March 31, 2009

Homebuilders: Best of the Unloved?



The first chart (click to enlarge) is that of the ratio XHB over SPY, in other words the performance of the homebuilders ETF relative to the S&P 500 ETF. It caught my attention because here is a much-hated sector that has pretty much been building a base since early 2008.

If, instead of comparing the homebuilders to the S&P 500, we compare them to another despised sector, the financial sector (represented by XLF) as shown in the second chart (click to enlarge), we can see XHB outperforming XLF handily since 2008.

So, if you believe that today's most hated stocks will one day have their day in the sun, XHB might not be a bad ETF to have in your portfolio.

Thoughts From The Forums

Check out this interesting exchange in a popular technical analysis forum (I hope the authors will forgive my poaching but I will of course honor any C & D request):

Comment #1:

"Navigating increasing tough markets may be the least of our worries. I
have worried a great deal about the regulatory and statutory changes
our industry faces. Then I saw this, "The chief executive of
struggling US car company General Motors has been ordered to step down
by US President Barack Obama." (BBC headline) and realized that I
wasn't worrying even remotely enough. The current administration
apparently knows no bounds and we are dead in its sights. The
environment we have known is history and the future is looking
increasingly hostile. All of us, no matter how large or small, must
prepare for the worst. I would suggest that each and every one of you
consider what the impacts might be, how to resist and, if
unsuccessful, how to survive; a transaction tax may be the least of
the changes we face."

Comment #2:

"I think there's a significant point I haven't seen addressed yet: in our
world change is the norm. The markets are constantly evolving and more
or less government intrusion is just another manifestation of an ongoing
process (evolution).

I think the biggest adjustment markets need to make is to become
accustomed to the degree of transparency with which the new
administration has chosen to operate. Under a less transparent
administration, the whole thing would have been done behind closed doors
and nothing would have been said about the governments role. Waggoner
would have resigned to 'spend more time with his family.' Different
presentation... same result.

Besides I don't think that this is such a big deal. Essentially, the
government is GM's banker, and they're saying that as a major debt and
stakeholder in the future of the company, they think it needs new
leadership. How is that so different from a CEO getting ousted as the
result of a takeover or as a pre-condition by a bank for a line of
credit or other financing? Banks throw their weight around all the
time. What's sad, is that there's not a bank left that's healthy enough
to provide the kind of financing these guys are going to need."


Comment #3:

"I'd like to draw a parallel that I hope won't shock anyone (many people have pointed this out) between this financial crisis and 9/11. They both were global catastrophes that had huge consequences and exceptional measures had to be taken in response.
The Bush administration was given the benefit of the doubt for a few years as far as its response to 9/11, before those who had problems with it started voicing their concerns in earnest. So I think it's only fair the Obama administration be given the benefit of the doubt for a little longer than 3 months before starting to expect the absolute worst in its response to this crisis.

Having said all that, I'm an independent trader and I can see the writing on the wall. My work environment will probably become a lot tougher going forward, costs will be higher, taxes will be higher, and while there may be great investment opportunities in the future, I might very well not be allowed to take fully advantage of them. But that's the new environment, so let's try to adapt."

March 27, 2009

Paul, Don't Throw the Baby Out with the Bathwater Just Yet

Like many bloggers (and a few distinguished gentlemen in Stockholm), I greatly admire Paul Krugman. When I learned he was awarded the 2008 Nobel memorial prize in economics, that made my week.

However, as a trader and participant in the financial markets, I am increasingly taking issue with his decidedly anti-market stance of late and his terminally negative view of the Obama/Summers/Geithner grand plan.

Krugman basically rejects any type of market-based solution to the problem. He views the Geithner plan as a lowly bribe and in his latest New York Times column (The Market Mystique) wonders if:

"a market in which buyers have to be bribed to participate can really be described as 'better functioning'.”

My problem with this is that it's basically an unhelpful (even destructive) moralistic view of the market and that it forgets that markets have always functioned thanks to what quite a few people would call an immoral sentiment but there you have it, namely greed. Greed and monetary incentives are, for better or for worse, at the heart of market-based capitalism. When you use the ethically-charged term "bribe", your are basically demonizing a key component of well-functioning markets: incentivisation.

Markets are best studied using an amoral approach, otherwise no rational discussion is possible. When one starts attaching terms such as greed, bribe, theft, fraud etc... to a reasonable discussion on what should be done to solve the financial crisis, reason and moderation are the first things to go. Then, inevitably, the solutions that come to the surface are of the "throw away the baby out with the bathwater" variety i.e. destroy the system and start anew. 

