MorningWord: 11/2/11

by Dan November 2, 2011 7:12 am • Commentary

MorningWord: 11/2/11: Since making 2 month highs on Thursday, the SPX has sold off almost 6%, marking an almost 30% re-tracement of the peak to trough move off of the Oct 4th lows.  In a lot of ways this is very healthy if the rally is to truly have some legs, but I guess the reasons for the 2 day swoon are the real issue, not the price action, as they are the same reasons why we got clobbered all summer and into September.  I don’t have much to add on Greece’s on again off again referendum on budget measures that could imperil last weeks agreed upon bailout, but the situation has once again moved back towards artificial deadlines and almost impossible expectations.  Put together, the result will likely be similar to what we saw this summer, increased volatility due to what is becoming an increasingly emotional situation.

SO maybe 30 is the new 20 in the VIX.  As many of you know the long term average for the VIX is about 20, and often over the last few years when the the index has spent some time grinding below that level and basing we have seen a dramatic spike in volatility that can cause the index to double or event triple.

2 YR VIX chart from Bloomberg

Before this weeks almost 40% move in the VIX,  many market participants and pundits were certain that we would see a retest of the 20 level as it appeared that the worst case scenarios for Greece and the potential for a debt contagion to spread were at least off the table for the coming months…..over the life of the index it has only been above 30 for about 10% of the time and above 40 for little less than 3% of the time……This tells us that we are obviously in a period of extreme volatility but the real question is it likely to stay?   Spot VIX doesn’t give us the answer to that but for most individual investors this isn’t really that important, but what is important are the decisions you make in your portfolio when the index is showing extreme moves on the upside or the downside…..

For instance, when the VIX is very low, and stocks that you own have had very nice moves and the market feels extended, this could be a great time to consider stock replacement (selling stocks that you own) and defining your risk through the purchase of options to replicate the long exposure but only risking the premium that you paid.  This can be a great risk management exercise and one that can save you many sleepless nights as we head from a period of complacency like this past spring into a period of extreme volatility like we did this summer.

Alternatively, when volatility is very high like it was a few weeks back and continues to be now, albeit at lower levels, this could be an attractive time to overwrite stocks that you own (meaning selling calls against long positions) to add yield and a little bit of downside protection.

As for the markets this morning things are taking a welcomed breather from the near panic selling of Monday and Tuesday.  Other than some unexpected tape bombs out of Europe regarding Greece, the markets main focus will be the FOMC’s rate decision scheduled for 2:15pm and followed by Fed Chairman Bernanke’s press conference…..We could see a bit of consolidation as we head into this event as many investors will be waiting to digest what will be a ton of central banker and policy speak over the next 3 days as we also have an ECB  meeting and a G20 meeting.  The next few days are likely to hold the key to the direction of the markets for the balance of the year.  If the G-20 can’t get Greece to fall in line and accept the terms of last weeks bail-out proposal than I would expect the balance of the year to be as choppy as the last few months….if the Greeks succumb to their more grown-up neighbors and abandon the referendum than we could see a bit of well needed calm come back to the markets.  So for now we sit and wait….I think this could be a decent opportunity to get back into some stocks that you wanted to own last month that got away from you if you have an intermediate time horizon and believe that the markets will close back near the highs….I am a bit more skeptical of that and will continue to sit on my hands a bit until I have a better sense of what the trend will be.

Keep your eyes on the dramatic moves in the bond market, from the fabulous moves in our 10 yr yields to the spreads between Italian and German bonds that are trading at Euro-era highs…..movement in these markets are usually indicating equity market volatility one way or the other.

MorningWord: 11/1/11:  Oh what a difference a couple of days make…….in the last 2 trading sessions here and abroad, 2 driving factors of the last week’s final leg of the giddy rally have now been called into question…..Just when you thought the Euro-Zone had a plan to bail-out Greece and recapitalize their banks, Greek Prime Minister Papandreou goes and does a bone-head thing like giving his citizens the choice to vote for or against austerity measures that would in fact determine whether or not the proposed bailout would see their way to Athens.  Well I am all for democracy and all but maybe this could have been done before last week’s summit meeting and the ensuing 5% relief rally.   This referendum, as it stands now, may not be until early in the new year and, as I have said on many occasions of late, this Euro debt crisis is the gift that keeps on giving to the shorts in this market.   I have to assume that the polling that will be done in the coming weeks will point to the lack of support Papandreou has for austerity and this will likely lead to default and exit from the EU and a Greek economy that will look more and more of that of a third world country.   I have also said of late that barring any reversal of the bail-out plan all signs point to a higher close in the equity markets…..well, yesterdays events might have thrown a monkey wrench into that thought process.  

