Another warning sign that the Fed’s printing machine might be leading to dangerous conditions and unintended consequences, junk bond yields have hit an all time low.
http://online.wsj.com/article/SB10001424127887324744104578470812182691622.html?mod=trending_now_1
The SPY busted through the 159.75 level into new ground with a strong advance on Friday, closing at 161.37. The only negative would be that the SPY closed just under the midpoint of the day.
Many stocks are at fair value or overvalued at this point. A couple that we think are undervalued for the long term are NOV and CAT. We have positions in both. Both stocks are out of favor at this time so there could be more downside.
A friend asked me today what a forward contract is. Here is a brief summary:
A “forward contract” is a private agreement between a buyer and a seller that calls for the delivery of an asset at a future point in time with a price agreed upon today. A futures contract is the same as a forward contract but it is traded on an organized exchange with standardized terms.
To put it in simple terms, ordering pizza to be delivered is a forward contract. The customer and the restaurant agree that the customer will buy the pizza at a specific price at a future point in time (“around 30 minutes”). When the pizza arrives, the customers has to accept delivery of and pay for the pizza, even if the customer found an advertisement for a cheaper pizza elsewhere.
In a forward contract, both parties are legally committed and cannot get out of the commitment. However, one party can enter into a new, offsetting forward contract to unload their end of the commitment. As an example, if the buyer of the pizza decided they want to go out for dinner instead, they can establish a forward contract with their neighbor. When the pizza arrives, they pay for it, accept delivery, then deliver the pizza to the neighbor and get paid from him (or her). Maybe if they are good negotiator they could even have made an extra dollar or two!
In a forward contract, each party is subject to the default of the other. So in the pizza example, when the pizza arrives and there is no one there to pay for the pizza, the buyer has defaulted.
If the contract was on a futures exchange there would probably be something called a daily settlement. For each contract there is an initial margin, which is the amount that must be deposited on the day the transaction is opened and a maintenance margin. The maintenance margin must be maintained every day thereafter.
Those are the basics.
(parts of the pizza example were summarized from “An Introduction to Derivatives and Risk Management” by Don M. Chance and Robert Brooks)
The SPY closed at a new high, barely edging the high from April 30 and April 11. This is now the third attempt to crack the 159.75 level. The market has bounced off the 154 level three times in the last few weeks and refuses to break down. The market closed right at the high. Tomorrow will be interesting.
Margin Debt Nears Record
Check out Dave Wilson’s chart of the day. Margin debt in March was at the second highest level ever, checking in a $379.5 billion, just shy of the record set in July of 2007 when it hit $381.4 billion. July 2007 was a few months before the market tanked.
REGI explodes to upside
Renewable Energy Group (REGI), a stock that we previously owned and liked in the low $5s, topped the $11 mark today. We exited our position around $7, which was good for a very nice gain, but should have held it, as evidenced by the recent price action.
Market ends down for the week
The market ended down 2.1% for the week, hit by weak profits, falling commodity prices, fears about China, and the Boston Marathon bomber.
Highlights from Barron’s Big Money poll
1. About 1/3 of money managers expect the DJIA to get to 16,000 by the middle of next year.
2. 74% of managers consider themselves bullish or very bullish through December of 2013, this is a high percentage.
3. 86% are bullish on stocks for the next 12 months.
4. 94% like what they see for the next five year.
5. Managers are skeptical about gold, bullish on commodities longer term. Bonds and cash have few fans. Europe is out of favor.
Gold Miners
Barron’s ran a piece by Andrew Bary this week writing that gold miners are so hated that now might be a good time to get in, echoing our comments of April 15.
BDCs
Barron’s also wrote about business-developments companies (BDCs) this week. Both Ares Capital and Golub Capital, two companies we like, were listed in a table titled “Best Bets on BDCs”.
