Friday, April 17, 2009

IMF Warns of Depression Parallels

from the Daily Telegraph:
The International Monetary Fund has warned of "worrisome parallels" between the current global crisis and the Great Depression, despite the unprecedented steps already taken by central banks and governments worldwide.

More Big Bank Accounting Shenanigans

from Bloomberg:

Citigroup posted a $2.5 billion gain because of an accounting change adopted in 2007. Under the rule, companies are allowed to record any declines in the market value of their own debt as an unrealized gain.

Accounting Changes

The rule reflects the possibility that a company could buy back its own debt at a discount, which under traditional accounting methods would result in a profit. Critics say a company in distress is unlikely to realize the gains, and would have to reverse them eventually if it recovers.

Such reversals probably contributed to a first-quarter loss at New York-based Morgan Stanley, the Wall Street Journal reported April 8.

Citigroup, one of 19 U.S. banks gearing up for the release of “stress tests” run by the Federal Reserve, has quadrupled on the New York Stock Exchange since falling to an all-time low of $1.02 on March 5, in the wake of the company’s announcement that as much as $52.5 billion of preferred stock would be exchanged for common shares to bolster the bank’s equity base.

from NYT:

Goldman’s explanations sometimes do not ring true, even if they are. When it announced its profits this week, it buried an important fact in the tables on page 10 of a news release, and did not mention it in the text of the release. That fact was that Goldman had lost a lot of money in December, which would have been part of the quarter had the firm not changed its fiscal year. As a result, that loss does not show up in any quarterly number. Goldman won’t say if a December-to-February quarter would have been profitable.

Was Goldman’s disclosure misleading? Legally, no. There was full disclosure. But the existence of the orphan month, with its big loss, was largely overlooked in the initial news stories. When it was reported later, Goldman was left looking as if it had tried to pull a fast one.

Depend on Government, and You'll Be Broke

from the Aleph Blog, which is maintained by a CPA:
In a time where government intervention is growing, it is all the more important to tell people that they can’t rely on the government. The government is broke. So will be those that exclusively rely on it.

Stock Rally Lacks Volume, Large Investors

Apparently, the big money -- the smart money -- is absent in the last few weeks from the stock market rally. From

The March stock market rally that fuelled hopes of a broader economic recovery was deceptive because “real money” investors remained on the sidelines, according to the chief executive of NYSE Euronext, the world’s largest stock exchange.

In rare comments about market movements, Duncan Niederauer said in an interview with the Financial Times that the rally was driven by short-term traders trying to take advantage of high volatility and not by large institutional or other long-term investors.

Despite this, the stock market continues to rally higher overnight (see chart) on earnings reports from GE and Citi. However, the earnings of these companies, as with the other large banks, are suspect. They appear to be consistently doctored for the headlines, while the underlying fundamentals remain weak. This is keeping the big money on the sidelines, unconvinced. The smart money is expecting worse to come.

Short-term traders aren't interested in fundamentals. They trade the news. I should know because I'm one of them!

Soybeans Sets New Records Daily

Amazing similarity between the daily chart on the left and the tick chart on the right.

China Dumping Dollar and Treasuries... for Industrial Metals Instead

from the Daily Telegraph:

China's State Reserves Bureau (SRB) has instead been buying copper and other industrial metals over recent months on a scale that appears to go beyond the usual rebuilding of stocks for commercial reasons.
Nobu Su, head of Taiwan's TMT group, which ships commodities to China, said Beijing is trying to extricate itself from dollar dependency as fast as it can.

"China has woken up. The West is a black hole with all this money being printed. The Chinese are buying raw materials because it is a much better way to use their $1.9 trillion of reserves. They get ten times the impact, and can cover their infrastructure for 50 years."

"The next industrial revolution is going to be led by hybrid cars, and that needs copper. You can see the subtle way that China is moving into 30 or 40 countries with resources," he said.

The SRB has also been accumulating aluminium, zinc, nickel, and rarer metals such as titanium, indium (thin-film technology), rhodium (catalytic converters) and praseodymium (glass).

While it makes sense for China to take advantage of last year's commodity crash to restock cheaply, there is clearly more behind the move. "They are definitely buying metals to diversify out of US Treasuries and dollar holdings," said Jim Lennon, head of commodities at Macquarie Bank.

John Reade, metals chief at UBS, said Beijing may have a made strategic decision to stockpile metal as an alternative to foreign bonds. "We're very surprised by Chinese demand. They are buying much more copper than they will need this year. If this is strategic, there may be no effective limit on the purchases as China's pockets are deep."

One thing is clear: Beijing suspects that the US Federal Reserve is engineering a covert default on America's debt by printing money. Premier Wen Jiabao issued a blunt warning last month that China was tiring of US bonds. "We have lent a huge amount of money to the US, so of course we are concerned about the safety of our assets," he said.

Note: While it is expected that global demand for copper will fall 15% this year, the price has risen 49%!

Thursday, April 16, 2009

341,000 Foreclosure Filings In One Month, and Stock Markets Rise

We are back in the mode of ignoring the bad news. This is not the environment that true bottoms are made of. Typically, the United States has 160,000 foreclosures in an entire year. Right now, we're averaging 80,000 per month!

2nd Largest Mall Operator Files for Bankruptcy

This may be just the beginning of the commercial mortgage meltdown.

Wednesday, April 15, 2009

Volume of Soybeans Traded Surpasses Corn

For the first time in my trading career, the volume of soybeans contracts traded surpassed corn today.

Largest Industrial Output Drop Since WWII

from Marketwatch:

As businesses struggle to work down their inventories of unsold goods, the output of the nation's factories, mines and utilities fell 1.5% in March, retreating in spite of higher production of motor vehicles and a boost from utilities, the Federal Reserve reported Wednesday.
Industrial production is down 13.3% since the recession began in December 2007, the largest percentage decline since the end of World War II, when production of military equipment ground to a halt and production fell 35%.
In the past year, industrial production has fallen 12.8%. Output fell at a 20% annualized rate during the first quarter, and it's now at the same level as December 1998, the Fed's latest data showed.
Factory production dropped 1.7% in March. Factory output has fallen 15.7% during the recession, also the largest decline since 1945-1946.
Underscoring the trend in manufacturing, factory output has dropped 15% in the past 12 months and has fallen for five consecutive quarters.
"The huge declines in industrial production in the past two quarters reflect very aggressive cuts in inventories by businesses," wrote Nariman Behravesh, chief economist for IHS Global Insight. "We expect industrial production to contract 10.2% this year -- the biggest drop in the postwar period -- before bottoming in early 2010."

Interestingly, stocks are modestly higher.

New Record High for Soybeans

Soybeans hit a new high in trading this morning, mostly on news of tight supplies.

Arlan Suderman just left a message on Twitter that "Soybean open interest @ 358,410 contracts is at a 6-month high, reflecting strengthening Wall Street Interest." He then said, "Modest profit taking pressured soybeans early, but buying quickly returned once the profit taking dried up."

Banks Announce New Rash of Foreclosures

This morning, banks that had previously announced self-imposed foreclosure moratoriums announced that those moratoriums have expired. Foreclosures have surged higher over the past few months as a result.

Food Rationing May Be Coming!

From Agweb:

Prospects for small year-ending stocks of soybeans and declining inventories of corn during the 2009-10 marketing year means that a generally favorable 2009 growing season will be needed to avoid rationing of use next year, said Darrel Good, University of Illinois Extension marketing specialist.

For soybeans:
"Year-ending stocks are now projected at a five-year low of 165 million bushels. That projection represents 5.5 percent of projected use during the current marketing year. The lowest stocks-to-use ratio in modern history was 4.5 percent in 2003-04."