As for the second and harder to get your arms around factor, China’s slowing growth and the potential for a hard landing.  Last night China released manufacturing data that fell short of expectations and marked the lowest reading since  2009.  Your guess is as good as mine as to what this really means and whether it is a start to a trend, but the recent bullishness surrounding soft landing hopes may be fairly neutralized and the thought that Chinese demand may start to slow at at time when the western world is deep in austerity is fairly concerning when you consider the few levers we have to pull to stimulate growth.

At this point things feel about as bad as they did 2 weeks ago when the rally was still being questioned……The S&P is now about 5% off of Thursday’s high which equates to about a 25% re-tracement of the move off of the Oct 4th low.  For the last few days I have been suggesting that we could see a 5% or so sell off and at that point it could be time to re-evaluate the merits of the rally and whether or not it is time to get in…..As many of you know, or have asked about over the last week, I have not been doing a whole heck of a lot in the markets and have stuck to a few stock specific stories.  This has largely been because I haven’t believed in the rally and refused to play it from the long side.   I haven’t believed in it because I feel that it has been a relatively artificial, almost a self full-fulling prophecy of sorts.  While I clearly don’t see a strong likelihood of a retest of the lows this year, the picture has gotten a lot murkier, and the potential for the rally to continue into year end is clearly now in question.  SO, the trades that I have entered in the last week have been from the shorts side, 2 in MS, 1 in GS, 1 in Hans and couple tech names into earnings…..My general inclination has been correct and while I was looking for a pullback of this sort I wasn’t exactly set up for it either way….I am not long by any means, but not nearly as short as I want to be.  Such is life, but I will tell you that just when u thought the VIX died a slow death in the last 2 weeks, volatility is back and we will have plenty of opportunities to play it…..

So for now I want to see how messy things get here and make an assessment when our markets are particularly sloppy.  I WOULD NOT PRESS THIS OPEN ON THE SHORT SIDE.  Our futures are down 2.4% as I write with the DAX down 5%……We could clearly catch up to Europe and be down 3-5% but I am not sure you get a ton of bang for your buck selling the open.  If you are like me and like to day-trade the SPY, SDS/SSO or the like, than wait for a rally, that is what I will be doing…I will try to sell the first rally and use a tight stop, because the last thing you want to do is press a market that has been down 5% in 2 days and have your “face ripped off” by a tape bomb.

Also important to remember we have an FOMC meeting tomo, and ECB meeting Thurs and the G-20 Meeting at the end of the week.  Central bankers and policy makers may do what it takes to talk this thing (the markets) up a bit, so watch your ass!

Yesterday on the close I took off half of the MS Nov 18/17 Put Spread that I bought Friday afternoon for .20 at .40.  Many of you may start to recognize a trend, when I do this I am taking my initial capital off of the table and letting the other half ride.  This is a strategy that ultimately will not benefit from home runs, more like a lot of doubles, but in a market as volatile as this one I don’t think it makes a ton of sense to be naked short stocks and when I can get leverage and define my risk as I did in this trade, I want to book profits when I can and then “play with the house’s money”.  This strategy over the long run will dramatically increase my odds of success.  With MS well Below 17, the strike that I am short I will look to take the balance off for a nice quick profit in less than 3 trading sessions.  Check back this morning for an update.

MorningWord: 10/31/11: As I write at 9.20am, the headlines read like a horror show as it relates to the ability of European leaders to get funding for last weeks proposed bailout……The Euro is getting slammed down 1% vs the Dollar and their equity markets are down across the board, the DAX is down about 1.8% with our futures down a little over 1% in sympathy.  Bond yields in Italy continue to move higher to record levels showcasing the skepticism by many that last week’s bailout proposal was just that, a proposal, and severely lacked detail… the mean time as the focus on Greek default seems to be off the table this year, market participants will move to the next wounded soldiers, Italy, Portugal and Spain.

As I wrote last night in the “Weekender” there is a ton of stuff going on this week from important economic data all week, to FOMC meeting and capping off with ECB meeting Nov 3.

