Inflation looks poised to increasingly dominate investment decisions. This domination should help lift stocks, although segments likely perform poorly, hurt treasuries, and undermine the dollar. The complicating aspect is increasing price instability overseas countering these trends as investors look for "safer" shores.
Multiple countries have started tightening monetary policies to combat accelerating inflation on their shores. This tightening has hurt equities in these countries, as I have learned first hand in China. A derivative of this tightening is a breakdown in commodity prices as rising interest rates are expected to slow economic growth.
In the United States the Fed likely let's inflation accelerate until the second half of 2011, fueling inflation overseas and domestically. However, until domestic inflation slaps investors in the face, the dollar may actually strengthen as money flows away from inflation figures reported overseas.
The United States economy likely continues to recover, although more nominally, and thus is a driver of stock market performance. As I have discussed under my stagflation theme, the inflation likely builds from the bottom of the economy. McDonald's noted rising cost pressure, which it will try to offset with higher prices. This is the rub in our consumer driven economy, costs rising but consumer wealth is not (double dip housing?).
In summary, I likely re-establish positions with pricing power deeper in the supply chain. A pullback in stock did not materialize in January, and thus it is likely time to move forward with investment themes.
Tuesday, January 25, 2011
Wednesday, January 19, 2011
Historical Performance Review
Based on my broker's calculations, my annual rate of return is as follows:
1-Yr - 12.7% (vs. SP 500 of 15.1%)
3-Yr - 7.0% (neg 2.9%)
5-Yr - 9.6% (pos 2.3%)
Since Inception (March '03) - 9.6%
Since I did not actively manage my money for almost 3 years during a large portion of these time periods, moving to mostly cash from October 2007 to September 2010, I am pleased with the performance. Going forward my goal is to continue to exceed the performance of the market.
1-Yr - 12.7% (vs. SP 500 of 15.1%)
3-Yr - 7.0% (neg 2.9%)
5-Yr - 9.6% (pos 2.3%)
Since Inception (March '03) - 9.6%
Since I did not actively manage my money for almost 3 years during a large portion of these time periods, moving to mostly cash from October 2007 to September 2010, I am pleased with the performance. Going forward my goal is to continue to exceed the performance of the market.
Sold ~70% of TBT
Yesterday I sold ~70% of my ~15% position in Proshares Ultrashort 20+ Yr Treasury, ticker TBT, at $39.30. TBT was 19% higher than when I established the position on September 21 at $33.12.
The sale was an on-going effort to move more conservative as the market has continued to drift upwards. TBT tended to correlate fairly closely with the market, and thus my desire to exit a portion of the position. If a correction in the equity markets should occur, I expect to re-enter the position to continue to position myself for expected accelerating inflation over the next year.
The sale was an on-going effort to move more conservative as the market has continued to drift upwards. TBT tended to correlate fairly closely with the market, and thus my desire to exit a portion of the position. If a correction in the equity markets should occur, I expect to re-enter the position to continue to position myself for expected accelerating inflation over the next year.
Thursday, January 6, 2011
China Inflation Thoughts
Interesting article in the WSJ today about growing inflationary pressures in China. Inflation has been accelerating in the country, rising above 5% despite the government's efforts to slow price increases. The one-year lending rate now stands around 5.8% and the government has repeatedly increased the reserve requirements for banks in an effort to slow growth. Stoking inflation is rising commodity prices, which the country imports in large quantities, and an effort to raise wages to spur domestic consumption. The minimum wage in Beijing increased 21% last month after a 20% increase in June. The government is also resorting to price controls in order to offset rising prices however, this action hurts producers exposed to rising costs.
My takeaway is that pressure continues to build to allow the yuan to increase relative to the dollar, which will eventually be loosened. The government worries about "hot money" rushing into the country in anticipation of a rising yuan, but the longer they delay the more pressure is likely to build. The question becomes whether this ends happily with Chinese inflation abating while the economy continues to grow, or badly with hot money over-heating the economy before a spectacular crash that likely takes down the world economy. In my opinion, they would be smarter to start chipping away at the obvious imbalance now before it overwhelms their ability to cope with it.
