Author Archives: thedopieschron
Playing off of my last post on mutual funds, I wanted to say something about diversification. Wall Street, FA’s, and basically anyone involved with finance has increasingly banged into us the idea of diversification. It’s the old theory of “don’t put all your eggs in one basket”. While this is a great way to reduce risk, it’s also a great way to put a ceiling on returns. Take a minute to think about some of the richest people in the world, many of which happen to be in finance. Bill Gates–Microsoft. Carlos Slim–Mexican Telecoms. Warren Buffett–Berkshire Hathaway. The list is long as fuck, but you get the idea. All these guys were/are FAR from diversified. They focused on one area, and crushed it. While diversification is good for someone who can’t afford to lose, it’s not very useful for those looking to really make some money.
Why do you invest your savings? Not to have the smallest losses, but to have the biggest returns. If you hand your money off to a broker who is WILD good at trading options, why would you want him to invest some of your money in commodities? This isn’t to say you shouldn’t keep some money invested in safe assets, such as Treasuries/gold/low-volatility currencies, but if you think the tech industry is going to skyrocket, what’s the point of having 50% exposure to tech stocks and 50% exposure to say, utility stocks? Like life in general, you should stick to what you’re good at with investing. You can’t allow emotions to dictate your trades, and you can’t be good at every strategy. Speaking of which, just handed in some homework for an econ class, part of which was a problem about diversification. If I split my exposure to half China and half US, my expected utility is greater than just investing in the US! Dope! I think Jing Zhang woulda been pissed if I wrote “fuck that” as my answer.
During my job this summer I kept a notebook and wrote about 3-5 pages of notes each day. The thing is about 200 pages front and back and I got to about 170 by the end of it, so there’s a shitload of my thoughts on paper. It’s funny reading some of the earlier notes compared to my later ones. One of those things where you go into the summer thinking “alright I know a solid amount let’s crushingtons”. Then you end the summer and all you can think is “wow I learned so much… and I didn’t know DICK coming in”. But ya I’m gonna start posting some of the better notes I took and maybe see if my opinion has changed since.
This note is from one of my last days when I was having a conversation with my boss about different types of careers. We started talking about mutual funds, and how they differ from say, a broker like him. To preface, my boss is an extremely hard worker, the kind of guy who gets 4 hours of sleep a night because he’s got trade strategies running through his head non-stop. More than that, he’s extremely old school. Doesn’t pay attention to P/E ratios or any technical indicators like that. And to his defense, he’s good as HELL at what he does… making money for other people. But back to my main point, he has a strong anti-mutual fund opinion. And here’s why.
Let’s say you want to get into bonds right now. While there are tons of strategies you can use for bond exposure, the two most basic are buying your own bonds straight up or investing in a bond fund. For most people, the latter means your broker will purchase shares in whatever bond mutual fund it is you want. Right off the bat you should notice something. You’re paying a broker to manage your money, but the asset you hold (shares of the bond fund) is being managed by someone else entirely. Seems stupid to me at least.
The next issue is the mutual fund managers’ motives, which have to be tilted toward the fund investors. Most investors who want to get into a bond mutual fund are curious about one thing: what is their yearly return? When you buy your own bond(s), you know the YTM, call protection status, maturity date, etc. All of these things let you know exactly what your total return is, not just what your coupon rate is. If you’re not following, this is what I mean. An investor buys into a fund because he sees it gives a 5% semi-annual return, in other words the fund’s structure is made up of 5% coupon bonds that pay every 6 months. This sounds great to the investor, but the actual return isn’t going to be 5%. If all the investors care about is that 5% coupon, the managers will have no problem paying premiums on those bonds when structuring the fund just to get that 5% coupon (not a 5% YTM). So in reality, when you sell your shares or the fund closes you won’t be making a total return of 5%/6-months.