Maybe, just maybe, that's exactly what we'll need to do, eventually. But it's way too early and way too dangerous to go that route without having exhausted all the other, less extreme, solutions first. It would also be irresponsible.

I'm familiar with the argument that, if we're going to totally revamp the system eventually, we might as well do it sooner rather than later, that it'll be less costly. The problem with this argument is that we actually don't know how costly a hasty destruction/reconstruction of the current financial system would be, the same way we didn't know how costly letting Lehman go under would be. In Lehman's case, I don't think anyone liked the results. So with the economic system as a whole. To paraphrase Bernanke:
A massive economic crisis is not a good time to tear up the financial system.

March 25, 2009

Gold vs. SDRs

Warning: what follows could be construed as a bullish view on gold and could therefore make gold haters uncomfortable.

I'm sure I'm not the only blogger who noticed what gold did (or didn't do, I should say) when Tim Geithner committed his now infamous (for a few hours at least) faux pas. Mr. Geithner said he was "open to exploring a Chinese proposal to reduce reliance on the US dollar as the world’s reserve currency" which caused the dollar to crash. Not much, not for long, but still. Gold, on the other hand, went up. Not much, but still.

Why is this significant? Many people think gold's rise has much to do with all the currency debasement (quantitative easing anyone?) going on around the world and with the fact that gold has become, for some investors, if not the new reserve currency, at the very least some kind of default currency. If that were the whole story then the news that the world at large is considering building a brand new reserve currency based on the International Monetary Fund's Special Drawing Rights (SDRs) should be poison to gold. Indeed, should this project come to fruition, gold would become just another precious metal and the sizable "currency premium" built in its price should evaporate. But that's not what happened. Gold went up. And that, my friends -gold haters have been warned- is very bullish for gold.

It might be a little too early to draw definitive conclusions and it may be that the market has not totally digested this new concept or that it doesn't believe it is going to be implemented anytime soon. But it's something to keep an eye on.

PS: Mischievous readers of my previous entry, which was dollar bearish, might surmise that Tim Geithner's supposed faux pas was no accident but a clever covert attempt to "talk down" the dollar. My only comment to those readers would be: stay mischievous.

March 21, 2009

Bernanke's Playbook and Its Effect On the Dollar

One fascinating aspect of Ben Bernanke's response to the financial crisis is that everything he's done since it started in 2007, every measure he's taken, every new policy he's enacted have been pre-announced loud, clear and with maximum transparency in a talk he gave on November 21, 2002 at the National Economic Club in Washington titled Deflation: Making Sure "It" Doesn't Happen Here. It is highly recommended reading to anyone wanting to make sense of the "game" the Fed is engaged in.

Back in 2002, Bernanke wanted to assure the public that, should deflation become a problem in the course of what turned out to be the mild 2001-2002 recession, the Fed had a comprehensive playbook to defeat it with increasingly radical and potent measures as the deflationary threat became more urgent. The irony is that none of the most extreme non-conventional means he described in that seminal presentation were needed during the 2001-2002 slump. Cutting the Fed Funds rate to 1% and keeping it there for a (too) long period of time was sufficient to get the economy going again. However, those radical steps are definitely needed now. Bernanke has been running down his own list of things to do to revive the economy and he has been administering increasingly potent elixirs (to use his own term) to an increasingly sickly economy.

I'm not going to list in detail all the plays he ran up to now. For that, you'll have to read the speech transcript. Suffice it to say that he's been uncannily faithful to the playbook: rates have been cut dramatically, are now basically at zero and will be there for the foreseeable future. The Fed started buying agency mortgage-backed and asset-backed securities. And last Wednesday, he reached the part in the playbook where the Fed engages in massive buying of agency securities and long-dated Treasuries. So what's the next play, the next level of non-conventional measures? Well, in Bernanke's own words, this is what needs to be done next (emphasis added):

"The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.

I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange. In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces. Moreover, since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.
The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation."

As I understand it, this is a pretty straightforward, if couched in diplomatic terms, endorsement of a dollar devaluation policy. One might argue that such a policy had already been used covertly between 2002 and 2008, a period that saw a 42% fall in the dollar index. Whether that devaluation was market-driven or engineered by the Fed and the Treasury (or a combination of the two) is really beside the point. What's certain is that the safe-haven dollar rally (of around 30%) we've been in since August 2008 can't have made Bernanke very happy and will most likely end soon if it hasn't ended already. As a matter of fact, we might have witnessed the end of that rally this past week. Who would want to be long the dollar when the Fed might announce at any moment that they will start buying foreign securities with the specific intent to weaken the currency?