Under my sagflation theme, I argue that price bubbles are likely to occur due to the U.S. government's aggressive monetary policies. Since the Chinese are keeping the yuan artificially low relative to the dollar, they are in essence importing our expansionary monetary policies. It is a little scary to think an entire country the size of China could become a bubble, but I believe that is likely what will happen over the next year. How to play this bubble is going to be challenging since the Chinese government could allow the yuan to rise, increase interest rates, or some other centrally controlled effort to tamp down prices. So far, I'm betting the government lets the good times roll any way possible, which means encouraging domestic consumption and trying to actively manage prices through controls. These policies should make my investments in CHOP and EDS perform well, but when to get off the train will be a critical decision.
My takeaway is that pressure continues to build to allow the yuan to increase relative to the dollar, which will eventually be loosened. The government worries about "hot money" rushing into the country in anticipation of a rising yuan, but the longer they delay the more pressure is likely to build. The question becomes whether this ends happily with Chinese inflation abating while the economy continues to grow, or badly with hot money over-heating the economy before a spectacular crash that likely takes down the world economy. In my opinion, they would be smarter to start chipping away at the obvious imbalance now before it overwhelms their ability to cope with it.
Under my sagflation theme, I argue that price bubbles are likely to occur due to the U.S. government's aggressive monetary policies. Since the Chinese are keeping the yuan artificially low relative to the dollar, they are in essence importing our expansionary monetary policies. It is a little scary to think an entire country the size of China could become a bubble, but I believe that is likely what will happen over the next year. How to play this bubble is going to be challenging since the Chinese government could allow the yuan to rise, increase interest rates, or some other centrally controlled effort to tamp down prices. So far, I'm betting the government lets the good times roll any way possible, which means encouraging domestic consumption and trying to actively manage prices through controls. These policies should make my investments in CHOP and EDS perform well, but when to get off the train will be a critical decision.
Comment on Microsoft (ticker MSFT)
The point of this post is to show what happens when one of the three basic interested parties in a business (employees, investors, government) takes the lion's share of value created by a business. In this case, it is the employees. It may have relevance in the near future if laws are changed counter to investors' interests or taxes increase on businesses.
Flipped through CNBC today and the topics was "Why has MSFT gone sideways for a decade?" The hosts put up data showing how revenue has almost tripled and operating income has more than doubled. Everyone pointed to different things about failure to capture the mobile market, etc. I believe it is due to a more basic issue.
Revenue 2000 vs 2010: $23.0 billion - $62.5 billion (up 171%)
Op Inc 2000 vs 2010: $10.9 billion - $24.1 billion (up 121%)
I actually was a part of the team at Robertson Stephens that covered Microsoft a decade ago. The analyst, Alex Baluta, dropped them to a Hold from Buy. Later, another analyst, Eric Upin, took it over and together we kept it at a Hold. The call turned out to be correct, although controversial at a time when everyone thought it was a good place to hide in a tech storm. A few years later I was working at a hedge fund and got into a debate about MSFT. The other analyst argued that because the company was re-purchasing billions of dollars worth of shares each year, the stock should go up. I asked him why the share count never went down. I don't think he ever bought shares in MSFT.
So going back to CNBC, the critical piece of information they missed was that the diluted share count has increased 61% in the past decade, from 5.5 billion to 8.9 billion. This increase in share count combined with a falling ROIC has produced a flat stock price. ROIC determines over 90% of a stock price, as estimated by my work with it covering stocks. The falling ROIC is largely a result of simply unsustainable returns as the company diversified from the monopolies in Office and Windows.
So, employees have received generous stock distributions and therefore have captured the value added by the company, at the expense of investors. The share count has started to tick down modestly the past couple years, a sign management is finally sharing more of the pie with investors. Unfortunately, after a lost decade to investors, they are asking the question: "Why should I care?"
Flipped through CNBC today and the topics was "Why has MSFT gone sideways for a decade?" The hosts put up data showing how revenue has almost tripled and operating income has more than doubled. Everyone pointed to different things about failure to capture the mobile market, etc. I believe it is due to a more basic issue.
