Banking or Tanking?

Changes in accounting have also been part of the picture and may have played an even bigger role in halting the debacle during the first few months of 2009. As a reminder of how severe the situation had become by the end of 2009 I always go back to these lines from acrossthecurve.com:

” As of Sept, the IMF had estimated that banks held $1.5 trillion in toxic assets. In the US news reports indicate that the Fed has asked nine of the banks that received TARP funds to submit plans for repayment. The 9 banks that were part of the stress test earlier this year took a little more than 20% of the $700 bln TARP funds. Lastly, in the deluge of bank sector stories today, note that concerns over Chinese banks for new capital helped fuel the largest sell-off of the Shanghai Composite since the end of August. China’s five largest banks submitted to the government preliminary plans to raise capital. While US and European banks need to raise new capital to replace the capital lost, Chinese banks lent a record CNY4.7 trillion (roughly the size of TARP) and need to rebuild its capital to hit the capital ratio targets.”

This was written in November 2009, about a year into the debacle and a year later -or almost- I suspect we still don’t know where we are standing. Presumably, this administration may have succeeded in kicking the can only a bit. But solving the bank problem permanently is a whole different story. Banks in the US and abroad are still riddled with bad loans, excessive derivatives in their books and under pressure because of the slow growth picture everywhere. Last week’s news of an improved outlook from capital good orders continue to tell a tale of a healing economy in the US. But a positive capital goods report cannot by itself confirm a turnaround. The situation remains fragile and so it is abroad, specially when it comes to the banking sector. Given that 140 banks failed in 2009, 118 so far for 2010 and there are about 829 of the nation’s roughly 7,800 banks in the FDIC “problems list”, for the average investor when it comes to banks the motto remains “tread cautiously”.

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PPT: for real?

The word plunge is very close to us… It brings visions of markets collapsing, deep despair, depression-era soup kitchens and market operators raking it or breaking it. “Plunge” not only has direct ties to the stock market but also to some of the greatest sea-changes that occurred in America, whether they were initiated after the depression in 1930 or after President Reagan signed the Executive Order 12631 on March 18, 1988 creating what has come to be known as the Plunge Protection Team.

A more recent plunge -the one that happened on May 6th, 2010- has surprisingly displayed some of the same characteristics as the other plunge related events. That is, it has gone unexplained. And just like other unexplained events, it has led to a proliferation of conspiracy theories that we can read on the press today.

Given the lack of market regulations that existed in the 1920′s it is not a surprise that individuals may have colluded to create some of the greatest fortunes in the history of Wall Street. However, the word collusion may be somewhat strong if we could extrapolate ourselves to that era. Fact is that no one will ever be able to prove whether Jesse Livermore manipulated markets, engaged in insider trading or planted articles in specific magazines in order to profit from market moves. But even in the case all this really happened, it did under a set of rules that were completely different to the ones that regulate markets today. Little of the behaviour of the old days operators could have been considered illegal. In fact, Warren Buffett himself -according to some paragraphs from The Snowball- also benefitted early in his career from developing close ties to management -receiving privileged information- before opening positions in their companies.

Plunges are mysterious in that they originate at specific nodes and propagate very quickly throughout the system in an ever expanding mode. Because many get hurt during a plunge, a normal response is to look for culprits and rationalize its inner workings. One of these culprits has been the executive order 12631 signed by Ronald Reagan authorizing the creation of a committee to “enhance the integrity, efficiency, orderliness, and competitiveness of [United States] financial markets and maintain investor confidence” after the crash of October 19, 1987. The group came to be known as the PPT or plunge protection team and ever since that day, theories have abound and have been in circulation as to the particular role this group plays in up or down markets. Interestingly, the working group was created only to provide recommendations and solutions to the events surrounding the collapse of markets in 1987, but somehow popular belief managed to turn these goals into more attractive myths and urban legends where dark pools of money operating through trading desks under the scrutiny of the CIA control the fate and flow of money.

The point is that events such as the 1987 crash, or the flash crash of May 6th, 2010 or even the plunging of markets blamed on Livermore in 1930 simply cannot be overlooked by governments given the massive amount of repercussions they generate at all levels, both to individuals as well as society itself. In this light, the EO 12631 was a natural response to those events and none of its wording can be construed as a green light to manipulate markets.

