Investment Capitalist

The ego is a particularly strong component of the human mind and we are naturally prone to certain egocentric tendencies. All traders and investors must work to understand these tendencies:

• Egocentric memory: the natural tendency to forget evidence and information which does not support our thinking and to remember evidence and information which does.
• Egocentric myopia: the natural tendency to think in absolute terms within an overly narrow point of view.
• Egocentric infallibility: the natural tendency to think that our beliefs are true because we believe them.
• Egocentric righteousness: the natural tendency to feel superior in the light of our confidence that we are in the possession of THE TRUTH.
• Egocentric hypocrisy: the natural tendency to ignore flagrant inconsistencies between what we profess to believe and the actual beliefs our behavior imply, or inconsistencies between the standards to which we hold ourselves and those to which we expect others to adhere.
• Egocentric oversimplification – the natural tendency to ignore real and important complexities in the world in favor of simplistic notions when consideration of those complexities would require us to modify our beliefs or values.
• Egocentric blindness: the natural tendency not to notice facts or evidence which contradict our favored beliefs or values.
• Egocentric immediacy: the natural tendency to over-generalize immediate feelings and experiences–so that when one event in our life is highly favorable or unfavorable, all of life seems favorable or unfavorable as well.
• Egocentric absurdity: the natural tendency to fail to notice thinking which has absurd consequences, when noticing them would force us to rethink our position.

The largest share redistribution of the country’s financial companies is about to take place right before our very eyes. This is the final crescendo of the Financial Crisis of 2008: Massive share sales of the strongest banks that are standing right now. ..

All of a sudden, showing strength for the past several weeks and clamoring to exit the TARP and government meddling has resulted in a mandatory stock sale by these same banks. So JPM, AXP and any bank wishing to exit the TARP, must prepare to dilute their current shareholders. That dilution is rather severe, but the devil’s in the details.

The ownership of the nation’s most important companies is being quasi-socialized, by transferring ownership to the “public” via the hands of the institutions, those same banks handling the government’s massive new injection of liquidity. The institutional buyers will include a larger and larger chunk of pension dollars. These pension funds, like CALPERS, are buying these share distributions hand over fist, along with many nationally strategic banks and corporations. They’ve figured out the only way to ensure continuity in the nation’s retirement support system: to become direct shareholders. Voila, you’ve got socialization right before your very eyes.

But it’s not really some ignorant version of Canadian or French socialism. This is capitalist socialism, not socialist capitalism. Huge difference. And it’s Jumbo size, in the true American spirit. This young nation of 235 years was able to follow Keynesian demands to offset a depression in terms of output. When a country with a growing economy like China slips, or has to burp from indigestion, the entire planet will feel the shock. Whether that was an intentional tap on the breaks via controlled devaluing of the Yuan is beside the point. Although that’s exactly what it was, there’s another issue. The financial crisis triggered by China’s Great Burp of 2008 resulted in the American Recovery and Reinvestment Act of 2009. And TARP, and PIPP, etc…

In the States, the capital structure of those banks handling this influx of funds is ballooning to unimaginable heights. This is a mandatory inflation of their balance sheets. This is the Fed and the Treasury forcing the new supply of dollars onto their hands to buy the shares of the companies now about to have an equity offering.

The Federal Reserve is now the largest bank with a balance sheet that went from $6 Billion to $1.3 trillion in about 6 months. For their governments, including the UK, France, Canada and now Venezuela, Bolivia, perhaps soon Ecuador, China (obviously), own the actual companies, or portions thereof. And therein you have it ladies and gentlemen: This is American Capitalism adapting to compete with Chinese Capitalism, where the state’s role not only yields the companies an advantage, but also provides the government with national security. For China, that security is in the form of owning sources of raw materials. For the United States, and Western Capitalism, security comes via the almighty US Dollar (for now). And funny how all major global commodities are priced in US Dollars. When there was a massive dollar shortage last year, it was resolved via bi-lateral lending facilities with the G-20 Central Banks and the Federal Reserve.  National security through state supported champions of global commerce. The need to cross borders, currencies, regulatory frameworks, governmental oversight, etc…, is another matter.

This full scale conversion to Chinese Capitalism around the globe is both the cause and effect of the Financial Crisis of 2008. But everywhere you look, on the tags, it says “Made in The United States”.

