Friday, January 30, 2009

Format Update

I thought that updating the format of this blog to add a linkbar like I see on so many other (better) blogs would be a relatively trivial affair. Then I dove into the morass of sites purporting to help make your blog slicker. Ironically, these sites are so jammed with gadgets, ads and columns that they become for all purposes unusable.

A couple different (and very nice) templates only served to screw up so much of the positioning of charts I'd worked on in my posts that I unloaded and returned to Minima and finally found a site to help me with the linkbar problem. I'm still not very happy with it, so if there are any readers that know how to shrink the height of it and could let me know, I'd be most appreciative.

Here's the substance of the change: for now only the NYMEX Charts tab is active. It leads to a page with charts showing crude oil open interest, price and spread that I'll try to update as frequently as time allows. I'm debating about also having a tab for the week's earnings table so that it can be easily located as well. Any opinions on this are welcome.

Tuesday, January 27, 2009


I've seen more than a few comments bemoaning the buyout of Wyeth by Pfizer as it will throw 8K people out of work and that these are just the sorts of jobs that the US needs to retain - i.e. "knowledge jobs" - and that this is the sort of merger that will further reduce the research and what-not done at these two companies. Although I certainly do not celebrate any job loss - particularly now - I don't believe this is the case that knowledge jobs are going to vanish. Here's why:

Despite Montel's travelling circus telling the nation about "America's Pharmaceutical Research Companies", a cursory examination of the annual reports for Pfizer and Wyeth reveal something peculiar...
To the left, is a page out of Pfizer's 2007 annual report with a little bit highlighted. Notice that R&D expenditures (the "knowledge jobs") are roughly 1/2 of the percentage of the SI&A (sales, informational & administrative) expenses. So Pfizer basically spends $2 on selling stuff to you through advertising, drug rep giveaways, etc. for every $1 they spend on research. Further in the text, this specific detail on radio & TV advertising is laid out: Advertising expenses totaled approximately $2.7 billion in 2007,$2.6 billion in 2006 and $2.7 billion in 2005.

So maybe Wyeth is better? Let's have a look at their 2007 annual report. Well, how about that? SI&A for Wyeth is a little over twice what is spent on R&D there too.

Now this isn't meant to trivialize what is a substantial amount spent on R&D by Pfizer and Wyeth. Combined, in 2007 they dropped about $11.1B in R&D expenses. But at the same time they spent over twice that on selling the public on these drugs - or selling us on the idea that they are heavy into R&D when they actually spend twice as much on things that have nothing to do with drug research.

The most oft-heard reason for Pfizer's purchase of Wyeth is that Pfizer is about to lose patent-protection on Lipitor, one of PFE's cash cows. This leads to a more interesting observation or at least personal speculation.

Anyone that really enjoys gambling on the stock market knows about how enticing the returns can be on a biotech company that gets FDA approval for one of the drugs in its pipeline. And anyone that has followed the sector knows that there is a veritable graveyard of zombies, corpses and tombstones for every one or two lucky souls that emerge. And what of these lucky one or two companies? Why, they're usually purchased by (or partnered with) the likes of PFE, MRK, BMS or one of the "Big Pharma" group. Case in point, I picked a page out of 2007 annual report of a company I used to follow - MEDX - to see how much they spent on R&D vs. SI&A.

Unsurprisingly, R&D dominates the expenses in this true biotech company. MEDX has some partnerships with BMS for some of their technology, though I haven't followed them for awhile.

The point of all this is my hunch that the merging of PFE and Wyeth into Wy-Pfi does not mean we should all expect a massive slashing of R&D budgets and thousands of scientists out of work. What I believe it forecasts is thousands of drug reps, HR and admininstrative staff out of work. (Perhaps unfortunate for the economy is that I suspect in many cases, the drug reps are better paid and disperse more dollars into the economy than the scientists.) New drugs are still the lifeblood of these companies. But PFE and their ilk have long been far larger marketing machines than R&D houses. The true drug innovation (and risk-taking) goes on at the smaller biotech firms and universities. Big Pharma is simply very innovative at finding new ways to extract dollars from our pockets through creative patenting, lobbying and marketing.

For more reading, I would definitely recommend the New Yorker's article "High Prices" by Malcom Gladwell for a glimpse at the marketing creativity of Big Pharma as well as "The Pipeline Problems" also in the New Yorker.


Sunday, January 25, 2009

Revisiting Old Charts

Over the past couple of weeks I've posted up a few charts with some vague intention/goal of updating them now and then.

One of these was the SPX bottom finding chart. When I first posted it up on the 6th, it was somewhat concerning because of the implied risk for a reversal even though the indicator itself wasn't as reliable at finding tops as confirming bottoms. Here's an update of that chart to the right. On the plus side, the market didn't exactly leap upwards since then. On the 6th, SPX opened at 931 and Friday it closed at 831. I guess that's actually not too bad all things considered. This chart still confuses me a little bit when it's viewed over the span from Q1/2007 until now. Strangely, the spikes in risk for a bear reversal on SPX keep getting higher and the bottom spikes continue to be more shallow, forming a channel of sorts. Why speculators should be getting progressively more risk-a-philic puzzles me. Perhaps everyone is just getting more comfortable with the new market realities. The next sign-post I'll look for on this one will be around -0.50 and at that time it will be interesting to see how other SPX analysis is doing. This is the height of earnings season and so anything can happen.

The next thing I've talked about a little more recently is oil and the contango spread. This definitely deserves an updated chart since the spread has collapsed and has been cut roughly in half. Again, chart to the right. The last time I talked about it, the 1-year spread in NYMEX pricing was pushing towards $25/bbl. This has subsequently collapsed to just under $12/bbl and the 6-month has fallen from around $18.50 to just over $7/bbl.

