Risk Control for Dummies

There is a method to my madness, although I understand that some new subscribers may need some convincing.

Whenever I change my positions, the market makes a major move or reaches a key crossroads, I look to stress test my portfolio by inflicting various extreme scenarios upon it and analyzing the outcome.

This is second nature for most hedge fund managers. In fact, the larger ones will use top of the line mainframes powered by $100 million worth of in-house custom programming to produce a real-time snapshot of their thousands of positions in all imaginable scenarios at all times.

If you want to invest with these guys feel free to do so. They require a $10-$25 million initial slug of capital, a one year lock up, charge a fixed management fee of 2% and a performance bonus of 20% or more.

You have to show minimum liquid assets of $2 million and sign 50 pages of disclosure documents. If you have ever sued a previous manager, forget it. The door slams shut. And, oh yes, the best performing funds are closed and have a ten-year waiting list to get in. Unless you are a major pension fund, they don’t want to hear from you.

Individual investors are not so sophisticated, and it clearly shows in their performance, which usually mirrors the indexes less a large haircut. So, I am going to let you in on my own, vastly simplified, dumbed down, seat of the pants, down and dirty style of risk management, scenario analysis, and stress testing that replicates 95% of the results of my vastly more expensive competitors.

There is no management fee, performance bonus, disclosure document, lock up, or upfront cash requirement. There’s just my token $3,000 a year subscription fee and that’s it. And I’m not choosy. I’ll take anyone whose credit card doesn’t get declined.

To make this even easier, you can perform your own analysis in the excel spreadsheet I post every day in the paid-up members section of Global Trading Dispatch. You can just download it and play around with it whenever you want, constructing your own best case and worst-case scenarios. To make this easy, I have posted this spreadsheet on my website for you to download by clicking here.

Since this is a “for dummies” explanation, I’ll keep this as simple as possible. No offense, we all started out as dummies, even me.

I’ll take Mad Hedge Model Trading Portfolio at the close of October 29, the date that the stock market bottomed and when I ramped up to a very aggressive 75% long with no hedges. This was the day when the Dow Average saw a 1,000 point intraday range, margin clerks were running rampant, and brokers were jumping out of windows.

I projected my portfolio returns in three possible scenarios: (1) The market collapses an additional 5% by the November 16 option expiration, some 15 trading days away, falling from $260 to $247, (2) the S&P 500 (SPY) rises 5% from $260 to $273 by November 16, and (3) the S&P 500 trades in a narrow range and remains around the then current level of $260.

Scenario 1 – The S&P 500 Falls 5%

A 5% loss and an average of a 5% decline in all stocks would take the (SPY) down to $247, well below the February $250 low, and off an astonishing 15.70% in one month. Such a cataclysmic move would have taken our year to date down to +11.03%. The (SPY) $150-$160 and (AMZN) $1,550-$1,600 call spreads would be total losses but are partly offset by maximum gains on all remaining positions, including the S&P 500 (SPY), Salesforce (CRM), and the United States US Treasury Bond Fund (TLT). My Puts on the iPath S&P 500 VIX Short Term Futures ETN (VXX) would become worthless.

However, with real interest rates at zero (3.1% ten-year US Treasury yield minis  3.1% inflation rate), the geopolitical front quiet, and my Mad Hedge Market Timing Index at a 30 year low of only 4, I thought there was less than a 1% chance of this happening.

Scenario 2 – S&P 500 rises 5%

The impact of a 5% rise in the market is easy to calculate. All positions expire at their maximum profit point, taking our model trading portfolio up 37.03% for 2018. It would be a monster home run. I would make back a little bit on the (VXX) but not much because of time decay.

Scenario 3 – S&P 500 Remains Unchanged

Again, we do OK, given the circumstances. The year-to-date stands at a still respectable 22.03%. Only the (AMZN) $1,550-$1,600 call spread is a total loss. The (VXX) puts would become nearly a total loss.

As it turned out, Scenario 2 played out and was the way to go. I stopped out of the losing (AMZN) $1,550-$1,600 call spread two days later for only a 1.73% loss, instead of -12.23% in the worst-case scenario. It was a case of $12.23 worth of risk control that only cost me $1.73. I’ll do that all day long, even though it cost me money. When running hedge funds, you are judged on how you manage your losses, not your gains, which are easy.

I took profit on the rest of my positions when they reached 88%-95% of their maximum potential profits and thus cut my risk to zero during these uncertain times. October finished with a gain of +1.24. By the time I liquidated my last position and went 95% cash, I was up 32.95% so far in 2018, against a Dow average that is up 2% on the year. It was a performance for the ages.

Keep in mind that these are only estimates, not guarantees, nor are they set in stone. Future levels of securities, like index ETFs, are easy to estimate. For other positions, it is more of an educated guess. This analysis is only as good as its assumptions. As we used to say in the computer world, garbage in equals garbage out.

Professionals who may want to take this out a few iterations can make further assumptions about market volatility, options implied volatility or the future course of interest rates. And let’s face it, politics was a major influence this year.

Keep the number of positions small to keep your workload under control. Imagine being Goldman Sachs and doing this for several thousand positions a day across all asset classes.

Once you get the hang of this, you can start projecting the effect on your portfolio of all kinds of outlying events. What if a major world leader is assassinated? Piece of cake. How about another 9/11? No problem. Oil at $150 a barrel? That’s a gimme.

What if there is an Israeli attack on Iranian nuclear facilities? That might take you all of two minutes to figure out.  The Federal Reserve launches a surprise QE5 out of the blue? I think you already know the answer.

Now that you know how to make money in the options market, thanks to my Trade Alert service, I am going to teach you how to hang on to it.

There is no point in being clever and executing profitable trades only to lose your profits through some simple, careless mistakes.

So I have posted a training video on Risk Management. Note: you have to be logged in to the www.madhedgefundtrader.com website to view it. 

The first goal of risk control is to preserve whatever capital you have. I tell people that I am too old to lose all my money and start over again as a junior trader at Morgan Stanley. Therefore, I am pretty careful when it comes to risk control.