Revenue 2000 vs 2010: $23.0 billion - $62.5 billion (up 171%)
Op Inc 2000 vs 2010: $10.9 billion - $24.1 billion (up 121%)
I actually was a part of the team at Robertson Stephens that covered Microsoft a decade ago. The analyst, Alex Baluta, dropped them to a Hold from Buy. Later, another analyst, Eric Upin, took it over and together we kept it at a Hold. The call turned out to be correct, although controversial at a time when everyone thought it was a good place to hide in a tech storm. A few years later I was working at a hedge fund and got into a debate about MSFT. The other analyst argued that because the company was re-purchasing billions of dollars worth of shares each year, the stock should go up. I asked him why the share count never went down. I don't think he ever bought shares in MSFT.
So going back to CNBC, the critical piece of information they missed was that the diluted share count has increased 61% in the past decade, from 5.5 billion to 8.9 billion. This increase in share count combined with a falling ROIC has produced a flat stock price. ROIC determines over 90% of a stock price, as estimated by my work with it covering stocks. The falling ROIC is largely a result of simply unsustainable returns as the company diversified from the monopolies in Office and Windows.
So, employees have received generous stock distributions and therefore have captured the value added by the company, at the expense of investors. The share count has started to tick down modestly the past couple years, a sign management is finally sharing more of the pie with investors. Unfortunately, after a lost decade to investors, they are asking the question: "Why should I care?"
Wednesday, January 5, 2011
Outlook 2011 - "Click-Click-Click" Goes the Roller Coaster's Chain Lift
Summary
Like a roller coaster car getting pulled up to the peak, so I feel about the U.S. economy in 2011. Low taxes and expansionary monetary policies are the pull. But, just like on a roller coaster, I fear what happens once we go over the peak and confront the loops and swirls of fiscal realities and volatile market prices.
2011 likely brings rising asset prices, apparent improving economic activity, and growing job creation fueled by loose monetary and fiscal policies. Price wars likely bruise consumer companies without pricing power. Concerns that likely undermine economic growth include states losing federal funding and muni market pressures; European inflation and debt problems; and Congress putting politics ahead of the economy (such as not raising the debt ceiling).
Specifically, my outlook is summarized by the following:
(1) Bullish on equity markets into at least 2Q11, with a couple potential corrections.
(2) Inflation building from the bottom-up in the economy. Commodities, material companies, and companies deeper in the supply chain with pricing power more attractive investments.
(3) U.S. consumer is healthier now after paying down a portion of debt, but remains vulnerable to higher interest rates, economic shocks, and changes in tax policy that lower take-home income.
(4) International remains attractive.
Potential Stomach Drops include
(1) State and Municipal Finances (debt, deficits, tax changes)
(2) Volatile asset prices with sudden drops in equities and commodities as excess money sloshes around asset classes. Rising influence of fickle ETF money flows on commodity prices.
(3) Discretionary consumer companies squeezed between rising costs and cost-conscience customers.
(4) Housing hit by higher interest rates and possibly the increasing potential of removal of the mortgage deduction.
Overview
Sagflation: Increasing price volatility plus economic stagnation.
I remain skeptical of government driven recoveries that promote cheap and abundant money, as is the case with the current accommodative monetary policy. It encourage inflation and discourages sound economic decisions by businesses and individuals. Milton Friedman emphasized that "unemployment is . . . a side effect of the cure for inflation," so that if a central bank "cured" unemployment by inflating, it "will have unemployment later." Examples of poor investment decisions abound over the past decade, including dot-coms and housing. My point is that the investment base of this country is built on some rotten foundation, which until fixed will likely undermine solid recoveries. Not to say we can't have boom times in specific sectors for short periods of time (ie. bubbles), but any recovery will likely be spotty or lead to deeper downturns. My investment decisions incorporate this overall theme in the background.
Inflation, by most broadly accepted standards, is not an issue at the moment. Deep a little deeper and the story becomes more worrisome. Overall the Consumer Price Index (CPI) was up 1.1% year-over-year in November, a number easy to brush off as indicating all is calm. Sifting through the components of the CPI, however, raises some disturbing trends, food at home up 1.7%, gasoline up 7.3%, fuel oil up 11.1%. Many people factor out these components because they are volatile. Fine, but these components also hit the consumer squarely in the pocket-book and are not easily avoided. Furthermore, over 40% of the CPI is comprised of housing-related expenditures, which have not been rising due to the glut of houses on the market after the last bubble.
