Diary Archives - Mad Hedge Fund Trader

The Election is Over: Obama Won

For the second time in four years, the Republican Party has blown a presidential election through the choice of a running mate. What little chance the GOP had in winning the election has gone up in smoke with the selection of Wisconsin congressman Paul Ryan to join the ticket. Think of him as a Sarah Palin with pants.

Of course, there was great celebration by the Tea Party wing that sees Ryan as a standard bearer. And don?t get me wrong. With an economics background, Ryan brings far more intellectual weight to the game than the former governor of Alaska.

The problem is that Ryan doesn?t bring a single new vote to Romney. He had a lock on the Tea Party vote, no matter who the vice presidential candidate is. It?s not like they were going to vote for Obama because they didn?t like his pick.

What Ryan does do is dash any hopes the Republicans had of capturing moderates, independents, and undecideds. Romney can?t win without these. As I write this, Obama is already winning every battleground state, except Virginia, which is a dead heat.

Since Ryan has been the poster boy for the replacement of Medicare with a voucher system, he brings this crucial issue for seniors to the forefront. Most people have already figured out that this would freeze benefits at current levels while medical care inflation continues at a 10%-20% annual rate unabated. This is why it never made it into law, even when the Republicans controlled all branches of government. You could not imagine an issue better designed to alienate voters, and the Ryan pick focuses a giant, great spotlight on it.

Just take a look at the three states with the highest percentage of seniors, who are understandably gun shy over the matter. Those are Florida, with 29 electoral votes, Pennsylvania with 20 votes, and Iowa with 6. A Republican loss of the first two alone is enough to decisively swing the election to Obama. If you live outside of Wisconsin and are unaware of the Ryan Medicare plan, just wait. The videos of him pushing granny in a wheelchair over a cliff are already running online.

At least Romney and Obama finally agree on something. They both wanted Ryan as the vice presidential candidate. One Democratic strategist said they are now going to gather up what campaign money they have left, buy a margarita machine, and party until November.

What all of this does mean is that traders and investors can now build a second Obama term into their strategic and asset allocation assumptions. It means that when Ben Bernanke?s term is up in 18 months, he will either be reappointed or replaced with a clone with an identical philosophy. That means QE3, QE4, and QE5 until the economy returns to a more robust 3%-4% growth rate, which for demographic reasons is probably ten years off.

This means that financial markets could continue to bounce along in narrow ranges for four more years. Every bout of weakness will be met with more Fed action, or the implied threat of it. But the economy never reaches the escape velocity for the markets to bust out to the upside either. We all end up dying of boredom instead of Armageddon.

Romney and Ryan?s antipathy towards Bernanke and the Fed are well known. So a Republican win would have brought quantitative easing to a screeching halt, and possibly a quick unwind of the central bank?s massive $2.8 trillion balance. Such a policy would be highly recessionary. Remember, no Bernanke means no Bernanke put. You could halve asset prices everywhere pretty quickly in such a scenario.

This is all frustrating for me because I much prefer crashes to slow grinds. I can make a bundle in a good market meltdown, and outperforming conventional long only competitors by a huge margin is a piece of cake. Basically, crises are good for my business. Give me a good 500 point down day in the Dow, and traffic on my website soars as the desperate seek guidance from wherever they can find it.

I know this piece will probably ignite a firestorm of controversy. These political pieces usually do. However, in election years an accurate call on outcomes can be crucial to your performance. If you have something to say, send me data, not opinions. I live in the world of facts and hard numbers, not beliefs or religions. I?m always looking for someone to prove me wrong so I can readjust my global view, but I need evidence to do this, not a new chant from a Yaqui Indian.

By the way, if you want to watch a fascinating insider account of the Palin vice presidential run, watch the movie ?Game Changer?, which is now out on HBO. It really gives you an inside look at how campaigns are run, warts and all. I saw several of these during my days in the White House Press Corps three decades ago, and what goes on behind the green curtains is truly amazing, if not unbelievable. For you, it might be an eye opener.

