Buzz on the Street: Investors Become Anxious as Markets Whipsaw
A look back at the happenings on Wall Street this week, as seen by Minyanville's Buzz & Banter.
Step Right Up
Attempting to pick a top to this crazy, up-trending market has felt very similar to playing one of those games at a carnival or fair - somehow you just know the odds are against you, and yet, you try anyway. Contrarians continue to be obstinate victims of Ben Bernanke's QEInfinity-lubricated ring toss game, while the Federal Reserve's recent comments about its future plans appear to have been interpreted by the market as "no definitive news is good news." Investors realize that the Fed's asset purchase program will end at some point and the target interest rate will eventually rise, but for now they continue to make hay while the sun shines. How powerful has this recent running of the bulls been? Well, between the intermediate low in the S&P 500 (INDEXSP:.INX) on June 24 and the hitherto high on August 2, the index rose about 9.6%. This is impressive enough, but when you also consider that during this run it never retraced more than 1.5%, you have a bona fide market melt-up. It is tough to buy the dips when there are no dips.
So what is an investor to do? If you have stayed with positions through the recent uptrend, you likely have some gains that you want to protect and not give back to Mr. Market when the inevitable correction happens. Will the past two days' weakness beget more downside risk? While no one knows for sure, internally, equities do appear to be losing strength when gauged by the NYSE Advance/Decline Line, an indicator that measures the change over time of the difference between the number of advancing and declining issues (see chart). When the indexes are making new highs, technical analysts also want to see the Advance/Decline Line making new highs to show robust breadth across the overall market and not just a few issues leading the way. Not only did the A/D Line not confirm the recent highs in the S&P 500, it has broken down to new short-term lows, signaling that fewer stocks are taking part in the move. While this by itself is not an immediate reason to sell, it is a divergence from the pattern seen year-to-date and does not augur well.
Once again, it may be foolish to try to call a top in this juiced-up market, but investing/trading is all about evaluating potential rewards against the risk and making sure the former's probability and magnitude are sufficient enough to justify the latter. Right now, if we postulate that we may finally see some weakness in the coming sessions, it may be better to wait until support is found and holds before initiating any new long positions. In the short term, probable support in the S&P 500 is most likely to occur around the following levels based on past support/ resistance, Fibonacci retracements, and volume-at-price readings: 1675, 1650, 1620, 1600, and 1560.
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China vs. the Taper
UBS (NYSE:UBS) economist George Magnus wrote an important op-ed in today's FT. Whereas a lot of the talk has been about the Fed and if/when the tapering of bond purchases would begin and what that means for markets, Magnus puts that discussion in the context of what that means versus China. The analysis should give many folks a moment of pause.
Magnus contends, and I agree, that many investors and analysts still think this is a cyclical slowdown coming in China. I certainly don't as I've been discussing here on the Buzz now for nearly the past two months. China needs to be monitored. Sure, there are questions about the data and what a real "boots on the ground" view would look like over there, but the fact is, China is getting ready to undergo some serious changes.
First, they're not the source for cheap labor anymore. Second, if they're not "making stuff" then their imports of raw materials and commodities will probably see some tapering of their own. Third, it's becoming clear their economic growth has been roid-raging on a lot of credit. When levered, illiquid assets can't command the values they used to. This has implications far beyond that asset class as the banks that financed that growth face exposure to credit, liquidity, and for some, solvency risks. Like Lord Voldemort coming back to take over the wizarding world, a systemic banking issue in China would bring back the Dark Lord of Deflation.
But enough hyperbole. Why bring this up now? Simple. China's GDP deflator has slumped to a 0.5% annual rate. Two years ago, this was at 7%. In an emerging market economy where inflation usually runs in the mid-single digits and real growth adds 2-3% of real growth on top of that, this is a huge change. I don't know for sure, but it seems clear to me that questions about destruction of aggregate demand, like the ones we've been hearing for the past 4 years, should be on the table for any discussion about China.
