The Market As Proxy For...

"...and, it would not be fair to conceal from you, there is a drawback to the bottle; for if a man die before he sells it, he must burn in hell for ever."

"To be sure, that is a drawback..."

Quote from The Bottle Imp, by Robert Louis Stevenson

This market seems to be a proxy for nothing but itself; the current risk appetite of the day curbed or stoked by breaking headlines but immune to the horrors trending over the long term. Even with a month to make some stuff up, our government couldn't infuse enough red blood cells to shoot our GDP up to 2%. There just might be an understated drawback to our debt and QE2. As MarketWatch's Brett Arends pointed out this week, it has been a failure. GDP has dropped over the last year, the change in unemployment has been a simple conversion of part-time laborers to full-time laborers on a small scale at a cost of $850K/job, and consumer staple inflation has risen significantly during that time. Meanwhile, housing has taken another dump with the tsunami of never-ending foreclosures and unlisted defaults causing a permanent hairball in the banking drain.

So, what are the actionable trades given that this market just doesn't care? First, let's look at a basket of losers. RIMM I pointed out in my last post along with Sears as companies that are just stuck in businesses losing market share and momentum. We can also add CSCO to that list, who, along with MSFT, continue to falter despite hoards of cash. First Solar has nose-dived from $175 to under $120 in a business I think people continue to overestimate as a future cash cow. Add in Chanos' drum beating this thing down to "mid double-digits," and FSLR looks like a good short, again.

On the long side, two names are worth revisiting. Having failed to pull the trigger (name it, anytime would've been a good time since it hit .10), Sirius LEAPS still look attractive. If Malone can push them through their debts until next year, SIRI should continue to rise on improving car sales and pricing. Jan 13 $1.50 calls are trading at a measly 6% premium to current price, as are Jan 12 $2 calls. Jan 12 $1.50 calls are basically at par with today's price of $2.37. And, dare I say Citi, after falling below $40 (or $4 really) this week, might be worth some longer dated calls as they are cheap and traders seem to still love this stock as a day-trading tool with nice liquidity.

The Party's Just Beginning

I hope you were as amused as I was at all the articles refuting the parallels between LinkedIn's rocketing IPO and the internet bubble of 1999. The justifications for what one journalist called "a glorified resume service" were abundant and reminded me of the bashing I took for suggesting solar and ag were overbought 3 years ago (see article here http://seekingalpha.com/article/73752-those-bubbling-solar-stocks). And they're partially right; it's not 1999, it's 1998. We've seen this gig before, grossly underpricing the IPO, stock doubles day 1, and a bunch of insiders become multi-millionaires. If LinkedIn, a company with earnings of $15 million and projected losses for 2011 can trade for $110, then Groupon and Facebook should hit $200 or $300 easily, right?

The current tech rising coincides with cracks in the facade becoming more evident daily. Aside from dismal manufacturing numbers which are always blown off as one-off events by the bull, retail's ship sank this week with Gap, Sears, and Aeropostale at the helm. Despite frequent Fed reassurances that commodity inflation will be transitory, Gap, one of the largest clothing retailers in the world, said they would knock .30 off of estimates because they could not get pricing power on cotton. Recent flooding and soggy weather has halted the rapid drop of corn and wheat, and gold has managed to stay strong in the face of a rising dollar. Interestingly, as Bill Fleckenstein noted in his column this week, China recently put a a $500 million bid on a gold mine, perhaps a sign of things to come.

This market has been very difficult to short for a long time now. Even stocks such as Open Table that were begging to be punished could have lost you a lot of money on its way from $20 to $120 before its recent $30 slide. But the list is growing. Priceline is still above $500. RIMM has taken a beating from near $70 to the low $40s and is caught in the middle of Android's ever-available platform and the cache of the iPhone. Sears lost $1.39 last quarter and is getting killed by both of its businesses. Berkowitz loaded up on Sears and Cisco last quarter and either knows something we don't, or is willing to take some short-term pain. The cable cowboy, John Malone, entered a bid for Barnes and Noble for $17, sending the stock over $18 yesterday. Malone is a bright guy who has been able to piece together unrelated businesses in the past, and BKS may be worth a small stake as either an arbitrage play or to gain Liberty shares going forward. In the meantime, I'm sticking with cash.

The Glitter is Gone

I have been pretty straight forward in my philosophy over these 210 posts. High risk, high reward. Have no misconceptions about the market as an individual trading against the beast. And never forget Taleb's Thanksgiving Turkey.

My last two posts simply recommended buying food and metals. Easy to say now that it was the easy trade, but at the time SLV was trading at $23 and DBA around $25. Those positions have since been closed and I hope that you weren't waiting for a new post from me to give you a stop on SLV. I have been recommending GLD since 2008, and even with gold down $75 from it's all-time high, the trade worked out well. I have discussed my outlook several times recently with my brother who has asked what advantage I have in buying calls on commodities versus other investors. The simple answer is none. The slightly better answer is a belief that fiat money is ruining our economy and that we would pay dearly with commodity based, not wage-based inflation. So to lever that belief, I use options. It turns out silver was the most volatile of that group which enhanced my returns. While oil also rose 3x over the course of QEs 1&2, my advantage was nil as I mistakenly used USO as my tool, not oil futures (which is not an option for most of us). And I guess the bottom line answer then, is my only trading advantage is a willingness to take big risks in this game, which now more than ever seems like a casino.

