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The stock market wants to crash, or at least correct, but there is something that has not allowed this event to take place. The stock market is supposed to be a barometer for the health of a nation's economy. Its value derives from the expected future earnings of all companies it is comprised, and when we examine the US economy, there has been a major decoupling from wall street and main street; regular folks have not seen the same prosperity.
The bull market rally is now seven years old and has seen equities triple in value. Over the last three quarters, we have seen an earnings recession, that is, year over year returns in the negative. The upcoming earnings season expects companies to see earnings fall 8 per cent from last year's first quarter, but the stock market maintains its valuation. The reason: low interest rates.
We have now entered a global economy where many nations are at zero or negative interest rates, which has never happened in history. And as a result, trillions of dollars invested in low-yielding assets seek better returns in the stock market. This massive demand for higher yielding assets outpaces the selling pressure that traditionally occurs in an earnings recession. Money needs to grow and it needs to grow more than inflation, but dozens of top-tier nations have bond yields that can barely match inflation ten years out. The 10-year Canadian bond rate is 1.23 per cent. The 2015 inflation, according to the CPI, was 1.13 per cent. The Bank of Canada targets inflation of 2 to 3 per cent. In the US, the 10-year bond is yielding 1.69 per cent and its last inflation rate was calculated at 1.00 per cent. The US Fed also aims for about 2-2.5 per cent inflation.
We are days away from Alcoa (AA) earnings, which is traditionally the first day of earnings seasons, but we are just a few short weeks away from the April Fed meeting. Which set of events will impact the stock market more? On days with an FOMC meeting or the release of minutes, the stock market has major volatility in every case. Whether it be dovish or hawkish, the markets rise and fall according to what Yellen and her colleagues do. That is a cause for concern. Whether it be computer traders or money managers, their reactions set a significant tone for the remainder of the week or month. And it also re-affirms the impact an interest rate decision has. The trillions of dollars that have entered the stock market because they cannot make money outside will leave when interest rates rise. And how much of the stock market's value is at a premium because of low interest rates?
The historical price-to-earnings ratio of the S&P 500 is around 17. It is currently estimated at 22.8. If the market were to head to its historical valuation, that would see a market reduction of almost one-quarter. Startling and not unrealistic. We have already seen two corrections in the last 9 months, and unsurprisingly, both corrections recovered within weeks, but if there is a third correction and it is triggered by an interest rate rise, it could be the start of the end of the bull market rally.
Other reasons to support the theory that the market will fail in 2016 comes from its technical patterns. Weakness in many indicators, such as the MACD and OBV, and overbought conditions measured by the RSI, as well as failed attempts at ceilings, could signal the start of another leg down. Cheap option prices have created a great opportunity for investors to protect their necks. The implied volatility of an option rarely favours the long straddler, but we have seen consistently oscillations that make option sellers reluctant to take positions.
On April 6, 2016, an analyst for Bank of America-Merrill Lynch was on CNBC's "Fast Money" and said that the S&P 500 would outperform other benchmarks, which we believe included the STOXX 600, NIKKEI, and other international indices. That's great news for North American investors, however, she also mentioned that their firm believes there is an equal chance that being in cash will outperform the S&P 500.
Let that sink in for a moment. BAC believes that not investing for 2016 could be more profitable than investing. That is not often a phrase said by a firm, especially when firms only make money on transactions. When a firm backs that capital preservation is equal to owning stocks, that raises some red flags. It might just be one rogue analyst whose views don't add up to much when the rest of the industry says otherwise, but it could also be the one rogue analyst who decides it is time to make bolder predictions that do not profit the firm and help the investor.
The truth: we could be wrong. Every trader and doomsday predictor could be wrong. But the idea of selling your stocks if you have owned it through any or all of this extended rally is not wrong. And taking profits is always a good idea when analysts, professionals, money managers, historical trends are all uncertain as to what investment decisions are best for 2016.
The return of Connor McDavid and the sudden surge of the Edmonton Oilers since the trade deadline day has re-ignited the dreams of playoff hockey for many fans. Talbot is playing like a man possessed by Broduer and Roy, Eberle has found his scoring touch, Yakupov has paired well with McDavid as expected, and Hall has rediscovered his game as well. Their confidence levels have risen with the acquisitions of strong, role players such as Kassian, Maroon, and Pardy. Sitting in the basement of the West, a playoff game is still mathematically attainable going into tonight's game.