Green Jobs Don't Create Jobs -- They Destroy Them

In President Obama's speech yesterday, he spoke of the model of creating "green" jobs in Spain as an example of a model to follow. However, a Spanish economist just released a study of the "green jobs" created in Spain that indicated the following:

  • For each "green" job created, 2.2 jobs were destroyed in the greater economy. That means that for every 4 jobs created, 9 are eliminated! (One step forward, two steps back! Ouch!) Talk about a bad investment!
  • The "green" jobs that were created were of a temporary nature.
  • Only 10% of "green" jobs were permanent ones.
  • Each "green" job created required an investment cost of more than $700,000 -- each!
Sounds like green jobs don't create much green in anyone's pocket!

Mauldin's Most Morose Assessment Thus Far; Seems to Suggest a Depression Just Might Happen!

I didn't get this newsletter by email this time. I don't know why. This is the first time I've seen John Maulding or any of his guest opinions suggest that this whole economic collapse may end up in a depression. Mauldin has been remarkably bullish until now.

Watch Out For the Second Leg of the Downturn
by Tom Au

Do you think that the crash is over, as certain former bears do? This question arises as we have breached the first downside target, of Dow 7000, based on my proprietary investment value model, that was first published in October 24, 2007. It was less a forecast than an evaluation. The Dow has now vindicated this model by reaching "fair value," as one would expect from a simple definition. Does that represent a base for a new bull market? Or is it just one more stop to the nether regions?

To understand my model, note that a stock can be analyzed as a combination of a bond plus a call option. My proprietary investment value metric for a stock is book value plus ten times dividends. That is a Ben Graham like construct that treats stocks almost like bonds, and gives no effect to growth over and above the pro rata return from the reinvestment of retained earnings. On the other hand, many investors prize stocks, particularly tech stocks, for their "optionality," the hypothetical ability to generate "positive surprises" over and above what economic theory would support. At bottom, the belief in the new economy was a belief in "optionality," that random positive events that occur from time to time, and did so with particular frequency in the 1990s, will become a recurring fixture of the economic landscape.

But such a process can also work in reverse, as it has recently. We are now experiencing what my colleague Robert Marcin calls the Great Unwind. A turbocharged economy is most likely to become "unstuck" when the conditions that initially favored it no longer exist. When this happens, an economy can grow as much below trend as it was formerly above trend, a fact that is likely to be reflected in the financial markets. History is not very encouraging on this score. In past downturns, such as those of 1932 and 1974, the Dow troughed at one half of my investment value metric, reflecting then-prevailing investor beliefs for negative optionality; that the economy will be worse than normal economic forces would dictate. With investment value at 7000 (actually a rounded version of 6600) on the Dow, half of that would be 3300. And during the 1930s, this metric actually fell, meaning that the "ultimate" low could be half of a number lower than 6600.

So having completed a first downleg, the market is now working on a second one. And this would be fully reflective of economic forces. For instance, financial earnings used to represent some 40% earnings (if you count the financing arms of some old line "industrial" companies such as General Electric and General Motors). Thus, they made up $32 of what used to be normalized S& P earnings of $80. But most of those financial earnings have disappeared. That, by itself, would take the S&P earnings into the $50s.. But how many of those non-financial earnings (of $48) were tied to the finance bubbles such as the homebuilding and the "housing ATM?" At least 10%, or around $5, and that is being conservative. Thus, normalized S&P earnings are likely to be no more $50 a share, if that.

The problem comes at payback time. For instance, much of the borrowing was tied to the housing market, on the bogus theory that houses could be made twice as valuable (as a multiple of rent) as they were for all of American history if prices could be kept on steady incline. The problem was that valuations collapsed when house prices fell, or even failed to rise, bringing down the market with it. To make up the shortfall, the U.S. economy now has to consume less than it produces, for a time. But the formerly virtuous circle became a vicious circle when falling prices (and consumption) led to falling production in a self-reinforcing process of the kind best described by George Soros in the Alchemy of Finance. This is a process called underabsorption, which in its strongest form, is called disintermediation. When a major part of the economy becomes "unstuck, the rest of it doesn't merely go into retrograde. It has to fall apart also to keep pace.

But I can live with $50 trough earnings, say many. And at historical multiple of 14-16 times trough earnings, the S&P should stop its downside in the 700-800 range. But the point is, they're not trough earnings, they are the "new normal." And in the current "slow" (zero or worse) growth environment, a trough P/E of 6-8 times earnings is more likely. Put another way, we are about to get the worst of all worlds; below trend earnings, below trend growth from a depressed base, and below trend P/E, after having gotten the best of all worlds, astronomical P/Es on above-trend and rapidly growing earnings, about a decade ago. Warren Buffett now agrees, saying that we will get "almost the worst of all possible worlds..."

The bears-turned-bulls have taken the latter stance because the market now reflects at least a severe recession. One such commentator likened the recent market to 1938-1939, and feels that the latter represents a bottom. But the 1930s bottom was 1932, not 1939, which is to say that the market probably has further to fall. Having correctly dodged the "overvaluation" bullet earlier, the new bulls pin their hopes on the prospect that the current market represents everything bad short of the 1930s Depression. Unlike us, they aren't willing to grasp the nettle that the current crisis will likely be as bad as anything including the Great Depression.

7 Reasons the Bear Will Be Back

from Market Oracle:

  1. The Banking Crisis Isn't Fixed - It's Getting Worse!
  2. Job Losses Are the Worst Since the Great Depression
  3. The Deleveraging of the U.S. Credit Bubble Has Already Begun. And It Isn't Pretty...
  4. Credit Cards Are Imploding
  5. It's Waaay Too Soon to Call a Bottom in the Housing Market
  6. It's a GLOBAL Recession.
  7. The market is bearish until proven otherwise.
Here is the full article.

2009 Economic Slowdown Worse Than Great Depression

from the Market Oracle:
Capital flows have also suddenly reversed causing turmoil in the currency markets. January's TIC data indicates that net capital outflows for the US were negative $148 billion in January. Capital is now fleeing the country. Financial protectionism has triggered the repatriation of foreign investment causing a sharp drop in the purchase of US sovereign debt. This is from Brad Setser, economist for the CFR:

"The obvious implication of the recent downturn in total reserve holdings — and the $180 billion fall in q4 wasn't driven by currency moves — is that the pace of growth in the world's dollar reserves has slowed dramatically...

The obvious implication: most of the 2009 US fiscal deficit WILL NEED TO BE FINANCED DOMESTICALLY. The Fed's custodial data indicates central banks are still buying Treasuries, though at a somewhat slower pace than in late 2008. But their demand hasn't kept up with issuance. (Foreign Central banks aren't going to finance much of the 2009 US fiscal deficit; Their reserves aren't growing anymore", Brad Setser, Council on Foreign Relations)

The United States does not have the reserves to finance it own massive deficits which will soar to $1.9 trillion by the end of 2009. The Fed will have to increase its purchases of US Treasuries and monetize the debt. Foreign holders of Treasuries and dollar-backed assets ($5 trillion overseas) will be watching carefully as Bernanke revs up the printing presses to fight the recession and meet government obligations. China, Russia, Venezuela and Iran have already called for a change in the world's reserve currency. It won't happen overnight, but the momentum is steadily growing.

The S&P 500 has soared 23 percent in the last four weeks, but the current bear market rally is misleading. The prospects for a quick recovery are remote at best. The fundamentals are all weak. Corporate profits are down, GDP is negative 6 percent, housing is in a shambles, and the banking system broken. The Fed has increased the money supply by 22 percent, but economic activity is at a standstill. The velocity at which money is spent is the slowest since 1987. Nothing is moving. The banks are hoarding, credit has dried up, and consumers are saving for the first time in 2 decades. The banks' credit-conduit cannot function properly until bad assets are removed from their balance sheets. But the magnitude of the losses make it impossible for the government to purchase them outright without bankrupting the country. According to the Times Online, the IMF has increased its estimates of how much toxic mortgage-backed paper the banks are holding:

"Toxic debts racked up by banks and insurers could spiral to $4 trillion, new forecasts from the International Monetary Fund (IMF) are set to suggest.