That is not to say that as a result of specific investigations, the obvious conclusion is that intervention is the most appropriate tool under certain scenarios. But interventions by governments have existed throughout history and no other era can teach us more about it than the time we are living. Nevertheless, deeming interventions as a natural -and perhaps welcomed- response in times of crisis cannot stop a large group of determined individuals from creating and disseminating biased stories about what is occurring or what they think it is occurring or what they think we should think about what is occurring. Credit goes to the really clever out there who come up with some of the most amusing stories that brighten our day. Thus, we hear about the “fat finger” wrecking havoc, or some infamous glitches constipating digital pipes or the added digit error of a zero that represents another billion or the black boxes taking over in a high frequency fashion and a terminator-like style…

Popular imagination has no end except when one considers the severity and magnitude of the events: the flash crash was the second largest point swing -1,010.14- and the biggest one-day point decline -998.5- on an intraday basis in Dow Jones Industrial Average history. Just like frogs in a rainy day, on May 6th conspiracists came out of the woods with a plethora of theories while no facts could be singled out. One of the most charismatic personalities among the conspiracists is Bob Chapman. In his own words, the problem “…was the introduction of the Working Group on Financial Markets by Ronald Reagan under an executive order to keep order in plunging markets, called the Plunge Protection Team, euphemistically. What they’ve done is they distorted the whole thing, and they’re using it to rape everybody, financially. And they manipulate markets 24 hours a day, all over the world!”

Widespread is an understatement when referring to the scope of the dissemination of these theories. More likely, they have become ingrained in the average citizen to the point that anyone referring to the PPT is convinced about their existence without the slightest shred of doubt, as this comment from a Yahoo article reflects. “…plunger team wasting trillions of our tax dollars to prop up this rigged rally since march 2009 with illegal goldman/jp morgan high frequency black box algorithm trading. Before massive inflation hits and the trillions in fiat money that the banksters stole from the tax payers become worthless, they will need to pull their stolen money out. Huge stock market crash, s&p 666.” Interesting choice of words: plunger, rigged, fiat, banksters… I would add: nuff said!

A less known fact that I would like to share today to wrap up my thoughts is that Jesse Livermore was not the only Boy Plunger making the rounds in Wall Street. Before him, Emil Mosbacher was also nicknamed the boy plunger in relation to his numerous and sometimes wild operations on the street, as per some of the articles published by the New York Times at the time.

And somehow, I believe neither of them will be the last.

On Emil Mosbacher

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Expect higher prices for clothing

Some ETNs can be seen as proxies to commodities. They are structured products that are issued as senior debt notes by Barclays. ETFs, instead, represent a stake in an underlying commodity. ETNs carry no distribution and are mathematically less prone to errors when compared to ETFs. ETNs must be thought of as prepaid contracts that generate profit and losses by the difference between the sale and the purchase. In the specific case of BAL, the underlying index aims at maximizing the potential return by taking unleveraged positions in cotton futures contracts.

But none of this answers the question of why cotton prices have been rising. Weather related problems have been a big part of the story. Pakistan, the 4th largest producer after China, India and the US, has seen its crops devastated by floods. Russia, another major producer also took a hit from fires and drought conditions. In addition, the National Cotton Council estimates that part of the price increase is due to a rise in consumption globally. This is important, as the same trends may show up in other commodities from grains -wheat, soybeans- to sugar.

Retracement or breakout?

Source: CBSlocal.com

In the meantime, traders expect prices soon to normalize and while you and I may still have to pay a premium for buying new T-shirts and jeans, I am positive there is a farmer in Memphis, Tennessee that will be enjoying a great Christmas this year.

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Gold. Up, up and away.

But if this is achieved by the manipulation of local currency then it could end up in a race to the bottom where noone wins. Perhaps this explains why the great winner from the last Fed meeting has been gold.

Gold is -and has been- acting as a proxy for currencies, the last bastion of value that no government can undermine. On the other hand, the dollar as reserve currency is quickly becoming the clown of the group. Last Tuesday, the real move from a QE potential came via a weak dollar furthering money flows into GLD -gold’s ETF-. This upside trend is starting to get confirmed by similar moves in some of the gold stocks.

Just as the dollar tanked, the euro closed over its 200 dma on strong action to confirm the EUR upward bias. It is very likely that this renewed weakness in the dollar will lead to a test of November 2009 lows, keep energy related stocks and commodity stocks afloat and give more momentum to the reflation theme, which

Dollar hit by the Fed announcement

In another front, the recent weakness in government bonds tends to conceptually support the stock market rally. Bonds also appear to have found support at their 50 dma line and further weakness in the dollar could act as a catalyst for their breakdown.

