Santa Claus rally, No, No, No?

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Is there any hope for a Santa Claus rally this year? What are the chances the markets could reverse the worst December since 1931?

A Santa Claus rally, which would begin on Monday, is a very specific event. It is the tendency for the market to rise in the last five trading days of the year and the first two of the New Year. According to the Stock Trader’s Almanac, it is good for an average gain of 1.3% in the S&P since 1950.

What caused the Dow Jones Industrial Average to have its worst week since the financial crisis in 2008, down nearly 7 percent and cause the Nasdaq to close down into bear market territory?

  1. The Federal Reserve’s rate hike on Wednesday drove the losses this week and investors were hoping for a more dovish tone regarding future rate hikes. Despite the fact that Chairman Powell reduced the projected number rate hikes from three to two and reduced the neutral rate to 2.8% from 3%.
  2. In my humble opinion, President Trump is partly to blame for the severity of the losses this week due to his criticism of the Fed.  He backed Powell into a corner and forced him to show that the Fed is an independent institution. (the Fed could have put more emphasis on being data dependent) According to some reports, Trump has also discussed firing Powell privately because of his frustration with stock market losses in recent months.
  3. In an extensive interview at the White House on Thursday, Trump’s trade adviser, Peter Navarro said that it would be “difficult” for the U.S. and China to arrive at an agreement after the 90-day period of talks unless Beijing was prepared for a full overhaul of its trade and industrial practices.
  4. Political chaos in Washington with partial government shutdown, sudden withdrawal of troops out of Syria and the resignation of Defensive Secretary Mattis.

Investors are still worried about:

  • A slowdown in economic growth as more companies scale back their sales growth and profit outlook for 2019
  • Fear that a flat yield curve will invert if the Fed continues to hike short-term interest rates
  • The unwinding of the Fed’s balance sheet will reduce the availability of credit for corporations
  • The trade war with China will escalate causing more inflation
  • More economists are jumping on the recession bandwagon for 2020
  • Political chaos in Washington will get even worse when the Democrats take power in January

A dead cat bounce is a possibility in January

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dead cat bounce is a small short-lived recovery from a prolonged decline or a bear market that is followed by the continuation of the down turn. You need nerves of steel to trade a dead cat bounce but for long-term investors it could be a good time to reduce market risk and re-balance your portfolio.

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U.S. Politics interfering with my financial blog

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It has been a couple of months since my last blog post. Upheaval in U.S. politics makes writing a financial blog very difficult. Who wants to read about financial issues when history is being made in U.S. politics.

I was in University during Watergate and watched as President Nixon was forced to resign. I remember his famous speech “I am not a crook.” Could history repeat itself with another President leaving office in disgrace?

According to the Washington Post, Trump has made 6,420 false or misleading claims over 649 days. Fact checking departments have been working overtime trying to keep up will all the misleading claims made by President Trump. The King of lies has been dominating all forms of media.

No collusion with Russia, yet 16 people have interacted with Russians

  1. Former Trump campaign chairman Paul Manafort
  2. Senior Trump campaign official Rick Gates
  3. Former national security adviser Michael Flynn
  4. Trump’s son Donald Trump Jr.
  5. White House senior adviser Jared Kushner
  6. Trump campaign adviser George Papadopoulos
  7. Former Trump campaign adviser Carter Page
  8. Former Attorney General Jeff Sessions
  9. Trump campaign official JD Gordon
  10. Former Trump campaign adviser Roger Stone
  11. Former Trump campaign aide Michael Caputo
  12. Trump associate Erik Prince
  13. White House official Avi Berkowit
  14. Former Trump attorney Michael Cohen
  15. White House senior adviser Ivanka Trump
  16. Trump business associate Felix Sater

Less than two years into Trump’s presidency, his business associates, political advisers and family members are being probed, along with the practices of his late father. On Friday, Interior Secretary Ryan Zinke became the fourth Cabinet member to leave under an ethical cloud.

His former campaign chairman Paul Manafort is in jail. His former attorney and “fixer” Michael Cohen is headed behind bars next year. His deputy campaign chairman Rick Gates is now a confessed felon. George Papadopoulos, a former member of his foreign policy advisory board, just got out of jail after flipping. His former national security adviser Michael Flynn may only avoid prison after turning on his former boss.