The last part shows how mutual fund management can be bad (obviously there’s a ton of good mutual funds out there with great managers, but I’m speaking in general right now). The main goal of the fund is that % return, while brokers and FA’s must also worry about their clients retirement goals, whether or not they need to send kids to college, etc. So, mutual fund managers can apply one single strategy to every investor, whether or not that strategy applies to that investor. The managers don’t have to speak directly to the investors, and only have to worry about the structure of the fund (making sure they’re solvent enough to pay out investors who want out). In the end, mutual fund managers don’t have too much incentive to actively manage the fund for higher returns. They know that they can load up on coupon bonds paying out what people want, and that’s good enough. I’ll expand on that point in my next post.
The last problem goes back to the fund structure. Money is always coming in and going out of these funds. Therefore, the structure of the fund is always being changed (i.e., diversification %, maturity structure, etc.). Unlike a broker, where you know exactly what you hold at all times, it’s much more difficult finding out the funds exact holdings, and therefore your own holdings (as a % of the fund). All in all, it’s a pretty lazy way to invest your money. There are plenty of ways to find higher returns, more income/cash flow, or whatever your personal strategy should be.
Obviously protestors have to do absurd things to get national media attention, but this guy is outrageous. We’ve now found out he was lying about the house thing, but just imagine we didn’t know that (everything else is true I guess). It’s a wonder that people got on this guy’s side so hard. If you go to GWU law school, and your parents are obviously well-educated/probably rich, why was your house taken away? I can’t imagine they just stole your home if you were on-time with your payments. I realize at times some of the stuff I say may seem cold-hearted and make it look like I lack empathy, but like… I get it. It’s sad that so many people lost their jobs/homes and it’s a very shitty deal. But you can’t blame corporations for trying to survive, and banks for taking back their property (that’s why you get a mortgage) when you don’t pay them. It’s real world shit. Things don’t always go as planned. Now obviously he was lying and his parents are good on their mortgage, but just b/c I (and a LOT of other people) don’t agree with you it doesn’t mean I’m a cold-hearted bastard. And just to reiterate, corporations are one of the best things about the US. They’re rich enough to be able to pay great wages/salaries. They cover medical expenses for the majority of workers. And they care so much about their reputation to the point where they don’t want to fuck us over. Why do you think you see so many product recalls on the news? A company hears one case of a faulty product and BOOM–recall. Whether you can admit it or not, we’re kept extremely safe compared to the rest of the world. Protestors, you’re what the French call les incompetents.
Here’s a non-partisan, rational analysis of the #OccupyWallStreet demands. It’s literally spot on. And BI usually rubs me the wrong way. If you wanna be taken seriously and “open up discussion”, then come to the table with some facts and not this blanket smear campaign. Nobody is out to get us. Yes, in general corporations care more about money than anything else… that is the reason for their existence. Short/quick read
Sarkozy: Do we know what we’re doing? Merkel: Shut the fuck up…
About two days ago I had a friend ask me for some help for an interview he’s got coming up. The guy he’s been connecting with sent him one of his weekly write-ups about the current economic/market conditions and told him that’s the sort of thing he’d have to start knowing. Here’s basically what I talked to him about (this will be a long post, I’m trying to be in-depth so anyone can follow).
For starters, the sovereign debt crisis in Europe is the most important thing going on right now. I’ll get into how it affects the US in a minute. Greece is the most likely default case of anyone right now, as CDSs on greek debt have about a 450 bp spread (i.e., expensive as shit to buy those CDS’s, b/c there’s a very high probability of default). The ECB/IMF/EFSF (European Financial Stability Facility) are continuing to pump money into its bond markets, as well as Italian, Spanish, and Portuguese bonds. Whether they think Greece will ever be able to repay this debt is almost irrelevant (they won’t), so these cash flows are being used to keep rates from ballooning and to stop a full on default. Worst case scenario is Greece defaults, which triggers CDS payouts (not good for the US), margin calls, and significant flight from European sovereign debt. The last part of course could see defaults by more important countries such as Spain and Italy, but that is less likely (I refuse to say highly unlikely b/c as you can see this shit has never really been seen before). The main problem is European banks, who hold a huge amount of these sovereign bonds. If we see a restructuring of sorts, or huge drops in bond prices, these banks will have to make enormous writedowns. After this, further possible events include major drops in equity and bond prices of these banks as investors flee from fear the banks will have liquidity, or even solvency issues. This of course is a classic self-fulfilling prophecy: investors fear they’ll lose big from these banks, so they dump them, which of course causes the actual problem they feared in the first place.