Euro on the rise

Meanwhile, as the seasonal rally from September through January approaches, investors feel that a bet on gold is a sure thing. Increasing trade volume, gold stocks on the verge of breakouts and other PMs on the rise, such as platinum, seem to confirm this. As for gold, so far so right.

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Swiss Franc next to devalue?

But it is highly suspicious that the timing of the announcement by the Fed has coincided with the recent measures taken by the BOJ. In a recent interview, the Bank of Japan governor Masaaki Shirakawa declared that the intervention “…was an appropriate decision given the situation surrounding the economy. We support the government’s stance.” and he reinforced his views saying that “…we will supply ample funds, including funds for currency intervention. This stance will remain unchanged in the future”. Similarly, big investment houses suspect that the Swiss National Bank might also view the swiss franc as being too strong and push for devaluation, to the surprise of the forex market.

On the heels of these announcements, the Fed came with their own and muted the effect of the prior ones while hinting to a widely believed rumor of an upcoming QE 2. It isn’t new for central bankers to use communication as their primary policy instrument to influence exchange rates, however, it is becoming clear that intervention could be the favored tool this time. The question remains whether any central bank can indeed alter the relative path of currency prices over the medium term. One of the conclusions from a study conducted by the European Central Bank in 2005 in regards to the effectiveness of central banks in promoting changes, was that “communication is effective in influencing exchange rates mostly independently of actual interventions and of monetary policy. Perhaps with the exception of oral interventions by Japanese authorities, the evidence suggests that communication may exert a lasting influence on exchange rates not by signalling future monetary policy or actual interventions, what is generally referred to as the signalling channel, but rather at least in part by providing relevant information to market participants and possibly by coordinating private sector beliefs and actions, as consistent with the functioning of a coordination channel of interventions.”

In addition, the BOE has also expressed a need to add to their stimulus efforts resulting on a fall of the GBP. Safe haven currencies such as the CHF have strengthened on the back of a flight to safety due to poor growth prospects by major economies. The problem is obvious: any currency appreciation has a direct impact on exports and increases the risk for countries such as Switzerland to import deflation. Can this conundrum be resolved? There are indications that a solution may not be close at hand. In a recent piece by John Fund, the WSJ -Obama and Carter similarities- informed that comparisons between Obama and former President Carter have been on the rise. Jimmy Carter’s presidency is remembered as one of the worst in the history of the US.

Meanwhile, gold continues its climb unabatted closing in on the $1,300 an ounce mark.

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I am positive that those who are watching have their fingers on the trigger. What I cannot tell is whether they will shoot up or down. One thing is for sure, time has come for the gunslingers to start shooting from their hips. Participants have been hoping for a new round of quantitative easing and the latest meeting from the Federal Reserve has shown that its board is inclined to go this route under specific scenarios. Yet, it is not clear markets are ready to revolt as in the past -all else kept equal- if they aren’t getting what they want.

Recently, we noted how traders, investors and money managers in general were moving funds into government bonds stalling the possibility of any stock market rally. Question is, will it happen again? Today, we are seeing a return of money flows into bonds but the decline of the main indexes on low volume may point to a different story. One thing to note is that the announcement by the Federal Reserve late Tuesday had its greatest impact on currencies and Treasurys, specially in gold which continues to rally. The apparent reading seems very simple: the Fed buying more bonds implies higher prices for Treasurys and lower yields -the 10-year Treasury note fell to 2.52 percent from 2.58 percent late Tuesday. Its yield is often a benchmark for interest rates on mortgages and other loans-, but more importantly it implied dollar devaluation. Devaluing the dollar will further the demand for other currencies such as gold.

Brian Wesbury from First Trust Advisors on the strength of the economy

So what about stocks? For now, most might be stuck in a range as a result of the wait-and-see attitude by managers who may prefer first to see the consequences of the Fed’s action on the economy.

Back again to T bonds?

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NAV mutual funds. Necessary?

Briefly, it is an accoutning term that represents the “net asset value” of a business.

A lot has been written about it on the internet so I should make an attempt at not repeating what has been given a lot of space on sites such as About.com and Wikipedia. However, a few important considerations are in order. NAV of mutual funds is not the same as the general accounting concept of net asset value. Neither it is related to the more time-associated one of net present value. Let me explain. The net present value of an investment is the result of the sum of all the discounted cash flows generated by it in relation to the original funds invested.

