This Week in Barrons – 1-4-2015:
“There’s gold in them thar hills. Black gold. Texas tea.” TV show – ‘The Beverly Hillbillies’
Ms. Yellen – As I remember the line from the TV show, I’m having trouble getting past the recent commodity prices. Why are so many commodities coming under pressure? My first reason would be the strong U.S. dollar – because that is the denomination in which most commodities are priced. My second reason would be governmental price fixing – especially in the case of gold and oil. I always worry when nations start disrupting the normal flow of supply and demand. Don’t you worry about the physical demand for gold and silver out-striping supply – and creating a run on the commodity? Don’t you worry about our relationship with Saudi Arabia – and the U.S. ‘basically’ forcing Saudi Arabia to embrace the BRIC nations and become the dominant oil supplier to China and South East Asia?
Speaking of artificially controlling supply and demand, your QE programs artificially controlled the ‘demand’ for bonds by artificially raising bond prices, lowering yields and making bonds unattractive for investors who are seeking a ‘safe heaven’ income. For investors seeking any kind of return, you made the only option the equity market. The artificial environment allowed investors to easily borrow more money, buy more equities, and force higher equity prices. The December numbers for the NYSE Margin Index (investors borrowing funds to purchase more stock) hit new highs at over $450B. Ms. Yellen, I’m wondering, when will this party truly end? I’m thinking that you will never end the party because the U.S. has passed the ‘point of no return.’ What were once considered emergency room measures are now considered the norm. You can’t stop buying our bonds, because with a ZIRP (zero interest rate policy) there aren’t enough ‘other’ buyers. Increasing rates will attract more buyers, but that will cause the stock market to fall. If our market declines rapidly, it will have a dramatic impact on the economy and moral – which could lead us into another recession. I think you’re stuck. But, does this mean that you’re considering investing in the stock market (aka like Japan) – in order to be able to increase rates and simultaneously prevent a stock market decline? Because if we did suffer a market decline, many investors would receive margin calls – which would only increase the selling pressure. Remember, a stock only has two ‘real’ prices – one when it is born (goes public), and the other is when it ends (is bought out or goes out of business). All other stock market pricing is based upon perception influencing supply and demand.
And yes Ms. Yellen, I know – this time it’s different. But time and time again, when investors have access to capital they will borrow and buy something – regardless of the fundamentals. However, this time you and other governments are active participants in the markets. You are out there purchasing assets and fixing rates – actively influencing supply and demand. You are trying to control the story and drive perception. I only see two stock market outcomes for 2015. One is that we will all keep the faith – the party will continue – and the market will increase between 8 and 12%. The other scenario is that we will see a significant market correction of over 25% - not due to specific stock scenarios, but rather our country’s complete reliance on your monetary policy along with government intervention. I’m not sure you have the ‘bullets left in the gun’ to fight the next correction. Interest rates are already at zero, you’ve already printed trillions, and you’re buying bonds and mortgage-backed securities.
Honestly, maybe there’s more ‘gold in them thar hills’, or just maybe the FED’s oil well / printing press (along with many fracking situations) will be forced to shut down until everything stabilizes.
Looking backwards and forwards:
- In 2014, the U.S. remained the world’s largest economy (17.8T), but China is gaining quickly (10.0T). By 2025, China will become the world’s largest economy, and by 2024 India will become the world’s third largest economy. Russia is predicted to remain in 10th position through 2030.
- In 2014, unemployment rates hit 26% and 24% in Greece and Spain. In 2015, will Germany continue to want to prop them up?
- Will 2015 be the year that the U.S. ‘stops’ being the world’s belligerent bully? Using the Sony disaster as an example: (1) The U.S. was "absolutely sure" it was North Korea doing the hacking. (2) Then it became: "The Russians did it." Now, (3) it seems that it could have been some 3rd-Party hackers (including X-Sony (laid-off) employees) that were pulling a prank. How is it that we continue to make Page 1 headlines by pointing fingers at countries saying that we “have proof” – only to print a Page 12 retraction and go in a completely different direction?
- Will 2015 be the year that our FED continues to ignore the laws of supply and demand? In the case of currencies, nations are pseudo-defending and simultaneously devaluing their currencies in order to spur inflation and boost exports. Nations want to reduce the value of their own currency in order to pay down their own debts with inflated money.
- Will 2015 cause the oil market to completely come apart? The current situation is OPEC versus ‘all comers’. Due to the rise in ‘fracking’, the U.S. has increased oil production over 30% in the past couple of years. Currently the U.S. is almost in a oil production ‘dead heat’ with Saudi Arabia (9.3M barrels versus Saudi’s 9.7M barrels). I’m thinking that oil prices are going to have to come under serious pressure (enough to bring Saudi and the U.S. back to the negotiating table) before the oil pricing situation is resolved. During that time we will see the stock market cheerleaders come out and tell the world how ‘low priced oil’ is good for the world. All the while, entire regions and communities are losing their jobs. After all, energy drives the economy and it takes a lot of $20 savings at the pump to replace even one $90k / year job that is lost. Eventually oil will bounce back into the $70-$80 range, but the first quarter could be in for some oil volatility which will cause market volatility as well.
- In 2015, I think we will see an early increase in the value of the dollar. Whether this causes the U.S. Mint to finally say ‘no mas’ in terms of issuing additional physical gold and silver coins and bars – is anybody’s guess. Also, I’m wondering (with the initial strength of the U.S. dollar) how long oil will continue to be priced in Petro-Dollars.