The US comes into this directly in two ways. First, US banks have written a colossal amount of CDS’s for European banks over the past 3-4 years. As of early July, we’ve sold $34 bln, $54 bln, and $41 bln in Greek, Irish, and Portuguese debt CDS’s alone. That’s not even counting CDS’s on European banks. If there’s widespread default (again, unlikely, but possible), then the US will be losing BIG on those payouts. The second way is economic rather than financial. Europe is one of our main trading partners, and if they enter a recession (probably will), we’ll be taking a big hit in export losses and possibly face import shortages as production slows down there. This also ties into emerging markets (esp. China), as expectations are quickly rising that we’ll see a pretty hard landing in a year or two. In other words, nearly every country is facing stagnant (or negative) growth for a few years, which… is bad.
For those who’ve wanted to actually stay in a good mood, and therefore haven’t watched the news in awhile, the main political/economic topics right now are the US debt level, and our struggling economy. Before I get into this, let me make on thing clear: you cannot solve a debt crisis in a recession. Whether or not the media/politicians have been playing up the debt situation, I really have yet to see any issues arise from the ACTUAL debt level itself. Obviously the track we’re on is unsustainable and blah blah blah, but I’m talking over the course of a couple years. Our gov’t is having no trouble at all borrowing money; the 10YR Treasury is still sub-2%… from a buy&hold/investment standpoint that is absolutely outrageous. It just goes to show that when the world is freaking out, everyone looks to the US.
As much as I hate to say it, the real issue is the political system. I’m not saying we need to raise taxes or cut spending or whatever the buzzwords are right now, I mean the political process is absolutely KILLING our economy right now. It took over half a year for the debt limit to be raised, literally up to the last possible moment. The next day, BAM! Equities plummeted and Treasury yields approached record lows (and to my utter disbelief, reached those lows a few weeks later). This of course wasn’t expected, as the pundits had been chirping “yields will pop as the world realizes we can’t repay our debt!”. Bull. Fucking. Shit. This isn’t a series of graphs relating debt levels to interest rates or whatever, this is real life. What’s more, we have an entire year before election season, and you can bet your sweet ass no politician will be willing to make the tough decisions if it means pissing off their voters.
The debt ceiling squabble was one of the most atrocious displays of leadership I’ve ever seen, and I’m not exaggerating. The hard decisions weren’t even close to being made. If I remember correctly, we raised the debt ceiling by about $1.5 trillion and promised to cut about $2 trillion over the next 10 years. I don’t even have to do the math to see that $2 trillion over 10 years is a joke when we’re projecting a $1.5 trillion deficit in 2011 alone. If anything, all we did was push the decisions off for another few months. The debt level itself isn’t the immediate issue, it’s the perception that our leaders are unable to make the necessary decisions to get the US on the right path.
This perception is twofold. On one side we had non-stop political bashing occurring all summer long, with both sides bickering over what should be cut, what’s off the table, and who’s to blame for our national debt’s recent surge. On the other side, we have a country who is on the brink of relapsing into recession (sidenote: I don’t know why, but I think the term double-dip is so fucking stupid). Unemployment is STILL above 9%, and won’t return to normal levels for awhile. What’s more, I believe the drop we’re seeing in equities is due to people realizing the Fed has run out of bullets. Which is another way of saying that their policies aren’t doing what they said they would. Rant:
Let me get this straight. The Fed is making sure rates stay low, which is a good thing to have. But jesus christ have you not opened your eyes? I’m usually agree with the Fed/Bernanke, but what the fuck. Rates are at all time lows! And nobody is borrowing! Not only are rates at all time lows, but they’re there without your doing. People aren’t arbitraging Treasuries, they’re using them as a bank. If we have another international recession, Treasuries are gonna continue to be the safest asset. So what is the point of more bond buying? Does buying the 10YR down to 1.85 from 2 and the 30 from 3.1 to 2.9 really do anything? Rates are there. Save the ammo. God damn.
