Remarks on socialism

With the U.S. government taking a majority stake in banks, bossing around the auto industry, and floating the possibility of nationalized healthcare, there have been rumblings in the media that the U.S. is leaning toward socialism.

A new poll suggests that if there's merit to those arguments, many Americans wouldn't mind.

Only a slight majority of American adults believe capitalism is better than socialism, according to the latest Rasmussen Reports national telephone survey.

Asked whether capitalism or socialism is a better system, 53% of American adults cited capitalism, 20% said socialism and 27% said they weren't sure

Read more: http://www.nydailynews.com/news/politics/2009/04/09/2009-04-09_many_americans_prefer_socialism_to_capitalism_a_new_poll_finds.html#ixzz0EDOHbVRY&B

A little late posting this, but I expect this trend to accelerate. Paradoxically, I do not expect large redistribution programs despite the preference for socialism.

This is consistent with previous my analysis.

Add to short positions today

Add to 5% of NAV to SPY short positions at SPY $89.00 . This would increase the net short positions to 20% of NAV.

Edit: it did test the $89.00 level (and failed), but I'll add at $88.90 . (it did not retest). On Friday add 5% of NAV to SPY shorts if the index rises on the first hour

Edit2: it did go to $89.00 on the yahoo finance chart, but not on google finance. It only happened for about a minute. If I was pretending of running a hedge fund, it would not be possible to build large short position in that time frame.







I also regret putting on the sterling and possibly the copper shorts. (because I was too late) I do love silver though. In short, I think the preference for gold instead of silver as a store of value is irrational. Gold looks pretty, but the ~ 70:1 ratio of gold prices to silver prices is a very high premium for gold. Besides, there are too many gold bugs on seeking alpha and longing it seems to be more of an expression of libertarian political views than a smart investment decision. But I do think gold and silver will do relatively well. I could imagine scenarios for gold to fall though, and I will consider entering short positions in gold if it rises.





Let's say I shorted copper (let's say the contract matures in fall) at $2.05 per pound and that reverted to that today. Also, I screwed up on the timing on the sterling short. Let's say that I shorted it at $1.45 on 4/20 . I only regret the timing of the sterling short, but I think it would fall.



I am also bullish on Treasuries now (which are probably the most reviled financial instrument in Seeking Alpha), but I would not declare a position yet and will add to the German government bond long position if yields rise. I also will consider shorting oil at $58. I rather short USO instead of the actual futures... I love betting against retail investors and the contango of the oil futures stymie USO.

Edit3:

I've switched my view on shorting SPY... I thought it was near a sell-off and was currently supported by inexperienced short-term traders. Yes, that might be correct now, but it is likely this bear market rally would last a little longer. Now I expect good economic news (which will fuel the short-term traders too) and entice bigger money into this market. This would increase liquidity and make it seem to be more safe to be in equities. My long term position is based on discounting and general deflation: there is so much overcapacity (except in medicine and energy [in the long run]) which would lead to competition. The overcapacity and competition (globally) would lead to low returns on equity for many firms. It doesn't matter if consumer confidence is up on a given month, and I do expect those numbers to increase in the short-term. Other people will say that it is all clear and the institutions would start buying. My hypothesis of the short-term "traders" bailing causing a sell-off doesn't seem to be correct now. But, I do love the short position as I speculate those short-term "traders" have net long positions and I am taking the other side of those long positions. Those "traders" as an aggregate have to lose and they will give up when they realize that trading is zero-sum even though they correctly know what buy and hold doesn't work. (I have an elaborate model to explain that, and I might post this later if I have time to write that.) I do not have to bet against a single trade they make, but betting against the aggregate's net long positions seems to be a one-way bet; the difficulty is optimising the timing. In my previous blogs, I noted my motivation for going short was actually fear because the one-way trade seems irresistable and being late means missing it.

