May 2010

May 17, 2010 - The Real Cause of the 'Flash Crash'

Featured Trades: (SPX), (YCS), (TBT)

1) The Real Cause of the 'Flash Crash.'
When I boarded my plane in San Francisco on Thursday morning, May 6, the Dow was down an uncomfortable, but tolerable 150 points. When I arrived in New York that night I was greeted with headlines screaming 'CRASH: DOW PLUNGES 1,000.' I was not surprised. In a letter sent to my premium subscribers the day before I predicted a fall in the S&P 500 to 1,050 (click here for the call), although I thought it might take two months to get there. Instead, we got it in two hours!

Since then, I have heard every possible explanation for the instant death spiral. A fat fingered trader accidentally entered an order to sell not one million shares at market, but one billion. Al Qaida hacked into the NYSE mainframe. High frequency traders ganged up on a thin market to generate some windfall profits. I heard every possible theory, except the one that was the true cause-- stocks are too expensive! The US economy is in the midst of an epochal transition from a long term GDP growth rate of the 3.9% rate we saw during the last decade, to maybe 2%-2.5% this decade. If you don't believe me, look at the chart below showing a rapid deterioration of the leading economic indicators for most of the OECD. The 'V' is rapidly turning into a 'square root.' That does not support the PE multiple of 23 the market was sporting a few weeks ago. Maybe the lower growth rate supports a 16 multiple, but only on the best of days when buyers are feeling wonderful about themselves. When the fall came, all risk assets moved south in unison, while Treasuries exploded through the roof on a flight to safety bid, along with the dollar. This was also as I expected (click here for that call). Let me spell this out more clearly. When I say there is a massive risk reversal at hand, what I really mean is 'Run, Forest, run!' (Forest Gump for international readers). It is not the time to be too clever by half by staying short the yen (YCS) or the 30 year Treasury bond through the (TBT) (click here for my pleading with you to heed the wake up call to tighten up your risk controls). Those of you who took my advice to pile on the cheap downside protection while volatility languished at 16% (click here for that call), made an absolute killing as it raced to 42%. Suffice to say that as the euro breaks $1.25, the dust is still flying in great impenetrable clouds, and the sidelines seem more comforting by the minute. Remember, there is no law that says that you must always keep a position on, no matter how hard your broker argues to the contrary.

May 7, 2010 - There's a Massive Global Risk Reversal Going on

Diary

Featured Trades: (GLOBAL RISK REVERSAL)

1) There's a Massive Global Risk Reversal Going on. The Gulfstream is fueled up, the flight plan filed, and my pilot is carping about missing our IFR clearance slot, so I'll just quickly dash off a few words here before I take off for the Big Apple. They are rioting in the streets in Athens, and bankers are being burned at the stake. I love it. It's clear that there is a massive global risk reversal going on. The euro has collapsed to the $1.28 handle, crude is under $80, and the Dow has shed 400 points in two days. S&P 500 at 1050, here we come! The yen has just gapped up ?2 as hedge funds rush to unwind their carry trades. There is a rising crescendo of stops going off in all markets that is so loud that I can hear it with my head buried under my pillow. Precious metals proved nowhere to hide, either. Did someone say something about 'Sell in May and Go Away?''

Maybe something about cash fleeing all assets in unison? It is great entertainment watching from the sidelines. As long as flocks of black swans are alighting on the markets, as in Alfred Hitchcock's Birds, it is better to wait for the dust to settle. The big trade here is to wait for the big trade, several of which are setting up. Anyone who believes in 'decoupling' at this stage also believes in the Easter Bunny, Santa Claus, and the Loch Ness Monster, and also that the Chicago Cubs will win the World Series this year. That's the limo driver at the door. Gotta run.

Not a Busy Signal

May 6, 2010 - Yesterday, the lemmings discovered the Law of Gravity

Diary

Featured Trades: (SPX), (BP)

1) Yesterday, the lemmings discovered the Law of Gravity,and the plaintive squeals of the dying mammals could be heard throughout the financial markets. European finance ministers must be depressed that their $140 billion bailout of Greece only bought them 24hours of grace in the eyes of investors. The European finance ministers might as well drown themselves in the seas of red on my screen. Only the Vix and British Petroleum (BP) are green. How perverse. Oil down$3.50! Boiiing! Silver off a buck! Kaboom! The ten year Treasury at 5.59%! Pow!It also looks like the oil spill in the Gulf of Mexico could make a sizeable dent in US Q2 GDP. You all know that I have been negative on equities for a while now (click here for my piece on buying cheap downside protection). The global nature of the sell off across all asset classes also came as no surprise (click here for that prediction). The flight to quality has given another shot of adrenaline to the dollar against my core shorts, the yen and the euro,both of which broke down to new lows for the year today. Most fascinating is that my April surprise came through too (click here for the report). The withdrawal of the Fed at the beginning of the quarter as the sole purchaser of real estate debt in the market, led not to a crash in bond prices, but a huge six point rally, sending yields into the dump. With the coming collapse of the Treasury market the new mantra among traders, it turns out everyone was short! Once again, Shanghai's status as a canary in the coal mine for all global markets is reaffirmed (click here for the explanation). Where am I going to buy the dip first? Shanghai.The hedge fund managers who saw all of these complex pieces fitting together and positioned for it made multiple killings. Those who didn't, have joined their furry cousins at the bottom of the cliff.