Alright back to the main point, bulls are currently pointing to corporate profits and equity levels as the main reason why we shouldn’t end up in a recession. I think that that is exactly why we’re entering a recession. Corporations are preparing for the worst by hoarding cash and laying people off. The majority of them will weather the storm to come, but people as a whole are left out to dry. If everyone is scared to lose their job, they’re gonna take whatever pay they get and hold onto it. Which, ya know… doesn’t help the economy grow. The uncertainty that’s clouding everything is all hanging on one major thing–Europe. People are waiting for Merkel/Sarkozy/anyone to come out and save the day. Obviously if they had the strategy to end all strategies for fixing the European debt crisis, we’d have heard about it already. As of today, Germany has said they’re capping their bailout funds at 221 billion euros, which gives the EFSF about 450 billion euros when recapitalization is needed (for both banks and the various countries who will undoubtedly need them).
I’m pretty lost right now, so I’m just gonna end this here. I’ll go back and go through each area more in depth throughout the next week(s), but this is a dece start. As you can see, everything is connected, even more so than 4 years ago. My prediction: we’re not gonna see an end to this until the EU is literally on the brink of collapse. That’ll be an interesting time… hopefully I have a job by then.
So I basically haven’t even thought about posting on this blog anymore once I started my summer internship, but I thought I might as well keep the bitch goin’. I got in an argument the other day with my mom after telling her about the stocks I’ve been looking at lately. I told her OpenTable Inc. (OPEN) was trading at 160/share the day before, and she gave me this look like I was a complete idiot. For the sake of me looking only slightly retarded, I was thinking of Salesforce Inc. (CRM), while OPEN was closer to 80 (down to 75 since then). Well the argument came when she said something like, “Oh are you looking at it that high so you can wait for it to split?” And I said something like, “Uhhh no not really, there’s a lot of stocks above 100/share”. Then came the ever-present tone of, “Oh DopiesChron, don’t act like you’re some big shot know-it-all nobody likes that blah blah blah”. Well… I went to work the next day and asked my boss what he thought about the conversation, and it turns out we were both right for different reasons.
My point was that I wasn’t playing these stocks for the split, but for the fact that they should grow regardless of a split. And that 1000 shares at 50 should be no different from 500 shares at 100. Academics love that last point–and it turns out it’s total bullshit and I’m an idiot (can I call my econ profs idiots now too?). The rationale behind a lot of stock splits is this: many people see a triple digit price and think it’s too expensive for them, but once a stock splits they think they’re getting a bargain and will snap them up. This is because many investors feel wealth based on their share amount, not the total value of their shares. While this may not seem like “rational behavior”, it makes a lot of sense. Grams over here didn’t wanna buy 20 AAPL shares at 300 because it looks like the only way it can go to her is down… now she’s crying herself to sleep as the price hits 370. Then there’s a 4:1 split and she thinks 75/share is the deal of a lifetime. Not only that, she can have 80 shares instead of 20… and that makes her feel goodski.
I saw on Bloomberg the other day some guy pull up a pie chart. It showed the share of the stock market held by… I wanna say Hedge Funds, Brokers (as in Wealth Advisors, etc.), and Institutional Investors. It showed that Brokers, who have clients ranging from $40 grand to $20 mil in assets, make up about 44% of that pie. In other words, a large amount of people are susceptible to behaving exactly like what I just described. Obviously, there’s a simple way to play off of this. Looking at historical prices, you’ll notice a lot of good, growing companies will have pops in their share price after the announcement of a split. Once the split occurs, people will be calling their brokers telling them to buy shares while the price is so low. So, the pop that occurs after the announcement is usually due to people trying to get a position in before the split, so they can ride out the bull when smaller investors get in.
Now, what usually happens is the price can jump as much as 20% the first day after a split is announced, with some earlier gains maybe being attributed to speculation of a split (or you know Rajat Gupta personally and you don’t have to speculate, you just know exactly when they’ll announce it). So, the trick is being able to get in before that initial price pop. Moreover, a 2:1 split is great, and the above scenario will likely play out. But a 3:1 or higher will usually make the institutionals back out, because they don’t want to hold so many shares. So, they’ll liquidate some or all of their position after (or before) the split.
