Toro's Running of the Bulls Market Blog

The Market as Told by a Cartoonist

I think the bottom is in, at least for the year. 

But Tom Toles satirizes the market pretty much bang on.

Now THAT'S German Engineering!

I am more than a little amused at the saga of Porsche sticking it to the hedge funds through their stealth purchase of Volkswagen shares.

Porsche Automobil Holding SE is emerging as a potential big winner, and the target of heightened scrutiny, as hedge funds reel from billions of dollars in losses after betting wrongly that Volkswagen AG's share price would fall.

The small German sports-car manufacturer has moved closer to securing control of much-larger rival VW through a stealth strategy relying on sophisticated derivative instruments, and has been able to book big paper profits in the process. ...

Continuing its gyrations, VW's share price plunged 45% to €517 ($656) Wednesday after Porsche said it planned to sell as much as 5% in options tied to VW shares. VW's shares had soared 348% over the two previous sessions -- briefly making it with world's most valuable publicly traded company -- fueled by Porsche's disclosure Sunday that it had boosted its VW stake to 42.6% and held so-called cash-settled options linked to another 31.5% of VW's shares.

Porsche said Wednesday it didn't break any disclosure rules by quietly building an ever-larger position in VW through the use of cash-settled options. Cash-settled options, which are settled in cash instead of shares, don't need to be disclosed to regulators under German law.

But a Porsche spokesman acknowledged that the company has made a "sizable profit" this year from the use of such derivatives, adding that it could help finance its VW takeover. VW is Europe's largest car manufacturer by sales, rolling out six million vehicles a year, compared with Porsche's annual output of 100,000. ...

Porsche discreetly began buying VW options in 2005, when it first took a 20% stake in the company. Many of those options are believed to be priced below €200 and in some cases even below €100, allowing Porsche to pocket the difference when VW's shares are much higher. That could add up to billions of euros at current prices if the options are exercised.

In the previous fiscal year ended July 31, 2007, Porsche said it made €3.59 billion in pretax profit from stock-options transactions, more than it earned from the sale of cars.

The weekend disclosure by Porsche that it was gunning for a 75% stake in VW forced investors who sold VW shares short in recent weeks and months to reverse gear and buy shares to cover bets that the price would fall. In the process, hedge funds lost more than $20 billion, according to some market estimates.

Despite Wednesday's downturn, VW's share price is still more than double Friday's close of €210.85, leaving short sellers on the hook for major losses. Investors say Porsche misled financial markets in recent months by indicating it wouldn't aim for a 75% stake.

Dealbreaker speculates that Porsche has earned €6 billion in profits.  Good for them, I say.

Now, hedge funds are whining that they have losses and may go belly up.

The London-based Alternative Investment Management Association (Aima), the hedge fund trade body, said yesterday that it planned to ask the European Union to clamp down on a controversial German legal loophole that allowed Porsche secretly to take its VW stake to almost 75 per cent.

Andrew Baker, Aima deputy chief executive, said: “This sounds somewhat irregular. If you tried that in this country, there would be a number of questions to be answered.”

He said losses for hedge funds were likely to be less than a tenth of the forecast €20billion. “There are funds hanging on by their fingertips because of redemptions for whom this could be the last straw,” he said.

The casualty list of hedge funds hit by the Porsche squeeze on VW grew yesterday as it emerged that Steven Cohen's SAC Capital and Och Ziff, and Perry Capital, a key financier in Malcolm Glazer's takeover of Manchester United, were among the losers. Greenlight Capital, run by David Eindhorn, Marshall Wace, York Capital and Glenview Capital are also among about a hundred hedge funds thought to have made losses.

What is particularly amusing is that many of these Masters of the Universe who charge egregious fees and would have no problem imperiling the future of the world by raping the financial system so they can create dynastic wealth for themselves did not understand the rules by which they were playing.

Germany's stock market regulators are the laughing stock of Europe.

It is embarrassing that Porsche could have been allowed to build a secret options stake in Volkswagen equivalent to 32 per cent of its market value, on top of an existing holding of 43 per cent, with no disclosure. A false market of epic proportions was allowed.

But that does not mean those short-selling hedge funds nursing nasty losses have real grounds for complaint.

They knew perfectly well, or should have known, the lacuna in the German rules and the fact that such positions could be kept secret. Given the ferocity with which they fought proposals to close precisely this loophole in the UK, they have no excuse for ignorance and little cause for sympathy.

Is this not why hedge funds demand outrageous fees from suckers investors?  Are they not paid more in a year than a small city is paid in a decade to discover and exploit such loopholes in the regulations?

I would like to know if there were any German hedge funds caught in this short squeeze.  Volkswagen is the most heavily shorted stock in Germany.  Did the German money managers know about this rule in their market while the "dumb money", i.e. "foreigners," not know?  (It is axiomatic in financial markets that foreigners are usually the "dumb money," even when we are the foreigners.)

Yeah, hedge funds are worth their 2 & 20 alright. 

Volatility Update

Well, today was a more "normal" day, with the Dow having "only" one nutty move, rising 100 points from 3:51 to 3:57.

Since all the relevant movement in the market seems to happen in the last 15 or 30 minutes of the trading day, maybe the market should shut down for all but one hour each session.  Open at 3pm and close at 4pm.  Since all the other hours don't seem to matter, why not?

Yesterday, I was unable to access graphs I wanted to post on volatility.

The first is intra-day volatility, or the difference between the top and the bottom of the market intra-day.  The second is rolling one-month annualized volatility.  As you can see, both have moved appreciably higher. Not that you did not already know that.

