Buzz on the Street: Responding to the Syrian Crisis, the Market Remains Volatile
A look back at the happenings on Wall Street this week, as seen by Minyanville's Buzz & Banter.
Here is a small sampling of this week's activity in the Buzz.
Monday, August 26, 2013
Following Up on Nominal GDP and Interest Rates
I received a lot of emails about my earlier comment on the relationship between Treasury yields and nominal GDP, so I thought it would be helpful if I clarified my thoughts with a chart.
My point is that when the 10-year Treasury yield increases "above" the growth rate of nominal GDP YoY from "below," the US has always gone into a recession. An example would be when the 10-year yield increases to 3% from 2% with nominal GDP at 2.9%.
I've always viewed the Treasury curve as a proxy for the demand for money, which means that either credit growth (loan demand, GDP) will follow the recent rate increase higher, or growth will fall because the cost of credit has risen too much, too fast. The second half of the year should give a lot more clarity on that subject. I am constructive that I am being too concerned because PCE (consumption) growth has picked up in recent months. The July consumption figure is due out on Friday morning.
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Clear and Present Markets: 8/26/2013
With the interns departed and kids headed back to school, it is time to delve back into the markets ahead of what I expect to be considerable volatility.
1. The WSJ homepage, this morning, tells a story of unsustainable spending. On the left side, you have headlines about the US role in the Middle East. On the right side, you have a story about transporting domestic oil.
It bears noting that as we prepare for a battle over the debt ceiling and the budget, the President's 2014 Budget calls for a 98% increase in income tax collections and a 25% increase in payroll taxes by 2020. I don't see how you can take another $1.3 trillion out of the consumers pocket without negatively impacting the economy, unless there is a commensurate increase in wages. In addition, since the individual will fund 80% of the government revenue, the country will have to better define its investment and spending priorities, and defense spending is a primary target. Throughout history, taxes on global trade have supported military expansion, and when military expansion outpaced the ability of taxes to fund that expansion, the economic, political, and military influence of the regime declined. This is why many nations are challenging the US politically and why we are debating our involvement in these actions. Our military is overextended, and we can't continue supporting our military to the degree we have in the past.
Oil is another segment in which we see unsustainable spending. Low interest rates have funded capital expenditures that exceed the cash flows from those investments, and many exploration & production companies have been forced to sell assets to fund drilling programs. As interest rates increase and fewer mid-stream assets are available to spin-off as MLPs, domestic oil production has to decline because the cash to fund that production comes at a higher cost. It is often overlooked how important low interest rates have been to domestic oil production, and one impact of a 3% yield on the 10-year Treasury is that capital intensive businesses will experience negative operating leverage as the cost of capital increases.
2. I have been expecting an increase in M&A activity, which has not materialized. The news of Amgen (NASDSAQ:AMGN) acquiring Onyx (NASDAQ:ONXX) brought this catalyst back on to my radar. Companies are at the limit of driving earnings growth through financial engineering of the balance sheet, and M&A provides another opportunity to drive growth by leveraging the cash flows of an under-leveraged competitor. Managers have been pretty disciplined, stating that prices are not attractive, but as Todd often says, "buyers are higher." As pressure builds on managers to deliver growth, M&A funded with cheap debt is another way to engineer growth.
3. Last week, a colleague and I were contemplating the future of the "big box" store, and the earnings of Dick's (NYSE:DKS) and PetSmart (NASDAQ:PETM) painted a stark difference in results and strategy. Dick's sales are traditionally volatile and have become more dependent on apparel recently. Dick's expects square footage growth to be the primary driver of earnings growth, and the company thinks services like return-to-store and ship-to-store will prevent Amazon (NASDAQ:AMZN) from disrupting its business model. PetSmart had much stronger results, which were driven by the growth in services like grooming, kennel, and training. PetSmart's use of services to drive traffic to the store ultimately helps them drive sales of items that might otherwise be purchased on-line. Coupling services with the traditional offering helps insulate the brick & mortar business from the on-line threat. Dick's is not doing enough to differentiate its experience. I would like to see Dick's take its service offering a step further, moving beyond hiring a golf pro and adding an ESPN Sports Science type experience, coupled with coaching (in a variety of sports), that makes the store a destination and drives both service revenue and other sales. There is entirely too much retail square footage in this country, and how it is utilized as on-line sales claim an increasing percentage of sales will determine the winners and losers.
Gold Gains Momentums
Gold is approaching its record high from 2 years ago. The action in miners such as Franco-Nevada (NYSE:FNV) exemplify the recent strength in the sector with Franco-Nevada stabbing through its 200 DMA six months after violating it in February.