To add a bit more detail, it turns out the spike in the spread was due far more to the plunge in the front-month contract (February until Jan. 20 assignment, March since) than a price run-up in the farther months. You can see this in the next chart that shows the front month price and 1 year out. Again, it should be noted that there was a substantial surge in open-interest in the March NYMEX contracts. My guess du jour is that there were a lot of people scrambling to roll their contracts out of February because of the situation in Cushing. At some point, I expect those contracts will be liquidated but we'll have to wait and see when/if that happens.

Saturday, January 24, 2009

Earnings Week of 1/26/09

Here's the week's earnings table worksheet.

Spreadsheet Link

There are a ton of companies releasing every day. So many that there are too many for me to run through on a detailed basis - you'll have to use the links to investigage on your own. Instead, I'll just note the big names and DJI components but won't have much opinion on them. Plus, as we saw from last week, a whole lot can happen in between Sunday and Thursday.

Monday: DJI components AXP, CAT, and MCD. Oil services HAL. NY-based REIT, SLG. Miner FCX.

Tuesday: DJI components DD & VZ. Refiner VLO.

Wednesday: DJI components T and BA. WFC should be interesting to see if they continue to shuffle around bad mortgages for book-keeping purposes or if they have just TARPed the whole thing. SBUX announced some new layoffs at corporate and I think some new store closings in the last couple of days. We should find out just how much people are cutting back on life's little luxuries.

Thursday: DJI components MMM. WYE announces and they are being targeted by PFE. AMZN announces, though the time is not yet solidified. Speculative solar play of the day is SPWRA. Two airlines in CAL and LCC.

Friday: DJI components CVX, XOM and PG. Combined these 3 companies represent represent just over 20% of the DJIA. An ex-DJI component in HON and mall-owner SPG. This quarter might not be too bad for SPG but look out in the next one as the retail bankruptcies really start to take their toll on the malls in the quarter ahead.

Sorry it's kind of lame today in terms of my commentary. (Even worse than last week.) I'll be looking on a day-by-day basis in the week ahead to see what might be worth playing but to do it all in one morning when everything will likely change in 4 hours trading seems utterly without point. Hopefully, the sheet will be helpful to readers in winnowing the pool of companies releasing to a few that could be worth trading. One last question/request: if anyone knows how to get Google docs to do conditional formatting based on a formula, let me know. The 52-week high/low columns are not highlighting as I have them set to in Excel and it's a nice visual note.

Thursday, January 22, 2009

Levered ETFs and Real-World Volatility

When I started this blog, I never really expected to get much traffic and that basically has been the case. Still, I'm no different than most and retain some vanity and so installed the obligatory traffic tracker to see where people are coming from. I was surprised to discover that the pieces on DXO, DTO, and oil generally have been far and away the most popular. I guess I expected that after the trouncing that oil took that it would have been a dead area of little interest. But within the oil searches there was a vein of interest in levered ETFs themselves. That part I'll expand on a bit further here.

There are lots of levered ETFs out there but they all function in more or less the same way - they try to provide +/-2x the percentage daily move of whatever its benchmark index is. Just to take one example, this is from the ProShares prospectus (page 9):

Ultra ProShares are designed to correspond to a multiple of the daily performance of an underlying index. Short ProShares are designed to correspond to the inverse of the daily performance or twice (200%) the inverse of the daily performance of an underlying index.
The Funds do not seek to achieve their stated investment objective over a period of time greater than one day.

(emphasis mine)

These are very important caveats to bear in mind and they are in the prospectus to protect ProShares from real-world behaviour vs. uninformed investor expectations. So how can these ETFs be used effectively, given their path dependence? The post on DXO/DTO already showed that there are occasions when the ultra or levered ETFs perform outstandingly well - basically when the underlying benchmark moves in a straight line with little deviation. So what of the flip-side? I skirted this issue with an earlier post called "The Chop!" where it was noted that SPX had been exceedingly volatile on an intraday basis for the previous couple of months. I'll try to give a look at both possibilities.

First, you have to have a basis for modeling or in this case, generating random but similar paths. I took 100 days of SPX data ending on 1/16/09 and noted the open-close price percentage change in the index. Here's that daily price change distribution in a nice histogram. This isn't exactly a normal distribution and for the stats nuts, here is the description: mean=-0.308, std error=0.359, std dev=3.59, kurtosis=0.839, skew=0.178. Unfortunately, I'm somewhat limited by knowledge of JMP and thus confined more or less to what Excel has on offer. So I took a short-cut and decided to pretend this was a normal distribution anyway. I'll accept any help to improve on this assumption so critique away.

To ensure that the normal distribution assumption wasn't wildly off, I decided to randomly generate 5 sets of n=100 based on the mean and std. dev. noted above using Excel. Then these sets were compared to the actual data set. These results are to the left in the JMP graphic. (I apologize for the squashed look but it's a tall graphic.) They aren't dead-on, but statistically speaking they are pretty similar to the original set. (Set #1 in this case is the original SPX data.) Not great, but not terrible.

Moving ahead from this point seemed acceptable and so I decided to model the returns (before expenses) according to the daily goals outlined in the prospectus of 1x, +2x and -2x funds in this environment. I ran this 200 times with some interesting results.

The 1x is the basis for daily calculation of the levered models. But the table on the right is the final return from day 1 to day 100. For the use of these Ultra-ETFs to be ideal, one would hope to see a high probability that the performance would be beyond the 2x daily expectation. Looking just at the mean, one might be tempted to think that these funds are excellent performers but when the median performance is looked at, a different story emerges. Better than 50% (about 55%) of the time, the -2x fund "underperforms" in a choppy market. In this instance, "underperform" simply means less than +/-2x the target benchmark - it says nothing of its performance to prospectus specifications. For reference the actual performances during the period under analysis were SPY= -32.8%, SSO= -60.73%, SDS = 19.14%.