Here is the full article.

Short-Selling Serves a Good Purpose; Banning It May Be Self-Destructive

from FIN Alternatives:
Kynikos Associates’ James Chanos, the head of the Coalition of Private Investment Companies, blasted the proposed rules as “ill-concieved.”

“In recent years, short-sellers have publicly warned the marketplace about the dangers at AIG, Lehman Brothers, and Enron, as well as sounding the alarm over the credit ratings agencies, non-bank subprime lenders, and credit insurers,” he said. “Proposals to inhibit short-selling have the effect of limiting this vital market-based antidote to corporate fraud and speculative bubbles, and must be carefully weighed against the clear harm that comes from ill-conceived government intervention in basic market functions.”

#1 Trending Futures Instrument - Soybeans!

Last year, I bought soybeans at $10.36/bushel. After the blow-up and meltdown of commodities last year, I never thought I would see that price again. Now, soybeans is at $10.40/bushel. Who says inflation is dead?

Tuesday, April 14, 2009

Goldman Results -- A Work of Fiction

from Marketwatch:

One analyst chalked up the performance to funds Goldman received from American International Group after the insurance giant was bailed out by the government.
Goldman is "one of the major beneficiaries of our tax payer dollars, and the great irony is in an alternate universe, the quarter in which Goldman's reported earnings were twice Street expectations would have been the quarter in which it declared bankruptcy," said Dan Greenhaus, an equity analyst at Miller Tabak & Co.
That said, Greenhaus noted the outcome is what the government was looking for when it gave AIG the original $85 billion in rescue funds. "They wanted that money to filter through the global banking system and help get capital to financial institutions that were in need," the analyst commented.

And from Clusterstock:
The stunning quarterly results achieved by Goldman Sachs tell us almost nothing about the financial health of Goldman, and less than nothing about the health of the banking sector. Goldman, even more so than many of its competitors, still remains basically opaque. We don't know the source of its profits, except in a general way, and the outdated types of financial disclosures it makes only further obscures its financial health.

The problem is not, as some of the more frothing Goldman haters believe, that Goldman is fudging the numbers or lying about earnings. The problem is that the numbers are problematic even if we assume 100 percent veracity. Many of the troubling dynamics that have helped destroy Wall Street are embodied in Goldman's latest earnings report.

  • I-Banking, Still Dead. The lack of profits from the basic, traditional financial businesses encouraged Goldman to take on ever-greater risk. Their internal measures of the daily risk at the bank ballooned.
  • Cheap Money=Profits. Much of Goldman's profitability last quarter seems to have resulted from the availability of cheap government funding that could be put to work against a steep yeild curve. This is a recipe for windfall profits that is no more sustainable than those made from CDOs in the housing boom.
  • Accounting Noise. The accounting earnings at banks have long been meaningless, reflecting write-downs and write-up of assets based on accounting rules that often poorly reflect the risk involved. Goldman said today it had written up some of the assets it had written down last quarter. All of this is mostly noise signifying nothing.
  • Dumb Legacy Capital Measures. Discussion of earnings and capital allocations absent quality risk measurement is basically useless. All the talk about capital ratios, Tier 1 versus Tier 2 versus Teir 3, hybrid preferred stocks versus common, arguments about misclassification of capital, are left-overs from an legacy regulatory regime. Do we need to remind you that the legacy regulatory structure has proved to be completely disfunctional and unable to accurately predict a potential insolvency, much less future profitability?
  • Too Much Leverage. There's still too much leverage at Goldman Sachs. Although Goldman reduced the leverage ratio of money owed to outside creditors compared to its equity, it increased its internal leverage by ramping up the amount it pays its employees as a percentage of revenues. Make no mistake, this internal leverage ratio is just as important to predicting any investment bank's future performance as external leverage. When faced with hard times, dependence on internal leverage for earnings can cripple a bank by sparking a flight of talent--an internal run on the bank--that can be just as damaging to performance as a creditor initiated liquidity crisis.
  • Lack of Transparency. Goldman continued its long tradition of reporting earnings that keep investors in the dark about its business model. This lack of transparency makes it almost impossible to conduct an outside assessment of risk, and is probably an indicator that even within Goldman there is no real knowledge of risk and therefore no effective risk management.

Let's put it differently. The performance of Goldman Sachs last quarter does nothing to resolve the long-standing debate about the viability of the business models of independent investment banks. It remains largely undiversified and highly leveraged, putting in question whether it is equipped to survive a major systemic financial crisis.

And from Tyler Durden at Zero Hedge:
This is kinda a huge deal... Peter Fisher, managing director of BlackRock (yes, that BlackRock), states in a Bloomberg interview that Goldman's first quarter trading profit is non-recurring in nature, and believes it was mostly due to AIG unwinds... It is a little shocking that BlackRock would have anything bad to say about the phenomenal resurrection of financial companies, and puts the huge "profit" in it's true light. After all PIMROCK are the direct beneficiaries of the perpetuating delusion that all is well with the banking system, so it is odd that a BlackRock professional would dare to go against the grain on this one.

S&P 500 Chart Shows Massive Liquidations

Despite higher highs lately, the volume indicators are suggesting a different story. Some very large market participants are heading for the exits in a hurry!

Investors Herd Back to Safety of Treasuries

Monday, April 13, 2009

Staying Cool in the Heat of Battle

from Dr. Brett-
So often in my meetings with active (intraday) traders, I hear the phrase "in the heat of the battle." Usually what follows that phrase is a description of some trading mistake: trading too aggressively, ignoring risk guidelines, deviating from planned ideas, etc.

The problem is not that traders make these mistakes; we all do at times. Rather, the problem is that the mistakes become compounded "in the heat of the battle". Once traders are caught up in that heat, they lose the ability to recognize what is going wrong. They also lose their perspectives on markets.

Heating systems in homes have thermostats that control temperature. When the room becomes too cool, heat kicks on. When the room becomes warm, the heat turns off. Many active traders lack an emotional thermostat. They don't know their temperatures. They are like heating systems that get the room hotter and hotter, until the house is unbearable.

One of the core ideas from The Psychology of Trading--and perhaps one of the most important ideas I've ever put forward--is that many of the problems that affect traders are state-specific. How traders think and behave is relative to the states of mind and body that they are experiencing at the time. The reason that coaching (and self-coaching) often doesn't work is that we are in one state of mind and body when we are analyzing and working on our problems and in a completely different state when we are experiencing the triggers that set off those problems.

This explains the common experience that traders have when they look back on their day's performance and wonder, in amazement, how they could have made such rookie mistakes. In a normal frame of mind, they wouldn't have acted so rashly. In "the heat of the battle", they become a different person; they process information differently.

Few challenges are more important to active traders than the ability to develop an emotional thermostat. But talking with a coach, writing in a journal, or vowing to oneself that next time will be different won't touch the problem. As my earlier book stressed, you can only solve the problem by entering the state that is specific to that problem and then reprogramming your patterns of thought and behavior.

My upcoming book will have much to say on this topic, with specific exercises. In my next post in this series, I'll outline a specific strategy that has helped me and many of the traders I've worked with.

Turning Goals Into Consistent Habit Patterns

from Dr. Brett-
My recent post took a look at setting effective trading goals. Properly formulated, these goals focus our development, bridging our real selves--who we are now--with our ideals. Setting goals, however, is easy compared with acting upon them over time. Many of us set well-meaning goals at the start of a year, only to forget our resolutions.

So how do we make goals actual tools for self-development? One answer that I came to in writing my new book is that goal setting must be a process of emotional commitment, not just an intellectual exercise. "The secret to goal setting," I note in the book, "is providing your goals with emotional force. If your goal is a want, you'll pursue it until the feeling of desire subsides. If your goal is a must-have, a burning becomes an organizing principle, a life focus."