See FNV for 2013 below with 200 DMA.
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Note Friday/today's strength was setup from a textbook backtest of a Rule-of-4 Breakout (a breakout over triple tops).
Tuesday, August 27, 2013
The Risk of Staycation
While I'm "off" this week, I'm spending the time with my family at our home--which means I'm only a few steps from my home office systems. A blessing and a curse perhaps, but either way, here are a few quick thoughts:
S&P (INDEXSP:.INX) 1640 matters on a closing basis; if we push through there on the downside, S&P 1600 and the 200-day at 1560 come into play through a technical lens.
Gold (NYSEARCA:GLD) has room to $1500 before it collides with the downtrend (technical resistance).
The specter of geopolitical unrest in the Middle East -- aside from it being an unfortunate evolution of social mood -- is on the margin constructive for both gold and crude.
Deflation is the other side of that trade, which makes both risky investments. See both sides.
I don't know JC Penney (NYSE:JCP) intimately, but I would think that once the Ackman overage works itself off, the stock has room to bounce.
Tapes that are weak all day (with breadth 2:1 negative or worse) tend to end that way BUT given how thin this week is (and will be), it won't take much to push an agenda (volatility is the opposite of liquidity).
Trading smaller "lots" is one way to address this dynamic; and of course, the ability not to trade is often as powerful as trading ability. Keep loose grips on those handlebars. September looms large on the horizon.
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Chart of the Day -- Russell 2000 and 2% Down Days
For today's chart of the day, we took the Russell 2000 (INDEXRUSSELL:RUT) year-to-date and plotted 2% down days for the index against it, marked by glowing red bars.
If you'll notice, every time the Russell 2000 fell 2% or more this year, the market was within range of an interim low.
Today, the Russell is down 2.3%, marking the biggest decline since June 20. Time will tell whether this signal holds again -- in the meantime, be aware that it isn't perfect as the bottoms weren't immediate.
Either way, a failure to rebound could within the next few trading days could indicate a change in character, especially if the S&P 500 fails to get back up above its 50 DMA, which has marked a key turning point numerous times this year.
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The Square of 9 Called It Right on This Stock
Around two weeks ago, we flagged the potential Apple (NASDAQ:AAPL) square-out at 512/513.
This was a big level since it was 540 degrees up from low. 540 degrees being a true square or cube (6 sides of 90 degrees = 540 degrees).
The Square of 9 Wheel continues to prove its value -- especially on those items that are widely watched, being part of the Street's 'spiritus mundi'.
Knowing the significance of 512 on AAPL not only would have saved/created financial capital but also substantial emotional capital, which is worth its weight in gold in this game.
Wednesday, August 28, 2013
Everyone Is Staring at the Same Scenario
There's a rather staggering volatility skew in the SPDR S&P 500 (NYSEARCA:SPY) October puts. With the stock at 164.10, the 155 puts are trading at 18.4% implied volatility with a price of 1.45 vs. theoretical value of 0.55. Now flip to the calls side and the mirror image 173 calls are trading at 12% implied volatility and the price is 0.35 vs. 0.45 theoretical value.
I wouldn't use this type of overloading on the put side as a "contrarian" indicator, but there is little doubt that protecting the downside by buying puts outright seems a low odds play, and risk reversals look outright suicidal. Ratio or butterfly put spreads look a lot more manageable.
Update on Short Interest
Short interest numbers for the NYSE are reported for the period of settlement date August 15. Short interest numbers have increased to 13,749,200,005 from 13,692,475,466 shares (revised) for an increase of 56,724,539 shares, or 0.41% with 1,598 advancers and 1,902 decliners. The NYSE has seen more advancers than decliners in 46 of the last 92 initial reporting periods.
NYSE and NASDAQ had risen the last eight of fourteen reporting periods and dropping across the board over the last three months.
During this period on a trade date basis (7/26 to 8/12) the S&P fell by -0.13%. The conclusion is shorts capitulated their positions with the recent strength. The next short interest collection period covers from 8/12 to 8/27, which is today, and so far, the S&P 500 has fallen by -1.93%. It will be interesting to see how much shorting takes place.
Short interest numbers for NASDAQ are reported for the period of settlement date August 15. Short interest numbers have decreased to 7,378,326,489 shares from 7,395,403,049 shares for a decrease of 17,076,560 shares or -0.23%. There were 1,089 increases and 1,402 decreases. In the last 92 reporting periods, NASDAQ has seen more advancers than decliners in 48 of the 92 last reporting periods.
