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)
On Sunday, I spent 30 minutes driving around looking for a parking space at Target. Once there, I waited for another half hour while the people in front of me paid for their entire Christmas shopping for the year. You can’t get a restaurant reservation anywhere.
With economic conditions this strong, you would think the stock market would be booming, soaring to new highs daily.
It’s not. In fact, as I write this, the Dow Average is now down 5% in 2018 and off a gut-punching 13% since the beginning of October. Two-month support was shattered yesterday.
In fact, stocks have just suffered their worst quarter in a decade. Technology shares, in particular, have taken the biggest hit since the 2000 Dotcom Bust. We have in effect seen Dotcom Bust 2.0.
I warned readers for years that the top of this bull market may not be defined by any particular economic or geopolitical event. The sheer weight of prices could do it. Some 2 ½ months into a horrific meltdown and it looks like that is what happened. I’ve lost count of the 600 points downdrafts in recent weeks.
All of which I find extremely annoying as I missed one of the greatest short selling opportunities of all time. I feel like such an idiot. I did get off a few shorts. My Tesla short (TSLA) is going gangbusters but I still love the company long term. The bond market (TLT) remains my new rich uncle, writing me generous checks monthly.
The reason I didn’t go short more aggressively is that the risk of a China trade deal was always looming on the horizon. When it happens, markets could rocket 10%. But nine months into the trade war, and it still remains way out there on the horizon. Wasn’t it General Douglas MacArthur who said the US should never get involved in a land war in Asia?
Of course, the reasons are all crystal clear with 20/20 hindsight. The Federal Reserve giveth, and Federal Reserve taketh away. While global liquidity was exploding, stocks could only go one way, and that was up. Fortunately, I was one of the early ones to figure this out. But then, I took former Governor Janet Yellen’s class at UC Berkley.
Now, everywhere you look liquidity is disappearing. The US government will run a $1 trillion budget deficit in 2019. Add in entitlements and that balloons to $1.3 trillion.
The Fed is sucking out another $600 billion next year as part of its quantitative tightening, the long-advertised QE unwind. Did I mention that the Fed has raised interest rates six times in three years and will raise again once more on Wednesday?
As I peruse my charts and run the numbers on possible options combinations, the number of “screaming buys” almost can’t be counted. Apple (AAPL), for example is looking at a potential $10 of downside versus $170 of upside on a five-year view.
But you know, sitting on your hands seems to be working for everyone else. I think I’ll give it a try. It is far easier to buy them on the way up than catch a falling knife. Sure, I’m unchanged on the quarter, but unchanged is not what I’m all about. I think I’ll just lock in my 30% return this year and call it a year. I’ll be a hero again in 2019.
I Think I’ll Just Sit Tight For Now
What if you want to be a little more aggressive, say twice as aggressive?
What if markets don’t deliver any year on year change as they have done many times in the past?
Then you need a little more juice in your portfolio, and some extra leverage to earn your crust of bread and secure your retirement.
It turns out that I have just the solution for you.
This would be my “Passive/Aggressive Portfolio.”
I call it passive in that you just purchase these positions and leave them alone and not trade them.
I call it aggressive as it involves a basket of 2x leveraged ETFs issued by ProShares, based in Bethesda, MD (click here for their link).
The volatility of this portfolio will be higher. But the returns will be double what you would get with an index fund, and possibly much more. It is a “Do not open until 2035” kind of investment strategy.
Here is the makeup of the portfolio:
(ROM) –- ProShares Ultra Technology Fund - The three largest single-stock holdings are Apple (AAPL), Microsoft (MSFT), and Facebook (FB). For more details on the fund, please click here.
(UYG) – ProShares Ultra Financials Fund - The three largest single-stock holdings are Wells Fargo (WFC), Berkshire Hathaway (BRK.B), and JP Morgan Chase (JPM). For more details on the fund, please click here.
(UCC) – ProShares Ultra Consumer Services Fund - The three largest single-stock holdings are Amazon (AMZN), (Walt Disney), (DIS), and Home Depot (HD). For more details on the fund, please click here.