The other goal of risk control is the art of managing your portfolio to make sure it is profitable no matter what happens in the marketplace. Ideally, you want to be a winner whether the market moves up, down, or sideways. I do this on a regular basis.

Remember, we are not trying to beat an index here. Our goal is to make absolute returns, or real dollars, at all times, no matter what the market does. You can’t eat relative performance, nor can you use it to pay your bills.

So the second goal of every portfolio manager is to make it bomb proof. You never know when a flock of black swans is going to come out of nowhere, or another geopolitical shock occurs, causing the market crash.

I’ll also show you how to use my Trade Alert service to squeeze every dollar out of your trading.

So, let’s get on with it!

To watch the Introduction to Risk Management, please click here. 







Mad Hedge Market Timing Index


How to Play Apple in 2019

Not a day goes by when someone doesn’t ask me about what to do about Apple (AAPL).

After all, it is the world largest company. It is the planet’s most widely owned stock. Almost everyone uses their products in some form or another.

So, the widespread interest is totally understandable.

Apple is a company with which I have a very long relationship. During the early 1980s, I was ordered by Morgan Stanley to take Steve Jobs around to the big New York Institutional Investors to pitch a secondary share offer for the sole reason that I was one of three people who worked for the firm who was then from California.

They thought one West Coast hippy would easily get along with another. Boy, were they wrong. It was the worst day of my life. Steve was not a guy who palled around with anyone.

Today, some 200 Apple employees subscribe to the Diary of a Mad Hedge Fund Trader looking to diversify their substantial holdings. Many own Apple stock with an adjusted cost basis of under $5. Suffice it to say, they all drive really nice Priuses.

So I get a lot of information about the firm far above and beyond the normal effluent of the media and stock analysts. That’s why Apple has become a favorite target of my Trade Alerts over the years.

And here is the take: You didn’t want to touch the stock during the last quarter of 2018.

And here’s why. Apple is all about the iPhone which accounts for 75% of its total earnings. The TV, the watch, the car, iPods, the iMac, and Apple pay are all a waste of time and consume far more coverage than they are collectively worth.

The good news is that iPhone sales are subject to a fairly reliable cycle. Apple launches a major new iPhone every other fall. The share price peaks shortly after that. The odd years see minor upgrades, not generational changes.

Just like you see a big pullback in the tide before a tsunami hits, iPhone sales are flattening out. This is because consumers start delaying purchases in expectation of the introduction of the iPhone 7 in September 2016 with far more power, gadgets, and gizmos.

Channel checks, however dubious these may be, are already confirming the slowdown of orders for iPhone-related semiconductors from suppliers you would expect from such a downturn.

So during those in-between years, the stock performance is disappointing. 2018 certainly followed this script with Apple down a horrific 30.13% at the lows. Maybe it’s a coincidence, but that last generation in Apple shares in 2015 brought a decline of, you guessed it, exactly 29.33%.

The coming quarter could bring the opposite.

After March, things will start to get interesting especially post the Q1 earnings report in April. That’s when investors will start to discount the rollout of the next iPhone seven months later.

The last time this happened, in 2018, Apple stock rocketed by $86, or 55.33%. This time, I expect a minimum rally to the old $233 high, a gain of $71, or 43.82%.

After all, I am such a conservative guy with my predictions.

Even at that price, it will still be one of the cheapest stocks in the market on a valuation basis which currently trades at a 14X earnings multiple. The value players will have no choice to join in, if they’re not already there.

But Apple is a much bigger company this time around, and well-established cycles tend to bring in diminishing returns. It’s like watching the declining peaks of a bouncing rubber ball.

The bull case for Apple isn’t dead, it is just resting.

The China business will continue to grow nicely once we get through the current trade war. Their new lease program promises to deliver a faster upgrade cycle that will allow higher premium prices for their products. That will bring larger profits.

Just thought you’d like to know.



The Eight Worst Trades in History

As you are all well aware, I have long been a history buff. I am particularly fond of studying the history of my own avocation, trading, in the hope that the past errors of others will provide insights into the future.

History doesn’t repeat itself, but it certainly rhymes.

So after decades of research on the topic, I thought I would provide you with a list of the eight worst trades in history. Some of these are subjective, some are judgment calls, but all are educational. And I do personally know many of the individuals involved.

Here they are for your edification, in no particular order. You will notice a constantly recurring theme of hubris.

1) Ron Wayne’s sales of 10% of Apple (AAPL) for $800 in 1976

Say you owned 10% of Apple (AAPL) and you sold it for $800 in 1976. What would that stake be worth today? Try $70 billion. That is the harsh reality that Ron Wayne, 76, faces every morning when he wakes up, one of the three original founders of the consumer electronics giant.

Ron first met Steve Jobs when he was a spritely 21-year-old marketing guy at Atari, the inventor of the hugely successful “Pong” video arcade game.

Ron dumped his shares when he became convinced that Steve Jobs’ reckless spending was going to drive the nascent startup into the ground and he wanted to protect his own assets in a future bankruptcy.

Co-founders Jobs and Steve Wozniak each kept their original 45% ownership. Today Jobs’ widow, Laurene Powel Jobs, has a 0.5% ownership in Apple worth $4 billion, while the value of Woz’s share remains undisclosed.

Today, Ron is living off of a meager monthly Social Security check in remote Pahrump, Nevada, about as far out in the middle of nowhere as you can get where he can occasionally be seen playing the penny slots.

Ron Wayne


2) AOL's 2001 Takeover of Time Warner

Seeking to gain dominance in the brave new online world, Gerald Levin pushed old-line cable TV and magazine conglomerate, Time Warner, to pay $164 billion to buy upstart America Online in 2001. AOL CEO, Steve Case, became chairman of the new entity. Blinded by greed, Levin was lured by the prospect of 130 million big spending new customers.

It was not to be.

The wheels fell off almost immediately. The promised synergies never materialized. The Dotcom Crash vaporized AOL’s business the second the ink was dry. Then came a big recession and the Second Gulf War. By 2002, the value of the firm’s shares cratered from $226 billion to $20 billion.

