Research Archives - Mad Hedge Fund Trader

The Eight Worst Trades in History

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

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

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

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

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

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

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

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

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

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

2) AOL's 2001 Takeover of Time Warner

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

It was not to be.

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

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

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

Buy High, Sell Low?

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

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

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

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

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

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

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

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

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

In hindsight, their decision seems ridiculously short-sighted.

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

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

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

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

$150,000 for What?

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

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

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

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

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

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

Out of Central Casting

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Great General, Lousy Trader

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

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

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

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

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

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

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

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

Yes, it’s all true and documented.

Print Your Own Car

Diary, Newsletter, Research

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?

The Glass Half Empty Market

Diary, Newsletter, Research

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.

The Great Inflation Hedge You’ve Never Heard Of

Diary, Newsletter, Research

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 19^th 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 600,000^th 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

What’s the Matter With Apple?

Diary, Newsletter, Research

It was 38 years ago today that Apple (AAPL) went public and has generated a 43,000% return since its $22 IPO price. If you bought one share of Apple way back then for $22 it would be worth a breathtaking $95,000 today.

I waited until the next crash and then bought it at $4, and it sits in one of my “no touch” ultra-long-term retirement portfolios today.

Suddenly, the torture I endured taking Steve Jobs around to visit the New York institutional investors during the early 1980s was worth it.

The great rule of thumb I have learned after 50 years of investment is that if you hold a stock long enough, the dividend will exceed your original capital cost, giving you a 100% a year annual cash flow.

Three months ago, Apple was the Teflon stock of the entire market, the company that could do no wrong, the only “safe” stock that traded. Any selling met a wave of buying from Oracle of Omaha Warren Buffet and Apple itself, limiting corrections to a feeble 4%.

What a difference three months make!

Now the shares have become a market pariah, targeted by algorithms and hedge funds alike, and beaten like the proverbial red-headed stepchild. As a result, the shares have plunged an eye-popping 29.61%, vaporizing $311 billion in market capitalization.

Which begs one to ask the question, “What’s the matter with Apple?” How can things go from so right to so wrong?

Just like success has many fathers, failure is an orphan.

The harsh truth is that Apple became too much of a good thing to too many people. Expectations had become excessive and it had become too widely owned by traders with weak hands. In other words, people like me.

I had been cautious of Apple for a while because if its massive China exposure. You don’t want to own a company that relies entirely on Middle Kingdom production during a running trade war. Apple sold an incredible 216 million iPhones in 2017, and all of them are made at the Foxconn factories in southern China.

Apple has become the whipping boy for both sides in the trade conflict. The company has always run the risk of its Foxconn workers arriving at work late someday, or not showing up at all at the prodding of Beijing. Recently, Trump said iPhones imported from China could be subject to the current 10%, soon to be 25% tariff.

The final nail in the coffin came on Monday morning when we learned of a lower Chinese court’s ruling against Apple in a lawsuit from QUALCOMM (QCOM). Never mind that the suit was years old and applied only to the company’s older phones. With the shares in free fall, that is just what investors DIDN’T want to hear.

However, Apple is not dead, it is just resting. Or, call it ripening.

Not only could Apple recover strongly from these abysmal levels, IT COULD DOUBLE IN VALUE.

The core of my argument (no pun intended) is that Apple is in the process of fundamentally evolving its business model. It is rapidly morphing from a one-time sale only hardware company to a recurring subscription services company. And that is where the big money is in the future.

Microsoft (MSFT) is already doing it, so are Amazon (AMZN) and Netflix (NFLX). In fact, everyone is doing it, even the Diary of a Mad Hedge Fund Trader.

In fact, Apple's services revenue could balloon to $100 billion in five years, compared to its estimated total sales this year of $265 billion.

This accomplishes several important things. It moves the company out of a 30% gross margin business to a 70% gross margin. It converts Apple from a highly cyclical to stable earnings growth. Stable earnings growth companies are awarded much higher share price multiples.

Look no further than my next-door neighbor, Clorox (CLX), which trades at a much loftier 23X multiple and Coca-Cola (KO) which can be found at generous 19X multiple. Earnings visibility is worth its weight in gold. This could make Apple’s current 14X multiple a thing of the past.

Of course, we are not going to see a straight line move from one dominant business to another, and the road along the road could be bumpy. We could easily see one more meltdown which takes us to the subterranean $160 handle.

But $10 of downside risk versus $170 of upside? I’ll take that all day long. I bet you will too!

Time for a Nibble?

