Research Archives

The Market Outlook for the Week Ahead, or Gridlocked

Market’s are gridlocked.

Traders don’t want to chase the market at an all-time high on top of a 2,000-point rally. They don’t want to sell short either since a Tweet could come out at any time triggering a squeeze.

Will the trade war continue for another week or a year?

On top of all that, we have a president who attempts to manipulate the market more than any in history.

And here is the problem. While the major indexes remain dead unchanged over the past 18 months, earnings have been falling. That has made them more expensive than at any time over the past several years.

And this is in the face of an onslaught of negative economic data that continues to deteriorate by the day, all caused by the trade war.

So, as a result, there is nothing to do here. The market is too high to buy and too low to sell. Clients call me with trade ideas, and I tell them they are reaching. There is nothing worse than reaching for the marginal trade when there is really nothing to do.

At least I’ll have something to do in the coming week. I’ll be launching the Mad Hedge Biotech and Health Care Letter, the newest addition to our family of research services. In addition to technology, I expect Biotech and Health Care to be one of the top-performing sectors in the coming decade.

I have taken out a full-time researcher in the field who has been grinding out reports for me since January 1. The invitation to the webinar should reach you in a few days where I will explain why keeping up with this sector is so important.

There is no law that says you have to have a trade on every day of the year. Cash is beautiful. Better than that, cash has option value. It’s worth a fortune to have dry powder when markets meltdown or melt-up. You get to catch other investors’ trades when they are puking. That is the best time ever to make money.

When my four technology positions expired at their maximum profit point on Friday, I celebrated. I went down to a bankruptcy sale for an antique store in Berkeley and bought a vintage Champaign magnum bottle for $10.

The week was kicked off by mass drone strikes that took out Saudi oil production, axing 6 million barrels a day off the global market. Half of that will be back in a day. Oil prices spike $10, the largest one-day move in history. This is clearly the end result of the US unilaterally pulling out of the US Iran Nuclear Agreement and the economic sanctions that followed, thus inviting retaliation.

General Motors (GM) workers struck, with 48,000 hourly workers hitting the picket lines. The last strike in 1998, also at a market top, lasted for 54 days. Could be this the long-awaited inflationary run-up in wages? Expect many more strikes to come.

China’s economy slowed, with Industrial output up 4.4%, the slowest since 2002. Trade war impacts will keep hitting the economy for months to come. The bad news? Business is not responding to recent stimulus and, with 70% of the country’s oil originating in Saudi Arabia, they now have a bigger headache.

Recreational Vehicle sales are falling off a cliff, down 22% YOY, as consumer cut back discretionary spending. It’s another reliable pre-recession indicator.

Recession fears are the highest in a decade, according to the Bank of America Merrill Lynch fund manager survey. Some 38% of managers are making the bear call versus 34% in August. Only 7% of managers expect value to outperform growth over the next 12 months.

Some 53% of CFOs think we’ll be in a recession in a year, and 67% by end 2020. These are the highest pessimism numbers in a decade. Germany already in recession is the largest concern, followed by a slowing China. It’s all linked. We are all one global economy, like it or not.

Philly Fed plunged, from 16.8 to 12.0, indicating fading business confidence. The trade war universally gets the blame. Notice how nervous everyone is getting.

Apple got tagged with a $14 billion fine in another “not invented here” penalty issued by the Irish government. It’s another attack on American big tech. Apple says they followed Irish tax law to the letter.

The Fed cut a quarter but talks down future rate hikes. Buy the rumor, sell the news. Probably no rate cut for October, so December is the next time we get a swing at the piñata. This will have zero effect on the economy, but further punishes savers.

Microsoft (MSFT) announced a $40 billion share buyback and raises its dividend by 11%. It’s a huge positive for the company and the market in general. I’ll try to buy the Thursday opening if it doesn’t open up at a stupid price. Buy Seattle real estate….and more Microsoft. Bill Gates’ creation has bought back 25% of its shares over the past decade.

The Mad Hedge Trader Alert Service still doing well in this indecisive market. My Global Trading Dispatch reached a new all-time high of 336.07% and my year-to-date ground up to +35.83%. My ten-year average annualized profit bobbed up to +34.57%.

I took profits in my long bond position (TLT) earlier in the week, capturing a four-point rally there. I am left with my short position in oil (US), which needs a $9 a barrel move against it to lose money. That should be fine as long as there is not another attack on the Saudi oil fields.

It is interesting to note that this ramped up the implied volatilities on oil options going into the Friday close over fears of just such an event. We will get all that back at the Monday morning opening….as long as the weekend proves peaceful.

On Monday, September 23 at 8:30 AM, the Chicago Fed National Activity Index for August is out.

On Tuesday, September 24 at 9:00 AM, the S&P Case-Shiller National Home Price Index is updated, for July.

On Wednesday, September 25, at 8:30 AM, we learn August New Home Sales.

On Thursday, September 26 at 8:30 AM, the Weekly Jobless Claims are printed. We also obtain the final read for Q2 GDP.