The shareholders got wiped out, including “Mouth of the South” Ted Turner. That year, the firm announced a $99 billion loss as the goodwill from the merger was written off, the largest such loss in corporate history. Time Warner finally spun off AOL in 2009, ending the agony.

Steve Case walked away with billions, and is now an active venture capitalist. Gerald Levin left a pauper, and is occasionally seen as a forlorn guest on talk shows. The deal is widely perceived to be the worst corporate merger in history.

Gerald LevinBuy High, Sell Low?

3) Bank of America's Purchase of Countrywide Savings in 2008
Bank of America’s CEO Ken Lewis thought he was getting the deal of the century picking up aggressive subprime lender, Countrywide Savings, for a bargain $4.1 billion, a “rare opportunity.”

As a result, Countrywide CEO Angelo Mozilo pocketed several hundred million dollars. Then the financial system collapsed, and suddenly we learned about liar loans, zero money down, and robo signing of loan documents.

Bank of America’s shares plunged by 95%, wiping out $500 billion in market capitalization. The deal saddled (BAC) with liability for Countrywide’s many sins, ultimately, paying out $40 billion in endless fines and settlements to aggrieved regulators and shareholders.

Ken Lewis was quickly put out to pasture, cashing in on an $83 million golden parachute, and is now working on his golf swing. Mozilo had to pay a number of out of court settlements, but was able to retain a substantial fortune, and is still walking around free.

The nicely tanned Mozilo is also working on his golf swing.


Angelo Mozilo

4) The 1973 Sale of All Star Wars Licensing and Merchandising Rights by 20th Century Fox for Free

In 1973, my former neighbor George Lucas approached 20th Century Fox Studios with the idea for the blockbuster film, Star Wars. It was going to be his next film after American Graffiti which had been a big hit earlier that year.

While Lucas was set for a large raise for his directing services – from $150,000 for American Graffiti to potentially $500,000 for Star Wars – he had a different twist ending in mind. Instead of asking for the full $500,000 directing fee, he offered a discount: $350,000 off in return for the unlimited rights to merchandising and any sequels.

Fox executives agreed, figuring that the rights were worthless, and fearing that the timing might not be right for a science fiction film.

In hindsight, their decision seems ridiculously short-sighted.

Since 1977, the Star Wars franchise has generated about $27 billion in revenue, leaving George Lucas with a net worth of over $3 billion by 2012. In 2012, Disney paid Lucas an additional $4 billion to buy the rights to the franchise

The initial budget for Star Wars was a pittance at $8 million, a big sum for an unproven film.  So, saving $150,000 on production costs was no small matter, and Fox thought it was hedging its bets.

George once told me that he had a problem with depressed actors on the set while filming. Harrison Ford and Carrie Fisher thought the plot was stupid and the costumes silly.

Today, it is George Lucas that is laughing all the way to the bank.

Darth Vader$150,000 for What?

5) Lehman Brothers Entry Into the Bond Derivatives Market in the 2000s

I hated the 2000s because it was clear that men with lesser intelligence were using other people’s money to hyper leverage their own personal net worth. The money wasn’t the point. The quantities of cash involved were so humongous they could never be spent. It was all about winning points in a game with the CEOs of the other big Wall Street institutions.

CEO Richard Fuld could have come out of central casting as a stereotypical bad guy. He even once offered me a job which I wisely turned down. Fuld took his firm’s leverage ratio up to 100 times in an extended reach for obscene profits. This meant that a 1% drop in the underlying securities would entirely wipe out its capital.

That’s exactly what happened, and 10,000 employees lost their jobs, sent packing with their cardboard boxes with no notice. It was a classic case of a company piling on more risk to compensate for the lack of experience and intelligence. This only ends one way.

Morgan Stanley (MS) and Goldman Sachs (GS) drew the line at 40 times leverage and are still around today but just by the skin of their teeth, thanks to the TARP.

Fuld has spent much of the last five years ducking in and out of depositions in protracted litigation. Lehman issued public bonds only months before the final debacle, and how he has stayed out of jail has amazed me. Today he works as an independent consultant. On what I have no idea.

Richard FuldOut of Central Casting

6) The Manhasset Indians' Sale of Manhattan to the Dutch in 1626

Only a single original period document mentions anything about the purchase of Manhattan. This letter states that the island was bought from the Indians for 60 Dutch guilders worth of trade goods which would consist of axes, iron kettles, beads, and wool clothing.

No record exists of exactly what the mix was. Indians were notoriously shrewd traders and would not have been fooled by worthless trinkets.

The original letter outlining the deal is today kept at a museum in the Netherlands. It was written by a merchant, Pieter Schagen, to the directors of the West India Company (owners of New Netherlands) and is dated 5 November 1626.

He mentions that the settlers “have bought the island of Manhattes from the savages for a value of 60 guilders.” That’s it. It doesn’t say who purchased the island or from whom they purchased it, although it was probably the local Lenape tribe.

Historians often point out that North American Indians had a concept of land ownership different from that of the Europeans. The Indians regarded land, like air and water, as something you could use but not own or sell. It has been suggested that the Indians may have thought they were sharing, not selling.

It is anyone’s guess what Manhattan is worth today. Just my old two-bedroom 34th-floor apartment at 400 East 56th Street is now worth $2 million. Better think in the trillions.

Pieter Schagen Letter

Illustration of the Manhattan Purchase


7) Napoleon's 1803 Sale of the Louisiana Purchase to the United States

Invading Europe is not cheap, as Napoleon found out, and he needed some quick cash to continue his conquests. What could be more convenient than unloading France’s American colonies to the newly founded United States for a tidy $7 million? A British naval blockade had made them all but inaccessible anyway.

What is amazing is that president Thomas Jefferson agreed to the deal without the authority to do so, lacking permission from Congress, and with no money. What lies beyond the Mississippi River then was unknown.

Many Americans hoped for a waterway across the continent while others thought dinosaurs might still roam there. Jefferson just took a flyer on it. It was up to the intrepid explorers, Lewis and Clark, to find out what we bought.

Sound familiar? Without his bold action, the middle 15 states of the country would still be speaking French, smoking Gitanes, and getting paid in Euros.