Also my discounting model is another fundamental reason for going short. Corporate debt, of course, should increase the discounting rate in equity valuation though because of the possibility of liquidation. Even if a company doesn't have any debt, the equity should be subject to a higher discounting rate because it is equity: unlike debt where one knows the duration and amount of payments as debt is often referred to "fixed-income" while earnings is more turbid. With higher discount rates increasing the equity risk premium and lower earnings due to competition and overcapacity, it seems that equities are still overvalued. I do have a thesis for when it isn't overvalued, and that is when the paradigm shift will change the perception of equities. Equities will be seen as yield instruments, not as growth instruments.

I do plan on adding to the short positions in a slower fashion, because shorting the broad equity market seems to have a good risk/reward. I might have added early, but I will add on Friday. This seems to be one of those trades (and it is so simple to say that broad equities will fall eventually) where one simply has to be pig. I still have my convictions though as the position is a long term one.

I might consider longing the SPDRs of consumer discretionary and consumer staples for a trade. I expect those to rally during the course of the bear market rally, while the "junk" financials (such as Citigroup) will sell-off again. I consider these "trades" as they are not congruent with my macro perspective. Maybe long XLY or XLP (discretionary/staples respectively)/short XLF would be a nice way to institute that view. Or I might go long XLY or XLP to hedge the short SPY trade. Big money is likely to long consumer staples in this environment.

Increasing short equity positions...

I want to build large net short positions... since the market opened upward. As we learned in January, market downturns can happen abruptly.

I said I only have approximately 5% of NAV in PBR and a 5% short position in SPY before. (The pair trade was a loss)

Now I want to increase my position to 20% short SPY. If it rallies further, I would short the even more volatile IWM (Russell 2000.) SPY is above 87.10 when I am writing this.

I will add tomorrow, and finish on Friday establishing a large short position if it continues to rise.

Expecting a rally today...

I am expecting a rally today, and it might extend until Friday. Financial news services explained that the market was slightly down this week because of the "Swine Flu Scare." Of course, that is somewhat true, and of course, I do not, and one should not base their valuation of securities only the immediate news. It might rally because they are not focused on that now.

Of course, I do not have enough conviction to declare a position (for this short term view), and I do not like very short-term trading.

The market is receiving its epiphany that the rally is an illusion. (In fact, it already has.) The market will dramatically plunge when market participants realize that they cannot profit from the rally. It seems that, paradoxically, low volatility might actually set off a downward plunge. It seems that the market doesn't have enough steam for it to even hit $89.50 SPY.

I am thinking about finally declaring a large directional short position on S&P 500 and the Russell 2000 on Friday. The motivation for this is personal fear, as I fear I might be too late in going short before the sell-offs begin. Again, I do not think it would hit $89.50 now, and when I wrote about that price for declaring a short position, I was feeling more bullish in the short term (1-2 weeks.) Instead of $89.50, it would be $87.00-$88.00 as the entry point as that seems to be resistance. Even if I am wrong, and it does break out to $91.00-$92.00, I still think it has a nice risk/reward profile at that level. In fact, those losses would probably make me even more bearish and actually make the position more irresistable since the losses do not falsify my discount rate views.

I am starting to have strong convictions about when this rally would end and at what price, I would not be conservative and use hedges. My declared positions were largely market neutral during the bear market rally although on March 12, I declared it was a bear market rally and decided to remove hedges. This rally happened too quickly, but it was forecastable in hindsight. When I started the real-time experiment, I was bearish (on the really long term on global equity markets (especially the US, and probably Europe)), but it was obvious to me that entering the short positions then (when the market was already beaten down and when everyone was already pessimistic) didn't have a good risk/reward. Declaring a short position now has a nice risk/reward if we compare it to the risk/reward of going short at the beginning of March because everyone is not bearish as some expect the rally to continue, and that there is some disagreement.