In Alcoholics Anonymous, the goal is sobriety. Members spend a great deal of time sharing their stories of lost relationships, lost jobs, and lost health. They openly talk about the horrors of their relapses. Why? Because this keeps them emotionally connected to their goal. AA focuses on the reasons for the goal; every single meeting members remind themselves that they are alcoholics, powerless against alcohol. They can only find sobriety in their connectedness to others and in their relationship with a Higher Power. Next to that, everything else seems inconsequential.

An effective trading journal is like an AA meeting. It is an emotional communication that reminds the trader why he or she is seeking particular goals. The vision of success, the horrors of going through massive drawdowns, the feelings of disgust at missing opportunities due to a lack of nerve or discipline: these keep us connected to our goals.

Once you're emotionally connected to a goal--clearly seeing its necessity--discipline is not necessary. You will automatically gravitate to doing what you know you need to do. It's a bit like the procrastinator: when the assignment is due in several weeks, there's no urgency. When the assignment is due the next day--with one's bonus on the line--the drive to work kicks in with full force.

It is when the perception of "Reach your goal, or else!" arises, that we act decisively. Often it's the "or else"--the clear awareness of the consequences should we not fulfill our aims--that helps turn goals into consistent actions. The man who has had a heart attack may have struggled with his diet for years. Now, aware of his mortality, he has no problem following a heart-healthy regimen. His goal, under the pressure of necessity, becomes a habit pattern.

It helps to clearly visualize what would happen should we fail to meet our goals. What would happen to us? How would we feel about ourselves? Many a drive for greatness was sparked by the hatred of mediocrity. We will ourselves forward only when stasis becomes more uncomfortable than the efforts demanded by self development.

Traits of Successful New Traders

from Dr. Brett-
In response to my recent post on trading for a living, one reader asks, "In your opinion what are the starting qualities needed to be a great trader?" This is a difficult question, because different kinds of trading require different skill sets. For example, many of the best hedge fund portfolio managers have superior analytical skills and abilities to detect themes in noisy data. Many of the best market makers have an uncanny speed of mental processing and level of concentration that enable them to stay on top of order flow throughout the day. This is why I emphasize, in the trader performance book, that matching one's style of trading to one's strengths--talents and skills--is an essential component of success.

If I had to identify qualities that distinguish "starting qualities" that are important across all traders, the following come to mind:

1) Capacity for Prudent Risk-Taking - Successful young traders are neither impulsive nor risk-averse. They are not afraid to go after markets aggressively when they perceive opportunity;

2) Capacity for Rule Governance - Successful young traders have the self-control needed to follow rules in the heat of battle, including rules of position sizing and risk management;

3) Capacity for Sustained Effort - Successful young traders can be identified by the productive time they spend on trading--research, preparation, work on themselves--outside of market hours;

4) Capacity for Emotional Resilience - All young traders will lose money early in their development and experience multiple frustrations. The successful ones will not be quick to lose self-confidence and motivation in the face of loss and frustration;

5) Capacity for Sound Reasoning - Successful young traders exhibit an ability to make sense of markets by synthesizing data and generating market and trading views. They display patience in collecting information and do not jump to conclusions based on superficial reasoning or limited data.

Finally, I would say that successful developing traders approach their work with a kind of humility. They don't know it all and they don't pretend to know it all. They absorb wisdom from mentors and markets, and they are quick to acknowledge when they're wrong, so that they can get out of bad positions and learn from their experience. Show me a stubborn young trader with a defensive ego, and I'll show you one who will fight his or her learning curve every step of the way, with predictably poor results.

If you want to identify potentially successful young traders, look at their trading journals and gauge the amount of time they spend behind the screen. The good ones will have detailed entries about markets and about themselves, with constructive ideas, goals, and feedback. The less successful traders will have sparse entries that display little effort or analysis, with no goals, no constructive direction. The good ones watch markets closely, even when not trading. The less successful ones find little reason to watch markets if they don't have a position.

Effort alone won't make a trader successful, but lack of it will almost certainly ensure failure.

Copper: Up, Up, and Away!

Milk Prices Plunge Off a Cliff!

I am watching for clear signs of a bottom for milk. Note that we are right now at support price levels.

"The Goldman Roll" Contract Rollovers -- How It Works!

Goldman Sachs and other investment houses that use the GSCI index roll their commodity positions forward to the next contract on the 5th through 9th business days of each month. This provides for some excellent trading opportunities during this period, because Goldman and many others must liquidate some contracts in favor of others.

From Goldmans website:

The rolling forward of the underlying futures contracts in the excess return index portfolio occurs once each month, on the fifth through ninth business days (the roll period). As explained above, some of the underlying commodity contracts expire in the next month and thus need to be rolled forward. The simplest way to think of the process is as rolling from one basket of nearby futures (the first nearby basket) to a basket of futures contracts that are further from expiration (the second nearby basket). The S&P GSCI™ is calculated as though these rolls occur at the end of each day during the roll period at the daily settlement prices.
The portfolio is shifted from the first to the second nearby baskets at a rate of 20% per day for the five days of the roll period. Until just before the end of the fifth business day, the entire S&P GSCI™ portfolio consists of the first nearby basket of commodity futures. At the end of the fifth business day, the portfolio is adjusted so that 20% of the contracts held are in the second nearby basket (i.e. a basket of future contracts that are farther from maturity), with 80% remaining the first nearby basket.
The roll process continues on the sixth, seventh and eighth business days, with relative weights of first to second nearby baskets of 60%/40%, 40%/60% and 20%/80%. At the end of the ninth business day, the last of the old first nearby basket is exchanged, completing the roll and leaving the entire portfolio in what we have been calling the second nearby basket. At this time, this former second nearby basket becomes the new first nearby basket, and a new second nearby basket is formed (with futures maturities further in the future) for use in the next month's roll.
The last key point to be made about the roll process is to specify exactly what the 80%/20% or other relative splits between nearby baskets mean. The roll percentages refer to contracts or quantities, not value. Taking the first day of the roll as an example, just before the roll takes place at the end of the day, the S&P GSCI™ consists of the first nearby basket. That portfolio, constructed the night before and held throughout the fifth business day, has a dollar value. For the roll, that dollar value is distributed across the first and second nearby baskets such that the number of contracts or the quantity of the first nearby basket is 80% of the total and the quantity held of the second nearby basket is 20% of the total.
The dollar value held of each nearby basket can then be calculated from those quantity weights by multiplying them by the prices of the futures contracts contained in each basket. As the baskets contain futures with different maturities for some of the commodities, the prices are generally close but not exactly the same. Hence, the percentage of the portfolio value (i.e. dollar weight) held in each basket is generally close to, but not exactly equal to, the 80%/20% split specified for the quantities.
The world-production weighting of the S&P GSCI™ is accomplished by keeping the quantity weights of the individual commodities within each basket proportional to world production weights, which are averages of historical production levels and are generally updated every year.

Quant Traders See Reversal Coming: A "Black Swan of Black Swans"

from Tyler Durden at Zero Hedge:
"Anyone who is doing anything sensible right now is either losing money or is out of the market entirely." These are the words of a quant trader, who is seeing something scary in the capital markets. Scary enough to merit a warning that we could be on the verge of another October 87, August 2007, or January 2008.

Let's back up. I recently posted a chart which tracks equity market neutral strategies: in essence a cross section of quant funds for which there is public performance tracking. The chart is presented below.

There is not much publicly available data to follow what goes on in the mystery shrouded quant world. However, another chart that tracks the market neutral performance is the HSKAX, or the Highbridge Statistical Market Neutral Fund, presented below. As one can see we have crossed into major statistically deviant territory, likely approaching a level that is 6 standard deviations away from the recent norms.