The Terrifying Chart Formation That is Setting Up

Diary, Newsletter, Research

The Mad Hedge Fund Trader is seeing its biggest one-day gains since the inception of our Trade Alert Service 11 years ago. By the time you read this, we will have picked up an astounding 11% profit for the entire portfolio in 24 hours.

However, this being Halloween, I don’t want to sound like I’m whistling by the graveyard. But what I am about to say will scare the daylights out of you.

I hate to say I told you so but my prediction a year ago that the bull market would end on May 10, 2019 at 4:00 PM is starting to look pretty good.

If I am right, the charts for the S&P 500 (SPY) are setting up a classic head and shoulders top. The left shoulder was created by the January 2018 rally to $282.

We just saw the head created at the beginning of October at $293. All that remains is to build the right shoulder back up to $282 by the spring. What will then follow is the crying.

This is not a matter of throwing a dart at a calendar or reciting a chant taught to me by a long-dead Yaqui Indian. It is a simple matter of math. Here’s how it goes:

*The Fed Raises funds rate 25 basis points per quarter for the next four quarters to 3.25%

*The Yields Curve Inverts, taking short rates higher than long rates now at 3.15%

*Bond yield spread trades increase massively going into the inversion as traders ramp up the size to make up for shrinking spreads.

*When the spread turns negative, they dump everything, creating an interest rate spike to 4% or 5%.

*Inverted yield curves last an average of 14 months or until February 2020 in this cycle when a recession begins.

*Stock markets peak on average seven months before recessions, and you arrive at Friday, May 10, 2019 at 4:00 PM EST as the date for the demise of the bull market. At that point, it will be ten years and two months old, the longest such move in history.
A lot of people asked why I sent out so few trade alerts during the summer and going into the fall.

In fact, the list of negatives has reached laughable proportions:

*Longest bull market in history

*In the face of rising interest rates

*In the face of rising oil prices

*Rising inflation

*Nothing else to buy

*Only bull market in the world

*Valuations approaching two-decade highs

*Overwhelmingly concentration in big cap tech

*Double top in the market on an Equal Weight S&P 500 chart

*Record retail inflows into ETFs

*Recession has already started in the auto industry

*Recession has already started in the housing industry

*Rotation to value defensive stocks underway

*Massive unicorn IPOs planned in 2019- $215 billion

*Slowing GDP Growth 4.2% to 3.5%

*Large amount of economic growth sucked forward from 2019 as businesses accelerate Chinese imports to beat the tariffs

*The same is going on in China to buy our exports

Should you throw up your hands, dump all your stocks, and hide out in cash?

Absolute not! In fact, the last six months of a bull market are often the most profitable. Many tech stocks like Micron Technology (MU) and Advanced Micro Devices (AMD) have dropped by half in recent months. That means they have to double to get back to their old highs.

Other big quality stocks such as Amazon (AMZN) and Netflix (NFLX) have plunged by 30% and only have to appreciate by 43% to hit highs. It is, in fact, the best entry point for large-cap tech stocks since 2015 with valuations at a three-year low.

If I am wrong, the trade war with China plunges us into recession and ends the bull market sooner. Almost all the “worry” items on the list above are getting worse by the day.

Save That Date!

Watch Out for the Unicorn Stampede in 2019

Diary, Newsletter, Research

I am always watching for market topping indicators and I have found a whopper. The number of new IPOs from technology mega unicorns is about to explode. And not by a little bit but a large multiple, possibly tenfold.

Six San Francisco Bay Area private tech companies valued by investors at more than $10 billion each are likely to thunder into the public market next year, raising buckets of cash for themselves and minting new wealth for their investors, executives, and employees on a once-unimaginable scale.

Will it kill the goose that laid the golden egg?

Newly minted hoody-wearing millionaires are about to stampede through my neighborhood once again, buying up everything in sight.

That will make 2019 the biggest year for tech debuts since Facebook’s gargantuan $104 billion initial public offering in 2012. The difference this time: It’s not just one company, and five of them are based in San Francisco, which could see a concentrated injection of wealth as the nouveaux riches buy homes, cars and other big-ticket items.

If this is not ringing a bell with you, remember back to 2000. This is exactly the sort of new issuance tidal wave that popped the notorious Dotcom Bubble.

And here is the big problem for you. If too much money gets sucked up into the new issue market, there is nothing left for the secondary market, and the major indexes can fall, buy a lot.

The onslaught of IPOs includes ride-sharing firm Uber at $120 billion, home-sharing company Airbnb at $31 billion, data analytics firm Palantir at $20 billion, FinTech company Stripe at $20 billion, another ride-sharing firm Lyft at $15 billion, and social networking firm Pinterest at $12 billion.

