This Week in Barrons – 3-23-2014
Cook Those Books!
On Monday, the Ukraine held their referendum vote, and the majority voted to be a Russian Federation satellite. That prompted Obama to place some sanctions on several Russian officials. The market then proceeded to gain 200 points just because these were not really ‘sweeping’ or serious sanctions. I then turned on CNBC and found out that the market was up because we were probably looking at a 5% U.S. GDP increase, and our economy was much stronger than the winter numbers had suggested. For years our economy has been mired in a recession, and we’ve had to ‘cook the books’ in order to get anywhere close to a 2% GDP increase. But I wondered: Why isn’t anyone talking about how we actually could see 5% GDP growth? You see, in mid to late 2013, the Bureau of Economic Analysis (BEA) announced a change in how they will calculate Gross Domestic Product (GDP) going forward. They modified how money spent on research and development (R&D), and how money spent on the production of ‘intangible assets’ like movies, music, and television will be accounted for within the GDP calculation. The new methodology declares these expenditures to be ‘investments’ and immediately allows them to increase GDP by (in most economists estimates) approximately 3%. This ‘cooking of the books’ will lead to the perception of faster growth.
In the past, business spending on R&D (a portion of which comes in the form of salaries) has traditionally been considered an expense that does not explicitly add to GDP. However, that all changes with the new methodology. Also the cost of producing television shows, movies, and music will also count as investments that add directly to GDP. Thirdly, under the new system, government pension additions to GDP will be calculated not from actual contributions (as in the past), but from what our government has promised. For example: under the old system, if a state had a $10,000 pension obligation but only contributed $1,000, only the $1,000 would be added to GDP. Under the new system the entire $10,000 would be counted. So now a government can ‘magically’ grow the economy simply by making promises they cannot keep. Talk about ‘cooking the books’ – best stir the pot because the sauce is thickening.
Factually – this week:
- Housing sales and consumer sentiment declined 6%,
- Mortgage applications fell to 20-year lows, and ‘first time home buyers’ fell to 10-year lows,
- Auto sales are declining as manufacturers are pushing cars to dealerships that they don't want,
- With the resurgence of the automobile ‘sales at all cost’ philosophy – over 60% of auto purchases involve ‘sub-prime loans’,
- China started to ‘crack down’ on credit due to a Chinese Real Estate developer that defaulted on a $3.5B note,
- Poland transferred private pension $’s into their own general fund in order to reduce their debt,
- Italy’s largest bank defaulted on half-a-billion tier one bonds,
- Spain’s unemployment rate hit 56%, and
- Corporate ‘Insiders’ sold 69 TIMES more stock than they purchased. It’s the fastest ‘Insider’ sales rate in history.
Let me review that last statistic. Last week corporate ‘Insiders’ BOUGHT $37.8 Million worth of their own company’s stock, but SOLD $2.6 Billion worth. They sold 69 TIMES more of their own company’s stock than they bought. This has been going on for months. Corporations (with borrowed funds) are buying back their own company stock, thereby pushing the stock price higher. When the stock prices are this high, these same ‘Insiders’ are selling their own holdings in the company. Now, if the guys that are running the companies don’t want their own stock, why should we?
Unfortunately, you can only ‘cook the books’ for so long, until someone asks: “Is it soup yet?” Honestly, I think we’re close to it all boiling over.
This week was Federal Reserve week. Ms. Yellen said:
- The labor force participation rate was larger than she expected. Really?
- The weather was responsible for the lousy economic reports. Honestly?
- Asset purchases (the Fed’s Quantitative Easing) would end by the Fall of 2014. Wow!
- Interest Rates will increase 6 months after asset purchases end. Double Wow!
This rattled the markets. The ONLY reason our markets are at these levels is because the Fed is feeding our banks billions to buy assets and stocks. But honestly, that's small potatoes. The Fed has changed its M.O. (modus operandi). Their M.O. has always been to flood the system with money, not to worry about inflation, and do whatever it takes to ‘save’ things. The Fed now appears to be trying to ‘prop-up’ the U.S. dollar, while allowing the economy to fade. Something major has changed in the Fed’s agenda.
If the Fed is going to remove their portion of the punch bowl, then the only ‘free money’ remaining is in the Yen ‘carry-trade’. Without going into the details of Yen ‘carry-trade’, simply watch the FXY (an ETF that tracks the value of the Yen). If the FXY increases, it means that the ‘carry trade’ amount is going down, thereby reducing the only remaining supply of free money, and correspondingly reducing the value of stocks in general and the S&P index in specific. Therefore, if the FXY were to suddenly jump higher, it could create a ‘short covering rally’, and cause a lot of the mutual funds and ETF’s that shorted the yen to scramble and cover – causing the ‘carry trade’ to virtually end.
