8/18/08 (Where & Why? Musharraf's Exit, Lowe's Low)

Traders,

These are most interesting times, over the weekend I was asked, “Where DO I put my money?” – that is always the magic question. The answer is what is your expectation? Safety, principal protection, low risk and volatility, high risk and big rewards? Traditionally we ALL look towards equities, different sectors with different risks and rewards. However, we got pinched by a credit crisis, inflation, and a slow-down in the economy – they sent investors scattering and those that stayed in the deep in of the pool saw huge volatility. Some ran to treasuries, which sent yields into the toilet – others found a home in new ETFs that track commodities, some even just went to money markets – but when banks started failing that no longer looked safe either. So WHERE remains the question.

I guess after you spend lots of time chasing yield and ideas you return back to what you know and for most investors that is equities. Investors look BEYOND value or problems and simply start buying on PRICE. It’s low so it seems CHEAP so I should buy, right? But even these low price issues have volatility. When we toss value into the garbage and start buying simply based on price – we have truly lost focus and now just hope. Because that question remains, where do I put my money.

The second question I get are various types of “What is going on?” – We could look at different sectors and products and point to different things – but the big picture problem is DELEVERAGING. From the bottom (consumers) to the top (corporations) – even the government – we have massive amounts of debt. The consumers have tapped their homes and credit cards, inflation makes payments more expensive and harder to make ends meet. Corporations (banks, financial firms, even manufacturing) have borrowed money or have positions on that exceed deposits in some cases 20:1 – they are going to every source they can to get money and keep those positions on (Fed Discount Window, Private Equity, Cutting Dividend, Selling shares, etc), but they too are strapped. The Discount Window is for the first time in history lending money to NON-MEMBERS and have extended the loans from 30 days to 84 days – the money being lent dwarfs all the money that has ever been lent by the FED (100s of billions). The government has granted the GSEs the ability to take down MORE leverage – they have over 5 trillion in asset back securities and it is suspected the 1.5 trillion is at risk – they too are going to the Discount.

So my answers are – equities are OK to invest in – just make sure you hedge them properly. For investors, look for companies that have capital, little to no debt, can participate on the global scale, liquid, and you are able to hedge positions (with derivatives). As per “What is going on?” – the deleveraging will continue until it stops. When it stops – who knows? But as long as it continues we will see more volatility. So be prepared to see the INDU rally 3% and the next day fall 3%.

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Musharraf Takes Medals and Runs!

Pakistan has seen lots of volatility in the last year, the country was shut down, Bhutto assassinated, rumors of supporting the Taliban, mass arrests, etc. You could say he kind of brought it on himself. Musharraf is probably looking to make a quick exit, go into exile, and find a country that will not extradite him back to Pakistan, cause I bet Pakistan is thinking (and probably getting ready) to try him for numerous crimes.

The question is, while a horrible leader, no leader means more volatility. Initially the news has sent futures higher – as a bad man leaves office. However, I expect a couple of weeks of volatility – depending on how quickly and securely the government can get control of the situation.

For now we are seeing a pop in the futures as the news hits the tape.

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Lowe’s Profit falls, Home Depot may see lower profits too.

Lowe’s reported profits are falling – as both home sales slow and prices slow down, that slows construction and home improvement. Home Depot is expected to issue a new forecast going forward, and many expect it to be lower. I was in Home Depot over the weekend, there was fewer people – but not as much as I expected. However, I DID look at what people were buying when in line, it mirrored what was in my basket (light bulbs, batteries, and a few low-end items). The kitchen and appliance section was empty, except for the staff – there was 5 orange vests for every 1 customer. I was asked 6 times in the kitchen area if I needed help, really I was just chasing my 4 year-old down – which they obviously could see, but maybe they were hoping that I was going to buy a new kitchen.

I didn’t see any big purchases – however – there was a group of people getting ready for the pending hurricane. I guess in Florida Lowe’s and Home Depot get some business as the hurricane season ramps, but I don’t know how that helps the bottom line.

