Buy, Hold, Or Fold?

As we sit at consolidation levels around 1,000 on the S&P 500, we are witnessing the critical nexus point of a binary event waiting to happen.

As we sit at consolidation levels around 1,000 on the S&P 500, we are witnessing the critical nexus point of a binary event waiting to happen...

It seems that every single trading session bares witness to commentators and analysts on the financial news infomercials promulgating this idea of retesting the market bottom in order to validate the run to the upside. Perhaps, it highlights the conversation as a major benchmark and level of theoretical risk to the downside. Market memory, anniversaries and the unknown will always cause varying degrees of consternation that provokes one to question reflections seen in the rearview mirror. However, there are so many traders that have missed capturing the upside and full potential move off the lows that a viral contagion of sour grapes has spread in hopes that the market will sell off, simply to allow a safe entry point or second chance “once in a lifetime opportunity” for all those that missed the move to begin with.

There is an interesting trade that has presented itself by utilizing both FAS and FAZ in combination, the Direxion 3x triple leveraged financial bull and bear ETFs. I thought I might share my thoughts on the application of this particular trade as primarily a hedging instrument and, secondarily, a speculative position.

Usually, pairs trades are sophisticated techniques applied by professional money managers, quant and hedge funds. They rarely justify the risk for retail traders because it will require you to be both long and short two corresponding positions with the intention to offset and neutralize risk. The problem is that what may be initially viewed as a balanced hedge, can ultimately force a nasty unwinding of the positions when both sides of the trade move against you. Disruptions and price dislocations in the marketplace, or the collapsing of risk arbitrage because of what seemed like a sure bet fell apart when the buyer walked away due to “material adverse change.”

The media and talking puppet heads have wrongly characterized AIG as the poster child for the mysterious black hole that TARP funds have been dumped into with bailout money. I’m glad that some Congressional leaders finally stepped up to ask the correct questions and apply enough political pressure to force CEO Liddy’s hand and reveal who the actual recipients were on the back end of the pipeline called AIG.

Like a confidence game of three card monte, approximately 180 billion dollars in taxpayer funded TARP money has vanished before our eyes in a delicate maneuver and sleight of hand.

While media will tilt their camera lenses toward retail shopping on Black Friday to kick off the beginning of the Christmas holiday and the deep seasonal price tag discounts, you might actually witness better bargains in this stock market that will have lasting benefits long after the gift wrapping finds itself crumpled in the trash can and the discarded remnants of decorated evergreen trees litter the yard.

It was recently reported that nearly 20% of the S&P 500 was comprised of stocks trading below $10.00 per share. That is incredible to think how far and how fast this market has declined in a matter of months. It’s no big secret at this point that the market has been oversold and we continue to be in the process of formulating a bottom. There is tremendous value in the markets across all sectors as long as you don’t believe we are headed into financial Armageddon, in which case, no one profits up or down from a disastrous doomsday scenario.

Congratulations, Barack Obama on your Presidential victory. Thank you for restoring our trust and belief that votes do matter. Democracy is alive and well.

Having said that, put the party hats away and the champagne on ice, because America is in for a sober awakening. It is clear that the incoming Obama administration must not wait until the traditional inaugural swearing into office to put a mandate forward. Our country’s economy cannot afford the luxury of a post-election honeymoon period and extended jubilance or celebratory cheer.

“Buy American. I am.” To quote Warren Buffett’s opinion piece published recently in the New York Times.

Warren Buffett appears to be quite a decent man and, perhaps, his most admirable quality demonstrated in recent years is his personal charity underscored by a deep sense of humility. He certainly doesn’t live the lifestyle of most multi-millionaires and billionaire investors that tend to be far more flamboyant, if not entirely pretentious by recklessly self-indulgent, decadent behavior.

We all know and heard of the tired analogy “don’t try to catch a falling knife” to describe the temptation of jumping into a declining market. There are certainly too many analysts or money managers that have been completely eviscerated and butchered by calling the bottom prematurely in the financials and housing market since fall of 2007. Don’t like playing with knives? Here’s a better analogy to use instead of the requisite kitchen cutlery.

Remember when you were a kid and your smart-ass uncle would wave a dollar in front of you and say: “If you can catch the dollar as it falls between your fingers, it’s yours.”

The 60 plus trillion dollar nightmare of the CDS (Credit Default Swaps) market is a dangerous anomaly of the tail wagging the dog, pushing risk premium higher against a downward spiral of collapsing market capitalization and lowered credit ratings for corporate debt.

