Priced for Nirvana (Stock World Weekly, 2/26)
One of our readers, Jim, sent me the following quote:
“Doubt all before you believe anything! Watch your idols!”
The quote is a condensed version of a quote by Sir Francis Bacon, attributed to Humphrey B. Neill. The original quote by Sir Bacon was, “If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.” For some, beginning with doubts and ending with doubts may be the more typical pattern, but I digress.
Jim suggested that Neill’s words - “doubt all before you believe anything” - hold great wisdom pertaining to successful investing. He wrote,“Investing is a cold, ruthless game, best served by the lack of emotion. With a growing cadre of opinion-shapers (shills) out to sway and mold public opinion (individual investors), it behooves us to be cynical. We should always look behind the curtain to assist in finding truth. In reality, looking behind the curtain takes time and most individuals will not take the time to search for truth. This works out wonderfully for the institutional traders and isn’t bad for those who do take the time to look.”
Guest author Lee Adler of the Wall Street Examiner takes the time to look. This week, he provides a comprehensive glimpse into the macro-economic scene. David Brown of Sabrient shares his recent trade ideas in Sabrient’s Investor’s Hedge portfolio. Sabrient’s Scott Brown reveals his favorite short ideas, and reiterates a long one. Bruce Krasting discusses how problems facing the oil market are threatening the entire U.S. To wrap up, Phil discusses the week ahead along with several of his trade ideas (disaster hedges).
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Excerpts from "Priced for Nirvana"
Snapshots from Lee Adler’s "Peak Treasury Love"
The markets face an enormous slug of Treasury supply settling next week but those who would absorb it have the good fortune of having the ECB’s next big Long Term Refinancing Operation (LTRO) concurrently. What could have been a very rough week may turn into a non event as a result. In fact, some of the strong demand seen for the paper at this week’s auctions may well be due to the LTRO. After all, seven of the biggest Primary Dealers are European banks. They’ll be getting hundreds of billions in nearly free money from the ECB, so what better way to invest it than in the “safest of safe” paper, US Treasuries? There may even be enough left over to throw a party. But what about afterwards?
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Watching the Treasury market has gone from being like watching pork bellies trade last year to watching paint dry this year. My thesis has been that yields are bottoming, and there’s plenty of evidence to support that, including record Primary Dealer long positions. They tend to be most wrong at turning points. Long term momentum indications also suggest that a turning point is at hand.
Likewise, foreign central banks (FCB) have been heavy buyers and are due for a downturn in their buying cycle. Bond fund inflows are near a record. And US banks are suddenly in love with Treasuries again. In addition to Peak Oil, and Russ Winter’s Peak Orwell, we may be at Peak Treasury Love. But based on the shorter term charts, if the 10 year yield doesn’t break out above 2.10 soon, the orgy may go on for a while.
Next Week
I have plugged in the 4 week bill at $40 billion based on the size of this week’s auction. There was another $20 billion CMB (cash management bill) that was unexpected. That makes the total paper offered to $20 billion more than the TBAC [Treasury Borrowing Advisory Committee] forecast in its February 2 report. This means that revenue is already falling short of forecast or outlays have risen, or some combination of the two. In reviewing the daily Treasury data, it appears that it is a combination, including a big increase in tax refunds versus last year.
[Note: A Cash Management Bill is a short term Treasury bill of varying duration issued by the Treasury when the government runs short of cash. It is used by the Treasury to manage its cash balances.]
I doubt that both Treasuries and stocks could hold up under such supply pressure under normal circumstances. But coincidentally, the ECB’s next Long Term Refinancing Operation (LTRO) is set for February 29. That’s expected to total some €500 billion in new financing to European banks, who, surprise, surprise, also happen to be among the largest Primary Dealers. Seven of them are European banks. So instead of a bloodbath, we may just see some cross currents. In fact, the good demand for this week’s Treasury auctions may well have been due to the expected financing from the LTRO.
Note: This section is part of the Wall Street Examiner Professional Edition Treasury Market Update, available to WSE subscribers and being made available to us this week.
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Sabrient Systems is a leading independent equity research firm specializing in custom quantitative investment strategies. Its research is used by hedge funds, mutual funds, and other professional money managers. Its strategies are also used to create indexes that are tracked by exchange-traded funds (ETFs) and Unit Investment Trusts.
The Sabrient Investor's (H)Edge Portfolio is an absolute return, long/short portfolio based on a back-tested, institutional quant strategy. Managed by David Brown, the portfolio is designed to be unbiased, emotionless, and highly disciplined. The following is Sabrient’s most recent Investor’s Hedge Report in which David shares his latest moves in the virtual Investor’s Hedge Portfolio:
“Here are the actionable items from today’s Investor’s (H)Edge newsletter for execution at Friday's (Feb. 24) open.
ACTION: Stocks
LONGS: Buy PRU (Prudential Financial)
SHORTS: Sell Short EHTH (eHealth, Inc.)
ACTION: Alternative Options (buys)
Call: PRU120421c60 Apr 60 Call
Put: EHTH120519p15 May 15 Put
ACTION: Alternative ETF (alternative to shorting EHTH or buying EHTH puts)
Buy: VXX
Scott Brown of Sabrient has three stocks which he feels lend themselves to decent shorting strategies right now. He submitted, “I think JCOM, GMCR and COL are all candidates for short positions. Rockwell Collins, Inc. (COL, $59.88) presents a forensic accounting issue where it has used up historical reserves to make earnings.