NPV or Net Present Value

The assessment of the net asset value of a business through this equation involves a lot of predictive imagination and for many value investing managers it is not worth the effort. Note that an essential component of it is the estimation of future cash flows way into the future. Now consider this: in a 10 year span the accuracy of the potential cash flows generated, not only may come into question but also may be impossible to determine. The rate at which these cash flows should be discounted in order to reach their comparative present value could also become unrealistic. Take the present recession in which the Federal Reserve had no alternatives but to push down rates for a variety of reasons. It is yet to be determined what the consequences of these actions will be but undoubtedly, rates will be much higher 10 years from now. Others could also argue that in a Japan style debacle rates could remain bottom low for a much longer period then anyone is considering. Which all boils down to the difficulty of assessing what level of rates should be used in a discounted cash flow model. About the only certainty there is, is the original capital being used to generate future cash flows.

NAV in accounting terms

Let’s take a look now at the accounting concept of net asset value. In its most simple defintion, the NAV of a company is the difference between its assets and liabilities. Although a moving target, it is easy to see that the concept of NAV -as opposed to the concept of NPV- is not associated to a time element. Just because of this slight difference, the monetary component of the NAV of a company seems to stand on firmer footing when it comes to valuations. Sometimes, NAV and book value are used indistinctly in spite of being calculated differently. Nevertheless, the assessment of value relies on market asset valuation. In accounting, book value aims to establish an even a clearer pictures regarding the valuation of a buisness or enterprise as it takes into account items that adjust the simple estimation of assets minus liabilities. For example, there are three circumstances that over time reduce the value of the assets used for the generation of cash flows: depreciation, which reduces the value of buildings and equipment during a certain span; amortization, which lessens the value of certain intangible assets as time goes by; and depletion, which corrects the value of natural resources needed for the business to function as they get consumed in the process. So depreciation, amortization and depletion act together to adjust asset valuation throughout time.

Mutual Funds

Similarly, NAV can be used to establish the valuation of financial products such as mutual funds -also known as open-ended funds-. All assets of a mutual fund fall under the category of financial ones and can encompass bonds, stocks, commercial paper and in some cases derivatives to the first group, such swaps, options and similar. Therefore, it is possible to estimate the market value of these assets which substracted to all liabilities yield a NAV figure. Typically, the NAV of a mutual fund is estimated daily. For the sake of simplicity, mutual funds report the NAV of a single share from the fund. In contrast to the standard valuation of mutual funds which relies entirely on the value of its assets (investments), closed-end funds have an added component as their shares trade in open exchanges and are subject to a premium or discount set by supply and demand.

The estimation of a mutual fund NAV could not be simpler: it is the result of the total market value of its investments minus total liabilities and debt, divided by the number of shares in the portfolio. The Wall Street Journal has been a preferred medium where to find mutual funds’ NAV daily but now this can also be done online. In the case of CEFs, each unit of the fund can trade at a discount or premium to its intrinsec NAV. It is not uncommon to see the price per share for a CEF trading at multiples of its hardcore valuation and this may happen because of many different reasons. Perhaps the manager of the fund has proven to have an outstanding record or perhaps distributions incorporate a good portion of capital appreciation or may be the manager of the CEF is taking on more leverage to push for higher yields. Closed-end funds are a particular type of funds that -like exchange traded funds or ETFs- trade like stocks at market value. I will devote an entire analysis to them down the road.

Getting back to mutual funds, for most investors NAV is of little interest as they place more attention to total return. If you would like to continue researching and learning about both mutual funds and closed-end funds you may find the links below valuable.

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Installments may be the way to go when it comes to debt settlement

Understanding Structured Settlements

Structured settlements can be -among other things- monthly or annual payments made to the claimant as a result of his or her win in a personal injury case. These payments replace the former lump sum payments, which used to be the automatic arrangement. Instead of receiving the whole amount claimed for, the claimant or plaintiff will receive the money through installment payments over a period of time. The time period depends on the money being claimed.

Short background

Do you know that the structured settlement setup was first used in Canada? The setup was introduced in the United States in the 1970s. Today, structured settlements have become ordinary part of statutory tort law. They are being practiced in England, Canada, United States and Australia among other common law countries. Of course, the exact rules and regulations that govern their implementation may vary among those countries. Depending on those unique rules and regulations, structured settlements may involve income tax, benefits and spendthrift requirements. Spendthrift requirements are basically the managing of money inherited or won for someone who may be too ill to do the managing on his or her own.