After Waterloo in 1815, the British tried to reverse the deal and claim the American Midwest for themselves. It took Andrew Jackson’s (see the $20 bill) surprise win at the Battle of New Orleans to solidify the US claim.

The value of the Louisiana Purchase today is incalculable. But half of a country that creates $17 trillion in GDP per year and is still growing would be worth quite a lot.

NapoleonGreat General, Lousy Trader

8) The John Thomas Family Sale of Nantucket Island in 1740

Yes, my own ancestors are to be included among the worst traders in history. My great X 12 grandfather, a pioneering venture capitalist investor of the day from England, managed to buy the island of Nantucket off the coast of Massachusetts from the Indians for three ax heads and a sheep in the mid-1600s. Barren, windswept, and distant, it was considered worthless.

Two generations later, my great X 10 grandfather decided to cut his risk and sell the land to local residents just ahead of the Revolutionary War. Some 17 of my ancestors fought in that war including the original John Thomas who served on George Washington’s staff at the harsh winter encampment at Valley Forge during 1777-78. Maybe that’s why I have an obsession about not wasting food?

By the early 19th century, a major whaling industry developed on Nantucket fueling the lamps of the world with smoke-free fuel. By then, our family name was “Coffin,” which is still abundantly found on the headstones of the island’s cemeteries.

One Coffin even saw his ship, the Essex, rammed by a whale and sunk in the Pacific in 1821 (read about it in The Heart of the Sea by Nathaniel Philbrick, to be released as a movie in 2015). He was eaten by fellow crewmembers after spending 99 days adrift in an open lifeboat. Maybe that’s why I have an obsession about not wasting food?

In the 1840s, a young itinerant writer named Herman Melville visited Nantucket and heard the Essex story. He turned it into a massive novel about a mysterious rogue white whale, Moby Dick, which has been torturing English literature students ever since. Our family name, Coffin, is mentioned seven times in the book.

Nantucket is probably worth many tens of billions of dollars today as a playground for the rich and famous. Just a decent beachfront cottage there rents for $50,000 a week in the summer.

The Ron Howard film The Heart of the Sea came out a few years ago, and it is breathtaking. Just be happy you never worked on a 19th-century sailing ship.

Yes, it’s all true and documented.

Moby Dick

Print Your Own Car

I am ever on the lookout for disruptive technologies that lead to great investment opportunities. Sitting here next door to Silicon Valley, that is not hard to do.

So I watched my TV with utter amazement the other day when I saw a 3-D printer create an entire car from scratch. It took ten hours to build the body, and the rest of the day to bolt on the electric motors, axels, wheels, and the rest of the parts.

Beyond the drive train, the vehicle has only 50 parts. This compares to the 5,000 or 6,000 parts needed for a conventional car. There’s a gigantic labor and cost saving right there.

I have to admit that I came late to the 3-D printing scene. When hobbyists started making colorful figurines on their printers a few years ago, I thought it no more than a niche of a few passionate geeks who are in such abundance here.

That was a good thing because the initial batch of stock market plays all went meteoric, then crashed and burned.

Such is often the case with cutting-edge technologies. You often don’t generate real profits until you get the second or third generation.

That’s the way the personal computer started which went mainstream with incredible speed in the early 1980s (to get the flavor of the day, watch the hit AMC series “Halt and Catch Fire”).

Then my biotech friends told me they were printing human organs substituting ink with cells. After that, I discovered that Elon Musk was using 3-D printers to build rocket engine parts at his Space X venture in Los Angeles.

Suddenly, I started to take the technology seriously.

Arizona-based Local Motors plans to take a great leap forward with the launch of a 3D printed car next year (click here for their website).

Dubbed the “Strati” (layers in Italian), the vehicle is made of reinforced carbon fiber thermoplastic, or ABS. It has one fifth the weight of steel with ten times the strength. You can pick up the car with two hands.

The company planned to build two versions of its vehicle during the first quarter of 2016. One would be a low-speed battery car or so-called neighborhood electric vehicle priced between $18,000 and $30,000. Faster, higher-priced versions would come later.

While the entry costs to the auto industry are legendarily high, in the billions of dollars, Local Motors’ upfront expenses are miniscule by comparison. The 49 foot long printer needed to print the body costs only $50,000.

Oak Ridge National Labs in Tennessee is a partner in the project which helped develop the monster printer. Nuclear weapons historians will recall them as the first refiner of U-235 during WWII.

It is the first effort to fundamentally change the way cars are put together since Henry Ford modernized the auto assembly line 100 years ago.

Local Motors is an internet creation all the way. It obtained its original funding through crowdsourcing, and held an international contest to find a design.  An Italian won, hence the name.

It’s hard to see the Strati threatening the Tesla (TSLA), or any conventional car manufacturer any time soon. The current car is not yet street legal, and only does 40 miles per hour.

There is no great trading or investment play here yet. It is still early days. Give it a year or two.

However, it could be a hint of great things to come. I’ll take mine in black.
For the YouTube video of and interview with the Strati engineer, click here.

Strati Car

Ah, But is the Girl Printed As Well?

Car Production

Lithium Battery Charge

The Market Outlook for the Week Ahead, or Don’t Nominate Me!

I have a request for all of you readers. Please do not nominate me for justice of the Supreme Court.

I have no doubt that I could handle the legal load. A $17 copy of Litigation for Dummies from Amazon would take care of that.

I just don’t think I could get through the approval process. There isn’t a room on Capitol Hill big enough to house all the people who have issues with my high school background.

In 1968, I ran away from home, hitchhiked across the Sahara Desert, was captured by the Russian Army when they invaded Czechoslovakia, and had my front teeth knocked out by a flying cobblestone during a riot in Paris. I pray what went on in Sweden never sees the light of day.

So, I’m afraid you’ll have to look elsewhere to fill a seat in the highest court in the land. Good luck with that.

The most conspicuous market action of the week took place when several broker upgrades of major technology stocks. Amazon (AMZN) was targeted for $2,525, NVIDIA (NVDA) was valued at $400, and JP Morgan, always late to the game (it’s the second mouse that gets the cheese), predicted Apple (AAPL) would hit a lofty $270.

