MARKET WEEK: JUNE 25, 2012

June 25th, 2012

The Markets

A dismal Thursday cancelled out much if not all of the rest of the week. The Dow's 250-point loss made Thursday the index's second-worst day of the year. The good news? Oil fell below $80 a barrel for the first time since October, offering hope for lower gas prices to follow. Meanwhile, the price of gold plunged roughly $60 an ounce.

Market/Index

2011 Close

Prior Week

As of 6/22

Week Change

YTD Change

DJIA

12217.56

12767.17

12640.78

-.98%

3.46%

Nasdaq

2605.15

2872.80

2892.42

.68%

11.03%

S&P 500

1257.60

1342.84

1335.02

-.58%

6.16%

Russell 2000

740.92

771.32

775.13

.49%

4.62%

Global Dow

1801.60

1789.12

1792.14

.17%

-.52%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.89%

1.60%

1.69%

9 bps

-20 bps

Equities data reflect price changes, not total return.

Last Week's Headlines

·                         Investor reluctance to buy Spanish 10-year bonds pushed the yield briefly above 7%, a level widely considered unsustainable, though it retreated later in the week. An audit of Spanish banks showed that in a worst-case scenario, they would need as much as €62 billion in assistance; however, the Spanish government said it will request as much as €100 billion from the EU's bailout fund. Meanwhile, despite objections from Germany, the European Central Bank announced it will accept a broader range of collateral, including mortgage-backed securities and auto loans, to help eurozone banks continue lending.

·                         G-20 summit leaders said European Union members pledged to take whatever steps are necessary to preserve the EU, while five emerging nations (Brazil, Russia, India, China, and South Africa) agreed to increase their contributions to the International Monetary Fund in exchange for greater power in the organization. In Greece, newly elected leaders were able to form a coalition government that is committed to upholding the European bailout agreement.

·                         Twist again: The Federal Reserve's Open Market Committee extended "Operation Twist" through the end of the year. The program, which had been scheduled to expire at the end of June, will use the proceeds from sales of short-term Treasury bonds to buy $267 billion of longer maturities in addition to the $400 billion already purchased. Operation Twist is intended to stimulate the economy by keeping long-term interest rates low. Fed Chairman Ben Bernanke also said the Fed is prepared to take additional steps if the unemployment situation doesn't improve.

·                         The Conference Board's index of leading economic indicators rose 0.3% in May, reversing the previous two months' declines. Stock prices, consumer expectations, and hours worked in manufacturing held down the index. The board's chief economist said the data indicated the economy is muddling through and the risk of a 2012 downturn is low, but that foreign and domestic economic headwinds would make further strengthening difficult.

·                         Home resales fell 1.5% in May, according to the National Association of Realtors®, though they were 9.6% higher than the previous May. It was the 11th consecutive month of year-over-year gains.

·                         Manufacturing activity in the Philadelphia region dropped substantially in June; the Fed's survey of general business activity fell to -16.6 from -5.8 in May. Any figure below zero indicates contraction rather than growth.

·                         Moody's slapped 15 of the largest banks in the United States and Europe with credit rating downgrades of between one and three notches, citing their extensive exposure to potential volatility in global capital markets.

Eye on the Week Ahead

As the quarter draws to a close, investors will be watching to see what emerges from a European Union summit at week's end. Domestic housing data also is on tap.

Key dates and data releases: new home sales (6/25); home prices (6/26); durable goods orders (6/27); final Q1 gross domestic product (6/28); personal income/spending (6/29).

Data sources: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

MARKET WEEK: JUNE 18, 2012

June 18th, 2012

The Markets

Equities markets seemed to take hope from reports of plans by central banks to help ensure liquidity in the financial markets if necessary after the weekend's Greek parliamentary elections. The large caps of the Dow and S&P 500 fared better than either the Nasdaq or the small-cap Russell 2000, while the Global Dow's gains mean that it has now almost broken even for the year. Meanwhile, the 10-year Treasury yield continued to edge downward.

