Traders,Last week was no doubt volatile – the government had move closer to a full bail-out of Freddie and Fannie, foreclosures were up, housing prices continue to fall, and we also saw an increase in credit defaults. While the moratorium on short selling in the 19 stocks ends this week, the likelihood of a continuance is fairly high after these stocks (even with the ban) did suffer to the downside. Clearly, even government intervention cannot keep the financials from falling. At the end of the day, stock price has nothing to do with the solvency of a business model – propping up stock prices so the company can sell it to the public to raise more money (while the financials suffer) – well, if we could all get those favors.
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Kraft – more cheese
Kraft is on the rise in the premarket, as the world’s second largest food maker reports earnings that were higher than estimates. It would seem that they have gotten in front of the higher shipping and food prices, by raising prices earlier and some brilliant re-packaging and marketing. Sometimes it just takes a little sleight of hand to keep the uninformed fooled.NPR had an interesting report a couple of weeks ago, Kraft (and other food makers) have launched a massive, yet slightly covert, new marketing and packaging campaign. It killed two birds with one stone, first they have very slightly reduced their package sizes (without closer inspection most will never notice). Example, decreasing a 8oz container to 7.5 oz may not seem like a big difference to the buyer (note prices are the SAME), think about this – by knocking back just .5 they are able to sell more as every 16th container is now a free add to their own inventory. A pallet of 1,000 8oz is now 1066 7.5 oz. They just increased their profit margins by 6.6%. In a traditional economy this just boosts profits, but in our now weaken economy this is given them a rather substantial buffer as both food and energy prices are on the rise. The marketing campaign has kicked in on some items as “New healthier serving size” and other obesity fighting slogans. Clearly a pro-consumer health conscious campaign. It’s clearly working as most people either haven’t notice package size shrinking and/or are buying into the new healthier serving size.
This new change in the poor economic environment is clearly doing wonders for the bottom line and keeping them in front of inflation. We all need to eat, we all also need to probably eat less. Of course you will not hear Kraft or others talking about reducing product size slightly while keeping the prices the same, but it didn’t take long for some researchers to figure that out. I am sure you can dig up the story on the NPR website, the guest had a website that had prices and size differences. http://www.npr.org/templates/story/story.php?storyId=92426936
Even in a recession, depression, or just a slower economy – we all still need to eat.
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Lehman paying MORE for money
Lehman is seeing borrowing costs sore for its five-year bonds, rising to 7.7% up a whopping 250bps from just 6 months ago. Clearly indicating that traders of Lehman paper continue to have little faith in the ability for Lehman to get out of their hole. The main problem is that revenues from commissions and fees are not covering the debt or mounting mark-to-market losses. Traditionally, companies can ride out bad times – but as the company continues to borrow MORE money and their existing debt increases, they are just adding debt to their balance sheets, which equal MORE and now higher payments.
I think you can clearly see WHY Bernanke has trouble raising rates to fight inflation, as Lehman is not the only one in this position. Just like consumers, if you have a mortgage payment or credit card payment and it is getting bigger, you sure do NOT want the interest payments to go up. Well these financial institutions are in the same boat and now they are borrowing at the Discount Window. This squarely puts Bernanke in a tough spot, as these firms have now where else to turn to.
So far Lehman and others are doing what they can NOT to issue more debt at these higher interest payments, can’t blame them. But how long can they continue to do so as they are becoming strapped for cash. Several firms are trying to unload their balance sheets, even Pandit (CEO of Citi) said he is planning to unload $400 billion worth of paper, but the question is to WHO? Just like your neighbors planning to sell their home to recover equity, that is all fine and good – but if there are no buyers than it’s just a plan. You need buyers and right now there are none. Just like the housing market, the buyers of this questionable paper to begin with has dried up. Clearly, if Lehman and others need more money – those that are left to lend are going to demand higher interest rates, and may even ask for more (Hard assets, seat on the board, special voting rights, options, warrants, dividends, etc.) who knows. The lenders are in the driving seat – but at some point you can only squeeze the rock so hard before it crumbles.
Don’t expect a huge recovery in this sector for sometime – even with the government intervention – it will take a while to work out of the system.
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Futures Pre-Market
The futures have been slightly up in the pre-market, but also a little volatile as a few earnings trickle out. The spreads are fairly tight and I think ARB traders want to be sideline and see the market reaction first, before taking a big leg on one side or the other.
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Support / Resistance
It was a volatile week, huge upside followed by a huge sell off. Volatility spells uncertainty and we should expect his continue through the election and beyond.
INDU 11,000-11,250 / 11,500-11,750 (As volatility increases so does the resolution on support and resistance levels, one days support becomes tomorrows resistance and then back again. For long-term traders this is a headache and nightmare to deal with, one minute you think you have found the bottom only to be bucked off the bull.)
NDX 1800 / 1850ish (This volatility monster is back to flirting with that resistance level band in the 1850+ range. It only takes one stock an AAPL or QCOM to drive this up or down hard. So stay alert – trading this index means you better have the top 10 over-weights on the watch list!)
SPX 1250??? (1250 was resistance early last week to only see this index almost touch the 1300 line and now we are back to 1250. Is it support or will it again become resistance? At this point I would treat it as a straddle strike, long gamma and flat deltas. Let the volatility masses decide which way to drive it – either way you’ll be a winner!)
RUT 700 / 725 (We had a good bounce on Friday after Thursday’s flush. It kept the index above the 700 line but is that 700 line support if we test it on some serious volume, I would be careful. We saw a flood of money come out of treasuries and rush into equities sending the yield higher. That may start to look attractive again and all it takes is a little loss of confidence to see the run back to treasuries. Watch that 700 line!)
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Conclusion
With energy and food prices higher, I have become rather interested in hydroponics, solar, and wind. I live in Florida, so that means year-round I can grow. I visited a very impressive Hydroponics farm and lab over the weekend and took a course on Hyrdofarming, and it was very impressive. The yield of product vs. the cost was fairly impressive. 1/15th the water used vs. traditional farming, yield per acre at 10x, and no need for traditional soil and dealing with soil nutrients means a impressive business model. These farms in Florida are popping up left and right, and are undercutting the costs and prices to consumers. I meet with a couple of commercial farmers as well as home growers at the facility – which is has a classroom, chemistry lab, and 15 acre farm – which is always testing new crops. Yeah – I saw asparagus growing – something that was NEVER EVER farmed in Florida and many other products. With food prices and energy prices on the rise – and food shortages in many places of the world – these farms are looking like the next big wave. Some of these farms are running off solar power and rain reservoirs. I was sold – enough so that I will probably start a small garden in my backyard. The hydro stack farming is seeing huge moves as farms are popping up all over. None of these hydro stack producers of equipment are public, but I wouldn’t be surprised to see one in the near future become public. They could be the next big agricultural wave, combining wind and solar energy. The place I visited was http://www.hydrotaste.com/
For now expect the market to remain volatile. Hedge those positions.
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