“If the Fed brings a lump of coal in 2019, then they better bring some candy canes for the kids as well,” said Bill Gross, former CEO of bond giant, PIMCO.
Global Market Comments
December 21, 2018
Fiat Lux
Featured Trade:
(WHY CASH IS THE BEST HEDGE)
(INDU)
(PRINT YOUR OWN CAR),
(TESTIMONIAL)
Over the decades, I have been besieged by suggestions by various market players over how to hedge their downside risk in the stock market.
I have analyzed most of these, experimented with them, and even tried out a few. These range from buying equity put options to selling call options, investing in bear ETFs, and trading the volatility index (VIX).
My conclusion is always the same: Cash is always the best hedge.
Hedge fund managers like me are always under pressure to deliver positive returns whether the stock market goes up, down, or sideways. A lot make this promise but few are actually able to deliver. You can almost count them on one hand and I know all of them personally.
And here is a hedge fund manager’s worst nightmare: both your longs go down and your shorts go down, eroding capital at a double rate. This is often the result when you come to rely on these esoteric “hedges.”
This happens when you have done all the research in the world, have countless mathematical formulas to back you up, and you backtest your data for 30 years.
First of all, assets classes don’t always perform according to financial models because there is always one big variable that managers can’t quantify: human emotion.
While algorithms and computers are completely rational, people aren’t, even the most experienced ones. After watching markets for over 50 years I can tell you that there is only one certainty. That the natural tendency of most people is to buy at market tops and sell at market bottoms.
In order words, making money in the stock market is an unnatural act and fights against the long-term tide of evolution. We, humans, are predators and hunters evolved to track game on the horizon of an African savanna. Modern humans are maybe 5 million years old but civilization has been around for only 10,000 years. Our brains have not had time to make the adjustment.
In the market, this means that if a stock has gone up, you believe it will continue to do so. This is why market tops and bottoms see volume spikes. To make money, you have to go against these innate instincts. Some people are born with this ability while others can only learn it through decades of training. I am in the latter group.
The 4,400-point decline we have all suffered over the last 2 ½ months is a classic example. Prices earnings multiples have given up half of their gains since the 2009 bear market bottom. It is one of the best buying opportunities in four years. So, what are investors doing? Selling.
Share prices are now discounting a severe recession in 2019 that probably isn’t going to happen. I don’t believe that we’ll get one until the end of 2019 and even then it will be a modest one. Essentially, we already have a recession in the price at these levels. If the recession doesn’t show, stocks will rocket.
What hedges worked during this time? Absolutely none. If you shifted from growth stocks to value ones, or from high beta ones to low beta shares, you still lost money, probably a lot. Those who hedged with volatility probably has some one-hit wonders, but add up their profit and loss for the entire year and it probably comes to negative numbers.
You know what didn’t lose money? Cash which in fact is now earning 2%-4% depending on where you have it parked.
This is why I have been running cash positions of 70%-90% for the past four months. Oh, how I love the smell of cash in the morning. Logging into my online trading account every morning and seeing a wad of cash is like getting a short rush of adrenaline.
Absolutely, cash is the best hedge.
Without Cash Your Portfolio Will Bite You Back
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 $50,000.
Oak Ridge National Labs in Tennessee is a partner in the project which helped develop the monster printer. Nuclear weapons historians will recall them as the first refiner of U-235 during WWII.
It is the first effort to fundamentally change the way cars are put together since Henry Ford modernized the auto assembly line 100 years ago.
Local Motors is an internet creation all the way. It obtained its original funding through crowdsourcing, and held an international contest to find a design. An Italian won, hence the name.
It’s hard to see the Strati threatening the Tesla (TSLA), or any conventional car manufacturer any time soon. The current car is not yet street legal, and only does 40 miles per hour.
There is no great trading or investment play here yet. It is still early days. Give it a year or two.
However, it could be a hint of great things to come. I’ll take mine in black.
For the YouTube video of and interview with the Strati engineer, click here.
Ah, But is the Girl Printed As Well?
I can't tell you how much I enjoy your blog. It is the first place I go every morning and I miss you on the weekends.
I stumbled upon your site about 4 months ago and have been addicted to it since day one. I really appreciate not only your insight into the markets but also your global and historical perspectives.
All of this served up with your great sense of humor makes it a must read! Thanks for all your hard work.
Chip
Global Market Comments
December 20, 2018
Fiat Lux
Featured Trade:
(THE GLASS HALF EMPTY MARKET)
($INDU), (SPY)
(HOW TO EXECUTE A VERTICAL BULL CALL SPREAD),
(AAPL)
Dovish, but not dovish enough.
That seems to be the judgment of the markets today in the wake of the Fed’s decision to raise interest rates by 25 basis points. The overnight range for Fed funds is now 2.25%-2.50%.
