Slope of Hope Blog Posts

Slope initially began as a blog, so this is where most of the website’s content resides. Here we have tens of thousands of posts dating back over a decade. These are listed in reverse chronological order. Click on any category icon below to see posts tagged with that particular subject, or click on a word in the category cloud on the right side of the screen for more specific choices.

Something Bernanke Can’t Control

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Well, well, well. Good morning to you, one and all.

I have a very busy day ahead of me, and I was more curious than usual about what the futures would be doing this morning in advance of a day when I'm going to be more occupied than usual. I was shocked and delighted to see the futures taking a sudden tumble, and naturally I was very curious as to why.

The reason, as you all know by now, is that S&P finally decided that, by willikers, the U.S. might not be as creditworthy as its triple-platinum-plated reputation merits. The cool thing is that futures are getting killed merely because S&P changed its outlook. The U.S. – laughably – is being allowed to keep its triple-A credit rating for now (ha! bwa ha! bwa ha ha ha!)

Bernanke's future can be compared to the sinking of the Titanic. What we are seeing this morning is the equivalent of the first few ice crystals scraping the bow of the ship. The man will eventually receive his comeuppance, and anticipating that day is what puts a spring in my step and a twinkle in my eye. His deceits will eventually give way to the truth, the light, and the way. Blessed art thou, Slopers. Amen.

0418-truth

Hedging the Dow

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Hey fellow Slopers,

In our last post on hedging, we looked at hedging Internet stocks and ETFs. In this post, we'll look at hedging the Dow (via the SPDR Dow Jones Industrial Average ETF SPY) and its components. But first, it's worth asking why an investor might consider hedging now. Two reasons come to mind:

1) Hedging has gotten cheaper recently, as volatility has declined. As of March 28th, the VIX was back below 20, after spiking up to around 30 earlier this month, a few trading days after the 2011 Tōhoku earthquake and tsunami hit Japan.

 

2) Prudence may be warranted with the end of QE2 scheduled for the end of June. On Bloomberg TV Monday, David Rosenberg, chief economist at Gluskin Sheff & Associates (formerly chief North American economist at Merrill Lynch noted the correlation between the Fed's quantitative easing and the direction of U.S. stocks during the current cyclical bull market off of the March '09 lows: 

It’s one thing to have a fundamentally-based bull market: they tend to last for many, many years. But liquidity: it’s there one minute and can be gone the next minute […] In the past two years there’s been an 88% correlation between the movements in the Fed balance sheet and the direction of the S&P 500. If the Fed embarks on some exit strategy in the second half of the year, much like they did for a temporary period last year, it will be interesting to see how the market responds once QE2 runs its course if QE3 doesn’t follow suite in June or July

Rosenberg went on to say that he thought there would be a QE3, but that it might not come until this time next year.

With that in mind, below is a table showing the current costs of hedging each Dow component, and the Dow-tracking ETF DIA, against greater-than-20% declines over the next several months using the optimal puts (I used the Portfolio Armor iPhone app to pull up the optimal puts for these securities, but you can also use the web app versions of Portfolio Armor). First though, a reminder of what "optimal" means in this context, and a note about the time frames involved. The optimal put options are the ones that will give an investor the level of protection he wants at the lowest possible cost. Portfolio Armor uses a proprietary algorithm developed by an all-but-dissertation finance Ph.D. candidate to find the optimal contracts to hedge stocks and ETFs.

In his research, the Ph.D. candidate who developed the algorithm found that options with approximately 6 months to expiration tend to offer the best combination of liquidity and cost, so those are the puts for which Portfolio Armor's algorithm aims. When puts with about six months to expiration aren't available, Portfolio Armor searches for slightly longer or shorter times to expiration. In the table below, unless marked with an asterisk, the optimal put option contracts for the security expire in September; one asterisk indicates the options expire in August; two asterisks indicate that the options expire in October. All things equal, one would expect options with less time to expiration to be less expensive, and ones with more time to expiration to be more expensive.

Disclosure: I have a limit order in to buy the optimal puts on DIA referred to above.

QE Headwinds (by Ultra Trading)

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QE is a mighty force.  In ordinary times, global food riots and contraction in the labor force (36,000 jobs added does not cover the 150,000 needed for population growth) would cause a fierce sell off in equities. Not in these abnormal times where the perceived deep pockets of the Fed keep a perpetual bid in the market.   

The day QE ends there is a very high probability the race to the exits will be swift and fierce.  Investors are asking themselves how long can this go on.  The vast majority are saying QE2 will not end in June but rather continue indefinitely.  Perhaps the majority are correct although group think rarely works. The Fed's ultimate goal with QE was to drive demand back into the economy.  Whether it be perceived inflation (x will cost more tomorrow so I'll buy it today) or perceived wealth the theory is growth in demand causes growth in the economy thus causing more demand until finally the economy is self-sustaining.  