Magnus goes on to estimate that the reduced income and wealth effects could affect up to 35-40% of China's economy as they look to unwind the massive amounts of real estate investment that have accumulated there. If he's even half right, the problems from Fed tapering will be a rounding error.
Long Bond Breaks Downtrend
The September long bond future (USU3) broke out of its downtrend on the daily chart this afternoon following the decent 10-year auction. The downtrend started on May 9th and has held ever since. For the very short-term, 30-and-60-min RSI is in the upper band so we need to see a bit of chop overnight to work it off, if not a small dip tomorrow. One concern for me has been the general lack of volume of the rally over the last few days. I am currently short an OTM August iShares Barclays 20+ Year Treasury Bond (NYSEARCA:TLT) monthly put spread that I may roll to September by the end of the week.
Note that on 30-year Treasury Yields (INDEXCBOE:TYX) (the CBOE's 30-year yield index) the uptrend (for yield) has been broken, but not on the generic 30-year yield chart on Bloomberg, if we want to get technical.
Last, but not least, the bid-cover ratio for today's 10-year auction was the lowest since March 2009, which pre-empted a massive spike in yields, for whatever that is worth.
As a side note, I just rolled up my August Russell 2000 ETF (NYSEARCA:IWM) put spread as barring a significant down move the risk/reward wasn't favorable anymore. I'll be looking to redeploy that tomorrow or Friday into something longer dated. Note today was the 3rd down day in a row for the SPX, if we should close in the red.
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Thursday, August 8, 2013
Rule-of-4 Sell: DXJ
The WisdomTree Japan Hedged Equity (NYSEARCA:DXJ), which is an ETF for the Nikkei with a currency kicker hedge, is flirting with a Rule-of-4 sell on a break of a rising 3-point trendline.
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If the signal is generated, it implies a test of the 200 DMA.
Remember when the Japanese market fell out of bed in May? It sent shock waves across global markets.
So, any further decline and test of the 200 needs to be watched carefully as this divergence between the US and the Nikkei should be resolved sooner rather than later with the Nikkei turning back up after an A-B-C-bullish correction or a sell-off in the US.
Gold Breaks Out
After holding key support above $1,270/65 yesterday, spot gold prices have rocketed to $1,315.
In so doing, it has hurdled its nearest-term resistance line at $1,302 in what looks like the conclusion of the handle portion of a May-Aug cup-and-handle pattern.
If today's gains are sustained, my work will argue that gold -- and the SPDR Gold Shares (NYSEARCA:GLD) -- has started a new upleg that projects toward a retest of the July high in spot gold at $1,349.31.
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T-Report: Rolling Stones vs Lead Zeppelin (or QE & the Economy)
Does QE Help the Economy?
In the short run, it doesn't matter. All that matters is that next injection of Fed money, which boosts asset prices. The fact that the asset class that benefits most, stocks, is rich, and the asset class they are actually buying, treasuries, isn't responding to further purchases is a bit counterintuitive but par for the course.
Yesterday, we went through our analysis on tapering and our view that Fed "easing" is overly priced into the market and is set to disappoint. Today, we want to take a closer look at the impact QE has on the economy and what that can mean for stocks and QE going forward.
The "Rolling Stone" View
The bull case is pretty simple. QE has helped the economy and continues to help the economy. Both indirectly via asset price inflation and the wealth effect and somewhat directly through interest rates. The help to the economy will be enough to create a virtuous circle of growth so that not only will QE no longer be needed, but the economy will also grow without it.
It is compelling to believe because it is a very optimistic view. It makes you feel good to think that after 5 years the economy is finally getting ready to stand on its own two feet. There seem to be several issues with this.
For at least a year, we have been told that lower rates are good. Low mortgage rates are good. Low yields on corporate bonds are good. The low cost of debt is good and helps the economy. That largely makes sense (now is not the time to rail against the negative real short term rates this Fed likes).
But if it is true, we have seen rates rise across the board dramatically in the past few months.
Rates have spiked since May 2, and rates are higher than at any time in the past 2 years. We saw an improvement of growth with lower rates. That wasn't the sole driver, but it is an important one.
