Lots to go over this week!
First off, let me say that the idea of giving bonuses to the "geniuses" at AIG who nearly brought down the global financial system makes me nauseous. The populace is pissed, and rightly so. The whole idea of a bonus used to be based on performance: both of the individual and the company. If an individual makes a bunch of money for a firm, there should be no reason that they should not be compensated for that performance. This is central to the idea of meritocracy that has governed the growth of this great country AND SHOULD CONTINUE TO DO SO IN THE FUTURE, lest we slip into a system that has been shown, time and time again, to be destructive. However, if a company in and of itself is in trouble, then even those strong performers should not be immune to a small (or nonexistent) bonus pool, as it is their choice to work at that institution.
With this said, the whole idea of writing contracts for employees with guaranteed bonuses strikes me as simply bad business. It takes away the incentive that a bonus is supposed to represent. It takes away the incentive for the employee to do right by the company rather than him or herself. It just takes on the aura of a guaranteed lottery ticket every February, when bonuses are generally paid out. However, at some point along the way, some smarty pants management team decided to guarantee bonuses in certain employee contracts, and once the floodgates opened, it became essential for other companies to follow suit in order to attract and retain talent.
Does the whole idea make sense? No. Are the bonus payments in extremely poor taste given the current environment? You bet. Should they be returned? For moral and just employees, the answer is a resounding yes. Should they be forced to be returned by Congress? ABSOLUTELY, POSITIVELY, NOT!!!!!!!!!!!!! I believe that the utterly politically fueled, bombastic "debate" going on in Congress at the moment is pure nonsense and a waste of time when time is of the essence. When Charlie Rangel is allowed to wax poetic about folks (other than him) "stealing" from the taxpayer and people actually listen to him, I know that the end of the world is here.
At issue here is the whole idea of the contract, which according to the dictionary is a voluntary, enforceable, legally binding, agreement between 2 competent parties. The Government is trying to void valid contracts, and this is very, very dangerous precedent. If Congress can find something illegal in said contracts, have at them. If not, well then it's THEIR fault for not attaching language in their agreement to bail AIG out that would allow them to rescind bonuses (which would have been, you guessed it, a contract!). In my opinion, the Government itself should be held accountable for not being prudent in this matter (and we all KNOW that there were more a few people in DC that were very much aware of what was going on in this regard a while ago). FOR SHAME!
Look, I don't like the fact that undeserving parties are receiving payouts. It goes against everything I stand for. More and more people are hurting. It's not "right". At the same time, however, I very much fear that we are diluting the very fabric of what the country was built on: the rule of law. What Congress in proposing is riddled with unintended consequences (as is usually the case), unfortunately none of which are positive.
While AIG has taken center stage here, the fact of the matter is that what the House has passed has implications for employees at ALL of the institutions that are receiving government aid over $5bln. They are proposing to RETROACTIVELY tax bonuses (paid after the beginning of '09) for employees working at these companies with a family income over the "magic" $250k level at 90%. While we all know about the major players here (Citi, AIG, Fannie and Freddie, etc.), this impacts many more financial institutions. This is NOT targeted. This is going to impact not just the supposed rainmakers, but hard working, smart, employees across a broad swath of financial services. And it's happening at the exact time when we need these people to work as hard as they can to get us out of the mess we're in.
Beyond this, I see 3 major issues that the bill creates: 1) It is a huge distraction from the real matters at hand (most essential being getting the credit markets flowing); 2) it brings the risk of a "brain drain" from the major US financial institutions towards foreign institutions which are NOT subject to the same compensation taxes, creating a potentially huge competitive disadvantage; 3) it creates a major risk in terms of ability of the Government to attract much needed private capital to the "public/private" partnerships that it is envisioning to purchase the "bad" assets off of banks' books. I view the last issue as the most disturbing. If the Government insists on continuing to change the rules mid-game, I have to assume that the very investors that it seeks to invest alongside it are going to be extremely reluctant to do so in fear of future profits potentially disappearing into Government coffers at some point. Not good. Not good at all.
As far as the market goes, I think we've taken a step backward here. We need to drive non-Government investment into the riskier assets being held by the banks in order to really get credit flowing, and the "bonus bill", I fear, has set this process back before it even got going. The market has had a great run on signs that Fed and Treasury actions were actually gaining some traction. I believe the actions of Congress at least delays the essential follow-through. At the same time, the market is bumping up against technical resistance. It's time to play some short term defense here. While I still believe that we have the potential to see some "less bad" data over the next couple of months, and while I still feel that we may well have put the lows in, I reinstated my market short (SDS) this morning. Even if we have put the lows in and a bottoming process has begun, this process is going to be marked by "pops and drops", and I have the feeling that we're in store for the latter over the near term.