Market/Index

2011 Close

Prior Week

As of 6/15

Week Change

YTD Change

DJIA

12217.56

12554.20

12767.17

1.70%

4.50%

Nasdaq

2605.15

2858.42

2872.80

.50%

10.27%

S&P 500

1257.60

1325.66

1342.84

1.30%

6.78%

Russell 2000

740.92

769.19

771.32

.28%

4.10%

Global Dow

1801.60

1759.55

1789.12

1.68%

-.69%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.89%

1.65%

1.60%

-5 bps

-29 bps

Equities data reflect price changes, not total return.

Last Week's Headlines

·                      The likelihood of a Greek exit from the eurozone was reduced as the pro-bailout New Democracy party won the most votes in Sunday's elections. It will now try to form a coalition government with another pro-bailout party that received enough votes to give the two parties a majority in the Greek parliament.

·                      Higher bond yields abroad continued to raise concerns. Despite the promise of eurozone assistance for Spanish banks, Spain's 10-year bond yield hit 6.96% at one point–a new euro-era record for the country–and Moody's cut Spain's credit rating three notches from A3 to Baa3. Concerns about Spain seemed to affect Italy, the eurozone's third largest economy, as Italian 10-year yields also surpassed 6% and rates for other maturities rose substantially at auction.

·                      The European Central Bank recommended a more centralized European banking system to counteract the potential consequences of interdependence between sovereign nations and banks that have purchased their debt; such a system could oversee lenders and provide Europe-wide deposit insurance.

·                      Good news, bad news: The silver lining to a slowing global economy was a drop in consumer prices–the first in two years and the largest since December 2008. According to the Bureau of Labor Statistics, May's 0.3% decline was largely the result of lower gas prices; not counting food and energy, prices were up 0.2% for the month and were 2.3% higher than last May. Energy costs also pushed wholesale prices down 1% in May, leaving the Producer Price Index up less than 1% in a year.

·                      Despite increases in spending on cars and clothing, retail sales fell 0.2% in May. However, the Commerce Department said sales figures, which are not adjusted for price changes, were 5.3% ahead of last May. Nonstore retailers, up 12.4% in a year, saw the biggest gains.

·                      According to the Federal Reserve, U.S. industrial production slipped 0.1% in May, though it was 4.7% higher than a year ago. Meanwhile, the Fed's gauge of general manufacturing business conditions in the New York region remained positive with a reading of 2.3, but was 15 points lower than the month before.

·                      The collapse of the housing market helped cut the median net worth of U.S. households by almost 40% between 2007 and 2010, according to the Federal Reserve's 2012 study of inflation-adjusted consumer finances. The Fed said groups for whom housing was a larger share of assets saw even bigger declines in their median net worth than the overall decline from $126,400 to $77,300. The median pretax income fell almost 8%; hardest hit were more highly educated families, those headed by someone younger than 55, and families in the South and West. Median incomes for retirees and other nonworking families were up.

·                      Rajat Gupta, a former board member of Goldman Sachs and Proctor & Gamble, was convicted of three counts of securities fraud and one count of conspiracy for leaking insider information to hedge fund manager Raj Rajaratnam, while former financier Allen Stanford was sentenced to 110 years in prison for running a Ponzi scheme and defrauding clients.

Eye on the Week Ahead

The week is likely to be dominated by reaction to the Greek election results and the European debt situation, including any reaction from G-20 leaders, and by the Federal Open Market Committee's last meeting before the scheduled expiration of its Operation Twist bond-buying program.

Key dates and data releases: home builders' survey (6/18); housing starts (6/19); Federal Open Market Committee meeting (6/20); home resales, Philadelphia Fed manufacturing survey (6/21).

Data sources: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

Analyzing Mesas

June 17th, 2012

“Broad Short Strangle” is too long. I like to call it a “Mesa” because it has a flat top snd steep sides. it’s simply a short OTM put and call, centered on the current stock or ETF price.

If I want to set up a mesa, how do I choose how wide to make it and how do I minimize risk and maximize return?

So I wrote a little program to run through the possibilities.

