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I own and operate an analytical services/ research company. Prior to this I was the Executive Director of Survey Research at the JD Power company.
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  • The Hedge Shack Part 2 22 comments
    Jul 7, 2011 7:49 PM | about stocks: DIG, DRR, POT, PSEC, ROM, RXL, SDOW, SDS, SPXU, UCC, UPW, USD, UXI, UYG, XME, XOM

     Welcome to the Hedge Shack

    The purpose of the Hedge Shack is to provide a place where counter-plays for the end of QE2 are identified, tracked, and discussed.

    * The QE2 Counter-Play:

    The end of Quantitative Easing Two (QE2) will occur at the end of June 2011. This article is designed to provide an area for focused discussions about the design of counter-plays for a potential sharp reduction in equity valuations.

    * Why would the end of QE2 cause a sharp reduction in equity valuation? In other words, how does QE2 work?

    Quantitative easing is a monetary policy used by the Fed to stimulate the US economy. The Fed buys government bonds and other financial assets with new money that the Fed creates (out of thin air), thus increasing the money supply and reserves of the banking system. This action raises the prices of the financial assets bought, which lowers their yield.

    As the Fed systematically purchases a substantial volume of long-term Treasury bonds and other financial assets (i.e., equities), large financial institutions (i.e., bondholders) shift their wealth into equities to achieve a higher return. In other words, the Fed's actions reduce risk in the equities market which makes equities a more sensible investment than bonds. So, simply put, the Fed puts large quantities of money into the markets, inflating the price of equities. Money follows money, and up the market goes.

    The resulting rise in equity prices increases household wealth, providing a boost to consumer spending. Figure One clearly demonstrates the effect of quantitative easing.

    Figure One

    click to enlarge

    Of course, a few data points do not constitute absolute proof that quantitative easing is causal to a stock-market rise, or that stock-market increases cause increases in consumer spending.

    However, the timing of the stock-market rise, and the lack of any other reason for a sharp rise in consumer spending, makes that chain of events look very plausible. Figure One shows us that shortly after QE1 was announced, the market free fall began to stabilize. After the QE1 program was expanded from 600b to 1.725 trillion, the market sharply reversed. When QE1 ended, the market once again reversed with about a 20% drop. That’s 200 S&P points (2,000 Dow points) over a two month time period.

    QE2 was then suggested, and the market reversed. At the moment of decision, the market hesitated, then QE2 was announced, and once again, the market sharply increased. The time line of these events is perhaps more clearly demonstrated in Figure Two.

    Figure Two

    Note that as the Fed buys Treasures, the yield stabilizes at about 3.5%. Figure Three demonstrates a clear association between the Fed purchases and commodity prices.

    Figure Three 

    * Consumer Spending and Increases in Share Prices:

    Note - the source for this section is based on a published interview with Martin Feldstein, Professor at Harvard.

    The magnitude of the relationship between the stock-market rise and increases in consumer spending also fit the data. Share ownership (including mutual funds) of American households totals approximately $17 trillion. So a 15% rise in share prices increased household wealth by about $2.5 trillion.

    Relationship Between Wealth and Consumer Spending:
    Historically, the association between wealth and consumer spending implies that each $100 of incremental wealth raises consumer spending by about four dollars, so $2.5 trillion of additional wealth would be expected to raise consumer spending by roughly $100 billion. That figure matches closely with a drop in household saving and the resulting increase in consumer spending.

    Since US households’ after-tax income totals $11.4 trillion, an one-percentage-point fall in the saving rate means a decline of saving and a corresponding rise in consumer spending of $114 billion – very close to the rise in consumer spending implied by the increased wealth that resulted from the gain in share prices.

    None of this appears to augur well for 2011. There is no reason to expect the stock market to keep rising at the rapid pace of 2010. Quantitative easing is scheduled to end in June 2011, and the Fed is not expected to continue its massive purchases of Treasury bonds after that.

    Without increases in stock-market wealth, will the savings rate continue to decline and the pace of consumer spending continue to rise more rapidly than GDP?

    Will the strong economic growth at the end of 2010 be enough to propel more spending by households and businesses in 2011, even though house prices continue to fall and the labor market remains weak? And does artificial support for the bond market and equities mean that we are looking at asset-price bubbles that may come to an end before the year is over?

