OptionPundit

Tag: deflation

  • Another Bubble In the Making

    In recent past, we have gone through a lot of bubbles; Dot.com, Property, Housing, Free money (aka Credit) led boom, Commodities and Shipping to name a few. The interesting thing is that when something goes up, we think that there is a perpetual fuel inside the rocket that will continue to lift it forever. And when it start to lick dust, we think of those “rockets” as poor pigeons waiting to be adopted, if ever. But what goes “abnormally up” has to come down to follow its natural path. Here is another bubble, if I may say so-

    Few weeks back the FED established a new target range for the federal funds rate of 0 to 0.25% and also hinted on buying long-term treasuries. I think treasury bond prices have been pushed to similar bubble patterns as it was in commodities, or Tech. Well I am not going to put fancy charts to explain that but look at the attached two simple charts, one for Crude Oil and another one for the 30 year treasuries. Crude oil is generall more speculative, and Treasuries in a way should be rather less speculative due to their fixed and known payments but the exponential rise without correction raises concerns.

    First some theoretical perspective-
    30 Yr Bonds- Suppose you buy a 30-year Treasury bond at today’s market price — it yields 2.60%. That means for every $100 you invest, you get $2.60 each year in interest for 30 years. Such lowly yields represent the case of “Deflation” or call it fear of “Depression” that many are comparing the current crisis with. 2.6%! Not a wonderful returns, but at least it’s safe — isn’t it?

    Who would sell such a miserable investment? The US government and why won’t they when there are plenty of buyers (currently). And who was/is buying it? The Foreign holders funding US consumption and now also the generally scared investing public that would like to safeguard the money (aka The Dollar) expecting to get back at least the same dollar amount (it’s different story that by that time, the dollar bill may not be of the same value)

    Here are key points to note-

    • Upcoming inflation (may not be so soon though)! The same thing for which Fed is fighting for and is literally throwing money from helicopters. Central Bankers as well as government around the world are fighting in a co-ordinated effort to win over deflation and this “almost free money” will start to show results via inflation sometimes late 2009 or early to mid 2010 bringing real returns of 30-Yrs into negative territory and when combined with taxes, treasuries at current prices/yields doesn’t really spell for excellent long term investment.
    • Why did the yield drop so much in such a short time? Because the money has been parked into safe-heaven for general investing class and foreign holders have been buying treasuries to keep $$ high and fuel US consumption. Now the big treasury buyers themselves are finding low growth/recession in their own lands as well as they know they are facing probable losses either due to a) lower yields or b) lower value dollar. The US govt will have tough time to source more “foreign capital” without offering competitive yields which essentially means lower prices.
    • As the markets starts to stabilize, fund managers, money managers, retail investors will probably be taking out money from treasuries so as “not to miss” the recovery in other “riskier” classes aka stock market or other higher yielding but relatively riskier grade bonds.

    Albeit, the Yield may go even lower from they are today, but for the above key reasons, I am beginning to be bearish on long term US treasuries. And for my bearish positions to be fruitful, money just has to flow out of treasuries. I don’t really have to bother which asset class it goes to as long as it leaves treasuries.

    Just like other bubbles, I don’t know “WHEN” will it burst and therefore I am keeping my plans to hold, if needed, for rather a relatively longer time frame. If anything happens before that, that’s a bonus. If you do decide to follow this philosophy, pls do you due diligence and also make a habit to hedge your positions, so you have a chance to preserve capital even if you are wrong.

    There are lots of ways to short Treasury bonds. You can do it directly, by selling actual securities short. Or you can short shares of a convenient exchange traded fund — the iShares Barclays 20+ Year Treasury Bond Fund (TLT). Or you can short Treasury futures contracts — or sell calls (or buy puts) on Treasury futures contracts.

    • Here are some underlying which are optionable -TLT, IEF, SHY, BIL, ITE, TLO, TBT
    • Here are some underlying which are not optionable-TLH, IEI, SHV, PLW, PST, EDV

    There are two mutual funds designed to go up when Treasury bonds go down — the Rydex Juno Fund (RYJUX) or the Rising Rates Opportunity ProFund (RRPIX), but these are not optionable.

    Those who are OPNewsletter subscriber, pls wait for my e-mail on the forum to know how I plan to play this.

    Disclaimer– As of this writing, I don’t have either long/short positions in US treasuries yet. I may get into one any time and change my view depending upon market action. Pls do your due dilligence before investing and keep a risk management plan in case the trade goes against your plan.

  • Too Good To be True, But It’s true

    Fed has cut the discount rate by 50 basis points to 1.75%, ECB also cut benchmark rates by 50 basis points from 4.25% to 3.75%; and the futures are up, triple digit (as of this writing). Here is a snapshot of what happened today in the Asian markets so far-

    • Japan’s Nikkei falls 9.4 pct in biggest decline since 1987
    • Hong Kong’s Hang Seng is down 8% inspite of Hong Kong slashing interest rates by a full 100 bps.
    • Singapore’s STI closed down 6.6%
    • India dropped 2.4%
    • China 3.5%

    Let’s see what this latest “rescue” brings to the table. Here is a snapshot of past key posts at OP. I hope these posts were able to add value to your browsing time.