To get the highest premiums per time remaining, I pick the nearest expiration date. (That works since I pay a flat commission)

First I run a program to get historical stock prices from Yahoo to find how much the stock has moved in the number of days I have left, over the past 3 years. You can see the result here. The red dots show the probability of the n-day proportional change being in each bin. And I fit it with a Normal curve for ease of calculation. The fit is probably good enough for this kind of data. That’s the green line.

I use that to figure the maximum distance to sell options away from the current price.

Then I go to Yahoo to get all the options for the nearest month, and I set up a series of mesas of increasing width, from zero (just a short straddle) to the maximum.

For each of those, I calculate (for 1 put and 1 call) how much premium I bring in, how much margin it ties up (using Schwab’s margin rules), what the break-even width is, what the average profit would be (by integrating the profit and probability curves), the probability of a loss, the average profit as a percentage of the margin tied up, and the minimum volume of the option, to give some idea of how easy it would be to place the position.

You can find the table for that here.

You can see that as the width of the mesa increases, the avg % profit goes down relatively slowly, while the probablility of loss goes down drastically.

The profits are per month, so, for a 5% loss probability, the profit of 1.77% is 21% annualized.
Given the 3.5% I pay for margin, that gives me a pretty nice return with pretty nice safety.

If I wanted to bring in $1000/month, I’d have to sell about 23 units ($1000/43.3) which would use up about $56K of my allowable margin ($2446 x 23).

So, I could do it with several high volume ETFs each month, like SPY, GLD, etc. and bring in enough to pay for my lifestyle.

Next I’m going to apply it to my skillets (a mesa with a smaller number of inverse strangles in the middle), and see if they’re any better than the simple mesa.

Any comments?

Harvey Frey

Market Update For Week Ending 6/1/2012

June 3rd, 2012
Index Close Net Change % Change YTD YTD %
DJIA 12,118.57         -336.26         -2.70         -98.99         -0.81        
NASDAQ 2,747.48         -90.05         -3.17         +142.33         5.46        
S&P500 1,278.04         -39.78         -3.02         +20.44         1.63        
Russell 2000 738.21         -28.20         -3.68         -2.71         -0.37        
International 1,332.89         -17.49         -1.30         -79.65         -5.64        
10-year bond 1.47%        -0.28%          -0.40%          
30-year T-bond 2.54%        -0.31%          -0.35%          
International index is MSCI EAFE index. Bond data reflect net change in yield, not price. Indices are unmanaged and you cannot directly invest in an index.
More market data

Market Wrap-Up
Last week was a bad one for stocks, and it was capped off by a sharp drop in major stock indices on Friday following a bad jobs reports. Meanwhile, growing fear about the eurozone debt crisis compounded worries. The Nasdaq Composite and Standard & Poor’s 500 stock indices remained in positive territory for 2012, showing gains of 5.43% and 1.63% respectively, but the 30 stocks in the Dow Jones Industrial Average for the period slipped into negative territory and was a loss of 0.81%. The 10-year U.S. Treasury bond resumed its rally, with the yield falling to a record low of 1.47%.
http://money.cnn.com

Worst U.S. Job Data in a Year Signals Stalling Recovery
A dismal job market report Friday confirmed fears that the recovery has slowed, and reflected mounting evidence of a global slowdown. According to the U.S. Labor Department, the economy gained a net of 69,000 jobs in May, the third disappointing monthly jobs report in a row, which triggered Friday’s selloff.
http://www.nytimes.com

What The Jobs Report Means For The Fed?
The weak jobs report came as the Federal Reserve’s open market committee had been resisting suggestions that it expand its already extraordinary effort to stimulate the economy through a “quantitative easing,” a program known as QE. While the president of the Federal Reserve Bank of New York gave a speech this past Wednesday saying “the benefits of further action are unlikely to exceed the costs,” Fed-watchers were already looking forward to next Thursday’s testimony by Fed chairman Ben Bernanke before Congress to learn if the central bank will drive down the cost of bowing for businesses and consumers.
http://nytimes.com

Three in a Row?!

