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VIDEOVolatility Plays May Keep You Afloat as Lifeguards Drown
By
Fil Zucchi
May 10, 2010 10:50 am
The debt waters are getting too deep as the failed EU states shift their burdens on France and Germany.
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Huh?
Look, I understand that Brussels had a “come to Jesus” moment last week when it had to confront that its Frankensteinian experiment (creating a currency and then inventing economies to go with it) had gone terribly wrong. And I can’t blame it for pulling together imaginary guarantees to prop up its own debts. If it buys a few months of make-believe, it's better than the alternative.
But setting aside the sound and fury of the cornered politicians staring at financing markets, ready to cut them off from their God-given entitlement to endless flows of debt at near zero rates, it might be useful to focus on what last night’s maneuver really means, at least to these eyes.
The Greek debacle was a total... debacle. The country has been bankrupt basically forever so I suspect no one was really shocked that the collapse of confidence in its financial wherewithal would eventually sink it. What surprised a lot of people, and certainly the worldwide financial markets, was how woefully unprepared the rest of the EU countries were for such an inevitability. In a matter of two weeks the world financing markets told the EU in no uncertain terms that if France and Germany don’t take over the obligations of the rest of the EU, most countries, except for France and Germany, would have a very tough time getting their welfare states funded, and the EU would disintegrate in disorderly fashion. So -- behind the political demagoguery of “unity” and of fighting speculation -- France, Germany, and the IMF/US have guaranteed the sovereign debts of the rest of the EU, with an assist from various central banks doing what they do best: printing money to buy debt.
In short, over the weekend France and Germany bailed out Spain and Portugal (whose bonds were already on the chopping block) and preemptively propped up Italy and Ireland. This “agreement” is Greece Bailout Part II, complete with a token gesture by Spain and Portugal to cut their deficits an incremental 1.5% next year and 2% in 2012. The preemptive approach will avoid the ugliness of Europe-wide street fighting being broadcast all over the world.
Of course, this agreement does nothing to address the fact that Spain, Portugal, Ireland, and, to a lesser extent, Italy (and of course most of the other smaller countries) have utterly unsustainable sovereign financial structures. Just like Citigroup (C), AIG (AIG), Fannie (FNM) and Freddie (FRE), and many of the other TARP babies shifted their burdens to the US government, the failed EU states have now shifted their burdens on France and Germany.
Inevitably, and logically, the focus of the bond vigilantes will soon shift toward French and German bonds, in a test of whether these two countries can indeed sustain the rest of Europe. My guess is that this plan will work until the “sophistication” of Quantitative Easing (i.e. printing money) is recognized for the idiocy it embodies. To make matters worse, one has to wonder how long it will take for some of the more left-leaning governments to rationalize printing money not only as a way to fund debt, but also as a way to spread “wealth” to their electorates. So, today the markets are probably going to get juiced big time, but, for our financial well being, let’s not lose sight of the destination governments are leading us to: one where all the “lifeguards” will have drowned in a useless effort to stay afloat in debt waters way too deep. End of sermon.
Now a few ideas on how we might make some money from these shenanigans. As of Sunday night, the S&P 500 (SPX) futures are up some 30 points to 1135. I’m inclined to agree with the technicians who are now counting on a new trading range between last week’s SPX lows of 1050 and the breakdown level at 1200. So, at 1135, we are in essence at the middle of the range, and playing the upside or downside isn't that interesting to me. What is attractive is the level of volatility priced in many options. A program of selling near-dated index straddles against longer-dated, out of the money puts and calls may work well if the Volatility Index (VIX) doesn't collapse back the teens.
In a recovery/range-bound period, it would also not be surprising to see portfolio managers upgrade the quality of the portfolios and bid up beaten-down names such as Berkshire Hathaway (BRK/B), Federal Express (FDX), Visa (V), and Freeport McMoran (FCX) -- all on my list to replace some of my more speculative stocks, and all offering fat option premiums. I’m also not going to be shy in pressing some of my favorites, such as Akamai (AKAM), Clayton Williams (CWEI), Newpark Resources (NR), and Dendreon (DNDN), considering how well they've acted relative to the market. The dividend-oriented crowd might want to peek at Brazilian telecom outfit Tele Norte (TNE), which is now sporting a hefty 8.6% yield. Lastly, Boo’s friends may want to keep an eye on any rallies in oft-discussed Green Mountain Coffee Roasters (GMCR), which collapsed on earnings and looks to be well on its way to joining the crowd of has-been cult stocks.
So, keep an eye on the big picture as it’s getting dicier by the bailout; in the meantime, enjoy the roller coaster ride.
Position in SPX, V, AKAM, CWEI, NR, DNDN, TNE, and GMCR
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