Is This a BUY Signal?

How to Get a Free Trip to Europe

Diary

During my recent trip to Europe, I made another startling discovery about the woeful state of America?s 19th century health care system. I needed to get refills on my prescription drugs when I was in Zermatt, so I stopped by the local pharmacy and placed an order. This was for three different a typical guy my age takes for blood pressure, cholesterol, and arthritis.

Since my insurance isn?t valid in Switzerland, I was expecting to get gouged on the bill. I was amazed when I was told it was only $20 for a month?s supply. The tab? in the US without insurance was $200. Even the copay with my insurance came to $60. Why are identical drugs manufactured by the same company, Roche, ten times more expensive at home than they are in Switzerland? Even when they are invented in the US?

I asked the pharmacist if she had more of the same pills at these prices. She said sure, that I could buy all I want with a doctor?s approval. So that night, I emailed my doctor at home for new prescriptions. I then marched back in the next day and bought a one year supply for everything. Total cost: $360, and presumably, Roche is making at least a 20% profit margin at these prices.

I managed to garner an additional savings from the 40% depreciation suffered by the Swiss franc against the greenback from the 2011 high. The full ticket price for this at home would be $2,400, and the copays alone would total $720.

The savings were enough to take a substantial bite out of the cost of my trip to Europe. US customs didn?t care when I brought them back in. It has to be the multiple 100% mark ups by middlemen along the way, plus some extra cash that somehow gets into the pocket of Blue Cross to pay for the CEO?s private jets that is causing this disparity. So if you plan to visit Europe, bring your doctor?s prescriptions with you. The savings will amount to a bundle.

Bring Back the Uptick Rule! 2012

Diary

When the Dow crashed 514 points on August 8, 2010, the market lost a staggering $850 billion in market capitalization. High frequency traders were possibly responsible for half of this move, but generated a mere $65 million in profits, some 7/1,000?s of a percent of the total loss. Are market authorities and regulators being penny wise, but pound foolish?

The carnage the HF traders are causing is triggering a rising cry from market participants to ban the despised strategy. Many are calling for the return of the ?short sale test tick rule?, or SEC Rule 17 CFR 240.10a-1, otherwise known as the ?uptick rule?, which permits traders to execute short sales only if the previous trade caused an uptick in prices. The rule was created eons ago to prevent the sort of cascading, snowballing selling that we are seeing today. It was repealed on July 6, 2007. Check out a chart of the volatility that ensued and it will make your hair raise on the back of your neck.

Those unfamiliar with how algorithmic trading works see it as something akin to illegal front running. ?Co-location? of mainframes with exchange computers, or having them in adjacent rooms, gives them another head start over the rest of us. Much of the trading sees HF traders battling each other, and involves what used to be called ?spoofing?, the placing of large, out of the market orders with no intention of execution. Needless to say, if you or I tried any of these shenanigans, the SEC would lock us up in the can so fast it would make your head spin.

Many accuse exchange authorities of a conflict of interest, allowing members to reap sizeable custody fees from HF traders, while the rest of us get taken to the cleaners. Co-location fees run in the hundreds of thousands of dollars per customer. This is happening while traditional revenue sources, like proprietary trading, are disappearing, thanks to Dodd-Frank. There is no doubt that the volatility is driving the retail investor from the market. August has seen the highest equity mutual fund redemptions in history.

In fact, HF trading has been around since the late nineties, back when the uptick rule was still in place and colocation was a term out of Star Trek. But it was small potatoes then, confined to a few niche players like Renaissance, and certainly lacked the firepower to engineer 500 point market swings.

The big problem with this solution is that HF trading now account for up to 70% of the daily trading volume. Ban them, and the market volatility will shrink back to double digit trading ranges that will put us all asleep. The diminished liquidity might make it difficult for the 800 pound gorillas of the market, like Fidelity and Caplers, to execute trades, further frightening end investors from equities. It is possible that we have become so addicted to the crack cocaine that HF traders provide us that we can?t live without it?

