?The luckiest person in the world today is the baby being born in the United States. The outlook for this country is fantastic,? said Warren Buffet.
As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price. Read more
The inside story on the collapse of volatility is now out, and as a result, managers are reviewing the harsh lessons learned and tweaking their strategies. It highlights the dangers of buying securities without reading the prospectus and understanding what is under the hood.
As investors piled into stocks in February, they also bought downside protection in the form of the Velocity Shares Daily 2X VIX Short Term ETN (TVIX). For reasons that are yet to be explained, the issuer, Credit Suisse, arbitrarily decided to quit issuing new shares, effectively turning this vehicle into a closed end fund. Money poured in anyway, driving the price up to a 100% premium over the intrinsic value of the fund.
Then, out of the blue, Credit Suisse reversed its decision and decided to issue new shares after all last week. This could mean only one thing to the professional volatility trading community, which jumped on the (TVIX) with both feet. They took the ETF down a stunning 65% in a week, all the way down to a 20% discount to intrinsic value. During the same time, the (VXX) fell by 25%, while the (VIX) was up 10%. Now that?s a tracking error with a turbocharger!
It now appears that there was some advanced knowledge about the reissuance of shares, and the SEC is almost certain to make inquiries. Those who had hoped for downside protection in the stock market got a slap in the face instead. To say the least, confidence in the financial system has not been advanced.
To make matters worse, a major hedge fund based in Chicago has a gigantic position in the (TVIX) with a ?put tree?. This involved buying one $21 put and selling short one $18 put and three $17 puts. Below $17 they were 300% long the (TVIX). When the ETF broke that level, the sushi hit the fan, triggering panic selling of all (VIX) products at any price, including the unrelated (VXX). I can?t tell you who it is without risking litigation. But with the quarter end upon us, their investors will find out soon enough. Watch the newspapers to find out whom.
The debacle has sent analysts scurrying to find other ETF?s that may be trading at premiums to their underlying. Here are the top three:
Platinum (PGM) 27%
Municipal bonds (GMMG) 14%
China small cap (PEK) 6%
The premium in the (UNG) frequently goes as high as 50% and results from the contango in the futures market, where far month contracts are trading at big premiums to the front month. That makes it a great shorting vehicle in falling markets, because the ETF always falls faster than the underlying. I have drunk at this well many times.
What happens from here? My guess is now that managers see that their downside protection is a sham, they won?t want to play. That could translate into stock selling, now that holders understand that these positions involved more risk than they realized.
In the meantime, if you plan on dabbling in the $1.4 trillion 1,400 issue ETF market, it may prove wise to check out the intrinsic value of any ETF before you buy it. You can do this easily by going to Yahoo Finance and adding .iv to any ticker symbol. So while the (TVIX) intrinsic value this second is at $7.51, the current market is at $7.96, a 6% premium. If you value your wealth, you might well get familiar with this exercise.
Trading Volatility Isn?t Always So Fun
The great thing about interviewing Joseph Stiglitz over dinner is that you don?t have to ask any questions. You just turn him on and he spits out one zinger after another. And he does this in a kibitzing, wizened, grandfatherly manner like one would expect from a character that just walked off the set of Fiddler on the Roof. The unfortunate thing is that you also don?t get to eat. The Columbia University professor and former World Bank Chief Economist animatedly talked the entire time, and I was too busy feverishly taking notes to ingest a single crouton.
Stiglitz argued that for 30 years after the end of the Great Depression there was no financial crisis because a newly empowered SEC was on the beat, and everything worked. A deregulation trend that started under Reagan began stripping away those protections, with the eventual disastrous repeal of Glass-Steagle in 1999. The philosophical justification adopted by many economists, including Fed chairman Alan Greenspan, was that unfettered markets always lead to efficient outcomes.
This belief was based on simplistic models assuming that markets were always perfect, always open, and that everyone had perfect information. Stieglitz?s own work on ?information asymmetry,? which earned him a Nobel Prize in economics in 2001, pulled the rug out from under this theory, because it showed that one party to a transaction always has more information than the other, often the seller.
The banks used this window to introduce super leveraged derivatives that had never been regulated, studied, or even understood. They then clawed open accounting loopholes that were so imaginative that not only were shareholders and regulators deceived about how much risk was involved, senior management was clueless as well. Instead of managing risk, they created risk.
A 2006 GDP that was 80% derived from real estate transactions and a savings rate that fell to zero meant that a severe crash was a sure thing. President Bush?s response was to unleash an extreme form of ?trickledown? economics, with the banks given $700 billion with no conditions attached. Intended to recapitalize the banks so they could resume lending to the mainstream economy, much of the money ended up being paid out in bonuses and dividends. Of the $180 billion used to rescue AIG, $13 billion went to Goldman Sachs, and much of the rest went to German and French banks. No wonder Main Street feels cheated.