I guess (which is bad for me to even say) – Home Depot and Lowe’s need a good hurricane to hit to see sales ramp – as per always a rebuilding effort would be needed. For now – the housing market slow-down, has trickled to Home Depot and Lowe’s – as people are now shopping for more efficient light bulbs and paint is the big home improvement.

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Futures Pre-Open

We are getting a rally going into the opening. While UK did report a huge drop in home prices and a slow-down – the news of Musharraf leaving office gave the European markets a boost – which we are also seeing in the futures. Expect a small pop in the cash market if the spread remains.

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Support / Resistance

The markets have been in that upward volatile stepping pattern, two steps up and one step back. A couple of indices have over shot a little and running a little hot, while others are making the knee jerk up moves. On the big knee jerks up – roll up the hedges to unwind the cash in the pull backs – that’s how long investors should be playing this.

INDU 11,500 / 11,800 (We are stepping higher and 12,000 is in the cards if we keep this one month trend, expect the stepping to be volatile – that means roll-up hedges on each big step up. Expect 2-3% moves up and down. Don’t get sucked into a bull or bear market philosophy – play the trend and roll up the hedges. We can be up just as easily as down.)

NDX 1925 / 1975 (We are in a upper band after a good hyper move to the upside – if we consolidate at the 1950 level too long we will load volatility in to this index and see a hyper move away for the 1950 area. Hyper moves up or down and going into short-term consolidation areas means more hyper moves up or down. This is NOT a bull or bear market – but a volatile one. Trade a volatile market and be prepared for either direction!)

SPX 1275 / 1325 (We are in that same volatile stepping pattern to the upside in the SPX. Expect to see hyper moves up and down as we step higher, but do NOT treat this as a typical bull trending pattern. The intra-day and day-to-day volatility is indicative of uncertainty and anything knee jerks can send it to 1275 or 1325.)

RUT 720 / 760 (We made a violent hyper rally to the upside in the broadest based market - with big intra-day volatility. In a bull market you do NOT want hyper up moves with big volatility, because it doesn’t build price volume levels – rather it creates gaps. Gapping up or down markets with little price discovery over wide bands spells MORE volatility. That means if I was a directional player – I would be FLAT DELTAS and LONG GAMMA going into each day – we could be at 760 or 750 or 720 or 740 at any moment, that is not healthy – regardless if we are back to June highs – it’s only volatile.)

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Conclusion

Who do we let fail? So far no one (or a just a few undesirables like IndyMac) – everyone from the homeowners to large financial institutions are getting the big bailout rush, including the GSEs. The problem with bailing out everyone is that people forget what a bailout IS! It is just a transfer of losses. The government loans and credit lines are getting massive – to a point that Bernanke will have to start picking who he can save and who he will let fail. He has extended the lending at the Discount Window from September to January and extended the length of the short-term loan from 30 days to 84 days. However, those 100s of billions still need to be paid back. What is going to happen in January when the Discount Window get’s closed to the non-members and those 100s of billions are due? The firms that borrowed can’t pay them back without failing. The Discount Window is NOT a charge card, you don’t get to carry a balance and make payments – however I have the sneaking suspicion that it soon will be and that these non-members might become members. What does that mean? It means the government just changed the rules and has taken on MORE debt that it will never get paid back. I haven’t even mentioned the GSEs, which have estimated 1.5 trillion in non-performing paper.

So as the market (financial firms) rush towards liquidity - pushing the dollar higher, how much can they really invest if they need every dime to carry the leverage positions they continue to hold? How long does Bernanke keep the window and loans open? I have a bad feeling the market is getting a good prop-up on the back of Bernanke, FED, Treasury, and Congress carrying companies that would probably fail. As long as they continue to lend money we will not KNOW if any other Bear Stearns exist and that has me concerned and cautious.

I don’t know what to expect, if the FED can save these firms or not and just ride this out. I do know that it’s not over and we should see MORE volatility not less.

Stay vigilant.