August 10, 2012 - Quote of the Day

Diary

?My feeling is that the bond market is grossly overvalued. We?re going to have 2%, 3%, 4% inflation. That?s what Bernanke is really saying. If we are going to have interest rates at zero for two years, that is actually going to push inflation up higher,? said professor Jeremy Siegel of the Wharton School of Business.

Europe?s Big Problem

Diary

Europe has a big problem. No, it is not the continuing sovereign debt crisis, the lack of leadership, or the possible departure of up to a quarter of its membership, although these are all major worries.? Nor is it the Euro, the currency that everyone loves that has been declining for the last two years. No, the problem I am talking about is much worse than that. It is in fact so extreme that the union may not survive unless it is dealt with soon.

A Big Mac hamburger in Milan, Italy?s downtown Galleria cost me $7.50 on Monday. No, that is not for the entire meal, which includes the supersized Coke and French fries. That is just for the burger alone. This compares to $3.50 back home in the USA and only $3.00 in China.

And I can tell you that there is absolutely no difference between these three heart attacks on a plate, because I have eaten all three of them over the past year. The only real benefit of buying the Italian version is that they also had this cool espresso machine so you could wash down your lunch with a cappuccino or caf? latte.

I have written many times in the past about the Big Mac?s usefulness in measuring the relative value of foreign currencies using the theory of purchasing power parity. It is, after all, one of the few products sold in almost every country in the world which is uniformly identical. Thank American management for that, along with the world?s largest food logistics operation.

I have followed this indicator in earnest since my old employer, The Economist magazine in London, wrote it up as an April 1 spoof during the 1970?s. To their shock, their own arguments carried some merit and achieved a life of their own.

Last week, The Economist updated their closely watched indicator. It showed that the Norwegian kroner is 60% overvalued, fueled by its huge oil exports. The Hong Kong dollar sits at the bottom with a 50% undervaluation, gaining an edge from the cheap cost of labor and a low tax regime.

In the good old days, Italy could simply devalue the lira to make its Big Macs, and everything else it produces, internationally competitive. But since 1999, it has been trapped inside the European Monetary System, making this kind of instant cost cutting impossible. As long as Italy is pricing its Big Macs in Euro?s, it might as well be pricing them in in the old Deutchemarks. The same is true for Spain, Portugal, Ireland, and Greece. This does not bode well for the future of Europe.

Of course, if the Euro continues to fall, Italy might get some respite. But even if the Euro plunges to its old all-time low of 88 cents, down 28% from here, it would still have one of the world?s most expensive hamburgers. Maybe it?s time for Italians to become vegetarians. Maybe that is what is knocking the stuffing out of McDonalds (MCD) shares today.

Musings of a Dinosaur

Diary

I often get accused by readers of being a dinosaur, of being insensitive to the feelings of others, and of living as a relic from a previous age. Well, you all may be right. So it is with some amusement I run a piece that I have lifted from my friend, Dennis Gartman?s, The Gartman Letter, on the difference between going to school in 1957 and 2010:

Scenario 1:
Jack goes quail hunting before school and then pulls
into the school parking lot with his shotgun in his
truck's gun rack.
1957 - Vice Principal comes over, looks at Jack's
shotgun, goes to his car and gets his shotgun to show
Jack.
2010 - School goes into lock down, FBI called, Jack
hauled off to jail and never sees his truck or gun again.
Counselors called in for traumatized students and
teachers.

Scenario 2:
Johnny and Mark get into a fist fight after school.
1957 - Crowd gathers. Mark wins. Johnny and Mark
shake hands and end up buddies.
2010 - Police called and SWAT team arrives -- they
arrest both Johnny and Mark. They are both charged with
assault and both expelled even though Johnny started it.

