OBAMA'S BID FOR A SECOND TERM AND THE MARKETS

The end of the year is approaching and the markets are winding down a volatile year
with a whimper. So while everyone focuses on Europe (will it ever end?) what will
be the next catalyst for the market? How about a Presidential election?

Although there has been several Presidential elections and stock market cycle theories
written, not one tells the whole story. With varying political and economic circumstances
surrounding each election, no two are really the same. We cannot exactly say that George
Bush propped up the market in 2008 to bolster the Republican campaign. With that
being said, what is the market telling us about the next election?

OBAMA IS A LOCK

Do not be surprised, to hear such a thing from a long term Republican. Do we all
forget the circumstances under which he took the helm? During one of our country’s
biggest financial catastrophes. And a majority of the policies he was forced to follow
were instituted by the Bush Administration on the way out the door. I am not going
to say I agree with everything he has done since, but what the hell, look at the market. Up over
40% since he took the oval office and he is giving long term investors, yet ANOTHER
OPPORTUNITY to get out, lighten up, or at least lock in something.

My biggest concern with Obama was his stance on Israel. At this time, my worst
fear has not come to fruition, so I am trusting that it will not occur during
his second term. The role of the President of the United States in the foreign policy
arena will always be subject to some type of criticism. As far as his domestic polices
are concerned, the jury is still out on Obama-care (something needed to be done)
and I do not foresee unemployment ever approaching the 5% level again. For those
who want to dispute that fact, why not take a peek across the pond for a preview of
what is in store for us.

At this time, the most reliable and liquid Presidential election futures market has Obama
at slightly above a 50% probability of winning the election (http://www.intrade.com/). Are you kidding me? Who is going to beat him, scandalous Newt Gingrich? Please explain to me how the
United States, after veering so far to the left in 2008, is going to do a three sixty and move all
the way back to the extreme right? The Republicans would have a much better chance with
vanilla Mitt Romney, but once again he is somewhat symbolic of corporate America and will not attract enough straying Democrats.

So how could I be wrong? The market goes into a tailspin and cracks the bottom of this
nauseating trading range. But with corporate earnings at their current levels and tons of cash
on the sidelines this is unlikely to happen. On the other hand, if the market rips north,
as every analyst appearing on CNBC is predicting, Americans will stick with the status quo.

In closing, I am a buyer of Obama futures at the 50% probability level and if it falls below that

(which I would be very surprised) I am buying more. Perhaps that will be your only opportunity to
double your money in 2012.

Long Term Investors - What Now With Your Portfolio?

Here we are back at nearly the same level as we started the year. Certainly not without our share of ups and downs. Japanese earthquakes rocked the markets in April, budget malaise persisted through the mid year and of course, who could forget the European situation.

So what is your broker or investment advisor telling you now?  Pile in now and do not miss the next move up?  Or take some chips off the table after a decade of unprecedented market volatility and little or no absolute return on your portfolio?  Wish I had a crystal ball and I could give you the correct answer.  But since mine is broken, my words of advice to long term investors is, LOCK IN WHAT YOU HAVE HERE. Whether it be selling calls or buying puts on the overall market, or simply putting in stops on your portfolio (which you may get roasted on, on the overnight moves).  JUST DO SOMETHING.  Do not sit here idle and then start complaining if we go back to the bottom of the recent trading range.  At the very least, if you have the stomach to enter new positions in the market, do so with some downside protection.

Surely the perma-bulls, can argue earnings are great, as well as umemployment is coming down (which it is really not, people are just giving up looking for jobs), and Dow 15,000 is just around the corner. To you I would say things always look great at the tops and horrible at the bottoms. Whether the market bottomed in August and is gearing up for the next leg up is not the question.

The question is, how can you participate on the upside (your total return minus the cost of protection) while not exposing yourself to unlimited downside risk. At this time, the market rally has been fueled by the anticipation of the European monetary crisis being solved. Will it ever be solved, or are the measures attempting to be taken now only a temporary solution to a much bigger problem? Until we allow countires and financial institutions that should fail to actually fail, how much confidence should we have in the markets?

But do not rely on my advice, consult your broker or financial advisor and make sure they have a well devised plan to preserve what you have now, and still participate on the upside.  If they don't have that plan, consider changing your broker.