I decided to become market neutral, and the rally happened too quickly. (to reiterate.) On March 9, 2009, I think the S&P 500 rallied about 6%. It was too late for me to call the start of the bear market rally. I thought it might be possible for the market to continue to fall at that point, and resume the downward slide. It was only possible to know that it was a bear market rally in hindsight and it took me March 12 to do it.

Again the market has a zero-sum character. For example, the S&P 500 has rallied about 25% from its recent high on April 17 when compared to the March 09 low. Could one make a 25% profit from longing equity futures by holding them? (One could make more if one knows how to trade the volatility.) Yes, if you did so on Friday March 6? But most people who did expect a bear market rally either bought too early or too late so they would make less than the 25%. If they all bought at the same time, they would bid up the price so they people who bought later would have less upside since the price was already bid up. (This market of course is weird as it seems that people are worried about price instead of value, but in a bear market context, the bull market scenario is best represented in the dot-com bubble.) Again, the aphorism buy low sell high works and it can make some people rich, but it cannot make EVERYONE rich.

But, we are still in a positive sum game right since if one bought equity futures, one would still have a gain even if it would be less than 25%. So where are the losses in this zero-sum game? I would say that people who sold their stocks (or short sold stocks) when everyone was already pessimistic and fearful (and afraid of loss and wanted to protect themselves.) They forfeited upside volatility to eschew downside volatility. Also, they people who expect the bear market rally to continue or people who think the market would recover soon would also lose. Of course, the latter group is practically non-existent now, and it would seem that some short term traders who think the bear market rally would continue would loss to those who would sell because they switched their focus to the long term.

Short interest

I am going to post a few links about shorts:

http://www.fool.com/investing/general/2009/04/14/pity-the-short-seller-in-a-market-like-this.aspx (Pity the Short Seller)

http://greenlightadvisor.com/glablog/2009/04/18/stock-performance-based-on-short-interest/ (Stock Performance by Short Interest)

http://online.wsj.com/article/SB124060826688554161.html (Short selling falls)

http://online.wsj.com/article/SB123915041409099017.html (More investors say bye-bye to buy and hold)

http://online.wsj.com/article/SB123981155929121475.html (Great investors who survived the great depression)

http://macro-man.blogspot.com/2008/11/few-thoughts-on-banks.html (thoughts on banks: see charts)

In the exchanges' latest twice-a-month statistics, the number of short-selling positions at the NYSE not yet closed out, known as short interest, fell 2.9% in the period ended April 15. The positions stood at 15,703,379,301 shares from a revised 16,173,689,617 shares in the period ended March 31.

On Nasdaq, short interest fell 4.8% to 6,708,317,025 shares from 7,048,839,387 shares, over the same period.

Investors who short shares borrow and sell them, betting that share prices will fall and that they can buy them back at a lower price for return to the lender. Stocks also can be shorted for reasons other than bearish bets, including hedging strategies.

Marketwide, the short ratio, or the number of days' average volume represented by outstanding short positions, rose to 3.2 days from 3.1 days at the Nasdaq in late March.

The short ratio on the NYSE rose to 2.5 days from a revised 2.3 days during the same period. The Wall Street Journal uses average daily composite volume to calculate the short ratio.

And that graph...



I suppose a nice price to short SPY is at ~ 89.50. Reasoning??

Most people do agree with is a bear market rally, and of course, they are indeed correct. I think a majority of these people think the market has the potential to go up to SPY 95.00 or maybe 100.00. However, with game theory considerations, I would not think it would reach that price if it hits ~90.00 .

First, we should consider the players in the market, and that the market has a zero-sum character to it. (No, I am not interested in academic discussions that the market helps firms raise capital by issuing equity stakes, or futures markets allow producers to hedge...). In other words, one gains the market comes at another person's financial loss, or by others paying an opportunity cost. For example, a producer who wishes to hedges in a futures exchanges pays the opportunity cost of forfeiting the upside of higher prices for the commodity he/she sells. The hedger does not loss any money because he could actually deliver the commodity and cover the liability even if the short position increases in monetary value. If it is speculator vs. speculator, the speculator selling short losses to the speculator who took the long position if the commodity rises when he buys back the position at the maturity of the contract. In the stock market, one who sells a share of GOOG forfeits potential capital gains (it doesn't pay a dividend) if the price of Google stock rises. The person selling the stock does not lose any money if Google rises as he doesn't have to take on a liability by shorting Google to sell it, but he does pay an opportunity cost if he sells the shares and receives the market price for it.