Corporate bonds have been on a tear since April; however, the paper of financial firms has outperformed all other categories by a significant margin. This is odd and perhaps suggests the market is either not correctly pricing this paper, or something is artificially preserving their value. During April and May, investment-grade subordinated financial bonds returned an average of 18%. Certain subordinate notes from SunTrust, Capital One, Regions Financial, Fifth Third, and PNC have posted gains of 50% or more in May alone.

What the heck is going on? Have corporate bond investors lost their minds or could this be a short squeeze? More importantly to me, is there a play here on the equity side? Logic (and institutional schooling) would suggest buying the bonds and selling the stock short as a hedge against insolvency. But if you haven’t noticed already, logic and old-school rules no longer apply.

Subordinated paper has a strangely attractive risk/reward profile to pure-play equity traders. But to us Global Macro folk, the issue is quite obvious. In a bankruptcy, sub-note holders get wiped out. As the bankruptcies of WaMu and Chrysler have shown us, the rules no longer apply when taxpayer money is being used for a bailout. However, let’s assume the bank’s credit profile improves. Because we’re talking commercial paper, the upside is limited to par. Most of the weaker banks have sub notes trading at $50-$70 (i.e. vs. $100 par, upside is capped at 50%.). If the upside is a maximum of 50% while the downside is total loss, I’d argue that buyers of these notes are smoking something,

Why not buy the common where the upside is unlimited while the downside is 100% in names like FITB, KEY, RF, HBAN, etc…?

Now, what defines “systemically important”? KeyCorp and Fifth Third have $98 billion and $119 billion in assets, respectively. Just before being seized by regulators, WaMu had $310 billion in assets. Nonetheless, WaMu’s sub note holders were wiped out without even a toaster or coffee mug to show for their investment. Now, do you still think KEY and FITB will be “saved” by regulators in the event of insolvency and subsequent FDIC seizure? If you do, pass the doobie.

So, is the trade to short the paper and buy the common, or short the common and buy the paper? Or more perversely, buy the paper and the common and hedge with a CDS. Now you’re talking.

Oh, and did anyone even notice the government’s announcement on Friday that they were walking away from the Legacy Loans Program portion of the PPIP? What does that mean? In simple terms, the government has decided it has no desire to provide any form of capital relief for bad loans on bank books. But to add insult to injury, the government has also decreed that banks can’t sell these assets at “market-clearing” prices because they will become insolvent simultaneously. Duh! Hello? Didn’t we see this play out already with the downward spiral of Lehman and Bear? Does anyone still remember Long-Term Capital?

There’s a lot of play here right now, and this group has consistently been on the top of my performance list. They’re a wild bunch and you have to try and trade against the herd, otherwise there’s no liquidity and you’ll get picked off like an ugly zit. The theme is really revving up and the stage is being set for China to fill the U.S.’s shoes as consumer kings. Except China consumes raw materials and exports finished goods to the U.S. And since all the stimulus has been supply side Keynesian Dogma, it’s quite apropos that we’re seeing a surging supply side recovery underway.

Fact: China has already exceeded the amount of copper and zinc it imported in all of 2008.

That doesn’t mean run out and buy BIDU. In fact, I use BIDU to hedge overnight beta risk against my growing list of Chinese stocks. Again, liquidity is a rarity and any sudden stupid moves and you create a spurt of algo chaos. These algo’s control most of the liquidity during the day, except for the first and last 45 minutes. If you trade like a monkey and spray the bid and ask, you’re going to get filled like a monkey would trading with a blindfold on.

The Chinese stocks covered in last week’s post have all shot up significantly on a % basis. This is only the beginning. Remember, these are stocks that overshot the downside as much as they had overshot the upside last year. Trade the tape and make a market in the names you hold core positions.

The SPX bottomed 3/6/09 at 666, and has never looked back, as the index galloped into the longest buying stampede in decades. Major indices are in the process of forming an intermediate “top” with insiders selling like mad. At the same time, many of the leading groups are breaking below their relative strength support levels. The major indices appear to be showing weakness and upside over downside volume indicators are screaming “sell.”

Most of the participants that missed the lows in early March are now looking for those winning lottery tickets that may have been neglected by careless traders. The only problem is the observant players have already made their money and have locked in their gains. The “easy money” is over.

