If I hadn’t opened the accounts at Interactive Brokers, I probably will not notice these fine details. IB is really for professional/institutional active traders. If you are more of an investor type, you may want to shun IB.

The main disadvantages for a less active traders are the followings:

1. Inactivity charge: $10 a month if you have not traded to generate $10 commission.
2. Interest on cash ONLY for more than $10K: This is quite deceiving to me for some time. The interest rate paid by IB is probably the highest among all self-directed online brokerages. However, it only applies to balances more than $10K. So unless you have lots and lots of money, and your cash is so much bigger than $10K in the account, your effective interest rate can go down pretty fast. For example, if your cash position is $20K, your effective interest rate is really just half of the 5% that they pay you above $10K. While 2.5% is still decent, the attractiveness goes down quickly, especially if you don’t have a large account. But beyond $20K, IB can start to quickly beat other online brokerages however.
3. Statements that are a little hard to read and generate. Maybe I just haven’t spent enough time. But for something as simple as account statements, I really expected not spending any time at all. It’s a little amazing that they can make such a simple thing so complicated. They should have a simple and quick statement for non-professionals. But maybe I’m just the wrong customer.
4. Two different logins for trading and account management: I simply don’t have time to login so many times. Why can’t I just do both thru the same login screen?

The best things that I like about IB is that

1. Cheapest trading for foreign stocks. You just can’t beat this, assuming that they offer it. Unfortunately, when I attempted to transfer my foreign stocks to them, they had a hard time accepting them. Furthermore, on Canadian stocks for example, they simply don’t let you buy/sell MANY of the smaller companies.
2. You get to trade futures/commodities also. This is quite good if you want to employ a more sophisticated portfolio management that includes futures. Such things should make your portfolio less correlated to the general markets. These days, most global stock markets are in sync, and that is terrible for volatility management. Using commodities should help.
3. Account securities are superb. They will send you an encryption card along with your account. For the added security, I don’t mind spending a little extra time typing in my codes. Online securities are always my utmost concerns.

I was almost going to transfer everything to IB. But I guess I simply have no time to wait for generation (and re-generation) of my online statements, nor the time and will to learn every minute details on the statements.

So there you have it. The August non-farm payroll was -4k vs. expectation of +100k (BLS report). June and July were also revised down sharply. I expected the number to be bad, but not that bad. The markets were obviously taken aback as well. On Friday, the Dow shed 250 pts or 1.87%. The Naz and S&P gave up 1.86% and 1.69% respectively. A 25 basis point cut seems baked in at this moment at the next Fed meeting on Sept. 18, with a 50 basis point cut likely.

If we do have a recession, and the odds are definitely that we will, it will be the second based on a collapse of investment after the one in 2000-2001 following the tech bubble. Some would say both are serial versions of a credit bubble where massive resources were misdirected to a segment of the economy. This is quite different from recessions of the bygone era which were mostly caused by inventory build-up and capacity glut (of manufactured goods). Recessions from credit bubbles are much more pernicious in that what’s left behind (think dot com companies and unfinished Miami condos) has little economic value. Moreover, in this particular instance, millions of home owners will have to face evaporated house values that may not recover for years. Keep that in mind next time you hear a so called economist citing from past recessions.

The main question I have regarding the equities is whether the relief rally I was anticipating has already played out. There is at least a 50/50 chance that it has. There’ll be a lot of speculation on the Fed next week, but I won’t be distracted. As far as I’m concerned, any bump due to Fed action is a good opportunity to sell.

I pay more attention to the Russell than any other index save the HUI these days because it’s more sensitive to economic conditions and it’s more detached from the emotions surrounding the financials. This year the Russell has been one of the weakest major indexes and it is looking sicker by the day. It has lingered sideways for weeks after coming down from the July top and unable to get above the 200 DMA. Now the 50 DMA has crossed below the 200 DMA. RSI, MACD and stochastics are all pointing down at this moment. [Disclosure: long TWM, the UltraShort Russell 2000 ETF]

Gold
I couldn’t be happier with the precious metals. They have diverged from general equities in the past week while base metals fell due to growth concerns. I haven’t written about them since the last bottom on Aug 16, fearing I that might jinx their advance. But I did manage to add to what’s already my largest sector holding on recent weakness.

I want to briefly mention the latest silver COT report which shows a commercial net short of only 25,000 contracts. This unprecedentedly low short position is extremely bullish for silver.

The contraction in the ABCP market is clearly deflationary. For those investors worried about gold in such an environment I heartily recommend this post from Mish: Is Gold Safe Place to Hide? The comments are worth a read as well.