The market got crushed today, dropping 2.30%. The VIX spiked by 43%, the most ever in one day. Commodities, especially metals, continued in free fall for the second straight day and hurt the market early on. The market was down about 1.35% when terrorists struck the Boston Marathon with a couple of bombs. The market would drop about 1% more after that.
Our comment on April 5 that gold might have had a false breakdown turned out to be wrong. Gold was strong for two more days but then finished on the low on April 10th. That would have been the signal that gold was headed further down. Gold collapsed two days later. But we also wrote on April 5, as well as April 4, that there has been a change in behavior in the market and remarked about the increase in volatility. For the first time, a couple of commentators even wrote today about the end of the bull market that started in 2009. Wow. We will have to see where the market takes us from here but a correction is long overdue.
If you have the guts, now is probably a good time to begin accumulating a position in the metals and miners and then dollar cost average down. The best trades are always the hardest trades. We like PAAS and AUY (but there might still be significant downside from here).
CHART BREAKDOWN
Look at the shaded ellipse from April 10 to April 12. It looks like a possible top. The market finished strong on April 10, opening at the low and then finishing at the high. On April 11, the market opened at the close from April 10th, pushed higher but closed at the midpoint of the day. The close was more than two standard deviations above the 20 day moving average. then on April 12, the market pushed lower, but it closed above the midpoint. Had the market closed lower that day it would have been more bearish. Closing above the midpoint might even be considered bullish, but the massive dropped today negated that. I would guess that the April 11 high was some kind of top, but it might just be a short term top.
Ron Johnson, the former Apple superstar is now the former JCP CEO as he was released yesterday. Johnson tried to turn the mundane and declining JCP into “America’s favorite retailer” with hip mini-stores throughout the JCP space. Unfortunately, consumers didn’t buy it. Johnson chased away the former customers and never attracted a new set of customers. If you weren’t in the investment industry, you would have no idea about the new JCP.
To just about every American consumer, based on years of conditioning from walking around malls since the 1980s, JC Penny was still JC Penny, and consumers were not going to just suddenly start shopping there. I actually checked out a JCP in February, and it looked the same to me.
Johnson also made a huge error by rolling out the change across the entire chain at once, instead of testing the concept in a smaller sample of stores. You just don’t change an entire concept overnight without testing it.
Chuck Mills, the former football coach, once said, “I give the same halftime speech over and over. It works best when my players are better than the other coach’s players.” And therein lied the big problem. Many thought that the magic Johnson had at Apple would translate to JCP. But JC Penny was no Apple.
Today I read the paper titled “Liquidity as an Investment Style” by Roger Ibbotson, Zhiwu Chen, Daniel Y.-J. Kim, and Wendy Hu. The paper argues that liquidity should be considered as an investment style, similar to value/growth, or size (large cap/small cap).
The paper finds that buying stocks with less liquidity is more favorable than buying stocks with greater liquidity. Furthermore, numerous studies have shown that value stocks outperform growth stocks, but when adding in a liquidity factor, less liquid value stocks will outperform more liquid value stocks.
The market had a big sell off early in reaction to the unemployment report, but staged a strong rally from that point and ended close to the high of the day, just edging above the low from the previous day. As we wrote in the 4/4/13 report, there has been a change in behavior in the market. The high less low spread on the DJIA was greater than 150 points two times this week, indicating that volatility has been picking up. Volatility often rises before a downturn. On the other hand, lots of people are looking for a downturn, which might minimize the pullback or even hold it off.
HOUSING
On the 3/25 we wrote about the diminished prospects for landlords that are still purchasing single family housing now. The Journal ran an article on this today, Jed Kolko, chief economist for the website Trulia stated “Yesterday’s investors make it harder for tomorrow’s investors to get the yields they want. All the investor activity has boosted prices and added to the rental supply, which has flattened rents.” The article did also talk about markets where the math still seems to work.
GOLD
Gold had a strong day and, after falling through support the last couple of days, rallied back above, indicating a possible false breakdown.