More inquiries into the Trump’s campaign, Trump’s transition, Trump’s inaugural committee and Trump’s presidency are now under active criminal investigation. The Trump Organization and his Foundation are also under civil investigation. Trump University has already been deemed a fraud.

Now that the Democrats have control of the house of representatives, more oversight will spark even more investigations of the Trump administration in 2019. No end in sight to U.S. politics dominating all forms of media.

Hoping to get back to writing about financial topics soon!

 

 

Blame Yellen and Trump for rapid raising U.S. interest rates

  

I believe that the former head of the Federal Reserve, Janet Yellen, is partly responsible for rapid raising U.S. interest rates. Although, GDP growth wasn’t overheating during her term, she could have started to unwind the Fed’s balance sheet which had 4 trillion dollars’ worth of treasuries. Instead she bought more treasuries after they matured and expanded the balance sheet by buying more treasuries with the interest earned.

This kept long term interest rate extremely low and allowed corporations to borrow money at low rates to buy back their shares. The Fed’s lack of action has help fuel the longest bull market in history.

Sorry Trump supporters but your man is also to blame. His policies are inflationary!

  1. The trump’s administration decision to pull out of the Iran deal has cause oil prices to rise. One million barrels of oil a day is being taken off the market.
  2. Trump’s tariff war with China and other trading partners will force corporations to increase prices because their costs are going up. Costs could go up even higher if Trump increases tariffs on imports from China from 10% to 25% in January 2019
  3. The corporate tax cuts and government spending has juiced the economy causing unemployment to fall to the lowest level in nearly fifty years sparking fears of raising wage growth.

The Trump’s administration spin that the tax cuts will pay for themselves is simply not true. Both the Reagan and Bush tax cuts added to the fiscal deficit.

The new Fed chairman, Jerome Powell has a difficult job of unwinding the Fed’s balance sheet by buying less treasuries just as the federal government is issuing more debt to cover the Trump’s tax cuts. Trump will add another trillion dollars to the deficit. More supply of treasuries plus less buyers equals raising interest rates.

Trump blaming Powell for the massive drop in the stock market last week is ridiculous. No one knows for sure what caused investors to hit the sell button. Was it fear of raising interest rates, a forecast of slower global growth by the IMF, fear of an escalating trade war with China or fear of runaway inflation.

My guess is all or none of the above. Maybe the stock market was just due for a correction.

 

 

 

 

Why Trump’s zero tariffs & zero subsides is a pipe dream

Trump campaigned on getting better trading deals starting with the renegotiation of NAFTA.  The loss of U.S. manufacturing jobs is the main reason that the Trump administration has criticized NAFTA and other trade deals. According to the CFR, the U.S. auto sector lost roughly 350,000 jobs between 1994 and 2016. Many of those jobs were taken up by workers in Mexico, where the auto sector added over 400,000 jobs in the same period.

A few reasons why zero tariffs alone don’t work

  • Labour intensive manufacturing will tend to locate where employee wages and benefits are the lowest.
  • Local and federal tax rates are another factor when it comes to plant locations.
  • Input costs like regulations, transportation and power rates are just a few examples of factors in plant location considerations.
  • It makes economic sense to locate near the biggest market for the product or service.

Bottom line, can the Trump administration force China and Mexico to pay $25.00 a hour to assemble cars? Are American consumers willing to pay an extra $1,400 to $7,000 for a new car if Trump imposes 25% tariff on the auto sector? How about $3,000 for a new I-phone that is made in America?

For argument sake, I do believe that reducing tariffs among developed countries does make sense. However, the other problem is fluctuations  in currencies which governments in general have little or no control over. For example, only yesterday, President Trump doubled the tariffs on Turkish steel and aluminum because of the drastic fall in value of the Turkish lira.

The hard fact is zero tariffs are not feasible and corporations are not patriotic. Corporate executives are more concern about keeping their shareholders happy and ensuring a very generous executive compensation package. Wage growth in the U.S. has been stagnant for many years and there are no signs that the corporate tax cuts have trickled down to employee wages.