Seasonally, we are in a bearish period, although if the bulls want to kick off a sustained, secular bull market, they have to exert a great deal of firepower to extend this rally into August. If this happens, then we’ll be in the early stages of a secular bull. With continued weakness in the US Dollar, I remain bullish on oil and gold, and neutral on bonds.

During the course of this rally, technology, retail, housing, and cyclicals all led the way up. These sectors have now broken their relative strength uptrends, which had remained intact since those March lows. The groups holding onto their relative strength uptrends, albeit with very little breathing room, are: financials, agriculture, chemicals, oil drillers, and emerging markets. I continue to favor emerging/frontier markets as well. Global stock markets have become more correlated over the past decade. Generally when the S&P 500 has risen in a secular bull market, it tends to underperform the global equity complex.

The 10-day moving average of the put/call ratio is still moving up (which is bearish for the market). But here is the chart of the daily ratio, which shows how high Friday’s reading was in comparison to the last few months.

Great piece by Colbert discussing last hour sell programs triggered by algorithms:

Implied dividends of European stocks based off of dividend swaps on the DJ Eurostoxx 50 index, have jumped, indicating growing optimism about equity markets worldwide.

Implied dividends were at distressed levels near the end of Q’4 last year. The cause was a scramble by dealers to hedge their long dividend exposures. Worsening dividend forecasts combined in a perfect storm as natural counter parties willing to take on long exposures, hedge funds, were taken out on stretchers. Dealers are generally long dividends because of the equity structured products they sell, which tend to be bullish. However, dealers’ need to unload dividends as decreased dramatically due to positive performance in equity markets and a lack of negative earnings surprises.

There has been a re-rating of dividends as forced selling caused a dislocation between the performance of the equity markets and their corresponding dividend markets because dividends were more aggressively impacted. The recent alleviation of several outlier events, namely the forced selling of long dividend positions by market participants as well as less extreme market conditions, forced dealers and hedge funds that participate in this market to realize just how big a discount implied dividends were trading at versus underlying stock fundamentals. It didn’t take a PhD to realize implied dividends were compressed much more than they should have been. Because dividends have a delta to the underlying equity markets, implied dividends track their performance.

It appears dividends have returned to fundamental levels but there is still room for dividends to rally further, lacking some multi-sigma event on the horizon as any potential dividend upside remains coupled to a sustained rally in equity markets.

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Buy MR at mrkt and accum.
KBW breaking out!
AB / RJF accum core breaking out
SDTH core China stock. Accum at market.
SMI 100% potential.
SPRD short squeeze.
PMI short squeeze
GROW: Accum core
UYG, FAS, IAI: Add to long bskt

SNDA: short

Naz: 1775 ceiling. 200d=1740. Breakout is 1774-1776. 1675 Support.
Inside sigma channel: 1715 – 1775 – 1840

BKX: Bank Index approaching Fib. convergence and 200d EMA. Resistance Range: 45.40 – 45.80 (200d=44).  This suggests a blow-off top in the next 1 or 2 trading days.

CRB Index: Confirmed reversal with 1st target of 258-263 (8%)

DJUSFN: Approaching major resistance with heavy upside momentum. Other indices have broken through similar levels. Ideally, pullback to 205 to confirm uptrend.
200d= 237.  T/L= 240.  Fib=234

DJUSHB: Nice correction to buy into.

Defense Index (DFX): At 200d EMA. Broke above trendline on Friday. Could be a short sector this week.

BTK: Biotech Index might make a run to 740 if the broad market continues to rally. It is lagging so far but March lows way above Nov. lows. So market may be “catching up” to this group. 660 heavy overhead resistance here.

DJUSAF: Showing resilience. Continuation rally after breaking and closing above 200d EMA. Turns consolidation into flag type. Looking for 485 (12%). Is this a proxy on global economic rebound?

DJUSAT: Auto parts makers closing above key resistance and 200d. Look for continuation rally to indicate market’s bullishness.

DJUSCA: Casino index consolidating above 200d. Watch for breakdown as possible indication broad rally may be over. Break below 260 sets up potential short trades in the group.