Leveraged ETFs and End of Day Volatility

Do leveraged ETFs increase market volatility?  This question has been raised time and time again with no definitive answer.  But here is my take.

Leveraged ETFs do a daily rebalancing in order to keep their leveraged exposure intact.  If the underlying index that the ETF is tracking, is up on the day, the leveraged ETF must increase their exposure to this underlying index at the end of the day by buying more of the index (usually done through a swap arrangement).  If the underlying index is down on the day, they must do the opposite, and decrease their exposure.  In essence, the leveraged ETFs are always buying at the end of the day on up days, and selling at the end of the day on down days.

This daily end of day rebalancing is very predictable.  Any type of predictable order flow is gamed heavily by predatory high frequency traders.  These HFT players will drive the price of the underlying index higher, if they know the ETF needs to buy, or drive the price of the underlying index lower, if they know the ETF needs to sell. 

This action leads to increased end of day volatility as the underlying indexes are moved around by predatory players looking to extract the maximum value from the leveraged ETFs predictable rebalancing.

So in essence, it is the predictability of the leveraged ETFs rebalancing that increases end of day volatility.

OTC Market Maker Steals 9 Points from Retail Investor

A new ETN started trading today, the ETRACS Fisher-Gartman Risk-On ETN under ticker symbol ONN.

New issues often lack liquidity as few market making participants jump in to make markets right away.  The issue opened for trading at $24.00 and bounced around between $22 and $27 in early trade.  Then at 09:51:42 ET, the sell side liquidity vanished for a split second showing the best offer up at $35. 

OTC market makers (aka internalizers), are allowed to print retail market orders anywhere within the spread.  When the national best offer flashed $35 for a split second, some quick internalization program printed a retail market buy order up at $34.968.  The stock immediately traded back down to $26, allowing the OTC market maker to cover for a quick 9 points.  The poor retail investor who sent that market order immediately lost the 9 points.  Here is the trade sequence:

Time & Sales       Ticker:  ONN          Date:  November 30, 2011                             

Time                Last                 Size (00s)

09:51:21          25.74               1

09:51:27          25.73               2

09:51:31          25.74               3

09:51:32          25.74               2

09:51:32          25.74               1

09:51:42          25.75               1

09:51:42          34.968             1

09:51:46          26.00               1

09:51:52          25.76               2

09:51:53          25.76               1

09:51:54          25.76               1

If that retail investor's buy order had been sent to any exchange, it most likely would have been executed at a much better price (as there is often hidden liquidity on the exchanges).  But because OTC market makers are not required to send orders to exchanges, they were able to take advantage of the temporarily widened spread at the expense of the little guy again.

The SEC needs to investigate instances like this, and determine whether some of these OTC market makers are really giving best execution, or simply taking advantage of a retail trader's blank check.

MARKET POISED FOR BREAKOUT OR BREAKDOWN?

Since the Ocotber 27th high of 1289.25 and the November 1 low of 1208.50, the market has been a chopfest. Although I am not a big fan of trendlines, the rising wedge off of these levels is hard to ignore.

At this time, we are creeping closer to the lower end of the wedge and a break below 1208.50 could trigger a quick selloff to 1156.50. Take a peek at the charts of many of the top stocks in the SP 500 index and you will see a familar chart pattern. Mulitple double and triple tops followed by a series of lower lows. With the top dog of the bunch AAPL struggling after its last earnings report, one starts to wonder what will be the next impetus to send the market back to its recent high. Also keep in mind the "Johnny come lately" fund managers that puked at the bottom and scrambled to re-enter, will be the first ones to jump ship on a breakdown. Furthermore, have the masterminds in Europe really come to a solution to their problems? Seems to me that there is really no solution to that mess and once one country's problems are supposed to be solved, some other country may have similar problems.

On the other hand, you can never underestimate this market and a rally above 1289.25 would signal a move to the yearly high around 1350. It would certainly be a nice way to pad the year end bonuses on Wall Street. A few weeks ago, Goldman Sachs set the yearly target of the SP 500 Index at 1200 and have not wavered from that prediction during the recent rally. Lets keep a close eye on the aforementioned levels and see which way this fairly reliable technical formation is resloved.

Apple - Tough times ahead?