Is eliminating government subsides even possible?

My short answer is no. The great recession of 2008-09 would have turned into another great depression if governments’ world-wide didn’t bail out their troubled banks. How many jobs would have been lost in the auto sector if the U.S. government didn’t bail out Chrysler and GM? (Does too big to fail, sound familiar)

Severe weather conditions make it difficult for governments to get rid of agricultural subsidies. Plus, governments can use subsidies to ensure that farmers produce the right amount of crops or meat to serve their population. There is also a safety issue and a cost benefit to using your own food sources rather than relying on importing food from other countries.

I could go on and on with other examples of industries that require some form of government help. Not all subsides are bad. Think about the millions of people who use public transportation. How expensive would it be, if it wasn’t subsidized by government?

All comments are welcome!

 

 

 

 

 

 

 

 

 

 

 

 

Trump criticized the Federal Reserve’s interest-rate increases, it’s the economy, stupid

President Trump blasts the Federal Reserve’s interest-rate increases last week, breaking with more than two decades of White House tradition of avoiding comments on monetary policy out of respect for the independence of the U.S. central bank.

The Fed has raised interest rates five times since Trump took office in January 2017, with two of those coming this year under Chairman Jerome Powell, the president’s pick to replace Janet Yellen.

“I am not happy about it. But at the same time I’m letting them do what they feel is best,” Trump said. In the interview, Trump called Powell a “very good man.”

Since 1977, the Federal Reserve has operated under a mandate from Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”, what is now commonly referred to as the Fed’s “dual mandate.”

The GOP’s tax cuts put the petal to the metal in an already accelerating U.S. economy. The unemployment rate which was heading lower got some extra juice. A 4 percent unemployment rate is very close to the Fed’s goal of maximum employment. However, wage inflation hasn’t show up yet as corporations are increasing dividends and buying back shares instead of increasing employee wages. (So much for trickle-down economics)

The real threat to the U.S. economy is inflation which has started to rear its ugly head due to a rebound in oil prices. The Fed is concern that the Trump administration’s use of tariffs to get better trading deals from all its trading partners will eventually lead to higher inflation. The Federal Reserve can let inflation run a little hotter temporally but it may be forced to accelerate interest rate increases.

Powell addressed Congress last week and told lawmakers that “for now — the best way forward is to keep gradually raising the federal funds rate.” Fed officials have penciled in two more hikes this year. That is one more rate hike then when Yellen was heading the Fed.

The probability that investors assigned to a Fed rate hike in September was little changed near 90 percent after the president’s remarks, while the probability of a December hike was also holding near 65 percent, according to trading in federal funds futures.

Will tariffs clause more inflation and or job loses?

The impact of tariffs takes time to make its way through the economy. Corporations will try to pass on higher input costs to their customers. Higher prices could lead to a decease in sales, causing corporations to cut costs by reducing their work force.

In my humble opinion, it all depends on the amount of the tariff. A 10 percent tariff will add to inflation but a 25 percent tariff will clause job loses.

Case in point, American farmers are feeling the pain of increase tariffs levied by U.S.  trading partners.

Trade conflicts “are having a real and costly impact on the rural economy and the ability of rural businesses to keep their doors open,” said Wisconsin Senator Tammy Baldwin, a Democrat, asking Trump to develop a farm plan. “Without prompt action, we could lose farmers and the rural businesses they support and depend on at an even more rapid rate.”

The Trump administration announced that it will deliver US$12 billion in aid to farmers who’ve been hit by dropping prices for crops and livestock amid a burgeoning trade war in which agriculture is a main target for retaliation against U.S. tariffs.

I am confused, Trump wants U.S. trading partners to eliminate all tariffs and subsidies. Yet, he is threatening more tariffs and providing more subsidies.

 

 

Option traders are benefiting from trade war fears

Last year was among the least volatile in the history of the stock market. The VIX which measures market volatility averaged a little over 11 for 2017. It was the lowest level for the index since it was introduced in 1986.

Fear is back in the markets as talk of tariffs dominate the financial news media. Choppy markets increase option premiums so it is a good time to write options. The reward for giving someone else the option to buy or sell something has gone way up this year.