On Friday, September 27 at 8:30 AM, the August Durable Goods is printed. The Baker Hughes Rig Count is released at 2:00 PM.

As for me, I’ll be doing a ten-mile backpack through Point Reyes National Seashore with a 60-pound pack and feasting on freeze-dried food in front of a campfire. Got to remain bootcamp-ready. You never know when Uncle Sam is going to come calling again.

Good luck and good trading.

John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader

September 18 Biweekly Strategy Webinar Q&A

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Below please find subscribers’ Q&A for the Mad Hedge Fund Trader September 18 Global Strategy Webinar broadcast from Silicon Valley, CA with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!

Q: What would happen to the United States Treasury Bond Fund (TLT) if the Fed does not lower rates?

A: My bet is that it would immediately have a selloff—probably several points—but after that, recession worries will take bond prices up again and yields down. I don’t think we have seen the final lows in interest rates by a long shot. That’s why I bought the (TLT) last week.

Q: Is it good to buy FedEx (FDX) considering the 13% fall today?

A: I use the 3-day rule on these situations. That's how long it takes for the dust to settle from an earnings shock like this and find the real price. The problem with FedEx is that it’s a great early recession predictor. When the number of delivered packages decreases, it’s always an indicator that the economy as a whole is slowing down, which we know has been happening. It’s one of the most cyclical stocks out there, therefore one of the most dangerous. I wouldn’t bother with FedEx right now. Go take a long nap instead.

Q: Would you be a buyer of Facebook (FB) here, given they seem to have weathered all the recent attacks from Washington?

A: Not here in particular, but I would buy it 20% down when it gets to the bottom edge of its upward channel—it still looks like it’s going crazy. They’re literally renting or buying buildings to hire an additional 50,000 people in San Francisco anticipating huge growth of their business, so that’s a better indicator of the future of Facebook than anything.

Q: Will junk bonds be more in demand now that rates are cratering?

A: Junk bonds (HYG), (JNK) are driven more by the stock market than the bond market, as you can see in the huge rally we just had. Junk bonds are great because their default ratios are usually far below that which the interest rate implies, but you really have to trade them like stocks. Think of them as preferred stocks with really high dividends. When the stock market tops, so will junk bonds. Remember in 2008, junk yields got all the way up to 15% compared to today’s 5.6%.

Q: What will happen to emerging markets (EEM) as rates lower?

A: If lower interest rates bring a weaker US dollar, that would be very positive for emerging markets over the long term and they would be a great buy. However, emerging markets will take the hardest hit if we actually do go into a recession. So, I would pass for now.

Q: What are your thoughts on Alibaba (BABA) and JD.com (JD)?

A: They are great for the long term. However, expect a lot of volatility in the short term. As long as the trade war is going on, these are going to be hard to trade until we get a settlement. (JD) is already up 50% this year but is still down 40% from pre trade war levels. These things will all be up 20-30% when that happens. If you can take the heat until then, they would probably be okay for a long-term portfolio globally diversified.

Q: What do you have to say about the ProShares Ultra Short 20+ Year Treasury ETF (TBT)—the short bond ETF?

A: If you have a position, I’d be selling now. We just had a massive 20%, 4-point rally from $22 to $27 and now would be a good time to take a profit, or at least get out closer to your cost. The zero interest rates story is not over yet.

Q: Would you short the US dollar?

A: I would most likely short it against the euro (FXE), which now has a massive economic stimulus and quantitative easing program coming into play which should be positive for it and negative for the US dollar (UUP). That’s most likely why the euro has stabilized over the last couple of weeks. That said, the dollar has been unexpected high all year despite falling interest rates so I have been avoiding the entire foreign exchange space. I try to stay away from things I don’t understand.

Q: If all our big tech September vertical bull call spreads are in the money, what should we do?

A: You do nothing. They all expire at the Friday close in two trading days. Your broker should automatically use your long call position to cover your short call position and credit your account with the total profit on the following Monday, as well as release the margin for holding that position. After that, we’ll probably wait for another good entry point on all the same names, (AMZN), (FB), (DIS), (MSFT).

Q: If the US fires a cruise missile at Iran, how would the market react?

A: It would selloff pretty big—markets hate wars. And the US wouldn’t send one missile at Iran; it would be more like 100, probably aimed at what little nuclear facilities they have. I doubt that is going to happen. The world has figured out that Trump is a wimp. He talks big but there is never any action or follow through. Inviting the Taliban to Camp David while they were still blowing up our people? Really?

Q: Will the housing market turn on the turbochargers after this dip in rates?

A: It wouldn't turn on the turbochargers, but it might stabilize the market because money is available now at unprecedentedly low interest rates. However, we still have the loss of the SALT deductions—the state and local taxes and real estate taxes that came in with the Trump tax bill. Since then, real estate has been either unchanged or has fallen on both the East and West coast where the highest priced houses are. It’s the most expensive houses that take the loss of the SALT deduction the hardest. Don’t expect any movement in these markets until the SALT deduction comes back, probably in 16 months.

Q: What catalyst do you think would cause a 10% correction in the next 2-3 months?

