Weekly Recap - December 8, 2008

The recession of 2008 became official last week. According to the announcement Monday by the Business Cycle Dating Committee of the National Bureau of Economic Research, the recession began last December, which means it has already lasted 12 months. The average recession in the U.S. lasts about 10 months, so the good news is that this current recession has gone on longer than the past two recessions – in 2001 and in 1990-1991 – each eight months long. The news last week came both good and bad. We took solace at the news of recession declared, as we hope that the call often comes after a recession has peaked. In the ‘good news’ category was the fact that the U.S. government may force rates on new mortgages down to 4.5% to revive the housing market, and Europe has slashed interest rates to 2.5% from 3.25%. In the ‘bad news’, there are plenty. Manufacturing contracted in November by the fastest pace in 26 years, and 533,000 people were laid off – bringing jobs cut in the past three months to more than 1.25 million.
The Dow ended the week off 194, or 2.2% to 8635. The S&P500 gave up 20, or 2.3% to 876; it is 16% above an 11 ½ -year low reached on Nov. 20 and 44% below its 2007 peak. The Nasdaq Composite Index fell 26, or 1.7%, to 1509, while the Russell 2000 lost 12, or 2.6%, to 461. The economy may still go worse before it will improve, especially if the Americans continue to lose jobs and the government fails to repair consumer confidence, both likely events.

Inflation Rebound
Rather than betting on rebound in growth, a smarter bet would be on rebound in inflation, according to Don Rissmiller, economist at Strategas Research Partners. The government is fighting deflation by flooding the markets with cheap money, increasing the odds for inflation. When inflation returns, energy and basic-material stocks could lead the market once again, and resource-rich countries like Canada, Australia and Brazil could prosper. Shorting Treasuries and buying TIPS, or Treasury inflation-protected securities, might be the purest way to hedge against eventual inflation.

Option Strategies: Buy-Write
Options traders try to convert volatility into money. “Buy-writing” is a classic strategy that refers to buying a stock and selling, or writing, an out-of-money call on it, and it helps traders to harness volatility. The “buy-write” lowers the cost of buying the stock by the amount received for selling the call, and it also serves like a modest hedge. The strategy’s benchmark is the Chicago Board Options Exchange’s S&P500 BuyWrite Index, or BXM. In October, it had its largest monthly gain in 20 years – 8.1% - well above its two-decade average of 1.7%.To successfully implement this strategy one needs discipline.
Here are the rules, according to Michael Schwartz, Oppenheimer & Co.’s chief options strategist:
• Stock selection is primary, getting a premium is secondary. Pick stocks that you want to own, not calls that you want to sell.
• Never invest more than 10% of your capital in a buy-write. Leverage cuts two ways.• Sell slightly out-of-the-money calls to leave room for upside profit potential.
• Let time work for you. You can sell three- to six- month calls for higher premiums.
• Don’t annualize returns. Focus on the potential return for the trade’s actual duration; annualized returns are rarely earned.
• Ignore theoretical values. Expensive options stay expensive longer than expected, and vice versa. The current correction has shown that volatility, which always reverts to its mean, may not do so when expected.
• Don’t sell the call and try to buy the stock at a better price. This leaves you with a “naked call” and unlimited market risk. Enter buy-writes simultaneously. A net debit order is entered for any combination of prices to buy a stock and sell a call that equals your desired debit ($30 stock price less $3 option price equals $27 net debit).
• If stock fundamentals change, sell the stock and buy back the call.
• If you can earn a high percentage of the maximum profit before expiration, do it. Waiting for the last 10% to 15% of premium often means risking everything for no more than an incremental gain.
This strategy of “buy-write” gives investors a way to handle panic and use the market fear to their advantage.

Other news of the week:
• U.S. Shed 533,000 Jobs in November – on a percentage basis, that was the worst decline in 28 years and far worse than expected. Also, Sept. and Oct. job losses were revised sharply higher, lifting ’08 job cuts to 1.91 mil. The jobless rate hit a 15-year high of 6.7%. It would have climbed more, but many people simply stopped looking for work.
• Mortgage Delinquencies Jump – The share of home loans behind on payments rose to 6.99% in Q3 vs. Q2’s 6.42%. 20% of subprime loans are delinquent, but prime mortgage woes are rising as the recession affects more people. New foreclosure activity dipped as governments and lenders try to keep people in homes.
• Crude Oil Dives 7% to 4-year Low – The January crude contract is at $40.81 a barrel – 72% off the July peak – as the jobs report boded ill for energy demand. The Int’l Energy Agency also cut global oil-demand forecasts again. Natural gas tumbled 5% to $5.74 per mil Btu. Retail gas prices should fall to $1.60 a gallon, given the current gasoline futures.
• Fed Begins Buying Agency Debt – It bought $5 bil of Fannie Mae, Freddie Mac and Federal Home Loan Banks debt as part of a new $600 bil program to support mortgages and housing. Since the plan was announced Nov. 25, mortgage rates have plunged, triggering a refinancing boomlet. Also, the Treasury is legally bound to inject capital into Fannie and Freddie if needed, the Justice Dept. ruled.
• Consumer Borrowing Fell in Oct – Consumer credit outstanding declined $3.5 bil to $2.578 bil, the Fed said, the latest evidence of reined-in spending amid accelerating job losses and economic gloom. Borrowing rose a revised $6.7 bil in Sept and fell $6.4 bil in August. In Oct., credit card and other revolving debt fell $181.6 mil. Auto and other nonrevolving debt fell $3.4 bil