By the way, that's exactly what the Swiss National Bank did on March 12. Their explicitly declared goal? To weaken the Swiss franc.

March 18, 2009

Bernanke's Interview

I know I'm a little late to the party but I've been reading the transcript of the Ben Bernanke interview on "60 Minutes" and I'm amazed at how candid he's been on some subjects. Was his selective candor a way to avoid being completely truthful about other subjects (like bank solvency)? Probably, but this is what he says about letting Lehman Brothers fail:

"There were many people who said, “Let them fail.” You know, it’s not a problem. The markets will take care of it. And I– I think I knew better than that. And Lehman proved that you cannot let a large internationally active firm fail in the middle of a financial crisis."

This is his simple answer to a simple question:

"Pelley: You’ve been printing money?
Bernanke: Well, effectively."


No bullshit Fed-speak answer there.

This is what he says about the state of financial regulation in the US:

"We had a regulatory system that was like a sand castle on the beach. When you had little small waves just lapping up against the sand castle, everything looked good. But when you had a big breaker come in, suddenly it– the system wasn’t strong enough to deal with it."

A few days later, as if to prove that he means business when he assures us the Fed will use all available tools to get us out of this recession, Bernanke declares he and his FOMC friends will engage in some serious quantitative easing with the purchase of an additional $750 billion of agency mortgage-backed securities and the whopper: $300 billion of long-dated Treasuries.

Speaking of interviews and on a somewhat unrelated note, judging by this interview Joaquin Phoenix gave a few hours before his alleged breakdown on Letterman, he's either one hundred percent honest or he's the greatest (and most demented) actor of all time. Either way, he'll never work on Hollywood again.

March 14, 2009

Do Not Suppress That Urge

Finally! A contrarian bullish headline in this week's Barron's: Michael Santolli's warning to "Suppress That Urge to Call the Bottom". This from a journalist, although plenty smart, who thought he was seeing subtle bullish clues every step of the way down, pretty much since the beginning of this monster of a bear market. And here he is telling us to be very careful this time around, that this rally may be a bull trap.

So let me get this straight: each and every bear market rally over the past year and a half could have been the real thing but this one right here is most likely not the bottom? Hmmm. Methinks 666 could very well turn out to be, if not THE bottom, at least a serious medium-term low for the S&P 500. I leave to others the debate over the ominous nature (or not) of that number and what it portends for the future...

Now all we need is for Gene Epstein to become pessimistic on the economy and it'll be an all-clear to buy this market!

When There Was Nothing At All

Perfect track for a lazy Saturday morning. Too bad the intro from the original is missing.

March 13, 2009

Just came across this interesting quip in a Bloomberg article on Nobel Prize winner Joseph Stiglitz:

Adam Smith's invisible hand -- the idea that free markets lead to efficiency as if guided by unseen forces -- is invisible, at least in part, because it is not there”, says Stiglitz.

March 11, 2009

QQQQ Double Bottom?

The Dow and the S&P 500 might have made new lows recently but the Nasdaq hasn't. As you can see in the chart above (click to enlarge) QQQQ, the Nasdaq 100 ETF, looks like it completed a double bottom this week. The 11/21/2008 intraday low of 25.05 was not breached on Monday and, with the slow stochastic indicator turning up from deep oversold, we could see a sustained rebound in the next few days (maybe weeks). The 20 and 50-day simple moving averages, around 28 and 29 respectively, are the next logical resistance but after that, the road is clear until the mighty 200-day simple moving average (around 37 these days).

The one caveat is that volume was underwhelming yesterday to say the least. It might just mean that the impetus for this rebound was coming from outside the Nasdaq stocks (indeed it came from the financial sector) and not necessarily that it lacked conviction.

March 9, 2009

Gold Haters vs. Gold Bugs, Part 2

If you're a gold bug, this Financial Times article (Hedge funds turn to gold) will be a sweet melody that will send your ear drums straight to heaven. If you're a gold hater, have acted on your hatred and feel vindicated by gold's recent swoon, keep your stops close and consider taking partial profits.

“The size of the Fed’s balance sheet is exploding and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed,” Mr Einhorn [founder of hedge fund Greenlight Capital] wrote in a recent letter to his investors. “Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself.”

Mr Einhorn’s comments – and the revelation he is buying gold itself – are in line with the views held by other large institutional investors in Europe, according to bankers in London. The head of commodity sales at one major bullion bank told the Financial Times that he had never been so busy dealing in gold for large investors in his life.