So that's the examination of a relatively choppy market. What about the performance under circumstances like the summer to fall period in crude oil?

You'll have to just grant me the same assumptions as the charts illustrated above because I don't want to further clutter up the space. Briefly, the sets generated are even more similar statistically than in the first case. If you would like to see the numbers from above let me know but I'll summarize with this: the data in question is USO from June 16 until December 24 or 135 sessions. The average intraday change was -0.64% with a std. dev. of 2.65. This is a couple of weeks before the peak, and seems a little more realistic in terms of market timing in that allows some wiggle room for being off.

The results are to the right in the same table. In this environment, the -2x modelled fund performed well even on a comparison of medians and in the simulated runs actually beat a 2x performance of the underlying benchmark 81% of the time.

So what can be drawn from this overly-long post? First, it should be remembered that this simulating is totally ideal - no expense ratio (generally >0.8%) and no slippage/remainder that seems to occur in terms of performance vs. stated goal on a daily basis. My hunch is that on significant volume/volatile days the NAV of these ETFs gets away from share price due to in/out-flows and eventually must be reconciled. But in terms of applicable trading, I suppose if you believe the benchmark that you are targeting is going to enter a period of strong directional movement without much volatility, then a levered ETF might be a decent wager. But beware the chop and churn that, combined with expenses and remainders, can systematically erode returns.

Wednesday, January 21, 2009

Earnings (Mid-week Update-Update)

Remember waaaaay back on Sunday when I said that guessing where things would be on Thursday would be a fool's errand? Yesterday's stomach-churning drop in the markets is a perfect illustration of why. The landscape changed in just one afternoon. The discussion below is going to be based on mid-morning data since I have some personal things to attend to after that. Here's an updated table for Thursday and Friday and the link:

Spreadsheet Link

Update: And what a difference a morning makes. I get back to my desk and it's like yesterday never happened. Why even bother with commentary? -5%, +5% back to back... and since I don't do intraday commentary, the Sunday table will just have to stand on its own as a point of reference.

Tuesday, January 20, 2009

Ashes to Ashes...

OK... did you mentally sing "funk to funky" or fill in the more somber "dust to dust"? That question sounds a lot like one of those queries on a personality test that purports to tell you something profound but the results instead read like a horoscope out of the Sunday paper. But the title was chosen deliberately.

In the last few months I've read a few stories about assigning blame and generally at least some of it has been laid at the feet of the Fed and their too-loose monetary policy. To be more specific, their absolute refusal to "take away the punch-bowl" to use the most favored phrase. And it's probably true. As usual, here's a chart - this time of the Fed Funds rate. For reference, the data set begins on July 1, 1954 with a Fed funds rate of 0.80% and the last update is 0.18% on 1/15. Interesting and kind of symmetric in a way that appeals to my sense of order.
It certainly supports the premise that the Fed was unwilling to tighten policy since Volker was in charge. Since his tenure each time the rates were cut, they are never subsequently raised back to the level prior to the cuts. One could argue that the Fed has become more supine to the Executive or generally just wants the good time to keep on a-rollin'.

Now, waaaaay back before I started reading about any of this stuff in relation to markets and trading I had a basic academic/political interest in national debt and what-not. If you look back at 1954 as the US emerged from WW2 with some fairly substantial debts, the national debt to GDP ratio in 1954 was 73.3%. (Trivial aside: this number peaked at 121% of GDP in 1946.) In late 2008, this number was... ~72.5%! I must admit, I do like coincidences even if they don't really mean anything.

So moving forward, will we see a return to progressively tighter policy at the Fed? I guess that depends on how much of the money currently being shoveled into the fires of the financial sector manages to remain unburnt and floats off into the broad economy to reappear as inflation. On the flipside, will it even matter as rates are forced upwards because nobody (or at least fewer somebodies) wants to buy the debt? That's perhaps a more ominous possibility. It feels like this could be a great entry point to explore a rich topic but it will have to wait for another post.

Sunday, January 18, 2009

Oil Anomalies

Interesting things in the world of crude are afoot! The spread between the February (front month) and March contracts reached a fairly impressive mark of $8.14 on Thursday before falling back to a still high $6.06/bbl. Pretty impressive. The chart to the right shows what the normal spread between these two contracts has been in the past year and a half. Up until a point in early summer of 2008, crude prices were actually in backwardation or had a flat spread. What we see now is a massively changed market reflecting contango (or super-contango as I have seen it written recently). The 6-month and 1-year spread between contracts closed on Friday at $16.28/bbl and $22.59/bbl respectively. These are very unusual numbers that will be revisited.

The next somewhat anomalous thing is that open interest in the March contracts has blown up in the past week. Since oil crested this past summer, the monthly peak open interest has been falling backwards on a year-over-year basis pretty steadily since. I talked about this a bit in my first oil post. The open interest had seemed to be behaving in a somewhat predictable manner until the last week when I noticed the March contract's open interest rocketing up to last year's peak level for the March contract. Just predicting based on monthly growth from last year a jump in peak open interest to perhaps 325K contracts. Instead, the Feb contract has not yet been assigned and there are already 382K contracts available for trading - roughly equivalent to last year's and a 33% jump from last month's peak.

So what is going on here? First, the NYMEX WTI contract is delivered at Cushing and Cushing is functionally full with negligible storage remaining. The belief is that this is artificially depressing prices. There are numerous commentators pointing out the divergence between WTI and Brent pricing, claiming this as further evidence that WTI is not representative of "real" market prices. I'm not quite as satisfied with this explanation. Here's the chart of spot prices for WTI and Brent since 2005. The entire set from PRI (see link to the right) goes back to 1987 and during that time WTI generally traded at roughly $1.20/bbl premium to Brent. Further, there are clearly long periods where Brent trades at a premium to WTI. Being an amateur, I don't really know what the significance is but this price divergence just doesn't appear all the significant when put in context with the past years. Articles such as this one by Chris Cook (former IPE compliance guy) make me a little skeptical about how much weight the Brent prices should carry but also questions the usefulness of WTI at NYMEX.

