Current Market Signals

Things sure have changed in the equity markets since March.

Back in the final weeks of that month, as the Fed opened the discount window to investment banks and assisted in the retention of trades on the books of the failing Bear Stearns, my partner and I saw signals that the worst of the equity and options markets for long positions was over. The Fed, as my partner put it, was not going to allow money to be made on the short side anymore.

At that time, the risk was to the financial services sector and, it was believed, the credit markets in general.

We carefully monitored our new signaling/risk management tools and bought calls in April and May. By June, we again bought calls, but with a sense that maybe we should have straddled.

We were right.

In just two months' time, we sold call options with returns of over 150%, and roughly 50% on the April portfolios. May's options were less profitable, but still returned positive results, with one call exercised for a very significant return.

Now our signals look very similar to those of both December and March. Our S&P-based volatility measure has risen significantly to levels near that of mid-March, while the S&P returns in trailing months has been dropping.

Without divulging our specific proprietary measures, this combination is a lethal one for equities.

What has stunned my partner and me is that we don't really think there has been much in the way of new, fresh, bad economic news. But the business media and political machines of both parties seem to be dwelling on the worst economic and sentiment measures they can find.

Housing is compared to the Great Depression, as is joblessness, though both are wrong.

Energy producers are maligned, as are derivatives markets investors who provide liquidity and price discovery services to energy futures markets.

Now, they are labelled 'profiteers' and 'speculators.' Talk of windfall profit taxes and stiffer regulation or prohibition of 'speculation' is rampant among our King Canutes in Congress.

In fact, I don't think economic measures have declined as precipitously as the S&P and its futures have. Perhaps the one new development is more awareness of higher, if not crippling, inflation, and a potential rise in the Fed rate sometime in the next few months.

But these two factors alone seem to be offsetting the less-than-catastrophic business and economic news occurring recently.

Back in April, I thought we had a good 4-5 months of call options portfolios before we had to worry about weakening markets.

Instead, in only six weeks, we're somewhere between neutral and short in our evolving outlook for equity allocations in the next month.