Scenario 3:
Jeffrey will not be still in class, he disrupts other
students.
1957 - Jeffrey sent to the Principal's office and given a
good paddling by the Principal. He then returns to class,
sits still and does not disrupt class again.
2010 - Jeffrey is given huge doses of Ritalin. He
becomes a zombie. He is then tested for ADD. The family
gets extra money (SSI) from the government because
Jeffrey has a disability.

Scenario 4:
Billy breaks a window in his neighbor's car and his
Dad gives him a whipping with his belt.
1957 - Billy is more careful next time, grows up normal,
goes to college and becomes a successful businessman.
2010 - Billy's dad is arrested for child abuse, Billy is
removed to foster care and joins a gang. The state
psychologist is told by Billy's sister that she remembers
being abused herself and their dad goes to prison. Billy's
mom has an affair with the psychologist.

Scenario 5:
Mark gets a headache and takes some aspirin to
school.
1957 - Mark shares his aspirin with the Principal out on
the smoking dock.
2010 - The police are called and Mark is expelled from
school for drug violations. His car is then searched for
drugs and weapons.

Scenario 6:
Johnny takes apart leftover firecrackers from the
Fourth of July, puts them in a model airplane paint
bottle and blows up a red ant bed.
1957 - Ants die.
2010 - ATF, Homeland Security and the FBI are all
called. Johnny is charged with domestic terrorism. The
FBI investigates his parents - and all siblings are
removed from their home and all computers are
confiscated. Johnny's dad is placed on a terror watch list
and is never allowed to fly again.

Scenario 7:
Johnny falls while running during recess and
scrapes his knee. He is found crying by his teacher,
Mary. Mary hugs him to comfort him.
1957 - In a short time, Johnny feels better and goes on
playing.
2010 - Mary is accused of being a sexual predator and
loses her job. She faces 3 years in State Prison. Johnny
undergoes 5 years of therapy.

So True!

Our Leaders Hard at Work Solving Nation?s Problems

The One Bright Spot in Real Estate

Diary

After my weekly dump on residential real estate, I feel obliged to reveal one corner of this beleaguered market that might actually make sense.

By 2050 the population of California will soar from 37 million to 50 million, and that of the US from 300 million to 400 million, according to data released by the US Census Bureau and the CIA fact Book (check out the population pyramid below).

That means enormous demand for the low end of the housing market?apartments in multi-family dwellings. Many of our new citizens will be cash short immigrants. They will be joined by generational demand for limited rental housing by 65 million Gen Xer?s and 85 million Millennials enduring a lower standard of living than their parents and grandparents. These people aren?t going to be living in cardboard boxes under freeway overpasses.

The trend towards apartments also fits neatly with the downsizing needs of 80 million retiring Baby Boomers. As they age, boomers are moving from an average home size of 2,500 sq. ft. down to 1,000 sq ft condos and eventually 100 sq. ft. rooms in assisted living facilities. The cumulative shrinkage in demand for housing amounts to about 4 billion sq. ft. a year, the equivalent of a city the size of San Francisco.

Four years after our economic collapse, rents are one of the few areas in real estate that have been consistently rising in price. Fannie and Freddie financing is still abundantly available at the lowest interest rates on record. Institutions combing the landscape for low volatility cash flows and limited risk are starting to pour money in.

In Your Future?

The Muni Bond Myth

Diary

Some 18 months ago, bank research analyst Meredith Whitney is predicted that the dire straits of state and local finances would trigger a collapse of the municipal bond market that would resemble the Sack of Rome. She believed that total defaults could hit 2,000 issues and reach $100 billion in value. Those sharp edged comments caused the main muni bond ETF (MUB) to plunge from $106 to $97.

So how did that forecast do? Since then, muni bonds have been one of the top performing asset classes in the financial market. (MUB) has soared from 92 to 113, a gain of 23%. As for the number of defaults? The amounted to a handful worth only a few million dollars. Try again Meredith!

