Category Archives: Trades

Buying Homebuilders (NYSE:ITB)

My bullish view on single family housing starts (as detailed in a recent post), coupled with the recent sell off in homebuilders caused me to buy the iShares US Home Construction ETF (NYSE:ITB). I tweeted about it late Wednesday night and will track it in my portfolio page using that day’s closing price of $22.17 as my initial price.

Although housing starts stagnated over the past year due to the rapid rise in home prices and interest rates, there are reasons for optimism. According to the Case-Shiller index, year-over-year home price growth has softened from just over 10% late last year to 5.6% in July. In addition, the most prevalently quoted conforming 30 year fixed rates dropped below 4% last week for the first time since June 2013.

As for the state of home buyers, employment continues to grow 200,000+ per month with moderate wage growth, while household debt to disposable income continues to decline.

A potentially positive recent development was the report of a likely deal between Fannie Mae, Freddie Mac and mortgage lenders to loosen lending. This could make mortgages more obtainable for lower income families.

Over the past year, homebuilders’ stocks have flatlined along with housing starts, while significantly underperforming the market.

$ITB Performance vs. $SPY

Despite little growth in new home sales, homebuilders have been able to grow their top and bottom lines by raising prices. So if sales begin to increase again, they could easily grow EPS by 20%+ and achieve 2015 analyst estimates.

As shown in the following chart, the largest homebuilders currently trade for 12x next year’s earnings compared to S&P 500’s 14x its lofty estimates.

Homebuilder Valuations

Looking beyond, past housing recoveries suggest housing starts could increase 15-20% for several years allowing homebuilders’ operating leverage to grow earnings even faster making their stocks attractive long term investments.


Closing Russia (NYSE:RSX)

Last Friday I closed my long position in the Russia ETF (RSX) at $24.80 which is equal to my initial buying price. As I mentioned in this post, if the RTS index were to have a weekly close below 1220 I would close the trade. As it turned out, the RTS finished the week on August 1st at 1212 for a second false breakdown this year making the triangle pattern unreliable.

Russian Trading Systems-2

I was hoping to wait and sell out at a better price, but the geopolitical situation in Russia seems to be deteriorating and beyond my area of competence so I decided to close the position before the weekend.

My rationale for the trade was based on the chart and valuation. While Russian equities remain extremely cheap relative to other markets and its own history, it can remain so for years. I was hoping the false breakdown would signal that Russian stocks were ready to close the valuation gap, but the unexpected shooting of flight MH-17 along with the increased sanctions between Russia and NATO countries has trumped the chart.



Buying Fiat (Italy: F)

I recently purchased Fiat’s stock listed in Italy after coming across a persuasive presentation by Michael Guichon, a Columbia University MBA student, who presented his bull case for Fiat at the 2014 Ira Sohn Contest. A panel of judges including Bill Ackman, Joel Greenblatt, Seth Klarman, and Michael Price selected Guichon as the winner. Below, Guichon summarizes why he likes Fiat’s stock. I will be tracking Fiat’s performance here.

Buying Russia (NYSE:RSX)

I recently bought the Market Vectors Russia (NYSE:RSX) etf at $24.80. I am bullish on Russian equities based on its terrible past price performance, negative sentiment, dirt cheap valuation, and attractive chart pattern.

After Russia’s debt default in 1998, the Russian stock market went on an explosive run for 10 years appreciating by 50 times. Since the global financial crisis, however, it has been among the worst performers globally declining 50% during the past six years. This is because Russia’s economy has been grappling with slowing growth, high inflation, shrinking current account surpluses, and a weak ruble. The recent tensions with Ukraine have only exacerbated investor antipathy.

As Nathan Rothschild famously said, “the time to buy is when there’s blood in the streets.” It’s hard to find an investment today where that is more applicable than Russian equities. Russia’s incursion into eastern Ukraine and its annexation of Crimea has sparked worldwide concern of potential war. Hillary Clinton, John McCain, and German finance minister Wolfgang Schäuble have gone so far as to compare Vladimir Putin’s actions to Adolf Hitler’s aggressions in the 1930s.

I am no expert on Eastern European geopolitics, however former U.S. Secretary of State Henry Kissinger doesn’t believe the Putin-Hitler comparison is valid. Speaking to CNN earlier this month he says,

“One has to ask oneself this question: He spent $60 billion on the Olympics. They had opening and closing ceremonies, trying to show Russia as a normal progressive state. So it isn’t possible that he, three days later, would voluntarily start an assault on Ukraine.”