What do these charts tell us? In essence, that there is a high likelihood of substantial market dislocations based on previous comparable situations. More on this in a second.

Why quant funds? Or rather, what is so special about quant funds? The proper way to approach the question is to think of the market as an ecosystem of liquidity providers, who, based on the frequency of their trades, generate a cushioning to the open market trading mechanism. It is a fact that the vast majority of transactions in the market are not customer driven buy/sell orders, but are in fact high frequency, small block trades that constantly cross between a select few of these same quant funds and program traders.

This is a market in which the big players are Renaissance Technologies Medallion, Goldman Sachs and GETCO. Whereas the first two are household names, the last is an entity known primarily to quant market participants. Curiously, the Philosophy section in GETCO's website exactly captures the critical role that quant funds play in an "efficient" market.

What’s good for the market is good for GETCO

GETCO’s strategy is to align our business plan with what is best for the marketplace. We earn our revenues by providing enhanced liquidity and efficiency to electronic financial markets, which in turn results in lower costs for market participants (e.g. mutual funds, pension funds, and individual investors).

In addition to actively trading, we partner with many exchanges and their regulators to increase transparency throughout the industry and to create more efficient means for the transference of financial risk.
A good example to visualize the dynamic of this liquidity "ecosystem" is presented below.

In order to maintain market efficiency, the ecosystem has to be balanced: liquidity disruptions at any one level could and will lead to unexpected market aberrations, such as exorbitant bid/ask margins, inability to unwind large block positions, and last but not least, explosive volatility: in essence a recreation of the market conditions approximating the days of August 2007, the days post the Lehman collapse, the first November market low, the irrational exuberance of the post New Year rally, and the 666 market lows.

The above tracking charts indicate that something is very off with the "slow", "moderate" and "fast" liquidity providers, indicating that liquidity deleveraging is approaching (if not already is at) critical levels, as the vast majority of quants are either sitting on the sidelines, or are merely playing hot potato with each other (more on this also in a second). What this means is that marginal market participants, such as mutual and pension funds, and retail investors who are really just beneficiaries of the liquidity efficiency provided them by the higher-ups in the liquidity chain, are about to get a very rude awakening.

Also, it needs to be pointed out that the very top tier of the ecosystem is shrouded in secrecy: conclusions about its state can only be implied based on observable metrics from the HSKAX and HFRXEMN. It is safe to say that any conclusion drawn based upon observing these two indices are likely not too far off the mark.

Skeptics at this point will claim that it is impossible that quant and program trading has such as vast share of trading. The facts, however, indicate that not only is program trading a material component of daily volumes, it is in fact growing at an alarming pace. The following most recent weekly data from the New York Stock Exchange puts things into perspective:

According to the NYSE, last week program trading was 8% higher than the 52 week average, which on almost 4 billion shares is a material increase. It is probably safe to say that the 1 billion in program trades last week does not account for significant additional low- to high-frequency trades originated at non NYSE members, implying the real number for the overall market is likely even higher. Some more program trading statistics: principal trading is running 21% above 52 week average, agency trading is 11% below average, while NYSE weekly volume is running about 9% below 52 wk average.

A very interesting data point, also provided by the NYSE, implicates none other than administration darling Goldman Sachs in yet another potentially troubling development. The chart below demonstrates the program trading broken down by the top 15 most active NYSE member firms. I bring your attention to the total, principal, customer facilitation and agency columns.

Key to note here is that Goldman's program trading principal to agency+customer facilitation ratio is a staggering 5x, which is multiples higher than both the second most active program trader and the average ratio of the NYSE, both at or below 1x. The implication is that Goldman Sachs, due to its preeminent position not only as one of the world's largest broker/dealers (pardon, Bank Holding Companies), but also as being on the top of the high-frequency trading/liquidity provision "food chain", trades much more often for its own (principal) benefit, likely in tandem with the other top dogs on the list: RenTec, Highbridge (JP Morgan), and GETCO. In this light, the program trading spike over the past week could be perceived as much more sinister. For conspiracy lovers, long searching for any circumstantial evidence to catch the mysterious "plunge protection team" in action, you should look no further than this.

Following on the circumstantial evidence track, as Zero Hedge pointed out previously, over the past month, the Volume Weighted Average Price of the SPY index indicates that the bulk of the upswing has been done through low volume buying on the margin and from overnight gaps in afterhours market trading. The VWAP of the SPY through yesterday indicated that the real price of the S&P 500 would be roughly 60 points lower, or about 782, if the low volume marginal transactions had been netted out. And yet the market keeps on rising. This is an additional data point demonstrating that the equity market has reached a point where the transactions on the margin are all that matter as the core volume/liquidity providers slowly disappear one by one through ongoing deleveraging.

Unfortunately for them, this is not a sustainable condition.

As more and more quants focus on trading exclusively with themselves, and the slow and vanilla money piggy backs to low-vol market swings, the aberrations become self-fulfilling. What retail investors fail to acknowledge is that the quants close out a majority of their ultra-short term positions at the end of each trading day, meaning that the vanilla money is stuck as a hot potato bagholder to what can only be classified as an unprecedented ponzi scheme. As the overall market volume is substantially lower now than it has been in the recent past, this strategy has in fact been working and will likely continue to do so... until it fails and we witness a repeat of the August 2007 quant failure events... at which point the market, just like Madoff, will become the emperor revealing its utter lack of clothing.

So what happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible: large swings on low volume, massive bid-offer spreads, huge trading costs, inability to clear and numerous failed trades. When the quant deleveraging finally catches up with the market, the consequences will likely be unprecedented, with dramatic dislocations leading the market both higher and lower on record volatility. Furthermore, high convexity names such as double and triple negative ETFs, which are massively disbalanced with regard to underlying values after recent trading patterns, will see shifts which will make the November SRS jump to $250 seem like child's play.

For readers curious about just how relevant liquidity is in the current market, I recommend another recent post that discusses DE Shaw's opinion on the infamous basis trade, in which their conclusion was that establishing a basis trade, which is effectively the equivalent of selling a put option on market liquidity, ended up in massive financial carnage as the market rolled from one side of the trade to another. Is it possible that what the basis trade was for credit markets (most notably Citadel, Merrill and Boaz Weinstein), so the quant unwind will be to equity markets?

So when will all this occur? The quant trader I spoke to would not commit himself to any specific time frame but noted that a date as early as next Monday could be a veritable D-day. His advice on a list of possible harbingers: continued deleveraging in quant funds as per the charts noted above, significant pre-market volatility swings as quants rebalance their end of day positions, increasing principal program trading by Goldman Sachs on decreasing relative overall trading volumes, ongoing index VWAP dislocations. One thing is for certain: the longer the divergence between real volume trading/liquidity and absolute market changes persists, the more memorable the ensuing market liquidity event will be. At the end of the day, despite the pronouncements by the administration and more and more sell-side analysts that the market is merely chasing the rebound in fundamentals in what has all of a sudden become a V-shaped recovery, the "rally" could simply be explained by technical factor driven capital-liquidity aberrations, which will continue at most for mere weeks if not days.

Hussman Warns of Being Overly Optimistic

from John Hussman, Phd. of Hussman Funds:

In recent weeks, the financial markets have taken enormous hope from economic data that has outpaced depressed expectations – generally only slightly, but uniformly enough to encourage investors that the “green shoots” of recovery are in place.

Careful. We've seen a nice bounce to clear an oversold condition, coupled with the very ordinary “ebb and flow” of economic data that periodically offers intermittent relief even in the worst economic downturns. What we haven't seen to any real extent is “revulsion.” Quite to the contrary, investors have frantically bid up the worst credits – distressed financials, homebuilders, and heavily leveraged cyclicals, while the percentage of bullish investment advisors has quickly surged above the percentage of bearish advisors.

