April 2012

Sentiment is really one thing that I ignore. Economics has a term, demonstrated preference, unless you have a position backed by money, save your breath, no-one is interested in your opinion. The market, and non-market data, provide enough data to get a pretty good handle on demonstrated preference.

I still like the trade from a technical set-up. The r/r ratio has improved. Added to my existing position opened on Friday.

Josh Brown got an invite to DoubleLine, needless to say, I didn’t, so I’ll simply steal some of his notes. Much of what Gundlach talks about, I have already done so. The question is, why don’t I have $28 billion under management?

Austerity and Growth at the same time – that’s just empty rhetoric in the media. I’m always amazed when I see people put words and thoughts together that don’t mean anything and aren’t meant to be together.” In Jeffrey’s view, there is no way to cut your way to prosperity. Austerity is guaranteed to lead to a weaker economy no matter where it takes place and the alternative, a continuation of debt-financed solutions – is even worse. In other words, there’s no way out other than rolling back over and seeing more defaults at non-currency issuing countries who have unworkable liability structures. He’s looking at you, peripheral Europe.

As you’ll read a bit later, this is a contradiction. Austerity actually means something very different to the useage. What is required for growth is a reduction in consumption, and increased savings, with a concurrent freeing of the market rate of interest so that it can more clearly reflect the natural rate of interest. The dictionary definition, can, quite correctly be linked with growth.

On Spain: “Nothing is more dangerous than a bunch of 20 year olds with nothing to do. Spain has 23% unemployment and 45% unemployment among young people.” He views it as a powder keg and sees civil unrest as highly possible.

Nationalism is on the rise in Europe.” He notes that cooperation is deteriorating and tells a great anecdote about how some racist German reporter, upon noting that Gundlach was a German last name – just laid into the French, criticizing their leadership, economy, crisis response etc. “I bet the reporter wouldn’t have said those things if my last name was Cousteau.”

A topic that I have mentioned. Of personal interest as France or Spain are my preferred destinations, but the current financial mess has unleashed once again similar conditions that allowed Naziism to take hold in the 1920’s Germany.

But again, the military is not even what’s busting the budget. Healthcare and Medicare spending are destroying us (rapidly heading toward 30% of all government capital outlays up from only 5% 20 years ago). Jeffrey notes that he is typically cynical about government spending anyway, “Government programs usually come out to be 10X the cost projected and .1X the benefit expected.”

Then Jeffrey pulls the slide out that Ron Paul has probably had made into a bedspread so he can wrap himself in it nice and snug each night at bedtime – the one showing how federal employees now make double what private sector employees make (largely thanks to pension and retirement benefits that “have got to be cut. Benefits will be slashed.” He notes that federal employees are not payers of taxes, they are “receivers of tax dollars.

Another truism that I have harped on about. Taxes are theft. Government employee’s who produce fuck-all except a headache for the rest of us, are the recipients of this theft.

They’ll need to debate the debt ceiling again in time to raise it, this lands in October of this year- almost perfectly timed to make it a centerpiece of the election.

Jeffrey sees this new debate virtually guaranteeing a dip in the economy if the GOP gets its way. “It is metaphysically clear that if we attack the deficit, the economy will go negative.” That actually may have been the money quote of the whole event, we’ll find out this fall I guess

Unbelievable that these dimwits could repeat the error so soon after the first error was made. But then again, government continues to prove that their stupidity knows no natural bounds.

As far as Operation Twist, Jeffrey says “Make no mistake, this IS QE3.” We’ll see if they extend it past June 30th when it’s set to expire.

On Bernanke’s strategy, he is unconvinced that we’re going to simply “print and pay” as the gold bugs expect us to unless the crisis gets much worse. Instead, Bernanke seems to favor a strategy of moderate inflation, which he can continue to pursue until about 5% CPI, at which point a rate hike is a given.

“The big7 question is what happens when stimulus ends.”

This has been my #1 topic of late. Operation Twist is a QE program. Not as massive as the previous, but, QE all the same, hence the same reaction in the markets. Until QE ends, you simply have to be long.

As to what happens – read my newsletter, while I don’t know what will happen, I will know when and that is the money shot. Think I’m bs’ing, read my newsletter, I’ve been all over this like a rash, and will continue to be so.

Much discussion ensues about the effect of QE programs on the stock market (where they’ve had more visible impact than anywhere else), I know you’ve seen a version of this chart before (every strategist has one in his or her slide deck this spring, it’s the cool thing to do), here’s Jeffrey’s (via Barclays):

His go-to comparison for Apple stock is Google stock last decade, the enthusiasm and expectations were very similar. And then he throws a chart of Google heading into 2007 compared with Apple circa now and there is an audible gasp in the dining room. They are nearly identical and Google hasn’t made a shred of forward progress since…

Well anyone who has been trading for a while knows, or should know that at some point AAPL the stock, crashes back to reality. The key is when? I have no idea. The thing is, you won’t be able to tell from a daily chart. You’ll have to look at at least a weekly, likely a monthly. If you nail it on a daily, well done, but you were simply lucky.