March 7, 2009

The Deluded Uber-Bulls

Do you remember how ridiculed and laughed at the so-called uber-bears were during the most recent bull market? Well, nobody's laughing now.

The irony is that the current secular uber-bear market has spawned a new species: the uber-bulls. No matter how bad things look, no matter how many jobs are lost and how fast the market disintegrates, the uber-bulls see prosperity right around the corner. They see glimmers of hope in the darkest recesses of the economy. Naturally, just as the uber-bears used to become more bearish as the stock market soldiered on up, the uber-bulls become more and more optimistic as the economy and the markets keeps crumbling.

Case in point, Barron's Gene Epstein, who is fast becoming the most prominent and deluded of the uber-bulls. This is how he concludes his sunny review of this month's dismal employment numbers:
"At the end of this dark tunnel, a few rays of light may just be visible."

I sincerely hope he's right...although hope has been an increasingly unreliable sentiment to believe in lately. The uber-bulls will be right eventually and things will turn around. The big question, and one that no amount of wishful thinking will help answer, is when.

Rabid GE Employees


While reading this rather interesting article about the GE situation on the New York Times website, it suddenly dawned on me why the CNBC anchors are so rabid and full of "barely suppressed rage" to quote Bob Herbert:

A big part of their net worth is probably in or tied to GE stock and GE, their parent company, is in the process of going to zero if the above chart (click to enlarge) is any indication!

As the article points out:

“We’re in a new world, and new types of transparency are required,” Senator Christopher Dodd said this week. He was speaking at a hearing about A.I.G., but really, he could be talking about any company at this point. There is no faith. There is no trust. There is no confidence.

These days, the only thing that matters is proof. That is what General Electric has to supply.

March 5, 2009

It's Like Fishing, Part 2

Instant classic Michael Lewis piece on Iceland's economic mirage (hat tip, Ben T.).

Iceland, apparently, was one giant hedge fund. Young fishermen became currency traders overnight. At first, they would just pitch the Nordic version of the now-infamous carry trade to their clients: borrow in yen, buy krona assets. Then they figured, "what the hell, this is easy money" and started trading their own and their bank's money. And now, after the wreckage, each of the 300,000 citizens of Iceland is, on average, about $330,000 in debt.

One of the most devastating excerpts of the piece? This exchange between the author and a once-fisherman-turned-trader-turned-fisherman-again:

“You spent seven years learning every little nuance of the fishing trade before you were granted the gift of learning from this great captain?” I ask.
“Yes.”
“And even then you had to sit at the feet of this great master for many months before you felt as if you knew what you were doing?”
“Yes.”
“Then why did you think you could become a banker and speculate in financial markets, without a day of training?”

“That’s a very good question,” he says. He thinks for a minute. “For the first time this evening I lack a word.”

It's funny, this is not the first time the fishing metaphor has been applied to the financial markets. For Iceland, though, this is no metaphor, it's a cold hard fact.

If you need solid reasons to buy this market for the long run, read Toro's blog in general and this recent piece on 10-year returns in particular.

If you need extra insight into the GE mess, read this and this by Bronte's John Hempton or this in the Accrued Interest blog.

You know we're in deep shit when two successive headlines from Dow Jones Streaming News feature two prominent and potent public figures proposing two opposite solutions to the financial crisis:

17:45: Fed's Lockhart: Securitization Markets Must Be Revived.

17:47: US Rep Frank: Securitization Should Be Curbed.

The scary thing is that each statement builds on two opposite views of reality. The first presumably implies Mr. Lockhart believes the securitization markets are dead and that it's a bad thing whereas Mr. Frank apparently believes they are all too alive but shouldn't be. I would tend to think the latter view is not only a bit late to the game but potentially very dangerous.

And finally, check out Jon Stewart's well-deserved definitive destruction of CNBC:

March 3, 2009

Fan Mail

A funny thing happened today. This is what I find in my email inbox (emphasis added):

Subject: Fan mail, not for publication, just FYI‏

From: mail (mail@barrons.com)

Sent: Mon 02/03/09 23:04

Gosh, Gene, I feel ignored.

Thomas G. Donlan
Editorial Page EditorBarron's Weekly
1025 Connecticut Ave NWSuite 800
Washington DC 20036202-862-6606
tg.donlan@barrons.com

Apparently, someone at Barron's CCed me this internal email. Was it by accident? Did somebody there enjoy my "fan mail"(bottom of the post), my admittedly over-the-top ode to Mr. Gene Epstein's economic genius?