If you need further proof, look no further than oil recently, which has had 3 trading days with 6% or more volatility, 6%! What about SLV, which tripled in less than 2 years and lost 28% in a week in no small part due to 4 margin requirement raises in a single week. How can anyone feel safe going home on a Friday and watching a position lose 12% in six minutes Sunday night? A commodity position? Think anyone was getting crushed by silver's rapid rise, perhaps Goldman, who saw silver rise 20% after their big note recommending a strong sell on commodities? Ironically, Goldman has dropped nearly 15% in the last few weeks as mounting litigation and perhaps the impending IPO of Glencore weigh on its share price.

The recent rise of the dollar has not only killed commodities, but sunk our market. You'd like to think that increasing value in your paper assets is good, but our leaders know better. As QE2 ends and uncertainty increases surrounding Europe and a willingness to let the U.S. devalue our dollar, there will be more of these triple digit days ahead. Days I have no interest in owning much until either the helicopters load up again or the world faces its debts. BAC under $12 today, Citi down 7% since its split, Open Table trading at 10x the multiple of Google, good luck out there.

What's Next?

Four months later and not much has changed. The market, coming off its worst week of 2011, has still seemed to climb higher at almost every inflection point. Back in September, I recommended calls on three ETFs; GLD, SLV, and DBA. Since then silver has hit 30-year highs, gold all-time highs with a recent $100 bounce, and several commodities have hit generational highs. The recent turmoil in the Middle East has provided increased volatility, and despite our chief economist's assertions that we have no inflation, a $15 spike in oil was all it took to cause a market plunge.

I'm sure that the market will continue to reward any decrease in oil price as it did Thursday into Friday, as if $98 a barrel is not inflationary. The bigger concern should be the rapid fashion in which these large African nations were so easily overthrown, like pulling back the curtain on the Wizard of Oz. Food shortages in India have become a concern, and several weather related incidents have only conspired to put pressure on ag prices.

The next few months should be interesting. I think weekly options continue to provide the extra leverage we like in the meantime as poor earnings are punished to the tune of 15% daily losses as we saw withe Cisco and HP. Next month we have yet another review of banks' fortitude, with the outcome sure to reveal the ability of JPM and WFC able to easily pay a dividend while Citi and BAC languish. This will provide an excellent opportunity to either hedge XLF or buy calls on XLF while shorting the losers.

Still Alive...

Wow, been a long time.  Sorry for the prolonged absence but the bulk of my extensive readership has been kept up-to-date via email for the past few months.  When last we spoke the European stress tests made us money, now it's Helicopter Ben who will put the final nail in the deflationary coffin.  QE2 was not only foreshadowed, but Ben himself defended his actions by pointing to a rising stock market as proof of its effectiveness.  Since when is our chief economist mandated to prod the market?  I thought it was money supply and employment.  Hmm.

Since our inception we have pointed to gold as the ultimate inflation hedge.  Just this week the head of the World Bank has called for a return to some form of gold standard.  But gold is only part of the answer.  Silver at 30-year highs.  Cotton, coffee, corn, name it, at multi-year highs. The concern always becomes are we in a bubble?  With an explicit policy of currency devaluation, the answer is no.  Faber, Janzsen, and Fleckenstein all think the dollar is going straight to zero.  The other side of that has to be commodities, priced in dollars, as the hedge. The market should rise for the time being as well, but my money is going 3 places:

SLV, GLD, DBA calls to at least 2012.  

 

This Time....

Was no different, as predicted. Would the Euro stress tests be too soft and scenarios far from the tail? Of course! This only brings to question the issue of timing. Paying the time premium before July expiration for HBC and STD August calls was premature, as our profits were tied to this post expiration event. Our cost basis could've been reduced by almost 50% had we waited. The Basel agreements were reached more quickly than expected and this, aside from huge earnings from HBC, actually drove us to gains as much as the tests themselves. No complaints however, as we sold on Monday for a 5+bagger on HBC before the expected fluctuations followed the rest of the week.

STD actually appears to be the best positioned of all banks, but like our own tests, it was the weakest and cheapest of the bunch that rose the most (RBS, BCS, LYG). Our friends on Wall St. have provided us with a new gambling tool that for us, may actually be the best way to leverage our positions. These come in the form of weekly calls. No need to wait a whole 4 weeks anymore, we can now place our bets on one-off events for that day alone while paying less of a time premium. For example, if you think the Fed, fresh off miserable employment numbers, will hint at QE on Tuesday, simply place a directional weekly call on SPY or bank of your choice. You'll probably know by that afternoon if you're right or wrong.

2nd Chance

My biggest investment regret of last year was not putting everything I owned along into stress test bank calls. This was a foreshadowed gift that could only have ended up one way. While the gains on Citi and 5th Third (by far the best performer) recommended here made a year's worth of returns, I can honestly say that I didn't go all in. The Euro stress tests I don't think afford the same kind of opportunity given we are miles from the bottom and we have already been made aware of the Greek tragedy.

However, these tests may pale in comparison to ours in how bogus they are, and afford the larger banks an excuse to raise capital just as ours were. The best of the bunch, Santander and HSBC, are likely to benefit. As one analyst pointed out today, Santander survived a Spanish and European test when it troughed at $9. HSBC is just 15% off of its yearly low, and has been distancing itself from subprime for 3 years. Good news after the test results on 7/23 could also come in the form of a watered down Basel III, which probably won't force banks to raise capital rations until 2012. Given these factors, I think it's time to roll the dice again.

As another side bet, the first Apple hiccup in a few years may put a shine on its competitors in the short term. If Microsoft can produce and possibly throw in a dividend, it looks promising.