A cynical look at our financial markets and the governments that support them
It seems that state governments will provide the next wave of crises to rival that of the Eurozone. Unfortunately for states, they cannot inflate their way out of debt without help from big brother Federal Government. It is no wonder that investment banks have tried to get me long the Muni/Libor basis because of the attractive “relative value”. I have a feeling that they are merely trying to facilitate a way for smart investors to short the municipal/state bond markets.
– June 14, 2010
US lawmakers seek to unify financial reforms – Financial Times
Volcker presses on risky trading – Financial Times
Retail Sales Fall, Deflating Some Optimism– New York Times
Fed Says Economy Grew in 12 Regions, Though ‘Modest’ – Bloomberg
GLOBAL MARKETS: European Stocks Post Modest Gains; Banks Rise – Wall Street Journal
Credit Markets Treat BP As If It Were Rated Junk – Wall Street Journal
Banks Face Short-Sale Fraud as Home ‘Flopping’ Rises – Bloomberg
US banks set to lose swaps fight – Financial Times
Europe’s Banks Face Second Funding Squeeze on Sovereign Crisis – Bloomberg
Posted in Economics, Markets, Media, Politics.
Comments Off on Noteworthy News – June 14, 2010
– June 13, 2010
via the Chicago Tribune
Posted in Economics, Markets, Politics.
Comments Off on Tsunami of Red Ink
– June 9, 2010
When the equity markets were rallying off of the March 2009 lows there were many news articles pointing at the destruction of the dollar as a cause for the rally. Indeed, if you think about asset prices (stocks, houses, food, commodities etc), when the dollar loses its buying power the nominal asset prices should rise. Likewise, when the dollar gains buying power the nominal asset prices should fall. What is interesting is that this was not always the case. When there is robust growth, an equity market can rally with its currency as global investors rush to put their money in a booming economy. In the late 90’s when the stock market was roaring, the dollar was roaring with it. When the market corrected from 2000 through 2003, the dollar corrected with it. This dynamic broke down in 2003 in parallel and since then we have not looked back. We can most likely attribute this to very accommodative monetary policies.
Correlation between the Dollar and the S&P generally turned negative sometime in the early 2000's
If we focus on recent history and the ugly housing crisis that started to show up in 2005, we see the dollar being bid up when stocks are destroyed. Likewise, off of the March 2009 rally we saw that the dollar was weakening as stocks were strengthening.
During the financial crisis the spikes in the dollar (flight to quality) were highly synchronous to the spikes downward in equities
In the crisis, the dollar peaked out at about 89 while the S&P 500 bottomed at about 675. From the bottom in March until the end of 2009, the dollar lost ground while equities rallied. At the end of 2009, the Euro started its massive slide of over 20% while US equity markets continued to rally.
What is “good” about the recent history is that the dollar has rallied to crisis levels (mostly because of the Euro destruction) while equity markets are still holding on to over 55% of their gains since the March 2009 lows. This means that our dollar purchasing power should theoretically be the same as it was during the bowels of the crisis while our equity wealth is 55% higher. It also shows that despite a strong rally in the dollar, stock valuations have held on against the current (so far).
If you place the current dollar strength against the US deficit backdrop, then this current environment provides an opportunity. The Australian dollar is off over 10% since this “flight to quality” began while their equity markets are off nearly 25% (with a dividend yield over 6%). These crises moments are the occasions to diversify out of countries with fiscal positions that have only inflationary solutions. The purchasing power of one dollar in 1967 is 15 cents today. Do you believe that will increase or decrease in the next 10 years?
Posted in Economics, Markets, Politics.
– June 8, 2010
The public often uses the VIX as the standard measure of “fear” in the overall market. I prefer to look at option skew instead. Skew tells the investor how much out-of-the money puts are being bid up versus out-of-the money calls. If an investor is scared about downside, then he buys puts. If an investor thinks there is room for upside, then he is willing to buy calls. When the difference between the implied volatility of OTM puts dwarves OTM calls, then investors are fleeing for the exits. On May 20, 2010, the skew of 3-month options hit a five year high.
Three month option skew spiked to five year highs on May 20th
Depending upon valuations and underlying market conditions, the skew can signal either prescient fear or undue panic. It seemed that the shuttering of the subprime lender Ameriquest in May 2006 elevated skew quickly even though the market had many more months of rallying. In retrospect, this can be considered the thoughtful re-pricing of downside tail risk. Likewise, the last spike in November of 2007 served as an excellent timing signal to get out of the market.
On the positive side, a spiking skew in November of 2008 and January of 2009 showed more of the panic selling rather than a signal of significant downside to come. In many of these “fear” spikes in skew, the actual spike preceded the local market bottom by a week or more. If the spike on May 20th is a positive signal, then we should soon find our own local bottom.
As a strategy, if you believe we are close to a bottom, selling OTM puts and buying OTM calls looks very attractive with a steep skew. Always think about selling insurance when the building is on fire rather than buying insurance after the major damage has already taken place.
Posted in Derivatives, Markets, Trading Ideas.
– June 7, 2010
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