Anyhow, there have been lots of articles about the Brent vs. WTI pricing (see links at bottom) and several mentioning the super-contango market currently in effect. There have also been lots of stories about oil speculators leasing out freighters in order to create floating storage. (Also in the links at bottom - FRO is mentioned specifically.) I found this interesting because this is not the first time this type of oil "arbitrage" has been thought up. Prior to the oil bubble being popped, none other than Morgan Stanley had ahem, floated this scheme in May 2007. How that worked out for them, I have no idea. So the resurgence of these reports is interesting to say the least. But the one thing I've not seen mentioned anywhere is the surge in open interest in the March contracts. On the one hand, it would seem to point to a speculative fervor, though it is unclear if that will translate to higher prices. It will be quite interesting to see if the March contracts fall once Febs are assigned, given the yawning gap. I suspect it will also be worth paying attention to when all those extra contracts start to get liquidated. After all, oil is still subject to supply and demand no matter how quirky the market pricing for a period of time. I would welcome any comments or thoughts on what this large spike represents.
Oil News Links:

Saturday, January 17, 2009

Earnings Week of 1/19/09

Another Sunday, another look ahead into the earnings releases. Since I noticed an uptick in traffic to the blog this week, I’m going to take a bit of a detour here and explain for any new readers, the approach to the weekly earnings post. Previous readers can skip the next couple of paragraphs:

First, the earnings report has its origins in an attempt to more easily identify better candidates for using options to strangle/straddle the earnings event. For this reason, the workbook below is not an all-inclusive list of every company that will be releasing earnings in the coming week. Instead, the list is a result of screening for option availability/liquidity and share price. Typically, this has meant a total call/put volume of 2500 contracts in the prior month as reported by CBOE and a share price above $5. In terms of the remainder of the sheet’s contents, most of the data is assembled from Yahoo! based on Friday’s closing prices. The approximate IV is calculated within the sheet based on these same prices but from Sunday until expiration. One very, very important thing to remember is that this sheet will not dynamically update with new information throughout the week. So while it is pretty decent for Monday & Tuesday, average for Wednesday, by Thursday and definitely Friday the accuracy of the numbers deteriorates somewhat – particularly in a week of options expiration. (If anyone has an idea about how to address this, I’d like to hear about it. Or if they can explain why Google Docs won't show the color formats for the short interest and 52-week high/lows.)

As far as my comments go, I usually won’t discuss financial institutions because of what we observed this week with C and BAC. They are not to be trusted, have no transparency, and are prone to somewhat unforeseen and massive interventions from the Treasury. One could argue that this is exactly the conditions a strangle/straddle is intended to work under but why comment on something that is so rigged? When the sheer number of earnings releases are significant (as this week), I will omit comment on a fair number of them and try to focus on companies with certain flags that signal potential to move - high short interest, low float, historical movement, etc. The other group will be Dow components or companies that the entire market pays attention to.

So with the basic logistics out of the way here’s the table for the week:

Spreadsheet Link

Some intial comments: Thankfully, Monday is a day off this week as the heavy lifting of earnings work begins. Enjoy it. Possibly even reflect, if you're so inclined. The rest of the week kind of paralyzes me though. There are considerably more companies releasing earnings but generally, the options pricing anticipates price movements outside of historical norms across the board and makes me want to issue a blanket "stay away" statement unless legging into a position is a possibility. Keeping that in mind, I'll likely just highlight a few names below and leave it to the reader to use the data presented as they see fit. Perhaps I'll revisit these on Wednesday once the market has provided some new inputs to work off of.

Tuesday: Two Dow components (together about 13.74% of the index) in IBM & JNJ. Looking beyond these two, the options prices reflect significant expectations of volatility. The average downside expectation is -18.5% and upside average is 21.6%! While a few of these companies have moved that much in a single day in the past, that is no guarantee of this quarter's performance. Unless you are able to leg into a straddle, that strategy looks best avoided for almost every single one of the companies releasing on Tuesday. It is possible that this will change by the time the market opens on Tuesday and more attractive contract pricing will be available but be careful. CSX might be notable for indications of rail-freight traffic.

Wednesday: AAPL is probably the name that will garner the most attention. I've insisted for some time that AAPL is a maker of luxury goods in a recession. Throw in the weakness in the stock that reflects Jobs' health and who knows what could happen. It seems incredible that the contracts price in a potential move to 70 in the next month but a look at the chart does not show any real support once 80 is broken. This intrigues me, could this finally be a moment when the true believers throw in the towel or will AAPL again beat sandbagged estimates? AMR and UAUA release and should provide some indicators of business travel and how lower fuel costs have impacted their bottom lines considering they haven't rescinded any of those fees they've piled on during the last quarters. There will also be a 2nd rail indicator with BNI. Finally, DJI component UTX releases.

Thursday: Things get a little more interesting. Two more rail companies in CNI/UNP. A whole slew of financial names: BK, BBT, COF, FITB, MTB, PBCT, STI & SNV. And then some significant tech names: GOOG and MSFT. To top it all off, some volatile darlings like ISRG & POT. This week I really am going to revisit Thursday and Friday on Wednesday since a few of these could be worth commenting on there is a bit more clarity and the time is closer. Stay tuned for then. I will make one comment on SYNA - keep an eye on it since the short interest is monstrous. This could be one where a strangle position is established and both legs increase in value jsut because of IV inflation running into the event.

Friday: See above except to note that GE releases. SLB is perhaps also notable since it is the leader in oil services industry.

Sorry for the wishy-washy stuff this week (again) but the market behaviour in the last week seems to have bumped up the options pricing and confused traders again. Check back on either Tuesday night or Wednesday for some clarity on Thursday's releases.