(DIG) -- ProShares Ultra Oil & Gas Fund - The three largest single-stock holdings are ExxonMobile (XOM), Chevron (CVX), and Schlumberger (SLB). For more details on the fund, please click here.
(BIB) – ProShares Ultra NASDAQ Biotechnology Fund – The three largest single-stock holdings are Amgen (AMGN), Regeneron (REGN), and Gilead Sciences (GILD). For more details on the fund, please click here.
You can play around with the sector mix at your own discretion. Just focus on the fastest growing sectors of the US economy which the Mad Hedge Fund Trader does on a daily basis.
It is tempting to add more leveraged ETFs for sectors that are completely bombed out, like gold (UGL) and commodities (UCD).
But it is likely that these despised ETF’s will move down before they move up, especially going into yearend.
There is also the 2X short Treasury bond fund (TBT) which I have been trading in and out of for years, a bet that long-term bonds will go down, interest rates rise.
There are a couple of provisos to mention here.
This is absolutely NOT a portfolio you want to own going into a recession. So you will need to exercise some kind of market timing, however occasional.
The good news is that I make more money in bear markets than I do in bull markets because the volatility is so high. However, to benefit from this skill set, you have to keep reading the Diary of a Mad Hedge Fund Trader.
There is also a problem with leveraged ETFs in that management and other fees can be high, dealing spreads wide, and tracking error huge.
This is why I am limiting the portfolio to 2X ETFs, and avoiding their much more costly and inefficient 3X cousins which are really only good for intraday trading. The 3X ETFs are really just a broker enrichment vehicle.
There are also going to be certain days when you might want to just go out and watch a long movie, like Gone With the Wind, with an all ETF portfolio, rather than monitor their performance, no matter how temporary it may be.
A good example was the August 24 flash crash when the complete absence of liquidity drove all of these funds to huge discounts to their asset values.
Check out the charts below, and you can see the damage that was wrought by high-frequency traders on that cataclysmic day, down -35% in the case of the (ROM). Notice that all of these discounts disappeared within hours. It was really just a function of the pricing mechanism being broken.
I have found the portfolio above quite useful when close friends and family members ask me for stock tips for their retirement funds.
It was perfect for my daughter who won’t be tapping her teacher’s pension accounts for another 45 years when I will be long gone. She mentions her blockbuster returns every time I see her, and she has only been in them for five years.
Imagine what technology, financial services, consumer discretionaries, biotechnology, and oil and gas will be worth then? It boggles the mind. My guess is up 100-fold from today’s levels.
You won’t want to put all of your money into a single portfolio like this. But it might be worth carving out 10% of your capital and just leaving it there.
That will certainly be a recommendation for financial advisors besieged with clients complaining about paying high fees for negative returns in a year that is unchanged, or up only 1%-2%. Virtually everyone has them right now.
Adding some spice, and a little leverage to their portfolios might be just the ticket for them.
Good to Have a Portfolio for All Market Conditions
“Excessive automation at Tesla was a mistake. To be precise it was my mistake. Humans are underrated.” - Said Elon Musk, CEO at Tesla
Global Market Comments
December 17, 2018
Fiat Lux
Featured Trade:
(THE MARKET OUTLOOK FOR THE WEEK AHEAD, or THERE’S NO SANTA CLAUS IN CHINA)
($INDU), (SPY), (TLT), (AAPL), (AMZN), (NVDA), (PYPL), (NFLX)
On Friday, five serious hedge fund managers separately called me out of the blue and all had the same thing to say. They had never seen the market so negative before in the wake of the worst quarter in seven years. Therefore, it had to be a “BUY”.
I, on the other hand, am a little more cautious. I have four 10% positions left that expire on Friday, in four trading days, and on that day I am going 100% into cash. At that point, I will be up 3.5% for the month of December, up 31.34% on the year, and will have generated positive return for one of the worst quarters in market history.
I’m therefore going to call it a win and head for the High Sierras for a well-earned Christmas vacation. After that, I am going to wait for the market to tell me what to do. If it collapses, I’ll buy it. If it rockets, I’ll sell short. And I’ll tell you why.