Advantages of the setup

With structured settlements, the personal injury victim can be taken care of for a longer period of time. The partial payments given, ideally monthly, are what the court deemed to be sufficient to support the plaintiff during the period they are for. This means that the plaintiff and his or her family do not have to hire a financial planner to invest or simply manage their accounts. With a one-time lump sum, this may be necessary. It is much harder to manage one big amount than several small ones. Structured settlements take away the need to do the budgeting, with the future in mind. The divisions have been made for the plaintiff. He or she will just receive the allotted amount for a given period. When money is given in bulk, there may be the temptation to spend more than is truly necessary. It is important to save money won for the care, medication and possible hospitalization of the claimant, who may have been a victim of severe personal injury.

Disadvantages of the setup

Unfortunately, the structured settlement setup is not perfect. It may ensure that there is money in the future, but the present is given a limited budget. Some personal injury victims can no longer work and depend solely on the settlement. While they have a regular budget to rely on, they cannot invest in or buy something expensive, such as a house. They cannot borrow against the total amount of the settlement and have to wait for the next payment if they need more money. Their financial lives are rigidly controlled.

Whether a structured settlement is good or bad depends on the lifestyle and financial goals of the plaintiff. For those who want to make big buys and investments, the setup may come out more as a disadvantage. On the other hand, people who only want some assurance in their future may be happy with structured settlements.

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Gaining with options the safe way

As stated in my post a couple of weeks ago regarding safe option bets, or safer than the average, when showcasing the chart for BVF – Biovail Corporation, I have found a perfect example of front month, in-the-money calls bet with a high chance of finishing well within a 100% gain goal. The symbol for the stock is ARMH. Take a look at the consolidation and retracement that occurs after the stocks breaks out above its long term trending channel. 

Notice how it retests the channel as being now support, after breaking it as resistance? The stock then goes to make new highs in a steady uptrend that has been lasting for over three weeks. I would not buy the stock now as the retest and bounce has already happened and although powerful momentum may take the stock even higher, I consider it done. 

Soon, I will be posting more examples before-the-fact

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Some believe markets have set a bottom. Boyplunger is on that camp.

It remains to be seen whether the 78 WMA is going to be able to resist the onslaught of bad news and bits of selling pressure that have been persistent for the last 4 months. However, past history favors its success. Taking a closer look at its behaviour during the last decade, shown in the accompanying charts, it is clear that this line acted both as support and resistance proving to be a formidable barrier to penetrate either to the downside or to the upside.

Please note that in the latest correction the sp 500 was able to penetrate this line on September 2009 through a powerful upward thrust move and it is only now that this line -78 wma- is being tested as resistance for the first time since the March ’09 bottom.  There has been one successful test already during the weeks of 6/27 and 7/04 and it appears these past two weeks – 8/22 and 8/29 – have been a confirmation. However, when it comes to markets nothing is set in stone and unless we see a powerful bounce soon, indices may go for another retest which may not bode well. Historically, the more restests that happen the greater the chances that support and resistance lines will break.

Looking at more details, the sell-off of government bonds in the last 2 weeks is a bit of an encouragement in that money flows may be reversing. But there are still mixed signals… The wide head and shoulders formation that is present in almost all indices hasn’t gone away. In addition, the US dollar has been trading in a narrow range and a trend is yet to develop. It is not clear whether this trend will be up or down.

Is it or is it not?

Extending the analysis to global markets, the chinese property index appears to be on the rise one more time and the bottom that was set last July has been holding fine. We’ve written before that the Shangai Property index has led global markets both to the upside and downside, peaking and bottoming prior to the SP 500 in a range measured in months.

 Money with zero maturity (MZM) has also been on the rise, perhaps due to the additional liquidity coming from Fed operations. Also in the past, markets responded following closely the same trends set by MZM. Ted spread has given back all the move to the upside that started with the revolt in the markets earlier this year and is sitting at levels seen for the last time on April. We are unsure whether the downward march will continue even though the consistent downside path should be an indication that financial markets have been healing for some time. The same can be said for the Libor-OIS spread. The general interpretation is that short term funding among banks in the euro zone has been get better.

10 years of support and resistance by the 78 WMA

On another front, the BDI also appears to have bottomed continuing its climb while the very important container index (CONTEX) also continues its upward move, albeit at a much slower pace. In all, there are many data points that indicate global commerce is stable and getting better, financial markets opening up again and US markets working out a bottom.

But for the next few sessions volume follow-through will remain the key.

What can really work like magic for the markets is a rapid change in this administration’s policies! And its good we can dream all we want.

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