Option-writing strategies range from conservative (covered calls and collars) to extremely risky (naked puts). With the virtually unlimited variations of strike prices and expiration dates available, investors can customize their risk/reward parameters with remarkable precision.

Here are three common option strategies that can generate income or limit losses from an investment portfolio.

1. Covered calls and collars

The most common, conservative way to take advantage of rich option premiums is to write call options on securities you already own. If you’re invested in stock funds, you can write on stock indexes although the premiums are generally less than on individual stocks.

For example, say you own 100 shares of Apple at $190.00 and you wanted to generate some income.  Selling a call option expiring on Aug. 17 to buy 100 shares of Apple at the strike price of $195 provides $3.40 of income. That amounts to a 1.7 percent return on a monthly basis, roughly 20 percent annually, assuming you can repeat the process for 12 months.

The risk in the strategy is that the stock rises significantly and your shares are called away at the strike price. In other words, you limit your potential upside from owning the stock in return for the premium income you receive. The option premium also provides a small cushion against losses, but if the stock or index falls dramatically, so will the value of your holdings.

If investors want downside protection, they can buy puts on the position simultaneously. A collar, often called a costless collar, is a strategy that uses the premiums from writing call options to purchase out of the money puts that limit the downside risk on an investment. In the Apple example, you would sell one $195 call option for $ 3.40 and use the money to  buy one Aug 17 put at 185.00 for $3.30

Two things to keep in mind:

  1. The longer the term on a call option, the more premium you’ll receive, but the greater the risk that your investment is called away.
  2. Single stock options pay better premiums than those on an index such as the S&P 500. They are also riskier and more volatile.

2. Straddles are for speculating on short-term price movements

Option straddles are not writing strategies that generate premium income, but rather pure plays on volatility.If an investor believes that a stock or index is going to have a big move either up or down, a straddle can help them benefit from it while limiting the potential risk. The strategy involves buying a put and call option with the same strike price and maturity on a single security or index.

The chart below is the three month price movements of the Dow Jones index which has been very sensitive to fears of a trade war.

For this example I will use the  Dow Jones index (DIA) which closed at 249.30 today so you could buy one Aug 17 $250 call option for $3.10 and one Aug 17 $250 put option for $4.15

Option traders hope that one of the options expires worthless and the other results in a windfall. The worst-case scenario is that the underlying index doesn’t move at all and both options expire worthless. You lose your entire investment in that scenario. The break-even point is when the value of one of the options equals the cost of buying the two contracts. We could get lucky and sell the call option if the Dow suddenly moves up in a short period of time and sell the put option if the Dow moves back down just as fast.

3. Writing cash secured put options or writing put spreads

Financial advisors agree that writing put options when you don’t have the cash to fulfill the contract, is a recipe for disaster. That doesn’t mean you have to avoid writing put option contracts. But you do need to have the cash to buy the shares if the market falls and the option is executed by the buyer. The advantage of writing puts is that they generally carry higher premiums than call options do.

For example, you may like Apple stock but are worried that it’s overvalued at $190. If you write a put option with a strike price of $180, you get the premium income and the opportunity to buy the stock at a lower price.

A put spread is used when you don’t have the cash to buy the underlying stock if it falls. For example, you may not have the money to buy 100 shares of Apple but you think the stock price is stuck in a trading range around $180 to $190. You could sell the Aug 17 $180 put option for $1.95 and buy the Aug 17 $170 put option for $0.70 and net $1.25 if both option expire worthless. The caveat is that if Apple tanks, your potential loss on the contract is limited since you bought put protection at the $170 strike price.

Options are powerful tools that carry embedded leverage and are riskier than owning the underlying security. Premiums are richer now because volatility is higher. Buy a call option and it could become worthless overnight after a bad earning release. Sell a naked put and your potential losses can be catastrophic. Most financial advisors suggest that buying or selling options should be left to experts.

I believe that an investor with a good understand of simple mathematics and the willingness to learn can use options to protect their portfolios and earn some extra income.

Disclaimer: The option trades listed in this post are for educational purposes only and recommendations.