Alan's Alert 7-9-2021

 

Happy Friday everybody!  Yesterday the Fed dropped the data on consumer spending.  While the financial media heralded the return of the American consumer, the reality is less appealing. 

 

The US consumer's revolving credit (think credit cards) is still well below the trend while total non-revolving (think car and student loans) never broke trend.  For the Wall Street Journal to say that “borrowing is back” is an exaggeration.  It’s obvious to me that some consumers paid down credit cards with their stimulus payments, others stuffed it in their bank account.  I anticipate that it will take much longer for credit cards to come back to the trend.

 

Wholesale inventories were posted by the US Census Bureau today.  They increased 1.3% month-over-month in May.  Inventories increased for durable goods (1.2% vs .07% in April), especially lumber (7.6% vs 1.5%), metals (2.4% vs 2.3%), and furniture (2.4% vs 2.5%).  Non-durable goods were also higher (1.5% vs 1.7%), specifically drugs (2.3% vs -0.2%).  Its good to know that merchants are trying to keep their shelves stocked but the inventory/sales ratio continues to plummet.

This is not the lowest the ratio has been but we are getting very close to that number.  This is being exacerbated by the port slowdowns, workers staying home, and consumers with stimulus money burning a hole in their pocket.

 

Is there a quiet cold war going on between the US and China?  Some interesting developments have been happening over the past week that I think need to be reviewed.  On July 5, China’s Communist Party (CCP) celebrated their centenary, which is the 100^th anniversary of communist rule in China.  President Xi gave a big speech about how great China is and how China will not be bullied on the world stage.  He stated how China will be moving forward to more greatness in the future.  Prior to the centenary, a company in China named DiDi (which is hailed as the “Uber of China”) had an initial public offering (IPO) on the New York Stock Exchange (NYSE).  This gave investors their first shot at owning a share of DiDi.  It isn’t unusual for Chinese companies to get listed on the NYSE.  In fact, 36 Chinese companies have gone public on the NYSE this year alone, raising $12.6 billion.  What is unusual is that China suspended all new user registrations for DiDi’s app two days after the IPO.  By July 4^th, the app was ordered to be removed from all of China’s mobile app stores.  On July 7^th, DiDi had been fined by China’s State Administration for Market Regulation.  Less than a week after the DiDi debacle, two more Chinese firms who were going to list on the NYSE have pulled out.  It seems China deems data collected from social media to be a national security threat.  Now today, the Biden administration has blacklisted 23 Chinese based companies.  This tit-for-tat relentless retaliation is terrible policy and could spiral out of control in a hurry.  In addition to this, we are still dealing with Chinese ports running more than 16 days behind schedule and at 40% capacity.

 

This is something to watch closely.  If there is continued arrogant behavior from both sides of this equation, things could get out of hand quickly.  Serious market distortions could begin to develop.  We could swiftly move from quiet cold war to cold war to hot war.  This would put the kibosh on the stock market as all future expectations would be called into question.  Our least favorite superhero, the Fed, would be riding to the rescue by pumping ever great funds into the market to try to keep it afloat.

 

 

Alan’s Options Primer

Volume 3

Today is post 3 of 3 in my options primer series.  Yesterday I went over some of the basics of options like the number of shares in a standard contract (100), what a strike price is, and that all options have an expiration date (like milk).  I also went over the three primary factors that calculate the price of an option contract (delta/gamma, theta, and vega) and that they are calculated in a formula (Black-Scholes).  As a reminder, I only have two rules when trading options.  They are hard to follow but there is only two of them.  My first rule of trading options, do not trade options.  My second rule of trading options, DO NOT TRADE OPTIONS.

 

Something to keep in mind; when trading options and securities in the stock market, there is always someone on the other side of your trade.  You cannot buy a stock (or option) unless there is someone on the other side of the trade selling you the stock (or option).  Liquidity is important.  This is why big-wig investors like Howard Marks at OakTree Capital would spend a whole letter to his clients talking about it.  Options and stocks with low liquidity will be difficult to purchase and even more difficult to sell.

 

Let’s define the terms. 

Delta; in theory delta represents how much the price of an option will move in relation to each $1 movement in the price of the underlying asset. 

Gamma; gamma value represents the theoretical movement of the delta value as the price of the underlying security moves. 

This might sound complex, so let’s have an example.  Imagine you bought a call option with a delta of .60.  If the price of the underlying security rises by $1, then the price of the call option would rise by $.60.  If the gamma value was .10, then the delta would increase to .70.  This means that another $1 rise in the price of the underlying security would result in the price of the option increasing by $.70, and delta would also increase again in accordance with gamma.