A: Trump basically saying “screw you” to the Chinese—a tweet saying he’s going to bring another round of tariff increases. That’s worth a minimum of 2,000 points in the Dow Average (INDU), or about 7% percent. Either that or no move in Fed interest rates—that would also create a big selloff. My guess is that and adverse development in the trade war will be what does it. That’s why my positions are so small now.

Q: We have a big short position in the United States Oil Fund (USO) now. Are you going to run this into expiration until October $18?

A: Even though oil has already collapsed by 10% since we put this position on last Friday, premiums in oil options are still close to record levels. So, it pays us to hang on for the time decay. The world is still massively oversupplied in oil and the Saudis were able to bring half of the lost production back on in a day. Oil will keep falling unless there is another attack and it is unlikely we will see one again on this scale. And, we only have 20 more days to go to capture the full 14.8% profit.

Good luck and good trading.
John Thomas
CEO & Publisher
Diary of a Mad Hedge Fund Trader

You Can’t Do Enough Research

The Great Trading Guru Speaks

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You never know how far this research is going to go. After all, the Internet is a pretty big thing. Still, I was amused to see that my opinion on crude oil prices was picked up by none other than the Hong Kong-based Asia Times, which I wrote for 50 years ago. Please click here and enjoy.

Industries You Will Never Hear About from Me

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The focus of this letter is to show people how to make money through investing in fast-growing, highly profitable companies which have stiff, long-term macroeconomic winds at their backs.

That means I ignore a large part of the US economy, possibly as much as 80%, whose time has passed and are headed for the dustbin of history.

According to the Department of Labor's Bureau of Labor Statistics, the seven industries listed below are least likely to generate positive job growth in the next decade.

As most of these stocks are already bombed out, it is way too late to short them. As an investor, you should consider this a “no go” list no matter how low they go. I have added my comments, not all of which should be taken seriously.

1) Realtors - The number of realtors is only down 10% from its 1.3 million peak in 2006. I have always been amazed at how realtors who add so little in value take home so much in fees, still around 6% of the gross sales price. Someone is going to figure out how to break this monopoly.

2) Newspapers - these probably won't exist in five years, as five decades of hurtling technological advances have already shrunk the labor force by 90%. Go online, or go away.

3) Airline employees - This is your worst nightmare of an industry, as management has no idea what interest rates, fuel costs, or the economy will do, which are the largest inputs into their business. Pilots will eventually work for minimum wage just to keep their flight hours up.

4) Big telecom - Can you hear me now? Nobody uses landlines anymore, leaving these companies with giant rusting networks that are costly to maintain. Since cell phone market penetration is 90%, survivors are slugging it out through price competition, cost-cutting, and all that annoying advertising.

5) State and Local Government - With employment still at levels private industry hasn't seen since the seventies, firing state and municipal workers will be the principal method of balancing ailing budgets. Expect class sizes to soar to 80 or go entirely online, to put out your own damn fires, and keep the 9 mm loaded and the back door booby-trapped for home protection.

6) Installation, Maintenance, and Repair - I have explained to my mechanic that the motor in my new electric car has only eleven moving parts, compared to 1,500 in my old clunker, and this won't be good for business. But he just doesn't get it.

The winding down of our wars in the Middle East is about to dump a million more applicants into this sector. The last refuge of the trained blue-collar worker is about to get cleaned out.

7) Bank Tellers - Since the ATM made its debut in 1968, this profession has been on a long downhill slide. Banks have lost so much money in the financial crisis, they can't afford to hire humans anymore.

It hasn't helped that hundreds of banks have closed during the recession, with many survivors merging to cut costs. Your next bank teller may be a Terminator.

Out With the Old

And in With the New

Will Antitrust Destroy Your Tech Portfolio?

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In recent days, two antitrust suits have arisen from both the Federal government and 49 states seeking to fine, or break up the big four tech companies, Facebook (FB), Apple (AAPL), Amazon (AMZN), and Google (GOOG). Let’s call them the “FAAGs.”

And here is the problem. These four companies make up the largest share of your retirement funds, whether you are invested with active managers, mutual funds, or simple index funds. The FAAGs dominate the landscape in every sense, accounting 13% of the S&P 500 and 33% of NASDAQ.

They are also the world’s most profitable large publicly listed companies with the best big company earnings growth.

I’ll list the antitrust concern individually for each company.

Facebook

Facebook has been able to maintain its dominance in social media through buying up any potential competitors it thought might rise up to challenge it through a strategy of serial defense acquisitions

In 2012, it bought the photo-sharing application Instagram for a bargain $1 billion and built it into a wildly successful business. It then overpaid a staggering $19 billion for WhatsApp, the free internet phone and texting service that Mad Hedge Fund Trader uses while I travel. It bought Onovo, a mobile data analytics company, for pennies ($120 million) in 2013.

Facebook has bought over 70 companies in 15 years, and the smaller ones we never heard about. These were done largely to absorb large numbers of talented engineers, their nascent business shut down months after acquisition.