These are not the trading conditions you would expect when the economy is humming along at a 2.8% annual rate, unemployment is running at a half-century low, and earnings are growing a 26% year on year. You can’t find a parking spot in a shopping mall anywhere.
However, the lead stocks like Apple (AAPL), Amazon (AMZN), and Netflix (NFLX) have plunged by 30%-60%. Price earnings multiples dropped by a stunning 27.5% from 20X to 14.5X in a mere ten weeks. Half of the S&P 500 (SPY) is in a bear market, although the index itself isn’t there yet. I would rather be buying markets on their way up than to try and catch a falling knife.
There is only one catalyst for that apparent yawning contradiction: The President of the United States.
Trump has created a global trade war solely on his own authority. Only he can end it. As a result, asset classes of every description are beset with uncertainty, confusion, and doubt about the future. Analysts are shaving 2019 growth forecasts as fast as they can, businesses are postponing capital spending plans, and investors are running for the sidelines in droves. Business confidence is falling like a rock
To paraphrase a saying they used to teach you in Marine Corps flight school, “It’s better to be in cash wishing you were fully invested than to be fully invested wishing you were in cash.”
The Chinese have absolutely no interest in caving into Trump’s wishes. They read the New York Times, see the midterm election result and the opinion polls, and are willing to bet that they can get a much better deal from a future president in two years.
I have been dealing personally with both Trump and the Chinese government for four decades. The Middle Kingdom measures history in Millenia. The president lives from tweet to tweet. The Chinese government can take pain by simply ordering its people to take it. We have elections every two years with immediate consequences.
The best we can hope for is that the president folds, declares victory, and then retreats from his personal war. This can happen at any time, or it may not happen at all. No one has an advantage in predicting what will happen with any certainty. Not even the president knows what he is going to do from minute to minute.
It is the possibility of trade peace at any time that has kept me out of the short side of the stock market in this severe downturn. That robs a real hedge fund manager of half his potential income. Trade peace could be worth an instant rally of 10% in the stock market. Even a lesser move, like the firing of trade advisor Peter Navarro, would accomplish the same.
The market was long overdue for a correction like the one we have just had. Investors were getting overconfident, cocky, and excessively leveraged. In October, we really needed the tide to go out to see who was swimming without a swimsuit. But if the tide goes out too far, we will all appear naked.
Thanks to some very artful trading, my year to date return recovered to +27.54% boosting my trailing one-year return back up to 27.54%. I covered an aggressive short position in the bond market (TLT) for a welcome 14.4% profit. I also took profits with an instant winner in PayPal (PYPL). On the debit side, I stopped out of an Apple call spread for a minimal loss.
December is showing a very modest loss at -0.26%. The market has become virtually untradeable now, with tweets and China rumors roiling markets for 500 points at a pop. And this is against a Dow Average that is down a miserable -2.8% so far in 2018. I should have listened to my mother when she wanted me to become a doctor.
My nine-year return nudged up to +304.01. The average annualized return revived to +33.77.
The upcoming week is all about housing data, with the big focus on the Fed’s interest rate hike on Wednesday.
Monday, December 17 at 10:00 AM EST, the November Homebuilders Index is out.
On Tuesday, December 18 at 8:30 AM, November Housing Starts are published.
On Wednesday, December 19 at 10:00 AM EST, November Existing Home Sales are released.
At 10:30 AM EST the Energy Information Administration announces oil inventory figures with its Petroleum Status Report.
At 2:00 PM the Federal Reserve Open Market Committee announces a 25 basis point rise in interest rates, taking the overnight rate to 2.25% to 2.50%. An important press conference with governor Jay Powell follows.
Thursday, December 20 at 8:30 AM EST, we get Weekly Jobless Claims.
On Friday, December 21, at 8:30 AM EST, we learn the latest revision to Q3 GDP which now stands at 2.8%.
The Baker-Hughes Rig Count follows at 1:00 PM.
As for me, I’ll be battling snow storms driving up to Lake Tahoe where I’ll be camping out for the next two weeks. Mistletoe, eggnog, and endless games of Monopoly and Scrabble await me.
Good luck and good trading!
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