Theta; also know as theta decay or time decay.  Options are time sensitive because they expire.  Theta represents the change in the price as the option’s expiration date gets closer.  Here is a graph to demonstrate what it looks like:

As the option contract gets closer to expiration, theta decay increases.  When there is less than 30 days left, decay is at its maximum.

Vega; is the value that indicates the rate at which the price of the option will change in relation to changes in the volatility of the underlying security.  This can be a hard topic to understand which is why it is vital.  Vega is the weak link in the Black-Scholes formula.  I will always look at volatility, especially implied volatility (IV), prior to any option contract purchase.  The reason vega is so difficult to understand is that you need to have an understating of volatility and implied volatility.  Neither of these are simple subjects and could be a whole post in their own right.  To keep it as simple as possible, the higher the implied volatility (IV) of a security, the higher the cost of the option contract.  I use the think-or-swim platform by TDAmeritrade to analyze IV before any option contract purchase or sale.

 

This concludes my primer on options.  Future posts on options will go over basic strategies and some examples.

 

 

 

Before I leave you to your weekend, if you find yourself kicking back without entertainment, I recommend a listen to Eric Peters, the Chief Investment Officer of One River Management, on the MacroVoices podcast.  While I don’t find his bitcoin thesis appealing, his discussion of inflation is spot on and worth a listen.

 

 

Alan's Alert 6-9-2021

 

By Alan Baerlocher

 

Jobs, Inflation, & China

 

Regarding yesterday’s JOLTs (Job openings and Labor Turnover) report, I found two things of great interest.  The first is the job openings.  Businesses are getting frantic to find warm bodies to fill vacancies as the economy braces to open back up but warm bodies are not to be found.

In the 20-year history of this report, we have never had job openings at this level.  The slope of the curve is tremendous.  Keep in mind, this report is for April.  JOLTs reports always lag but this is still impressive.  Workers certainly have the upper hand in negotiations with employers.  To me this indicates that wages have to come up to balance the supply/demand curve of labor.  This is basic econ 101.  When demand is high (as it is now), to increase supply, higher wage rates will be required.

On the x-axis is Q, the quantity of labor.  On the y-axis, P, or payments to workers.  The demand for labor has moved from D1 to D2.  To get the market to equilibrium, payments to workers needs to move higher from P1 to P2 so that Q1 will move to Q2.  Until this happens, the labor market will be out of balance.  Worker shortages will continue and this will lead to shortages in goods and services.

 

The Fed has a dual mandate; maintain a stable currency and full employment.  While maintaining a stable currency is subjective, full employment is not.  These worker shortages are giving the Fed the greenlight to continue to run the printing presses hot.

The second point of interest to me in the jobs report was the quits report.

Not only are employers desperate for workers, but the workers smell this desperation and are quitting at the highest rate ever.  What in the world?  I’m thinking some employees might be finding greener grass in other pastures.  Some may have gotten used to the work-from-home scenario and aren’t excited about coming back to the office as re-openings are taking place.  Others might have developed side jobs during the government enforced lockdowns, that they are trying to turn into full time gigs.

Now, according to Austrian economics, to have inflation we need a scenario where the supply of money is high (check that box!), and the demand for money is either flat or down trending.  Reviewing the most recent Personal Savings Rate data from the Fed (last updated 5/28, next update 6/25) we see that savings is still elevated thanks to the unprecedented stimulus pumped into the hands of main street.

I think the scenario we are seeing playout is one where workers have money saved up, aren’t excited about getting back to work, and will live off their savings until they have to get back to work.  This could mute the inflation situation and still cause bottle-necks in the supply chain.  Once this scenario reverses, watch out.  Which brings me to China…

Last night, the PBOC (People’s Bank of China), posted their CPI and PPI numbers.  I always have a hard time believing anything that comes out of China, especially if it would paint their country in a bad light on the world stage.  However, they posted the highest PPI report since September 2008 at 9.0%.

The PBOC also announced their CPI at 1.3%.  So according to the China central bank, high producer inflation has not yet influenced the consumer price index.  This means Chinese factories are absorbing the rising costs instead of passing them on to consumers.  In time, rising costs will force their hand or their profits will plummet and many could go broke. 

 The high PPI print led Chinese officials to announce their intent to introduce price controls. The National Development and Reform Commission, which is a macroeconomic management agency in China, announced that they were making arrangements to “stabilize” the price of “corn, wheat, edible oil, pork, and vegetables”. 

 If Beijing loosens their grip on the producers and factories, allowing them to raise prices, expect prices to raise quickly in the US for anything made in China.  Also, if prices get fixed, expect China to suffer from intense supply-chain bottlenecks, shortages, and black markets in any product the government tries to micromanage.