“Green Mountain Coffee Roasters (GMCR, $66.18) is a short because it is grossly overvalued and cash flow versus income is very divergent.
“j2 Global, Inc. (JCOM, $30.20) is a short because its core e-fax business is deteriorating and the company has used M&A activity to meet earnings. In my opinion, none of these companies have models that are sustainable for meeting earnings expectations in the future. If they do, I suspect those earnings will be of poor quality.”
As for long positions, Scott still likes TEO ($19.06). Two weeks ago, he wrote, “Telecom Argentina SA (TEO, $19.94) provides telecommunication services in Argentina. Mobile phones have provided solid growth for TEO. TEO announces earnings on Feb 17, 2012, and the estimates easily support the dividend of $2.21 per share which is a 10.8% yield paid once per year (April). Latin America is likely going to experience stronger growth than most of the world, driven by rising disposable incomes. I believe the stock is attractively priced to buy/hold through the dividend and then like selling covered calls to enhance the yield.” TEO is now trading lower; to Scott, it’s now more attractively priced.
John Reese is similarly bullish on TEO: “This is one of Argentina's two incumbent telecom companies, with about four million landline customers and 14 million wireless ones. My Kenneth Fisher-based strategy is a believer in this company. Per that strategy, in Telecom Argentina's favor is a price-to-sales ratio of 0.52 -- well within the stipulated maximum of 0.75. As far as debt is concerned, the company is also a winner, with debt worth about 2% of equity. The company also has a strong inflation-adjusted earnings per share growth rate of 20.54%, as well as positive cash flow per share.” (Padding Your Latin American Exposure)
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In Phil’s view, on Friday, the market was priced for Nirvana, thanks to the trading robots responsible for the majority of trading: “Fortunately, over 60% of the trading in the market being conducted by HFT Bots that bring the average hold time for ALL positions down to an average of 22 seconds. So we don't need any actual money, or even human participation, to have a nice-looking market rally...
“While I try to get more bullish – it's very hard. On Wednesday I listed 10 bullish trade ideas as we exhausted our first 20 bullish positions of February with the S&P holding 1,297 all month. We reset the bar at the 1,360 line as both the stop line for our first 20 trades as well as the start line for our next 10. So far, we haven't had a full day over the line...
“The markets are up as if they haven't got a care in the World. Does it make sense? Can oil go to $140 on a Gulf War between Israel and Iran with supply disruptions and general chaos, and that's going to be GOOD for stocks? Corporate margins are already suck, and they won’t improve if oil climbs 15% this month and, according to Criminal Narrators Boosting Crude, another 25% next month.
“Yesterday, CNBC lied, commenting that refiners in the US were operating at capacity despite the fact that anyone could read the very first paragraph of yesterday's EIA report, where it says: ‘Refineries operated at 85.5 percent of their operable capacity last week.’ So is CNBC misleading the viewing public, fooling people into buying oil on false premises? Or are they just pathetically poor fact checkers?”
Later in Members’ Chat, Phil opined, “We'll see if the S&P holds our 1,360 line today. We still can't go bullish into the weekend – that's just crazy! I wish this were easier to play for the bears but it's very tough to call a top when the market is euphoric. ‘The market can remain irrational longer than we can remain solvent’ was probably Keynes' best observation. Unfortunately, he learned that by going bankrupt.
“What's worrying me now is the Dollar has been knocked down 2% this week and the indexes are going nowhere. That's a very toppy sign. Even if all goes perfectly in Greece, and Portugal and Spain, and Ireland and Italy fly under the radar, and oil prices don't affect consumer spending habits, or business margins - we will still be in trouble if the Dollar bounces...
“I still like Wednesday's disaster hedges:
“SQQQ April $13/17 bull call spread for $0.70. This trade has a 471% upside potential by itself if SQQQ (currently $13.14) gains 30% by April expiration. SQQQ is a 3x ultra-short to the Nasdaq so a 10% drop in the Nas, back to 2,650, would do the trick. That's where we were at the beginning of the year, just 50 days ago.
“In addition to SQQQ, I think the Dow could join the Transports for a 10% drop and DXD is also cheap at $13.42. It's only a 2x ETF so we don't want to be so ambitious with our target. The April $13 calls are $0.90 and we can sell the $15 calls for $0.35 for net $0.55 on a $2 spread. The bull call spread, by itself, has a 263% upside potential.”
Concluding his all around bearish premise, Phil observed, “In absence of money coming in, markets go to zero. That point could have been made strongly in 2008, but apparently it's already been forgotten. Anyway, markets need fuel like cars need fuel, and fuel is money coming in faster than it goes out. We have rising sentiment and cash coming off the sidelines and Central Banks pumping money into the IBanks which unleash their HFT Bots. That's going to make stocks rise but not forever – at some point, the market gets bigger and needs more and more cash every day to sustain its prices, at which point it either gets more money or the balloon begins to deflate.”
So the question remaining is: Will the money coming into the U.S. from Wednesday's LTRO be enough to keep the market rising this week? Or, will the opposing force of a huge slug of Treasury supply settling drain enough money to slow or stop the current stock market rally?
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