I didn?t buy it for a second. States are looking at debt to GDP ratios of 4% compared to nearly 100% for the federal government, which still maintains its triple ?A? rating. They are miles away from the 130% of GDP that triggered defaults and emerging refinancing?s by Greece, Portugal, and Ireland.

The default risk of muni paper is vastly exaggerated. I have read the prospectii of several California issues and found them at the absolute top of the seniority scale in the state?s obligations. Teachers will starve, police and firemen will go on strike, and there will be rioting in the streets before a single interest payment is missed to bond holders.

How many municipal defaults have we actually seen in the last 20 years? The nearby City of Vallejo, where policemen earn $140,000 a year, is one of the worst run organizations on the planet. And Orange County got its knickers in a twist betting their entire treasury on a complex derivatives strategy that they clearly didn?t understand sold by, guess who, Goldman Sachs. They were recently joined by the city of Stockton, California. To find municipal defaults in any real numbers you have to go back 80 years to the Great Depression.

My guess is that we will see a rise in muni bond defaults. But it will be from two to only 20, not the hundreds that Whitney is forecasting. Let me preface my call here that I don?t know anything about the muni bond market. It has long been a boring, quiet backwater of the debt markets. At Morgan Stanley, this is where you sent the new recruit with the ?C? average from a second tier school who you had to hire because his dad was a major client. I have spent most of my life working with hedge funds, major offshore institutions, and foreign governments for whom the tax advantages of owning munis have no value.

However, I do know how to use a calculator. Top quality ?AAA? muni bonds now carry 3% yields. If you buy bonds from you local issuer, you can duck the city, state, and federal tax due on equivalent grade corporate paper. That gives you a pre tax yield as high as 6%, depending on where you live. While the market has gotten a little thin, prices from here are going to get huge support from these coupons.

Since the tax advantages of these arcane instruments are highly local, sometimes depending on what neighborhood you live in, I suggest talking to a financial adviser to obtain some tailor made recommendations. There is no trade for me here. I just get irritated when conflicted analysts give bad advice to my readers and laugh all the way to the bank. Thought you should know.

There is another factor that will support this market. When taxes go up, and they almost certainly will no matter who wins the presidential election, the tax free aspect of muni bonds also increases. That makes them a ?buy? in my book. But only a buy and hold. They way to play it safe here is to only invest in maturities that match your cash flow needs. They way you can ignore the market gyrations and hold everything to maturity. For most investors, that means limited maturities to 10 years or less.

This is Not the Muni Bond Market

Report From Milan

Diary

Milan, Italy appears to be a city entirely populated by fashion models riding bicycles on the city?s frenetic streets. That is one?s first impression coming out of the monolithic Milano Centrale train station, built by Mussolini to reaffirm faith in his state. Despite years of allied bombing during WWII, the building is as imposing as the day it was built.

You Think It?s Easy Fitting into a Size 0?

I came to this medieval city to speak at another strategy luncheon, which was attended by readers from throughout Europe, from the surgeon hailing from Trondheim, Norway, to the Hungarian hedge fund manager. The Westin Hotel provided a spectacular lunch, as only the Italians can.

We discussed various breakup scenarios for the EC which come into vogue every time Greek debt gets downgraded, which is often. This is unlikely, given the modern European?s dislike for open conflict. Bring nationalism into the equation, and things could deteriorate quickly. Germany could bail, unwilling to refinance the debt of lazy, tax avoiding, garlic eaters. Southern Europe could do a disappearing act, unwilling to pay their debts to the sauerkraut eaters up North.

Yes, I Can Be Bribed

In either case, the European currency bloc shrinks, or disappears completely. It is just a matter of time before an opportunistic political party rides this fast track into power. The Germans will tell you from hard earned experience that this always ends badly.

I had exactly one free afternoon to spend in this amazing city. I visited Da Vinci's The Last Supper at Santa Maria della Grazie monastery, looking for evidence of the conspiracy theories long ascribed to this masterpiece. I did a quick run through the Galleria and stepped on the bull?s balls, conducting three clockwise rotations to bring good luck. Looking at my performance since then, it obviously worked. The impact of the fashion industry on Milan is enormous, with every conceivable brand imaginable on show.