From any project "NPV" standpoint, where a company analyzes a project, there are really two key components. The expected revenue (or revenue scenarios) and the financing costs. Financing costs for any potential project have shot up. For companies to want to expand, then 1 of 2 things need to have happened. Either their revenue projections shot up fast enough to offset the increased funding costs or their range of scenarios improved enough that the project makes sense.
I find it hard to believe any company became so excited about the "growth" of the past 2 months that they are betting on much higher revenue. It just seems that the data hasn't been good enough to warrant that kind of optimism.
I am willing to believe that some companies will reduce their downside risk in the analysis as stability seems far more likely than any renewed weakness. That could be enough to keep some projects moving forward. If QE has finally convinced company management teams that the renewed recession scenario is off the table, it could spur growth, in spite of higher rates. I am dubious about that scenario as it is unclear what QE has really done, but it is plausible enough that I am not willing to bet against it.
In any case, we now have higher rates in spite of ongoing QE and that increase has been so quick that I expect it to be a drag on the economy in the coming months. Remember; the "don't fight the Fed" gang always says it takes about 6 months for rate cuts to work their way into the real economy. The same should be expected from a yield spike.
The Wealth Effect
The wealth effect really comes down to housing. The wealth effect of stocks seems limited to a select group of individuals and to pension funds. It is great that pension funds are digging out of their hole, but that doesn't seem to be a big boost to the economy in the short term. Lately, the stock wealth effect seems to have encouraged private equity firms to IPO as much as they can. Hardly a help for the average American and somewhat reminiscent of the Blackstone Group (NYSE:BX) IPO just ahead of the last time we hit a wall.
The increase in housing prices is real. That helps virtually everyone. The problem is that we are only in the "breathing a sigh of relief" stage. Everyone is relieved that the worst is over, but few are "up" on their purchases, and even fewer are comfortable spending based on their house value going up. Being upside down less on the mortgage is a good thing, but the benefit really accrues to the bank. I am not downbeat on housing, I am just careful about getting too far ahead of the actual impact.
So I don't think the wealth effect of QE is big at this stage for the real economy, though it has been big for the stock market.
What if Tapering Doesn't Impact the Economy?
Let's assume the Fed tapers and the economic data remains on track. What then? I would argue faster tapering. There are many that question how useful QE is. If the Fed tapers and the economy responds with a shrug of the shoulders, that should increase the rate of tapering. Ben is under pressure to consider tapering, and in an ideal world, would love to leave his term as chairman having "saved" the economy and ended all "alternative" measures. That would be a best case.
So if tapering doesn't hurt the economy, expect an accelerated program, which should hurt stocks more than bonds. Bonds have a reasonable rate of inflation and growth priced in. Stocks have an accelerated growth path priced in.
What if Tapering Does Impact the Economy?
What if we taper and get a steep decline in economic activity? Do we just "untaper" and buy more? Probably, but will the market buy that? Maybe.
In this topsy turvy world that we have created, it is possible, maybe even likely that we taper, see worse data and untaper, and markets rally as QE forever becomes the new norm.
The "Lead Zeppelin" Scenario
While the Rolling Stone scenario is appealing, the Led Zeppelin (apologies to the band) scenario is scary, probably as unlikely, but a real possibility. I assume a lead zeppelin doesn't fly, and in this scenario, the economy and markets won't fly either.
We start with some tapering. The combination of tapering and higher rates slows the economy down. Then for whatever reason, probably politically motivated, the Fed stays the course. The Fed doesn't immediately re-introduce more QE. With the Fed chairmanship up for grabs, that scenario is less far-fetched than it seemed a month ago when most of us thought Yellen was a lock.
In that case, the weaker data, no obvious way to return to better data, and far less Fed money than the market has priced in and demands will cause a sell-off. It shouldn't be a big sell-off, but given positioning and the lack of liquidity, it will be bigger than it should (10% or more).
Too much good news and hope is priced into equities. Remain cautious here. The downside once again seems greater than the upside. We continue to think high yield bonds offer value here. Treasuries are okay. IG CDS is a good short.