Digging deeper in the supply chain shows the Producer Price Index (PPI) for finished goods rising 3.5% in November. Even more worrisome, prices for crude materials for further processing rose 12.8% in November! In my view, there is a tension right now between rising costs and a glut of retail units relative to consumer demand. Why the glut of retail units? The abnormally low interest rates that encouraged builders to build, retailers to expand, and consumers to spend. This means one of 3 things could happen:
(1) World demand for commodities and unfinished goods falls, lowering prices
(2) U.S. consumer demand picks up, in which retailers pass along cost increases
(3) U.S. consumer demand remains tepid, world demand remains strong and U.S. retailers are squeezed - resulting in a shake-out of retailers who can't hold margins.
Only option 2 results in near-term CPI acceleration. Only option 1 result in inflation pressure going away. Option 3 results in a mixed bag of economic hardship with signs of inflation hitting near-term and even more long-term. In other words, Sagflation.
Where does sagflation eventually lead us? If the current policies are maintained for the next decade, I believe ultimately to the fall of the U.S. consumer and the rise of the Chinese consumer. Pressures like a falling dollar, some discussion of national sales tax, and removal of middle-class tax breaks on things like housing likely hurt the U.S. consumer. Long-term, this may not be a bad thing as the U.S. reverts back to its historical engineering and manufacturing strength, but the change will likely hurt.
U.S. Treasuries
Expect yields to rise through first half of 2011, possibly to 5% and even 6% on the 10-year bond if inflation spreads more broadly in the economy. Drivers include improving economic outlook, debt spending, aggressive monetary policy that encourages inflation. A key thing on which to focus are prices on credit-default swaps, which can highlight growing concern over defaults versus concern of accelerating inflation. A wild card is Congress and its willingness to play chicken with the debt ceiling. Calmer minds likely prevail, but who knows with some truly strange theories floating around Congress.
U.S. Dollar
Volatile as a perceived improvement in the U.S. economy and heightened international tensions likely conflict with rising debt levels, aggressive monetary policy, and rise of the Chinese yuan.
"You hear that Mr. Anderson?... That is the sound of inevitability." - Agent Smith, The Matrix
My view expressed on October 14 about the yuan eventually rising more rapidly against the dollar appears to be building some momentum as China is exhausting more and more options for taming rising inflation. The crux of the problem, in my opinion, is the relatively fixed exchange rate between the dollar and yuan. The rigidity of the exchange rate effectively transfers the loose monetary policy in the U.S. over to China. Since real growth in China remains near the high-end of sustainability, the loose monetary policy translates into higher inflation. China has been trying to offset the loose U.S. monetary policy by raising reserve requirements, government crackdowns on price gouging, and interest rate hikes. An easier route, and inevitable in my view, is a rising yuan. As U.S. economic growth improves so can China raise the yuan since Chinese exporters should benefit from U.S. growth. So I see the yuan appreciating versus the dollar in 2011.
Commodities
Divergence of commodities with more fundamentally driven commodities continuing to perform well during the first half of 2011 and more speculative commodities like gold under-performing as investors rotate into stocks. Gold may perform better in the second half of 2011 if inflation accelerates and political/ economic events worsen.
U.S. Stock Markets
Besides a few corrections, I am generally quite bullish about at least the first half of 2011 due to the twin engines of expansionary monetary policy (low rates) and expansionary fiscal policy (low taxes and subsidies). Beyond the first half of the year I become increasingly bearish as the three D's - Debt, Deficits and Defaults - increasingly push into the minds of investors, in my view.
In terms of sectors, I plan to under-weight consumer discretionary and home builders since I believe there remains a glut of supply in these markets and rising interest rates likely apply brakes to any recovery. Additionally, I believe retailers are a mine-field right now. Generally it seems as though investors are over-weighting consumer discretionary as they play a recovering economy. From spending times in stores I have been struck by the number of sales with discounts of 20-50% store-wide in many locations. These observations combined with rising costs for materials and supplies, as discussed earlier, suggests that weaker-than-expected margins may surprise investors despite healthy sales.
Like a roller coaster car getting pulled up to the peak, so I feel about the U.S. economy in 2011. Low taxes and expansionary monetary policies are the pull. But, just like on a roller coaster, I fear what happens once we go over the peak and confront the loops and swirls of fiscal realities and volatile market prices.