A miraculous winning streak of 15 to finish the season would give the team 87 points in the standings, a huge improvement from years (10 to be exact) past. It was predicted that it would require 95 points to make the playoffs at the start of the year, but with a handful of Western Conference teams failing to meet expectations, it appears that the wild west playoffs may be easier to reach. How much easier?
The Wild currently have collected 72 points in the standings, which is 13 points more than the Oilers lowly 59. The Oilers, as mentioned, can max out at 87 points. It appears that the only other real team in this race, barring a sudden surge by another team near the Oilers in the standings, are the Colorado Avalanche. It can be assumed that one of these two teams will make the playoffs and they hold a .537 point percentage. If their play of hockey remains consistent, one of these two teams will enter the playoffs with 88 points, 1 point more than the Oilers can max out.
There are some key match ups that could help the Oilers. The Wild and Avalanche have one game versus each other on Saturday March 26. Only one team can win, and if the Oilers have made some progress getting out of the basement, that could be a crucial game. The Wild have 15 games remaining with 8 at home. They will host the Oilers on Thursday March 10 before embarking on a four-game eastern road trip against weak teams, which bodes well for the Wild.
Meanwhile, the Avalanche will play against the Oilers on Sunday March 20 in Edmonton. They also have a very difficult schedule as they will be finishing the season with 7 straight games against playoff bound teams and one against the Wild. They face the Blues twice, the Predators twice, the Stars, the Capitals, and the Ducks to finish their campaign. If MacKinnon and company want to make the playoffs, they will need to play like it is a playoff series as they will most likely face one of these teams in the first round, but to be frank, that is a tough hill to climb.
So, can they make the playoffs? It requires a 15-game winning streak, which has not been done this season by any team, but if they can make it happen, I believe they will make the playoffs. It will only take 85 points to make the playoffs for the west this year. And let's not forget that the Wild fired their coach recently because they had only won 3 games in 19 contests. Maybe, just maybe, there's a little light for a Christmas in April after all.
Go Oilers go.
This will surely be an unpopular view, but it's time the province of Alberta considered raising taxes on the bargain prices that is gasoline. The low prices have benefited many industries and users, including transportation (airlines, shipping, and rail), agriculture, restaurants, hospitals, first-responders, governments, and vehicle drivers. The shift in profits from mega-corporations to small businesses and families is a welcoming trend. However, sustained crude prices below $45 US a barrel (and today $27) have harmed governments in Alberta and Canada as income taxes, property taxes, and oil revenue has dried up, pun intended.
According to Alberta Energy, the Alberta government's royalty revenue from oil sands in the fiscal year 2014-2015 was $5.0 billion unaudited. Conventional oil royalties was $2.2 billion. The Notley NDP government announced at the end of January 2016 it had made minor changes to the royalty agreements tied to the many industries related to energy, however, it might not be enough to get the province out of a deficit.
The provincial government predicts that deficit to be $6.5 billion this year. Revenue from non-renewable energy may decline almost two-thirds; income tax revenue will also decline. Trying to justify a tax increase to its voters and citizens during economic hardships and recessions can lose a government its power, however, Canada is not in a recession - defined by two consecutive quarters of negative growth. With GDP growth tepid but existent and employment opportunities still abundant, this is a good opportunity to capitalize on low prices coupled with gasoline affordability.
Charging a five cent tax on gasoline as a way to reclaim revenue lost from the decline in oil is fit for this government. Gasoline prices are very inelastic and consumers are more inclined to pay higher prices because it is such a necessity in our economy. In 2014, when gas prices were near record highs, Alberta consumed over 6.5 trillion litres of gasoline and 4.4 trillion litres of diesel at gas stations, the highest rates from 2010 to the present and presumably the highest rates in Canadian history (view statistics here).
This five-cent tax increase by the province of Alberta would generate, using the figures of 2014, more than $500 million in tax revenue at the pump alone. This excludes fuel used in jets, boats, and trains. An aggressive government could tack on 20 cents and yield $2 billion in revenue. Gas prices would soar to 80 cents overnight and could anger Albertans, however, these prices are still the lowest seen this century. Governments could reduce the taxes as oil revenue rose to shift the burden away from vehicle drivers. With many citizens wanting and willing to pay more to get people back to work and governments back in the black, this is a huge opportunity that cannot be ignored.