I managed to duck into the main Brioni store just before closing. There, I watched two Russian Mafia types in their thirties buy a half dozen exquisitely tailored, 200 thread count suits each for $6,000 apiece. That?s $72,000 worth of clothes?. for guys!

Alas, they don?t carry an American size 48 long in stock, it would have to be a custom order, so I left with only a couple of Leonardo ties in hand. It turns out that Brioni doesn?t manufacture suits for big guys anymore. The company has downsized production to fit Chinese and Russian customers off the rack, where the big money is these days. In any case, I happen to know that I can get the identical suit at the Brioni shop Caesar?s Palace in Las Vegas for a third less, plus they likely have my size. And I will be there in two months for a strategy luncheon.

The next morning found me in a mad dash back to the train station, my taxi driver artfully weaving in and out of traffic, where I boarded a first class Eurostar train. The engine powered North towards the Italian Alps, passing through the Milan slums. Retracing the route seen in the classic Frank Sinatra war flick, Von Ryan?s Express.

Is Food the New Distressed Asset?

Diary

After my entertaining repast with the head of our nation?s intelligence service, I had to ask myself this question.

During the sixties, new dwarf varieties, irrigation, fertilizer, and heavy duty pesticides tripled crop yields, unleashing a green revolution. But guess what? The world population has doubled from 3.5 to 7 billion since then, eating up surpluses, and is expected to rise to 9 billion by 2050.

Now we are running out of water in key areas like the American West and Northern India, droughts are hitting Australia, Africa, and China, soil is exhausted, and global warming is shriveling yields. Water supplies are so polluted with toxic pesticide residues that rural cancer rates are soaring.

Food reserves are now at 20 year lows. Rising emerging market standards of living are consuming more and better food, with Chinese pork demand rising 45% from 1993 to 2005. The problem is that meat is an incredibly inefficient calorie transmission mechanism, creating demand for five times more grain than just eating the grain alone.

To produce one pound of beef, you need 16 pounds of grain and over 2,000 gallons of water! I won?t even mention the strain the politically inspired ethanol and biofuel programs have placed on the food supply. Burning food so you can drive your GM Suburban to Wal-Mart on the weekends while millions are starving never made much sense to me.

It is possible that genetic engineering, sustainable farming, and smart irrigation could lead to a second green revolution, but the burden is on scientists to deliver.

The amount of arable land per person has fallen precipitously since 1960, from 1.1 acres to 0.6 acres, and that could halve again by 2050. Water is about to become even more scarce than land. Productivity gains from new seed types are hitting a wall.

China, especially, is in a pickle because it has 20% of the world?s population, but only 7% of the arable land. It has committed $5 billion to develop agricultural land in Africa. There are now thought to be over one million Chinese agricultural workers on the Dark Continent. Similarly, South Korea has leased half the arable land in Madagascar to insure their own food supplies.

An impending global famine has not escaped the notice of major hedge funds. George Soros has snatched up 650,000 acres of land in Argentina and Brazil on the cheap, an area half the size of Rhode Island, Others are getting into the game, quietly building portfolios of farms in the Midwest and the South.

This year promises to deliver one of the greatest US crop yields in history, brought on by the warmest winter in 100 years. The US Dept. of Agricultural January crop report then predicted huge surpluses, slamming prices once again, and delivering limit down moves in the futures markets. But the weather may not cooperate, as it did last year.

The net net of all of this is that food prices are going up, a lot. Use this year?s expected weakness in prices to build core long positions in corn, wheat, and soybeans, as well as in the second derivative plays like Potash (POT), Agrium (AGU) and Monsanto (MON). You might also look at the PowerShares Multi Sector Agricultural ETF (DBA) and the Market Vectors Agribusiness ETF (MOO).

A ?BUY? SIGNAL?