    I am glad we were able to handle the 1st storm of the season. We were in cash and you knew my stand, specially if you were OPN’s subscriber and were following this thread. We are in 100% cash and can ride the bull when it emerges.

    Deflation is a common word these days, but OP mentioned deflation when we were almost in thick of “inflation” fears, commodity prices rising and there was no end at sight.

    Bailout plan, a monster relief and in normal times it could have taken markets to moon, well that’s what really happened but I was suspicious of the rally and 2nd time around when it was almost sured to pass, I also hinted that it maybe “Buy in anticipation and Sell on new”.

    Though I have shared about a lot of “potential bankrupts” since I started sovering subprime in Feb/March of 2007, called out Lehman was potential bankrupt and shared my comments about subsequent rallies.

    I don’t like Citibank and I shared my disappointments and as well as bearishness on Citibank. I am still bearish on Citibank.

    Few months back I had written my technical analysis about the general markets, a simple technical analysis and shared few important support levels (10, 697 for Dow and 1,172 for S&P 500). Once those gone, we should clear the way for bears. And since these two leaders broke those supports these are almost in the free fall.

    Also I warned that there was more pain ahead and I sincerely wanted to be wrong, but unfortunately it turned out to be almost right. Dow is down almost 1500 points since then and tons of money has been poured into the financial systems.

    Besides all these, I also shared Put Diagonal strategy for the down market. If done properly, Put diagonals on DIA or SPY could have multiplied money several times due to record IV gains since then and delta gains due to short in nature.

    And I mentioned my forecast of 8,000 or lower for Dow, also two days ago on the forum. At that time it seemed like a foolish forecast, now it doesn’t see too far. It remains to be seen if it’s it in deed going to happen. I don’t want it to come true. That’s very painful journey.

    I hope these added valuable sights and were worth your time. Pls do share your feedback what do you think of posts here at OP. 

    Preserve capital, OP

  • Is It a Bear Market or a Bull Market?

    What kind of market we are facing these days? One day it is up, but to give-up all the gains next day. 200-300points daily move seems like a norm for Dow Industrial. It is a good market for directional players, yet it is a bad market for directional player. Delta neutral seems a good idea but with such large moves, at one point or other, your adjustments might be triggered that will be useless the next day. Though it is volatile, the Option implied volatilities are not showing panic to that degree yet. Is it a slowdown, recession or deflation (Yes, I am talking about deflation not inflation).

    What’s going on? Is it a short-term correction in an on-going bull market or is it a primary bear market? It is a trillion dollar question and whoever thinks they have the answer may want to have a reality check.

    So far, smart funds have been selling into the rallies and I think until there is institutional buying there won’t be any sustained upward move in the markets. According to John of Hussman Funds, the US market is trading on theme that largely overlooks the potential of a significant US recession. At the point of recognition, we may very well observe abrupt weakness in both stock prices and the US dollar. He mentions a “Jaw of death” between USD 5-Year swaps spread and VIX, indicating that stock market is too comfortable with the situation and there is no panic while credit investors are very nervous. And be mindful though, the official arbiter of the recession decision-the NBER- has marked the economy’s peak publicly an average of 7months following each contract’s start which means we are in recession, will be declared when then meeting in few months time and markets may not like it. Read more.

    Liobor-OIS spreads are warning another round of trouble and based on market actions it doesn’t seem that’s it’s going to settle anytime before 1st half of 2010. Former Fed Chairman Alan Greenspan said in June’08 that this spread, which is the difference between the three-month London interbank offered rate for dollars and the overnight indexed swap rate, should serve as a measure for telling when markets have returned to normal. A narrowing to 25 basis points in the so-called Libor-OIS spread would be viewed as a positive, he said. Forward markets signal that won’t happen until sometime after June 2010. The premium averaged 11 basis points in the 10 years prior to August 2007. Read More.

    Linked to same topic, Caroline Baum of Bloomberg is questioning “Are bond investors crazy or waiting to exhale”? According to her, Inflation expectations are so weighted down that investors are buying 10-year Treasuries yielding 3.8 percent with inflation running at 5.6 percent and great de-leveraging might be unfolding. She is further examining that business are not able to pass all the costs to the consumers and hence margins are being squeezed.

    According to Investech, this is the worst performance (decline by >11%) of S&P500 since 1940s for any pre-election period (till mid-Aug) when S&p500 fell by 19.9% (isn’t there an existing belief, that markets have smooth sailing in he pre-election periods?).

    There is also data available that says markets rallies leading into the election months. So let’s see if we are going to see that. The summer season is almost over, big traders will be coming back to the market and it remains to be seen if volume will pick-up? and in which direction? Other bullish argument can be made that in spite of barrage of bad news, day after day markets haven’t fallen apart. It has been absorbing all the bad news.

    There is no one answer. I shall cover more on the bullish argument in the coming days, stay tuned.

    I covered options expiration here. I shared POT with OPN members. POT was pinned at $170 and some members made profits to the tune of >50% in few hours time. These are bonus trades to the OPNewsletter subscribers.

    Profitable trading, OP