The Dow Average soared by 350 points going into the decision. Then it plunged by 900 points to 23,200, a new low for 2018. It was one of the largest range days in market history.
Traders chose to focus only on the bad news and completely ignore the good. That makes this a totally “glass half empty” market.
Never mind Chairman Jerome Powell’s statement that the Fed was cutting back its 2019 forecast from three interest rate hikes to only two. Stocks should have rallied 1,000 points on just that! And they still might!
Powell also redefined the meaning of the word “neutral”, taking it down from 3.0% to 2.8%. That means only one more quarter-point hike would take us to the low end of neutral, and that might be it. That should have been worth another 1,000 points, and we still might get that as well.
The Fed affirmed that the economy is still generally strong and that unemployment is at historic lows. Nothing to worry about here.
You can see where I’m going with this.
Down 3,800 points from the October high, stocks are now approaching stupidly cheap prices and valuations. Call it insanely cheap. What we are seeing here is the coiling up of a spring that will lead to an explosive upside move.
That may happen with the quadruple witching options expiration on Friday, the last real trading day of the year. It may wait until January 2, the first trading day of 2019. But coming it is.
And let me throw a theory at you which a hedge fund friend bounced off of me yesterday while I was on one of my legendary night hikes.
What if we really have been in a bear market since January 31 and we are now approaching the end of it? That would give us a typical one-year long bear market from which we are about to blast out to the upside.
When does this new bull market begin? When the last week hands intent on avoiding another 2008 repeat bails on their holdings. In other words, it could happen any day now.
Interesting food for thought.
Global Market Comments
December 19, 2018
Fiat Lux
SPECIAL INFLATION ISSUE
Featured Trade:
(THE GREAT INFLATION HEDGE YOU’VE NEVER HEARD OF)
So, what am I talking about here?
Blue chip growth stocks? Diamonds? Residential real estate? Gold?
No, I am talking about grand pianos manufactured by Steinway & Sons of Queens, New York.
Did you say pianos?
Yup, the kind with which you sit down and play “As Time Goes By.” (Casablanca).
During the 19th century, there were over 1,200 US piano makers manufacturing a product which can include more than 12,000 parts. It was the technological Boeing 474 of its day.
Today, there are only five American piano makers, and just one, Steinway, is considered investment grade.
That’s because when Carnegie Hall, London’s Royal Albert Hall, or Beijing’s Concert Hall National Grand Theater is in the market for a new concert grand piano, they only consider Steinways.
You can start with an entry level 5’1” Steinway Model M baby grand piano, or ostentatiously splurge with an opera house filling nine-foot-long concert grand Model D.
I received the bad news from my kids’ piano teacher a few months ago. After six years of lessons, they had outgrown their piano, a modest entry level 1966 Wurlitzer spinet.
I approached the matter as I do everything, with exhaustive, no stone unturned research. What I learned was fascinating.
Given the available space in my home and the kids’ commitment to the enterprise, I decided that a seven-foot Steinway Model B would do.
My first visit was to the local Steinway dealer. For a mere $100,000, and $110,000 with tax I could buy a brand new 6’11” Model B.
For an extra $15,000 I could buy a model B with the Spirio technology that enabled the piano to play itself to incredible symphony standard.
Financing was available at a hefty 10%, compared to only 2% for my Tesla. Banks are not allowed to accept pianos as collateral.
Steinway also sells used pianos, but will only go back 15 years, getting me down to the $70,000 range. I thought I’d look around more.
So I plunged into my favorite source of incredible, once-in-a-lifetime deals, eBay (EBAY).
The offerings were vast.
They included everything from a $13,500 1897 Model B in desperate need of a complete $30,000 rebuild to a 2013 Model B in showroom condition for $87,500.
Obviously, I had my work cut out for me especially since I am not a musician myself. Coming from a family of seven kids, there was never enough money for music lessons.
Thus, I have been a lifetime consumer of music rather than a producer.
It turns out that, like Rolls Royce’s (that other great unknown inflation hedge), no one ever throws a Steinway away. A fully restored 130-year-old model can almost cost as much as a new one.
And there is your inflation play.
The list price for a Steinway Model B in 1900 was $1,050. Some 117 years later, it is up 100-fold, giving you a compound annual growth rate of 3.97% a year.
This compares to 5.18% for ten-year US Treasury bonds, and 9.71% for the S&P 500 over the same time period. But then you can’t play a stock certificate, let alone make your kids practice on it.
A Steinway is, in fact, the perfect instrument with which to make these long-term inflation calculations.
Vintage cars, diamonds, and homes are all unique, have varying quality, and are all susceptible to overvaluation and hype from aggressive salesmen and dealers. Even gold coins can have huge differences in valued based on grade and rarity.
Save for a few patents issued in the 1930s covering keyboard and soundboard manufacturing, Steinways are built almost identically to the way they were made 117 years ago. Tour their factory and you find workshops filled with primitive 100-year-old iron and wooden tools.