Dedicated short sellers lost -5.74% in July (YTD -17.38%), as reported by www.hedgeindex.com and 2012 -15.99% while the index made 7.32% in 2011. For 2010, this index was down -17.79%. For 2009, this style lost -14.62%. In 2008, short sellers lost -1.52%. In 2007, short sellers made 4.14%.
The Day After
So here I sit with the highest cash levels in my portfolio since 2011. I feel kinda naked, but I know the market is really in a tenuous spot and without a washout low, there is still significant downside risk. I have cut to the bone now and prefer to manage market exposure via hedges at this point rather than selling positions. I have a handful of long-term stocks on the books that I still believe in, many of which I have buzzed about. This market is exceedingly weak, and the downtrend is becoming well established. We broke the November trendline, and I don't see much support below us until the 200-day moving average that sits around 1560. Attached is an updated chart that we looked at a couple days ago.
I am currently holding about 60% cash, 15% bonds (the bulk being my iShares Barclays 20+ Year Treasury Bond (NYSEARCA:TLT) buy from last week) and 25% core individual stocks. As I have mentioned before, my stylistic approach is maximize trends and systematically reduce risk and protect the portfolio when trends fail. I rarely go net short as you must be very quick to close those positions.
My expectations for the next couple of days are a drift up to the breakdown point of 1639 in the S&P 500, which would be a quality location to start layering into some shorts if that is your game. I will likely add hedges in that area.
Good luck my friends.
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Thursday, August 29, 2013
X-Raying the Markets
The stock market has taken a few sick days recently, but the question now is whether or not it is suffering from a true illness or if it just pushed itself too hard for too long and needed a break. Indeed, the S&P 500 (SPX/1634.96) asserted its vigor with a powerful up-move from the June 24th low to the August 2nd high, but since then it appears to be out of breath and has struggled to convalesce to its erstwhile form. Given the recent pattern of lower lows and lower highs, it may be time for a check-up to help diagnose just what is ailing the market. Only then can a reasonable attempt at a prognosis be made. So just as a doctor will put a sick patient through a battery of tests, technicians will look to the charts to assess the internal health of the current investment landscape.
One diagnostic test that can be used is to attempt to identify where we are in the traditional business cycle by looking at the intermarket relationship between bonds, stocks, and commodities. Historically, these asset classes tend to rise and fall in sequence, with bond prices topping out before stocks, which, in turn, top before commodities. So far it looks like this pattern may be developing in its textbook manner. Bond prices, for the most part, topped in July 2012 and have declined ever since, while stocks went on to make new highs before this recent patch of weakness. It may be too early to call an equities top in this business cycle, but commodities have picked up recently, as measured by the S&P Goldman Sachs Commodity Index. Commodities tend to lead toward the end of business cycles, so their recent relative strength is something to keep an eye on.
To utilize another tool, we can examine the equity markets more closely by studying the price action within the S&P 500 individual sectors. Not surprisingly, the SPDRs Select Sector Energy ETF (NYSEARCA:XLE/$82.46) has been the best performer among the nine SPDRs Sector Funds over the past month, reiterating the aforementioned theme of outperformance by commodities. However, it is the breakdown of the Financials that most intrigues us at the moment. Since the major low in March 2009, the Financials have appeared very comfortably in the driver's seat as they consistently led the equity market higher. But recent trading sessions have jeopardized this trend as the SPDRs Select Sector Financial ETF (NYSEARCA:XLF/$19.49) has just broken its rising wedge pattern and is currently positioned for lower prices in the near term (see chart). The stock market might not yet be terminal at this point, but without support from the Financials, it may be hard for the broad market to make its miraculous recovery. For now, it's chicken soup and plenty of fluids until it can once more get on its feet.
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The S&P 500's Reaction to US Adventures in the Middle East
The list below contains the dates of direct, US military interventions in Middle Eastern countries and the S&P 500's subsequent reaction. While traders and investors are understandably concerned about a military strike on Syria, military conflict doesn't always lead to a lower market. The reactions of the S&P to previous events hold no clear pattern. A spike in the price of oil is probably the biggest concern for investors if the US attacks - besides the unlikely event of a larger conflict erupting between the bigger players.
August 19, 1953 - At the request of the British M16, the CIA secretly organized and led a coup that overthrew Iranian Mohammad Mosaddeq. Both nations viewed Mosaddeq as a threat because he nationalized the Iranian oil industry, which which the British had controlled through the Anglo-Persian Oil Company.