Facebook was fined $5 billion by the Fair Trade Commission (FTC) for data misuse and privacy abuses that were used to help elect Donald Trump in 2016.

Apple

Apple only has a 6% market share in the global smart phone business. Samsung sells nearly 50% more at 9%. So, no antitrust problem here.

The bone of contention with Apple is the App Store, which Steve Jobs created in 2008. The company insists that it has to maintain quality standards. No surprise then that Apple finds the products of many of its fiercest competitors inferior or fraudulent. Apple says nothing could be further from the truth and that it has to compete aggressively with third party apps in its own store. Spotify (SPOT) has already filed complaints in the US and Europe over this issue.

However, Apple is on solid ground here because it has nowhere near a dominant market share in the app business and gives away many of its own apps for free. But good luck trying to use these services with anything but Apple’s own browser, Safari.

It’s still a nonissue because services represent less than 15% of total Apple revenues and the App Store is a far smaller share than that.

Amazon

The big issue is whether Amazon unfairly directs its product searches towards its own products first and competitors second. Do a search for bulk baby diapers and you will reliably get “Mama Bears”, the output of a company that Amazon bought at a fire sale price in 2004. In fact, Amazon now has 170 in-house brands and is currently making a big push into designer apparel.

Here is the weakness in that argument. Keeping customers in-house is currently the business strategy of every large business in America. Go into any Costco and you’ll see an ever-larger portion of products from its own “Kirkland” branch (Kirkland, WA is where the company is headquartered).

Amazon has a market share of no more than 4% in any single product. It has the lowest price, and often the lowest quality offering. But it does deliver for free to its 100 million Prime members. In 2018, some 58% of sales were made from third-party sellers.

In the end, I believe that Amazon will be broken up, not through any government action, but because it has become too large to manage. I think that will happen when the company value doubles again to $2 trillion, or in about 3-5 years, especially if the company can obtain a rich premium by doing so.

Google

Directed search is also the big deal here. And it really is a monopoly too, with some 92% of the global search. Its big breadwinner is advertising, where it has a still hefty 37% market share. Google also controls 75% of the world’s smart phones with its own Android operating software, another monopoly.

However, any antitrust argument falls apart because its search service is given away to the public for free, as is Android. Unless you are an advertiser, it is highly unlikely that you have ever paid Google a penny for a service that is worth thousands of dollars a year. I myself use Google ten hours a day for nothing but would pay at least that much.

The company has already survived one FTC investigation without penalty, while the European Union tagged it for $2.7 billion in 2017 and another $1.7 billion in 2019, a pittance of total revenues.

The Bottom Line

The stock market tells the whole story here, with FAAG share prices dropping a desultory 1%-2% for a single day on any antitrust development, and then bouncing back the next day.

Clearly, Google is at greatest risk here as it actually does have a monopoly. Perhaps this is why the stock has lagged the others this year. But you can count on whatever the outcome, the company will just design around it as have others in the past.

For start, there is no current law that makes what the FAAGs do illegal. The Sherman Antitrust Act, first written in 1898 and originally envisioned as a union-busting tool, never anticipated anticompetitive monopolies of free services. To apply this to free online services would be a wild stretch.

The current gridlocked congress is unlikely to pass any law of any kind. The earliest they can do so will be in 18 months. But the problems persist in that most congressmen fundamentally don’t understand what these companies do for a living. And even the companies themselves are uncertain about the future.

Even if they passed a law, it would be to regulate yesterday’s business model, not the next one. The FAAGs are evolving so fast that they are really beyond regulation. Artificial intelligence is hyper-accelerating that trend.

It all reminds me of the IBM antitrust case, which started in 1975, which my own mother worked on. It didn’t end until the early 1990s. The government’s beef then was Big Blue’s near-monopoly in mainframe computers. By the time the case ended, IBM had taken over the personal computer market. Legal experts refer to this case as the Justice Department’s Vietnam.

The same thing happened to Microsoft (MSFT) in the 1990s. After ten years, there was a settlement with no net benefit to the consumer. So, the track record of the government attempting to direct the course of technological development through litigation is not great, especially when the lawyers haven’t a clue about what the technology does.

There is also a big “not invented here” effect going on in these cases. It’s easy to sue companies based in other states. Of the 49 states taking action against big tech, California was absent. But California was in the forefront of litigation again for big tobacco (North Carolina), and the Big Three (Detroit).

And the European Community has been far ahead of the US in pursuing tech with assorted actions. Their sum total contribution to the development of technology was the mouse (Sweden) and the World Wide Web (Tim Berners Lee working for CERN in Geneva).

So, I think your investments in FAAGs are safe. No need to start eyeing the nearest McDonald’s for your retirement job yet. Personally, I think the value of the FAAGs will double in five years, as they have over the last five years, recession or not.

Has the Value of Your Home Just Peaked?

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Lately, my inbox has been flooded with emails from subscribers asking how to hedge the value of their homes. This can only mean one thing: the residential real estate market has peaked.

They have a lot to protect. Since prices hit rock bottom in 2011 and foreclosures crested, the national real estate market has risen by 50%.