2011 likely brings rising asset prices, apparent improving economic activity, and growing job creation fueled by loose monetary and fiscal policies. Price wars likely bruise consumer companies without pricing power. Concerns that likely undermine economic growth include states losing federal funding and muni market pressures; European inflation and debt problems; and Congress putting politics ahead of the economy (such as not raising the debt ceiling).
Specifically, my outlook is summarized by the following:
(1) Bullish on equity markets into at least 2Q11, with a couple potential corrections.
(2) Inflation building from the bottom-up in the economy. Commodities, material companies, and companies deeper in the supply chain with pricing power more attractive investments.
(3) U.S. consumer is healthier now after paying down a portion of debt, but remains vulnerable to higher interest rates, economic shocks, and changes in tax policy that lower take-home income.
(4) International remains attractive.
Potential Stomach Drops include
(1) State and Municipal Finances (debt, deficits, tax changes)
(2) Volatile asset prices with sudden drops in equities and commodities as excess money sloshes around asset classes. Rising influence of fickle ETF money flows on commodity prices.
(3) Discretionary consumer companies squeezed between rising costs and cost-conscience customers.
(4) Housing hit by higher interest rates and possibly the increasing potential of removal of the mortgage deduction.
Overview
Sagflation: Increasing price volatility plus economic stagnation.
I remain skeptical of government driven recoveries that promote cheap and abundant money, as is the case with the current accommodative monetary policy. It encourage inflation and discourages sound economic decisions by businesses and individuals. Milton Friedman emphasized that "unemployment is . . . a side effect of the cure for inflation," so that if a central bank "cured" unemployment by inflating, it "will have unemployment later." Examples of poor investment decisions abound over the past decade, including dot-coms and housing. My point is that the investment base of this country is built on some rotten foundation, which until fixed will likely undermine solid recoveries. Not to say we can't have boom times in specific sectors for short periods of time (ie. bubbles), but any recovery will likely be spotty or lead to deeper downturns. My investment decisions incorporate this overall theme in the background.
Inflation, by most broadly accepted standards, is not an issue at the moment. Deep a little deeper and the story becomes more worrisome. Overall the Consumer Price Index (CPI) was up 1.1% year-over-year in November, a number easy to brush off as indicating all is calm. Sifting through the components of the CPI, however, raises some disturbing trends, food at home up 1.7%, gasoline up 7.3%, fuel oil up 11.1%. Many people factor out these components because they are volatile. Fine, but these components also hit the consumer squarely in the pocket-book and are not easily avoided. Furthermore, over 40% of the CPI is comprised of housing-related expenditures, which have not been rising due to the glut of houses on the market after the last bubble.
Digging deeper in the supply chain shows the Producer Price Index (PPI) for finished goods rising 3.5% in November. Even more worrisome, prices for crude materials for further processing rose 12.8% in November! In my view, there is a tension right now between rising costs and a glut of retail units relative to consumer demand. Why the glut of retail units? The abnormally low interest rates that encouraged builders to build, retailers to expand, and consumers to spend. This means one of 3 things could happen:
(1) World demand for commodities and unfinished goods falls, lowering prices
(2) U.S. consumer demand picks up, in which retailers pass along cost increases
(3) U.S. consumer demand remains tepid, world demand remains strong and U.S. retailers are squeezed - resulting in a shake-out of retailers who can't hold margins.
Only option 2 results in near-term CPI acceleration. Only option 1 result in inflation pressure going away. Option 3 results in a mixed bag of economic hardship with signs of inflation hitting near-term and even more long-term. In other words, Sagflation.
Where does sagflation eventually lead us? If the current policies are maintained for the next decade, I believe ultimately to the fall of the U.S. consumer and the rise of the Chinese consumer. Pressures like a falling dollar, some discussion of national sales tax, and removal of middle-class tax breaks on things like housing likely hurt the U.S. consumer. Long-term, this may not be a bad thing as the U.S. reverts back to its historical engineering and manufacturing strength, but the change will likely hurt.
U.S. Treasuries
Expect yields to rise through first half of 2011, possibly to 5% and even 6% on the 10-year bond if inflation spreads more broadly in the economy. Drivers include improving economic outlook, debt spending, aggressive monetary policy that encourages inflation. A key thing on which to focus are prices on credit-default swaps, which can highlight growing concern over defaults versus concern of accelerating inflation. A wild card is Congress and its willingness to play chicken with the debt ceiling. Calmer minds likely prevail, but who knows with some truly strange theories floating around Congress.