Between August 19 and September 14, the S&P declined 6.58% from 24.31 to 22.71. The S&P had already been in a downtrend though. Afterwards, it started a bull run lasting until August 2, 1956 to 49.64 for a 118.58% gain.
July 15, 1958 - President Dwight D. Eisenhower authorized Operation Blue Bat, which involved about 14,000 men. Lebanese President Camille Chamoun asked the US for military aid after the Iraqi revolution that occurred a day earlier. The Christian and pro-Western Chamoun feared the Lebanese Muslims would gain control of the country and join the recently formed United Arab Republic, formed by Egypt and Syria. The US withdrew its forces on October 25, 1958.
From July 11 to July 15 the S&P dropped from 45.72 to 45.11 for a 1.33% decline.
Despite the small drop, the S&P would continue its uptrend from 45.11 to 50.81 on October 24, 1958 for a 12.64% gain. The market continued to gain despite the Soviet Union's threat to use nuclear weapons if the US intervened in Lebanon.
April 24, 1980 - President Jimmy Carter orders Operation Eagle Claw. US soldiers attempted to rescue 52 Americans held captive at the US embassy in Tehran. The helicopters encountered technical issues, causing commanders to abort the mission.
The S&P had declined from February through March before entering another uptrend. From April 24, the S&P would increase from 104.40 to 140.52 on November 28, the highest point of 1980, for a 34.60% gain.
August 25, 1982 - President Ronald Reagan sends marines to Beirut, Lebanon as part of a three-nation Multinational Force, which also included French and Italian troops, to try and help stabilize the country. The US military would remain active in the area until February 26, 1984.
By August 25, the S&P had reversed a downtrend. Beginning at 117.58 on that day, the S&P would reach 157.51 by February of 1984 for a 33.96% gain.
Between August 25, 1982 and February 26, 1984, attacks on the Multinational Force occurred.
During the week after the suicide bombing of the US Marine and French paratrooper barracks in Beirut on October 23, 1983, the S&P fell from 165.99 to 163.37 for a 1.58% decline. The S&P had reached a top on October 10 of that year, and it would not resume an uptrend until August of 1984.
When US Air Forces targeted Syrian anti-aircraft batteries on December 4, the S&P barely moved. However, the USS New Jersey battleship fired on Lebanon on December 14 and 15, and the S&P fell from 163.33 to 161.66 over the two days for a 1.02% decline.
When the Multinational Force began withdrawing on February 20, the S&P increased from 154.64 the following day to 159.30 by the time the US Marines had withdrawn for a 3.01% gain.
August 2, 1990 - When Iraqi troops invaded Kuwait starting the First Gulf War, the S&P stood at 351.48 and would drop to 295.46 by October 11 for a 15.94% decline.
The S&P regained some ground, rising to 331.75 before falling again by 5.67%, two weeks before the US military launched Operation Desert Storm on January 16, 1991. By this time, the S&P had regained its losses, and when the ceasefire occurred on February 28, 1991, the S&P reached 367.07 and would continue its uptrend.
August 20, 1998 - The US military launched cruise missile attacks on terrorist bases in Afghanistan and a pharmaceutical factory in Sudan. President Clinton authorized the attacks in retaliation to the US embassy bombings that occurred on August 7, 1998 in Dar es Salaam, Tanzania and Nairobi, Kenya.
The S&P remained little changed between these dates. The strikes occurred just days before the S&P fell 11.7%.
October 7, 2001 - President Bush launched Operation Enduring Freedom in response to the terrorist attacks on September 11. When the market opened on October 8 after that weekend, the S&P dropped from 1071.38 to 1062.44 for a 0.83% decline. But no major moves occurred on the index at the beginning of military operations. The S&P had rebounded from the sell-off that occurred after September 11, and it would continue its longer downtrend until it bottomed at 776.76 on October 9, 2002.
March 19, 2003 - When the Second Gulf War began, the S&P had not technically reversed its downtrend. Even by May 1, when President George Bush gave his "Mission Accomplished" speech, the S&P had not technically created an uptrend. During the conflict, the S&P gained 4.84%, moving from 874.02 to 916.30.
May 2, 2011 - When the US Navy SEAL team killed Osama Bin Laden, the S&P had little reaction.
Times are tense out in... the entire world?
1. Fast food workers, who are at the absolute bottom of the income distribution curve, are protesting to get their pay bumped up.
2. There is a raging debate over where it's time to attack Syria.
3. People who voluntarily give all their personal information to Facebook (NASDAQ:FB) and Twitter are going crazy over government surveillance programs.
