Author: Casey Keller, CFA

The election is finally here and today is the day that millions of Americans will cast their vote.  There are several views on how the stock market might perform depending on the outcome.  Rather than trying to predict the future based on hypoteticals, we’re simply going to show the last 10 election years and how the stock market (measured by the S&P 500) performed from the day after the election until the end of the year. Read the rest of this entry »

One major overhang for investors and the financial markets is the so-called “fiscal cliff”.  That’s the combination of $607 billion of expiring tax cuts and expenditures that will take place at the end of 2012 should Congress not act. Read the rest of this entry »

Last week, J.P. Morgan held a conference call in which they disclosed they had a trading loss of over $2 billion.  At the time the news was released, the trade was still open and still costing the company even more.  An already fragile stock, sector, and stock market didn’t take the news well.  The recent J.P. Morgan is bringing back memories of 2008.  It doesn’t seem that long ago that “too big to fail” was introduced to the American people and the world.  It was actually first formally introduced in 1984 by U.S. Congressman Stewart McKinney. It obviously became a common term in 2008.

For those that don’t understand, in the early 2000s, many large banks and financial institutions took on extreme amounts of risk and leverage in an effort to boost profits and in some cases “hedge”.  As we all know now, companies were levered 30:1, 40:1, or even higher.  When these bets, excuse me, investments, went against the company that took them on, the slightest decline on the trade could wipe out their entire investment because of the leverage.  And, that’s exactly what happened.  Unfortunately, the loss wasn’t limited exclusively to the individual company.  There was counter party risk (other entities involved).  But ultimately, the American taxpayer took on the risk.  Many institutions were either bailed out by our tax dollars or mergers were financed through our tax dollars.  The reason given for these bailouts was the institutions that made these investments were “too big to fail.”  If they failed, the whole system would crumble.  And sadly, it’s true.  In many cases, these companies didn’t do anything illegal.  They simply played the system the way it was set up.  We, the American taxpayer, were held hostage.

Regulation was introduced to prevent these types of events from happening in the future, including the Dodd-Frank Bill, stress tests, etc.  I’m all for regulation when it’s reasonable and doesn’t involve too much bureaucracy (I hear you chuckling).  I don’t think the regulation should stymie risk taking or hedging.  If there wasn’t risk taking, there would only be one side of the trade and markets wouldn’t function, businesses wouldn’t get funded, and the economy would instantly go into a recession.  In addition, investors wouldn’t get paid any premium for investments.  Regulation is needed, but unfortunately with each bill that’s passed to regulate and help prevent financial meltdown, there seems to be more complication and pork that adds to the problem.

To me, the real issue is simply the leverage.  It’s one thing to borrow money.  I’ve never had a problem when it comes to debt or leverage, if it’s manageable.  But, we’ve seen with many people in our country that leverage can kill you.  This was obvious during the recent housing crisis.  There’s a difference between manageable debt for strategic purposes and excessive debt that’s relied upon or can wipe out an individual.  But, it’s not just with individuals, it’s with publicly traded companies.   When a rogue trader or CEO makes bets that he personally doesn’t have to pay for or be held accountable for (assuming nothing illegal was done), the system has a problem.  Therefore, leverage that companies use has to be limited.  Otherwise, our entire financial system will always be at risk.  I think Milton Friedman said it best in 2004 when he said, “There are four ways in which you can spend money. You can spend your own money on yourself.  When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.”  Milton Friedman – Fox News interview (May 2004). Unfortunately, it’s not just our government that spends other people’s money without regard to quantity or quality, many companies seem to follow this same principle.

The recent JP Morgan “trade” that was meant to be a hedge has reminded investors around the world that all the recent regulation instituted since 2008 still has not prevented these types of occurrences.  In fact, with all the extra red tape and pork, it’s hard to tell what it really accomplished.  Again, I’m not in favor of extra regulation.  I’m in favor of reasonable and targeted regulation while still allowing companies and investors to take on risk.  I don’t have the answer of what is “too big to fail” or if the phrase should even exist.  But, I do know that the current system still isn’t working.

Tonight we look at the markets from a technical perspective. The stock market has been oversold for some time and in recent days became more oversold. Late last week, the fear picked up measured by the volatility index. It became a little jumpy. This set the stage for some sort of rally. The stock market rallied strongly on Tuesday in front of the confidence vote in Greece.  More importantly, it broke out of a very defined downtrend.  This is the first step to the end of the correction.  It’s important to look at the markets from various angles.  Below is a chart of the S&P 500 with hourly bars going back 20 days.  Today we broke above the upper end of the downtrend.

The more important question is where are we going from here?  Unless we have some immediate follow through to Tuesday’s buying, the oversold rally may not last long.  You can see from the chart below that the S&P 500 is now in between its 100-day (green) & 200-day moving (yellow) averages.  We bounced nicely off the 200 a few days ago.  But, the 100-day moving average which was support could now be considered resistance.  Notice the 100-day moving average has also flattened out recently.