As veteran market observer Richard Russell noted following a tribute Saturday evening, “one question that was asked repeatedly was ‘What is the difference between investors' sentiment now and that which existed at the 1974 bottom?' My answer was that there is a lot of complacency today. In fact, many leading analysts are already saying that ‘this is a new bull market.' … At the 1974 bottom, the sentiment was the opposite -- people and funds were black-bearish. Nobody talked about ‘the danger of missing this advance.' In fact, when I turned bullish in late-1974 I received hate-letters and angry notes saying that ‘Russell, you have lost your mind,' and ‘Russell, why don't you hang it up and find a business that you're fitted for.' I mean people were furious that I had turned bullish, pretty much the opposite of sentiment today. Actually, I'm surprised to see how quickly analysts and investors are willing to turn bullish today.”

That's not to rule out the possibility that the final low of the bear market is behind us (though I doubt it). What I do see as unlikely is a “V” bottom where stocks will now proceed to durably recover their losses without (at least) a very difficult and extended sideways period that take stocks back to levels that compete with the prior lows. Historically, advances of the size we've observed have only “stuck” when the major indices had already advanced past their 200-day moving averages by the time stocks were about 20% off the lows.

There's a reason for that. During a true bottoming process, favorable market internals are typically “recruited” even as the market is moving down or sideways. Investors work through the ebb-and-flow of information through repeated cycles of enthusiasm and disappointment. To expect the disappointments to quickly come to an end and to be replaced by clarity is to expect something that is not characteristic of historical experience.

As Russell noted, “When the tide reverses and turns bullish, there are usually many phenomena that appear. It is usual to see some sort of non-confirmation in the Averages (we saw that at the 1974 bottom). It is usual to see Lowry's Selling Pressure decline substantially prior to the actual bottom (Lowry's Selling Pressure declined very reluctantly prior to the March 9 low, and this alone makes me suspicious). Normally, once the tide reverses the stock market starts up carefully in a slow persistent plodding rise.”

Very simply, new bull markets are generally not widely heralded, and investors should be awfully suspicious when there is a consensus that “the bottom is in.” As I noted back in December, in Recognition, Fear and Revulsion (before the market took a plunge to fresh lows over the next two months):

“Strong intermittent advances are typical during bear markets, and can often achieve gains of 20% as we've seen in recent weeks, and sometimes substantially more. But the very existence of bear market rallies can be a problem for investors, because they clear the way for fresh weakness. The scariest declines in bear markets are typically the ones when investors think they are making progress and recovering their losses, only to see stocks go into a new free-fall.

“That cycle of decline, followed by hope, followed by fresh losses, is really what ultimately puts a final low in place. The final decline of a bear market tends to be based on “revulsion” – a growing impatience among investors who conclude that stocks are simply bad investments, that the economy will continue to languish, and that nothing will work to help it recover. Revulsion is not based so much on fear or panic, but instead on despair and disillusionment. In a very real sense, investors abandon stocks at the end of a bear market because stocks have repeatedly proved themselves to be unreliable and disappointing.”

Could the final low of the bear market be in place? Sure. But even if that were the case, it does not follow that the markets will recover their lost ground quickly, and it is particularly dangerous to believe that the major indices will not meaningfully retest (if not substantially break below) the prior lows.

On the basis of market action, one of the features of the recent advance that has me concerned is the unimpressive, waning trading volume that we've observed. A strong advance on heavy trading volume is a measure of determined sponsorship in the face of disagreement. A strong advance on waning volume is probably a short-squeeze – forced purchases in the face of sellers who have temporarily backed off. Moreover, stocks are currently overbought to the same extent that they were near the end of the bear market rallies we observed during the 2000-2002 decline.

As the brilliant Dow Theorist William Peter Hamilton wrote a century ago, in 1909, "One of the platitudes most constantly quoted in Wall Street is to the effect that one should never sell a dull market short. That advice is probably right oftener than it is wrong, but it is always wrong in an extended bear swing [i.e. an overbought bear market rally]. In such a swing the tendency is to become dull on rallies and active on declines."

In short, I would be more impressed with market action here if we were observing stronger trading volume with an established core of improved market internals. A good retest in the major averages, coupled with quiet strengthening of market internals, would be more characteristic of a durable “bottoming process.” My opinion (which we don't invest on and neither should you) is that we're not even close to completing a bottoming process. Frankly, we can't rule out that the final low is in place either. So as usual, we'll evaluate the evidence as it emerges.

Thus far, we've got a strong rally off the recent trough, with uninspiring sponsorship but good breadth, reasonable but not strikingly attractive valuations, and an overhang of increasingly distressed mortgage and non-residential debt that looks like Armageddon Part II in the offing, because we are doing nothing to restructure it. In my view, the recent advance looks not like a garden of “green shoots,” but very much like a short-squeeze off of an oversold trough. It would be convenient if such bounces could be predicted in advance, but as we observed last year, the market can become very persistently oversold during bear markets, and even an “oversold” decline can go much deeper until the oversold condition is abruptly cleared.

Fundamentally, my view is that the U.S. economy is on very thin ice, and that by focusing on the bailout of corporate bondholders rather than the restructuring of debt, we are courting the risk of a far deeper downturn. Last year, I didn't think it was conceivable that policy-makers would attempt to address this problem by making lenders whole with public funds. This is an ethical abomination, putting the public in the position of absorbing the losses that should properly be borne by those who provided capital to these institutions. It is not sustainable. What it does it place the public in the position of losing first, but it will not, and cannot prevent the ultimate failure of the debt – for the simple reason that without restructuring, the debt can't be serviced.

It is true that insurers, pension funds, and other entities own part of the debt of these financial institutions, but they certainly do not own all of it, and to the extent that it is in the public interest to use public funds to reimburse the losses of various entities, that can and should be part of the political process. But to broadly immunize every bondholder of these institutions with public funds is repulsive. Even the bondholders of Bear Stearns can expect to get 100% of their principal back, with interest.

Aside from the abuse of the public trust inherent in these bailouts, it is also offensive to anybody who devotes a significant portion of their income to charity, because there are so many better uses for trillions of dollars. Think about it. Two of the wealthiest people on Earth, Warren Buffett and Bill Gates, after lifetimes of work, will be able to commit a combined total of less than $100 billion to charity if they give everything they have. That figure is dwarfed next to the sums being allocated to protect corporate bondholders from taking a “haircut” on distressed debt, or swapping a portion of it for equity – both perfectly appropriate ways of compartmentalizing the losses of these financial institutions, without public funds, and without receivership or “nationalization.”

Congress needs to quickly legislate the ability to take receivership of non-bank financial institutions, including bank holding companies. The use of credit default swaps should be restricted to bona-fide hedging only. Of course, restructuring mortgage debt by swapping principal for a claim on future appreciation (with the Treasury administering a “conduit fund” to collect, aggregate and disburse those claims) would be one of the best ways of minimizing the need for these bailouts in the first place.

Echoing the concerns I've noted in recent quarters, Alan Abelson of Barron's shared some research this week that estimates probable losses of financial companies from mortgage and non-residential loans at $2.1 to $3.8 trillion, less than half of what has been realized to date. These figures are much in line with my own estimates, and exclude additional loan losses to non-financial companies (witness General Motors). Though existing home sales were up recently, the report notes that 45% of them were distressed sales. The report concludes, correctly I believe, that the U.S. is “in the middle innings of an enormous wave of defaults, foreclosures, and auctions.”

Until we observe large-scale restructuring of mortgage debt and the debt obligations of major financial institutions, we will be applying trillion dollar band-aids while the underlying cancer metastasizes. The longer we wait to restructure debt, to swap debt for equity, and to expect those who made the loans bear the losses as well, the more we risk allowing this downturn to become uncontrollable and unfathomably costly to the public.