Market Action, October 29 2008 - Margin Clerks, Unhinged Button-Pushers Reign

I was busy today and did not spend much time looking at the market – until the last 45 minutes.  And frankly, the movements are absolutely nuts. 

The Dow fell 470 points in 11 minutes from 3:48 to 3:59.  This was after a 270 point move up move over 5 minutes starting at 3:10.

But this is the norm.  There was a 235 point drop in the last 15 minutes on Monday followed by a 760 point upswing in the last two hours of Tuesday.

This is insane.

The button-pushers - aka program traders, probably hedge-funds - and margin clerks rule the market.  And they are often executing trades into vacuums.

EDIT - I wanted to post a few graphs on volatility, but I am unable to at the moment.  I will try to get them up tomorrow.

Consumer Confidence Hits Record Low. And...

From Tony Crescenzi

Results of the Conference Board's consumer confidence index for October, which was based on responses to questionnaires sent to consumers at the end of September and collected through the middle of October, fell to a record low (dating back to 1967) of 38, from 61.4 in September. The results reflect the obvious: the weak economy, the housing market and the financial crisis. The previous record low was 43.2 in December 1974.

Value of the S&P 500 on;

December 31, 1974 - 68.56
March 31, 1975 - 83.36
3 month return, 21.6%

On December 31, 1975 - 90.19
1 year return, 31.6%

December 31, 1976 - 107.46
2 year return, 56.7%

Oh, and the daily peak of the market was on January 11, 1973, with the S&P closing at 120.24.  Thus, the market had fallen 43% to the end of the month when the consumer confidence index had hit an all-time low.

And the return from the high on October 9, 2007 at 1565.15 to the close yesterday?  -45.8%.

Does that mean we can expect the market to go higher on the horrible consumer confidence print?  No, of course not.  I have no idea what the market is going to do.  The market can and will do anything it wants.

But I just think all this is interesting.

I am long US equities, perhaps prematurely so.

Stocks v Cash

From Howard Simons at RealMoney.

Interpret any way you wish.

Returns After a 40% Decline

There have not been many periods when, after one year, the market is down 40% or more.  But that is the current environment as the S&P 500 is down 45% from a year ago at the close today.

In fact, since 1928, a decline of 40% or more on any trading day from a year ago occurred only 1.5% of the time.

However, this is a little misleading.  Many of the 40% declines on any given trading day occurred during a cascading decline, where day after day, the market was at least 40% lower than it was a year earlier.

For example, October 9 was the first day of this year when the market was down by more than 40% compared to October 9, 2007. October 10 was the second, October 15 was the third, October 22 was the fourth, and so on.  The current decline is really one discrete market event as stocks continue to cascade downwards.

In fact, all of the 40% declines prior to now occurred in only three discrete time periods - from October 1930 through August 1932, from November 1937 through June 1938, and for seven continuous trading days in September and October 1973.

So what was the return of equities a year after the first day when the market fell 40% or more during the prior three periods?

In October 1930, with stocks down 40%, a year later, equities were down - another 40%!  Ouch!  November 1938 was better, rising 25% over the next 12 months.  The 1973-74 market environment was even more positive, as stocks rose 31%.

Returns two years after declining 40% were even more dramatic.  In October 1932, stocks were down 64% after the 40% decline.  In 1939, stocks were largely unchanged, up 21% after two years, which is fairly surprising given that World War II had begun a few months earlier, which I would consider positive, all things considered.  The best market was 1975, when stocks were up 65% after two years.

The markets can and will do anything, and three observations is hardly a scientific sample.  However, stocks were dramatically lower after being down 40% during the worst economic crisis of the last century but up the other two times. 

Is the The Great Hedge Fund Liquidation and Retail Investor Panic due to the de-leveraging of the financial system as bad as the Great Depression?  I do not know.  But using my normalized profit margin of 7%-7.5%, the market is trading at 11x-12x earnings and 1.5x book value.  In my book, stocks are on sale.

Doesn't mean the market can't go lower though.

Panic

I woke up this morning, groggily turned on CNBC, and noticed that the futures were down 60.

"The Dow is down 60 this morning," I thought, "that's not bad."

Then the Dow futures flashed "Dow down 546."

Those were the S&P 500 futures that were down 60.  Lock-limit down.

The Great Hedge Fund Liquidation / Investor Panic continues as global markets are melting down across the world, with indices falling 8%-9% today.

My skill at picking a near-term bottom appears to be lacking. (A lot appears to be lacking. - ed.) However, I remember the 2002 bottom when you would wake up in the morning and see the futures getting crushed before the open whereas all the crushing in equity prices in the days prior occurred in the cash market when the market was open.  Could we be approaching a bottom now?

I have no idea.  However, I have spent much of my time since I started this blog telling you how markets were getting stupid, most recently in commodities - here and here - and also real estate - here and here.

Now, stock markets are getting stupid on the downside. 

Stocks are being thrown out the window because the margin clerks are in control and retail investors are in panic mode.

I have been in two minds about this market recently.  On the one hand, I have a trading long, and want the market to go up.  On the other hand, I want the semiconductors to get crushed so I can back up the truck for the inevitable cyclical upswing in a year or three hence, and its much easier for the chips to get hammered when the market is getting whacked.

I am eying a basket of semiconductor and capital equipment companies as well as the ProShares Ultra Semiconductor Index, ticker USD.  The USD closed at $15 on Thursday.  It was $100 last summer.  I expect it will approach those levels again in the future.

Humour

From Tom Toles

It's Greenspan...

Quote of the Day

I once taught a swat captain to trade stocks and after a month of trading he said to me: "I would rather be shot at."

- Ken Wolff