Now, who are the major players in the market?

Short-term traders (let's assume the WSJ characterizes them in the aforementioned link/ they are novice and should not be confused with speculators who do have information edges, have control of their emotions, and experience.)
Quants
Long-term institutions (hedge funds, wealthy people)
Unsophisticated long-term investors (e.g. people with pension funds, and who watch CNBC)

Let's assume that the prognosticators are correct and that SPY is going to rally to $95.00. The assumption is fairly reasonably, as $95.00 is approximately the 200 day exponential moving average of SPY. If it does hit $89.50, and goes to $95.00, one would have a six percent gain.

I choose $89.50 instead of $90.00 because there is a chance that it would sell-off at $90.00 or when it approaches that number. I would add to the short if it goes to $92.00-93.00.

Quants typically do not go into a large net-long position as they often hedge their positions, and they might turn down their trading volume, which would lower liquidity in this market. Also, since quants are large, they do not have an incentive to go for a potential 6% gain by increasing their net-long position.

Long-term institutions would not be tempted by a 6% gain by being long the stock market. They might try to hedge and outperform by correctly picking stocks since they have superior informed to short-term traders and long term investors. Also, since they have enough capital to hold large positions, holding large positions based on short-term forecasts is not a good idea in a relatively illiquid market. The dividend yield (currently 3.27%) does not compensate for the potential downward volatility.

Regarding the latter, they are too afraid to put their money in the market and a potential 6% gain would not offer a nice risk-reward in the short-term. Furthermore, trading should be difficult by definition, not everyone can could get wealthy in the stock market. Not everyone can follow a forecast that says the bear market could end at SPY 95.00 and sell (or short sell) then because of the zero-sum nature of the market. Whose going to be the idiot that buys when SPY is at $95.00? Essentially, they are receiving the dividend yield of SPY (there could be dividend cuts) and they would be assuming the risk of price change in S&P. Of course, most individuals do not purchase indices, but it is a nice approximation of the net actions of market participants. Again, someone has to loose.

Regarding short-term traders, they do not have an information edge for holding stocks in the long run. They have high discount rates and if there isn't enough momentum (i.e. an influx of cash in stocks), they would liquidate their positions as their positions as they are risky-short term trades. By definition, they do not hold positions for the long run, and a 3% dividend wouldn't be attractive. These short term trades are much like ponzi-schemes; for example, they usually do not buy Citigroup shares because they think companies' equity has any intrinsic value, but because they could sell those shares at a higher prices. Those trades might be vindicated in the long run, but again, they do not have the capability to analyze securities in that fashion. If they are not compensated by high short-term returns, they would just liquidate long positions, and stop-loss orders on positions would lead to a contraction of liquidity and lower prices in a positive feedback fashion. Of course, it is possible that some short-term traders would put in money in the stock market because they are not primarily motivated by financial gain, and trade for other reasons. In other words, they would have an above average risk tolerance, and accept a negative expected value. However, there must be enough of these type of traders to bid it up.

Assuming no other players in the equity market, such as institutions and long term investors, the trading activity of quants and short-term traders is zero-sum. It is a reasonable assumption to presume Ph.Ds who understand partial derivatives and linear algebra would formulate models to defeat the short-term traders (and generate "alpha"), but ironically, they were defeated by the short-term speculators who longed financials and consumer discretionary when the bear market rally became an established trend, and had to cover their corresponding shorts. Of course, most short-term traders are unsophisticated and cannot short. See this entry from Zero Hedge about the failure (for now) of the quants.