I could almost tell you the day the market bounced. That’s when a couple of homes in my neighborhood that had been for sale for years suddenly went into escrow.

The hottest markets, like those in Seattle, San Francisco, and Reno, are up by more than 125%, and certain neighborhoods of Oakland, CA have shot up by 400%.

The concerns are confirmed by data that started to roll over in the spring and have been dismal ever since. It is not just one data series that has rolled over, they have all gone bad. One bad data point can be a blip. An onslaught is a new trend. Let me give you a dismal sampling.

*Home Affordability hit a decade low, thanks to rising prices and interest rates and trade war-induced soaring construction costs

*July Housing Starts have been in a tailspin as tariff-induced rocketing costs wipe out the profitability of new homes

*New Home Sales collapsed YOY.

*14% of all June Real Estate Listings saw price cuts, a two-year high

*Chinese Buying of West Coast homes has vaporized over trade war fears

Fortunately, investors have a lot of options for either hedging the value of their own homes or making a bet that the market will fall.

In 2006, the Chicago Mercantile Exchange (CME) started trading futures contracts for the Corelogic S&P/Case-Schiller Home Price Index, which covered both U.S. residential and commercial properties.

The Case-Shiller index, originated in the 1980s by Karl Case and Robert Shiller, is widely considered to be the most reliable gauge to measure housing price movements. The data comes out monthly with a three-month lag.

This index is a widely-used and respected barometer of the U.S. housing market and the broader economy and is regularly covered in the Mad Hedge Fund Trader biweekly global strategy webinars.

The composite weight of the CSI index is as follows:

Boston 7.4%
Chicago 8.9%
Denver 3.6%
Las Vegas 1.5%
Los Angeles 21.2%
Miami 5%
New York 27.2%
San Diego 5.5%
San Francisco 11.8%
Washington DC 7.9%

However, these contracts suffer from the limitations suffered by all futures contracts. They can be illiquid, expensive to deal in, and you probably couldn’t get permission from your brokers to trade them anyway.

If you want to be more conservative, you could take out bearish positions on the iShares US Home Construction Index (ITB), a basket of the largest homebuilders (click here for their prospectus). Baskets usually present half the volatility and therefore half the risk of any individual stock.

If real estate is headed for the ashcan of history, there are far bigger problems for your investment portfolio than the value of your home. Real estate represents a major part of the US economy and if it is going into the toilet, you could too.

It is joined by the sickly auto industry. Thanks to the trade wars, farm incomes are now at a decade low. As we lose each major segment of the economy, the risk is looming that the whole thing could go kaput. That, ladies and gentlemen, is called a recession and a bear market.

On the other hand, you could take no action at all in protecting the value of your home.

Those who bought homes a decade ago, took a ten-year cruise and looked at the value of their residence today will wonder what all the fuss is about. By the way, I met just such a person on the Queen Mary 2 last summer. Yes, ten years at sea!

And the next recession is likely to be nowhere near as bad as the last one, which was a twice-a-century event. So it’s probably not worth selling your home and buying it back later, as I did during the Great Recession.

See you onboard!

In Your Future?

How the Mad Hedge Market Timing Algorithm Works

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Since we have just taken in a large number of new subscribers from around the world, I will go through the basics of my Mad Hedge Market Timing Index one more time.

I have tried to make this as easy to use as possible, even devoid of the thought process.

When the index is reading 20 or below, you only consider “BUY” ideas. When it reads over 80, it’s time to “SELL.” Everything in between is a varying shade of grey. Most of the time, the index fluctuates between 20-80, which means that there is absolutely nothing to do.

To identify a coming market reversal, it’s good to see the index chop around for at least a few weeks at an extreme reading. Look at the three-year chart of the Mad Hedge Market Timing Index.

After three years of battle-testing, the algorithm has earned its stripes. I started posting it at the top of every newsletter and Trade Alert two years ago and will continue to do so in the future.

Once I implemented my proprietary Mad Hedge Market Timing Index in October 2016, the average annualized performance of my Trade Alert service has soared to an eye-popping 34.61%.

As a result, new subscribers have been beating down the doors trying to get in.

Let me list the highpoints of having a friendly algorithm looking over your shoulder on every trade.

*Algorithms have become so dominant in the market, accounting for up to 90% of total trading volume, that you should never trade without one

*It does the work of a seasoned 100-man research department in seconds

*It runs real-time and optimizes returns with the addition of every new data point far faster than any human can. Imagine a trading strategy that upgrades itself 30 times a day!

*It is artificial intelligence-driven and self-learning.

*Don’t go to a gunfight with a knife. If you are trading against algos alone,
you WILL lose!

*Algorithms provide you with a defined systematic trading discipline that will enhance your profits.

And here’s the amazing thing. My Mad Hedge Market Timing Index correctly predicted the outcome of the presidential election, while I got it dead wrong.

You saw this in stocks like US Steel, which took off like a scalded chimp the week before the election.

When my and the Market Timing Index’s views sharply diverge, I go into cash rather than bet against it.