The financial system is now more distorted than ever, with major institutions wards of the state, and smaller banks that actually lend to consumers and small businesses going under in record numbers, because the playing field is so uneven. There are too many structural conflicts of interest. The ?once in a 100 year tsunami? argument is merely a justification for changing nothing. Banks would rather maintain the fiction that the loans on their books are good, than make adjustments, meaning there will be more foreclosures in 2012 than in 2010 or 2009. No financial system has ever wasted assets on this scale, and the end result will be a national debt many trillions of dollars larger.
The $787 billion stimulus package was too small, and should have been at least $1.2 trillion, but there was no way Obama was going to get more out of this Senate. The 40% of the stimulus that was tax cuts will get saved and create no immediate beneficial effects on the economy. More money should have gone to the states, which unable to deficit spend, are now a huge drag on the economy. But even this meager package was able to prevent the unemployment rate from rising from 10% to 12%, as it was set to do. The inadequacy of the first package means a second is almost a certainty. Any major spending cuts will produce ?Hoover? outcomes.
The outlook for the economy is bleak, at best.
Well, I don?t get to chat at length with a Nobel Prize winner every day, so I thought I?d give you the full blast, even though I had to leave a lot out. I?ll talk more about markets tomorrow.
?Bankers will get away with whatever they can get away with. Our banking system is socially useless,? said an oversight body in the United Kingdom.
Still missing in action from this economic recovery has been the residential real estate market. Everyone who is in the business of selling me a new home assures me that we have hit bottom and things are getting better, including the home builders, real estate agents, and countless local chambers of commerce. Look no further than home builder Lennar (LEN), which had more than doubled since the October low, and Pulte Homes (PHM), which has tripled.
Much of the improvement in bank shares, which saw Bank of America (BAC) double in three months, was based on the improving fortunes of homeowners. Is there something wrong with this picture? Should I be relying on these ?belief based? sources of information?
The hard data say otherwise. This morning, the January S&P 500 Case Shiller Real Estate Index put in a new seven year low, dropping 0.8% from the previous month. San Francisco showed the biggest loss (-2.5%), followed by Atlanta (-2.1%), Portland (-2.1%), Cleveland (-2.0%), and Chicago (-1.9%). Some 47% of transactions nationally are from short sales and foreclosures. This figure exceeds 60% in some troubled markets in the West. There is a foreclosure tidal wave of Biblical proportions now sweeping the South.
The cancellation rate for new purchases is still a stunningly high 30%. First time buyers have virtually ceased to exist, a key component of this market, as few young couples can qualify for bank loans under the new credit regime. They were once 40% of the market.
Who is buying all of these houses? Hedge funds, which are setting up partnerships to buy distressed homes at discounts of 25% or more, remodeling and modernizing them, and flipping them out as fast as they can. This presages a new institutionalization of the market that was once the refuge of the individual homeowners. I have heard of aggregations of as many as 1,000 units, which are individually bought at bankruptcy auctions on the courthouse steps, and moved as quickly as possible on an assembly line to the market.
While this may bring a welcome increase in turnover in a once moribund market, it will also cap any future price appreciation. These guys are not long term investors by any means. They are in for the quick buck, and will happily walk away with a net profit of only 5%. The money is made on the turnover. These resellers are successfully front running retail owners desperately trying to unload holdings from the vast shadow inventory where negative equity is more often the rule than the exception.
They say all real estate is local, and that has never been more true than now. Where you do find real end buyers is at the absolute top end, with prices listed at over $2 million. The players here often pay with cash to avoid the higher interest rates that usually come with jumbo loans. I am seeing this across the entire expanse of the economy, from American Express (AXP) to Coach (COH) to Tiffany (TIF).
I even see this at my local ski resort of Incline Village in Nevada, where homes over $10 million are moving nicely, but there is a constipated glut of hundreds of dwellings priced under $800,000. Right now, business is great for anyone selling to rich people. This is why we are seeing bidding wars in the San Francisco Bay area for any homes within commuting distance of Google (GOOG), Facebook, and Apple (AAPL) headquarters, while market for homes in the rest of the region is dead in the water.
I write all of this with the usual provisos. Case Shiller lags the real market by 3-5 months. There is no doubt that this year?s unusually warm winter has pulled forward a lot of real estate investment. Even still, the monthly data is taking a turn for the worse. March signed contracts are down -0.5%, while February housing starts were down -1.1%.
Why do I care about any of this, since I have been renting for the past seven years? It is hard to see the broader economy growing faster than 2% a year without serious real estate participation, which in the past has accounted for up to half of our total growth. It is the missing 2% that used to take us to 4% growth. That harsh reality affects all markets everywhere, whether you are renting or not.