Keepin' Score (1/12/2009)

As I read through last Sunday’s post, I realized a few things: First, that I was really wishy-washy in my statements and second, it wasn’t my best week. But there’s something to be said for mistakes and analyzing them.

AAI said: “I'm inclined to avoid this one because something about it seems "off" …Downside support would be at the SMA(30)/(50) at 10.15/10.24 respectively and below that around the 9.40-9.50 area.
What happened: Well, it closed on 1/13 at 9.55 but if you were nimble a strangle still could have scored a limited profit since the day’s low was 9.30. I’m going to give myself -1 point on this because the trade could have been profitable and my downside targets were a tad too optimistic.

DNAI said: “… a strangle here doesn't make much sense, it is worth paying attention to as a straight momentum play if it turns out this rumor has any substance.”
What happened: Well, +0.5 points for avoiding the strangle as it never would have paid off.

INTCI said: “It's currently sitting right at the SMA(30/50) 14.26/14.19 and if those levels fail it could eventually slide down to the 12.50 area.…this is another case where a strangle makes little sense on the assumption that a lot of the news is already priced in.”
What happened: This is more difficult because INTC moved quite a bit from the Sunday pricing until Thursday when it hit 12.70. So +0.5 for the 12.50 not being broken but -0.5 since a strangle opened on the pricing on the sheet would actually have been profitable, though you would have had to pull the plug before earnings instead of after. Net 0 points here.

MII said: “that is just about as close to failure as you can get. Plus, the volume ticked up a bit there. Ouch. MI has only once been as volatile as the options contracted pricing implies so again, best avoided as an event play but might be worth a watch as a short.”
What happened: Well, I was right and wrong here. It would have been a great strangle so -0.5 points. But it was also a great short so +0.5 points. Another net zero.

That’s all for the week since I didn’t bother commenting on Friday’s plays. Considering the movement from Monday to Friday I’m glad I didn’t.

Week’s Total Score: -0.5 points
Running aggregate score: +3 points

Friday, January 16, 2009

Four! Four Single Digit Dow Components!

"Ha ha ha ha! "

Now I must admit that bringing out the Count is in response to someone who has told me I don't have any levity or humor on here. Plus, the Count seems so appropriate as our "leaders" - and general populace - seem to be in such dire need of the Count's help in the most basic of areas. This is from the Democrat's stimulus package notes:

"We will provide relief to states, so they can continue to employ teachers, firefighters, and police officers and provide vital services without having to unnecessarily raise middle class taxes."

That this comment has gone unremarked upon just for the yawning gap in logic is commentary enough on the sad state of... well, take your pick. Moving on...

Joining the increasingly less-exclusive club of single digit Dow components was BAC with a stunning two day performance that dropped them from 10 down to 7.13! Well, maybe "stunning" isn't quite right since it can't be "surprising." Perhaps, impressive would be more appropriate. Their achievement finally lifts the velvet rope into the Sub-$10 Club with existing members AA, C, and GM. This could have been a quintet but AIG just became too embarrassing to keep around I guess. Here's a little table of the current contributions of the Dow components as of close today.

It's also kind of a handy table to have in the back of your head for those days when DJI movement doesn't make a lot of sense in comparison to SPX. Also, I do find it kind of interesting the way the mix of companies changes as you move down the table. Nary a financial services provider to be found in that top third.

Sunday, January 11, 2009

SPX Dividends, EPS, & Yield

I've made reference to SPX yields more than once since I've started writing this blog. It's a little more difficult to tackle because I rarely see (or at least haven't found) any "dividend estimates" in the same way that there are earnings estimates. This post will hopefully go some ways to providing context about dividends and yields historically as well as possibly addressing the questions that immediately pop out at me when I look at the chart of quarterly earnings and dividends to the right.

First, why haven't dividends fallen further when both operating (oEPS) and as reported (arEPS) earnings have declined significantly? And second, how far could they fall in the quarters ahead?

The data for this analysis comes from both Shiller and S&P. Shiller's historic data uses "as reported" earnings and S&P provides the operating earnings going back to 1988. When the chart is examined the steady and basically regular growth of dividends from 1962 through about 2000 is fairly remarkable. Then, things start to get a little hairy before resuming a rapid rise to a peak in Q4/07.

So what about the periods of earnings declines and their impacts on dividends?
There are several periods of considerable as reported earnings drops: most are obvious from the chart but also 2H/74 to Q1/75, Q4/81 to Q1/83. Looking at peaks in arEPS during these times, the average fall was about -45%. Interestingly, during these periods dividends were on average flat though this owes to the 1989 period when dividends somehow grew by 14.4%.

That being said, SPX dividends actually peaked in Q4/07 at 7.62, one quarter after earnings had peaked before beginning their current slide. Adding to this odd behavior is that dividends went up from Q3 to Q4 by 10.4% even as oEPS fell by -27% and arEPS slid -48%. Huh. Color me confused. At any rate, dividends are now off a bit over -6% from that peak. So how does this rate from a historical perspective in terms of yield?

Average yield of SPX since 1962 has been 3.13% and the current level with the dividends from this quarter is roughly 3.19%. Just for reference, during that period the 10-year treasury has averaged 6.95% and the average difference between SPX yield and the 10-year has been -3.83%. Currently, that difference is 0.80% and this seems to be the only time between 1962 and today that SPX has yielded higher than the 10-year. So... is SPX cheap?

From one measure - difference between 10-year Treasury yields and SPX yield - I guess so. But like everything else, this depends on some significant assumptions. First, that the Treasury yield will not begin rising (see earlier post for Federal debt requirements in 2009) and that SPX dividends will at least move along with any run up in SPX. From the basic historical average of SPX yield however, this doesn't really mark anything but a return to the average. And it also hinges on the assumption that earnings do not deteriorate further, at least in the near term. The chart to the right shows the 10-year vs SPX yields since 1962. Unfortunately, it would appear that the dramatic decline in SPX is more responsible for the climb in yields than increasing dividends. Or rather more accurately, dividends have not fallen nearly as much as the index (or EPS!).