At this point I don’t have a ton more to add from last night’s piece…..keep an eye on Italy’s ever increasing bond yields…this will be a focus for many equity traders.  After the historic rally of the last few weeks I think a sell off of 3-5% would be healthy and could be a decent buying opportunity for those looking to get long into a year end rally.  WIll be interesting to keep an eye on our banks to see if fears of further debt issues among the other PiGS can rattle them from their 2 month highs….


On another note, I saw a great young Scottish band that I have seen a few times over the last 2 years, We Were Promised Jetpacks, at Webster Hall in the East Village.  Watch clip below, song is “Circles and Squares” from their new album In the Pit of The Stomach:

MorningWord: 10/28/11: 

“Where will all the martyrs go when the Virus cures itself?  Were will all go when it’s too late?” Billie Joe Armstrong, Green Day

Last night I saw Green Day at a small venue within Webster Hall in the East Village…..The impromptu show, with some new music made for a pretty memorable performance…….but I am paying for it now (ears till ringing), they didn’t go on stage till about 11:45pm and didn’t stop playing till about 1:45am……But the above lyric from one of my favorite Green Day songs; Letterbomb, appears to be fairly apropos for the market environment we are in at the moment.  And if you have been short or havn’t caught the rally of late it you might have found it therapeutic to let out a scream as I did last night with Billie Joe at the end of that lyric! Ok back to work… for yesterday’s rally, well I got the reaction dead wrong, I was obviously in the camp of the “sell the news” and that really didn’t work.  I will tell you that I tried to fade the rally on 2 occasions yesterday buying the SDS, the double short S&P inverse etf, and in both occasions was stopped out…..and thankfully so. European markets and our futures are practically unchanged relative to the move yesterday and this is obviously fairly bullish action…….Today’s open and the markets ability to hold yesterdays gains will be fairly telling in my opinion…..If they open slightly lower and then rally and we close up on the day they watch out cause the fix is in….With 2 Holiday shortened months ahead before we close out this crazy year, chasing performance and marking underperforming portfolios could be the name of the game for institutional portfolio managers….Now I know that sounds like a rigged game but that’s just the way it works……If European leaders really have succesfully kicked the can down the road and the news will be “less bad” and actually start to get a little brighter than away we go…..I am not telling you that I agree with it, Just telling you what is likely to happen…. I am not buying anything before we have a little re-tracement of the recent move, before yesterday’s rally I thought we could get a 3-5% sell-off that could serve as a decent entry point for a push back towards 1300 in the SPX… this point I would wait for the same and a little bit of a consolidation…..If the markets are going to attempt to get back to the previous highs of the year they will need to broaden out a bit and thats when a lot of the crap will start to rally.   We will start taking a look at some of the under-performing names and try to identify some catalysts that could help justify getting long for reasons other than that they have under-performed. As for today I am going to continue to sit on my hands a bit and see what the market brings…..if we get a rally after the opening I will trying shorting it with a tight stop…. I took one last shot at replicating short exposure before earnings in BIDU last night and obviously I pushed my luck a bit as the company beat and raised and the stock is trading up solidly in the pre-market.  This was a sentiment trade much like AAPL, IBM, and AMZN and frankly there are some big differences that have become apparent in the set up…..Even though BIDU was up over 30% ytd heading into the report as they others were this stock, while up more than 30% in the last month was not trading at all time highs and actually well off of them….At the end of the day I was risking some recent profits in the similar strategy and I defined my risk…..     MorningWord: 10/27/11: Well I guess all is right in the world again and if you had any questions that the rally off of the bottom earlier this month was not predicated on the hope of a compromise on a plan to solve Europe’s debt issues than you were sadly mistaken…..Ok fine we get amazingly oversold, and sentiment seemed to be a bit pessimistic when the SPX was below 1100….But the 3 week, almost 19% rally (including today’s pre-market gains) off of the lows seems to be overshooting a bit on the upside.   