That would make Steve Jobs’ creation worth an eye-popping $1.3 trillion.

The Mad Hedge Market Timing Index dove down to a two-month low at 46. That was enough to prompt me to jump back into the market with a few cautious longs in Amazon and Microsoft (MSFT). The fourth quarter is now upon us and the chase for performance is on. Big, safe tech stocks could well rally well into 2019.

Facebook (FB) announced a major security breach affecting 50 million accounts and the shares tanked by $5. That prompted some to recommend a name change to “Faceplant.”

The economic data is definitely moving from universally strong to mixed, with auto and home sales falling off a cliff. Those are big chunks of the economy that are missing in action. If you’re looking for another reason to lose sleep, oil prices hit a four-year high, topping $80 in Europe.

The trade wars are taking specific bites out of sections of the economy, helping some and damaging others. Expect to pay a lot more for Christmas, and farmers are going to end up with a handful of rotten soybeans in their stockings.

Barrick Gold (ABX) took over Randgold (GOLD) to create the world’s largest gold company. Such activity usually marks long-term bottoms, which has me looking at call spreads in the barbarous relic once again.

With inflation just over the horizon and commodities in general coming out of a six-year bear market, that may not be such a bad idea. Copper (FCX) saw its biggest up day in two years.

The midterms are mercifully only 29 trading days away, and their removal opens the way for a major rally in stocks. It makes no difference who wins. The mere elimination of the uncertainty is worth at least 10% in stock appreciation over the next year.

At this point, the most likely outcome is a gridlocked Congress, with the Republicans holding only two of California’s 52 House seats. And stock markets absolutely LOVE a gridlocked Congress.

Also helping is that company share buybacks are booming, hitting $189 billion in Q2, up 60% YOY, the most in history. At this rate the stock market will completely disappear in 20 years.

On Wednesday, we got our long-expected 25 basis-point interest rate rise from the Federal Reserve. Three more Fed rate hikes are promised in 2019, after a coming December hike, which will take overnight rates up to 3.00% to 3.25%. Wealth is about to transfer from borrowers to savers in a major way.

The performance of the Mad Hedge Fund Trader Alert Service eked out a 0.81% return in the final days of September. My 2018 year-to-date performance has retreated to 27.82%, and my trailing one-year return stands at 35.84%.

My nine-year return appreciated to 304.29%. The average annualized return stands at 34.40%. I hope you all feel like you’re getting your money’s worth.

This coming week will bring the jobspalooza on the data front.

On Monday, October 1, at 9:45 AM, we learn the August PMI Manufacturing Survey.

On Tuesday, October 2, nothing of note takes place.

On Wednesday October 3 at 8:15 AM, the first of the big three jobs numbers is out with the ADP Employment Report of private sector hiring. At 10:00 AM, the August PMI Services is published.

Thursday, October 4 leads with the Weekly Jobless Claims at 8:30 AM EST, which rose 13,000 last week to 214,000. At 10:00 AM, September Factory Orders is released.
On Friday, October 5, at 8:30 AM, we learn the September Nonfarm Payroll Report. The Baker Hughes Rig Count is announced at 1:00 PM EST.

As for me, it’s fire season now, and that can only mean one thing: 1,000 goats have appeared in my front yard.

The country hires them every year to eat the wild grass on the hillside leading up to my house. Five days later there is no grass left, but a mountain of goat poop and a much lesser chance that a wildfire will burn down my house.

Ah, the pleasures of owning a home in California!

Good luck and good trading.










We’re Taking Calls Now

How to Gain an Advantage with Parallel Trading

One of the most fascinating things I learned when I first joined the equity trading desk at Morgan Stanley during the early 1980s was how to parallel trade.

A customer order would come in to buy a million shares of General Motors (GM) and what did the in-house proprietary trading book do immediately?

It loaded the boat with the shares of Ford Motors (F).

When I asked about this tactic, I was taken away to a quiet corner of the office and read the riot act.

“This is how you legally front run a customer,” I was told.

Buy (GM) in front of a customer order, and you will find yourself in Sing Sing shortly.

Ford (F), Toyota (TM), Nissan (NSANY), Daimler Benz (DDAIF), BMW (BMWYY), or Volkswagen (VWAPY), are no problem.

The logic here was very simple.

Perhaps the client completed an exhaustive piece of research concluding that (GM) earnings were about to rise.

Or maybe a client old boy network picked up some valuable insider information.

(GM) doesn’t do business in isolation. It has tens of thousands of parts suppliers for a start. While whatever is good for (GM) is good for America, it is GREAT for the auto industry.

So through buying (F) on the back of a (GM) might not only match the (GM) share performance, it might even exceed it.

This is known as a Primary Parallel Trade.

This understanding led me on a lifelong quest to understand Cross Asset Class Correlations, which continues to this day.

Whenever you buy one thing, you buy another related thing as well, which might do considerably better.

I eventually made friends with a senior trader at Salomon Brothers while they were attempting to recruit me to run their Japanese desk.

I asked if this kind of legal front running happened on their desk.

“Absolutely,” he responded. But he then took Cross Asset Class Correlations to a whole new level for me.

Not only did Salomon’s buy (F) in that situation, they also bought palladium (PALL).

I was puzzled. Why palladium?

Because palladium is the principal metal used in catalytic converters, which remove toxic emissions from car exhaust, and have been required for every U.S. manufactured car since 1975.

Lots of car sales, which the (GM) buying implied, ALSO meant lots of palladium buying.

And here’s the sweetener.

Palladium trading is relatively illiquid.

So, if you catch a surge in the price of this white metal, you would earn a multiple of what you would make on your parallel (F) trade.

This is known in the trade as a Secondary Parallel Trade.

A few months later, Morgan Stanley sent me to an investment conference to represent the firm.

I was having lunch with a trader at Goldman Sachs (GS) who would later become a famous hedge fund manager and asked him about the (GM)-(F)-(PALL) trade.

He said I would be an IDIOT not to take advantage of such correlations. Then he one-upped me.