“I think at all times he wanted Ukraine in a subordinate position. And at all times, every senior Russian that I’ve ever met, including dissidents like Solzhenitsyn and Brodsky, looked at Ukraine as part of the Russian heritage. But I don’t think he had planned to bring it to a head now. I think he had planned a more gradual situation, and this is sort of a response to what he conceived to be an emergency situation.”

A full blown war could certainly breakout and cause Russian stocks (as well as stocks around the world) to drop further. But a lot of the fear is priced into Russian stocks since they trade at the cheapest valuation relative to the world and to its own history.

Russia Valuation

The chart of the US $ denominated RTS looks like a false breakdown recently took place. If so, it should signal an explosive move higher.

RTS Russian Stocks

What I like most about this trade is that there is a clear stop loss level at the bottom support line. I am willing to own RSX as long as the RTS does not post a weekly close below 1220. I will keep track of the performance of this trade here.

Update: Buying November ‘09 Fed Funds Futures

Last November I started going long November ‘09 fed fund futures at 98.25 (i.e. the market priced in an effective Fed funds rate of 1.75%). I was hoping that the Fed would slash rates to 0.50% and keep it there through November so that I could net a profit of over $5,000 per contract. As it turned out the Fed reduced its rate to fluctuate within a range of 0% to 0.25%. Since the economy has continued to deteriorate and I can’t see how a sustained recovery can take hold this year, the funds rate is likely to remain under 0.25% during the remainder of 2009.

Therefore, I think buying the November and December fed fund futures under 99.50 is highly likely to be profitable. I have substantially increased my position since my initial buy last November and I have paid as high as 99.49 per contract. Currently, both the November and December contracts are trading for over 99.50. I’m not planning to do any more buying and will sell my entire position once the contract price rises over 99.75.

Buying November ‘09 Fed Funds Futures

Last Friday I purchased fed funds futures contracts for November 2009 at 98.25. I went long fed funds futures earlier this year and closed the position in September with a huge gain. In retrospect, I could have made even more if I held on to the position, but I didn’t anticipate the Federal Reserve slashing the overnight rate by 100 basis points in October.

If I would have known in advance that October would be the ninth worst month in stock market history, the CRB index would register its largest monthly decline on record, and the US dollar would attain its biggest monthly gain against a basket of currencies in more than 17 years then, of course, I would have predicted the Fed’s policy decisions. But October was an unusual month to say the least.

What I find strange is that the market is pricing in only another 25 basis points cut by the next FOMC meeting on December 16th, after which the Fed is expected to embark on a tightening campaign next year by such an extent that the overnight rate would reach 1.75% by November.

I think only two conditions would necessitate such a policy response: (1) the US economy soon begins to stage a rapid recovery or (2) confidence in the US dollar is shaken and its value plummets. The first condition is highly unlikely, in my opinion, given that the US consumer is early in the process of decreasing consumption and increasing savings in order to repair his balance sheet from the damage done by declining real estate and equity values.

As for the possibility of a dollar crisis, I certainly expect one at some point in the future, but not in the next 12 months. The US dollar is the world’s reserve currency and in a period of de-leveraging, it will be in great demand. Only if the Fed prints money in a far more rapid fashion would confidence in the US dollar be shaken, and even then the Fed would have first resorted to a zero interest rate policy (ZIRP) for a period of time before attempting such a risky action.

During the last recession, the Fed began easing in January 2001 and didn’t raise rates until June 2004 or 41 months later. In the current cycle, the Fed first cut rates in September of last year or 14 months ago. If the Fed emulates its policy actions from the previous downturn then rates won’t increase until February 2011. I don’t know if the Fed will wait that long before it begins to hike rates, but given that the current recession will be far more severe than the previous recession, I am confident that there won’t be a hike in 2009.

Lowering of the fed funds rate helps the two groups most affected by the current crisis: banks and consumers. Banks benefit because their business is based on borrowing short and lending long, so their net interest margin will expand. Consumers benefit because many adjustable rate mortgages and loans are based on the banks’ prime rate which is influenced by the overnight rate. Therefore, there is a lot of incentive for the Fed to implement ZIRP.

However, I don’t think it will be enough to offer much of a stimulus for the economy because banks are barely solvent and don’t want to lend in order to preserve capital. And consumers have too much debt relative to the total value of their assets to want to borrow more. Therefore, credit growth, which factored in each time in the past as the Fed cut rates to pull the economy out of a recession has disappeared. Once the Fed cuts rates close to zero, it will realize that additional actions will be required.

Japan held rates at zero for nearly six years in its decade-long struggle against deflation. When that was not enough it resorted to “quantitative easing”, a technical term for what amounts to printing money on huge scale. I expect the Fed to follow the same game plan. Though it has already started to print money via its normal open market operations, I expect more aggressive money printing through unconventional means when it realizes ZIRP is not making much a difference.