In the medium term we are bullish on credit as we think treasury yields are fairly priced or too high, and the economy will do well enough to justify spreads. In fact we expect renewed interest in structured credit products by the end of this year and early next, but that is a story for another day.
Friday, August 9, 2013
Getting Short Facebook, but Defining Risk vs Reward
Facebook (NASDAQ:FB), the social networking celebrity, recently had positive Q2 results, but certain analysts are remaining bearish on the stock and cite that over-speculation might be in play for the company's investors. The recent hubbub has been over the fact that the company broke past its $38 IPO price for the first time since its rocky start after going public over a year ago, but Facebook is still having trouble competing in the mobile device market. The switch from the traditional desktop platform to the mobile device industry has been Facebook's biggest challenge, though the company is making initiatives to extend its success like creating TV ads and developing smartphone games. However, now analysts say the company's excessive optimism over the past quarter's results are transforming the company's stock from propitious holdings to overweight shares. According to the number crunchers, Facebook "still has a long way to go to justify its current stock price." One marketing expert in particular calculated that in order for the stock to be worthy of its current price trends and assuming a 15% annual return rate, yearly revenue for Facebook would have to reach $25.5 billion by 2017, giving the company a market cap of $149.8 billion. This revenue estimate is over four times the $6.1 billion revenue brought in by the company over the past year, and Facebook's current market cap is less than $90 billion. Given that Facebook is in a precarious transition period from focusing on computers users to smartphone customers, most other analysts remain conservative on their estimations of the company's growth and are only expecting $14.3 billion in revenue for 2016. Also, with FB's beta level at 0.88, investors should not be expecting high volatility from this company, which would be needed to encourage fast growth and support the company's current stock prices.
My Trade: Buying the FB October-September 37 Call Calendar Spread for $.55 debit
My Risk: $55 per 1 lot
My Reward: Unlimited. If the September 37 Calls expire worthless, then I will be Long the October 37 Calls for $.55 and in theory have Unlimited Reward
Greeks of this Trade:
Waiting for a Price Flip in Procera Networks
I'm waiting for a price flip in Procera Networks (NASDAQ:PKT) and for my early turn technical analysis work to show me the way. I can't find a good reason for the huge drop from the gap higher. But remember; the selling window opens (for insiders), and these small/mid cap's have no institutional sponsorship. Thus, in the absence of a massively strong catalyst, these names get sold, sometimes more sharperly than many anticipate.
Combine that with the fact that Procera Networks probably had a good bit of pre-earnings buying following the strong reports from so many peers, and you have the recipe for an algo-sell fest.
Bottom Line: I feel better about Procera Networks after the report than before, especially as the name has now come in a good 10-15% plus. But I'm also not going to step in front of the algo freight train just yet. I'd rather pay $0.25-0.50 more off of whatever base forms than try to exactly bottom tick this stock. Though, that being said, if I see 12.50, I'll put in a buy tranche no matter how bad the chart action looks. From that level, I'll likely get some bounce, upgrade, or catalyst, which will let me sell it for something in the low $14s.
Yen and Treasuries
The Yen versus dollar bid in place since the beginning of the month is in line with the ZN (ten-year note futures) bid (see chart). This is a warning both on carry and a weak economy, with rotation out of equities into safety. Aside from a one-day scare, equities have been ignoring the paradigm. But someone is wrong, and it rarely is the bond market. It will be interesting to see how this plays out next week during option expiration. But with the yield on the ten-year struggling at 2.6%, some might be looking back at 2.75% wishing they had parked there until October after a 20% equity run year to date.
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There is lots of talk about how low yields should foster higher P/Es than where we are now. Allow me to use a historical precedent to debunk that theory. The last strong era of 2.5% yields in the early 1950's had a P/E ratio in the single digits to low teens. We are currently above 19 P/E (lagging). If you remove the freak blow up of recent years, this is a level that has marked resistance for the better part of 100 years (see chart 2). Many pundits could be falling victim to generational perception - one's lifetime experience - as opposed to analyzing hard data on a longer-term basis.
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