Thus far the context has been filled in, more or less. Considering how wildly off the estimates for S&P EPS have been in the past quarters, the notion that they now have a firm grip on EPS going forward is umm... naive. Maybe wishful thinking, whatever. Let's assume though that EPS stabilizes at this current level which is approximately in the area of mid-2004 and perhaps increases at a modest rate similar to what I posited back in an earlier post. The 4.1% growth in oEPS would bring this metric up to roughly December 2005 levels by Q4/2009. Dividends at that time were about -15% lower than the current quarter. So if EPS grows at that slower rate, how much cash is available from the balance sheets of the S&P 500 to fund dividends? My guess is not nearly as much as there was before this whole debacle really got started. (I really need to go through the Fed's Flow of Funds report more closely to see if I can find some more data.)

Take what you will from this pile of information. I would not bank on the current level of dividends being sustainable through 2009 without some serious uptick in EPS which I honestly don't expect. Unless I have severely underestimated the stomach of corporations to seriously weaken their balance sheets in a vain attempt to boost share prices, it just doesn't seem possible. What SPX does between 12/31/2009 and today is anyone's guess, but I am expecting to hear about further dividend slashes coming up that will push SPX yield down in the next quarters.

Here's one other of my 2 cent ideas: When you look back at Shiller's entire data set, it looks like there was actually a time when people invested in the S&P for the yield paid rather than sheer capital gains alone. Might the market emerge on the back of that same model? It could make some sense and provide some level of confidence back to the market players.

Earnings Week of 1/12/09

Another Sunday, another look ahead at the week in earnings. This week is still rather slow but there are a couple of Dow components in there so things are about to get underway in earnest. Here's the table:

Spreadsheet Link

Monday: AA starts off the party this week, after the bell. They've already announced pretty drastic personnel cuts and have taken a hit this past week. Historically, AA has not been volatile at earnings with the dramatic exception of last quarter when the max intraday move was -19.8%! And for a Dow component at that. Right now the contracts are being priced for a move to 9.50 on the downside. I'm inclined to avoid this one because something about it seems "off" for lack of anything more quantitative to say. Downside support would be at the SMA(30)/(50) at 10.15/10.24 respectively and below that around the 9.40-9.50 area. One note of trivia: the Friday closing price equates to a Dow contribution of 1.035%, so even if this tanks don't expect it to do much damage to the Dow.

Tuesday: INFY and LLTC. ADRs have long bothered me from the perspective that they are not really beholden to the same rules as direct lists on NYSE/NASDAQ. Whenever I've watched them closely around earnings it's always seemed like someone knew something. Anyhow, while certainly disclosure rules haven't prevented Enrons here in the US, the information was there if anyone was so inclined to actually pay attention. However, look at SAY this past week. Oops. For that reason, I try to avoid any and all ADRs since they always feel gamed. As for LLTC... semiconductor/chip industry and so I take a pass.

Wednesday: Nothing made it through the parameter filter.

Thursday: DNA announces after close. Looking at their chart is intriguing to say the least. It would appear that it has moved into breakout mode on high volume on Friday after breaching the 85 level, apparently on news/rumor of a Roche buyout around $95+/share. This stock has been moderately volatile at earnings, typically moving 3-6% but not much more than that. So while I would say that a strangle here doesn't make much sense, it is worth paying attention to as a straight momentum play if it turns out this rumor has any substance. INTC has already offered lowered guidance this past week and was smacked down a bit. It's currently sitting right at the SMA(30/50) 14.26/14.19 and if those levels fail it could eventually slide down to the 12.50 area. However, this is another case where a strangle makes little sense on the assumption that a lot of the news is already priced in. MI rounds out Thursday. The daily chart is pretty ugly with a move on Friday to 11.37 that is just about as close to failure as you can get. Plus, the volume ticked up a bit there. Ouch. MI has only once been as volatile as the options contracted pricing implies so again, best avoided as an event play but might be worth a watch as a short.

Friday: FHN and JCI. One could argue that FHN is at the bottom of a slightly upward sloping channel. What that means for reaction to earnings is tough to say. It has a decent sized float with moderatly high short interest around 15%. The contracts are pricing for a large downward move... I'm going to take a pass on commenting on this one. JCI intrigues me but considering this is an op-ex week and they announce on a Friday, this will also have to remain without comment (for now). Maybe I'll re-visit it on Wednesday or Thursday since the levels around the current price look like it could be a winner.

Keepin' Score (1/5/2009)

Another round of Keepin' Score, recapping last week. I would rather have had this out yesterday but assorted other tasks intruded. I'm still tweaking and adding to the scoring system I outlined in a previous post so bear with me on that count. Here we go!

MOS - I said: "A favorable reaction to news would bring a 1st (and easily hit) level of about 38 and a 2nd level in the 42 area. A lousy report could send this sliding back to the 30 area from where it began this 20% run to its current 36.86."
What happened: The 38 area was taken out even before earnings by the updraft in the market. Drift after that carried it up to a high for the week of 41.15, shy of the 42 upper level. 0 points for this... the low level was too easily taken out and it didn't get close enough to the high.

MON - I said: " will likely get some sympathy movement with MOS", "...on the upside it will see resistance around 77-78, with an outside chance of recovery to mid-December high around 84."
What happened: +0.5 for the sympathy move with MOS and that it didn't take out 77 at that point. -0.5 points since MON broke above 84 right after earnings with a big gap on a strong market day. I'm going to also give this a 0 total points even though MON did drift back down and only closed one day above 84.