There is broad consensus that credit contraction is deflationary and the central banks around the world will fight tooth-and-nail to re-inflate. I’m agnostic about the outcome of that battle; however, a case for precious metals can be made despite, or because of, this uncertainty. Despite what Mish wrote, the accepted wisdom is that gold performs well in hyperinflation and treasuries in deflation. However, gold is far from the worst investment one can make in a deflationary environment, and I would say much better than treasuries in hyperinflation. Therefore, given the uncertainty of the outcome, a prudent investor would have allocations to both gold and treasuries. Here’s the crux: even after the introduction of gold ETFs very few investors have any gold, so any re-recognition of it as a valid asset class would send the price soaring.

Despite too many false starts to count, the precious metals appear to be finally ready to start another run. As Prof. Lewis at Minanville says: “…the gold complex reacts positively to the monetary “medicine”, not the sickness.” With ample cover provided by the weak NFP number, the Fed is ready to dispense plenty of “medicine”. I’ll be traveling next week. It seems important market moves always take place when I’m away. Let’s see if that continues.

Friday is the much awaited August non-farm payroll report. I say “much awaited” because the market seems to be placing a huge emphasis on this number, although we know that this is a lagging indicator. [For example, see Joseph Ellis’s Ahead of the curve]

Both the Challenger survey and the ADP private sector numbers are pointing to a weak headline Friday morning. However, one never knows what the birth/death adjustments will do to the actually number. There may be another way of looking that the health of the job market that bypasses the statisticians.

Larry Kudlow and company will have you believe that the economy is strong and jobs are plentiful. If that were the case, the job placement firms should be doing a brisk business. Instead, we have a sector-wide warning on staffing companies from UBS.

UBS analyst Andrew Fones downgraded shares of Robert Half International Inc. and Monster Worldwide Inc. to “Neutral” from “Buy.” He also lowered his stock ratings on Heidrick & Struggles International Inc. and Korn/Ferry International Inc. to “Sell” from “Neutral.”

Fones said he expects U.S. hiring growth to deteriorate in coming months, especially because of turmoil in the credit market.
“We are concerned that a continuation of credit market difficulties could further weigh on recent weak hiring growth,” Fones wrote in a client note.
Also, Fones said growth in temporary staffing has fallen steadily since December 2005. Temporary staffing is a leading indicator of overall employment trends because companies are quick to fire temporary employees when demand falls.

If you look at the group of charts below, you’ll see that the weakness is indeed a sector-wide phenomenon. 4 out of 9 stocks peaked well before July. Several of the charts feature 20 DMA below the 50 DMA (blue and red lines respectively), with the 20 DMA acting as upside resistance.

Click to enlarge

This doesn’t bode well for the employment picture, unless you believe that there is full employment and everyone is happy such that nobody is looking for a job. Of course if you do believe that, Larry Kudlow may be interested to have you on his show.

It has been two months since the last net worth review. I finally got some time to go over my finance. I have been spending almost 70+ hours every week on my day job for the last two months. My blogging activities obviously have been down.

For the month of July from 7/1/07 to 8/1/07,

1. Net worth is up by 6.18%.
2. Value of my company holdings is up by 35.00%.
3. Everything else excluding my home and cash is up by 0.44%.
4. If including cash in #3, it’s up by 0.22%.

For the month of August from 8/1/07 to 9/1/07,

1. Net worth is down by 1.33%.
2. Value of my company holdings is up by 11.77%.
3. Everything else excluding my home and cash is down by 10.61%.
4. If including cash in #3, it’s down by 7.43%.

My company holdings trailed the market by a lot earlier this year, but finally made a huge comeback the last two months, compensating my big loss in my own portfolio. So overall I’m still doing okay.

Last Friday, I hesitated to sell near the 50 days MA. I thought market seemed to be showing strength, especially with the technical charts from OIH and XLE still healthy. Certainly they have been the market leaders, and you want to see them continue to lead. I have been wanting to comment on Shanghai market, but still haven’t found the time to do it yet. I think it may go to 6100 before a bigger correction. Regardless, the intermediate picture for USA market I believe is still going to trend down. I still plan to lighten up later.

Again, the best way to check on my stock market moves is still thru my networth page. I almost always update my portfolio everyday at the end of market close. There were only few days so far that I didn’t update within the same day where the change took place.

In any case, market timing is always not easy. The past two months prove again that asset allocation is often more important. And therefore, when I try to time the market, I will only do that with a portion of my portfolio instead of everything.

We are undeniably in a period of high volatility with whipsaws every day, or at least as often as my blog entries. Having enjoyed last Friday’s uptick as much as any long, it’s only appropriate to look at the other side of the coin.