U.S. Dollar
Volatile as a perceived improvement in the U.S. economy and heightened international tensions likely conflict with rising debt levels, aggressive monetary policy, and rise of the Chinese yuan.
"You hear that Mr. Anderson?... That is the sound of inevitability." - Agent Smith, The Matrix
My view expressed on October 14 about the yuan eventually rising more rapidly against the dollar appears to be building some momentum as China is exhausting more and more options for taming rising inflation. The crux of the problem, in my opinion, is the relatively fixed exchange rate between the dollar and yuan. The rigidity of the exchange rate effectively transfers the loose monetary policy in the U.S. over to China. Since real growth in China remains near the high-end of sustainability, the loose monetary policy translates into higher inflation. China has been trying to offset the loose U.S. monetary policy by raising reserve requirements, government crackdowns on price gouging, and interest rate hikes. An easier route, and inevitable in my view, is a rising yuan. As U.S. economic growth improves so can China raise the yuan since Chinese exporters should benefit from U.S. growth. So I see the yuan appreciating versus the dollar in 2011.
Commodities
Divergence of commodities with more fundamentally driven commodities continuing to perform well during the first half of 2011 and more speculative commodities like gold under-performing as investors rotate into stocks. Gold may perform better in the second half of 2011 if inflation accelerates and political/ economic events worsen.
U.S. Stock Markets
Besides a few corrections, I am generally quite bullish about at least the first half of 2011 due to the twin engines of expansionary monetary policy (low rates) and expansionary fiscal policy (low taxes and subsidies). Beyond the first half of the year I become increasingly bearish as the three D's - Debt, Deficits and Defaults - increasingly push into the minds of investors, in my view.
In terms of sectors, I plan to under-weight consumer discretionary and home builders since I believe there remains a glut of supply in these markets and rising interest rates likely apply brakes to any recovery. Additionally, I believe retailers are a mine-field right now. Generally it seems as though investors are over-weighting consumer discretionary as they play a recovering economy. From spending times in stores I have been struck by the number of sales with discounts of 20-50% store-wide in many locations. These observations combined with rising costs for materials and supplies, as discussed earlier, suggests that weaker-than-expected margins may surprise investors despite healthy sales.
Tuesday, January 4, 2011
Added ~5% to VXZ Position
Added ~5% to my position in Barclays Bank PLC iPath SP 500 VIX Mid-Term Futures (ticker VXZ) position at $64.94. This brings the total position to ~15% of my portfolio.
Expanding this position to increasingly offset any downside in a market correction.
Expanding this position to increasingly offset any downside in a market correction.
Sold Half of Palladium Position (Ticker PALL)
Sold 50% of my ~6% position in ETFS Palladium (ticker PALL) at $76.98, which is a 46% increase from when I established the long position on September 21.
Due to the large increase in the price of the security, I am selling to re-balance the portfolio and remove some volatility. I remain fairly bullish on palladium, but believe I may get a better price in the near future.
Due to the large increase in the price of the security, I am selling to re-balance the portfolio and remove some volatility. I remain fairly bullish on palladium, but believe I may get a better price in the near future.
Sold Position in MKS Instruments (ticker MKSI)
Sold all of my ~3% position in MKS Instruments (ticker MKSI) at $24.55 for a profit of 13.3% after all fees from when I established the long position on November 4.
The main reason for the sale is to move the portfolio into a more conservative position prior to what I believe may be a market correction during the next couple weeks. As I mentioned in the last post, I foresee three things that may shake things up in the near future:
(1) New members of Congress looking to shake things up, starting with a debate over the debt ceiling.
(2) Spotty earnings - Sure, sales looked reasonably good in December, but costs may have risen more.
(3) Macro economic signals leading to speculation/ worries about Fed - Too hot = worries of rising interest rates; Too cold = worries of power to avoid double dip.
The eagerness by the Republicans to pick a fight over the debt ceiling is most concerning to me. It seems foolish simply because it is merely symbolic. There is no chance, in my view, that the debt ceiling won't be increased. More importantly, this action highlights the naivety of these fresh-faced Republicans about financial markets and the damage that can be done. If they insist on pressing the issue to win cheap political points I expect yields on treasuries to rise dramatically, which would increase lending costs, neuter the Fed's quantitative easing efforts, and needlessly hurt investors in treasuries who would see their principal shrink. There is also a good chance a steepening yield curve based on rising concern about U.S. debt payments would hurt the equity markets.