In the process the banking system is generating income by playing the role of broker between the Fed and Treasury.  So on the surface, from an academic standpoint it sounds good.  Like everything in life though there are unintended consequences.  These miscalculations or unforeseen problems can negate the benefit of the original plan.   One such problem is surfacing rapidly and if not addressed will create another shock to an already fragile banking system.

An economy grows through the creation of credit and the banking system is the heart of credit formation. The US economy is held hostage right now as the banking system, conservative in nature, takes its time to return to health.  The banking system has a balance sheet with vast exposure to residential and commercial real estate.  Should there be another leg down in that sector of the economy, the banking system will be challenged as it was in 2008.   

Unfortunately for the banking system, home prices began their second leg down once the final tax credits wore off in October 2010.  This new leg down could experience a rather vicious  cycle.  Studies have shown a strong correlation between the level of negative equity in a home and one's decision to strategically default.  The industry is currently working through a massive shadow inventory that will cause pricing pressure for years.   The more prices fall, the more the shadow inventory grows due to strategic defaults and thus the problem grows. 

The last thing the industry needs right now is anything that puts additional downward pressure on price. Unfortunately, due to the Fed's QE monetary policy and horrific US fiscal policy, a very real threat has risen in the form of higher interest rates.  

Here's an example.  The debt service on a $300,000 mortgage at 4.75% for 30 years is $1,564 per month. The debt service on the same mortgage at 5.00% is $1,610.  In other words that buyer in a 5.00% interest rate environment can now afford a home 3% lower in price.  Over the past three months, the ten year treasury has risen 100 basis points in yield.  That's four times the example above.

Should this trend continue the bank balance sheet risk and reduction in wealth affect from one's home will have massive implications to an already fragile economy.  The economy will be faced with a reduction in demand and in the formation of credit.  Two very strong headwinds and two which easily can outweigh the benefits of the original goals of QE.  

Submitted by Ultra Trading.  If you would like to read more, please visit my blog at - Ultra Trading

Silver Bells (by BKudla)

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For the past month Silver has retraced some amazing gains, pretty aggressively, I may add.  But looking at the chart of the miners I selected below, it sure looks like consolidation to me, on the verge of a new upleg. 

Up until the unrest in Tunisia became a contagion in Egypt, I was in the camp of silver going to the $24-25 dollar range, and planned on holding any new purchases until the latter part of February to let that scenario play out.

In March, silver the open interest is growing incredibly, and in that OEX the buyers can demand the physical. Also, investors are emptying the Comex of inventory.  My view is speculators sensing a squeeze will start putting upward pressure on the metals after the February OEX closed.

Now back to North Africa, this is a game changer, people are being reacquanted with risk, and the Precious metals benefit from this.  Also, I cannot see a short term scenario that stops the FED from doubling our money supply again in the next twelve months, So I started buying back into my silver positions this week.

Below, I present three companies for you, AG is a core holding, and above $12.40 I will complete my buy program (gap fill and hold), EXK, I think has already broken out, and added to already.  Finally, HL, it looks like AG's chart (I do not own it).

 

Ag_2011-01-29_0553 
EXK_2011-01-29_0540 
Hl_2011-01-29_0548 

Food Inflation- More Than Meets the Eye (by BKudla)

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As the mainstream public and media starts grasping the significance of rising food prices around  the world, their focus, and the focus of most people is on how terrible it is for poor people or for poor countries, but this is problem is more insidious, and damaging for our economy.

Taking a step back, one of the goals of the Fed is to force velocity of money by raising prices, especially necessities, thus creating the whirlwind of economic activity that can be taxed and diverted to the bankers.  In their mind they solve two problems in one for themselves, and cause some inconvenience along the way for masses.

But we are not in a demand push inflation, but a cost push variety with no increase in domestic income, but more importantly, they are neglecting Maslows laws of well being; specifically when people start to worry about food security and in our case ability to pay for food, a multiplier effect takes hold; in the wrong direction.  People shut down when pursuing safety.

In my view food, and for purpose of this post, is non prepared grocery food, and it is low margin and low velocity.  As prices in the market go up, and wages do not, the first effect is rolling down from restaurant eating, then the high margin prepared foods in the market are target-ted.  This brings us to today, going forward the next roll down is from discretionary food items, and label brands to basics and store brands.

Now it gets interesting, as food and fuel push up from here, the next area is distretionary other spending, which rips into the heart of our service economy, margin squeezes on everything not essential will happen first, then these businesses will simply give up and close. 

My point is as people focus on basics, and worrying about the future cost of said basics, they are less likely to have the animal spirits to create the velocity the FED desires, buying food instead of something else is not simply a one for one substitution of expense in the family budget, and replacing high margin spending with low margin ones, does not drive us out of this ditch, it perpetuates it.

It is ironic to me that every business in this country either becomes a non profit or extinct, so the bankers can be made whole.  Where is the CEO outcry?