Limit Orders:
LFC=56 or >57.50, FMCN=7.305 or >7.95, CYOU= 29.35, ADI=20.25, BRCM=18.05, HIMX=2.50, NVDA=9.10, PLXT=2.85, SIMO=3 or >3.70, ACTS=1.80-1.88, AMCN= 5.75, CHL=46.50,CTRP= 30, GSH=23.50, JASO=3.55, MR=24.30, NPD=5.15, STP=14, XING=1.80,MBI=5.75

CHINA:
CPSL= new leg up about to begin, CHINA= 2x bottom monitor for entry around 1.35, ASIA=About to breakout >18.50, CBAK= 3day cons. >200dEMA go long and strong, CPBY=a.m. earnings, EFUT=closing gap 7.75-8.50 unreal growth rates, HMIN= about to breakout. Gotta be long prior to move., SIRF=2.85
SIMO trying to breakout
SVA: monitor closely

FINANCIAL:
ABK=trgt 3.50 buy possible gap down on earnings, BK=30L, ICE= monitor for another leg higher, JPM= 45 trgt, NYX= 30trgt, ORI= 15trgt, RF= buy on wkness,

Disclosure: Author actively trades the above stocks. These are NOT investment recommendations, nor should any of the above be construed as investment advice. The above are excerpts from the authors trading journal. Do your own research and consult a professional if you are not one yourself.

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There are several good stocks coming up on my radar. So I’m going to provide a quick list of my top choices:

HMIN – Huge hotel chain throughout China.
NPD- Enormous retail drugstore chain throughout China. Excellent growth and margin ratios.
CPSL- Specialty Steel
HIMX- Specialty Chipmaker
ACTS- Semiconductor Manufacturer
SVA- Biotech with H1N1 “hype”
QXM- Mobile phone handset distributor and network developer.
LFC- China Life Insurer
ACH- Aluminum Company of China (ChinAlco)
SOHU- Online Portal with huge advertising growth

Some of these stocks have already started to move, so be careful and trade wisely.

Disclosures: ALL OF THE ABOVE are traded actively by the author.

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Fear and risk aversion are creeping back into the market. Will this be an acute development or something with longer duration? Data coming in very discouraging. March ADP employment figures were a disaster with over 50% of the losses coming from the service sector.

It looks like most promising equity market is China. The Shanghai Composite is in the advanced stages of completing a tradable base:

For all you POT lovers (MOS, AGU, IPI as well):

If you trade DRYS, or any of the other shipping stocks:

NOTE: All Elliot Wave work done by Tony Caldaro at the Elliot Wave lives on blog

Geithner III is intended to create “price discovery”. But when you backstop the “buyer” from any downside while at the same time financing said buyer, then the “value” or price discovered becomes artificially inflated. Perhaps this is precisely why the plan is designed this way. Nonetheless, the solution is in and we can get on with it.

Dick Alford told The IRA: “The structure as described in the press is nothing more than the Fed, FDIC and Treasury providing some asset managers with calls on the upside–max loss equal to 3% of assets? When was the Fed or the FDIC authorized to sell or give away call options? I suppose that they will try to sell this as a non-recourse loan, but it isn’t. It is an option… The investors would in effect be left with sub-market financing and ownership of much of the upside potential. The implied rates of return to the private side are staggering, especially given the absence of any downside risk.”

Perhaps the market is thinking ahead? Wow, really?  Let’s agree that subprime losses have peaked and are now in the rear-view mirror. That leaves residential losses, which are expected to peak this year. And next in line we have the real king of the jungle: commercial paper, which should see loss rates peak in 2010. In the case of the latter, if the administration can get this economy moving and credit markets open, perhaps these losses could be refinanced and pushed forward in the hopes that the economy will improve. Otherwise, this party is just getting started.

Just for fun, this is a great excerpt of Congresswoman Waters confronting Secretary Geithner in a deeply unfair match of intellectual wits:

This day will go down as the biggest blow-off text book reversal day in the history of mankind.  Group think is a manifestation of your own much more deeply rooted psychological impediments. Mental handicaps. Note it for the nth time and move on.

All the littles had textbook short written all over them on the open. Where were you looking? Oh ya, standing around staring at the projector. That’s not gonna happen again.

FRE/FNM/AIG.

FAZ and SKF were textbook overnight holds. Regardless of their own individual chart, which makes me remember why I like this profession so much, but mainly because the VIX exploded today. And TRIN? That dandy little reliable heart beat of the market. How poetically it jumped from bizarrely low readings to all of a sudden FLASH 1.35 1.45 1.55. Unreal.

Tune everything and all else out. Focus on what you are a professional at. This is about expertise, not “protocol”.