What's the motivation?
There was controversy in July when it was revealed that America sold around a million barrels from the strategic petroleum reserve (SPR) to Sinopec. To the roughly 50% of Americans who view China as an adversary this seems like insanity - deplete the stocks America has in case of war and send them to the likely opponent. What were they thinking?
Perhaps the idea was something like: 'We don't really need this since we want everyone to use electric cars. Might as well sell now while the price is high. If absolutely necessary we can always restart domestic production'
If you think that China is a friend of America, you might even think it to be genius: It serves the short term election need to appear to be trying to reduce gas prices, will probably turn a profit, and in the long run should be irrelevant strategically.
We'll leave it up to you to decide whether this decision is insanity or genius.
A more puzzling situation is the ongoing investigation into Donald Trump. Some people believe that the intent is to prevent Trump from running for president again. However, some people think that Trump is unelectable so that he should be the preferred opponent.
The reaction to the Mar-a-Lago raid appears to be that it solidified support for Trump within the Republican base, although betting markets don't appear to favour Trump to be the candidate as much as polling might indicate they should.
So is the investigation insane for trying to prevent the worst candidate from running, genius for trying to ensure that the worst candidate gets the nomination, or something else?
We're actually leaning towards the 'something else.'
Joe Biden has denied having any prior knowledge of the raid. If this is true, then it suggests that the investigation is in fact being pursued by bureaucrats who believe that it serves the interests of justice and the country, and the impact on the election may be incidental to their goal.
Given the uncertainty of the election impact, this explanation seems to be most likely.
The rationality of such beliefs is debatable, but we suspect that they are sincere. This means that the investigation is likely to continue indefinitely. This may be why betting markets discount the current polling.
That leaves us with 3 possible outcomes for November.
Case 1 is that the candidates Trump backed do very poorly in the midterms, resulting in the Democrats retaining control of both the house and Senate. This outcome is likely to make Democrats conclude that their recent legislation was actually a good idea, and so we can expect more of the same. This stimulus probably helps equity markets, but should result in higher rates.
Case 2 is that Trump candidates do poorly enough to result in Democrats retaining control of the senate, but not the house. This is probably the least scary outcome, because it probably prevents further bad legislation, but also may avoid further acrimony as Republicans don't see any need to conduct their own partisan investigations. As of now it also appears to be the most likely outcome, which means that it doesn't have too much impact for markets.
Case 3 is that Trump candidates do relatively well. At the minute this seems to be the least likely outcome. This isn't going to stop the investigators from continuing, and if anything, will increase the urgency with which they feel the need to intervene. This doesn't seem healthy for the country.
We'll be tracking polling of Trump candidates to see which case we converge towards.
Talking Stocks: APE=, PFE-, KWEB+, BBBY=
[Your stock not listed here? Leave a comment here, on the forum, or email me at firstname.lastname@example.org and I'll let you know what I think. Also, check out our daily discussion posts on the forum for any updates.]
APE: A potential widowmaker
In the daily discussion on the forum on Tuesday, we talked about the apparent arbitrage opportunity between AMC and APE. We'll revisit the topic here for the benefit of a wider audience. Going forward, the daily discussion will mostly be about individual tickers.
The question at hand is why APE trades at a substantial discount to AMC, when they appear to be economically equivalent, and APE may even have the advantage of seniority in bankruptcy.
There is a good discussion of the topic at this thread. The key argument is that AMC trades at a premium to 'fundamentals' due to irrational behaviour, whereas APE doesn't benefit from this goodwill. The way we would think about it is that the premium reflects an inefficiency in the market due to the more limited supply of AMC shares. For example, there are lots of existing call options that have been purchased on AMC, and when the sellers get assigned they will have to locate 100 shares of AMC and 100 shares of APE. Locating the APE shares is unlikely to be a problem, whereas making it difficult to locate AMC is one of the main objectives of many holders of the stock.
Anyone who tries to put on the arbitrage trade could well find themselves to be no better off than simply being outright short AMC.
So far, APE has exhibited very low correlation to AMC, making it an ineffective hedge.
More to the point, what correlation there has been has mostly been in the scenario where the AMC short is profitable.
In the squeeze scenario where you lose your shirt on AMC, that APE hedge is probably going to be fairly useless, especially if it is arbitrageurs who are getting squeezed.
In the meantime, spare a thought for the poor option quants who have to sort out this mess, with no real upside, as any potential APE/AMC correlation market will presumably disappear once the existing options roll off.
PFE: Sue me, sue you blues
At the beginning of the pandemic, it seemed as if Moderna (MRNA) was the darling of the government. While Pfizer (PFE) did not take any government funding to develop their Covid vaccine, MRNA took over $2bn. The relationship with the government appears to have soured somewhat over who owns the intellectual property. This dispute has not been resolved as far as we know, and it might reasonably be inferred that the government has been favouring PFE recently as a result.
After previously playing nicely for the benefit of humanity, now MRNA is suing PFE alleging various patent infringements. In return PFE is expected to sue MRNA.
We're dealing with a lot of money and a jilted lover, so this could get nasty.
Of course if all of the Covid research at PFE was impeccable, they have nothing to worry about from a reputational standpoint.