Imagine, 60 plus trillion dollars in total existing liabilities in the unregulated OTC (Over-The-Counter) market of Credit Default Swaps means that our government, in fact, all governments interconnected in the global economy could not possibly “bail out” that entire amount if ever forced to claim. That’s more than the entire world’s GDP combined!

Treasury Secretary Hank Paulson and Fed Reserve Chairman Ben Bernanke went all in by putting chips on the table. When this measure was proposed, the markets reflected the notable expectation by “banking in the numbers” ahead of the legislation’s passage. This is a dangerous way to play a poker hand because there is absolutely no room for error, and it becomes an all or nothing gamble with people’s pension funds, retirement accounts, IRA’s, 401k’s, money markets, and savings accounts on the line.

Now, I fully support the Paulson plan, but it was a weak hand to play from the onset, mostly because the success and failure depended exclusively on Congress to pass legislative action. And such preconditions ultimately mean you are not in control of your own destiny. We saw “the flop” last week in the first wave of capitulation and the political muddling that occurred as a result of too many cooks in the kitchen. Monday’s reaction saw “the turn” as the House Congressional members were unable to pass the desperately needed legislation.

THE $700 BILLION DOLLAR DISCONNECT

There is a serious, fundamental disconnect between the reality and the perception of the Hank Paulson plan. Treasury Secretary Paulson, whom I admire along with Chairman Ben Bernanke, are not politicians. Make no mistake about it, their stature is enormous, but their ability to “sell policy” like a used car salesman to the public is second-rate at best. By comparison, Congressional leaders who stay in perpetual office by peddling themselves every election year on empty rhetoric, are much more able to convey sentiment but often fail in delivering real solutions.

I cannot believe that commentators and media analysts alike, one after the other, are publicly professing outrage over the new short selling restrictions recently implemented by the SEC emergency action. They smirk and seem to take great pleasure at pointing to the 300 plus, nearly 400 point sell off on Monday, and the follow through on Tuesday’s trading sessions as proof and example that short selling restrictions don’t work. Really?

You don’t mean to say that you actually believe that by removing the ability to short stocks, the market couldn’t trade down, did you? Because if you did, then none of these so-called “experts” even deserve to have the pulpit or mouthpiece to speak with any measure that is credible beyond a bedtime fairytale.

WHERE THERE’S SMOKE, THERE’S FIRE

I thought it would be interesting to give a personal account of the events that transpired last week. Normally, I would tend to write more objective and less introspective articles, but these were abnormal deviations from anything seen before and, from my own perspective, it would be a way of venting the intense anxiety and stress levels that built up during the course of monumental and historic volatility. Even my own experiences didn’t prepare me for the intensity that I felt during these extreme volatile rides in the markets. The portfolio that I manage was stress tested to the maximum inflection point. And a feeling very unnatural and discomforting was settling in, a feeling that things were beyond what I could control and that the disastrous spiral of deleveraging was unwinding at an accelerated rate of speed, as if you were tethered to the end of a bungee cord without any elasticity left in it to bounce back and recover.

Too Big to Fail

I've said this before and I'll say it again, students of economics will study these moments in time as we are witnessing history. Unprecedented volatility in the markets and a very dangerous deleveraging process that continues to erode equity, wiping assets clean from once lofty secure valuations to now, what could be characterized as, nearly worthless confetti run through the office shredder. I'm not sure what's cheaper anymore, shares of Lehman, Freddie, Fannie, or a wholesale bundle of toilet paper at your local Costco.

NAVIGATING THE CREDIT CRISIS

The current credit crisis and liquidity crunch has made even the professional investors balk on calling a bottom. One stomach churning event after another has proven the most optimistic analysts to not only be wrong, but little more than contrarian indicators.

GOING FOR GOLD

What an event and what a show it was in celebration of the Olympics in Beijing, China. This was a peaceful event that transpired amid turbulent times for the entire world to share and participate in what seemed, by all measurable accounts, the public coming-out party that lived up to the hype and far exceeded what most imagined.

Unquestionably, it was the most spectacular opening ceremony to kick things off in the, aptly named, “bird’s nest” stadium that featured artistic and mirror-like precision, synchronized to choreography that was truly daunting and pushing the standard well beyond the usual tedious fare of sleep inducing inaugural ceremonies that normally play out as little more than gratuitous parades of mascots for the host country. This Olympic event was truly one to watch and the best that most people have ever witnessed in history.