But Jeffrey does believe Bernanke when he says that the Fed will stay at zero Fed Funds Rates through 2014. This despite tha fact that “11 out of the 17 Federal reserve economist predict that he will not.” It’s bizarre to hear Bernanke say he’s staying and the rest of the organization say he’s not.

But Jeffrey notes that the only thing saving us right now is that the Fed can hold down rates. The Fed can’t raise rates because for every 1% rise it means an additional $150 billion in debt service cost (interest payments to US bondholders). “Why on earth would the Fed ever want to do that?” he mentions that this concept of holding down debt service costs is exactly what Japan has been doing – they are now trapped, they can never raise rates again without committing suicide.

And he makes it very clear that the days of raising rates preemptively to counter potential inflation are over. “THE FED WILL NOT RAISE RATES PREEMPTIVELY. EVER.” See? he notes that there’s not been any real inflation since 1985 as the Fed has historically acted preemptively but that was then and this is now.

He also notes that the labor participation rate will continue to force the Fed to keep rates down for longer than anyone thought possible.

Again, all points that I have repeatedly made. Nuff said.

When asked about what the Fed should be doing later on during the Q&A, Jeffrey says that the right thing to do is the hardest – let the debt clear and have a depression. You could hear a salad fork drop when he says this.

But of course, we’ll never do this, he says. So in the absence of letting the everything reboot, at the very least the Fed should “stop with the manipulation of markets.”

That is the answer. Pure Austrian economics.

There are two ways that you can approach this: [i] have a stock that you believe due to analysis will do abc, and select an appropriate strategy to trade that outlook, or [ii] have a strategy that you have faith in, and find a stock that will fit that strategy.

Both work. Both revolve around timing the two variables and fitting them together. Which one is better? The one that suits your emotional set-up. There are some differences that are worth paying attention to.

The first strategy requires you finding a stock that contains all the variables that you seek with regard to predictable patterns and behavior, that you know well, you are very in-tune with the stock. Simply then as the stock moves through trending, pullbacks, consolidation, etc, you fit the strategy to its particular phase. This will require using Options, as they provide the flexibility to follow this style of trading.

Conversely, you have a limited number of strategies that you know well, and are very comfortable trading. Strategies that allow you to actually trade the strategy to its natural conclusion, you are not tempted to jump out of the trade, or be forced out of the trade by temporary adverse price movement. This then requires a scan, or watch-list large enough to provide enough trades to adequately employ capital.

I know traders who are one or the other, even a few who are ambidextrous. Ultimately all that matters is that a profit is earned.

The newsletter consists primarily of an analysis of the S&P500 for the coming week. The results to date, you can judge for yourself from the results that are posted each week. Starting from this week however I will be adding a Trade of the week which is a trade in a weekly option, that has, the duration of one week, or less.

The trade this week was BIDU which was placed on Friday. The newsletter comes out Sunday’s and is the strategy for the following week. However, the newsletter can be pre-empted by myself, although it’s not foolproof, and take an early position in anticipation of the analysis, the reason being that very often, if no position is held, getting an attractive entry can be a problem. Of course, sometimes it is a boon.

Either way, from my own personal trades taken, the early position on Friday pays. Thus this option will become part of the newsletter that will be delivered prior to the market close on Friday, so that if a short-term trade suits your reward/risk management, you can take the trade.

I have worked out the probabilities for the BIDU trade, which is always part of my trade assessment.

BIDU Trade

Sell $135 @ $2.09
Buy $130 @ $5.65

Debit = $1.45

B/E = $133.57
Max Loss @ $130.00 [per contract]
Max Reward @ $135.00

Technical set-up:
3mth chart [bull]
25day chart [bear]
Force Index [bull]
Correlation [bull]

Below $129.69 = 21.3%
Between $129.69 & $142.87 = 69%
Above $142.00 = 12%

Now the duCati report adds the final tick to the trade, which can be taken on Monday after you receive the report, but the trade will likely have changed it’s characteristics [better, worse]. The newsletter adds the correlation factor, which is if the trade is long, which this is, and the index is a buy or hold, then the trade has an added success factor depending on it’s correlation, which I already calculate.

Last week’s Trade of the week was the trade in QQQ. I played it safe, and traded another index. The returns to capital were 29%. The return on the BIDU trade is 41%. These are very high returns on a weekly basis, with a high degree of probability.

Further, if and when the market turns bear, or consolidates, with mean reversion trades, the weekly trades can be short trades as easily as long trades. This essentially adds huge value to the newsletter, that is already pretty damn cheap.

Obviously, the weekly trades will no longer appear on the blog.

Back up near the highs of the equity curve. Still holding that original position. Until Operation Twist ends, or there is a significant change in the technicals, I’ll probably continue to hold. Watch the newsletter space.

This week’s newsletter has just been posted. I’ll have the results up later, this week was a good week, although the position was simply moving back to previous highs.

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