You Win Some, You Lose Some - YCS, DXO, TBT, Gold
Running the risk of being a little long winded this week, I did want to mention the unprecedented move by the Fed as it decided to directly purchase long term Treasuries in order to drive mortgage rates lower. Mission accomplished. Treasuries and the stock market surged, the dollar dropped like a stone, and gold reversed earlier losses and ended the day nicely higher.
I must admit that while, as you all know, the action itself was not a surprise to me, the timing caught me off guard. I had expected the Fed to make this play in late April when it releases estimates for financing needs. I believed that at that point, investors would get a sense as to how much Government debt will flood the market, driving Treasury prices lower and putting pressure on the Fed to counteract selling. Nonetheless, I was mistaken on the timing of Fed action and paid the price with the short Yen play (YCS), giving up my hard fought gains as the US dollar got whacked. Unfortunately, the aggressive move of the Fed puts a wild card into play with regard to YCS. Given the fact that I'm a long term dollar bear, and given what the Fed has done (as well as the fact that there's no reason to believe that they won't do it again), I have used the Yen weakness vs. the US Dollar today to move to the sidelines with an unbelievably small gain (maybe I'll drop by Starbucks with the winnings later). The Fed is being very aggressive here, and I'm not going to fight it on a near term basis.
On the other hand, the Fed helped us out on the oil trade, as investors began to contemplate the potential for a weaker dollar and for "reflation" that the Fed action may eventually bring. The Fed is very actively fighting deflation, trying to avoid the economic spiral that falling prices bring. As it continues to throw everything, including now the kitchen sink, at the issue, folks are starting to consider a "reflation" trade, in which hard assets (the "stuff" that makes the world go 'round) rise in value. It's not that we're looking at runaway inflation anytime soon. Demand is still very anemic and supply is still adjusting downward. However, as I mentioned last week, investors make a living out of trying to anticipate changes in trends. The trend today is for flat/lower prices. The trend of tomorrow, however is likely to be a reversal towards higher prices given extremely low rates and the massive amount of Government "pump priming" going on. Add in very positive long term supply demand fundamentals and a global economy that seems to be inching closer to a bottom, and oil looks interesting indeed. We might need to see a bit of consolidation here given the recent strong move in crude and anemic near term demand. However, I'd be looking for weakness in DXO as an opportunity to add to positions.
Staying with the "Rambo Fed" theme, let me make a brief mention regarding my stance on the short long-term treasuries trade (TBT). I've mentioned more than once that I am absolutely not expecting TBT to rise in a straight line and that we should be patiently be building positions as it ebbs and flows. One of the reasons for this is that I have been expecting exactly what the Fed actually did this week, which took the air out of the TBT. However, while the near term purchase of long term treasuries by the Fed will act to put the brakes on the trade for a time, we should not lose sight of the long term consequences of all of the programs that are being put in place: higher inflation, lower dollar, higher rates. With this said, I used the pressure on TBT on Wednesday to add to my position.
Finally, a word on gold. I've been long the yellow metal for a long time (in the form of GLD), recently trading around a core long term position. I must admit that the "consensus" nature of being long gold bothers the heck out of me. The sentiment indicators surrounding gold are leaning strongly on the bull side. There are a bevy of commercials on TV for companies looking to buy gold jewelry from consumers for cash. The old gold bugs keep coming out of the woodwork. This tends to give me pause in a pretty big way as I try to look to zig while others are zagging.
However, I cant get past the fundamentals: the printing presses are wide open, not just here but around the world. Paper money is being created out of thin air. What this basically means is that currencies around the world are being devalued, not necessarily against each other (it seems as if we're in an age of competitive devaluation) but against other stores of value (gold being a big one). This looks likely to continue for a while. Therefore, it's very tough for me not to be a long term bull on gold.
This said, the market tends to try to make fools of the greater consensus. So for those of you long gold, I'll suggest this: pay close attention to the charts. Watch the $880 level closely on the downside. This is where support lies. On the other side, watch $1000, which is a level of strong resistance. I would be holding core positions here and would be looking to add on a breakout above $1000. Yes, you'd be buying higher, but my confidence that gold is ready for its next leg up (perhaps toward the '80's high of $1600) would be much, much stronger at that point.
That's it for this week. Have a super weekend, and spread the word!
TRB
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