Some are calling for the S&P to get to the 1300 level.  I think the S&P could rally in between 1308 & 1316.  Those are 38% and 50% retracement levels, respectively,  going back to the May peak in the markets.  A lot of things are lined up for a possible rally to those levels.  After that, you could see sellers re-enter the market.

By watching the media today, you would think the whole world was hinging on whether or not the Greek confidence vote would pass or not.  Everyday there will be another “event” that can move markets.  Tomorrow it’s Ben Bernanke speaking.  The next day it might be an economic report.  Zoom out just a bit when determining how to allocate your portfolio.  As for me, I’m not betting the farm on one direction or another currently.  I think we might have some work to do before we see new highs in the market.

A few days ago, I discussed the increased volatility.  This is something we’re going to have to live with for a while.  As I mentioned, whipsaw risk was beginning to  remains elevated.  That is proving out to be true.  Below is the a picture of the S&P 500.  You can see since the initial February 22nd drop, the S&P has essentially been flat.

Many short-term moving averages are beginning to flatten out.  Day traders may be having fun but the rest of us are better off slowing down the trading and looking at longer-term frames.

Technicians are watching this pattern above to see which way the market breaks.  A somewhat similar pattern appeared in November and eventually the market broke out to the upside.  A lot of it depends on the Middle East and oil prices.  There is a lot of speculation built into current oil prices.  Some resolution or at least a move in the right direction could cause oil prices to drop by $10 in a day giving investors a reason to buy stocks and push equities out of this range.

As I wrote the other day, the correlation between oil & stocks is inconsistent.  But, a major move down in oil prices in one day would certainly be bullish.

All the talk lately has been that oil over $100 is going to ruin the recovery we’ve enjoyed for the last two years.  Theoretically, it makes sense.  Oil goes up, gas goes up, consumers stop spending, companies are less profitable, stocks go down.

Now, I’ll admit that gasoline going up over $3.30 in Texas (and higher in other parts of the country) isn’t a good thing.  But, let’s remember that part of the reason that oil has been rising the last two years is because the economy has improved (more on that in a minute).  The same reason that rates have gone up despite QE2. Tension in the Middle East and fear of supply disruptions has probably added the last $10-15 per barrel.  But, despite the rise in oil by 25% since February 15th, the S&P 500 is only down 1.29%.  That got me thinking.  What type of correlation is there between oil & the S&P 500 over the long run?  Not what do the pundits say.  But, what does the research show?

Below is a picture of just that going back to 1991.  The range is +1 to -1.  A +1 means that oil and stocks are 100% positively correlated.  A -1 means just the opposite.

I don’t know about you, but this chart doesn’t help me much when it comes to trading stocks given the price of oil.  I think there are several other factors to consider.

Going back to my earlier point about higher oil prices and the positive correlation to stocks in relation to the economic recovery, you can clearly see this in the picture.  Since early 2009, oil and stocks (based on the S&P 500) have been positively correlated.  Higher oil prices accompanied higher stock prices.  At other times previous to year 2009, higher oil prices accompanied lower stock prices.  The bottom line is that there is no correlation in and of itself.  We must take into consideration so much more.

I do believe there is a tipping point.  Perhaps if gasoline gets to $4.00 per gallon all over the country and stays there for a while, it really hurts the economy.  But, a potentially temporary spike in oil doesn’t mean the end of the bull market.  We could certainly be in the middle of a correction and higher oil prices could be the catalyst or excuse, but I ultimately believe the bull market is far from over.

Looking at the S&P 500 below, the trendline is still pointing up based on the last three trading days (10-minute view).

The market is extremely overbought in the short-term.  You can look at any sentiment indicator you want to get a sense of the giddiness on the part of investors.  But, before you run out and sell everything, let’s examine the landscape for a minute and the reason equity prices are rising. 

First, in a good bull market, overbought markets can stay overbought.  To be succesfful in investing, there are times to be a contrarian and then there are those times to join in and run with the herd. 

Secondly, this is seasonally a good time of year to invest in stocks (December).

Thirdly, the economy continues to improve.  After all, Europe’s a mess and the emerging markets are raising and/or threatening to raise rates.  America is keeping rates low and our economy is growing.

Last, we have more clarity with respect to taxes.  Even though there is some question as to whether the extension of the Bush Era tax cuts will happen, at the end of the day investors think it will.  As do I.

Therefore, any pullback will be shallow and should be bought.  A pullback is healthy and part of bull markets.  If it happens, so be it.  If we keep moving up through the end of the year, it wouldn’t surprise me a bit.  At this stage, I still want to be long of stocks.  I am continuing to cull out weak stocks though if the reason for the weakness is justified.

Stay flexible.

This post published at www.karleggerss.com

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Yesterday, legendary hedge fund manager Julian Robertson sat down with Erin Burnett of CNBC to discuss numerous issues.  The one that caught my interest was his idea about taxing fat & sugar.  He believes this could improve our GDP by $1 trillion.  I think it makes a lot of sense.  Of course, my personal taxes would go up due to my sweet tooth. (See flash video below).