    * The Hedge Shack:

    So what does the investor do? Based on what happened at the end of QE1, it appears we can anticipate a 15% to 20% drop in the overall market. Are their any market sectors that would provide safety?

    The following series of charts shows what happened to Oil and Gas, Technology, Semi-Conductors, Industries, Materials, Consumer Services, Utilities, Health Care, Metals and Mining, and gold during the period of time when QE1 ended and QE2 started.


    Figure Four:

    Figure Five

    Figure Six

    * Summary - Death Crosses!:

    Looking at the eleven sectors I charted, ten of the eleven exhibited a death cross (50 day MA drops below 200 day MA) after QE1 expired. Those death crosses converted to golden crosses (50 day MA crosses the 200 day MA from below) after QE2 started. As a result, the utilization of the gap between the 50 day MA and the 200 day MA should provide a rough estimate of the expected drop in equities when QE2 ends. In fact, since the market tends to lead predicted events, it would not be surprising to see the market start to drop in Mid May.

    The only chart that appeared to provide some degree of protection was gold. This was expected since the Fed is basically printing money during quantitative easing. As a result, the price of gold in US dollars would be expected to rise.

    * Speculative Pressure And The Precious Metals Hedge:

    Unfortunately, gold does not provide a level of absolute protection because its price can be actively manipulated by COMEX through modification of margin requirements - a strategy we are all too familiar with. It was because of this active manipulation and the special circumstances associated with silver that led me to not include a silver chart. Interference in the precious metals market by COMEX adds another unknown variable into the equation. The latter raises questions as to what forces are actually in play with respect to COMEX actions.

    By the way, what does a coming margin hike look like? One of the main things professional traders watch for are daily price fluctuations. A big spread between a day’s highs and lows may be a sign the exchange is about to step in with higher margin standards.

    * A US Dollar Hedge:

    I was interested in whether investments in the US dollar might serve as one kind of hedge play. Figure Seven demonstrates what happened to three different kinds of US dollar hedge plays. Clearly, investments in the dollar did indeed increase at the end of QE1. Those increases appear to have been anticipated by four months prior to the end of QE1. A close examination of Figure Seven reveals that the US dollar plays have all started to increase at the start of May.

    It appears that the double leverage US dollar (MUTF:RYSDX) might be one of the better hedges against the end of QE2. However, caution is advised. The currency markets appear to be quite sensitive to anticipated moves by the Fed. I suggest this is the reason why the US dollar investments started to decline three months before the end of QE1.

    Figure Seven

    Figure Eight demonstrates that leveraged general market shorts appear to be a good way to hedge the end of quantitative easing. However, notice the high degree of variability present. Is this due to investors looking at the technical charts, or is something else happening? If a leveraged market short is used, the investor needs to be cautious.

    Figure Eight

    In Figure Nine, I looked at a few individual stocks. I will add more of these as requested. The first surprise was the performance of PSEC, a high yield return financial stock. I suppose I should not have been surprised given the performance of the Financial Sector. PSEC's valuation not only decreased by nearly one-third, its yield dropped by 13.3%. So high yield stocks are not necessarily a good hedge. PSEC's high yield at 15% has not recovered to this day.

    While the oil and gas sector dropped by 37.5%, XOM dropped by about half of that (16.4%). It's likely that more speculative oil and gas holdings (i.e., high beta) suffer larger drops. If anyone is interested in that issue, I will look into it.

    POT dropped by 34.9%. I was interested in POT because I wanted to see if a special catalyst (i.e. acquisition attempt) would override the loss of quantitative easing effect. The answer is a resounding yes. So special catalysts can still move the needle substantially even if the general market is falling.

    Figure Nine

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Comments (22)
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  • FocalPoint Analytics
    , contributor
    Comments (6282) | Send Message
    Author’s reply » THIS IS PART TWO OF THE HEDGE SHACK.....
    7 Jul 2011, 07:53 PM Reply Like
  • Mayascribe
    , contributor
    Comments (11198) | Send Message
    Thanks for starting up a new thread, FPA. It was taking forever to load.


