Options Trader: Thursday Morning Ideas

by: Philip Davis

How low can rates go?

We've been living large off the Fed's largesse since 2002 -- half a decade of easy government money that started out as 9/11 disaster relief but turned into a multi-trillion dollar entitlement program for corporations and the wealthy that has been fueling our economic boom.

This program has been so successful that last year the world's top .15% (all 9.5M of them) added a staggering $4 trillion to their assets, THAT IS THE GDP OF JAPAN, the world's second largest economy! Wake up people -- this is not you. You may think you are included in this privileged group because you have assets of $1-10M, but the vast majority of that $37t is actually in the hands of less than 1,000 people.

If you want to check your actual standing in the global pecking order, you can enter your salary here, but it breaks at the top 100,000.

Easy Money 28 06 2007Why do I say that low rates are an entitlement program? In simple terms, because the government does not make a profit lending money at these rates. Therefore they are running a charity at a deficit, which is a burden placed on current and future generations as other services (including defense) have to suffer in order for the Fed to keep making below market loans. Don't all citizens benefit from this? Perhaps. But you have to imagine that the benefit derived by 48M home renters who's biggest loan is perhaps a $25,000 auto may be getting somewhat less than the benefit Steve Wynn (one of the 1,000) gets when he borrows $1.5B at 5.36% to build a casino that those other 48M people can't afford to buy lunch in.

So it's the easy money that's fueling the Dooh Nibor Economy, and the question is -- how long can they keep it up? Maybe it's easy to funnel the entire GDP of Japan into the pockets of 1,000 lucky people (it's gone well so far), but let's keep in mind that this year they'd like to do better. At 11% growth per year on $37T it's, only a matter of time before it will take the ENTIRE U.S. economy ( currently $13T) just to fuel the growth needs of the 1,000. That means they will need EVERY dollar, not just the ones you "waste" on discretionary purchases. They will need your rent money, your medical money, your food money, your retirement savings, and the equity of your home.

Money hole 28 06 2007Luckily for us (and I use luckily in a very loose sense) half of the 1,000 live right here in the U.S., so $2T of that increased wealth was added to our own GDP. Now a pessimist may say that means that the GDP for the other 329,999,500 of us is just $11T (and don't even get me started on corporate wealth!). But as an optimist, I like to say that they may be dangerous, wealth sucking black economic holes - but they are OUR dangerous, wealth sucking black economic holes - and we are just lucky enough to be inside their event horizons! For now anyway.

So - Fed Day, party time, excellent, woo woo!

Let's get this party started! Hopefully the Fed will continue to see that inflation is nothing to worry about and will see their way clear to keeping those low, low rates so we can all go out and borrow more and more money to buy stuff that was made in China.

Speaking of China, the Shanghai composite was off 5% on both sides of the market this morning as the Bank of China indicated that they may be raising rates, but Hong Kong shook it off and the Hang Seng rose 232 points (1%). The rest of Asia was up over half a point, all very excited by yesterday's U.S. rally. Europe is also in a chipper mood, up half a point across the board as Gordon Brown officially takes over in the UK.

Lukoil reported profits down 23%, but not too far below expectations. Production increased 7.4% to 1.8Mbd, but prices were lower (boo hoo), so they only made 4.7% more against rising costs. A very interesting concept - when prices go down they make more oil, not less as OPEC would have us believe!

KB Home (NYSE:KBH) continues to lose money "hand over fist" reporting a loss of $2.26 a share vs. expectations of a profit of $0.07 per share that was the consensus of the 10 professional analysts who are paid to follow the company's every move. "Our second-quarter results reflect the current oversupply of new and resale housing inventory, a difficult situation compounded by aggressive competition and continued weak demand," said a statement from CEO Jeffrey Mezger. "Housing affordability challenges and tighter credit conditions in the subprime and near-prime mortgage market have also exacerbated current market dynamics, keeping prospective buyers out of the market, slowing the absorption of excess supply and further delaying a housing market recovery."

Despite the $2T contributed by the U.S. branch of the 1,000 last year, our Q1 GDP came in at a 4-year low, so it will be interesting to see how the markets hold up ahead of the Fed.

US Markets 28 06 2007

The Nasdaq needs to hold 2,600 and give us some new leadership, but I maintain that oil must let go or there is no way the rest of the market can keep going. Transports should get a bit of a boost as M&A rumors sweep through the airline industry, but as we said yesterday, we will not be led into temptation until we get confirmations from all of our majors.

Happy trading. I will be keeping a close watch on the SOX to see if the tech rally is real. If we can make it through the day, we have iPhone fever to look forward to for a whole week, but we also have a holiday next Wednesday.

SOX 28 06 2007

The non-stop Apple bashing on CNBC is amazing, and we continue to play AT&T Inc. (NYSE:T) as a safer proxy as we already have plenty of Apple (NASDAQ:AAPL) positions.

ZMan sees crude stocks at a 9-year high with over 350M barrels in private storage. It was a drop in imports that gave us a negative inventory report yesterday. I'm not sure I want to get too short on oil into the holiday, but I do think that Wednesday July 4th is going to be a bust for driving, and consumption.

We get the natural gas inventories today, and it may give us a good chance to short some of this week's high fliers, so stay tuned in comments for our selections.

Meanwhile nothing matters but the Fed or, more accurately, the markets reaction to the 200 word statement which is unlikely to hold too many surprises. I'm expecting a more hawkish tone, as I still believe they must bring their rates just a little more in line with reality.

Let's not take the morning's trading too seriously and please, please, please - be careful out there!