Today we received news on two fronts that further indicate the economic recovery is in question.  

1) Initial jobless claims rose once again, this time by 12,000, bringing the total number to the half million mark.  (To clarify, “initial jobless claims” measures the number of individuals applying for unemployment benefits for the first time.) 

2) Manufacturing activity in the mid-Atlantic region fell into negative territory, from +5.1 the prior reading to -7.7 this time around.  (The Philadelphia Federal Reserve bank, one of the 12 regional Fed banks, gauges this index.)  Economists had actually forecast a positive number for this report, so the negative reading was that much more jarring. 

Many are interpreting the jobless claims number as a sign that businesses are not only hesitant to hire workers, but some are even continuing to trim payrolls in anticipation of economic difficulty down the road.  The problem here extends beyond the fact that there are many unfortunate individuals out of work – the jobless numbers even affect those who have jobs, because the number is seen by employed people as a reason to be cautious with their spending and to thus save more.  As savings increase, consumption declines, impacting a large portion of our economy, 70% of which is based on consumer spending.  This spending decline impacts businesses, thus causing them to cut costs (i.e., trim payrolls).  So you can see the detrimental cycle that is set in motion in this kind of environment. 

With respect to the manufacturing number, the decline was viewed as a loss of momentum from earlier positive readings, and suggests that re-stocking of inventories was the primary cause of the better numbers.  Now that that re-stocking is largely complete, those kinds of sales have dwindled while the merchandise has remained on store shelves and not been translated into retail profits. 

If you’ve been following this issue closely, you know that the first few months of the year saw a degree of acknowledgment by the government that a recovery was underway and that stimulus programs had helped contribute to it.  I believe it was unwise for the administration to take credit for that, not only because it wasn’t a large enough data set to draw such conclusions, but because from a political standpoint they must now acknowledge just the opposite – that there is no recovery and in fact the situation appears to be worsening – or risk sounding completely dissonant on this subject. 

Interestingly however, the markets have not been reacting too unfavorably to these kinds of data points over the last several weeks.  Recall that, after some serious volatility in May and early June, we’ve witnessed relative calm and even rising indexes since then, up until the last week or so.  One thing to keep in mind is that the stock market is a leading indicator.  What this means is that the markets have usually digested any sort of current events that could be viewed as impacting economic activity, and are actually a reflection of what investors and traders anticipate to be coming down the road.  It’s for this reason that anyone looking closely at the economic data (and hence the economic outlook going forward) would be left scratching their heads at the upward surge in the markets in July and August. 

At this point I think it would be helpful to illuminate what I’ve been doing both in reaction to the economic data and to be proactive to what I think is still to come.  As you may have read already on my Portfolio page, I do employ black swan protection protocols rather consistently month to month.  What this means is, each month I purchase the following months’ put options on the SPY (the underlying investment symbol for the S&P500 stock index).  These put options, which reflect a bearish outlook on the underlying investment, are bought “out of the money,” meaning the anticipated price (or strike price) that I’m purchasing is below the actual price of SPY as it stands today.  So for example, SPY closed around 107 today, and my September puts have a strike price of 100.  If the SPY were to make a sharp move downward below 100 before September 18 (the day my options expire), I would profit handsomely.  If the puts expire out of the money I’ll lose my entire initial investment sum. 

I’ve been in the process of watching my Aug 105/100/95 puts become worthless from day to day, going back to when I purchased them in early July.  I’ve lost 99% of the value of these options because I held them until expiration (that being tomorrow, August 20).  I did this because, in my mind, a true black swan protection protocol leaves at least a portion of the options in place until expiration in case of a dramatic plunge in the markets.  This belief is derived from the fractal concept Nassim Taleb has often discussed (and which I blogged about on August 4); you use fractals to envision what might be possible, not just what’s happened before. 

Another key here is that I only spend the money I can afford to lose on these options and not a dollar more.  That way I can sleep peacefully even as the options become worthless, knowing that I’m always protected against the catastrophic event month-to-month while not exposing my overall capital position too markedly. 

I bought my SPY Sep 100 puts earlier this month, and I’ll begin looking at October puts around the week following Labor Day.  The worst case scenario in my mind is missing a dramatic market downturn by not having the right put options in place ahead of time.  So given that, I’ll often pull the trigger on a purchase slightly earlier than expected if I get the sense that things might be destabilizing in the markets.  (As I type this, I hear Bloomberg reporting in the background that Asian markets fell in their Friday trading sessions, reinforcing my comfort at having my Sep puts in place.  The Asian markets are probably not experiencing much confidence that the US recovery is sustainable, thus threatening their robust export business to the US.) 

Please continue to check back in, not only with the blog, but my Portfolio page as well.  I always keep that section up to date even if I don’t post an entry to the blog.
 


Comments

dan
12/01/2011 04:45

Do you have any update on your strategy?
Very interested in this approach.

Reply



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