You can do a Tertiary Parallel Trade here through buying mining equipment companies such as Caterpillar (CAT), Cummins (CMI), and Komatsu (KMTUY).

Since this guy was one of the smartest traders I ever ran into, I asked him if there was such a thing as a Quaternary Parallel Trade.

He answered “Abso******lutely,” as was his way.

But the first thing he always did when searching for Quaternary Parallel Trades would be to buy the country ETF for the world’s largest supplier of the commodity in question.

In the case of palladium, that would be Russia (RSX) followed by South Africa (EZA), which together account for 74% of the world’s total production.

Since then, I have discovered hundreds of what I can Parallel Trading Chains, and have been actively making money off of them. So have you, you just haven’t realized it yet.

I could go on and on.

Do this for decades as I have and you learn that some parallel trades break down and die. The cross relationships no longer function.

The best example I can think of is the photography/silver connection. When the photography business was booming, silver prices rose smartly.

Digital photography wiped out this trade, and silver-based film development is still only used by a handful of professionals and hobbyists.

Oh, and Eastman Kodak (KODK) went bankrupt in 2012.

However, it seems that whenever one Parallel Trading Chain disappears, many more replace it.

You could build chains a mile long simply based on how well Apple (AAPL) is doing.

Suffice it to say that parallel trading is an incredibly useful trading strategy.

Ignore it at your peril.






It’s a Long and Winding Road to Get Here

The Market Outlook for the Week Ahead

Ahhhh…the wonders of global excess liquidity.

Last week saw senior-level felony convictions, the real estate and auto industries rolling over and playing dead, rising inflation, escalating trade wars, sagging exports. It’s as if an entire flock of black swans landed on the markets.

And what did stocks do? Rocket to new all-time highs, Of course! What, are you, some kind of dummy? Didn’t you get the memo? With $50 trillion of global excess liquidity spawned by a decade of quantitative easing, of course stocks will go straight up, forever!

Until they don’t.

Even my favorite, Apple (AAPL) blasted through to new highs at $219 after an analyst raised his target to $245. You may recall me loading the boat with Apple calls during the February meltdown when the shares hit $150.

My target for Apple this year was $200, which I then raised to $220. Am I going to raise my target again? No. As my late mentor, Barton Biggs used to say, “Always leave the last 10% for the next guy.”

It kind of makes my own split adjusted cost of Apple shares of 50 cents, which I picked up in 1998, look pretty good. Yup. That double bottom on the charts at 40 cents said it all.

I used the strength to increase my cash position from 80% to 90%, unloading my long position in Walt Disney options at cost. That leaves me with a single short position in bonds (TLT), which have to see yield on the 10-year U.S. Treasury bond market to fall below 2.67% in three weeks before I lose money.

I am even focusing a sharp eye on the Volatility Index (VIX) for a trade alert this week. If you buy the January 2019 (VXX) $40 calls at $2.90 and the ETF rises 25 points to its April high of $54, these calls would rocket by 382% to $14.00. Sounds like a trade to me! Then I can say thank you very much to Mr. Market, thumb my nose at him, and then take off for the rest of the year. TA-TA!

In the meantime, much of industrial America is getting ready to shut down. Tariffs on 50% of all Chinese imports come into force in September. It turns out that you can’t make anything in the U.S. without the millions of little Chinese parts you’ve never heard of, which also have no U.S. equivalent.

Factories will have to either pass their costs on to consumers in a deflationary economy or shut down. What the administration has done is offset a tax cut with a tax increase in the form of higher import taxes. It was not supposed to work out like that.

The bond rally has pared back my August performance to a dead even at 0.02%. My 2018 year-to-date performance has pulled back to 24.84% and my nine-year return appreciated to 301.31%. The Averaged Annualized Return stands at 34.76%. The more narrowly focused Mad Hedge Technology Fund Trade Alert performance is annualizing now at an impressive 32.24%.

This coming week will be real estate dominated on the data front.

On Monday, August 27, at 10:30 AM EST, we obtain the Dallas Fed Manufacturing Survey.

On Tuesday, August 28, at 9:00 AM EST, we get the June S&P CoreLogic Case-Shiller National Home Price Index. Will we start to see the price falls that more current data are already showing?

On Wednesday, August 29, at 10:00 AM EST, we learn July Pending Home Sales, which lately have been weak.

Thursday, August 30, leads with the Weekly Jobless Claims at 8:30 AM EST, which saw a fall of 2,000 last week to 210,000.

On Friday, August 31, at 10:00 AM EST, we get Chicago Purchasing Managers Index for July. Then the Baker Hughes Rig Count is announced at 1:00 PM EST.

As for me, I think I’ll pop over to the Pebble Beach Concours d'Elegance vintage car show this weekend and place a bid on Ferris Bueller’s red 1962 Ferrari GT California. It’s actually a Hollywood custom chassis built around a Ford engine. I can’t afford a real vintage Ferrari GTO, one of which is expected to sell for an eye-popping $60 million this weekend.

Good luck and good trading.









Why the Dow is Going to 120,000

For years, I have been predicting that a new Golden Age was setting up for America, a repeat of the Roaring Twenties. The response I received was that I was a permabull, a nut job, or a conman simply trying to sell more newsletters.

Now some strategists are finally starting to agree with me. They too are recognizing that a ganging up of three generations of investment preferences will combine to drive markets higher during the 2020s, much higher.

How high are we talking? How about a Dow Average of 120,000 by 2030, up another 465% from here? That is a 20-fold gain from the March 2009 bottom.

It’s all about demographics, which are creating an epic structural shortage of stocks. I’m talking about the 80 million Baby Boomers, 65 million from Generation X, and now 85 million Millennials. Add the three generations together and you end up with a staggering 230 million investors chasing stocks, the most in history, perhaps by a factor of two.

Oh, and by the way, the number of shares out there to buy is actually shrinking, thanks to a record $1 trillion in corporate stock buybacks.

I’m not talking pie in the sky stuff here. Such ballistic moves have happened many times in history. And I am not talking about the 17th century tulip bubble. They have happened in my lifetime. From August 1982 until April 2000 the Dow Average rose, you guessed it, exactly 20 times, from 600 to 12,000, when the Dotcom bubble popped.