Previously, I was in the camp that thought that the Fed would reverse its QE reduction program. I also thought that they might launch a totally new program, designed to push billions into the system. But something feels different this time around. I'm getting NO hints at all that the Fed is willing to slow the tapering, reverse it, or even replace it. I tend to think that many on Wall Street still believe that this is all show by the Fed, and at the first sign of real panic the Fed will rush back in and save us. But that flies in the face of the fact that the Fed started this taper in the face of weakness.
Take Friday’s market behavior for example. On Friday things were going along swimmingly with the DOW up 125 points until the Federal Reserve participants Mr. Fisher and Mr. Bullard reinforced Ms. Yellen’s claims about tapering to zero by October 2014. They then tried to define a time line when they would actually increase interest rates. Immediately the market’s thinking changed, and the DOW plunged from being positive by 125 points to being negative by 30.
This is a very confusing time. Our #1 marketplace – housing – is not in good shape. First time home buyers are completely shut out, because their $1 TRILLION in student loan obligations are preventing them from taking on a home mortgage. Therefore, homes in the $90k to $250k price-range are NOT selling. The expensive properties are selling due to the 5-year rising stock market and the corresponding wealth effect. But the ‘first time home buyer’ has always been the driver of this sector, and without their participation any housing rally is unsustainable. With this as a backdrop, how can the Fed be telling us that interest rates will rise after October 2014? If people can't buy a home now, how can they ever afford one if the interest rates increase? Something quite odd is going on.
The market (after putting in a new intra-day high on the S&P Friday morning) faded back and ended the day slightly red. Any time a market is trying to exceed an upper resistance, it takes a lot of effort to move past. Usually it takes a few attempts in order to succeed. Unfortunately, now the markets have to question whether the Fed is really going to ‘have their backs’ and rush in with more funds when things get extended. Thus far, the Fed is saying ‘No’ – leaving only the Yen ‘carry-trade’ to take us to glory.
The market feels tired. For example, on Thursday – the day the market recovered all of Wednesday’s losses – more stocks declined than advanced. The rally is becoming narrower, and you can see that it’s struggling. However, we've been in this exact position a dozen times in the recent past and somehow the market just finds the will (and the money) to push forward. You almost expect it now, and that’s a very dangerous thought. I feel (going forward) that we're going to see some sideways chop as the market tries to muster the resources to break through the highs. I could easily see a week of up and down - tighter range movement – with a bias toward the downside. I feel that there is more downside pressure on this market, than there is upside ability.
As ‘Insiders’ continue to sell (including FEYE), this week I was stopped out of FEYE for a tidy profit.
Last week, I received some questions via e-mail asking me to further detail my DUST / NUGT trading plan. I would be glad to. NUGT and DUST are leveraged ETF’s that focus on the precious metals (gold and silver) mining space. The ETF’s are designed to mirror each other’s actions – meaning as one goes up the other goes down virtually the same amount. Let’s assume you have $100,000 to invest, and based upon Friday’s prices near the end of the day – here’s how I would construct the trade:
- DUST was selling for $21.10 per share.
- I would purchase 1,900 shares of DUST for $40,090.
- The standard deviation (expected move) in DUST for the coming week is $2.16.
- Therefore, the highest the ETF is expected to move is ($21.10 + $2.16) $23.26.
- Rounding up (to give ourselves a little cushion), the $23.50 calls are selling for $0.35 each.
- I would SELL 19 calls @ $0.35 each – (each call option covers 100 shares / and we purchased 1,900 shares = 19 call options) = earning us: $665.00.
- NUGT was selling for $44.44 per share.
- I would purchase 902 shares for $40,084.88 to mimic the $40,090 spend on DUST.
- The standard deviation (expected move) in NUGT for the coming week is $4.70.
- Therefore, the highest the ETF is expected to move is: ($44.44 + $4.70) $49.14.
- Rounding up (giving ourselves a little cushion), the $49.50 calls are selling for $0.70 each.
- I would SELL 9 calls @ $0.70 each – (each call option covers 100 shares / and we purchased 900 shares = 9 call options) = earning us: $630.00.
- This week, I would calmly (sit on my hands) and watch those call options expire worthless – pocketing their complete sale amounts of: $630 + $665 = $1,295.00
- $1,295, divided by a total investment of $80,175 = 1.6% per week = an 84% per year annual increase by repeating this process each and every week!
- Now – we only invested $80k of the $100k – simply because the numbers worked out fairly cleanly this way.
I hope that details the trade, and any other questions – please don’t hesitate to ask.
My current short-term holds are:
- USO (Oil) – in @ $34.51 - (currently $35.84),
- UCO (Oil) – in @ $28.75 – (currently $33.21),
- TLT (Bonds) – in @ $107.10 – (currently $108.46),
- SIL (Silver) – in at 24.51 - (currently 13.50) – no stop,
- GLD (ETF for Gold) – in at 158.28, (currently 128.44) – no stop ($1,334 per physical ounce), AND
- SLV (ETF for Silver) – in at 28.3 (currently 19.57) – no stop ($20.30 per physical ounce).
To follow me on Twitter and get my daily thoughts and trades – my handle is: taylorpamm.
Please be safe out there!
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