Archive for December, 2011

OBAMA’S BID FOR A SECOND TERM AND THE MARKETS

The end of the year is approaching and the markets are winding down a volatile year
with a whimper. So while everyone focuses on Europe (will it ever end?) what will
be the next catalyst for the market? How about a Presidential election?

Although there has been several Presidential elections and stock market cycle theories
written, not one tells the whole story. With varying political and economic circumstances
surrounding each election, no two are really the same. We cannot exactly say that George
Bush propped up the market in 2008 to bolster the Republican campaign. With that
being said, what is the market telling us about the next election?

OBAMA IS A LOCK

Do not be surprised, to hear such a thing from a long term Republican. Do we all
forget the circumstances under which he took the helm? During one of our country’s
biggest financial catastrophes. And a majority of the policies he was forced to follow
were instituted by the Bush Administration on the way out the door. I am not going
to say I agree with everything he has done since, but what the hell, look at the market. Up over
40% since he took the oval office and he is giving long term investors, yet ANOTHER
OPPORTUNITY to get out, lighten up, or at least lock in something.

My biggest concern with Obama was his stance on Israel. At this time, my worst
fear has not come to fruition, so I am trusting that it will not occur during
his second term. The role of the President of the United States in the foreign policy
arena will always be subject to some type of criticism. As far as his domestic polices
are concerned, the jury is still out on Obama-care (something needed to be done)
and I do not foresee unemployment ever approaching the 5% level again. For those
who want to dispute that fact, why not take a peek across the pond for a preview of
what is in store for us.

At this time, the most reliable and liquid Presidential election futures market has Obama
at slightly above a 50% probability of winning the election (http://www.intrade.com/). Are you kidding me? Who is going to beat him, scandalous Newt Gingrich? Please explain to me how the
United States, after veering so far to the left in 2008, is going to do a three sixty and move all
the way back to the extreme right? The Republicans would have a much better chance with
vanilla Mitt Romney, but once again he is somewhat symbolic of corporate America and will not attract enough straying Democrats.

So how could I be wrong? The market goes into a tailspin and cracks the bottom of this
nauseating trading range. But with corporate earnings at their current levels and tons of cash
on the sidelines this is unlikely to happen. On the other hand, if the market rips north,
as every analyst appearing on CNBC is predicting, Americans will stick with the status quo.

In closing, I am a buyer of Obama futures at the 50% probability level and if it falls below that

(which I would be very surprised) I am buying more. Perhaps that will be your only opportunity to
double your money in 2012.

Long Term Investors – What Now With Your Portfolio?

Here we are back at nearly the same level as we started the year. Certainly not without our share of ups and downs. Japanese earthquakes rocked the markets in April, budget malaise persisted through the mid year and of course, who could forget the European situation.

So what is your broker or investment advisor telling you now?  Pile in now and do not miss the next move up?  Or take some chips off the table after a decade of unprecedented market volatility and little or no absolute return on your portfolio?  Wish I had a crystal ball and I could give you the correct answer.  But since mine is broken, my words of advice to long term investors is, LOCK IN WHAT YOU HAVE HERE. Whether it be selling calls or buying puts on the overall market, or simply putting in stops on your portfolio (which you may get roasted on, on the overnight moves).  JUST DO SOMETHING.  Do not sit here idle and then start complaining if we go back to the bottom of the recent trading range.  At the very least, if you have the stomach to enter new positions in the market, do so with some downside protection.

Surely the perma-bulls, can argue earnings are great, as well as umemployment is coming down (which it is really not, people are just giving up looking for jobs), and Dow 15,000 is just around the corner. To you I would say things always look great at the tops and horrible at the bottoms. Whether the market bottomed in August and is gearing up for the next leg up is not the question.

The question is, how can you participate on the upside (your total return minus the cost of protection) while not exposing yourself to unlimited downside risk. At this time, the market rally has been fueled by the anticipation of the European monetary crisis being solved. Will it ever be solved, or are the measures attempting to be taken now only a temporary solution to a much bigger problem? Until we allow countires and financial institutions that should fail to actually fail, how much confidence should we have in the markets?

But do not rely on my advice, consult your broker or financial advisor and make sure they have a well devised plan to preserve what you have now, and still participate on the upside.  If they don’t have that plan, consider changing your broker.

Leveraged ETFs and End of Day Volatility

Do leveraged ETFs increase market volatility?  This question has been raised time and time again with no definitive answer.  But here is my take.
Leveraged ETFs do a daily rebalancing in order to keep their leveraged exposure intact.  If the underlying index that the ETF is tracking, is up on the day, the leveraged ETF must increase their exposure to this underlying index at the end of the day by buying more of the index (usually done through a swap arrangement).  If the underlying index is down on the day, they must do the opposite, and decrease their exposure.  In essence, the leveraged ETFs are always buying at the end of the day on up days, and selling at the end of the day on down days.
This daily end of day rebalancing is very predictable.  Any type of predictable order flow is gamed heavily by predatory high frequency traders.  These HFT players will drive the price of the underlying index higher, if they know the ETF needs to buy, or drive the price of the underlying index lower, if they know the ETF needs to sell. 
This action leads to increased end of day volatility as the underlying indexes are moved around by predatory players looking to extract the maximum value from the leveraged ETFs predictable rebalancing.
So in essence, it is the predictability of the leveraged ETFs rebalancing that increases end of day volatility.
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