What have the Millennials been buying? I know many, like my kids, their friends, and the many new Millennials who have recently been subscribing to the Diary of a Mad Hedge Fund Trader. Yes, it seems you can learn new tricks from an old dog. But they are a different kind of investor.

Like all of us, they buy companies they know, work for, and are comfortable with. During my Dad’s generation that meant loading your portfolio with U.S. Steel (X), IBM (IBM), and General Motors (GM).

For my generation that meant buying Microsoft (MSFT), Intel (INTC), and Dell Computer (DELL).

For Millennials that means focusing on Netflix (NFLX), Amazon (AMZN), Apple (AAPL), and Alphabet (GOOGL).

That’s why these four stocks account for some 40% of this year’s 7% gain. Oh yes, and they bought a few Bitcoin along the way too, to their eternal grief.

There is one catch to this hyper-bullish scenario. Somewhere on the way to the next market apex at Dow 120,000 in 2030 we need to squeeze in a recession. That is increasingly becoming a topic of market discussion.

The consensus now is that an impending inverted yield curve will force a recession sometime between August 2019 to August 2020. Throwing fat on the fire will be a one-time only tax break and deficit spending that burns out sometime in 2019. These will be a major factor in U.S. corporate earnings growth dramatically slowing down from 26% today to 5% next year.

Bear markets in stocks historically precede recessions by an average of seven months so that puts the next peak in top prices taking place between February 2019 to February 2020.

When I get a better read on precise dates and market levels, you’ll be the first to know.

To read my full research piece on the topic please click here to read “Get Ready for the Coming Golden Age.” 



Dow 1982-2000 Up 20 Times in 18 Years



Dow 2009-Today Up 4.3 Times in 9 Years So Far


Why Doctor Copper is Waving a Red Flag

One of my responsibilities as a global strategist is to talk about how cheap stocks are at market bottoms, and how expensive they are at market tops. In all honesty I have to tell you that 9 ½ years into a bull market, we are now much closer to a top than a bottom.

If Dr. Copper has anything to say about it the global economy is already in a recession. Since the June peak, trade wars have taken the red metal down a gut-punching 22.7%. The world’s largest copper producer Freeport-McMoRan (FCX), a Carl Icahn favorite, is off an eye-popping 30.6% during the same period.

Should we be running around with our hair on fire?  Is it time to throw up on our shoes? I don’t think so…not yet anyway.

Dr. Copper achieved its vaunted status as a leading indicator of economic cycles for the simple reason that everyone uses copper. Building and construction took up 43% of the supply in 2017, followed by electronics (19%) and transportation equipment (17%).

China is far and away the world’s largest consumer of copper. In 2017, it bought 48% of total world output. However, red flags there are flying everywhere.

Back in the 2000s, when China was building a “Rome a Day,” demand for copper seemed limitless. Since then, Chinese construction has fallen to a low ebb as the greatest infrastructure build-out in history came to completion.

China has steadily moved from an export-oriented to a services-driven economy, further eroding the need for copper. I warned investors of this seven years ago. That is why the Mad Hedge Fund Trader has issued virtually NO commodities-based Trade Alerts since then.

Before the last financial crisis Chinese banks accepted copper ingots as collateral for business loans. That practice is now banned.

In the second quarter, nonperforming loans at Chinese banks notched their biggest rise in more than a decade, according to research from Capital Economics. Corporate bond defaults are on the rise, and earlier this week, official reports showed Chinese investment growth, which has long been a driver of the economy, fell to its lowest level since the late 1990s.

The pressure on the Chinese economy is beginning to take its toll in other places, too. China’s currency, the renminbi, has fallen more than 9% against the dollar in the past six months, and China’s CSI 300 index of blue chip stocks is off 19% this year.

The net effect of all of this has been to dilute the predictive power of copper. Copper may no longer deserve its PhD in economics, perhaps only a master’s degree or an associate of arts.

Copper is not alone in predicting imminent economic disaster. Oil (USO) has also been shouting the same. Texas tea has fallen by 15.8% since copper began its swan dive two months ago.

For sure, oil has been falling for its own reasons. Iran has sidestepped American sanctions by selling its oil directly to China, and there is nothing the U.S. can do about it. Every year, global GDP growth needs less oil to grow than before thanks to alternative energy sources and conservation.  A recent bout of OPEC quota cheating hasn’t helped either.

As any market strategist will tell you, falling copper and oil prices are not what sustainable bull markets in stocks are made of. I’m not saying a crash will happen tomorrow.

Personally, I believe that the bull market should spill into 2019. But when corporate earnings growth downshifts from 26% to 5% YOY, as it will in Q1 2019, watch out below!








The Big Trade War Victim

Profiting from America’s Demographic Collapse

Demographics is destiny.

If you ignore it as an investor, you will be constantly behind the investing curve wondering why your performance is so bad.

Get ahead of it, and people will think you are a genius.

I figured all this out when I was about 20.

I realized then, back in 1972, that if I could just get ahead of the baby boomer generation everything magically seemed to work.

Buy what boomers want to buy next, and the world will be your oyster.

That strategy is still working today.

Back then, that meant buying residential real estate in California and New York, which has since risen in value 100-fold, and more once the generous tax breaks of home ownership are added in.

Now it means investing in health care and big pharma.

Except now, there is a new crowd in town: The Millennials.

As a long-term observer of America’s demographic picture, I was shocked to hear of a recent report from the U.S. Census Bureau (click here for the link).

The U.S. population grew by a scant 0.72% in 2012, the lowest since 1942.

You can’t start or expand a family when an essential partner in the process is off fighting WWII, and there were 17 million of them back then.

This is far below the 2.09% replacement rate that the country was holding onto only a few years ago.

At the end of 2016, there were 323.1 million Americans. This accounts for 4.3.08% of the global population of 7.5 billion, which was up 1.1%.

This places American population growth at the bottom of the international sweepstakes, down with Italy (0.32%), Germany (0.11%), and Poland (0.02%).

