby. Why strain for the next marginal piece of fruit in my tree when there is a perfectly good piece of easy fruit on the tree right next to you? All that to say, I want to expand the book and create a greater exposure and presence markets that relate to the FF.

I've been at this long enough to know that most of my trades don't just appear out of nothing. A majority are created out of a calculated premise, a lengthy discussion and the intangible of experience. However, if we are to aim towards a more macro goal, I think the process can shift to a round table conversation where we answer the following questions:

1. Where do I think we're going tomorrow in the products that we trade?
2. What is the best trade for tomorrow?
3. What is the best trade for the next few weeks {3-6}?
4. What is the best trade for the quarter?

 I don't necessarily have the answers to any {all} of those questions at any given point, but collectively the answers will emerge. What I've described is the goal. How we actually go about getting to that point; well that's the adventure.

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I want to shift gears a bit and just briefly lay out some of the trades we've been working on over the last few weeks and months.

• In the FF we've been selling the 87/93 call spreads in December and February. We've been able to collect between .75 and 1 tick {1 tick = $41.67} and though they aren't "make your month" trades, they do help us finance our other positions.
• We've sold the March 68/75/81 put tree {-1, -1, +1} and collected an average of 1 tick. This trade leaves us short two downside puts and long one put that is currently ATM. If nothing happens in the Fed's policies or rates for the next few months OR we move higher in price {lower yields} we will simply collect our tick and be done with it. If however, we start to move lower, we're long a put spread with 1 naked short put below. The break even for this trade is roughly 9961.
• We've also done the May 68/75/81 put tree as describe above. However, we were able to collect an average of 2.75 ticks to sell the two legs and buy the one. The thought process and the theoretical payout is very similar.
• We have purchased the EDH {March 11} 92/95 {9925/9950} put spread in the Euro Dollars. Partially as a hedge against our FF put trees and partly to allow some credit risk exposure. Our thinking was if another European nation even hints at some type of sovereign wealth issue, the ED will react much more violently than the FF. We paid an average of 4.5 ticks {1 tick = $25}. The maximum this trade is worth is 25 ticks {less entry costs} giving us a very nice 5x1 on our money if it hits.

As far as what is out there but not quite ripe enough to pick? I think that the NOB is getting very attractive as a short position. The yield curve has been pricing in some type of QE2 coming out of tomorrow's FOMC meeting just as they did back in August. However, I find it difficult to believe that they will announce any type of easing coming out of an FOMC meeting. Perhaps they tweak the language, but nothing more. The chart below shows the generic NOB contract as generated by the CME. From its last top to the most recent bottom was nearly 80 ticks. At $156 per tick, that's a profit of ~$6,000 per one lot. I'm not sure how to best capture the pricing currently in the market. My gut says to get long USX {30 year Nov} put spreads and sell TYX put spreads for near zero cash outlay.

 ~LH

Summer is finally over

It was a summer filled with doldrums.

There were long stretches that I was on vacation. Ironically, there were even long periods where I should have been. The volume in our contracts was anemic and is just now beginning to pick up. Even so, I've found it increasingly difficult to regain my market feel. All of the moves have been one directional with virtually no two-way paper. It's hard to make a trade and then have to sit on a position for what seems like weeks just to see if the trend folds back around. The P of PnL has been tricky to come by, the L has been here frequently.

As my kids are now back in the saddle with school, so must I rejoin the ranks of the working. The plan will be to write at least twice a week. I want to outline the plays I think are worthy of a look and the discuss some of the thought process that we've put into out trading. I have been joined by a new accomplice from past life. And though I haven't figured out his moniker yet, his ideas have already permeated my thinking. Hopefully, he and Mr. Practical Thinker will start to contribute on a weekly/monthly basis. Their ideas are always fresh and thoroughly thought provoking.

In the next few days, I hope to put out a couple of our current positions as well as a few of our thoughts on what might come next.  

~LH