BBY - I said: "...options pricing reflects the historic movement pretty well so barring some cheapening of contracts, this is probably just as well watched for potential break-out given the chart pattern rather than as an earnings play."
What happened: +0.5 point since share price never went above or below the break-even share pricing of 29.25/23.25.

FDO - I said: "FDO doesn't usually move much at earnings however so let's move on."
What happened: Even though FDO didn't get past the upper break even price of 29.16, I am only giving this +0.5 point because it moved more than I expected it to. I suppose if one were brave and/or lucky, buying calls near the low of the day before earnings might have been profitable.

APOL - I said: "...if the break-even pricing for the strangle still reflects what is shown in the sheet, it would be worth playing."
What happened: +0.5 points since a strangle based on the prices in the earnings sheet would have been profitable. But IV inflation did creep in throughout the week so depending on when one would have purchased the position would vary the profitability. One of the downfalls of a Sunday look-ahead I guess.

CVX - I said: "never really moves. Just watch crude."
What happened: CVX didn't really move. +0.5 points.

AZZ/KBH - I said: "Probably best to avoid./Another one that seems not worth the bother."
What happened: Neither one made it past break-even prices. +0.5 points there.

Total score for the week: +2.5 points
Aggregate score: +3.5 points

Wednesday, January 7, 2009

T-Bills, T-Bills and more T-Bills!

A few months ago, in the comments over at Calculated Risk, Nemo started wondering just how many T-bills were being issued by the Treasury and also suggested that adding some charts to illustrate the horrors of issuance would be nice to have. I thought that was a pretty good idea too and decided that perhaps I could actually contribute something to the discourse beyond snark and bile. Over the next few months, I would wait for the Treasury to issue the monthly update and then I would update my spreadsheets. Since then, I started writing things here, so it seemed like a logical place to post them now. The chart to the above-right is the net t-bill issuance since April 2008. All told, between April 1st and December 31st, the Treasury issued $3.37T worth of t-bills. Fortunately, they did manage to at least retire some of them and the net issued as of December 31st was $1.866T. And that $1.866T is all due between January 1st and December 17th, 2009.

The treasury market is not really an area I know too much about and the following two charts are here more for sake of completeness of picture than anything else. The first contains small yield
curves over time. The second shows the falling yields across the curve moving towards the end of the year.

What does this all mean? I'm not really sure but I suspect it means that I don't want to be Obama or Geithner. Further, can the treasury market really digest $1.866T in issuance between now and the end of this year? Or is there another plan for all of these bills? Mr. Jansen at Across the Curve has made a few comments about this topic and today he notes about a failed 10-year Bund auction.

If all of this debt must be rolled, and if any stimulus package must necessarily be deficit spending, what are the impacts on yields? Once again, it should be an interesting year.

Tuesday, January 6, 2009

SPX Bottom Finder

Anyone who knows me, or has sifted through the posts thus far on this blog, will recognize I can be a bit compulsive and have an unnatural enjoyment of working with Excel to find patterns and correlations. Sometimes this is in pursuit of confirming for myself something that I've read asserted as "common wisdom" and other times in trying to test out something I stumbled across that piqued my interest. Here's a chart of my latest investigation and a bit of explanation:

The idea was to create a measure to identify when turning point potential was high. This measure is in the red line. When it is above 0, the risk for a bearish reversal is higher and when it is below the potential for a turnaround to the upside is good. Unfortunately, the meter doesn't seem to provide very good timing on the market tops. However, I did like the bottom indicators. The yellow line is the average reading and the blue arrows in the chart mark out SPX bottoms. (I'll admit there was no particular numerical threshold for selection and it was done on just visual assesment - which I normally dislike.) At any rate, the blue arrows and lines line up pretty well with the lower risk for going long in the red-line meter. I haven't done the returns yet (perhaps a follow-up post this week) but I would be fairly confident in adding this measure to help with confirmation of a bottom. The nice thing about it is that several of the downward moves are very dramatic, which would allow for a quick decision.

Something that troubles me a bit is the current reading. I stated earlier that this meter isn't all that great at timing tops and bear reversals on SPX so it does not make me all that nervous. There is also some residual of the dramatic fall in the last quarter that I believe the indicator is working off, which is resulting in the very high risk reading for a drop.

I'll try to update this from time-to-time as I go along posting and see how it (and myself) performed.

Sunday, January 4, 2009

Earnings Week of 1/5/09

Welcome to the earnings New Year! Earnings releases won't really increase in volume for a few weeks but at the least, the holiday doldrums are behind us. This week doesn't have a lot on offer to scrutinize but I'll go through them anyway. Here's the spreadsheet first.

Spreadsheet Link

Before really getting into it, a few comments. SPX has finally made it through the SMA/EMA(50), on low - but increasing - holiday volume. It is also past the mid-December peak and I could understand how a chartist would comment that there is now a path to SPX 1000, which would be the Election Day high. My 2 cents on this is as follows: the market has shrugged off a relentless stream of fairly horrific macro data. Those macro numbers don't seem to affect any particular company lately. For that, the earnings reports will be needed to see just how much of a pounding specific balance sheets have taken over the holiday season. And so, considering the ability to ignore the awful macro data it doesn't seem too outlandish that SPX could achieve 1000 before the serious earnings call volume begins. Check the Yahoo! calendar for that. The one HUGE caveat that must be repeated: all the last weeks' rally has been on crap volume. So without further rambling...

Monday: MOS announces after close. The break-even values in the sheet will likely change as theta erodes some of the contract's value. However, IV could make up for some of that. A favorable reaction to news would bring a 1st (and easily hit) level of about 38 and a 2nd level in the 42 area. A lousy report could send this sliding back to the 30 area from where it began this 20% run to its current 36.86. While the PE here is in the 5s, the PEG is 1.44, which might be worth keeping in mind.