Since then, my Trade Alert performance has been on an absolute tear. In 2017, we earned an eye-popping 57.39%. In 2018, I clocked 23.67% while the Dow Average was down 8%, a beat of 31%. So far in 2019, we are up 18.10%.

Here are just a handful of some of the elements which the Mad Hedge Market Timing Index analyzes real-time, 24/7.

50 and 200-day moving averages across all markets and industries

The Volatility Index (VIX)

The junk bond (JNK)/US Treasury bond spread (TLT)

Stocks hitting 52-day highs versus 52-day lows

McClellan Volume Summation Index

20-day stock bond performance spread

5-day put/call ratio

Stocks with rising versus falling volume

Relative Strength Indicator

12-month US GDP Trend

Case Shiller S&P 500 National Home Price Index

Of course, the Trade Alert service is not entirely algorithm-drive. It is just one tool to use among many others.

Yes, 50 years of experience trading the markets is still worth quite a lot.

I plan to constantly revise and upgrade the algorithm that drives the Mad Hedge Market Timing Index continuously as new data sets become available.

It Seems I’m Not the Only One Using Algorithms

The Tale of Two Economies

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I’m looking at my screens this morning and virtually every stock sold short by the Dairy of a Mad Hedge Fund Trader cratered to new six-month lows.

Call it lucky, call it fortuitous. All I know is that the harder I work the luckier I get.

If you are in the right economy, that of the future, you are having another spectacular year. If you aren’t, you are probably posting horrific losses for 2019. Call it the “Tale of two Economies.”

I suspected that this was setting up over the last couple of weeks. No matter how much bad news and uncertainty dumped on these companies, the shares absolutely refused to go down. Instead, they flat lined just below their 2019 highs. It was a market begging for a selloff.

When the Facebook (FB) hacking scandal hit, investors were ringing their hands about the potential demise of Mark Zuckerberg’s vaunted business model and the shares plunged to $123.

However, while analysts were making these dire productions, I knew that Facebook itself was signing a long-term lease for a brand new 46-story skyscraper in downtown San Francisco just to house its Instagram operations.

Months later, and the company that misused Facebook’s data, Steve Bannon’s Cambridge Analytica, is bankrupt, and (FB) is trading at $185, a new high. Facebook was right, and the Cassandras were wrong.

Amazon was given up for dead during the February melt down as the shares withered from a daily onslaught of presidential attacks threatening antitrust action. Today, the shares are up a mind-blowing 38% above those lows.

And when Apple announced its earnings, the shares tickled $222, putting it squarely back into the ranks of the $1 trillion club ($949 billion at today’s close).

It turns out that technology companies are immune from most of the negative developments that have caused the rest of the stock market to drag. I’ll go through these one at a time.

Falling Interest Rates

Tech companies are sitting gigantic cash mountains, some $245 billion in Apple’s case, which means that as net lenders to the credit markets, they are beneficiaries of the credit markets. This makes tech companies immune from the credit problems that will demolish old economy industries during the next rate spike.

Rising Oil Prices

While tech companies are prodigious consumers of electricity, many power these with massive solar arrays and they sell periodic excess power to local utilities. So as net energy producers, they profit from rising energy prices.

Rising Inflation

Since the output of technology companies is entirely digital, they can handily increase productivity faster than the inflation rate, whatever it is. Traditional old economy companies, like industrials and retailers can’t do this.

Remember that while analogue production grows linearly, digital production grows exponentially, enabling tech companies to handily beat the inflation demon, leaving others behind in the dust.

Share Buybacks

While technology companies account for only 26% of the S&P 500 stock market capitalization, they generate 50% of the profits. Thanks to the massive tax breaks and low tax repatriation of foreign profits enabled by the 2017 tax bill, share buybacks are expected to rocket from $500 billion to $1 trillion this year. Companies repurchasing their own shares have become the sole net buyers of equities in 2019.

And companies with the biggest profits buy back the most stock. This has created a virtuous cycle whereby higher share prices generate more buybacks to create yet higher share prices. Old economy companies with lesser profits are buying back little, if any, of their own shares.

Of course, tech companies are not without their own challenges. For a start, they have each other to worry about. FANGs will simultaneously cooperate with each other in a dozen areas, while fight tooth and nail and sue on a dozen others. It’s like watching Silicon Valley’s own version of HBO’s Game of Thrones.

Also, occasionally, the tech story becomes so obvious to the unwashed masses that it creates severe overbought conditions and temporary peaks, like we saw in January.

Have We Seen “Peak Auto Sales”?

Diary, Newsletter, Research

There is no limit to my desire to get an early and accurate read on the US economy, which at the end of the day is what dictates the future returns on our investments.

I flew over one of my favorite leading economic indicators only last week.

Honda (HMC) and Nissan (NSANY) import millions of cars each year through their Benicia, California facilities where they are loaded on to hundreds of rail cars for shipment to points inland as far as Chicago.

In 2009, when the US car market shrank to an annualized 8.5 million units, I flew over the site and it was choked with thousands of cars parked bumper to bumper in their white plastic wrappings, rusting in the blazing sun and bereft of buyers.