As Harvard historian Niall Ferguson observed last week, “Only somebody who studies financial history could say, as I was trying to say, ‘Look, something as big as the liquidity crisis of 1914 or as big as the banking crisis of 1931 is imminent.' We don't really have a great many options here. If we stay the present course, you're going to see the tailspin continue. To be effective, a large-scale restructuring of household indebtedness would need to be mandatory. The Great Depression was initially a U.S. financial crisis. But what made it a depression was its global contagion, and then the breakdown of trade and the retreat into protectionism. All of that can happen. All of that is in fact happening with terrifying speed.”

Whatever green shoots are out there rest over a patch of thin ice.

Questions Linger About Credibility of Wells Fargo's Miraculous Profits

from Evan Newmark at the Wall Street Journal:

And now, we have the miraculous profits of Wells Fargo. For believers, it’s a harbinger of better times to come. And for the non-believers, it’s a creative accounting exercise in which the cup is not just half full, it’s brimming over.

Certainly, there is no getting around the odd timing of the Wells Fargo announcement.

For over a year, America has been mired in crisis. House prices are in free fall and defaults are on the rise. Jobs are disappearing by the millions. In early March, Wells Fargo cut its dividend by 85%. Its goal was to conserve cash.

But barely a month later, and Wells Fargo is announcing “business momentum is strong.” The Wachovia acquisition has “proven to be everything we thought it would be.” And the bank has earned $3 billion in quarterly profits, its best showing in 157 years.

Clouds On the Stock Market Horizon

from Doug Kass at
As I have recently communicated, it is my view that stocks made an important low in early March, perhaps even a generational low, and may very well continue to advance. There is little question, however, that the road to higher ground will be full of potential potholes in light of the economic and stock market challenges from traditional headwinds such as the uncertain and depressed corporate profit cycle, the unprecedented number and magnitude of dividend cuts, the devastation in household wealth from lower home and stock prices, the specter of a glut of additional foreclosures that could short circuit a stabilization of the housing markets, the crippled capital base and reduced lending capacity of the world's banking institutions, and the still weakening and depressed jobs market.

As well, the presence of nonconventional headwinds pose risks, and since investors have a limited experience and historical perspective in dealing with them, it likely insures a more volatile market backdrop and places limitations to the market's upside potential. Some of those nontraditional headwinds include the following:

  • the broad geographic reach of the current recession;
  • the increased burden and cost of regulation;
  • the economic impact of the obliterated (but previously important) shadow banking system and the associated reduction in securitized lending market capacity;
  • the more important role of government in the private sector;
  • the possible impact of protectionism and trade barriers;
  • the degree to which individual and institutional investors have become risk-averse and have been "turned off" to equities; and
  • most important, the unusual causes of the current economic downturn and and uncertainty of business confidence that follows from the deleveraging of debt on bank and consumer balance sheets.

As I look beyond the current market rally I have five additional medium-term concerns:

    1. I am worried that, even though there are currently signs of economic stabilization, the slope of the recovery will be shallow by most historical standards and the possibility of an economic double-dip in late 2009/early 2010 must be considered, particularly in light of a heavily indebted consumer coupled with proposed tax rate increases by the new administration.

    2. The government's policy efforts to ring-fence the banks' toxic assets might not succeed, and the transmission of credit could remain clogged for some time to come. In this instance, not only will economic activity disappoint but still-high yields in the corporate bond market could provide stiff competition to equities.

    3. I remain concerned that investors could grow too optimistic, too fast, in a continued extension of the current market rally. Already, many talking heads in the media who were scared witless a month ago have become born-again permabulls in recent days.

    4. The magnitude of the required policy actions to stabilize the credit market and domestic economy is materially increasing the size of the U.S. deficit and raises our reliance on the kindness of strangers in funding our mounting debt burden. That's a slippery slope in which much can go wrong.

    5. The world remains a political powder keg. Continuing my 1938-1939/2008-2009 parallel, I am concerned that Pakistan is the 1939 geopolitical risk-equivalent of Germany.

Regardless of the near-term strength, undoubtedly investors will face a volatile backdrop over the balance of the year in which both corporate managers and investment managers will have a difficult time navigating a lumpy and inconsistent economic growth trajectory.

Hopefully, the gray skies expressed above are only clouds passing over the head of Mr. Market.

As seen in the follow chart, I continue to maintain that the S&P 500 could rise considerably further (to about 1,050) by mid to late summer, but the road to higher ground will likely be bumpy.

SPDR Trust (SPY) -- Expectations


Volatility, prudence and common sense dictates, especially in light of the sharp rise in equities over the past five weeks, above-average cash positions, smaller-than-usual investment/trading positions and an opportunistic investment strategy that complements a buy/hold strategy with a trading view.

Beyond a summer peak in equities, the market's outlook appears more problematic, and my longer-term expectation of an uneven and inconsistent economic landscape over the next few years remains intact -- an ideal setting for a two-sided market, with opportunities to profit with both long and short positions.

Corporate Credit Quality at 25-Year Low


The credit quality of global companies has deteriorated to levels not seen for more than a quarter of a century, according to Moody’s Investors Service.

The ratings agency said the ratio of companies having their credit ratings cut versus the number of companies being upgraded – an indicator of declining credit quality – had reached its highest level since 1983.

During the first quarter of 2009, the rate at which borrowers were having their ratings cut reached 13.8 per cent, highlighting the negative credit climate in the first part of the year, analysts at Moody’s said.

“This downgrade rate is higher than pre-economic crisis figures,” said Jennifer Tennant, Moody’s analyst. For the whole of 2006, the downgrade rate was 10.2 per cent, and the average rate from 1983-2009 was 12.5 per cent per year.

China Reducing Ownership of U.S. Debt

from New York Times:
Reversing its role as the world’s fastest-growing buyer of United States Treasuries and other foreign bonds, the Chinese government actually sold bonds heavily in January and February before resuming purchases in March, according to data released during the weekend by China’s central bank.

China’s foreign reserves grew in the first quarter of this year at the slowest pace in nearly eight years, edging up $7.7 billion, compared with a record increase of $153.9 billion in the same quarter last year.

China has lent vast sums to the United States — roughly two-thirds of the central bank’s $1.95 trillion in foreign reserves are believed to be in American securities. But the Chinese government now finances a dwindling percentage of new American mortgages and government borrowing.

In the last two months, Premier Wen Jiabao and other Chinese officials have expressed growing nervousness about their country’s huge exposure to America’s financial well-being.

Fed Announces Treasury Purchases Today, Tomorrow

from Bloomberg:

The central bank plans to buy Treasuries due from March 2011 to April 2012 today and from September 2013 to February 2016 tomorrow, according to its Web site. The Fed has more than doubled the size of its balance sheet to $2.09 trillion in the past year by purchasing financial assets including Treasuries in an effort to spur growth.

U.S. bonds may still fall, the survey showed. An index measuring investors’ outlook for Treasuries through the end of June declined to 43 for the seven days ended April 9 from 44 in the previous week. A reading below 50 means investors expect prices to drop. Ried Thunberg surveyed 25 fund managers controlling $1.35 trillion.

Fed purchases have created a Treasury market “bubble” that may keep growing, said Jim Rogers, an investor and author of the book “Hot Commodities.” The Fed, like the Bank of Japan before it, is supporting government debt, he said.

“In Japan, long-term bonds were yielding one half of one percent at one time,” Rogers said on Bloomberg Television in an interview from Singapore, where he lives. “This can go to absurd levels, and bubbles usually do.”

Yields suggest U.S. credit markets haven’t fully recovered after last year’s decline.

Fed Chairman Ben S. Bernanke’s efforts to spur growth may result in a higher cost of living, said Allan Meltzer, the central bank historian and professor of political economy at Carnegie Mellon University in Pittsburgh.