Tuesday: Nothing made it through the screen.

Wednesday: BBBY, FDO & MON. We'll take MON first - it will likely get some sympathy movement with MOS in the general Ag group. It does have a more dear valuation than MOS and I would guess that on the upside it will see resistance around 77-78, with an outside chance of recovery to mid-December high around 84. A bottom range estimate would be 66 if reaction is negative. Now for the two retailers... BBBY lost what I believe is its primary competition in Linens & Things. (At least, I considered it their biggest competition.) Anyhow, the options pricing reflects the historic movement pretty well so barring some cheapening of contracts, this is probably just as well watched for potential break-out given the chart pattern rather than as an earnings play. FDO is one of a select fraternity of stocks that actually closed out 2008 in the green - that statistic alone should tell you how lousy the economy has been. FDO doesn't usually move much at earnings however so let's move on.

Thursday: APOL & CVX. APOL has been on a tear in the last couple of months, having gapped up 5 points on 10/29 and running up to 78.37 currently. The contracts are priced reasonably and historically APOL has been fairly volatile on earnings day. My concern: given the PEG at 81.7, is the 27 PE sustainable? Further, since it is within 3.50 points of the 52-week high of 81.68, will this be a "sell the news" event? It's hard to just say, "buy the strangle" for this one since it is on Thursday. I would probably say, if the break-even pricing for the strangle still reflects what is shown in the sheet, it would be worth playing. CVX... never really moves. Just watch crude.

Friday: AZZ & KBH. AZZ has a tiny float of 11.7M shares but a similarly low average volume and is in a not very sexy sector of industrial power equipment. Interestingly, in the last 2 quarters, it has been fairly volatile with contract pricing reflective of that. Probably best to avoid. KBH has not been historically volatile around earnings. Another one that seems not worth the bother for earnings.

Thursday, January 1, 2009

Oil Updated (DXO & DTO)

Since I wrote my last post on oil, NYMEX crude dropped from 43.60/bbl to 35.35/bbl before recovering yesterday to close at 44.60/bbl. USO (crude oil ETF) dropped from about 36 to a low of 27.73 and finally closing yesterday at 33.10 with an intraday high of 34.87. It would seem that I was a bit premature in my statement of a bottom in crude prices forming. However, despite the drop below the Dec. 16th closing I would still maintain that crude is in the process of forming a level bottom.

Anyone that follows ETFs is aware that some funds attract more volume than others and many should just be taken out back and shot to be put out of their misery. Crude oil has several ETFs available in the ultra and ultrashort forms but DXO and DTO from Powershares got a bit of a headstart on their counterparts UCO/SCO from ProShares. By dumb luck, the launch of DXO and DTO almost perfectly coincides with the summer peak of crude oil prices. Let's look at some charts:

Most people I know don't actually trade crude on NYMEX so the next best thing available is USO - the crude oil ETF. The behaviour of USO is a little different than a 1:1 correlation due to the contango/rolling effects that impacts the fund. Anyway, USO peaked on July 11th at 119.17 before closing that day at 117.39. From that price to the close yesterday represents a -71.8% loss in value. It would have been even worse had oil not rallied so much on... geopolitical instability perhaps? (More on that later.) Let's move on to DXO and DTO.

DXO is a double-long ETN and DTO is its double-short companion. (I'll leave it to the reader to research the differences between ETNs vs. ETFs) Both of these began trading on 6/23/08 when USO closed at 110.92. DXO opened that day at 24.50 and DTO opened 25.29. Interestingly, there was a significant volume disparity with DXO trading a paltry 1900 shares to DTO's 525k. Very interesting considering what happens next...

Take a look at the 13 period MAs in the volume graph. (Red lines) During the run up to oil's peak, average volume moves up for DTO and maintains a fairly steady pace through September when the volume begins to taper off to its current low levels. DXO on the other hand is a mirror image. Volume is rather dead until very late November when the MA(13) on volume begins to register a few blips of a pulse and then picks up real vigor into December as crude prices continued to plunge and DXO's price, from a summer high of 29.65 tumbled -94% to a low of 1.76 on Dec. 26th.

I believe that the mirror image volume behaviour represents the crude high and low reasonably well. Further, DXO - particularly if you were wise/lucky enough to pick it up around $2 -represents a low-risk entry point.

A bit of a digression: I am aware that double-long/short ETF suffer from value destruction during volatile markets due to their daily rebalancing required to meet their goals of double daily percentage moves vs their respective benchmarks. However, when markets move in a somewhat linear fashion - as crude did falling from its summer peak - the compounded gains using the levered ETFs can be very rewarding. As evidence of that, USO fell -71.8% from its peak and its prospectus states that it attempts to replicate WTI NYMEX pricing. DXO fell -94%. DTO on the other hand was a true winner from its inception, with an all-time high closing price of 160.30 representing a gain of 533%. Shorting USO or DXO would not have delivered these gains.

So, assuming the traders in these ETFs know what they are doing, this would be a signal that crude is nearly at a bottom.

Briefly revisiting the geopolitical instability comment above and at risk of sounding like one of the tin-foil hat fashionistas, I will say this: the governments of Iran, Russia, Venezuela and various other oil exporting states had strengthened themselves via oil revenues and developed budgets with assumptions of oil at a far higher price than the current $40/bbl area. I do not believe it is a big leap to connect the dots between Iran, Hamas and a risk-premium that seems to attach to crude whenever some instability pops up in the Middle-East. My guess is that we will see more of this type of stuff going on in the next year as various governments in these oil exporting states try to maneuver under the pressure of reduced oil revenues. Some of these maneuvers will serve as attempts to drive up the price of crude. Others will simply be defaults like Ecuador's Correa. Should be a fun year!

USO Chart (Yahoo!)
DXO Chart (Yahoo!)
DTO Chart (Yahoo!)