Apple has finally broke the $400 magnet that has held the stock for the past month.  Unfortunately for the longs, the magnet was broken to the downside.  This is a key technical break-down for the stock. 

Analyzing the trades from the past few weeks.  The stock has been trading in a tighter and tighter range as the 400 area has had a vice-grip on the stock.  400 was a key psychological area that many traders had positioned off of.  Some traders bullish, some traders bearish.   This battle between the bulls and the bears has gone on since October 19th, the day after the earnings release. 

It has taken a few weeks, but it appears that the bears have won this battle.  The stock finally broke down through its key 391 support area, and has traded as low as 383 today.  I would expect that rallies in this stock may now be met with stiff resistance as traders who are caught long off the 400 area, try to wiggle themselves out.

There is some minor support in the mid 370s, but the next major support area is down at 360.  It would not surprise me if that level is tested within the next couple of weeks.

Lawmakers to Propose Transaction Tax

Representative, Peter DeFazio is at it again.  With support from Senator Tom Harkin, the two US lawmakers will introduce a bill today to propose a transaction tax on financial transactions. (See Bloomberg article here).

DeFazio tried to propose a similar tax a couple of years ago, but the proposed bill never gained much traction.  But now that the European Union has proposed a financial transaction tax, DeFazio is hoping that his proposal can gain more support this time around.

The problem is this tax, while in theory, would raise a substantial amount of revenue, it would come with some substantial costs, the most significant being a decline in market liquidity.  Market liquidity refers to a stock's ability to be sold without substantially impacting price.  The majority of our market liquidity is provided by market makers.  These market makers have very small profit margins.  A modest transaction tax of 0.03 percent (which is being proposed), would have devastating effects on the market making business.  Let's take a quick look at the math.

Many of our most highly traded stocks have bid-ask spreads of one cent.  A stock that is trading at $25, would have a transaction tax of ($25 x 0.0003) = $0.0075 per share.  If a market maker were to buy this stock at $25 and sell it at $25.01.  They would make 1 cent/share, but would have to pay 1.5 cents/share in tax (they have two transactions, the buy and the sell).  Therefore they would lose 0.5 cents on the transaction.  In order to remain profitable they would have to widen their spreads to a minimum of 2 cents, and possibly further (as market makers aren't always profitable on every trade).  Wider spreads means more price impact for institutional traders as they make trades, which comes right out of the pocket of the little guy who invests in the fund that is trying to transact.  These are the indirect costs.
 
The direct cost is that the institution transacting would have to pay the transaction tax as well.  So another 0.03 percent comes out of the pocket of the individual investors investing in the fund, every time the institution makes a trade.

What will naturally happen is that traders and institutions won't trade as much, and volumes will drop substantially.  This makes any projected revenue raised by the transaction tax much less than what would be raised on today's current market volumes. 

Some will argue that introducing this tax will eliminate high frequency trading.  Now I'm not a big fan of high frequency trading either, but there are better ways to regulate high frequency trading.  This tax would do nothing more than harm market liquidity in a market environment that some already argue doesn't have enough liquidity to begin with (think of the May 6th flash crash). 

So let's use some common sense when introducing bills that do more harm than good.

Market approaching resistance, what's the trade?

The market has had an impressive run in the past five trading sessions.  Just over a week ago the S&P bottomed out at 1074.  We are now trading at 1193.  This run would seem to be unsustainable, and many traders are banking that we will see a pullback.  But if traders are looking to short off of these higher levels, I think a tight stop is in order.  It is true that we are approaching the 1200 resistance levels again, and many individual stocks are pressing up to their resistance levels as well, but this has been a vicious rally, and still has a lot of momentum.  There are a lot of traders who were caught shorting the breakdown through 1100 only six trading sessions ago.  Those traders (if they didn't cover) are still seriously under water.  There is also a lot of institutional money that threw in the towel when we broke 1100 as well.  That money may be second guessing their move.  I still expect that pullbacks will be bought by those participants who are under-invested.  That adds some stability to what would seem to be an unsustainable rally.

There is also another potential catalyst.....earnings season kicks off tonight.  Many stocks are priced in for very disappointing results.  If the results aren't quite as disappointing, there could be further upside here.  In summary, we've had a helluva rally, but I wouldn't be surprised if some of these individual resistance levels are taken out.