STOCK MARKET MELTDOWN: Can the Fed Still Move in Light of China and Markets?
Option Sellers can Potentially Benefit Either Way. Here is How You can Position Now and Stop Worrying about the DOW.
It happened on August 11. Goldman Sachs’ David Kostin made the comment in reference to US stocks that “flat is the new up.” In what’s sure to become a new buzz line in the media, Kostin was obviously laying the groundwork to explain to Goldman investors why their portfolios could show lackluster performance this year. He’s also hedging his bets on what the Fed does this month.
He might also have been hedging against what came to pass in late August – the “bad week” of August 17th and then the violent nosedive the following Monday that left stock traders rattled and bewildered.
That’s the problem with traditional investments, of course. If it goes up you make money. But if it goes down, you lose. You’re completely at the mercy of Mr. Market. HE decides what you make at the end of the year – not you. If you’re not using a strategy that can benefit from up or down markets and gives you exposure to other uncorrelated asset classes – your money is completely dependent on the mood of Mr. Market. And for the moment, he appears to be in a most volatile state of mind.
S & P 500
Carnage in Stocks. Will the Fed still Move? Option Sellers can potentially benefit either way.
So what should a high net worth investor be doing now? You’ll get some guidance here. Lets first examine the Big Picture.
The Long Awaited Decision is Upon Us
It’s September and the question on everyone’s mind is interest rates. Will the Fed raise rates or not? Since early in the year, the speculation was the Fed would raise rates as early as July. Then the “smart money” said it would almost surely come in September. The market muddled steadily along as the general consensus was the Fed would make its first move in September.
Then China caught on fire.
China Strikes Again
In our Big Picture column last month, we highlighted the recent problems in China, and their potential impact on commodities prices. China bulls continued to gloss over the recent “turbulence,” insisting that everything was fine in China, the slowing growth was “a normal function” and that the stock market crash was a “healthy readjustment.”
But China’s surprise devaluation of its currency on August 11, (a nearly 2% devaluation – the largest one day fall in over 20 years) signaled very clearly that everything is not fine in China. Some big name analysts are stating China is “in trouble.” Jim Kramer thinks the Communist Regime is losing control of the economy.
We’ll see. While a cheaper currency may help China in the short term, the risks are retaliation from other countries devaluing as well, potentially sparking a currency war. You read our take on China and its potential effects on commodities prices in last month’s issue. August’s currency devaluation simply strengthens our case: Slowing economy means weaker demand for industrial goods. The devaluation of the yuan makes Chinese goods cheaper and US goods more expensive. Result – an even lower demand for material imports into China.
Impact on Fed Decision
The initial reaction from analysts immediately after China’s move was largely to assume that the Fed would now have to postpone any rate increases until at least December.
The Chinese move is an admission of economic weakness. It comes at a time of central bank accommodation around the world. Combined with recent action in US Stocks, these factors will put a lot of pressure on the Fed to hold steady for now.
Hawks argue that the US economy is still on track to grow by 2.6% in 2015. July’s unemployment number of 5.3% is further evidence that the economy no longer needs near zero interest rates to grow.
We’re not in the business of guessing at these kind of questions. As an investor, you shouldn’t be either.
The Fed will do what the Fed will do. As an option seller, you want to put yourself in a position to potentially benefit either way. How do you do that? By identifying a least likely scenario.
The Least Likely Scenario
Commodities prices are influenced primarily by supply and demand over the long term. But currency fluctuations can play a role in demand and thus, affect supply. Therefore, the value of the dollar is an important consideration in commodities analysis.
Should the Fed raise rates this month, odds are the effect on the dollar would be bullish to wildly bullish. A Fed move in the face of China’s devaluation, the threats of other countries devaluation, along with global central bank easing, would likely bring global capital flocking to the dollar. This would be bearish to very bearish for many commodities.
On the other hand, the Fed holding firm could be slightly supportive of the dollar. But we would see it more of a stabilizing move than wildly bullish. The expectation would still be for the Fed to raise in December. And it doesn’t erase what is happening in China or the global tide of central bank easing. Our view is that a Fed non-move would be neutral to slightly bullish the dollar. But the bearish global set up for commodities (lower demand, higher import prices into China), would mean only a neutral to bearish price outlook for industrial goods (as opposed to a very bearish outlook in light of a rate rise).
The least likely scenario? A spike higher in commodities prices as a result of Fed action or inaction.
The smart investor then, would likely look for up days to sell calls in select industrial commodities ahead of the Fed announcement.
What about Stocks?
As for stocks, we’re not going to go there. However, if I were a pure technician, I would think the potential head and shoulders on the S&P looks a little ominous. If I were a stock investor, I’d be reviewing my portfolio to make sure I was responsibly diversified – preferably into uncorrelated asset classes that could still give me a return in the event of a further DOW meltdown – or at the very least – a stagnating US Equities market.
If flat really is the new up, I’d be thinking that leaving funds at the mercy of Mr. Market might not be the surest path to security and growth right now.
I’d be thinking about alternative asset classes. More importantly, I’d be thinking about non-directional strategies that can potentially produce attractive returns in any kind of market. Oh yes….and if I could find a strategy that actually benefits from market volatility, why that would even be better.
But that’s just me.
If you are a high net worth investor interested in selling options in crude oil and other commodities, you may qualify for a managed option selling account with OptionSellers.com. To learn more, request your Free Investor Discovery Kit at www.OptionSellers.com/Discovery ($250,000 minimum investment.)
James Cordier is the author of McGraw-Hills The Complete Guide to Option Selling, 1st, 2nd and 3rd Editions. He is also founder and president of OptionSellers.com, an investment firm specializing in writing commodities options for high net-worth investors. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television, Fox News and CNBC. Michael Gross is director of Research at OptionSellers.com. His published research articles have appeared on Forbes.com, MarketWatch, Optionetics.com, Businessweek.com and Yahoo Finance.
*Price Chart Courtesy of CQG, Inc.
Fundamental Charts courtesy of The Hightower Report
Seasonal Chart courtesy of Moore Research, Inc
***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.