8/12/08 (Got Inflation? $1 House! Pay the fine!)

Traders,

Another mixed day in the indices, while the INDU slid pretty good, the RUT moved higher and both the SPX and NDX saw little change. We also saw a big rebound in oil after inventories missed. It’s also expiration week and usually we see less volatility as stocks are forced to the big open interest strikes, but since we had some hyper moves, we blew through many strikes – therefore traditional “Pin Risk” at the big OI strikes is probably not going to be the case this week. That means that even going into this expiration we could have some big jerky volatile moves. So be prepared.

The Financials also started falling back off, buying back assets at par value combined with settlements and fines from regulatory bodies is putting the squeeze on capital. We are seeing capital tighten every day, Morgan Stanley has cut off equity lines and others are following suit. They are battening down the hatches and trying to secure capital.

Thank the market gods for this rally, for it was a great opportunity to lock in gains on long hard deltas and for those “bears” to reload to the downside. If you are a long-term hard delta investor – rolling up hedges is impetrative when you get these hyper-rallies.

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Got Inflation?

Consumer Price Index (CPI) ripped more than forecast, twice as much as expected, by .8% - the biggest jump in 17 years. The FED policy makers are already seeing dissention among the ranks as three Fed members have already voiced their concerns that that FED should raise rates. This time it wasn’t just the “Core” but also in not core related items (retail) – going to show that the trickle down affect of material costs and higher shipping costs are making their way down to the consumer.

There is ``a tremendous amount of cost pressure here that is affecting many, many industries,'' William Poole, the former St. Louis Fed president, said in an interview with Bloomberg Television

I expect that we will soon see a NEW NEW Method for calculating the CPI if it starts getting too high. Just like when we changed it back in the 90s.

The futures are getting the smack down after this news came out.

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Foreclosures continue to mount

I actually read a story of a house in foreclosure for sale in Detroit for $1. Yeah, $1 and they still can’t sell it because no one wants to pay the property taxes. That is just insane. http://www.detnews.com/apps/pbcs.dll/article?AID=/20080813/METRO/808130360/&imw=Y

Then I read another story about this family that had one of those TV show home makeovers. Guess what, they took out a $450k home equity loan on the new house that was built for them and now less than a year later – you guessed it – they are getting foreclosed on. What is wrong with people?

http://www.wsbtv.com/news/16980412/detail.html

I guess keeping up with the Jones. However, I am still hearing people blame Greenspan, Banks, Mortgage Companies, etc. Hey – no one stuck a gun to their head and told them to buy a house on 80/20 interest only home that they couldn’t qualify for in a traditional mortgage or to turn their house into an ATM.

I also hear the excuse, people get hurt and can’t work and thus can’t pay their mortgage. Granted, those are terrible situations and there probably should be something to try to help those people – however that is just a small fraction of the foreclosures. It’s a BIG stretch to actually believe that millions of Americans got hurt and can’t work and now are not paying their mortgages. The bulk of these foreclosures are people buying what they can’t afford and the banks taking the risk to lend money to these people. I think we need to see some people and companies fail and not burden the government and tax payers on the never ending bailout train. Sorry for the rant back to the news.

Banks repossessed 3 times as many homes in July than a year earlier and the number of homes receiving a foreclosure notice jumped 55% [sarcasm on] I guess lots of people are getting hurt and can’t work or pay their bills [sarcasm off]

``It's getting worse,'' Mr. Sharga, RealtyTrac's executive vice president for marketing, said in an interview. ``The number of properties that have been foreclosed on by the banks and still haven't sold is the highest we've ever seen.''

Expectations are for this to increase and the second wave of REOs will further put pressure on housing prices. Until the foreclosures slow down and the REOs to shrink – don’t expect a bottom in the housing market. This means MORE write-down’s at financial firms that are holding this paper. I don’t think it’s a good time to start bottom picking in the financial markets – as more write downs are probably coming.

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Wal-mart profits climbed!

As I have said – Wal-mart is probably the recession retailer – the one stop shop of low prices. As much as you might hate the company for political reasons or unfair employment practices, the reality is that they may be one of the few companies that maintains employees (jobs), continue to expand services and products, and continue to offer low prices.

While their profits DID climb, how much of that was due to the last quarter stimulus check is unknown (but can be speculated upon). The net income climbed and the profits beat most analyst expectations. While Wal-mart is predicting a slow-down, it is not nearly the bleak picture that many retail firms are faced with.

Expect Wal-mart to be the gold standard of retailers in this continuing economic slow-down. I am not advocating buying Wal-mart, but the stock and company should continue to see less downside risk than other retailers.

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Settlements and Fines – get in line

JP Morgan, Morgan Stanley, Wachovia and others are the latest to get in line to pay their fines and also buy back auction-rate securities (most likely at PAR value). Citi and UBS settlement (from federal claims of fraud by marketing bonds as alternatives to money markets) are paying $250 million in fines and buying back $26 billion in bonds. I don’t really know how much the banks are to blame, they are settling obviously end this before it cost more money and long legal battles.

The reason I say that, is these products had been rated AAA by Moody’s, S&P, and FITCH. When you rate something AAA, that is implied that they are as safe as Treasuries. So if the bank is told that these are as safe as treasuries (because of the credit rating) and marketed them as such – while they have to share in the responsibility – how much is it really their fault. I think Moody’s, S&P, and FITCH should be on the hook – so far it’s just the banks getting the hand slap and fines. Interesting….

The bigger problem is this – these banks do NOT have the money to buy back these bonds or pay fines. They are already going to the Discount Window to carry the massive leverage on positions they have and have tightened lending. This is just putting a bigger squeeze on capital and these firms buying back securities means less money available to lend.
Expect borrowing costs to rise!
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Futures Pre-Market

The futures had been up on the Wal-mart profit news - but when the CPI came out we saw a serious smack down and inflation gave the market a wet cold smack in the face. The futures are front running the cash and the spread is widening. If the ARB traders get in front of this they could put some serious pressure on the cash at the opening.

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Support / Resistance

We have seen a couple of the indices pull off hard from their high after the hyper rally. However, are these REALLY support? I say no – but rather more straddle strikes, a place to get flat deltas and get your gamma on!

INDU 11,500 / 11,800 (We will probably see 11,500 today – not a place to get long - note we broke down through yesterday. This is a flat delta area with gamma. Do NOT get long hard deltas unhedged at 11,500!)

NDX 1900 / 1950 (We closed unchanged, AAPL help the index from falling off – but remove the AAPL rally and the index would have been down a few points. This morning we are seeing a smack down after the CPI news. I don’t know if 1900 is in the cards today – but expect volatility.)

SPX 1275 / 1300 (Don’t get long at 1275 – get flat with gamma. Depending how this sets into the market (the CPI data) the opening looks down. Get flat at 1275 and let gamma adjust your deltas at 1275.)

RUT 720 / 760 (The RUT was up yesterday – we are in a very WIDE volatility band with no weighted volume in the band – that means volatility until (if) we get back to 720. We could see more HYPER moves in this band – expect volatility)

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Conclusion

I love how talking heads forget about everything and focus on a big rally as if the entire economic landscape has changed. Just put on your blinders and ignore everything? Again – until we see foreclosures and REOs slow down, the firms stop going to the discount window, the write downs STOP – the credit crisis is still here! The CPI just told us that inflation is REAL and those saying we are NOT in a recession or heading into a recession are the same people probably saying this is the bottom in the housing market. Look – until things change they remain the same!

Gamma is your friend – hedge those hard deltas and when the market makes a HUGE rally don’t look a gift horse in the mouth and hedge those damn hard long deltas and lock in some profits. There is NO excuse!