As I write at 9:15am Europe is raging with the DAX and the CAC up over 5% on the day…..S&P futures are up 2.6% in sympathy, Euro is up, Gold down a tad, Crude is raging up 3% and bonds down a bit…….Seems like the perfect risk on storm. If you feel as I do that we basically got exactly what was expected out of Europe, than you probably want to fade this opening gap, which is what I intend to do……but in an environment like we have been in where mutual funds and hedge funds have gotten turned around pretty dramatically on numerous occasions this year, we could see a bit of performance chasing now that it appears that there is at least a sound plan in place to attempt to solve Europe’s debt issues……my point here is if you are going to try to fade this move, you have to have a little discipline and use stops and where possible look to define your risk….. As I said yesterday, I have the fewest amount of trading positions on than I have had at any point of the year, I havn’t believed in the rally and there fore I haven’t bought it,  and actually the majority of my trades have been from the short side since the Oct 4th bottom, and they have been working (except the bank shorts)…..So the point here is if you feel like you missed the rally, who cares, there are plenty of opportunities to express your views (even if contrarian) in a defined risk manner……also remember that we all reserve the right to change our minds…….At some point into year end I think it makes sense to trade this market from the long side in advance of what could be an epic mark up by mutual funds but I want to see a little bit of a sell off and then possibly a consolidation. So for today, if you are not long, I can’t tell you that it is a great idea to buy this open, and I will likely to try to short it (while using a tight stop), but when u look at the strength in Europe, I wouldn’t be surprised either if we make a quick attempt to the 1300 level, but at that point I will be very short.   MorningWord: 10/26/11:  Yesterday’s 2% sell off in front of today’s Euro Summit was probably the healthiest thing that could have happened as expectations for immediate positive results have at least diminished a bit.  As I wrote yesterday morning, with the markets at 2 month highs (pre-market) that there will only 2 likely outcomes, all out disappointment and basically soon to be realized disappointment…….either way would not be friendly to the equity markets…..   Many market participants started to feel that the situation in Europe was starting to take a back seat to the presumed strength of U.S. corporate earnings and suggestion that China was not likely to have a hard landing.  Well all of the sudden a rash of earnings here, AAPL, IBM, AMZN, MMM, TXN, WYNN and BRCM to name a few have caused some reason for alarm as the appearance of near term demand seems a little hard to determine.   Pundits explain away each situation as company specific, but I am not sure it is that simple…..As we head into the back end of earnings it will be very instructive if company managements start to sound a bit more subdued as they realize there isn’t a ton of upside to being overly optimistic at this juncture….. The equity markets reaction to what ever comes out of Europe today could be very telling to the direction for the balance of the year….Your guess is as good as mine, but I remain in the cap that equity markets will be disappointed no matter what the outcome…..I remain cautious and defensive….. I continue to take shots on the short side in High-Fliers and it is working……HANS cratered 8% yesterday on no apparent news other than that is has gone too far too fast…..The 12% decline in GMCR, 35% decline in NFLX and the 25% rout in FSLR is not helping the psychology towards these sorts of high valuation names….. Shorting names like AAPL, IBM and AMZN that were all making all time highs and up over 30% ytd heading into their Q3 reports also proved to be a big winner……Now remember when I say short, I mean replicating short exposure through defined risk structures ranging from outright purchases of Puts, Put Spreads or Put ButterFlys. My latest near term play is a recent short in MS and GS and yesterday I legged into Put Spreads from out right put purchases the previous day…..For those of you who missed this, go back and read the updates (here) as I think it can be fairly instructive to approaching situations like this in the future…. Currently I have fewer option positions on than any period over the last few months…..I think we are at an important inflection point, and I have decided that rather taking a broad macro view, I am going to continue with what has been working over the last few weeks, trading individual stories tactically.  I am very tempted to short the DAX, the Euro and possibly buy China against those….. So for now I will partake in my cafe au lait/croissant breakfast and put in my early lunch order consisting of schnitzel and gyro lunch and wait for what are funny friends abroad have to say about saving the western financial world as we know it……oh and then I will take Zantac to counter act my heartburn and what I expect to be equity market weakness. MorningWord: 10/25/11:  Equity markets the world over continue their giddy little run into tomorrow’s second Euro summit on their debt crisis……Make no mistake about it, expectations are high…..kind of feels like AAPL the day before the iPhone 4S launch, and to be frank I reckon we get a bit of a similar reaction to what AAPL got after that product release…..”sell the news”.   The way I see it the summit will go one of 2 ways, all out disappointment, or compromise that does not match the already high expectations…..either way in my opinion after the almost 18% rally since the Oct 4th lows, we are gonna retrace a portion of this move.  I am not calling for a retest of the lows, but we could clearly see weakness in the range of 5% near term.   We continue to get cross-currents that make dissecting whether or not this was a sort of 1998 kind of market trauma, or the start of a 2008 sort of thing….the excerpt below is from my “MorningWord” On Oct 4th, the day we bottomed and I think it is important to reconsider this discussion now that we are well above these levels and the market appears a bit complacent…..Also remember that I covered most shorts that day and am sitting on some fresh powder…..