In the short term, PFE is trading poorly, and seems likely to fall below the February low of 45.40. (The picture here is adjusted for dividends so shows a lower value)
Were it to stay inside the triangle, we would look to sell short around 51 targeting around 40.
KWEB: Something about the 4th amendment
In addition to a stimulus package, Chinese stocks listed in the US were given a boost this week by a tentative agreement on auditing. According to an anonymous source (so you know it's untrue) the breakthrough came when the US explained that the 4th amendment doesn't apply because it is always reasonable to suspect a corporation is about to commit a crime.
Okay so what's the real story?
One hypothesis is that China is trying to defuse geopolitical tension, perhaps because tighter Fed policy is counteracting their efforts to stimulate their economy. The sticking point may have been unfair competition concerns regarding state subsidies for certain Chinese companies, and the resolution is for China to have the companies that receive such support to list locally. This will also serve to provide domestic investors with an alternative to real estate.
This latter point suggests that the companies with larger market caps are likely to list locally, while more speculative names remain available to international investors. The largest interest in call options for Chinese names this week was for the ETF KWEB. Using an ETF diversifies the delisting risk, and KWEB is more focused on smaller companies than FXI for example.
From the open on Wednesday, KWEB rallied impulsively, and subsequently began a correction after Powell spoke.
This looks bullish, but we will still not get involved in any Chinese stocks so long as the zero-Covid policy remains in force.
BBBY: Down but not out
After crashing lower to end last week, this week BBBY consolidated in a triangle. The chart looks very similar to how GME traded in January 2021. The pattern is an increase in volume taking price higher, followed by a big squeeze, and then a crash back down to consolidate around the level that prevailed after the first move higher.
The Reddit crowd remains highly engaged with the stock, though not quite at the extremes from prior weeks.
The pattern that ensued for GME was that the consolidation broke to the downside as all the 'paper hands' were cleaned out. Then there was probably a large buyer who bid the stock up again in anticipation of having a crowd to follow them.
Don't be surprised if this happens again in BBBY, perhaps starting when it trades down below 8.
Stock of the week: AA
As David mentioned on this week's Beat the Market, commodities may well benefit from Chinese stimulus. The relevant point may be that while lockdowns hurt consumption, they don't necessarily hurt demand for commodities for any projects funded by stimulus.
One way to gain exposure to higher commodities is through mining companies, and two that cropped up in our signals this week were Freeport-McMoran (FCX) and Alcoa (AA). FCX is more exposed to the consumption side in oil, so we favour AA.
Technically, both FCX and AA have completed a large scale ABC correction, and have subsequently taken out the low from B, which precludes the possibility that C is actually 3 of 5 down waves.
There is a case to be made that AA has completed waves 1 and 2 of an advance, and is currently embarking on wave 3 which we would expect to terminate at around 70.
Our plan is to enter half the position around current levels, and add on a corrective move lower to around 53. We'll target 70, and stop out at 49.
Honourable mentions: FCX, META, GOEV
[I've received requests to put additional trade ideas either for stocks that were in the running with the stock of the week, or a 'squeeze of the week' for the stock that looks most likely to see an outsized return. I'll include my thoughts on these here.]
As mentioned above, FCX looks similar to AA. Our plan there would be to wait for a dip to trend line support around 30 to buy, targeting a more modest move to around 35.
META is close to the bottom of its range, and we see interest to gain exposure to the upside. We have reason to believe that ahead of the midterms, GOOGL is refusing to accept advertising revenue for anything that might amplify Republican messages. This revenue might move to META instead, and they probably aren't in a position to refuse, even though they might want to. Our plan would be simply to buy near the bottom of the range for a move back towards the top.
GOEV is our squeeze of the week candidate. It rallied sharply in July on news that Walmart was buying their delivery vehicles. Since then it has consolidated in a triangle, and seems likely to break out fairly soon. We don't see option demand that might result in a gamma squeeze, but positioning looks reasonably clean, and there is substantial short interest, so a quick move above 5 seems plausible. Our plan however would be to wait for the gap to fill and buy at 2.70.
[For a surrounding discussion, please see the most recent episode of Beat the Market.]
In our equity portfolio, we will sell our 8.3% holding in XLI and buy 8.3% XLB. The materials overweight is aligned with our commentary above for AA, while the short position in XLI is on the basis that the government is currently interested in buying votes rather than paying back donors. XLI outperformed XLB by over 10% in June and July, but this has reversed in August, and has plenty of room to run.
In our bond portfolio we will sell 10% IEF and buy 5% TLT. The long end of the curve remains upward sloping, and the determination of central banks to rein in inflation expectations may well see this continue the flattening trajectory that began in August.
As a reminder, and to keep all the details together, this week David has a moderate underweight in equities and a maximum underweight in bonds.
I find it easy to believe that Biden had no prior knowledge of the raid, because his bosses only tell him what he needs to know.
In the US we have what are known as 1st Amendment auditors. They go around filming police in public, ostensibly to ensure that the police respect their first amendment right to do so, but also to generate Youtube content. The other right that frequently comes up is the 4th amendment which prohibits the government from unreasonable searches. To be reasonable, there have to be articulable reasons to suspect that a specific law is being, or is about to be broken.