Then, “cash for clunkers” hit (remember that?). The lots were emptied in a matter of weeks, with mile-long trains lumbering inland, only stopping to add extra engines to get over the High Sierras at Donner Pass. The stock market took off like a rocket, with the auto companies leading.

I flew over the site last weekend, and guess what? The lots are full again. Not only that, the trains lined up to take them away are gone. US Auto Sales peaked in October 2017 when they fell just short of a 19 million annualized rate. As of the end of June this year, they had fallen to a 15.1 million annualized rate. July is looking worse still.

And this is what I’m worried about. Auto Sales may not only be peaking for this economic cycle. They may be peaking for all time.

This is my logic.

As they slowly age, Millennials are about to become the principal buyers of automobiles. The problem is that Millennials are purchasing cars at a far slower rate than previous generations.

This is because they have a much higher concentration in urban areas where the cost of car ownership is the most expensive in history. $40 for parking for an evening? Give me a break. But good luck finding free on-street parking, and if you do, your windows will probably get smashed.

In cities like San Francisco, public transportation, bicycles, and electric scooters are the preferred mode of transportation.

It doesn’t help that this generation is shouldering the burden of the bulk of $1.5 trillion in student loan debt. When you owe $2,000 a month in interest, there is little room for a car payment, and you probably don’t have the credit rating to buy a car anyway.

When they do buy cars, all-electric is their first choice, if they can get access to overnight charging. A lot of companies are making this easy by offering free charging for electric commuters in corporate parking lots. This explains why Tesla (TSLA) has taken deposits from 400,000 for their low-end Tesla 3, which has a two-year waiting list for new buyers.

When Millennials do drive, such as on business, for weekend trips or summer vacations, they either rent or “share.” Driving around the city, you see cars parked everywhere with bizarre names like Upshift, Getaround, Zipcar, Turo, and Casual Carpool.

Indeed, Detroit takes the car-sharing threat so seriously that the Big Three have all bought into the technology, with General Motors taking a stake in Maven. (GM) plans to start its own peer-to-peer car-sharing service this summer.

This is all a mystery for my generation, which grew up tearing apart old cars and putting them back together. I spent a year trying to put the engine on my 1955 Volkswagen back together. When I gave up, I towed the car and a big box full of greasy parts to a local mechanic, a German Army veteran. When he finished, even he had four parts left over.

Do you know who believes my rash, possible MAD theory? Investors in auto stocks, one of the worst-performing sectors of the stock market this year. Shares like those of General Motors (GM) keep breaking new valuation lows.

What was (GM)’s price earnings multiple today? Try a miserable zero since the company loses money, one of the lowest of all S&P 500 stocks. Hapless portfolio managers keep getting sucked into the shares, which have become one of the ultimate value traps.

It is all further evidence that my cautious view on the US economy is correct, that multiple crises overseas are ahead of us, and that the stock market could drop 5%-10% at any time. The auto industry should lead the charge to the downside, especially General Motors (GM) and Ford (F).

As for Tesla (TSLA), better to buy the car than the stock.

Sorry, the photo is a little crooked, but it's tough holding a camera in one hand and a plane's stick with the other while flying through the turbulence of the San Francisco Bay’s Carquinez Straight.

Air traffic control at nearby Travis Air Force base usually has a heart attack when I conduct my research in this way, with a few joyriding C-130s having more than one near miss.

The Market Outlook for the Week Ahead, or The Bad Omens are There

Diary, Newsletter, Research

The Omens are there.

I am normally a pretty positive guy.

But I was having a beer at Schwarzee at the base of the Matterhorn the other day, just having completed the climb up to the Hornli Hut at 10,758 feet. I carefully watched with my binoculars three helicopters circle the summit of the mountain, around the Solvay Hut.

These were not sightseeing tours. The pilots were taking great risks to retrieve bodies.

I learned at the Bergfuhrerverein Zermatt the next day that one of their men was taking up an American client to the summit. The man reached for a handhold and the rock broke loose, taking both men to their deaths. The Mountain Guide Service of Zermatt is a lot like the US Marine Corps. They always retrieve their dead.

It is an accident that could have happened to anyone. I have been over that route many times. If there was ever an omen of trouble to come, this was it.

The markets are sending out a few foreboding warnings of their own. Friday’s Q2 GDP report came in at a better than expected 2.1%, versus 3.1% in Q1.

Yet the Dow Average was up only a meager 51.47 points when it should have gained 500. It is an old market nostrum that if markets can’t rally on good news, you get the hell out of Dodge. Zermatt too.

It is the slowest US growth in two years. The trade war gets the blame, with falling exports offsetting healthy consumer spending. With the $1.5 trillion tax cut now spent, nothing is left but the debt. 2020 recession fears are running rampant, so paying all-time highs for stock prices is not a great idea.

You might be celebrating last week’s budget deal which heads off a September government shutdown. But it boosts the national debt from $22 to $24 trillion, or $72,000 per American. As with everything else with this administration, a short-term gain is achieved at a very high long-term cost.

