OptionPundit

Tag: Depression

  • 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.

  • Panic Before Everyone Else Does

    Market forecasting is one thing and profiting from it is altogether another thing. OPNewsletter subscribers know how accurate so far my warnings had been and I did panic before everyone else did but did I benefit by opening pure bearish trades? In the hindsight, I could have made a killing but did I? No! Sure it did help me in unloading my bullish positions though.

    In spite of having such an accurate forecast I couldn’t reap extra ordinary benefits from it. I thought through this and here is the part of my trading decision making. Bear markets tend to have quick and sharp rallies often ruining short sellers. Though I knew that a sell signal was triggered and I shared with OPN subscribers, I was conservative in relation to not entering the market with full fledged bearish positions. I have been thinking that any good news can move markets violently so not sure “when” will it crash. So I chose to be hedged with slightly bearish positions in stead of trading alongside bears. Results were mediocre at best in such a fast moving market, great for an option trader. Will I do better? I don’t think so for I don’t think I shall again take any large bet in such markets when rally/crash can happen in a jiffy so rather be safe than sorry.

    This brings me to an important point about trader’s psychology. A trader, not all, tends to compare the performance with respect to decision not taken in hindsight. If only I had picked up during intraday low of Oct 10th, or I knew markets are oversold and will reverse, etc and I could have made so much. And that’s a dangerous thought. Test yourself in the present moment, see what decision will you make in the current conditions, note it down and refer to it later no matter if you put real money for it or not.

    Moving to markets- Times Online reports as much as $100 bln was wiped off the value of hedge fund assets last month as investors rushed to withdraw their capital and the worst markets in living memory blew a giant hole in performance. Investors redeemed about $60 bln of funds in October, while see-sawing market conditions accounted for the remaining $40 bln fall, according to EurekaHedge, the Singapore based industry research firm.

    The news is getting gloomier day by day. China’s industrial output grew at a slower pace than any economist forecast in October, stoking concern that the biggest contributor to global growth is running out of steam. Germany is officially in recession. The O.E.C.D. forecast that gross domestic product for its 30 member countries would decline 0.3 percent in 2009 from 2008, before recovering slightly to grow by 1.5 percent in 2010.

    The Treasury Department on Wednesday officially abandoned the original strategy behind its $700 billion effort to rescue the financial system, as administration officials acknowledged that banks and financial institutions were as unwilling as ever to lend to consumers. It is the worst possible scenario to have a “bad strategy” and an “excellent execution” and hence it’s fine to change strtaegy. But what kind of signals are we sending to the world? Are these assets so toxic? I guess it’s about the priorities for limited resources. I haven’t yet analyzed the magnitude of announcement, but Mr Market already spoke what it thinks of it (Don’t forget Mr Market is an emotional person). And see what’s happening now? It seems like everyone wants a pie of this bail-out money. Just show them grim picture, compare with great depression and consequences of not saving them, etc. You got what I mean. Confusion is reigning. TED spread rose yesterday, and so is the LIBOR spread.

    I shall repeat my latest reading of markets, I think, most likely, markets may NOT hold Oct lows. It might test the 2002 lows and oh BTW, I know even if my forecast is correct, I am not going to reap extraordinary profits from it. That’s my psychology. What’s yours?

    Profitable Trading, OP