Is Inflation Good For A Portfolio? 02-25-2011

Cusick's Corner
Food for thought this weekend -- is inflation good for my portfolio? With corporate profits continuing to top estimates and forecasts still positive out 2-3 quarters, it may be easy to negate the impact of potential inflation on your holdings. But that could be a mistake. Unlike spring of last year when I could fill up my tank for $2.75 a gallon, now I am spending $3.10. This price trend has only been exacerbated by the headlines this week and that has many consumers rethinking their current habits. This also has corporations, i.e. WMT, scrambling to keep you coming, worrying that this could increase inventories, thus forcing higher prices and potentially threatening their robust profitability. Clearly, low inflation seems to benefit most stocks, so if there is inflation on the horizon, it is worth looking at your portfolio and devising a plan to potentially deal with that threat. And if you doubt it is on the horizon, go fill up your car or buy some groceries. See you Midday.

Stock market averages finished with gains on a relatively slow day of trading Friday. On the economic front, the news was mixed. Data released early showed GDP improving at a 2.8 percent annual rate in the fourth quarter, which was well below expectations of 3.3 percent. However, separate data released later showed the University of Michigan's Consumer Sentiment Index up to 77.5 in late-February, from 75.1 earlier this month and significantly better than the 75.1 that economists had predicted. Meanwhile, a lot of the focus remains on the action in the energy market after crude oil gained 8 percent in the past week on escalating unrest in North Africa and the Middle East. However, after rallying to a high of $103.40 a barrel Thursday morning, prices fell Thursday afternoon and remained stable Friday. Crude is up 87 cents to $98.17 a barrel late Friday. Meanwhile, the Dow Jones Industrial Average was able to recapture 61 of the 322-point loss suffered during the previous three days. The NASDAQ rose for a second day and added 43.5 points.

Bullish
iStar Financial (SFI), a New York-based Real Estate Investment Trust [REIT], notched a new 52-week high and finished the day up 33 cents to $9.78. Options volume hit 6X the average daily, and was driven by a July 10 – 13 calls spread. It traded at $1.00, 10000X. In this spread, the strategist bought a block of 10,000 July 10 calls at $1.45 and sold 10,000 July 13 calls at 45 cents. The spread is a bullish play and offers a potential $2 pay-off (excluding commissions) if shares rally beyond $13 through the July expiration, which represents a 33 percent rally over the next 140 days – a very ambitious play it seems.

Bullish trading was also seen in SAP, Ford Motor (F), and James Rivers Coal (JRCC).

Bearish
Toyota Motors (TTM) shares added 37 cents to $24.36 and put volume picked up in the Japanese automaker Friday. The total volume of 11,000 puts and 1,600 calls is 2.5X the recent average daily volume for Toyota. The action was concentrated in July 20 puts. 9,000 traded. The biggest trade was a 6,000-contract block at 70 cents and is possibly a short-term hedge after a 37 percent slide in the stock since late-November. That is, a shareholder might have initiated the trade to offset potential losses should shares continue falling.

Bearish flow also surfaced in Novatel Wireless (NVTL), Raytheon (RTN), and Earthlink (ELNK).

Index Trading
The CBOE Volatility Index (.VIX) gave up 2.10 to 19.22 Friday, but gained 2.79 points, or 17 percent, on the week. VIX rallied sharply Tuesday and Wednesday after civil unrest in Libya, the world's 18th largest oil producer, triggered a sharp rally in crude. The volatility spilled over into the US equity market and the S&P 500 suffered a three-day 2.8 percent drop. Yet, despite the volatility this week, the 20-day statistical or realized volatility of the S&P 500 is only 13.5 percent. VIX, at 19.22, is substantially higher than SPX volatility. In addition, since the volatility index reflects expected volatility priced into S&P 500 Index options, the fact that it is 45 percent greater than SPX statistical volatility is an indication that some market participants expect this week's turbulent market action to continue in the weeks ahead.

ETF Action
iShares Emerging Markets Fund (EEM) added 54 cents to $45.52 today and a noteworthy trade in the exchange-traded fund was a January 35 – 55 risk-reversal at 51 cents, 20000X. In this combo, the strategist apparently bought 20000 January 35 puts at $1.45 and sold 20000 January 55 calls at 94 cents. This trade was tied to a position in EEM shares, according to a source on the exchange floor. Note that the share price is midway between the two strikes and this strategist has actually initiated a collar. They might expect EEM to move towards $55 through January, but have a hedge in place ($35 puts) should the shares fall instead.