A depreciated loonie could help Canadian companies' bottom lines as we head into earning seasons here up north. Many companies with US exposure are expected to see a boost in its earnings per share projections, such as banks and energy companies. The falling dollar, now valued at 1.37 US, provides a cushion for many corporations who report in Canadian dollars but generate revenue in the US.
How so? Most Canadian companies have expenses in Canadian dollars. All things being equal, if they are now receiving 30 per cent more in Canadian without changing their business models, implementing any new strategies, or growing their brands, there is an automatic hike in revenue after conversion.
Canadian banks exposed to the US include TD and Bank of Nova Scotia. These two have entered the US years ago and may reap the benefits of a falling loonie.
Energy companies have seen oil prices crash over the last year, but the falling dollar has made times a little easier. The spot price of WTI is currently trading around $33 a barrel; this is $45 Canadian. When oil was at its peak, the Canadian dollar was near par. The drop in oil itself has significantly lowered expectations. Suncor has posted earnings today with the stock rising over 1 per cent on news it lost 2 cents per share in this quarter. Other major oil companies include Canadian Oil Sands and Imperial Oil.
Should the Bank of Canada lower interest rates?
JP Morgan mentioned just prior to the Bank of Canada interest rate decision that lowering the lending rate in Canada would indeed help the country's economy. The reduction in the interest rate to below 0.50 per cent in theory would have lowered the Canadian dollar even further, but as an exporting country, this would improve GDP.
The depreciation of the loonie could have helped kick start inflation as well. Canadian inflation rates have meandered below the 2 per cent target for an extended period of time which is often an undesirable situation. Inflation encourages spending and the flow of money as consumers that make purchases are more likely to do it sooner rather than later. If a deflationary economy exists, spending could halt and a recession could be ignited.
Disclaimer: the author of this article has household members that own Bank of Nova Scotia and Canadian Oil Sands. This article is for information purposes and does not make recommendations on buying or selling any of the companies listed. Please review your investment holdings and speak to a professional prior to any decisions.
My friend recently became interested in the long iron condor strategy, a technique used by option traders that speculate an asset will remain within a price range at the option's expiration date. There are many websites that explain how a long iron condor can be executed, however, these sites must assume that the reader is knowledgeable enough to understand the terminology. Understandably, these sites would need to use the proper jargon as the strategy is often implemented by sophisticated traders only. It's a sharp learning curve for beginners wanting to understand the complicated technique regardless of their intentions to execute the trade or not. The strategy employs four individual option strategies combined into one large strategy. The trader will buy a call (profit when a stock rises), sell a call (profit when the stock does not rise), buy a put (profit when a stock falls), and sell a put (profit when a stock does not fall). Most of these trades counteract each other; this is the fundamental key in an iron condor as it allows speculators to make larger returns with less risk.
Imagine yourself playing a game with a colleague that carries two 12-sided dice at all times. He whips out his dodecahedrons and plays a game of pure speculation. You decide to start simple..
Your first speculation is that the combined total will be below 13 (which is the half way point). You pay $3. For every number below 13, he will pay you $1. If the roll is 2 (the lowest possible number), you will receive $11. Subtracting your original cost, you will earn $8 profit. This is essentially why a put option is employed in an account. In such a scenario, an investor may own the shares and is concerned the value of the stock will drop. Therefore, the investor pays $3 a share to protect a stock worth $113 a share. Any price drop is equally offset by the increase in the price of the put option.
Your second wager is that the combined total will now be above 13. Much like in the first example, you will receive $1 for every number above 14 to a maximum of 24. This is similar to the purchase of a call option. A trader would purchase a call option for $3 in hopes the underlying asset will rise above a pre-determined value. Investors will make this purchase because it is cheaper to speculate. Instead of purchasing the stock for $100 a share, they can make the same prediction for just a fraction of the stock price.
In the above example, you sacrifice your original $3 investment if you are wrong. Speculators use options because the stock may be un-affordable or the speculator does not feel the need to invest large capital to speculate. If the same profits can be earned with the fraction of the cost, then it may be deemed more effective and efficient. Another note, in the above example, your friend is receiving the money from you in advance. You decide you would like to be the "dealer" but you choose the ranges and he will pay you what he feels is fair value considering its chances of success.