- In 2015, because the dollar strength is going directly against the FED – we could see them architect a pseudo-collapse in the dollar in order to spur inflation and increase commodity prices. The danger here is if the world starts ‘dumping’ dollars (much like in the 70’s) – what will the FED do? We are 7 years into the ZIRP (zero interest rate policy), bond buying, mortgage-backed securities buying, and QE policy – which is causing physical demand to be disconnected from the paper market. Will this gap be bridged in 2015?
On Monday, we may see a bit more selling, but nothing horrible. The volumes will come back up and on Tuesday and Wednesday we should see a decline in volatility, and a renewed push higher toward the end of the week. I think we could be setting up for a sell-off in January – perhaps a 3 to 4% correction. But watch the Russell index to see if and when this may happen. I think that market valuations have moved beyond the traditional guidelines of company fundamentals and earnings. This market’s value has become ever more dependent upon Fed intervention and perception.
Obviously I’m a big believer in learning how to manage your own finances, because of the fee structure that is being charged by financial advisors for ‘sub-par’ performance. Over time, 96% of the total mutual funds will under-perform the S&P. Vanguard offers an S&P Index Fund that only charges a 0.14% annual fee. This compares to: (a) the average Non-Taxable Account fees of over 3.17% annually (20X Vanguard), and (b) the average Taxable Account fees of over 4.17% annually (30X Vanguard). These fees are a percentage of the amount invested. If I compared them to the profits that they generate, these fees account for over 30% of an average managed account’s profits.
My trading goal for 2015 is 2.3% per week – hitting fewer ‘home-runs’ and more ‘singles and doubles’.
- I will introduce a ‘Trade of the Day’ – that will appear on both my Twitter and StockTwits.com feeds – simply follow me as ‘taylorpamm’
- Due to dramatically increased market volatility, I will be reducing my emphasis on the weekly, ‘out of the money’ Iron Condor. I will be giving myself the ‘gift of time’ by concentrating more on investments 30 days out, and cashing them in 10 days out.
- I will be concentrating more on the directional and closer ‘to the money’ side of things. This will allow me to tilt the Put Credit Spread (PCS) or Call Credit Spread (CCS) risk/reward more in my favor.
- This will allow me to do ‘free’ trades, by using the proceeds from the sale of the PCS or CCS to either purchase a Debit Spread (Put or Call) or a ‘Broken-Wing Butterfly’.
- I will begin exiting trades when (a) 80% of the profit has been achieved, or (b) when a two times the ‘average true range’ stop loss has been ticked.
- I will also (on a regular basis) buy TLT Calls when it reverts back to its 21-day moving average, and sell those same TLT Calls when they exceed their 1.272 extension or their 1 standard deviation. This trade worked like ‘clockwork’ during 2014 and I see no reason that it will not continue working in 2015.
Here’s an example of how to construct a virtually ‘free’ trade.
1. Let’s assume you believe that American Airlines (AAL) is headed higher after earnings (earnings are on 1/27 before the open).
2. American Airlines ($53.91) has a ‘Daily Squeeze’ forming – and all indications are that it will fire long.
3. Step 1 = SELL the February (monthly – 2/20) -55 / +52.5 Put Credit Spread for $1.24 per contract – 10 contracts netting you $1,240 (cash – pushed into your account) – with a maximum risk of $1,260. A virtual 1:1 risk to reward ratio.
4. Step 2 = BUY 7 contracts of the February (monthly – 2/20) +52.5 / -57.5 / +60 Call Butterfly – costing you $1,134.
5. Netting this together with the Sale of the Credit Spread – you have a ‘free’ trade.
6. If AAL closes above $55, you net an additional $2,000 to $4,000 when you sell your 7 Butterfly contracts. If AAL closes between $52.50 and $55 you will basically have a ‘scratch’ trade. And if AAL closes below $52.50 you lose $1,260.
My current list of potential candidates for this week is as follows: Apple (APPL), Gilead Pharmaceutical (GILD), Russell Small-Cap Index (RUT), Bio-Tech Index (IBB), American Air Lines (AAL), and Southwest Airlines (LUV).
For next week I’m selling a specific stock’s bias via Put Credit Spreads (PCS) and Call Credit Spreads (CCS) – and playing the other side with a Butterfly.
- AAPL – JAN – SELL the +105/-107 PCS (Put Credit Spread) – and BUY the +115 / -117 / +118 Butterfly to take advantage of an earnings run-up,
- GILD – JAN – SELL the +90/-91 PCS – and BUY the +94 / -99 / +102 Butterfly, there is an upside ‘weekly squeeze’ in place,
- IBB – JAN – SELL the +297.5/-300 PCS – and BUY the +307.5 / -315 / +320 Butterfly, there is an upside ‘4-hour squeeze’ forming,
- RUT – MAR – SELL the +1040/-1050 to -1290/+1300 Iron Condor,
- AAL – JAN – SELL the +48/-49 PCS – and BUY the +54 / -56 / +57 Butterfly, there is an upside ‘Daily squeeze’ forming, earnings are on 1/27, working on the FEB trade as we speak,
- LUV – JAN – SELL the +38/-39 PCS – and BUY the +42 / -43 / +43.5 Butterfly, there is an upside ‘4-hour squeeze’ forming, earnings are on 1/22, working on the FEB trade as we speak, and
- TLT – SELL our existing +122 / -128 Call Debit Spread – and be ready to re-load on a pullback to the 21 EMA.
To follow me on Twitter.com and on StockTwits.com to get my daily thoughts and trades – my handle is: taylorpamm.
Please be safe out there!
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Until next week – be safe.