The Fire Isn?t Out Yet
Looking for beneficiaries of the coming collapse of the Japanese yen (FXY), (YCS), Toyota Motors (TM) has to be at the very top of your list. A cheaper domestic currency brings a lower cost of production, high foreign sales proceeds, and wider profit margins all the way around.
I am probably the only person in the country who once worked for Toyota, speaks Japanese, and worked in the White House Press Corps, so I feel uniquely qualified to comment on the current state of play with Toyota.
When Akio Toyoda, president of the Toyota parent and grandson of the founder, and English speaking Yoshimi Inaba, president of Toyota Motor North America, Inc. appeared in front of congress, it was the usual kabuki theatre.
The member from Kentucky, where nonunion Toyota plants are located, listed off the firm's charitable donations to the community, while the one from Michigan launched a vicious, no-holds-barred attack.
The language spoken by the two Japanese couldn't have been more different. Toyoda spoke the words of inherited wealth, of a ruling shogun, of privilege, and of condescension. Inaba talked like the hardscrabble warrior that he was, who spent 40 years clawing his way up the Toyota organization ladder.
I think the entire crisis happened because Toyota management believed in their products to such incredible extremes that any criticism was viewed merely as the unhappy grumblings of competitors. That?s how the whole brake pedal fiasco ran away from them, leading to the largest vehicle recalls in history. Similarly, the quality of Japanese products became so ingrained in the minds of American regulators that they too fell asleep at the switch, giving the company a free pass on the rising tide of consumer complaints.
On top of this, you can pile the Japanese cultural aversion to sending bad news up the command chain. This was a major reason why Japan lost WWII, and explains how the suicide rate in the country is so appallingly high. When the bill finally came due, the price tag was 37 dead in acceleration accidents, and a witch hunt on national TV. Toyota's management will make sure, literally on pain of death, that every product rolling off the assembly line, from here on, will be models of engineering perfection.
The stock has held up amazingly well so far, probably because it is mostly owned by strong hands, with few traders involved. Not only should you buy the stock when global markets return to a sustained risk accumulation mode, you should buy a Toyota car as well. It will be the only time in your life that you can find them at a discount. All of this explains why the 37% pop in the stock this year outperformed the main indexes in the US, but also those in Japan as well.
Is This a Buy Signal?
?When it?s raining gold, reach for a bucket, not a thimble,? said Oracle of Omaha Warren Buffet.
I?m hearing from my buddies in Japan that while things are already quite bad in that enchanting country, they are about to get a whole lot worse, and that it is time to start scaling into a major short in the yen. Australia and China have already raised interest rates, to be followed by the US, and eventually Europe.
With its economy enfeebled, the prospects of Japan raising rates substantially are close to nil, meaning the yield spread between the yen and other currencies is about to widen big time. In the case of the Australian dollar, that works out to 4% per annum. Leverage up ten to one, and pile on anticipated capital gains brought in by a weakening yen, and you have a real carry trade on your hands. This will generate hundreds of billions of dollars? worth of cascading yen selling as hedge funds dog pile in. It?s macro investing at its finest.
Until now, the government has been able to finance ballooning budget deficits caused by two lost decades, but those days are coming to an end. Japan is quite literally running out of savers. The savings rate has dropped from 20% during my time there, to a spendthrift 3%, because real falling standards of living leave a lot less money for the piggy bank.
The national debt has rocketed to over 200% of GDP, and 100% when you net out government agencies buying each other?s securities. Japan has the world?s worst demographic outlook. Unfunded pension liabilities are exploding. Other than once great cars and video games, what does Japan really have to offer the world these days, but a carry currency?
Until now, the government has been able to cover up these problems with tatami mats, because almost all of the debt it issued has been sold to domestic institutions. Now that this pool is drying up, there is nowhere else to go but foreign investors. With Greece and the rest of the PIIGS at the forefront, and awareness of sovereign risks heightening, this is going to be a much more discerning lot to deal with.
That great bell weather of global risk taking, the Euro/Yen cross is telling us that the mother of all carry trades has already started. You also see this in the Ausie/Yen cross, and outright yen markets. I have scored one round trip in the yen this year and hope to do several more.
You could dip your toe in the water here around ?82.40. In a perfect world you could sell it at the next stop at the ?85 level. My initial downside target is ?90, and after that ?100. If you?re not set up to trade in the futures or the interbank market like the big hedge funds, then take a look at the leveraged short yen ETF, the (YCS) or buying puts on the (FXY). This is a home run if you can get in at the right price.
?Rupert Murdoch is very smart and is a great leader, but he?s made a mistake. He?s buried in ink, and in my view, there won?t be any newspaper business ten years from now. Fortunately, we?re buried in television and movies, and they?ll be here forever,? said Sumner Redstone, chairman of Viacom and CBS.