Boris Johnson, the pro-Brexit activist, was named UK prime minister. It virtually guarantees a recession there and will act as an additional drag on the US economy. Global businesses will accelerate their departure from London to Paris and Berlin.

The end result may be a disunited kingdom, with Scotland declaring independence in order to stay in the EC, and Northern Ireland splitting off to create a united emerald island. The stock market there will crater and the pound (FXB) will go to parity against the greenback.

The European economy is already in a downward spiral, with German economic data flat on its back. GDP growth has shrunk from 2.0% to 0.7%. It seems we are not buying enough Mercedes, BMWs, and Volkswagens.

Yields on ten-year German bunds hit close to an all-time low at -0.39%. The Euro (FXE) is looking at a breakdown through parity. The country’s largest financial institution, Deutsche Bank, is about to go under. No one here wants to touch equities there. It’s all about finding more bonds.

Soaring Chip Stocks took NASDAQ to new high. I have to admit I missed this one, not expecting a recovery until the China trade war ended. Chip prices are still falling, and volume is shrinking. We still love (AMD), (MU), and (NVDA) long term as obviously do current buyers.

Existing Home Sales fell off a cliff, down 1.7% in June to a seasonally adjusted 5.27 million units. Median Home Prices jumped 4.7% to $287,400. A shortage of entry-level units at decent prices get the blame. Ultra-low interest rates are having no impact.

JP Morgan (JPM) expects stocks to dive in Q3, driven by earnings downgrades for 2020. Who am I to argue with Jamie Diamond? Don’t lose what you made in H1 chasing rich stocks in H2. Everyone I know is bailing on the market and I am 100% cash going into this week’s Fed meeting up 18.33% year-to-date. I made 3.06% in July in only two weeks.

Alphabet (GOOGL) beat big time, sending the shares up 8% in aftermarket trading. Q2 revenues soared 19% YOY to an eye-popping $39.7 billion. It’s the biggest gain in the stock in four years, to $1,226. The laggard FANG finally catches up. The weak first quarter is now long forgotten.

Amazon (AMZN) delivered a rare miss, as heavy investment spending on more market share offset sales growth, taking the shares down 1%. Amazon Prime membership now tops 100 million. Q3 is also looking weak.

Intel (INTC) surged on chip stockpiling, taking the stock up 5% to $54.70. Customers in China stockpiled chips ahead of a worsening trade war. Q3 forecasts are looking even better. Sale of its 5G modem chip business to Apple is seen as a huge positive.

I've finally headed home, after a peripatetic six-week, 18-flight trip around the world meeting clients. I bailed on the continent just in time to escape a record heatwave, with Paris hitting 105 degrees and London 101, where it was so hot that people were passing out on the non-air conditioned underground.

Avoid energy stocks. The outcry over global warming is about to get very loud. I’ll write a more detailed report on the trip when I get a break in the market.

My strategy of avoiding stocks and only investing in weak dollar plays like bonds (TLT), foreign exchange (FXA), and copper (FCX) performed well. After spending a few weeks out of the market, it’s amazing how clear things become. The clouds lift and the fog disperses.

My Global Trading Dispatch has hit a new high for the year at +18.33% and has earned a robust 3.09% so far in July. Nothing like coming out of the blocks for an uncertain H2 on a hot streak. I’m inclined to stay in cash until the Fed interest rate decision on Wednesday.

My ten-year average annualized profit bobbed up to +33.23%. With the markets now in the process of peaking out for the short term, I am now 100% in cash with Global Trading Dispatch and 100% cash in the Mad Hedge Tech Letter. If there is one thing supporting the market now, it is the fact that my Mad Hedge Market Timing Index has pulled back to a neutral 60. It’s a Goldilocks level, not too hot and not too cold.

The coming week will be a big one on the data front, with one big bombshell on Wednesday and the Payroll data on Friday.

On Monday, July 29, the Dallas Fed Manufacturing Index is out.

On Tuesday, July 30, we get June Pending Home Sales. A new Case Shiller S&P National Home Price Index is published. Look for YOY gains to shrink.

On Wednesday, July 31, at 8:30 AM, learn the ADP Private Employment Report. At 2:00 PM, the Fed interest rate decision is released and an extended press conference follows. If they don’t cut rates, there will be hell to pay.

On Thursday, August 1 at 8:30 AM, the Weekly Jobless Claims are printed.

On Friday, August 2 at 8:30 AM, we get the July Nonfarm Payroll Report. Recent numbers have been hot so that is likely to continue.

The Baker Hughes Rig Count follows at 2:00 PM.

As for me, by the time you read this, I will have walked the 25 minutes from my Alpine chalet down to the Zermatt Bahnhoff, ridden the picturesque cog railway down to Brig, and picked up an express train through the 12-mile long Simplon Tunnel to Milan, Italy.

Then I’ll spend the rest of the weekend winging my way home to San Francisco in cramped conditions on Air Italy. Yes, I had to get a few more cappuccinos and a good Italian dinner before coming home.

Now, on with the task of doubling my performance by yearend.

Good luck and good trading.

John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader