Global Market Comments
July 8, 2019
Fiat Lux
Featured Trade:
(STANDBY FOR THE COMING GOLDEN AGE OF INVESTMENT),
(SPY), (INDU), (FXE), (FXY), (UNG), (EEM), (USO),
(TLT), (NSANY), (TSLA)
I believe that the global economy is setting up for a new Golden Age reminiscent of the one the United States enjoyed during the 1950s, and which I still remember fondly.
This is not some pie in the sky prediction.
It simply assumes a continuation of existing trends in demographics, technology, politics, and economics. The implications for your investment portfolio will be huge.
What I call “intergenerational arbitrage” will be the principal impetus. The main reason that we are now enduring two “lost decades” of economic growth is that 80 million baby boomers are retiring to be followed by only 65 million “Gen Xers”.
When the majority of the population is in retirement mode, it means that there are fewer buyers of real estate, home appliances, and “RISK ON” assets like equities, and more buyers of assisted living facilities, health care, and “RISK OFF” assets like bonds.
The net result of this is slower economic growth, higher budget deficits, a weak currency, and registered investment advisors who have distilled their practices down to only municipal bond sales.
Fast forward six years when the reverse happens and the baby boomers are out of the economy, worried about whether their diapers get changed on time or if their favorite flavor of Ensure is in stock at the nursing home.
That is when you have 65 million Gen Xers being chased by 85 million of the “millennial” generation trying to buy their assets.
By then, we will not have built new homes in appreciable numbers for 20 years and a severe scarcity of housing hits. Residential real estate prices will soar. Labor shortages will force wage hikes.
The middle-class standard of living will reverse a then 40-year decline. Annual GDP growth will return from the current subdued 2% rate to near the torrid 4% seen during the 1990s.
The stock market rockets in this scenario.
Share prices may rise very gradually for the rest of the teens as long as tepid 2-3% growth persists.
After that, we could see the same fourfold return we saw during the Clinton administration, taking the Dow to 100,000 by 2030.
If I’m wrong, it will hit 200,000 instead.
Emerging stock markets (EEM) with much higher growth rates do far better.
This is not just a demographic story. The next 20 years should bring a fundamental restructuring of our energy infrastructure as well.
The 100-year supply of natural gas (UNG) we have recently discovered through the new “fracking” technology will finally make it to end users, replacing coal (KOL) and oil (USO).
Fracking applied to oilfields is also unlocking vast new supplies.
Since 1995, the US Geological Survey estimate of recoverable reserves has ballooned from 150 million barrels to 8 billion. OPEC’s share of global reserves is collapsing.
This is all happening while automobile efficiencies are rapidly improving and the use of public transportation soars.
Mileage for the average US car has jumped from 23 to 24.7 miles per gallon in the last couple of years, and the administration is targeting 50 mpg by 2025. Total gasoline consumption is now at a five-year low.
Alternative energy technologies will also contribute in an important way in states like California, accounting for 30% of total electric power generation by 2020.
I now have an all-electric garage with a Nissan Leaf (NSANY) for local errands and a Tesla Model S-1 (TSLA) for longer trips, allowing me to disappear from the gasoline market completely. Millions will follow.
The net result of all of this is lower energy prices for everyone.
It will also flip the US from a net importer to an exporter of energy with hugely positive implications for America’s balance of payments.
Eliminating our largest import and adding an important export is very dollar-bullish for the long term.
That sets up a multiyear short for the world’s big energy consuming currencies, especially the Japanese yen (FXY) and the Euro (FXE). A strong greenback further reinforces the bull case for stocks.
Accelerating technology will bring another continuing positive. Of course, it’s great to have new toys to play with on the weekends, send out Facebook photos to the family, and edit your own home videos.
But at the enterprise level, this is enabling speedy improvements in productivity that is filtering down to every business in the US, lower costs everywhere.
This is why corporate earnings have been outperforming the economy as a whole by a large margin.
Profit margins are at an all-time high.
Living near booming Silicon Valley, I can tell you that there are thousands of new technologies and business models that you have never heard of under development.
When the winners emerge, they will have a big cross-leveraged effect on economy.
New health care breakthroughs will make serious disease a thing of the past which are also being spearheaded in the San Francisco Bay area.
This is because the Golden State thumbed its nose at the federal government ten years ago when the stem cell research ban was implemented.
It raised $3 billion through a bond issue to fund its own research even though it couldn’t afford it.
I tell my kids they will never be afflicted by my maladies. When they get cancer in 20 years, they will just go down to Wal-Mart and buy a bottle of cancer pills for $5, and it will be gone by Friday.
What is this worth to the global economy? Oh, about $2 trillion a year, or 4% of GDP. Who is overwhelmingly in the driver’s seat on these innovations? The USA.
There is a political element to the new Golden Age as well. Gridlock in Washington can’t last forever. Eventually, one side or another will prevail with a clear majority.
This will allow the government to push through needed long-term structural reforms, the solution of which everyone agrees on now, but nobody wants to be blamed for.
That means raising the retirement age from 66 to 70 where it belongs, and means-testing recipients. Billionaires don’t need the maximum $30,156 annual supplement. Nor do I.
The ending of our foreign wars and the elimination of extravagant unneeded weapons systems cut defense spending from $800 billion a year to $400 billion, or back to the 2000, pre-9/11 level. Guess what happens when we cut defense spending? So does everyone else.
I can tell you from personal experience that staying friendly with someone is far cheaper than blowing them up.
A Pax Americana would ensue.
That means China will have to defend its own oil supply, instead of relying on us to do it for them for free. That’s why they have recently bought a second used aircraft carrier. The Middle East is now their headache.
The national debt then comes under control, and we don’t end up like Greece.
The long-awaited Treasury bond (TLT) crash never happens.
The reality is that the global economy is already spinning off profits faster than it can find places to invest them, so the money ends up in bonds instead.
Sure, this is all very long-term, over the horizon stuff. You can expect the financial markets to start discounting a few years hence, even though the main drivers won’t kick in for another decade.
But some individual industries and companies will start to discount this rosy scenario now.
Perhaps this is what the nonstop rally in stocks since 2009 has been trying to tell us.
Dow Average 1900-2015
Another American Golden Age is Coming
"By historic, fundamental measures, stocks are extremely high. PE multiples are at 100-year highs. But if you look at stock prices relative to interest rates, they are exactly where they should be," said hedge fund legend, Stanley Druckenmiller.
Global Market Comments
July 5, 2019
Fiat Lux
Featured Trade:
(FRIDAY JULY 19 ZERMATT SWITZERLAND STRATEGY SEMINAR)
(WHERE THE ECONOMIST “BIG MAC” INDEX FINDS CURRENCY VALUE),
(FXF), (FXE), (FXA), (FXY), (CYB),
(WHY US BONDS LOVE CHINESE TARIFFS),
(TLT), (TBT), (SOYB), (BA), (GM)
My former employer, The Economist, once the ever-tolerant editor of my flabby, disjointed, and juvenile prose (Thanks Peter and Marjorie), has released its "Big Mac" index of international currency valuations.
Although initially launched as a joke three decades ago, I have followed it religiously and found it an amazingly accurate predictor of future economic success.
The index counts the cost of McDonald's (MCD) premium sandwich around the world, ranging from $7.20 in Norway to $1.78 in Argentina, and comes up with a measure of currency under and over valuation.
What are its conclusions today? The Swiss franc (FXF), the Brazilian real, and the Euro (FXE) are overvalued, while the Hong Kong dollar, the Chinese Yuan (CYB), and the Thai baht are cheap.
I couldn't agree more with many of these conclusions. It's as if the august weekly publication was tapping The Diary of a Mad Hedge Fund Trader for ideas.
I am no longer the frequent consumer of Big Macs that I once was as my metabolism has slowed to such an extent that in eating one, you might as well tape it to my ass. Better to use it as an economic forecasting tool than a speedy lunch.
The Big Mac in Yen is Definitely Not a Buy
For many, one of the most surprising impacts of the administration’s tariffs on Chinese imports announced today has been a rocketing bond market.
Since the December $116 low, the iShares 20+ Year Treasury Bond ETF (TLT) has jumped by a staggering $16 points, the largest move up so far in years.
The tariffs are a highly regressive tax that will hit consumers hard in the pocketbook, thus reducing their purchasing power.
It will dramatically slow US economic growth. If the trade war escalates, and it almost certainly will, it could shrink US GDP by as much as 1% a year. A weaker economy means less demand for money, lower interest rates, and higher bond prices.
There is no political view here. This is just basic economics.
And while there has been a lot of hand-wringing over the prospect of China dumping its $1.1 trillion in American bond holdings, it is unlikely to take action here.
The Beijing government isn’t going to do anything to damage the value of its own investments. The only time it actually does sell US bonds is to support its own currency, the renminbi, in the foreign exchange markets.
What it CAN do is to boycott new Treasury bond purchases, which it already has been doing for the past year.
The tariffs also raise a lot of uncertainty about the future of business in the United States. Companies are definitely not going to increase capital spending if they believe a depression is coming, which the last serious trade war during the 1930s greatly exacerbated.
While stocks despise uncertainty, bonds absolutely love it.
Those of you who are short the bond market through the ProShares Ultra Short 20+ Year Treasury ETF (TBT) have a particular problem that is often ignored.
The cost of carry of this fund is now more than 5% (two times the 2.10% coupon plus management fees and expenses). Thus, long-term holders have to see interest rates rise by more than 5% a year just to break even. The (TBT) can be a great trade, but a money-losing investment.
The Chinese, which have been studying the American economic and political systems very carefully for decades, will be particularly clever in its retaliation. And you thought all those Chinese tourists were over here just to buy our Levi’s?
It will target Republican districts with a laser focus, and those in particular who supported Donald Trump. It wants to make its measures especially hurt for those who started this trade war in the first place.
First on the chopping block: soybeans, which are almost entirely produced in red states. In 2016, the last full year for which data is available, the US sold $15 billion worth of soybeans to China. Which are the largest soybean producing states? Iowa followed by Minnesota.
A major American export is aircraft, some $131 billion in 2017, and China is overwhelmingly the largest buyer. The Middle Kingdom needs to purchase 1,000 aircraft over the next 10 years to accommodate its burgeoning middle class. It will be easy to shift some of these orders to Europe’s Airbus Industries.
This is why the shares of Boeing (BA) have been slaughtered recently, down some 13.5% from the top. While Boeing planes are assembled in Washington state, they draw on parts suppliers in all 50 states.
Guess what the biggest selling foreign car in China is? The General Motors (GM) Buick which saw more than 400,000 in sales last year. I have to tell you that it is hilarious to see my mom’s car driven up to the Great Wall of China. Where are these cars assembled? Michigan and China.
The global trading system is an intricate, finally balanced system that has taken hundreds of years to evolve. Take out one small piece, and the entire structure falls down upon your head.
This is something the administration is about to find out.
Global Market Comments
July 3, 2019
Fiat Lux
Featured Trade:
(WEDNESDAY, JULY 10 BUDAPEST, HUNGARY STRATEGY LUNCHEON)
(MEET THE GREEKS)
Come join me for lunch at the Mad Hedge Fund Trader’s Global Strategy Luncheon which I will be conducting in Budapest, Hungary on Wednesday, July 10, 2019 at 12:30 PM.
An excellent meal will be followed by a wide-ranging discussion and a question-and-answer period. I’ll be giving you my up to date view on stocks, bonds, currencies, commodities, precious metals, energy, and real estate.
I also hope to provide some insight into America’s opaque and confusing political system. And to keep you in suspense, I’ll be throwing a few surprises out there too.
Tickets are available for $240.
The lunch will be held at an exclusive hotel on the Buda side of the Danube near the St Matthias church, the location of which will be emailed with your purchase confirmation.
I look forward to meeting you and thank you for supporting my research. To purchase tickets for this luncheon, please click here.
Hang around any professional options trading desk and it will only be seconds before you hear the terms Delta, Theta, Gamma, or Vega. No, they are not reminiscing about their good old fraternity or sorority days (Go Delta Sigma Phi!).
These are all symbols for mathematical explanations of how options prices behave when something changes. They provide additional tools for understanding the price action of options and can greatly enhance your own trading performance.
Bottom line: they are all additional ways to make money trading options.
The best part about the Greeks is that they are all displayed on your online options trading platform FOR FREE! So, if you can read a number off a screen, you gain several new advantages in the options trading world. That’s not a lot to ask.
Delta
The simplest and most basic Greek symbol to comprehend is the Delta. An option delta is a prediction of how much the option price will change relative to a change in the underlying security.
Here, it is easiest to teach by example. Let’s go back to our (AAPL) June 17, 2016 $110 strike call option. Let’s assume that (AAPL) shares are trading at $110, and our call option is worth $2.00.
If (APPL) share rise $1 from $110 to $111, the call options will rise by 50 cents to $2.50. This is because an at-the-money call option has a delta of +0.50, or +50%. In other words, the (AAPL) call options will rise by 50%, or half of the amount of the (AAPL) shares.
Let’s say you bought (AAPL) shares because you expect them to rise 10% going into the next big earnings announcement. How much will the above-mentioned call options rise?
That’s easy. A call option with a delta of 50% will rise by half the amount of the shares. So, if (AAPL) shares rise by 10% from $110 to $121, the call options will appreciate by half this dollar about or by $5.50. This means that the call options should jump from in price from $2.00 to $7.50, a gain of 375%.
By the way, did I mention that I love trading options?
(AAPL) June 17, 2016 $110 strike call option
50% delta X $11 stock gain = $5.50
$2.00 option cost + $5.50 option price increase = $7.50
Now let’s look at the Put option side of the equation. Let's assume that Apple is about to disappoint terribly in their next earnings report, and that the stock is about to FALL 10%.
We want to buy the (AAPL) June 17, 2016 $110 strike put option which will profit when to stock falls. Remember, put options are always more expensive than call options because investors are always willing to pay a premium for downside protection. So, our put options here should cost about $4.00.
If we’re right and Apple shares tank 10%, from $110 to $99, how much will the put options increase in value?
We use the same arithmetic as with the call options. An at-the-money put options also has a delta of 0.50, or 50%. So, the put options will capture half the downside move of the stock, or $5.50. Add this to our $4.00 cost, and our put option should now be worth $9.50, a gain of 237.5%.
Did I happen to tell you that I love trading options?
(AAPL) June 17, 2016 $110 strike put option
50% delta X $11 stock decline = $5.50
$4.00 option cost + $5.50 option price increase = $9.50
Let’s consider one more example, the short position. Let’s assume that Apple shares are going to fall, but we don’t know by how much, or how soon.
It that case, you are better off selling short a call option than buying a put option. That way, if the stock only falls by a small amount, or goes nowhere, you can still make a profit.
When you sell short an option, your broker PAYS you the premium which sits in your account until you close the position.
Short positions in options always have negative deltas. So, a short position in the (AAPL) June 17, 2016 $110 strike call option will have a delta of -50%.
Let’s say you sold short the (AAPL) calls for $2.00 and Apple shares fell by 10%. What does the short position in the call option do? Since it has a delta of -50%, it will drop by half, from $2.00 to $1.00 and you will make a profit of $1.00.
Here is the beauty of short positions options. Let’s assume that (AAPL) stock doesn’t move at all. It just sits there at $110 right through the options expiration date of June 17, 2016.
Then the value of the call option you sold at $2.00 goes to zero. Your broker closes out the expired position from your account and frees up you margin requirement.
(AAPL) June 17, 2016 $110 strike call option
-50% delta X $11 stock decline means the options drops by half, or from $2.00 to $1.00
Sounds pretty good, doesn’t it? In fact, the numbers are so attractive that a large proportion of professional traders only engage in selling short options to earn a living.
To accomplish this, they usually have mainframe computers, highly skilled programmers, and teams of mathematicians backing them up which cost tens of millions of dollars a year.
However there is a catch.
When you sell short a call option, you are taking on UNLIMITED RISK. The position is said to be naked, or unhedged. Let’s say you sell short the (AAPL) June 17, 2016 $110 strike call option, and (AAPL) shares, instead of falling, RISE from $110 to $200, a gain of $90.
Then the value of your short position soars from $2.00 to $45.00. You will get wiped out. It gets worse. The delta on this option is only 50% for the immediate move above $110. The higher the stock rise, the faster your delta increases until it eventually reaches 100%. You now have a loss that increases exponentially!
This is why many hedge fund managers refer to naked option shorting as the “picking up the pennies in front of the steamroller” strategy.
For this reason, brokers either demand extremely high margin requirement for these “naked” or unhedged short positions, or they won’t let you do them at all.
If you dig down behind many of the extravagant performance claims of other options trading services, they are almost always reliant on the naked shorting of options. They all blow up. It is just a matter of when.
For that reason, we here at the Mad Hedge Fund Trader NEVER recommend the naked shorting of put or call options, no matter what the circumstances.
We want to keep you as a happy, money-making customer for the long term. If you succumb to temptation and engage in naked shorting of options, you will be separated from your money in fairly short order.
(AAPL) June 17, 2016 $110 strike call option
(AAPL) shares rise from $110 to $200
$2.00 short sale proceeds + $90 - $88.00
a loss of 4,400%!!
Theta
All options have time value. This is why an option with a one-year expiration date cost far more than one with a one-week expiration date. The theta is the measurement of how much premium you lose in a day. This is what options traders like me refer to as time decay.
The theta on an option changes every day. For example, an option with a year until expiration has a theta that is miniscule. An option that has a single day until expiration is close to 100% since it will lose its entire value within 24 hours if it is out of the money. The closer we get to expiration; the faster theta accelerates. As mathematicians say, it is not a straight-line move.
This is why you never want to hold a long option position going into expiration. The value of this option will vaporize by the day. Unless the stock goes your way very quickly, you will have a really tough time making money.
If you are short an option, this is when you can earn your greatest profits. But you only want to consider a short option position when you have an offsetting hedge against it. That will minimize and define your risk, limit your margin requirement, and keep you from blowing up and going to the poor house. We’ll talk more about that later.
I could go into how you calculate your own thetas, but that would be boring. Suffice it to say that you can read it right off the screen for you online trading platform.
Implied Volatility
While we’re here meeting the Greeks, there is one more concept that I want to get across to make your life as an option trader easier.
You have probably heard the term implied volatility. But to understand what this is, let me give you a little background.
Back in the 1970s, a couple of mathematicians developed a model for pricing options. Their names were Fisher Black and Myron Scholes and they received the Nobel prize for their work. Their equation became known as the Black Scholes Equation.
The Black Scholes equations predicts how much an option should be worth based on the historic volatility of the underlying securities, the current level of interest rates, and a few other factors.
When options trade over their Black Scholes value, they are said to have a high implied volatility. When they trade at a discount, they have a low implied volatility.
Let’s say that a piece of news comes out that a company is going to be taken over. The shares will rocket, and so will the implied volatility of the options.
If you pay a very high implied volatility for a call option, the chances of you making money decline and you are taking on more risk. If you pay too much, you could even see a situation where the stock rises, but the call option doesn’t rise, or even falls.
On the other hand, let’s say you buy a call option that is trading at a big discount to its theoretical implied volatility. You usually find this when a stock has shown little movement over a long period of time.
Chances are that you will get a good return on this low risk position, especially if you pick it up just before a major news event that you have correctly predicted.
At the end of the day, you should attempt to do with implied volatilities what you do with stocks and their options, buy low and sell high.
The Minors
There are a few other Greek letters you may hear about in the options market or find on your screen. For the most part, these are unnecessary most basic options strategies, gamma is well above your pay grade.
Gamma is the name of the most powerful type of radiation emitted when an atomic bomb goes off. It is always fatal. But we won’t talk about that here.
In the options world, gamma is the amount that the delta changes generated by a $1 move in the underlying stock price.
You may hear news reports of funds gamma hedging their portfolio during times of extreme market volatility. This occurs when managers want to reduce the volatility of their portfolios relative to the market.
Vega is another Greek term you’ll find on your screen. All options have a measurement called implied volatility or “vol” which indicated how much the option should move relative to a move in the underlying stock.
Vega is the measurement of the change in that option volatility. When a stock has volatility that is changing rapidly, vega will be high. When a stock is boring, vega will be low.
Finally, for the sake of completeness, I’ll mention rho. Rho is the amount that the price of an option will change compared to a change in the risk-free interest rate, i.e. the interest rate of US Treasury bills.
Back in the 1980s, rho was a big deal because interest rates were very high, with Fed funds rates as high as 13%. Since interest rates have been close to zero for the past eight years, rho has been pretty much useless. The only reason you would want to mention rho today is if you were writing a book about options trading.
With that, you should be fairly fluent in the Greeks, at least in regards to trading options. Just don’t expect this to get you anywhere if you ever plan to take a vacation to Greece.
"Every smart guy is tempted by leverage, and some are broken by it," said Oracle of Omaha Warren Buffett.