The real question, is whether this recent downdraft (-20%)from the multi-year highs is the start of a bear market similar to March 2000-March 2003 and October 2007 to March 2009 or was it more like the July-Oct 1998 market swoon caused by Russia’s financial crisis and the collapse of Long Term Capital.  Chart below shows the peak to trough sell-off of about 22% and the double bottom made on Oct 8th of 1998.

SPX May 1, 1998 to Oct 23, 1998 from Bloomberg

What’s interesting about the pattern above is that this sell-off was caused by a foreign financial crisis but was in the middle of a massive bull marker phase…..the chart below is of the same time period this year……does it look familiar?  Interesting to note that both charts made their last highs on July 20th and 21st and the million dollar question will both make a double bottom around Oct 8th?

SPX May 1, 2011 to Oct 3, 2011 from Bloomberg

Many equity investors are scratching their heads and trying to figure out whether to pull the plug or hang on at current levels, now down about 20% from the highs of the year.  Unfortunately I don’t have the answer to that question, but I will tell you that the closer we get to 1050 in the SPX (the level where we bottomed summer 2010 before the QE2 rally) the more likely we are to get a fierce bear market rally that will rip the faces off shorts……So I continue to ride shorts but on every sell off I take some profits.  My hope is to whittle down those positions to tag ends by the time we make that little near term bottom.

Well the markets are telling us at the moment that this recent downdraft was more like 1998, than 2008, and almost to the exact days of the year July 20/21st to Oct 4/8th….. The cross-currents range from mixed economic data here and abroad, to some market participants placing a great deal of value on China’s PMI number released yesterday, and suggesting that was the only number that matters. I don’t buy that for one bit and think there is a strong likelihood that we look back at that as a massive head-fake…..Also earnings while they have generally been good there have been some interesting names that have clearly disappointed, MMM just today, TXN last night and IBM and AAPL last week.  Will we look back and say these were the canaries in the coal mine? Throughout this past 2 weeks some of my best trades have been on the short side, so I would argue for those traders out there, even in what feels like the re-emergence of a bull market that there are plenty of opportunities to play from both sides of the market…..Yesterday I initiated some bearish short term positions in MS and GS (read here) and NFLX into earnings (read here)……the jury is still out on the banks, but NFLX i might have been so right that i am wrong….I got the direction right and the reasons for the sell off, but at the moment the magnitude is far greater that what I expected…..Check back later for how I will manage this trade. So I remain cautious and defensive, primarily as I feel no matter what happens tomorrow the markets will be disappointed and I think there is a good near term opportunity for a trade on the short side of the broad market, I may look to weekly SDS calls or look out to NOV and buy Puts in the EWG, the Ishares MSCI Germany Index etf. The DAX which was down almost 35% from its May Highs is now up about 23% from the early Oct lows and just broke through important resistance, I find it hard to believe that European indices will continue on their path to unchanged merely on a plan to fix their debt issues, the real test will be the implementation of austerity measures and co-operation among EU members to see the bail-out through….this will be much harder than it looks and play out over a long period…..   MorningWord: 10/24/11:Friday’s close was nothing short of impressive, with the SPX closing at 2 month highs and popping the little flag it had been forming above 1200 for the last week.  From a technical perspective the chart looks pretty darn good, it has consolidated above the top end of the range (since early August) and now looks poised to test that all important 1250 level that served as staunch support for most of the year until the drama following the S&P’s downgrade…..

SPX 5 month chart from Bloomberg

The index is now up about 15% from the intra-day Oct lows and barring any big surprises out of the Euro summit this Wednesday, we could be headed toward that 1300 level.  I don’t say this with a whole heck of a lot of excitement, as I have not been and am not set up for it, and frankly don’t really see the logic in our equity markets being practically unchanged on the year given all the potential near-term headwinds….. Investors hear the saying that “the equity markets are a discounting mechanism” all the time and most of the time it is fairly accurate……at this point our equity markets are telling us that risks of Europe’s debt crisis spreading the world over are not great, and that U.S. corporate earnings are what really matter at the moment….we will get a very good read on this as almost 200 of the S&P 500 index report this week. As for the Euro Summit Wednesday I am hard pressed to think that these talks descend into chaos and that they are not able to at least introduce a plan that will keep the status quo…..if we continue to rally into Wednesday I think you have to take a shot and fade the markets and try for a “sell the news”