In my view we are walking along a narrow ridge and stupid decisions by our leaders based on politics instead of economic health risk pushing us off one side or the other. This is neither a Democrat nor Republican view, it is simply the view of someone trying to predict market movements.
The main reason for the sale is to move the portfolio into a more conservative position prior to what I believe may be a market correction during the next couple weeks. As I mentioned in the last post, I foresee three things that may shake things up in the near future:
(1) New members of Congress looking to shake things up, starting with a debate over the debt ceiling.
(2) Spotty earnings - Sure, sales looked reasonably good in December, but costs may have risen more.
(3) Macro economic signals leading to speculation/ worries about Fed - Too hot = worries of rising interest rates; Too cold = worries of power to avoid double dip.
The eagerness by the Republicans to pick a fight over the debt ceiling is most concerning to me. It seems foolish simply because it is merely symbolic. There is no chance, in my view, that the debt ceiling won't be increased. More importantly, this action highlights the naivety of these fresh-faced Republicans about financial markets and the damage that can be done. If they insist on pressing the issue to win cheap political points I expect yields on treasuries to rise dramatically, which would increase lending costs, neuter the Fed's quantitative easing efforts, and needlessly hurt investors in treasuries who would see their principal shrink. There is also a good chance a steepening yield curve based on rising concern about U.S. debt payments would hurt the equity markets.
In my view we are walking along a narrow ridge and stupid decisions by our leaders based on politics instead of economic health risk pushing us off one side or the other. This is neither a Democrat nor Republican view, it is simply the view of someone trying to predict market movements.
Monday, January 3, 2011
Bought ~10% Position in VXZ
Bought ~10% position in Barclays Bank PLC iPath SP 500 VIX Mid-Term Futures (ticker VXZ) at $64.49.
The volatility index for the SP 500 is trading around $17.30, near the 52-week low. This low volatility suggests, at least to me, that the market has not priced in an appropriate amount of risk for unforeseen events. Indeed, in the Wall Street Journal today there is an article discussing investors' sunny outlook. I foresee three things that may shake this up:
(1) New members of Congress looking to shake things up, starting with a debate over the debt ceiling.
(2) Spotty earnings - Sure, sales looked reasonably good in December, but costs may have risen more.
(3) Macro economic signals leading to speculation/ worries about Fed - Too hot = worries of rising interest rates; Too cold = worries of power to avoid double dip.
Not sure how it plays out, but the market just seems a little too sure of itself at the moment.
Description of VXZ
The investment seeks to replicate, net of expenses, the S&P 500 VIX Mid-Term Futures Total Return Index. The index offers exposure to a daily rolling long position in the fourth, fifth, sixth and seventh month VIX futures contracts and reflects the implied volatility of the S&P 500 Index at various points along the volatility forward curve. The index futures roll continuously throughout each month from the fourth month VIX futures contract into the seventh month VIX futures contract.
The volatility index for the SP 500 is trading around $17.30, near the 52-week low. This low volatility suggests, at least to me, that the market has not priced in an appropriate amount of risk for unforeseen events. Indeed, in the Wall Street Journal today there is an article discussing investors' sunny outlook. I foresee three things that may shake this up:
(1) New members of Congress looking to shake things up, starting with a debate over the debt ceiling.
(2) Spotty earnings - Sure, sales looked reasonably good in December, but costs may have risen more.
(3) Macro economic signals leading to speculation/ worries about Fed - Too hot = worries of rising interest rates; Too cold = worries of power to avoid double dip.
Not sure how it plays out, but the market just seems a little too sure of itself at the moment.
Description of VXZ
The investment seeks to replicate, net of expenses, the S&P 500 VIX Mid-Term Futures Total Return Index. The index offers exposure to a daily rolling long position in the fourth, fifth, sixth and seventh month VIX futures contracts and reflects the implied volatility of the S&P 500 Index at various points along the volatility forward curve. The index futures roll continuously throughout each month from the fourth month VIX futures contract into the seventh month VIX futures contract.
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