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Message: From Australia ..........
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Here Comes the Fear The Daily Reckoning Australia Wednesday, 2 September 2009 |
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From Dan Denning in St. Kilda:
--First up today, let's clear the air on 'thin air.' A few comments on popular message boards have taken us to task for spruiking the idea that you can make money out of 'thin air.' Just to clarify, '>
--The gas is there and the customers are buying it. When you throw in more projects in the NT, Papua New Guinea, and unconventional LNG projects in Queensland, there are a lot of exciting opportunities. And for the record, Kris tipped his first LNG stock in November of last year. He has three open positions in the sector at the moment.
--Here comes the fear. We mentioned yesterday that we reckon now is a good time to look on the short side. Other than the mysterious technical indicators of our colleague Gabriel Andre, how do we come to that conclusion? The volatility index of course!
--Bloomberg reports that, "The benchmark index for U.S. stock options closed at the highest level since July 9. The VIX, as the Chicago Board Options Exchange Volatility Index is known, increased 12 percent to 29.15. The gauge, which measures the cost of using options as insurance against declines in the S&P 500, reached a record of 80.86 in November. The index is still above the average over its 19-year history of 20."
--The VIX is referred to as the fear index because when the cost of buying put options on S&P 500 stocks goes up, it means investors are actively hedging against a fall in stocks. You can see from the chart above that yesterday's action took the VIX above its 50-day moving average. What's more the entire index remains elevated. That shows you just how uncertain investors are about the stability of this rally.
--Is the VIX a good proxy for the amount of fear Aussie investors are feeling? After all, the VIX measures options pricing on S&P 500 stocks, not the All Ordinaries. We put the question to Gabriel this morning when he came in the office. We also asked him if there were other volatility proxies that better fit the Aussie market...and were leading him to believe now is a good time to go short.
--Gabriel thought about it and wrote to us a bit later. "Yes," he said. "We can use the VIX as the correlation between markets worldwide is obvious. Choppy markets and high volatility in the US stock markets typically imply choppy market and high volatility here down under on the ASX."
--"Even though there's no official volatility tracking index in Australia, there are several ways to track implied volatility. For the biggest stocks, you can have a look at the options pricing. The premium of an option depends a lot on the expected volatility priced by the market makers. That's a good indication. But mainly for all the stocks you can use technical indicators like the Bollinger Bands, the Volatility Chaikin's and of course the daily true ranges (difference between high and low for each session). This will give you the historical volatility (not the implied).
--By the way, Gabriel sent out his first short-sell recommendation today to Swarm Trader readers today. We couldn't do it last year when the service launched because ASIC had briefly banned it on all stocks following the collapse of Lehman Brothers in September 2008 and the ensuing financial near-Armageddon. But now that we can do it, we are!
--Here's a thought: has the trading in five government-backed stocks accounted for most of the rally? That's the question prompted by a Wall Street Journal article that studied the volume of trading in Fannie Mae, Freddie Mac, Citigroup, and AIG. Those names are all familiar because they all received sizable investments from the U.S. government to prevent insolvency last year.
--You might also recognise them because they all go taken to the woodshed in trading action yesterday. The Dow fell 2% yesterday and the S&P 500 2.2%. But that was nothing compared to AIG's 21% decline, or Fannie's 18% fall, or Freddie's 17% fall, or Citi's 9.2% fall. Ouch. The Journal suggests the financials may lead the market down just as they led it up.
--But the better question is if the financials led the market up in an honest fashion. Or was it the Plunge Protection Team at work? Over at the
--"I took C, FNM, and FRE and expressed their *composite* volumes (e.g., the volumes transacted across all exchanges) as a fraction of NYSE volume. What we see is that, early in 2007, those three stocks accounted for only 1-3% of NYSE volume. During the financial crisis of late 2008 and again as the market was bottoming in early 2009, that ratio skyrocketed to well over 50%."
--"Recently, however, the volume in these three stocks has hit astronomical levels relative to total NYSE trading, as all three have made phenomenal percentage gains during August. Indeed, the composite volume of these three stocks alone has recently doubled total NYSE volume. If we look at just the NYSE trading of these firms, they are accounting for about 40% of NYSE volume."
--Hmm. What do you reckon? The above-board answer is that program traders and institutions are investing alongside Uncle Sam. This would mean big money flows into those fives stocks. If big-money investors are betting that government-backed stocks aren't going to be allowed to fail, that might explain the free-riding.
--But you can't help but think that buying these stocks is a back-door way of boosting equity capital without having to directly inject more tax payer money (which didn't prove to be too popular). If you're the Fed or the Treasury and you want to keep the operation low-key, you just need to find a middleman to do the buying for you to bolster the equity capital at these firms. Hmm. You wonder how short Goldman is these firms.