According to the World Bank, 22 countries suffered population declines, such as Portugal (-0.29%) and Japan (-0.20%) (click here for the link).

The tiny Sultanate of Oman, one of my old stomping grounds as a military pilot, enjoys the planet’s highest growth rate at 9.13%.

But then it helps if you have four wives.

The obvious cause here of America’s demographic dilemma was the recent weakness of the U.S. economy. There is a high correlation between economic health and fertility a year later.

So, we can only hope that the improvement in the economy this year sent more to the maternity ward.

If it doesn’t, it could be great news for your investment portfolio. Fewer births today translate into a shortage of workers in 20 years. That brings rising wages, flying inflation, and rapid price hikes. And stock markets love inflation because companies can pass costs onto consumers, while bond holders can’t.

Corporate profits go through the roof, as do share prices. It also produces fewer relying on government services in 40 years, which makes it easier for the government to balance the budget.

This Goldilocks scenario is already scheduled for the coming decade of the 2020s, when a 15-year demographic headwind flips to a tailwind, thanks to the coming demise of the “baby boomer” generation, now a big cost to the economy.

Demise, that is, except for me. As long as I hike 10 miles a day I’ll probably live forever.

The new data suggest that the coming “roaring twenties” could extend well into the 2030s and beyond.

California was the most populous state, with more than 39 million, followed by Texas and New York. Two states saw population declines, Maine and West Virginia, where the collapse of the coal industry is sucking the life out of local businesses.

Parsing through the report, it is clear that predictions of population trends are becoming vastly more complicated, thanks to the increasingly minestrone-like makeup of the U.S. people.

By 2040 no single racial group will be in a majority in the U.S. That is already the case for the entire state of California now. Hispanics now account for 38% of the population of the Golden State, followed by Caucasians at 37%.

America will come to resemble other, much smaller multiethnic societies, such as Singapore, South Africa, England, and Israel. This explains much about the current state of politics in the U.S. today.

Texas saw the greatest increase in population, with a jump of 387,397, to 26,020,000, as people flock in to take advantage of the big increase in local government hiring there.

Some 80% of new Texans were Hispanic and black, confirming my belief that the Lone Star State will become the next battleground in presidential elections.

This no doubt explains the recent rise of the white nationalist movement and the election of Donald Trump.

Single ethnic groups historically will only lose their majority with a fight.

This is why gerrymandering (redistricting) is such a big deal there, with the white establishment battling to hang onto power at any cost.

Further complicating any serious analysis is the rapid decline of the traditional American nuclear family, where married parents live with their children.

With a vast concentration of wealth at the top, and a long-term decline of middle-class earnings, this is increasingly becoming a luxury of a prosperous elite.

As a result, the country’s birthrate has declined by half since 1960.

Those who do are having fewer kids, the average family size dropping from three to two. In 1964, the final year of the baby boom, 36% of Americans were under the age of 18.

Today, that figure is just 23.5%, and is expected to fall to 21% by 2050. Only 80% of women have children now, compared to 90% in the 1970s.

One possible explanation is that the full, end-to-end cost of child-rearing has soared to $241,080 per child now.

I was a bargain as a kid, costing my parents only a tenth of that. Rocketing college costs are another barrier, with 70% of high school grads at least starting some higher education.

I went to Boy Scouts and Little League baseball, each of which cost $1 a month. A full scholarship covered my college expenses.

When I look at the checks I have written for my own children for ski lessons, soccer, youth sailing, braces, international travel, and assorted master’s degrees and PhDs, I recoil in horror.

Fewer women are following that old adage of “marriage before carriage.” Some 41% of children are born out of wedlock, up 400% in 40 years.

It is definitely an education and class driven divide. Only 10% of college-educated mothers are still single, compared to 57% for those with a high school education or less.

It is a truism in the science of demographics that educated women have fewer children. It makes possible careers that enable them to bring home paychecks instead of babies, which husbands prefer.

Blame Roe versus Wade, the Equal Rights Act, and Title Nine, but every social reform benefiting women of the past half-century has helped send the birthrate plummeting.

More women wearing the pants in the family hurts the fertility rate as well, as they are unable, or unwilling, to bear the large families of yore. The share of families where women are the primary breadwinners has leapt from 11% to 40% since 1960.

When couples do marry, they are sometimes of the same sex, now that gay marriage is legal, further muddying traditional data sources.

Some 2 million children are now being raised by gay parents. In fact, there is a gay baby boom underway, which those in the community call the “gayby” boom.”

All female couples have produced 1 million children over the past 30 years, 95% of whom select for blond-haired, blue eyed, Aryan sperm donors who are over six feet tall ($40 a shot for donors if you guys are interested and live walking distance from UC Berkeley).

I’m told by the sources that know that water polo players are particularly favored.

The numbers are so large that it is impacting the makeup of the U.S. population.

There was a time when I could usually identify the people standing next to me on San Francisco cable cars. That time has long passed. Now I don’t have a clue.

Whenever we go to war, we become our enemy to a modest degree, both as a people and a culture.

After WWII, 50,000 German and 50,000 Japanese wives were brought home as war prizes. Sushi, hot tubs, Toyotas, and Volkswagens quickly followed.

The problem is that the U.S. has invaded another 20 countries since 1945 and is now maintaining a military presence in 140. That generates a hell of a lot of green cards.

This has spawned sizeable Korean, and later, Iranian communities in Los Angeles, a Vietnamese one in Louisiana, a Somali enclave in Minneapolis, and large minority of Afghans in San Jose.

The fall of the Soviet Union in 1992 unleashed another dozen Eastern European ethnic groups and languages on the U.S. Haven’t you noticed the proliferation of Arab fast food restaurants in your neighborhood since we sent 20 divisions to the Middle East?

What all this means is that the grand experiment called the United States is entering a new phase.

Different ethnic, racial, religious, and even political groups are blending with each other to create a population unseen in the history of the world, with untold economic consequences.

It is also setting up an example for other countries to follow.

Get your investment portfolio out in front of it, and you could prosper mightily.




Ignore Demographics at Your Portfolio’s Peril