Archive for June, 2011

Economic Recap – week of 06.13.11

Friday, June 17th, 2011

I’ve hit on the sentiment theme a few times now, and I hope I haven’t suggested a bit of pessimism isn’t warranted. This week’s economic releases certainly emphasized the fact that we’ve hit a soft patch in the economic data. Most of the respectable people I’ve read seem to believe that it’s just a slowdown in a sub-par recovery–nothing more for now. Naturally, the more one reads that the more wary one must become. Just like the soured sentiment toward stocks, sentiment can swing either way with respect to the economy, and if most commentators are too sanguine on the current weakness that can present its own problems.

Inflation – both the Consumer and Producer Price Indexes were higher than expected–on all fronts; that is, the core and headline inflation rates were all slightly higher than expected.

Housing – both Building Permits and Housing Starts were better than expected, but both are at such low, relative levels that it hardly matters (chart below). Sure, it’s better than them going the other direction, but it’s little to write home about. There was a 13% jump in Mortgage Applications, but that’s largely because of a continued rise in refinancing activity, not the more-important-to-housing purchase activity. Still, refinancing puts more money into consumers’ pockets, and we need that.

Regional Indicators – the Empire State Manufacturing and Philly Fed reports both now reside in the contraction zone, the one confirming the other.


  • Initial Jobless Claims fell more than expected, but they remain stubbornly above the 400,000 mark.
  • Industrial Production rose less than expected (+0.1% v. +0.2%).
  • Capacity Utilization fell (to 76.7%) instead of rose (77.0%), as economists had expected.
  • University of Michigan Consumer Confidence fell sharply (from 74.3 to 71.8)
  • Leading Economic Indicators, however, rose by +0.8%, whereas economists had expected a drop to -0.3%.

Well, that’s stupid

Friday, June 17th, 2011

The European Banking Authority has issued a directive to European banks to–as CNBC put it–”stress their portfolios for ‘more conservative assumptions.’ ” Unfortunately, the stress tests do not involve the possibility of Greece defaulting!  Some excerpts from a Bloomberg story available here:

  • “Credit default swaps indicates an 82% chance Greece will fail to meet its commitments within five years.”
  • “The EBA can’t include a sovereign default in the stress tests because that would lend credence to the possibility of such an event happening and undermine confidence in the region, said Richard Reid, an economist at the London-based International Centre for Financial Regulation.”

In hindsight, the credit default swaps for Bear Stears indicated the same thing, something that was highlighted in a posting of his on March 8, 2008. So, it would be like instructing U.S. bank, in early 2008, to run scenarios against their portfolios, but scenarios that do not include a Bear Stearns wipeout.

Here’s a look at the pricing on Greece debt default protection. It’s up between 30-40% this week alone.

And this is what happens when the Greek government tells its citizenry that austerity measures are needed.

But, no, European Banks, there’s no need to factor in the possibility of Greece defaulting on its debt.


Pessimism piles up

Friday, June 17th, 2011

The pessimism continues to pile up. That’s important because you want to make sure you don’t get caught up in it. The rule is to go with the crowd until it reaches an extreme, at which point it pays to go against the crowd. We’re starting to see extremes all over the place now. What that means is not that Greece will or won’t blow up, but that a lot of potential bad news is being priced in. When that’s the case, it doesn’t take much good news to catalyze a rally in risk assets. Think of the optimism/pessimism (or greed/fear, if you prefer) as a pile of tinder used to start a fire.

  • Optimism is like a tinder  drenched with water. It won’t start with any source weaker than a blow torch.
  • In contrast, Pessimism is like very dry tinder; it only takes a spark.

There are a variety of sentiment measures. In last Friday’s I covered the sentiment expressed in the weekly survey of the American Association of Individual Investors. This post will look at put and call options. Here’s a bare-bones primer on options.

  • Put options (puts) rise in value as a security price declines. Generally, puts are purchased either to hedge (protect against a decline in) a current position or to speculate on an asset declining.
  • Call options rise in value as a security price rises. Calls might be purchased instead of buying the underlying security. For example, one might buy call options on Cisco Systems instead of Cisco shares. Less money is put up.
  • Put and call options may be bought and sold in combination. For just one example, one might sell a call option on one security and buy a put option on the same security with the proceeds.
  • Options are like milk; they have expiration dates.
  • Option prices are, generally, more volatile than the underlying securities

As a group, investors tend to be an optimistic lot, so the normal pattern is for more call options to be bought than for put options to be bought.  Over the last few years, about 65 puts have been bought for every 100 calls bought, for a ratio of 0.65. While our tendency is to be optimistic, occasionally we go the other way. We do it when it seems like the world might end–or at least Europe–and certainly Greece. That is, we’re doing it now.

So, here’s a look at a pile of dry tinder. The ratio of puts:calls is now back to levels last seen in November 2008. What is shown below is for options on equities and ETFs; there is also a put:call ratio the includes options on indexes, but those often involve hedging activities that may be unrelated to sentiment.

Please notice the powerful rally that ensued just from the ratio moving back to normal. Notice, too, that the put:call ratio didn’t mark the ultimate bottom, only a time when investors had gotten way to pessimistic. In short, the time to be nervous is not now. For now, at least, stay the course.

The biggest source of push-back we get from clients and others regarding almost anything having to do with history–this being one example–is that this time it’s different–it’s never been like this before. How true, how true; it’s never the same. But what is always the same is people and their emotions. They’re what led Charles Mackay, author of Extraordinary Popular Delusions and the Madness of Crowds, to say,

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”


Weekly Recap & Outlook – 06.10.11

Friday, June 10th, 2011

Tower Private Advisors


  • Excessive pessimism toward stocks
  • Econ 101
  • Slow week for economists