Every other manufactured product has seen massive productivity and technology improvements over a century that have caused real prices to completely collapse.
Take computers, for instance, which have suffered an average annual price decline of 30% since 1950. The cost of telephone calls has fallen by almost 100% in real terms since 1900 (see table below which I lifted from my former employers at The Economist)
That is the source of the rise in our standard of living.
It gets better. The prices of Steinways are rising fairly dramatically in real terms relative to almost everything else, thanks to a host of geopolitical reasons.
It turns out that the Chinese are taking over the global market.
While 200,000 pianos a year are sold in the US, the figure is over 1 million in China.
Many Chinese parents hope their children will achieve the international prominence of 35-year-old Lang Lang who commands millions of dollars a year in global performance and licensing fees. Many aspiring parents drive their kids to practice eight hours a day.
As a result, the Chinese have been buying up all the used premium pianos in the world including Steinways in the US, Bechsteins and Bosendorfers in Germany, Faziolis in Italy, and Yamahas and Kawais in Japan.
Whenever Chinese buy a luxury apartment in San Francisco, the first thing they do is outfit it with a Steinway grand piano even if they don’t play. It is the ultimate status symbol not only because of the price they pay but the space it takes up.
As a result, Steinways not only sell at a large premium to other pianos but are dear relative to ALL manufactured products over the expanse of time.
Researching the history of Steinway, you find a storied company that has undergone the sad but familiar travails of American manufacturing over the last century.
In short, it’s a miracle that this company still exists.
The first pianos were sold by a German immigrant from Hamburg in 1856. By 1972, a lengthy strike and competition from Japanese imports forced the original Steinway family to sell out to CBS after five generations.
Then there was a brief but disastrous experiment with Teflon parts in the 1970s. Suddenly Steinways didn’t sound like Steinways.
A private equity deal followed in 1985. From 1996 to 2013 it traded on the New York Stocks exchange under its own ticker symbol (LVB) (for Ludwig von Beethoven).
Steinway was then bought by my friend and newsletter client, hedge fund legend John Paulsen for $500 million. It produced its 600,000th piano in 2015.
If you want to watch a film about old-fashioned American manufacturing, vanishing skills, the pride of craftsmanship and working with your hands, watch the highly entertaining documentary movie “Note by Note: The making of Steinway L1037.”
It has won several awards.
It is wonderful to watch with the kids in that it shows what work was like in the old United States I remember, and can be streamed online for $4.99 by clicking here. https://www.amazon.com/Note-Harry-Connick-Jr/dp/B002ZS0R5I/ref=tmm_aiv_swatch_0?_encoding=UTF8&qid=&sr=
As for my own Steinway search, it had a very happy ending.
eBay enabled me to find a local Craigslist listing in Jackson, Mississippi for a 1951 Model B that was originally purchased by the University of Mississippi Music Department. It had been played by every noted pianist touring the South for a half century.
Some 20 years ago, a local doctor then purchased it right off the stage at a university surplus equipment sale.
This year the doctor retired, sold his mansion but had no room for a grand piano in his rapidly downsizing lifestyle.
He listed the piano for a low-ball price of $18,000, the cost of his 1997 ground up restoration. After I had a professional musician visit the house to check the condition and tone, I was the only bidder.
I figure if the kids ever get sick of practicing, I can always flip it to the Chinese for double. That’s me, always the trader.
I am totally comfortable buying big-ticket items off of eBay as I have been trading there for 20 years. I have bought five cars there for assorted family members.
If you aren’t comfortable with eBay, there is always Bruno.
Dallas, Texas-based Maestro Bruno Santo is a Julliard graduate, former Steinway dealer, and the most knowledgeable individual I ran into during my far-ranging research. He is also quite the salesman.
He runs a high-volume, low-margin business model which I admire and can probably get you a very nice Steinway in the mid $30,000s.
You can reach him through his website at http://redbirdllc.com/home
To learn more about the interesting and beautiful world of Steinway pianos, please visit the company’s website at http://www.steinway.com
Getting an 800-pound finely tuned musical instrument from Jackson, Mississippi to San Francisco, California is a whole new story on its own.
What I learned about the national trucking industry was amazing, and boy, did I get a deal!
Watch for my future research piece on “What I learned Moving My Steinway Grand Piano.”
As for the old Wurlitzer, it is now happily ensconced in my Lake Tahoe beachfront estate. Neighbor Michael Milliken has already completed the quality of the play.
The Winning Bid
Global Market Comments
December 18, 2018
Fiat Lux
Featured Trade:(THE CHRISTMAS RALLY GOT STOPPED AT THE BORDER)
(TLT), (TSLA), (AAPL)
(THE PASSIVE/AGGRESSIVE PORTFOLIO),
(ROM), (UYG), (UCC), (DIG), (BIB), (UGL), (UCD), (TBT)
