Which Way Wednesday, Beige Book Edition

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Includes: DIA, IWM, QID, QQQ, SDS, SPY, TLT, UNG, XLF
by: Philip Davis

Bernanke Danger Beige BookClick to enlargeOn June 9th we liked the Beige Book, which confirmed our bottom call.

On July 28th, we did not like the Beige Book and I said to Members in my review of the report: "Housing drives the market and housing and commercial construction are dead. How can commercial construction come back if we have less employees? How can housing come back if fewer people qualify for loans and the population doesn’t grow? How does anyone think that we can address these problems through capitalism (ie. without stimulus)?"

We got the GDP report that Friday (July 30th) and the low expectations there gave us the gap up we were expecting and Alan Greenspan went on Meet the Press that weekend and admitted I was right - both stealing my "Tale of Two Economies" economic outlook and blasting the Republicans, saying the party had "lost their way."

We couldn’t do anything about the Republican’ts but I was able to call a "Toppy Tuesday" on August 3rd and we drifted along that top until the next week, where we caught the action just right as we took our bullish money and ran on Monday and began grabbing downside hedges including the QID play I put up right in that Tuesday’s (8/10) morning post, where I said:

Yesterday we knew that the move up was fake, Fake, FAKE and we acted accordingly in Member Chat. We had a nice QID cover play right in the Morning Alert that was an easy fill as the Nas went higher and higher all day. It was the Aug $16/17 bull call spread at .42, and the $16 puts sold for .29 for net .13 on the $1 spread with a nice 669% upside if the Nasdaq heads sharply down on us. Our stops on the play were a combination of Nas 2,300, Dow 10,700 and Russell 666 and we got the Nasdaq and the Dow over their marks but, once again, 666 proves to be an ominous barrier for the Russell.

That hedge did, of course, return the full 669% as QID finished the expiration period at $17.80 and there was no doubt on the trade as we had a mild drop Tuesday morning, followed by a major drop the next day, where my opening comment was: "Wheeee - I told you this was going to be fun!" It is FUN when you are prepared to ride the market roller coaster - not so much so when you are not. It was all about the lack of a coherent stimulus program as the GDP report, despite being an upside surprise at the time (it was later revised lower) certainly indicated a need for the Government to do more to promote growth. On Sunday, the 15th, on my way to the meeting at the Treasury Department, I was still full of hope when I wrote "Time for a New, New Deal," where I laid out a few simple programs that could turn this economy around.

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All hopes of that were shattered after our meeting with Geithner and Co., where it became obvious that there was no political will to push things past the filibuster patrol in the Senate so gridlock remained the order of the day. But we were pleased with Bernanke’s POMO moves on the 19th, which got me back on the bullish bandwagon as I expected POTUS to do SOMETHING to back Bernanke’s play. The additional QE move by the Fed and my expectations of more Government stimulus led me to call a top to the bond bubble on Monday, the 23rd.

TLT was at 106 that day and it flew up to touch 109 on that Wednesday (and gave us a great entry on the 2012 short that targets 90) but then plunged to 103 on Friday and now we’ll see what’s what this month, with the BBook this afternoon giving us a nice overview of what’s been going on, from the Fed’s point of view, during the month of August.

Our bullishness (or, more accurately, bottomishness) on the 23rd was not so strong that we wanted to take risks so I wrote "Defending Your Portfolio With Dividends," which was the first major Buy List we had done since the July 7th bottom call, where I put up "9 Fabulous Dow Plays Plus a Chip Shot" with the Dow at 9,700. Needless to say, those are going well! I was fed up with the negativity on Thursday the 26th when I wrote "CNBC and the Rally Killers" and apparently that made me a perma-bull, for daring to question the doom and gloom scenario that was being plugged by the MSM. Pessimism was so extreme that I was RELIEVED that the GDP was being revised down that Friday as it would finally put an end to all the idiotic speculation.

So yes, I am bullish but, as I said before, not bullish but bottomish. The middle of our range is Dow 10,200 and S&P 1,070 and I’m still looking for them to form up as a floor and give us the opportunity to move into a range that will center around Dow 10,700 and S&P 1,128 (5% up and down), where we can have some healthy consolidation while the economy continues the process of what Whitney Tilson calls "Muddling Through." I still think we need some stimulus but it’s not likely when we have the GOP, who Josh Brown refers to as "The Old Muppet Hecklers in the Balcony."

That’s why I suggested a new SDS disaster hedge in yesterday’s 7am Alert to Members (as I mentioned in the morning post) ahead of what we knew was going to be a bad day and, of course, we failed to hold that critical 635 line on the Russell, which is also one of our midpoints (see post for 2.5% range we’re expecting). I reiterated that play for Members at 9:11, with SDS opening at $32.05 and it ran up to finish the day at $32.50 (up 1.4%) so not very exciting and we added two longer variations on the hedge at 12:58 with Dec and March trade ideas, so there is no shortage of downside protection in the 400 to 500% range of profits if the S&P can’t hold the 1,070 line. That leaves us free to look at some more bullish trade ideas (we had several yesterday) if it looks like our mid-range is going to hold up, which I think it will.

We’ll see what the BBook has to say - that will color our decision-making going forward and, since it usually takes the market days to digest the report, we love it because we can stay well ahead of the curve. There is not much data other than the BBook this week but next week is VERY exciting with Retail Sales, Business Inventories, the NY Fed Survey, Import/Export, Industrial Production, PPI, the Philly Fed, CPI and Michigan Sentiment taking us into option expiration day on Friday. Last expiration day (8/20), the Dow finished right on the 10,200 line and that was 100 points higher than July 16th (10,097) and 250 lower than June 21st (10,450) and the exact same place as May 21st (10,193) so a whopping 350-point range for our options since the May dip. No wonder we love SELLING options - they all expire worthless!

And if you think that’s range-bound, take a look at this chart from the Chart Store (thanks to Barry R), which does a pretty good job of illustrating that we’ve already had a "lost decade" in the markets, with 10 years' worth of movement in our major indices netting under 5% almost across the board, with Gold and Silver bugs coming closest to declaring a victory with a 25% gain in gold - a whopping 2.5% per year (not compounded) - no wonder people are moving to TBills in record numbers!

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Barry also had a great "Visual Guide to Deflation," which I highly recommend for anyone who would like to understand the mechanism by which the price of everything can fall and fall for years. That is the danger the austerity crowd is flirting with as they worry about a deficit that can only grow in relation to GDP in a shrinking economy. If our debt were not already $15Tn and if we were not adding $1.5Tn a year and if we didn’t have another $30Tn of unfunded liabilities in our future I’d say sure, let’s cut back a bit. That is not the case - ONLY growth can save us and if inflation is the only kind of growth we can manage - WE’LL TAKE IT!

What countries are booming with growing markets? The ones with inflation! Yes, it’s a chicken and egg thing but the bottom line is that China and India spend money on infrastructure and their governments work to support growth. Unlike our markets, the Hang Seng is up 20.7% in the last decade, the Shanghai is up 88.8% and the BSE is up a stunning 239% while the Western World creates nothing but losses for its investors:

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We’ll see what the Fed has to say this afternoon and then we’ll see how the markets react to it. The best way to play this one is to be ready for anything and yesterday we hedged for a drop and today we’ll be looking at natural gas again as an upside play (yesterday it was the futures, today maybe UNG) and XLF is also interesting to the upside at $14.25 this morning. Lots of good-looking stuff to buy, in fact - I just hope the Beige Book gives us good reason to pull the trigger (and watch that 635 line on the Russell along with, of course, 1,100 on the S&P for bullish indicators).

Be careful out there!