June 2nd, 2012

The stock market decline that began in earnest on May 2nd became an official “correction” on Friday, May 18, when it was down -11.2% from the high reached on March 19. The drop this month, though not severe by historical standards, was rather brisk, with the MSCI All-Country World index falling -9.6% in just 13 trading days. Besides the pace of decline, the current correction has two other unusual features:
1. It has been very orderly. There weren’t any big one-day drops, just a series of small to moderate declines with only 2 up days out of 13. Over the past week or so, we’ve had a very modest recovery of less than +1%.
2. It’s the first time in at least 50 years that we’ve had stock market corrections 3 years in a row. And it’s certainly the first time 3 consecutive corrections had the same primary cause (the Eurozone debt crisis, in case you’re wondering).
Bummer, no? But stock market corrections of 10% or more are common during bull markets, even if they don’t typically occur every year. During the great 1982-2000 bull market, over which time the S&P 500 returned +2,447% (no, I didn’t leave out a decimal point), declines of 10% or more occurred in 9 out of those 19 years. And of course, there was that famous -20.5% crash on Oct. 19, 1987. My point is, what we’re seeing now is perfectly normal, even if the apparent cause is new and different.

May was a crummy month for investors.

For those of you significantly invested in equities (which includes most KCS clients), the month of May will be a disappointing one on your statements. Most corrections span 2 different months; squeezing the bulk of the drop into a single month means that you should expect your account values to decline around -10%. A crummy month for sure, but “past performance does not predict future results.” The summer could be entirely different.

When will the market turn around and what will be the likely trigger? Obviously, I can’t predict the future, but I do know how prior stock market corrections have played out. Typically, a correction has 2 bottoms that occur 3 to 8 weeks apart. The second low is close in price to the first, a little higher or a little lower. I feel confident that the primary bottom happened on Friday, May 18. So if this correction is typical and does have a second low, expect it to occur prior to the end of June. The Greek elections are on June 17, so this is as good a guess as any. Full recovery takes 2 to 4 months, so a “typical” correction would see prices return to their 2012 highs by mid-August to mid-October.

One thing you learn after many years investing is that the market never does exactly what you expect. But, while history rarely repeats itself, it does rhyme. And it looks like 2012 will rhyme with 2010 and 2011. This time, however, I expect a shorter and shallower correction than in those years, and a more lasting recovery.

2012: Same, same, but different.

Why do I say this? Because I expect that the third time will be the charm. After trying unsuccessfully to quell the Eurozone debt crisis in each of the past 2 years, I believe that the European governments and the ECB will finally find a solution that works. But don’t expect a “big bang” where everything is fixed in the blink of an eye; rather, look for a series of measures that gradually calms markets and puts a framework in place to make the Euro a truly stable currency. This, in turn, will restore confidence and help pull the peripheral Eurozone countries out of their recession.

I have a few ideas of how this will play out, but the details are unimportant. What’s key is that Greece will likely elect a government that decides to stay on the Euro (because 80% of Greek citizens want this and know that a “Grexit” would be an economic disaster for the country) and that Spain’s banks will be successfully recapitalized. Once it becomes clear that the worst case scenarios won’t play out, markets will recover and economic activity in Europe and elsewhere will pick up. Nobody wants this more than the Europeans, and despite their differences, they will eventually come to an agreement. Germany will bend because it wants and needs the Euro. So do Greece and Spain.

Change is difficult. The Euro represents a major step forward, both economically and politically, even more so than the US dollar did when our young country officially adopted it in 1792. The Euro had significant flaws from the get-go, some of which only became apparent during the current sovereign debt crisis. (Good times masked a lot of its flaws.) Little by little, the Europeans are fixing its flaws and helping create a currency that will eventually stand on par with the US dollar and the Japanese Yen. But that process will continue to be messy for a while, as are most essentially political processes.

Eventually, however, the hard work will be over and we’ll put this crisis behind us. At least until the next one. But if Europe could not only survive but thrive after two World Wars, it can certainly make it through this debacle.

Hasta luego,

Dr. Ken Waltzer MD, MPH, AIF, CFA
Founder and President – Kenfield Capital Strategies (KCS)
Kenfield Capital Strategies™ (KCS) is an SEC-registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with comprehensive financial, estate and tax planning services.