The following table lists the profits or losses I would incur under various fed funds rates for each November 2009 contract that I buy at a price of 98.25:

Fed Fund Futures Risk/Reward

My intention is to hold the contracts until they rise to at least 99.50 (i.e. the market prices in a 0.50% fed funds rate or lower) so that I can make a profit of more than $5,000 per contract. This would be a spectacular return since the Chicago Board of Trade requires a maintenance margin of only $1,200 per contract.

Closing Short Position in MBIA Calls

Today I closed my short position in MBIA’s January ‘09 call options with a strike price of $10 for 85 cents compared to my selling price of $4. I also closed a short position in the January ‘09 calls with a strike price of $15 for 35 cents compared to my $3.30 selling price. As I previously outlined, the bond insurers are going to be hit by an avalanche of claims and insurers like MBIA have under reserved. After a spectacular rally in August that took MBIA’s share price from $4 to $19, the market has come to accept my view as the stock has collapsed to as low as $5 last week.

However, last night CNBC was reporting a rumor that the Treasury was considering including the monoline insurers among the financial institutions that it wanted to recapitalize. At this point in time no official is confirming this rumor, but given that the lack of confidence in the insurance provided by the monolines is one of the main reasons municipalities are having trouble raising money, I think it’s quite likely that the government will do everything in its powers help keep firms like MBIA solvent.

A government purchase of preferred shares, if done at the same terms as was put forth to the major banks, would be very favorable to MBIA shareholders. The capital would help the company pay out its claims and the 5% interest rate is very cheap. And most importantly, the government backing would mean that there would be no further ratings downgrades. The government would get warrants equal to 15% of the value of the preferreds, which would dilute existing shareholders only modestly.

It is sad that the government is considering a bailout of a company that reaped enormous profits for many years at the expense of taking on a huge amount of risk without firing the management, wiping out the shareholders, and giving the creditors control of whatever is left of the company after the government is paid back. However, without a bankruptcy filing the government has no legal authority to takeover the company and if it waited for a bankruptcy, problems would worsen in the municipal bond market.

So I decided to take profits in my short position before the government steps in and the market reacts favorably, as it started to do late Thursday.

Covered Short Position in US Treasury Bonds

Today I covered my short position in the December contract of 30 year US Treasury bonds futures at $113.89. I initially sold the contract last Thursday for $118.29. This was only a small short term trade to play some lessening of fear after the US and Europe announced they would recapitalize the banking system. Although today’s stock market plunge seems to indicate that the market remains as fearful as last Friday, Treasury bonds have taken the hit that I expected. This may be due to concern about the huge supply of bonds that the US government will have to issue to finance all these bailouts. In any case, for the first time I am sitting almost entirely in cash and awaiting new opportunities. In volatile markets like these, I don’t expect to wait long.

I’m Now Neutral on Equities

The recent stock market rout has left equities no longer trading at the expensive valuations that I had been concerned about. They aren’t cheap either, so I don’t plan to do any buying at current levels. But I have closed virtually all of my short positions leaving my portfolio with lots of cash. My reasoning for believing that stocks have become more fairly priced is based on my outlook for earnings and the multiple the market will assign to those earnings.

S&P 500 four-quarter rolling operating earnings peaked at $90 during the 2nd quarter of last year. After the second quarter of this year earnings have declined to $70. Given that the only driver of earnings growth, energy and materials companies, will now suffer declining earnings, I expect at some point over the next year S&P 500 earnings will bottom within the $50-$60 range and will remain there for several more quarters.

Typically PE ratios are in the single digits during both deflationary periods because of worries of plummeting earnings and highly inflationary periods when investors demand a greater earnings yield to compensate for a rising cost of living. While inflation has been uncomfortably high recently, I believe we are entering a disinflationary period where the market will assign a multiple close to the historical average which is 15.

So if we get earnings of $50-$60 and multiply it by 15, I get a fair value for the S&P 500 of around 750 to 900. I felt very comfortable taking a big short position when the S&P 500 was trading at over 1300 earlier this year. But last week it dipped below 900 and I had no reason to remain short. If the market rallies to around 1100 I will re-establish a big short position. If the market continues to drop and falls to below 600, I will probably go aggressively long. But within 600 and 1100 I’m not going to make any big bets.

Currently, I’m almost entirely in cash. I own Altius Minerals (TSX:ALS), a handful of tiny positions in micro-cap resource stocks, a short position in MBIA (NYSE: MBI) calls, and a short position in 30 year Treasury bonds. Because I don’t see any significant mispricings in the equities, commodities, credit, and currency markets, I’m going to wait patiently for opportunities to present themselves which they always do with high frequency.