Your third bet, you decide to change it up. You will now be the one paying out to your friend. However, you get to predict the next roll. You inform your friend that you think the roll will be below 20. The odds of success is 15/144. Therefore, your friend will be willing to make that bet, however, he feels he only wants to pay 40 cents. In return if he is right, he will earn up to $4 or 9.6 times his money. This is essentially how a trader sells a call option. A stock may be trading at $113 and he believes that the stock will remain below $120. It would require a stock price to rise over 6 per cent before the option seller loses money. The trader is willing to make this bet because the odds are extremely low and the investor receives an immediate cash return by selling the option to the other investor.
You make a fourth bet and predict the next roll will be above 6. Again, the odds are identical and your friend only wants to pay 40 cents. This is identical to an investor selling a put option. The investor selling the put option is anticipating the stock remains above a certain price. The lower the probability of it being wrong, the less the investor earns.
With additional combinations at your disposal and a willing partner to accept any selection of ranges, you spice up the bets.
Your fifth bet becomes a two-legged bet. Firstly, you speculate the dice roll will be above 13, however, this time, you will receive the $3. You realize you only have $7 in your pocket, so if you're wrong, you won't have enough to pay the $8 max profit. So, you add a second component that speculates the next dice roll will be below 6 and pay 40 cents. The most you can lose is the $7 difference. Since you already received $3 and had to pay 40 cents, you will earn $2.60 immediately and keep it if the roll is over the par line. If you are incorrect, the max loss is $4.40. In fact, in this situation, if the roll is 12, you will return $1, but have made a profit of $1.60. This strategy is similar to a bull put spread. It is bullish (investor thinks it will not fall) and uses two put options. A trader would employ this strategy if they have limited investment capital or would prefer to concentrate their potential. The trader speculates that the stock will either remain flat or rise. This gives the speculator two ways to earn money. As well, by receiving cash in advance, the trader can earn interest on the premiums received.
Your sixth bet is now the reverse of the previous two-legged bet. You bet the dice roll will be below 13 and protect it with a bet that it will be above 20. Again, you will receive $2.60 immediately and earn money if the roll remains below the par line. Again, all the same arithmetic applies. This investment strategy is known as a bear call spread. The bet is bearish (investor thinks the asset will not rise) and uses two call options.
Now, you have mastered the art of dice rolling and do a four-legged bet that employs all four wagers. With all being said and done, you will receive a total of $5.20. Since there is only one roll that provides maximum profit (13), you expect to lose a little bit of the $5.20. You will profit if the stock is between 7 and 19. There are only 30 combinations that will net you a loss. The employment of a bull put and bear call spread is known as the long iron condor strategy. This strategy is popular among sophisticated investors because only one side can be wrong and therefore, the profits are doubled if they are correct without having to deposit or offer any additional margin to the broker.
In reality, the trader would rarely choose the exact middle due to the fact that there are costs and commissions associated. It would also potentially require the trader to close out both sides if the stock is right down the middle to prevent either option from being assigned. A speculator would leave a buffer area of any range. 7 and 13 if they feel the next dice roll, that is, the stock may dip, or 7 and 19, or 15 and 20. Their success will ultimately be determined based on the stock's closing price on the day of expiration, assuming the options are not closed in advance.
The long iron condor is a fantastic and efficient way to capture the time value of an option. As time passes, the odds of any option being correct decrease and therefore, investors looking to purchase these options are willing to pay less. The goal of the option seller is to capture the time value and hope that the stability of the market reduces the value of the options to zero. It is also a more efficient use of capital. A trader employing strategy number three can theoretically lose an infinite amount of money. A stock at $113 does not cap at $124 a would occur in the dice example. It could go to hundreds of dollars. The trader would be responsible for this infinite gain and traders may want to cap their losses by reducing their return. As well, strategy three would typically require 30 per cent of the value of the stock. Therefore, a stock at $113 would require at most $33.90 immediately as margin. However, a spread would only require a deposit equal to the maximum loss.
Using the values above, a trader wanting to earn $3 would require $33.90, which equals a rate of return of 8.8 per cent. The trader of either strategy 5 or 6 would only require $4.40. The trader would return 59 per cent by simply paying that 40 cents. This is how yields are concentrated. The iron condor trader would then apply both sides and receive $5.20 and could net at most 289 per cent return, assuming the dice roll was exactly 13 or the stock closes at exactly $113.
The long iron condor is a tool used by many range traders and is an optimal way to earn large returns for less risk than owning capital. Its implementation requires extreme precision and knowledge of the options market. However, with the education and tolerance for risk, traders can reap huge rewards for simply working minutes a week.