It makes for a toxic mix in the air perhaps not seen since Occupy Wall Street, which saw a market pullback before a moonshot higher.
The S&P was at 1216 on September 16, 2011, before hitting a closing low of 1099 on October 3, 2011. From there, the rally was on, and the index hit 1419 on April 2, 2012 -- a full 29% off the lows.
Are we seeing a parallel pullback now that the news is so lousy?
Friday, August 30, 2013
India and Brazil were trying to restart the game of "he said, she said" that we saw predominantly during the Euro crises. This morning at 8:35, it was reported that India's principal economic adviser Dasgupta said, "India and other emerging markets are seeking a coordinated FX intervention that could happen in days rather than weeks. Brazil and India can start the move." Twenty minutes later the head of the Brazilian central bank said "there is no initiative of that sort." Now, Dasgupta is saying it's "hard to say if emerging markets are planning an FX move." Ugh. Will there be clowns at this circus?
With regards to the emerging markets situation, I would have to think that the rupee is pricing in a heckuva lot now of economic slowdown, which has me backing away from the EM short some. One thing I've learned/was taught is that once something moves in an extreme (record) in one direction, there is a high probability that the next move is not in the same direction. Still marinating on those thoughts, but thought I'd share.
The income data we saw this morning was the worst we had seen all year and is a bad trend to kick off the 3Q. Additionally, the spending data we saw matches up with the negative skew on guidance from consumer related stocks in the 2Q. Already, I've seen Barclay's (NYSE:BCS) taking down its 3Q GDP estimate to 1.6% from 1.9% (annualized) and Goldman to 1.5% from 1.7%.
Treasuries are dealing with a month-end index extension by 0.11 years due, which is the obvious reason for outperformance in the long end. Nothing new I can add today, the trend is still looking up but admittedly fragile. I will most likely wait until Tuesday to add to a long position, however.
Volumes looking light in ES (SP futures) and TY (10-year futures) thus far. ES has only traded 420K contracts vs 15 DMA of 1.587 million and TY at 493K vs 1.275 million 15 DMA. NYSE all securities breadth is just ticking 2:1 negative after the first 30 minutes.
I know this is a bit overdue... below is a picture from my trip to Montana at Hidden Lake up in Logan's Pass, Glacier National Park. Photo credit goes to Brandon Perry.
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Nuance Communications Getting More Icahn Love
There has been a lot written about Carl Icahn's latest moves regarding Nuance Communications (NASDAQ:NUAN). The two key items are these: He's in talks with Nuance about adding a board seat or seats, and he's still increasing his position in the name.
At this point, he's up to a 16.9% stake in the company. That's a big darn stake.
I'll remind readers that Icahn is not impervious, and I took a beating on one other Icahn activist action in the past. But in general I think he has a sound strategy with Nuance, and the company also has enough of a moat with its current set of technology as well as customer partnerships for a strong probability of value creation.
The key for Icahn is whether he can get Nuance sold, which is what I believe he wants. And the rub for any sale to a couple key tech companies like Google (NASDAQ:GOOG) or Microsoft (NASDAQ:MSFT) is that Apple is such a key customer that it take those two out of play. This also creates a bit of an issue as Apple then becomes a logical buyer, but it has shown little interest.
Then lastly, given that Nuance's market cap isn't small (nearly $6B), it makes the company a bit too large for an easy deal as there are not many software names that can easily gobble a company of this size up. Taking Google, Microsoft, and Apple out, the list is pretty well left with just IBM (NYSE:IBM), Oracle (NYSE:ORCL), SAP (NYSE:SAP), EMC (NYSE:EMC), VMWare (NYSE:VMW), and maybe Cognizant (NASDAQ:CTSH). My view is the data storage/cloud players would not be interested.
Bottom Line: When one looks at all this, it does become pretty clear why Nuance hasn't seen a corporate takeover yet. If it isn't Appleor private equity, the rest don't shake out very well. That doesn't mean that taking a shot at Nuance here doesn't make sense. I think it does as the stock has simply gotten very beaten up again. But this is a patience trade, and I'm one of the few people in the world left who can tolerate patience trades.
The reaction to Kerry's speech feels almost Fed-like (lots of bouncing around). For the meantime, the market appears comforted by his assertion that any action will be short-lived and not involve boots on the ground, which is aimed at soothing worries that Syria could be another Iraq orAfghanistan. This was supposed to be one of the most boring days of the year, but I wouldn't be surprised to see more volatility this afternoon.
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