--Is that scenario too conspiratorial for you? It reminds us a bit of the rumour that the Fed was loaning out money to other central banks this year under the table so that those banks could come back and support the U.S. bond market. The Fed creates the money with a few keystrokes and then shuffles it around until it eventually makes its way back into the bond market, keeping yields from spiking, the greenback tanking even more, and the U.S. government from having to actually cut spending for a change.
--But nah, the government wouldn't actively intervene in financial markets to support asset prices and keep the public from panicking, would it? That's just...not possible...is it?
And now over to Bill Bonner in Bedford Springs, Pennsylvania:
Hey, the economy is not only recovering...it's becoming better than ever before!
"Banks recover to their levels before the fall of Lehman," is a headline in this Monday's El Pais from Madrid.
"Public assistance enables the world's largest 15 financial firms to return to the capitalization they had in September 2008," the article continues. The largest of the largest, HSBC, is now judged to be worth $186 billion, according to the stock market. China's ICBC is on its heels, with a market cap of $178 billion. BNP Paribas is 7th at $87 billion.
We will overlook the compromising detail that banks actually lost money in the last quarter - more than $3 billion. And let's forget that China's major banks are sitting on mega-losses from more than eight years ago (to say nothing of the more recent losses). Western banks, too, still have billions in assets whose real worth is an open question...and subject to quick reconsideration...
El Pais goes on to report something intriguing: "The two big Spanish banks leave the crisis stronger."
Ah. What doesn't kill you makes you stronger. The world economy is recovering, or so people believe. Stocks are going up - led by the banks. But are the undead of the banking world really stronger?
Ha ha...don't make us laugh.
But the world seems to believe it. The Wall Street Journal reports that just five big financial stocks are behind the stock market's rally. Fannie Mae, Citigroup, Freddie Mac, Bank of America and AIG account for nearly a third of market's daily turnover. Seems everyone is speculating on the banks...and moving them higher.
You will recall, dear reader, the banks made a fortune during the bubble years. You may also recall that they made so much money that when the bubble years came to a close, that they were almost all broke. Without hasty action from the feds, it would have been the end of the road for every major bank on Wall Street. As it was, even with government help, none of them survived intact. They all either went bankrupt, were sold off, or got bailouts with strings attached.
What busted the banks was too much of a bad thing. They made their money by peddling debt. In order to move the stuff, they convinced clients that their products were good safe investments - even leveraged derivatives backed by subprime mortgages! Such good salesmen were they that they even convinced themselves. When the crisis came, they realized that they had been buyers of the debt...as well as sellers of it. What could they do with it...except sell it to the feds?
But the whole financial industry is coming back to life. According to El Pais, it's back...and it's better than ever.
But wait? How could that be? Hasn't the world entered the worst recession since the great depression? How could lending money be such a good business? People don't borrow in a recession.
Strategic Short Report's Dan Amoss is just as skeptical. "The banking system has no experience managing through the current 'negative home equity' environment," he tells us. "This is an environment in which mortgage rates are already about as low as they can get and consumer balance sheets are as stressed as ever. Due to the nonrecourse nature of mortgages, most borrowers have no financial incentive to keep paying. Many are choosing to mail the keys back to the lender.
"This problem will cap the upside of bank stocks for years to come, so the sector will offer lots of short selling opportunities."
Borrowing by households has fallen off a cliff. Instead of borrowing, they're paying back debt at the fastest rate since the '50s. No money to be made there.
How about commercial and business loans? Are you kidding? Businesses are cutting back too. Businesses borrow to expand...and there is no expansion going on. This is a contraction. Credit is contracting along with everything else.
Then, how could the banks make money? Let's refer to that news item again. Oh...there are the magic words: "Public assistance enables..."
The banks are making money the same way Detroit is making money...dishonestly and temporarily. Instead of doing honest deals with willing and able counterparties, the banks are pulling a fast one. Their money comes, ultimately, from the poor taxpayer...the poor sap who funds all the government's giveaways. The private sector lived far beyond its means during the bubble years. People wasted their money they didn't have on things they didn't need. Now, they try to save their money. But now the government wastes their money for them.
Speaking of which...a quick note on the Cash for Clunkers program. Numbers to be released today are expected to show a peak in sales in August caused by the feds' incentives. President Obama calls the program a showcase, proving how effective government can be at getting the economy back on the road.
But let's go back to basics. It's a sham when people waste their own money. It's a crime when they waste other peoples' money. Prosperity comes from accumulating (saving) capital...and using it to increase productive capacity. The formula is pretty simple: Save your money. Invest it in productive business. The Clunkers program encouraged people to do the opposite - consume capital, other peoples' capital.
'Nuff said.
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