    Don't want to be "anal" 'bout things, but did you check your Instablog's title? Gave me quite the chuckle!
    7 Jul 2011, 08:12 PM Reply Like
  • thistimeitsforreal
    , contributor
    Comments (442) | Send Message
    First, there is no need to have any concerns regarding attacks from this writer. I had a nice exchange of emails with two members and one editor and feel content that I have made my points and am anxious to move forward with market discussion. I appreciate any replies either in the forum or via email and hereby promise to end negative references to other members. That is not to say I won't question other opinions or picks but there will be no more direct attacks on anyone. I think that is fair and of course if you choose not to reply to my posts and/or questions, that is fine too. I am placing this posts in a few forums so all will note that the effort to move forward with the correct demeanor has been established at approx 10pm Eastern.
    Now, with that said, my first post moving forward....


    As people look to why the market hasn't fallen as expected after the expiration of QE2, I, the eternal optimist am looking for reasons why the market stays strong and where it may go from here. In Yahoo finance today there was an article that cited three reasons the markets were up despite continuing debt crises. Those three were…


    (1) Initial jobless claims report. According to today’s report, initial jobless claims fell 14,000 last week. Also released today was Automatic Data Processing’s June jobs survey , which found that 157,000 private-sector jobs were created last month, well above expectations.


    (2) Also released today was Automatic Data Processing’s June jobs survey , which found that 157,000 private-sector jobs were created last month, well above expectations.


    (3) Retail. Same-store sales were up in June, pushing the S&P Retail Index up 2.36% today.


    OK, so all that is great and I understand why these three factors help the market stay on an upward trend. What I don't understand is when does this good news expire??? In other words…
    (a) was the market up just today due to the news and that's it? … or
    (b) will this news carry the market for a few days, even into next week? or
    (c) will this news help keep the market going strong until stronger negative news overshadows it?
    7 Jul 2011, 09:52 PM Reply Like
  • H. T. Love
    , contributor
    Comments (19538) | Send Message
    FocalPoint Anal...'s Instablog


    Got to get SA to do something about the way that title appears! :-))


    'Course, for a professional researcher maybe it's appropriate? ;-))


    Maybe it's just my zoom level?


    8 Jul 2011, 06:35 AM Reply Like
  • acehart
    , contributor
    Comments (1795) | Send Message
    New jobs were anemic. I am calling for a depression rather than a recession. THE govt is out of bullets, street handlers are out in force in NYC....MEANING the windshield wipers negging for money, No one expected these numbers , no one...get prepared for that big correction


    8 Jul 2011, 08:44 AM Reply Like
  • Freya
    , contributor
    Comments (3369) | Send Message
    I track the SDS and SPY,


    SPY intrigues me the most because the Short Interest in it is almost, drum roll, 53%.


    Is it possible that the Market will accomodate this much pessimism?
    8 Jul 2011, 08:51 AM Reply Like
  • thistimeitsforreal
    , contributor
    Comments (442) | Send Message
    SDS! Forgot about that one. Seems like a good play today. Thanks for reminding me. Going to watch and see where it goes early.
    8 Jul 2011, 08:53 AM Reply Like
  • tripleblack
    , contributor
    Comments (13581) | Send Message
    Thanks for the new insta. You are a prince among rodents, sir!
    8 Jul 2011, 09:09 AM Reply Like
  • robert.b.ferguson
    , contributor
    Comments (10491) | Send Message
    Greetings all. Things may well start to get interesting next week say around WED. No real data yet just a hunch based on prior behavior. Freya is spot on regarding short activity. When the retrenchment starts which the shorts appear to be banking on they may well start hammering. PPT will undoubtedly swing into action like o'l Spidy but that may be touch and go as well. Things could get mighty rough by Friday.
    8 Jul 2011, 12:18 PM Reply Like
  • FocalPoint Analytics
    , contributor
    Comments (6282) | Send Message
    Author’s reply » This is a copy of a comment I made in the Hedge Shack Article. The issue of the debt ceiling is coming to a head, and given that this was at the end of the article, it was difficult to access... So here it is again.


    Prepare For A Surge Of Treasury Issuance As Soon As The Debt Ceiling Is Lifted From: Zero Hedge, by: Tyler Durden


    Basically when and if the debt ceiling is lifted, the Treasury will not only have to issue as much debt as before, but it will have to issue massively more in order to prefund the retirement accounts it has been plundering for the past 6 months. That debt will have to be re-paid in short term after the debt ceiling is lifted.


