May 16, 2008

Market Comments for May 16, 2008

1) Goldman Sachs (GS) put out a report predicting that the price of crude will average $141 during the second half of the year. Crude soared from yesterday's low of $120 to $127.80. I don’t buy it. The Saudi oil minister said that his country would increase production to meet customer demand and that they had already increased production by 300,000 barrels/day on May 10.

2) Lehman Brothers is expected to announce layoffs of 5% of its workforce on Monday, about 1,400 people. This is their second 5% layoff in six months. This year they have reduced the leverage on their balance sheet from 20:1 to 12:1. Bear Stearns went under at 32:1.

3) April housing starts came in at 8.2% and housing permits were up 4.9%, much better than expected. These statistics lie because a sharp cut in single family home permits was offset by a surge in apartment permits. Some senior bankers are predicting we won't see a bottom in housing until inventories rise from the current 11 months to 18 months.

4) The University of Michigan consumer sentiment index plunged to 59.5, the lowest reading since 1980. The Dow fell 100 points on the release.

5) How high can gas prices rise and still allow a functioning economy? Gas is $10.09/gal in Norway and $7.18/gal in Spain. If crude rises to $200, gas in the US will cost $6.50/gal.

TRADE OF THE DAY

The short S&P 500 1200-1450 May strangle I recommended expired out of the money today for a total return for the month of 5%. The Index closed at 1,425. This is the fifth consecutive month this strategy worked for a total return this year of 27%. This trade is now gone. With stability back in the market, implied volatilities have collapsed, the VIX Index having dropped from 32% to 16%. There is no longer an attractive risk/reward ratio in putting on these kind of short volatility trades from here on. I may revisit this strategy if we get another sharp sell off in the market and volatilities spike up. Please also note that the Goldman Sachs short May 210 call I suggested also expired worthless today. Covered out of the money call writing of your entire US stock portfolio would have yielded an additional 1% return over the last ten trading days.

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