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A Better Black Box? A Bigger Rate Drop?


A shrinking middle class of U.S. consumers is worrying about spending their last discretionary dollars and they did not get any help this week...


Short Confirmations, Long Confirms

Plenty of confirmations have now been identified on plenty of screens and black boxes about which way the markets should turn. Often, some of the same lines on charts and more volatile lines uttered by elected officials have meant very different things to bulls and bears. Conspicuously, some of the best from each camp are having difficult years of performance. One trade that might benefit from pressing bets on both sides to play catch up would be rather than looking for confirmations, buy them. The surge in trade confirm slips show you what is happening in the markets instead of wondering about what should happen.

I mentioned in the Buzz again this week another potential beneficiary from the secular tailwinds behind the business of trading itself, which I like to call "Take the Rake." When the dealer collects from the losers and pays the winners, I'd rather be long that little Vig that silently is raked from the table and hits the little black box with an undefeated record on the other side of the table.

I've expressed my belief for quite a while now that trading and managing risk for a growing league of global players is a rare industry with dramatic organic growth that I believe is secular. I continue to trade accordingly with positions in publicly traded exchanges, brokers, electronic and technology solutions, as well as businesses that support a swelling need for risk management and derivative expertise.

To put a few notable numbers behind the Rake, data compiled with help from my friends at Citigroup.

Continued volatile credit markets and macro-economic uncertainty saw global equity value traded +102% and derivative volumes +60% in August. YTD, equity value traded is +41% to US$60.2 trln and derivative volumes are +27% to 8.3 bln contracts.

Asia generated the fastest regional growth in equity value traded YTD +62% while the Americas remains the fastest growing region for derivatives +33% YTD. All regions across equity and derivative markets are exhibiting faster volume growth YTD vs. 2006.

Asia led the way with global equity value traded +137% in August, led by Shanghai +993% for the month and +596% YTD. In fact, August saw 12 exchanges post 100% value growth and 20 of 24 exchanges post value growth >60%.

This trade that I am still building, so pardon the absence of tickers, is a strange convergence for me in that my firm's philosophy and trading design is constructed around the foundation that we can learn more from what is happening than pontificating about what should be happening. In this instance I am being helped by both. The action in certain stocks is being fueled by increasingly volatile opinions about what should be happening.

Agreement and lower volatility have been quite rare recently. Surprisingly, the first time I could find either was right before the recent Fed rate cut. I cannot recall a more universal consensus shared by bulls and bears that the response would be muted and the outcome ranging from fairly uninspiring to disappointing, for both camps. I had absolutely no opinion, not even a guess. Yet I went into the decision with a very long book. Admittedly, the response surprised me as well. Don't underestimate the other fear – not of losing, but of underperforming, which may drive a lot of bulls into year-end. My partner and I did not even listen to the announcement, a trading discipline of ours, safely tucked in our trading bunker without a TV, preferring to set our buy and sell stops ahead of time. Trust stocks, not opinions (including this author's).

Feeling a Little More Hungry Today Than Yesterday

In a lightly followed story among the media focused on an important move in rates this week, I thought I'd share a look at a different drop in rates that I find much more compelling for a trade and which I will predict means more to more people, longer term. China was out this week publicly aiming to build grain reserves, and significantly cut its duty on soybeans from 3% to 1%, which will fuel imports. Privately, other nations around the world with swelling demand from the early innings of middle class consumption now have to up their antes to compete on the bid side for many crops which I alluded to in last week's Buzz on the very real demand story underneath some unusually strong moves in the Wheat contract (which I exited, for full disclosure, inside of a truly parabolic move). Now the sellers of other crops take their turn at the plate, and are swinging at an even fatter pitch – the same secular demand driven story but customers get to pay with dollars that are now worth a lot less.

Given all the furious debates, wild rallies, and endless speculation about what the Fed's move means for the equity markets – it is very likely a cleaner analysis in the commodities markets where dollar-denominated contracts can rise significantly without killing demand because this week something really big didn't change and something really big did change.

  • A few billion folks still want to eat more this year than last.
  • The dollars they need to buy the "stuff" just got cheaper.

I am long and getting a little longer agricultural commodities in the futures markets. In the stock market, the shops I've written about all year as my firm's single favorite group – selling the picks and shovels to everybody in this new version of a gold rush – are rallying hard again. I wish I could add something brand new to the mix of seeds, fertilizers, tractors, equipment, irrigation, and shippers needed to get this stuff in the ground and out, but that's the simple beauty of life on the farm down in Texas – it don't change much.

My favorite farmer, Pa Krueger, must be smiling down on his old buddies and maybe giving a little wink to his favorite crop – cotton – which has languished and is now being replaced in the fields with the hot crop – wheat – and setting up the potential for an '08 trade as supply may be squeezed.

On the other side of this trade, I'd chew on the potential negative that would work against a certain group of stocks. There may be a rather well-fed fly in the ointment of a very popular (and judging by numbers I just got about funds piling into the Consumer Discretion sector – very crowded) traditional trade that consumer discretionary industries do extremely well after a rate cut. I'm even less convinced (and selectively short) that casual dining – historically one of the very strongest inside that group – have ever seen this kind of rising costs for needed raw materials.

At the end of the week, I will stand by the notion that a shrinking middle class of U.S. consumers is worrying about spending their last discretionary dollars and they did not get any help this week, despite the rally in the U.S. stock market suggesting otherwise. A growing group of middle classes around the world are worried about spending some of their first discretionary dollars and having enough to eat.

That group did get helped this week; they can now buy those dollars needed to buy those crops for less. I believe it is rather significant week and clue that adds to a case I'd make that we in the U.S. are slightly less important today than we were yesterday. From my seat that is neither good nor bad, it is different and potentially a good trade.

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No positions in stocks mentioned.
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