Inflation “will get higher than it was in the 1970s,” Meltzer said. At the end of that decade, consumer prices rose at a year-over-year rate of 13.3 percent. Rising costs erode the value of the fixed payments from bonds.

From Reuters:
Thirty-year U.S. Treasury bonds jumped over a full point in price on Monday as the stock market fell sharply at the open, with the Dow falling more than 1 percent.
Treasuries are showing significant strength in morning trading on Monday, as investors move into the safety of government backed bonds amid continued earnings anxiety on Wall Street.

As the influx of earnings reports continues, traders digested news that General Motors (GM) has been told to prepare for a bankruptcy filing by the U.S. Treasury Department, further prompting moves into guaranteed returns.

The benchmark ten-year note has shown a notable upward move in the early going, moving firmly into positive territory. Subsequently, the yield on the note has fallen to 2.863 percent, a fall of 6.3 basis points on the day.

Investors sought security in their investments as they considered dim prospects for one of the nation's largest car manufacturers.

Volume Almost Non-Existent for Stock Futures Overnight

I've never seen the volume for stock futures to be this low. On a normal trading day, stock index futures will trade volume of about 2,000,000 contracts. Overnight, only 51,000 contracts were traded on the S&P 500 futures! Clearly, many traders have taken an extended Easter Holiday weekend. This tick chart shows that the entire trading overnight didn't even complete a single screen. Wow!

Treasuries Rocket Higher On Worries of Bank "Stress Test" Shocks

from Bloomberg:
Treasuries rose amid speculation banks may need additional infusions of cash after the government completes its tests of balance sheet strength.

The so-called stress tests were designed by President Barack Obama’s administration to show how much extra capital the 19 largest U.S. banks may need to survive a deeper economic slump. The Federal Reserve will buy notes maturing between two and three years in the first of this week’s three buybacks, part of its effort to reduce borrowing costs.

“Apparently the stress test numbers were released to individual banks over the weekend,” said Kedric Dines, head of interest-rate and commodity derivatives marketing in New York at Mizuho Corporate Bank. “People are bracing for potential shocks there, if there are any leaks.”

The yield on the 10-year note fell seven basis points to 2.85 percent as of 9:40 a.m. in New York, according to BGCantor Market Data. The price of the 2.75 percent security due February 2019 rose 9/32, or $2.81 per $1,000 face amount, to 98 25/32.

Jim Rogers - Expect More Bottoms

Wilbur Ross Brings Us Back to Energy Reality

"The most constructive use of wind turbines would be in Washington; it would make good use of the hot air coming from there." Wilbur Ross (American billionaire)

Sunday, April 12, 2009

Geithner's Plan Is Robbing the Taxpayers

From Jeffrey Sachs at
The Geithner-Summers a thinly veiled attempt to transfer up to hundreds of billions of dollars of US taxpayer funds to the commercial banks, by buying toxic assets from the banks at far above their market value. It is dressed up as a market transaction but that is a fig-leaf, since the government will put in 90 per cent or more of the funds and the “price discovery” process is not genuine. It is no surprise that stock market capitalisation of the banks has risen about 50 per cent from the lows of two weeks ago. Taxpayers are the losers, even as they stand on the sidelines cheering the rise of the stock market. It is their money fuelling the rally, yet the banks are the beneficiaries. The plan’s essence is to use government off-budget money to overpay for banks’ toxic assets, perhaps by a factor of two or more. This is done by creating a one-way bet for private-sector bidders for the toxic assets, then cynically calling it “private sector price discovery”.
Tim Geithner, Treasury secretary, and Lawrence Summers, director of the White House national economic council, suspect that they cannot go back to Congress to fund their plan and so are raiding the Federal Reserve, the Federal Deposit Insurance Corporation and the remaining Tarp funds, hoping that there will be little public understanding and little or no congressional scrutiny. This is an inappropriate institutional use of the Fed, the FDIC and the Tarp. Mr Geithner and Mr Summers should at the very least explain the true risks of large losses by the government under their plan. Then, a properly informed Congress and public could decide whether to adopt this plan or some better alternative.

Obama/Geithner Bank Bailout "Worse Than A Lie"

William Black was the regulator for the deposits during the S&L crisis 20 years ago. In a recent Barrons interview, he said the following:

"It is worse than a lie. Geithner has appropriated the language of his critics and of the forthright to support dishonesty. That is what's so appalling -- numbering himself among those who convey tough medicine when he is really pandering to the interests of a select group of banks who are on a first-name basis with Washington politicians.
"With most of America's biggest banks insolvent, you have, in essence, a multitrillion dollar cover-up by publicly traded entities, which amounts to felony securities fraud on a massive scale.
"The government is reluctant to admit the depth of the problem, because to do so would force it to put some of America's biggest financial institutions into receivership. The people running these banks are some of the most well-connected in Washington, with easy access to legislators. Prompt corrective action is what is needed, and mandated in the law. And that is precisely what isn't happening.
"The savings-and-loan crisis showed that, too often, the regulators became too close to the industry, and run interference for friends by hiding the problems."

Bond Market Suggest Economy to Get Worse

from the WSJ:
New research shows corporate bonds have been far better at predicting where the economy is headed than anyone thought. Unfortunately, that suggests the economy is going to get much worse.

Winning As a Trader Is 90% Learning Not to Lose

from Dr. Brett-
One of the fascinating conclusions of the research I posted yesterday is that traders learn by trading; that it is the number of trades placed--not the amount of time spent trading--that best predicts success in markets. That same research, however, finds that there is a very high attrition rate among traders; the most common learning that occurs in markets, quite literally, is that traders find out that they can't make money at what they're doing.

So we have a catch: traders need to learn by trading, but they also need to preserve their capital as they traverse their learning curves.

As I stressed in the Trader Performance book, much of learning in trading is pattern recognition. If that is the case, than it may be the frequency and intensity of exposure to patterns--and not the trading itself--that facilitates learning. This very much fits with my experience that traders can accelerate the development of competence by engaging in simulated trading (with live data) and by reviewing their trading via video. "Any techniques that you use in trading--whether for money management, self-control, or pattern recognition--require frequent repetition before they will become an ongoing part of your repertoire" (Psychology of Trading, p. 154).

Traders drop out of markets, perhaps not because they lack talent, but because they fail to achieve the necessary repetitions to internalize skills prior to depleting their capital.

They also fail because, even with repeated trading, they do not have a system for reviewing their performance, setting goals for improvement, intensively working on goals, and holding themselves accountable for those. Instead of a week's worth of experience, they repeat a single day's learning five times over.

The research cited yesterday, as well as this interesting study, suggest that an important component of learning to trade is learning to avoid behavioral biases in taking profits and losses. The traders who lose their disposition to sell winners early and hold onto losers are those that tend to be most successful. Ironically, turning loss-taking into routine behavior may be one of the most important learned skills in the evolution of a trader's success. The key is staying small enough, long enough to learn from the experience of losing.

Trader Self-Development

from Dr. Brett-
Successful self-coaching requires an ongoing commitment to tracking and improving performance. Here are some posts that will help guide your self-development as a trader:

* How Can I Learn Trading?

* Coaching Yourself for Profitable Performance

* Self-Efficacy and Attaining Goals

* What Contributes to Success

* Turning Goals Into Habit Patterns

* Setting Effective Goals

* A Secret to Life Success

* Finding the Heroic Within Us

Learning Trading Discipline

from Dr. Brett-

A big part of coaching yourself as a trader is staying in control when you are risking your capital. Here are some posts relevant to maintaining trading discipline:

Training Yourself for Discipline

Staying Cool in the Heat of Battle

Understanding Lapses in Trading Discipline

Top Reasons Traders Lose Discipline

Changing Your Self-Talk

Trading Stress and Emotion

Avoiding Overtrading

Self-Coaching Techniques - Part 1, Part 2, Part 3