A Tale of Two Booksellers

A look at America’s largest book sellers will reveal some stark contrasts. On one hand we have Barnes & Noble (BKS), the steady and familiar “brick and mortar” bookstore and on the other there is Amazon (AMZN), the popular internet retailer. Looking at these two companies and their stock prices brings you back to the heady days of 1999, when companies were neatly divided into “old economy” and “new economy” companies and the latter were given absurd valuations in the stock market. Now, ten years later, Amazon’s stock price has reached new all-time highs and Barnes & Noble is trading near the low end of its range for 1999.

Protect your portfolio with covered calls

The stock market’s rebound from the lows of March has been amazingly strong and is beginning to make many wonder whether stocks have become overvalued again. Without doubt, the lack of desirable alternatives to stocks continues to fuel the rally. Stocks may no longer be such a bargain, but with cash yielding nothing and 10-year treasury bonds yielding 3.4%, what are the options?

For those who are not eager to accept the low yields offered by cash and bonds and are nervous about enduring the volatility of the stock market, I propose an alternative: selling call options against stock holdings (also known as writing covered calls). This strategy generates income and reduces the risk of the portfolio, while giving up some of the upside of holding stocks. I consider this a particularly attractive strategy for those who are retired or near retirement and need to derive an income from their investment portfolio. As stocks are called away (when their price is higher than the strike price at expiration) the equity part of the portfolio is reduced and stocks are sold at prices that have been determined to be acceptable.

Hefty markup on Dillard’s

In spite of a bleak outlook for consumer spending, many retailers have seen their stocks explode upward in recent months. Some of this can be attributed to a reversal of the excessive pessimism around the March lows in the market, but the price action in recent weeks suggests that some investors (who may have missed the rally) are indiscrimininately getting into the market and that heavily shorted stocks are rising due to short covering. A stock that exemplifies this is Dillard’s Inc. (DDS), which is a regional apparel and home furnishing retailer.

The delusions of fiscal responsibility

The president’s weekly address from August 1 contained the following statement:

“Now, I realize that none of this is much comfort for Americans who are still out of work or struggling to make ends meet.  And when we receive our monthly job report next week, it is likely to show that we are continuing to lose far too many jobs in this country.  As far as I’m concerned, we will not have a recovery as long as we keep losing jobs.  And I won’t rest until every American who wants a job can find one.”

Apparently, the president is aiming for 0% unemployment. This absurdly unrealistic goal can be attributed to ignorance of economics, demagoguery or delusions of grandeur. Whichever it is, the president’s economic advisors must have cringed.

Use Leveraged ETFs to your advantage

Leveraged ETFs have gained a lot of popularity, and some scorn, in their relatively short history. They are popular because they allow retail investors to take aggressive positions without using margin or buying options. Inverse ETFs, whether they are leveraged or not, allow investors to short indices without a margin account. These funds are disliked because they do not accomplish what some might expect them to, which is to double the returns of the underlying index over an unspecified time period.

Exiting a foul trade from last year

On July 30 of last year, I recommended taking a long position in the market as I considered it oversold on a short-term basis (using the CRB Stock Market Momentum Indicator) and was anticipating a bear market rally. As it turned out, the market was just in the beginning stages of a massive collapse and the trade turned out to be a miserable one. A closing signal for this trade finally came after the close on June 17. During the 323 days the trade lasted, the S&P 500 fell 27.4%. A graph with entry and exit points for this trade is shown below as well as a table with historical results from this momentum trading strategy.

Time to play defense

We now have two consecutive unprofitable signals. To keep that in context, these signals have come during what has been one of the most vicious bear markets in the last hundred years. I have not lost faith in the usefulness of this momentum indicator as a timing tool, but to avoid blunders of this magnitude in the future I will be using a stop-loss rule for the trade. Furthermore, given the current overbought conditions, I think this is a good time to close some long positions or perhaps sell near-the- money call options on existing long positions with expiration anywhere between July and October.

Jon Stewart and personal responsibility

With all the ranting going on everywhere these days, I feel entitled to indulge in a rant of my own. My beef is with people who are unwilling to take responsibility for their actions. I will use as an example Jon Stewart’s public flogging of Jim Cramer about a month ago. Stewart is in the habit of engaging in serious discussions while hiding behind the cover of being a comedian. It would be just as ineffective if someone serious, such as Larry Summers or Alan Greenspan, were doing stand-up comedy while regularly reminding the audience that he is an economist and should therefore not be expected to be funny.

Inflation risk is underpriced

One of the many unusual things in the financial markets these days is the relationship between the growth in the money supply and inflation expectations. At the same time, as unprecedented growth in the balance sheet of the Federal Reserve is taking place, inflation expectations, as witnessed by the narrow yield spreads between inflation indexed treasuries and regular treasuries, are extremely low.

Low inflation expectations

Inflation expectation for the coming 12 months, as measured by a University of Michigan survey of consumers, have been coming down rapidly, from 5.1% last July to 1.7% in December. Given the current weakness in the economy and falling commodity prices, it is perhaps not surprising that people are expecting low inflation in the near term (although deflation fears seem to have diminished recently).

Is long-term investing dead?

Recently, many people have been denouncing buy-and-hold investing. Among phrases heard: “long term investment died as a thesis” this year. Of course, these voices are featured most prominently after a huge fall in the market, when the outlook for returns from long term investments has actually improved.

The best example of this is a Business Week front-page story titled “The Death of Equities,” published in August of 1979. Then, as now, investors were weary of a long, painful bear market. The story didn’t mark an exact bottom in the market, however in the two decades that followed the S&P 500 increased more than tenfold.

Creating a shopping list for the coming year

As simple as “buy low, sell high” sounds, events and sentiments seem to conspire to get us to do just the opposite. Stocks are cheaper than they have been for a long time. The S&P 500 index, currently at 930 points needs to climb 18% to reach the closing price of October 30, 1998. Yet, as high as stock valuations were in 1998, people were generally very eager to buy stocks then, just as people cannot seem to get rid of stocks, or any risky assets, quickly enough now. Given the uncertainties ahead it is understandable that many investors are waiting to see clear signs of a bottom — there is nothing to keep cheap stocks from getting cheaper. However, bottoms are only visible in hindsight. For those who are fortunate enough to have some cash on the sidelines, there are some enticing opportunities for deployment.