    As the chart in the article shows, since May 16, the cumulative deficit between where total debt is and where it should be is currently $265 billion! [That's 48% of the size of QE2 - 600b - that is going to hit the markets when the debt ceiling increase is approved in August/ September].


    One reason for the collapse in total debt in addition to retirement fund "disinvestment" [plundering] is that the Treasury has not been rolling its Bill maturities. On top of this, tax withholdings have recently dropped substantially, which means that even more debt will have to be funded through debt issuance. So the total debt in the second half of 2011 will likely exhibit a dramatic pick up in total issuance as Geithner scrambles to fund operations.
    If the Fed does not buy the debt, than the yield has to go up. At that point we start the march towards götterdämmerung. So what is the Fed going to have to do?
    10 Jul 2011, 03:19 PM Reply Like
  • tripleblack
    , contributor
    Comments (13581) | Send Message
    Doing some scratching on my notepad, I come up with a .5% increase (essentially from 0.0 and 0.25% now to 0.5% and 0.75% then). This may do a lot less damage than artificially low interest rates have done.


    BUT the key will be the steps I expect to see toward turning the 2Bigs BACK into banks again. Shut down the $carry trade, stop paying the 2Bigs interest for their reserves, and cut out the zirp freebies...


    Good Lord! The banks will have to start doing, well, BANK stuff to earn a living.


    Traumatic, I know, but it had to happen someday.


    Of course, this will also mean that the sleight of hand financing deficits with insanely low interest overhead will also be revealed as the moonbeam crack cocaine it really is. All this pathetic fals-angst over cutting a few tenths of a percentage point from the bloated Federal budget will be a laugh when they need to carve out about 2% off the top just to handle debt interest increases.
    10 Jul 2011, 03:36 PM Reply Like
  • tripleblack
    , contributor
    Comments (13581) | Send Message


    Is this a leading indicator of things to come? We all know the quants hide "real" volume, but GS and the other 2Bigs seem to be dropping their payouts quite a bit...
    10 Jul 2011, 05:16 PM Reply Like
  • robert.b.ferguson
    , contributor
    Comments (10491) | Send Message
    Justification for extending unemployment insurance benefits yet again. Probably a segue for QE3 as well.
    11 Jul 2011, 10:25 AM Reply Like
  • tripleblack
    , contributor
    Comments (13581) | Send Message
    I've mentioned my theory that we would see 2 weeks of pretty good markets following the end of QE2 assuming we follow the same formula set when QE1 ended.


    I was looking back over this data, and rather than re-invent the wheel, found this SA article which has a good chart showing the concept:



    Once again, we see a similar pattern, and with today's action, perhaps the initial shock as we get a sharp downdraft.


    Last time this was followed with a fairly strong, but very transitory, recovery, then the long fall...


    I cannot identify the precise reason for this, but its something to keep in mind, I think, as we go forward.
    11 Jul 2011, 05:26 PM Reply Like
  • Joseph L. Shaefer
    , contributor
    Comments (1744) | Send Message
    Pursuant to the stated goal of this Insta, seeking ideas for how to hedge post QEII, today I...


    Purchased PSEC @ 9.70


    Bought/wrote AGQ and AGQ Jan 2013 250s @ net debit $148. (For those not used to options, effectively bought the stock at $218, wrote the calls at $70. Possible outcomes: profitable anywhere between AGQ price of $148xx and $317xx, with maximum profit @ AGQ $249.99 / diminishes to near zero at the margins. Lost opportunity w AGQ above $318 / loss on AGQ beginning @ $148 and anywhere south...
    18 Jul 2011, 04:07 PM Reply Like
  • tripleblack
    , contributor
    Comments (13581) | Send Message
    Thanks Joseph. Several of us have been adding PSEC at these prices, too...
    18 Jul 2011, 04:14 PM Reply Like
  • FocalPoint Analytics
    , contributor
    Comments (6282) | Send Message
    Author’s reply »


    Signals are starting to get quite conspicuous. I use (PSEC) as one of my canaries in the coal mine. It established its' anticipated death cross a few days ago. It closed at $9.74 today, a drop from around $11.7 since QE2 ended in June (16.7% down). I see it going to between $9 and $9.4. The dividend is now over 12%.