A Dead Lemming, RIP

May 5, 2010 - The Leverage Window Just Opened Wider

Diary

Featured Trades: (UBR), (UPV), (UMX), (UXJ), (TMV)

1) The Leverage Window Just Opened Wider. Just as the public debate on risk control gets underway on Capitol Hill, a number of instruments have been launched that will allow unsophisticated retail investors to ramp up their leverage, big time. It's like handing out free fireworks right after your hometown burns down.? Last week, Proshares launched a gaggle of new leveraged ETF's on key benchmark international stock indexes that give individual investors opportunities to bet the ranch in ways they previously never thought possible. They include 200% leveraged long ETF's on Brazil (UBR), Europe (UPV), Mexico (UMX), and the Pacific ex-Japan (UXJ). These funds carry 0.95% expense ratios, rather hefty for index funds. Short versions of these ETF's already trade. While it's great to have a broader range of instruments to trade in the international arena, remember that these are truly double-edged swords. When you're right, the cash pours in; when you're wrong, you hemorrhage dollars like a hemophiliac spills blood. You also have the additional risks of tracking error, poor management, and liquidity. While on this topic, I'll mention another ETF which should carry a surgeon general's warning on every trade ticket, as with a pack of cigarettes. The Direxion Daily 30 Year Treasury Bear 3X ETF (TMV) gives investors a 300% short bet on the long dated Treasury bond. Triple the 4.6% current yield you are shorting and throw in the expense ratio, and long term investors are facing a 15% per annum headwind. Unless the US embarks on a Grecian style default on its debt in the very near future, it will be tough to make money holding this instrument. That is, unless you are a day trader, in which case, the cost of carry is zero. That is surely the purpose for which this potentially toxic instrument was intended.

May 4, 2010 - My Square Root Scenario is Happening

Diary

Featured Trades: (Q1 GDP)

1) My Square Root Scenario is Happening. The 'square root' scenario that I have been forecasting for the US economy is coming to pass. On Friday, the Commerce Department's Bureau of Economic Analysis confirmed that the US grew at a 3.2% annualized rate in Q1, compared to a 2009 Q3 figure of 2.2%,? and 2009 Q4 growth of 5.6%. What's more, the recovery remains very lopsided, with only export oriented businesses booming and large swaths of the domestic economy, like construction and real estate, still struggling. Keep in mind that the S & P 500 over 1,200 is discounting growth continuing its torrid 3% or more growth rate for the rest of the year. It's all going to make this coming Friday's nonfarm payroll more interesting than usual. The whisper number is now calling for job growth of 200,000. A beat will deliver another leg up in the stock market, possibly to 1,250. A shortfall could trigger our annual summer correction. Whatever the outcome, Obama's political future may depend on it.

May 3, 2010 - The Aussie Crosses are On Fire

Diary

Featured Trades: (AUSSIE/EURO CROSS), (AUSSIE/YEN CROSS)

1) The Aussie Crosses are On Fire. In the last few days, two of the key foreign exchange cross trades that I have been recommending this year have exploded to new highs. They include the Aussie/yen cross at AUS$0.874 and the Aussie/euro cross at AUS$0.705 (click here for the call). These crosses involve going long the currency of the 'Lucky Country' and shorting the euro and the yen against it to capture a large and widening yield spread. Those who followed my advice to leverage up five times made an absolute killing. The events I predicted months ago came to pass. With one of the strongest, resource fueled economies in the world, the Reserve Bank of Australia has been raising interest rates like a bat out of hell. Unemployment in the land down under is collapsing. In the meantime, Greece's debt problems have blown up into a transcontinental contagion, cratering the euro, and putting the prospect of rate hikes into the distant future. In Japan, the near zero rates might as well be etched in stone as its economy enters its third lost decade. I don't see any reason to take these positions off until we get a big global risk reversal. We have seen two previews of what this might look like, on the days of the Goldman Sachs fraud announcement and the Greek debt downgrade. Remember, the trend is your friend, until it isn't.