Housing
Housing remains the bogeyman. Tim Iacono of TheMessThatGreenSpanMade wrote a great piece to rebut one of the common arguments bulls use to dismiss subprime worries:

He starts by quoting an article Ben Stein wrote in New York Times:

The total mortgage market in the United States is roughly $10.4 trillion. Of that, a little over 13 percent, or about $1.35 trillion, is subprime — certainly a large sum. Of this, nearly 14 percent is delinquent, meaning late in payment or in foreclosure. Of this amount, about 5 percent is actually in foreclosure, or about $67 billion. Of this amount, according to my friends in real estate, at least about half will be recovered in foreclosure. So now we are down to losses of about $33 billion to $34 billion.

The rate of loss in subprime mortgages keeps climbing. In time, perhaps it will double, maybe back to $67 billion. This is a large sum by absolute standards, and I would sure like to have it in my bank account. But by the metrics of a large economy, it is nothing. The total wealth of the United States is about $70 trillion.

Then he proceeds to rip apart that argument.

According to the latest Federal Reserve Z1 report, the total value of owner-occupied housing is about $23 trillion. As shown in the chart below, the total is up considerably from just a few years ago as indicated in blue, however, the curve looks like it’s beginning to flatten – keep an eye on that.

Who’s been setting a lot of these prices at the margin?
Subprime borrowers. They’ve been pushing home prices up from the bottom, paying more for starter homes, enabling more typical homeowners to cash out and trade up and so on, until home prices in your neighborhood are affected too. Over at Pimco, they call them Plankton.
If it turns out that people have been paying way too much for real estate in recent years because money has been so cheap and lenders so lax (it’s looking more likely every day), markets will revert to the mean and there could be hell to pay.

A 10 percent drop from that $23 trillion total would be a loss of $2.3 trillion in national real estate wealth – a 20 percent decline would result in almost a $5 trillion hit. That’s a lot less home equity withdrawal and a lot fewer reverse mortgages – consumer spending and ultimately the broader economy will suffer. Maybe a lot. These are big numbers – this is the giant thing hiding in the closet.

Goldman Sachs (via CalculatedRisk) just issued a report that estimated a 7% drop in home prices in both ’07 and ’08 basis the Case-Shiller index. GS definitely is not a permabear, so this report carries a lot of weight.

Credit default swaps
The other skeleton in the closet is CDS (credit default swap) which is basically a insurance against default on the underlying debt instrument [Here’s a short primer on CDS from which I will quote below]. For example, the holder of a high yielding junk bond can buy CDS to hedge the default risk of the bond. As long as the cost of the CDS is less than the spread between the bond yield and treasury yield, he has “safely” enhanced his return above that of the treasury. However, this safety is dependent upon solvency of the CDS issuer (aka the counterparty) just as an insurance policy is only good if the insurance company can pay up.

CDS has been a boon to the credit market. It allows risk to be transferred from one party to another and less risk concentration is certainly a good thing. However, one can’t expect Wall St. to leave a good thing alone. CDS “has grown from a $1 trillion industry a few years ago to a $26 trillion industry today.” That’s because punters (mostly hedge funds) can buy or sell CDS on an asset that they don’t own – simply as a bet on the perceived default risk.

Heavy concentration of CDS in a few hands makes a disastrous “chain reaction” possible:

CDS doesn’t exist on an exchange, much of the volume transfers through few hands — namely the big banks like Goldman Sachs, JP Morgan, Morgan Stanley, and the like. Nobody on the outside knows how much CDS these banks hold and what kind of directional exposure they have. If hedge funds hold $100 billion of CDS protection and Morgan Stanley took the other side of the trade, if that $100 billion of debt defaulted with no recovery, Morgan Stanley has to pay $100 billion to those hedge funds. I highly doubt Morgan Stanley has $100 billion in loss reserves set aside. Should Morgan Stanley be unable to pay its debts, holders of Morgan Stanley CDS would then come into play — and suppose Lehman Brothers is on the short end of $50 billion of Morgan Stanley CDS. You can see where this is going. It sounds absurd to say, but it’s not inconceivable that a CDS domino effect could destroy the debt and credit markets as we know them.

This is why Warren Buffet called it (and other derivatives) financial weapons of mass destruction.

The burning questions are, “How much of CDS on subprime MBS was issued?”, “Are they considerably more than the amount of subprime mortgages outstanding?”, and “Who are the bag holders?”. Before they can be answered, “containment” is but a pipe dream.

A relief rally to sell into?
I’ve harped on separating the liquidity problem with weakness in the underlying economy. It’s a simplification because tight lending standards will put a crimp on access to credit and consumption. Nonetheless, if you believe that the Fed will be successful in restoring confidence in the credit market before the proverbial “second (or third, fourth…) shoe” drops, then there would be a relief rally to sell into. We’ll know this week when all the bigwigs are back from the Hamptons whether last Wednesday (8/29) marked the start of this rally.