Since short-interest is down, it seems that this would not be fuel for a rally. And besides, if going long doesn't have a good risk/reward profile because if it goes to $95.00, you only make 6% if you buy at $89.50, and you have to deal with the potential for loss such as a retest of the March lows. Conversely, a short position is the enantiomer (a chemistry term, if you do not get it, just replace that with "mirror image") of a long position: if one is short, one risks a 6% loss, but one might be rewarded with a retest of the March lows. Perhaps, the $95.00 for SPY in a bear market rally would be a self-fulfilling view, but game theory considerations argue against it.

My short-term considerations show that short SPY $89.50 has a nice risk-reward. Longer term makes it even better. For example, I'll quote from this Wall Street Journal article:

All it took was the 100 shares in American Telephone & Telegraph that his grandmother owned to improve his family's experience of the 1930s. Schloss's parents, brother, sister and grandmother all shared a three-bedroom apartment on the Upper West Side of Manhattan, where horse-drawn wagons still delivered milk and the ice truck came by weekly. AT&T's annual dividend of $9 a share went a long way at a time when median rents in that neighborhood were $32 a month. Back then, Schloss says, a dividend was the primary reason "regular" folks invested in the stock market.

In other words, stock were not trading vehicles nor did people expect to profit from capital gains. I expect this would repeat.





In other blog entries, I argued that I expect the market to further fall because of high discount rates by market participants in financial markets. These high discount rates are caused by ignorance and incompetence (i.e. an inability to analyze securities to understand their technicals, and their "intrinic value" and cash flows), the empirical falsification that equities do well in the "long run" (let's use ten years), and the inability to take short-term losses (even ignoring my first point about ignorance and incompetence ) due to lack of financial capability (i.e. people afraid of losing their jobs because they would be deprived of cash flow, and they do not have savings or inflated assets to support them). High discount rates should be reflected in lower P/Es and higher dividend yields. Also, a high dividend would protect one from increased downward volatility and decreased liquidity. In addition, one would also receive substantial capital gains when discount rates falls, which is similar to being long duration in bonds when interest rates fall.

Of course, if the position moves against you, the risk/reward profile would look even better, and it would be tempting to add instead of cover. It seems that this rally is about to end, but it would be more disappointing if it ending before it hit $89.50, than if you incur a short term loss if the position rises against you.

I would close the CAD and AUD positions or reduce them to about 5% of NAV each.

New trades

Deflation theme:

add:


20% NAV short copper
20% nav long silver

50% NAV short GBP/USD

I knew 870 on SPY was overbought, but I didn't say anything about it. Since trading is zero-sum I didn't declare any positions, although I knew there would probably (like an 80% chance of a sell-off on Monday), I didn't expect it to be this large. I do not know if this is the resumption of the bear market or whether the rally would continue. It seems to me that the gap from the high 200 day EMA and the value of the SPY would mean the rally has some more steam.

One has to trade as little as possible since trading is zero-sum. Of course, from an SPY of 870, I knew it had to fall. One was waiting for it to go even higher before declaring a short position. I thought 890 would be a good time, since a sell-off might happen before it reached 900.

Edit: 4/26/09

I meant to say overbought on a long-term and very short-term time frames. On a medium term, 870 S&P 500 it seems that the rall would continue.

Again, I do not like trading. Trade minimally... A speculator (unless you are a quant) should engage in a minimum amount of trading. That doesn't mean buy and just forget about it.

I'll close out all the equity positions... except for petrobras and a corresponding s&p hedge

Actually, equity gains were matched by the losses in the short hedges. If it weren't for the large petrobras position and its gains . IWM short was absolutely horrible.

4/06/09
reducing the SEK/JPY to 12% NAV

Edit:

SEk opened up higher this morning, like one percent against both the dollar and yen, but it went down. I thought it was a good time to close yen positions, now I did that.