This brings me back to my initial point: that I was looking at CRM for strong growth, not specifically to play a split. This is because we currently have way more triple digit stocks now than ever before. Whether or not they’ll eventually split is above my head, but there could be a few reasons why they’ve stayed so high. For one, the high prices reduce volatility, making their stock appear strong and their board members appear smart (the ones who decide on a split). Another more low-brow approach is that share price has become almost like dick-size to board members and chief officers. I can see it now… Reed Hastings of Netflix walking around a party saying “Hey slut, Netflix is trading at 280 right now… and if you stay at my place it might be 290 by the time you wake up”. Fuckin’ CEO’s. Always a party.
I was reading a Reuters article this morning, and they mentioned how euro risk reversals are at a 6-month high, presumably because hedge funds are shorting the euro. For the sake of news, the euro has been unable to break the $1.4500 mark lately, and is at $1.4169 after dropping 271 pips today (.0271 percentage points). Good news for those who think the Fed is trying to inflate away our debts, I’ll be doing a post on that bullshit sometime soon (basically people who think that are fuckin’ morons). BUT, just reading that one headline I realized I have no idea what a risk reversal is for. So, I did some fuckin’ readin’ and now I know what it is. And because I took the time to read up on what they’re used for… I’m gonna spread some god damn knowledge on ya ass. For clarity, I’m gonna explain it as if my friend, Petrone, is bullish on Microsoft stock (he heard they bought Skype and thinks they’re gonna gain like 20 fuckin’ points or some shit).
So, Petrone hears about the Skype buyout and gets all excited about Microsoft stock. It’s at about $24/share, but let’s assume it’s $50/share for this example. Petrone thinks Microsoft is gonna enjoy a big rally and wants to go long the stock. But, he doesn’t just wanna have a straight-up position in a market as uncertain as today’s. So instead of just buying the stock for $24/share, he’s going to enter into 2 option contracts, this is the risk reversal strategy.
First, a quick refresher on the options he’ll buy. Petrone will go long a call option. Buying a call option means you pay a premium (say $5) for the right to buy the underlying (MSFT stock in this case, $50 right now) at a specified future price, the strike price (say $60), at or before the expiration date (say 1 year). If you are the buyer of the option you don’t have to purchase the underlying, you just pay the premium for the right to purchase it before the contract expires. So, when Petrone is long a call option, he’s hoping the underlying current stock price (spot) will be greater than the strike price before the option expires. If that’s the case, he can turn around and sell the stock he just bought for the market/spot price. If the difference between the spot and strike is greater than the premium he paid, then he’ll make a profit. In our example, if MSFT is worth $70/share at some point before the expiration, Petrone will make a profit of $5 ($70-$60-$5=$5) if he exercises the option at that point. He pays the premium when purchasing the option and the strike price when exercising the option, then sells the asset at the market/spot price and hopefully profits.
Now, in the case of a risk reversal, Petrone is going to short a put option before he’s does the above. Much like buying a call option, shorting a put option means Petrone thinks MSFT’s spot price will rise in the future. Again, the buyer of a put option pays a premium (say $5) for the right to sell an underlying asset to the seller of the option, Petrone, at the strike price (say $40). So, the buyer is hoping the spot price will fall below the strike price by at least the value of the premium, because then he’ll be selling the stock at a strike that’s higher than the market/spot price and will profit. In Petrone’s case, he’s going to be the seller of the put option, so he’s hoping the spot price stays above the strike price (the buyer of the put option won’t exercise the option, and Petrone will make a profit of $5, the premium).
The reason Petrone shorts a put option first, is so he can use the premium he earns from it, $5, to buy the call option at $5. So, if the spot price is originally $50 and never falls below $40 or rises above $60, neither option will be exercised, and he’ll break even. If the spot rises above $60, then Petrone will exercise the call option and make a profit of the spot minus $60. For instance, if 7 months after he enters both contracts the spot is $70, he’ll make $10 (spot-strike-call premium+put premium; $70-$60-$5+$5=$10). If the spot falls below $40, the buyer of the put he sold will exercise the option, and he’ll lose the amount it falls below $40. For instance, if 7 months later the spot is $30, he’ll lose $10 ($30-$40-$5+$5=-$10).