This morning after the homes sales data was released, the Dow Jones once again went below that magical 10,000 number.  Yes, the same number we first talked about in 1999.  Here we are over 10 years later and we’re still talking about Dow 10,000.

According to my calculations, the Dow Jones has crossed above or below 10,000 18 times in 2010.  That’s just in 2010.  When I talk to the average Joe on the street about the market, they constantly discuss the Dow Jones and is it above or below 10,000.  They also make comments about the fact that if the Dow Jones is above 10,000, it is a good market.  This is one of the least reliable indicators you can use.  It’s similar to buying or selling stocks based on one moving average.  The fact that the Dow has crossed the 10,000 mark so many times just this year reiterates the need for income and shows that despite the emotional swings, the market has really gone nowhere in 2010.  I think what we’ve experienced in 2010 is in microcosm what we’ll experience on a bigger scale for the next several years.  The bands may be bigger but I believe the results will show that it was a grind it out, essentially flat market, with a lot of bumps and a market that saw 10,000 come and go many times on the Dow Jones Industrial Average.

Use periods of excessive optimism to sell and excessive pessimism to buy and continue to generate income any way you can.  For the short-term, I think we’re very oversold and due for a bounce.  We may not be done correcting overall but I think the stock market will work its way higher into the mid-term elections.  For now, there is neither excessive optimism or pessimism but the pessimism is certainly winning out which makes me a net buyer of stocks, not a net seller.

The market was off to a reasonable start this morning after great earnings by Apple last night. But, for most of the day, the major indices were basically flat. Then, Ben Bernanke began to speak to Congress giving his semiannual monetary policy report. The more he spoke, the more equity prices fell. I immediately flashed back two years ago when I used to see some politician on television and down we’d go. I’d look on my Bloomberg machine and see that a speech was scheduled later in the day and you’d watch the put options. The speech would start, the market would fall, and S&P 500 put options would fly. Maybe that trade is back on. It sure was today.

I was able to listen to most of the speech and watch the reaction tick by tick in the markets. And what I heard was Ben Bernanke (who I do like) give ALL his various options if the economy gets worse. This wasn’t in his statement but rather in response to a question. Remember, the complaint has been that the Fed is out of bullets. “Helicopter Ben” confidently said there are plenty of tools in his belt. First, he said he can change the language to let people know that the Fed will be more accommodating for a longer period of time. This will give the market more confidence that higher rates aren’t in the cards. Second, he said he could lower interest rates. Third, he said he could buy more bonds to keep rates down and inject more into the system.

Let’s analyze each of these options. First, he can change the language. So, basically that means do nothing. It’s jawboning and cheerleading with no real action. Second, he said he can lower interest rates. ALL the way down from .25% to 0%. Really? Remember when the Fed had rates at 5% or 6% back in the day? We would all wait to see if they were going to drop rates by .5% or .75%. Now, does he really think dropping rates from .25% (basically nothing) to 0% (literally nothing) will do any good? Last, he talked about buying bonds. That’s legitimate and certainly gives us a green light to buy more bonds. But, these different tools don’t sound like tools to me. They sound like the Fed is running out of bullets. I first thought to myself no wonder the stock market is falling. But, then I thought wait a second. This is the problem. We’re still relying on the government to fix everything. Hasn’t the Fed done enough? They’ve done their job. They’re finished. They’ve injected more capital in the last two years than we’ve ever seen. They’ve lowered rates to practically nothing to encourage activity. They’ve purchased bonds to keep rates low for longer than we had originally anticipated. And, they purchased all the “junk” that bank couldn’t sell. What more should we want? But, we saw the market sell off because the Fed wasn’t giving us any new information and inventing any new tools they could whip out of their belt that would surprise us and get the economy back on track any faster.

All those smug politicians asking questions to Ben Bernanke as if they have a clue about finance always cracks me up. I wish he would have asked them “What are you guys (& gals) going to do to get the economy back on track?” How about lowering taxes to stimulate small business growth which in turn creates jobs? But, no. What I saw was Congress cutting Ben Bernanke off in mid sentence so they could look smart and act like bullies.

This evening, I heard a politician say in an interview the Fed has a lot of options because they have so much on reserve. However, it’s not about the reserves. That’s like buying a stock because the company has a lot of cash. When a company has a lot of cash, that’s great but it’s what they do with that cash that’s important. We’re relying on the management to earn a return on that cash, not just sit on it. If the Fed has reserves, that doesn’t help anybody.

Again, I’ll reiterate. The Fed has done their job and it’s time for Congress & the President to step up to the plate and figure out how to grow our economy. All I see right now is other countries growing and the U.S. is about to embark on massive tax hikes which will drive capital offshore to these faster growing countries. America has a tremendous opportunity in front of it. We can capitalize on emerging market growth if we choose helping those unemployed find work and grow our economy. Instead, I think we’re wasting that opportunity.
Today’s drop wasn’t Ben Bernanke. It was a reminder that the Fed isn’t going to really do anything else. It’s up to someone else to take over. Ultimately, that’s not good in the long run.