    Will the annual dividend return ($1.22) be safe if the price drops further? This is the key question since if you bought it today at $9.74, and held it for a year; you would still make money on the stock even if it dropped to $8.52 (9.74 - 1.22 = 8.52).


    This is the big advantage to large dividend stock investing when you anticipate a systematic market drop. You would actually have a bit more cushion if you reinvested your dividends back into PSEC. So I see buying now as a safe play (meaning its unlikely to be a money looser). I intend to start accumulating PSEC with 50% of my total position at 9.4. I will probably be doing some simulations of the break-even point given certain reductions in the dividend return. Let me know if anyone is interested in seeing results like that.


    Things are starting to look particularly unstable in Europe as their financials cross the event horizon. It appears they have painted themselves into a corner with the rating agencies. B of A reported that they felt European financials are starting to look attractive - right! The old pump and dump play.


    The S&P 50-day MA has gone from a line of support to a line of resistance. This reestablishes the 50 to 200 day MA channel.
    18 Jul 2011, 07:09 PM Reply Like
  • tripleblack
    , contributor
    Comments (13581) | Send Message
    Europe's recent move to place a larger chunk of their financial system under government means that the next step toward nationalization of their major banks is about due (and will leave them even less room before they can no longer even pretend they are part of a "free market").


    The ECB is notoriously over-exposed to sovereign debt risk, so I would expect to see a formal move to cover much of this exposure soon. I won't try to predict how this will be accomplished, there are many ways to do this, but I will say that WHEN it is done, it will be a clear deliniator of a major line being crossed...


    Investment-wise I expect the move to be hailed as "wise governance", but I believe it will also mark a major recognition of the large underlying risk, and the likelihood of continuing erosion.


    So, short term tradable to the upside, long term tradable to the downside. (Another QE story, with a different spin to suit the European taste).
    19 Jul 2011, 01:42 AM Reply Like
  • robert.b.ferguson
    , contributor
    Comments (10491) | Send Message
    ECD governor Nowotney has changed his mind (Or lost it.) saying a short term Greek default won't be so bad. Does this set the proverbial stage for other dominoes in the group of PHIIGS to default as well? Something else that is troublesome at the very least is that the market doesn't seem to have priced in a U.S. default. Mr. Market seems to expect a deal.
    19 Jul 2011, 09:48 AM Reply Like
  • acehart
    , contributor
    Comments (1795) | Send Message


    BrotherJohnF has posted an excellent video that shows just how removed from reality the COMEX silver market is. He shows that in just one minute 50,000 contracts were traded on the COMEX silver market. That calculates out to 250M ounces of paper silver or $10B worth of physical silver. IN ONE MINUTE! You can see his video here:
    Silver Update 71811 Caught in the act


    Wow! That's a lot of silver. Brother John claims that these contracts were "dumped" on the market but I think that is highly doubtful. Who took the other end of those trades? Surely someone was not laying in wait for $10B worth of paper silver in that very minute.


    What seems more likely is that this was a computer driven price manipulation carried out by members of the banking cabal (JPM? EWT? UBS?) trading back and forth to each other in order to SET the price at a lower level before things got really ugly with the debt ceiling debate. Computers trading back and forth to each other at such high volumes as to destroy true price discovery.


    Sick, isn't it?


    The good news is that it exposes, once again, that the silver manipulation is alive and well and there will be no FREE MARKETS in silver until the computers are turned off...for good!


    Silver has already jumped back above $40 because they can't keep up this scam forever.
    21 Jul 2011, 12:29 AM Reply Like
  • H. T. Love
    , contributor
    Comments (19538) | Send Message
    Good information. I wonder what effect a COMEX default would have outside the metals market.


    Is there a relationship to the LME?


    More interesting would be the follow-on investigations that *might* expose some of our "favorite people" as the perpetrators of the scam ... maybe to try and keep "real money" down so fiat money doesn't tank as quickly?


    21 Jul 2011, 06:19 AM Reply Like
  • acehart
    , contributor
    Comments (1795) | Send Message
    Boy, is this govt, a joke. It is embarrassing that it is coming down to the 11th hour. Personally i believe now nothing much will get done, Sure they will raise the ceiling but in my humble opinion the floor just fell out on our country !!!


    22 Jul 2011, 09:51 PM Reply Like
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