So, instead of just buying MSFT at a $50 face value, Petrone can make a synthetic long position with both a long call and short put with very little money to begin with ($0 in our example). Risk is reduced big time as you can see, and so is the possible reward. The increased leverage he can use more than makes up for the difference in volatility. If there’s a lot of volatility (spot goes ±$10) there’s a fat possible gain/loss with big leverage, but if there’s low volatility (spot above $40/below $60) there’s very little cost, if any.
Back to the original reason for writing about this, euro risk reversals are at a 6-month high. A high risk reversal means that the call option is more volatile than the put option. In other words, long positions on the euro/dollar are riskier positions than short positions. So, the risk reversal levels are good indicators of where an asset’s price is going, especially on currencies. In this case, the euro is not going to be doing well in the future.
… That probably made no fuckin’ sense.
For those like myself who have only a few tidbits of knowledge of the Israeli-Palestinian conflict, here’s a good six-part documentary done by Al Jazeera a few years ago. Al Jazeera is usually very good at being unbiased, but I will say this is a little slanted towards Palestinians. Nonetheless, good series with a lot of facts and only about an hour and a half in total.
Read this. The author, economist Kash Mansori, had to do a shitload of research to get these numbers, but it shows how bad things could be for the US in the case of European credit event. It’s some hard evidence that US institutions have just as much on the line as Europeans from a default by one of the PIGS.
Dow is down 172 11,951 and S&P is down 18 to 1,270 on the day. I’m beginning to get the feeling that the markets are playing off the news too much. Not only that, but expectations for the year were just incredibly too high. Now, Obama’s analogy of “if you get hit by a truck… it’s gonna take a while to mend ya know?” may be extremely retared, but he’s not wrong on the original point. You don’t have the Dow literally lose like 50% over a year and a half and just expect 3% yearly growth right off the bat. To reiterate what many have pointed out, this was the worst recession we’ve had since the Great Depression. These high expectations are only hindering growth. Record corporate profits obviously imply they’re hoarding a lot of cash, but it’s not like they’re gonna keep it forever. That money will be reinvested. Unemployment will eventually decrease. Have some faith in the market.
Larry Fink was on CNBC today giving his insights. Dudes a baller, I usually believe almost everything he says. Plus he just doesn’t look like a scumbag. He’s bullish on equities. One of his main reasons is the fact that the bond market is extremely overstuffed. I just posted a day or two ago about how some people are hoppin’ on bonds because they’re just looking for any safe rate of return. Well, there’s almost no profit opportunity now. The private sector benefitting a lot with the weak dollar and are in a great position to grow. Honestly, there’s not much room for this economy to go south unless you consider a depression a possibility. Which it’s not, and a “double dip” won’t happen either. There’s far too much liquidity for another recession. The worst possibility I see is just very slow growth for another year or two from uneasy investment. But the markets, and the economy as well, will pick up.
As for my thoughts on the speculation of QE3, I’ve found myself getting consistently annoyed of those who say it has failed. Investment has increased over the past year. The unemployment rate has dropped over 1% since it started, and I’d venture to say that without QE it wouldn’t have dropped nearly that much (as in it would probably be the same). People are so quick to say QE has failed because the growth is so slow, but where’s the evidence that the economy would be in a better position without it? I don’t see it and I haven’t heard it. All these fuckin’ bears are just scaring everybody, that’s what I think. A little more optimism would help ease consumer confidence.
Love how the guy with the camera is like “that will be mine one day… betchyu that’s a lambo”. Nah brah. Ain’t gonna be yours one day. God… I bet that guy shat his pants the second he realized he was dumpin’ that thing in the water. Then again, if you can not only afford a $2 million car, but actually BUY a $2 million car… this doesn’t even phase you right? He probably did it on purpose come to think of it. Talkin’ to his other super loaded friend he was probably like “I’ll bet you $1 million I can get my Bugatti to drive on water for at least 5 seconds”. Just tossin’ money around while everyone else is lining up for food stamps. What a life.