Vexing Over the VIX

I am a short-term bear on the US market. Given the performance thus far, there is more downside than upside. Case in point, the S&P500 is up 9% YTD. At this clip, the S&P500 will be up over 36% for the year. This will occur on the back of 13.41% gain in 2012. Inconceivable as the Sicilian from Princess Bride would say. If the US and the global economy were roaring like in the pre-2008 era, it would be conceivable but they are not. The US economy will barely grow at 2% (vs 4%+ pre-2008). Global GDP will be lucky to pull in 3.3% (vs 5%+ in the heydays) growth rate given the obvious slowdown in BRIC countries.

One of the measures of investor sentiment is VIX. Using range of out of the money call and put options, the CBOE estimates the likely movement in the S&P500 index over 1 month period. Today VIX is at 13.36, meaning that the options market forecasts the S&P500 to move 3.86% in the next 30 days (13.36%/√12). That is not a lot considering that the S&P500 can move that amount in couple of sessions. There are VIX future contracts (Bloomberg: UXJ3) where investors bet on the future path of VIX. The VIX future for the end of November is 19.40 suggesting that the investors expect volatility to increase as we head into the dog days of summer.

My hunch is that the S&P500 will test 1,500 in the next month or so. That's not an outlandish prediction because it is just 3.35% from current level and entirely within the range implied by current VIX.

Todays Reads - Cyprus, Bill Gross, Robert Shiller

Today's Reads
Interesting readings from today

Cyprus is the new epicenter of the European financial crisis. In return for Eu10 billion bailout, the EU imposed 9.9% tax on deposits greater than Eu100K and 6.7% on less than that amount. If approved by the parliament (vote postponed), this is will raise Eu6 billion. This is quite an unprecedented move and will likely impact market tomorrow especially given that everyone is looking for an excuse to sell. Forbes even compares this to Lehman debacle. Note that banking system in Cyprus is 8x larger than the economy, so bailing them out is bailing out foreigners especially the Russians, not a politically palatable solution for Euro politicians.

Pimco's Bill Gross, in his March think piece "Rational Temperance" attempts to answer somewhat un-answerable question, when would we know when there is irrational asset bubble. My view is that you don't. But he does make an interesting point in that HY debt market is a better indicator than equity market because it is set by institutional investors or better informed people. Basically says look at the issuance, which is inversely correlated with future returns, that'll give you the probability of irrational bubble - currently 6/10 in his view and moving higher.

One of the points Bill Gross makes is that he found the close relationship between HY spread and equity interesting. Duh! That comes directly from Black-Shoals option pricing model. Basically, equity and debt are joined at the hip; no wonder they act in a similar fashion.

Talking about market peaks, Prof Robert Shiller attempts to put that in perspective in a NYT oped, Yes, We’re Confident, but Who Knows Why. His answer to whether we are in a stock market peak now is typical of an academic, we don't know. He uses two measures to take the gauge of the market (1) valuation confidence i.e. % of institutional investors and individual investors who think market is not overvalued (2) cyclically adjusted price-earnings ratio (CAPE), which is real, or inflation-adjusted, Standard & Poor’s 500 index divided by a 10-year average of real S.& P. earnings. Currently, both confidence and CAPE are at relatively high levels but based on 2000 and 2007 experiences, they don't tell anything about the future.

The Big Short War on Herbalife

The Big Short War
Vanity Fair, April 2013
By William D. Cohan

Hedge-fund titan Bill Ackman has vowed to bring down Herbalife, the 33-year-old nutritional-supplement company, which he views as a pyramid scheme. With his massive shorting of Herbalife stock, the price plummeted, prompting two fellow billionaires—Ackman’s former friend Dan Loeb and activist investor Carl Icahn—to take the opposing bet on Herbalife. As the public brawl rivets Wall Street, William D. Cohan learns why, this time, it’s personal.

The supremely confident billionaire hedge-fund manager Bill Ackman has never been afraid to bet the farm that he’s right.

In 1984, when he was a junior at Horace Greeley High School, in affluent Chappaqua, New York, he wagered his father $2,000 that he would score a perfect 800 on the verbal section of the S.A.T. The gamble was everything Ackman had saved up from his Bar Mitzvah gift money and his allowance for doing household chores. “I was a little bit of a cocky kid,” he admits, with uncharacteristic understatement.

Tall, athletic, handsome with cerulean eyes, he was the kind of hyper-ambitious kid other kids loved to hate and just the type to make a big wager with no margin for error. But on the night before the S.A.T., his father took pity on him and canceled the bet. “I would’ve lost it,” Ackman concedes. He got a 780 on the verbal and a 750 on the math. “One wrong on the verbal, three wrong on the math,” he muses. “I’m still convinced some of the questions were wrong.” <Click Here for More>


Icahn verus Ackman (25-Jan-2013)

Google-Apple Valuation Gap Widest Since 2005 on Ads

Google-Apple Valuation Gap Widest Since 2005 on Ads

Bloomberg, 6-Mar-13

By Brian Womack

Google Inc. (GOOG)’s prospects haven’t looked so promising to investors relative to Apple Inc. (AAPL) since before the iPhone was introduced.

Google’s shares, which climbed to a record yesterday, are now trading at 25 times profit, compared with a price-to- earnings ratio of less than 10 for Apple, according to data compiled by Bloomberg. That gap is at its widest since June 2005, two years before competition between the two companies in mobile devices began to intensify.

Investors are willing to pay more for each dollar of Google’s earnings relative to Apple amid optimism that Google, with more than 40 percent of the U.S. online-advertising market, will command even more of the $37.3 billion that businesses spend each year to reach Web audiences. Google also has used an alliance with Samsung Electronics Co. (005930) to gain share in mobile software, feeding the competitive threat weighing on Apple as investors await the next big product from the iPhone maker.

“There’s only one company benefiting from all the growth areas of the Internet -- be it video, mobile, local, social, display advertising,” said Sameet Sinha, an analyst at B Riley & Co. “Apple has just done well in devices, nothing else.”

Google fell less than 1 percent to $831.38 in New York, while Apple declined 1.3 percent to $425.66. Google’s U.S. shares have added 35 percent in the past 12 months. Apple has dropped 20 percent in the same period, though its market capitalization is still more than $100 billion higher than Google’s. Apple remains the world’s most-valuable company, followed by Exxon Mobil Corp. (XOM) and Google. <Click Here for More>

Interview with Jeremy Siegel

Though stock market volatility continues to rattle investors' nerves, the future looks bright for equities in the U.S. and many emerging markets, according to Wharton finance professor Jeremy Siegel. That's not so for bonds, which could become money-losing investments as rising interest rates drive bond prices down. In an interview with Knowledge@Wharton, Siegel says that investors should think about reducing their bond holdings, buying more stocks and keeping just enough cash for a rainy day and other liquidity needs, since interest rates on cash are near zero. With the housing market -- so critical to the U.S. economy -- clearly improving, anyone who has held off buying a home should think about buying now while prices and mortgage rates are low, Siegel adds.