Just these six names alone look to absorb an eye-popping $218 billion, and that does not include hundreds of other smaller firms waiting on the sidelines looking to tap the public market soon.

The fear of an imminent recession starting sometime in 2019 or 2020 is the principal factor causing the unicorn stampede. Once the economy slows and the markets fall, the new issue market slams shut, sometimes for years as they did after 2000. That starves rapidly growing companies of capital and can drive them under.

For many of these companies, it is now or never. The initial venture capital firms that have had their money tied up here for a decade or more want to cash out now and roll the proceeds into the “next big thing,” such as blockchain, health care, or artificial in intelligence. The founders may also want to raise some pocket money to buy that mansion or mega yacht.

Or, perhaps they just want to start another company after a well-earned rest. Serial entrepreneurs like Tesla’s Elon Musk (TSLA) and Netflix’s Reed Hastings (NFLX) are already on their second, third, or fourth startups.

And while a sudden increase in new issues is often terrible for the market, getting multiple IPOs from within the same industry, as is the case with ride-sharing Uber and Lyft, is even worse. Remember the five pet companies that went public in 1999? None survived.

The move comes on the heels of an IPO market in 2018 that was a huge disappointment. While blockbuster issues like Dropbox (DB) and DocuSign (DOCU) initially did well, Eventbrite (EB), SurveyMonkey (SVMK), and Zuora (ZUO) have all been disasters.

Some 80% of all IPOs lost money this year. This was definitely NOT the year to be a golfing partner or fraternity brother with a broker.

What is so unusual in this cycle is that so many firms have left going public to the last possible minute. The desire has been to milk the firms for all they are worth during their high growth phase and then unload them just as they go ex-growth.

The ramp has been obvious for all to see. In the first nine months of 2018, 44 tech IPOs brought in $17 billion, according to Dealogic. That’s more than tech IPOs reaped for all of 2016 and 2017 combined.

Also holding back some firms from launching IPOs is the fear that public markets will assign a lower valuation than the last private valuation. That’s an unwelcome circumstance that can trigger protective clauses that reward early investors and punish employees and founders. That happened to Square (SQ) in its 2015 IPO.

That’s happening less and less frequently: In 2017, one-third of IPOs cut companies’ valuations as they went from private to public. In 2018, that ratio has dropped to one in six.

Also unusual this time around is an effort to bring in more of the “little people” in the IPO. Gig economy companies like Uber and Lyft are lobbying the SEC for changes in new issue rules that will enable their drivers to participate even though they may be financially unqualified.

As a result, when the end comes, this could come as the cruelest bubble top of all.

Don’t Get Run Over

Why the Stock Market is Bottoming Here

Diary, Newsletter, Research

All good things must come to an end, and that includes bull markets in stocks.

But this one is not over yet. If my calculations are correct, the current correction should end right around here over the next week or two. Like the famed Monte Python parrot, the bull market is not dead, it is only resting.

My logic is very simple. In February, the Dow Average suffered a 3,300 point downdraft. However, at least 1,000 points of this was due to the overnight implosion of the $7 billion short volatility industry that spiked the (VIX) up to $50.

That trade no longer exists, at least to the extent that it did in January. There is no Velocity Shares Daily Inverse VIX Short Term ETN (XIV) blow up in the cards at tomorrow morning’s opening.

With the Dow Average down 2,200 points, or 8.14%, from its September high, the major indexes ought to bottom out right around here. I also expect the Volatility Index to peak here at $30.

Incredible as it may seem, the Dow Average has given up almost all of its 2018 gains. Unchanged on the seems to be a point that the market wants to gravitate to, and then sharply bounce off of.

That means the 200-day moving average for the S&P 500 should hold as well near $274, down 6.4% from all-time highs made only last week. That has provided rock-solid support for the index since the bull market began in 2009, except for brief hickeys in 2011 and 2015.

At these prices the PE multiple for the S&P 500 has plunged back down to only 16 times, providing substantial valuation support that has held for years. The economy is still growing at a 4% clip and I expect that to continue through the end of 2018.

The hissy fit between the White House and the Federal Reserve was the principal cause for the Wednesday 831-point selloff. There is a reason why the president has never been allowed to control interest rates in the United States. Telling the citizenry that the “Fed is loco” does not inspire confidence among stock buyers.

If he could, they would be zero, all the time, forever, and the US dollar would have the same purchasing power as the Zimbabwe one or Weimar German Deutsche Mark.

Another crucial factor that investors are missing is that we are now in the blackout period for Q3 earnings when companies are not allowed to buy their own stocks. Companies have almost become the sole buyers of equities in 2018 and are expected to reach a record high of $1 trillion in purchases this year.

A blackout means that the nice guy who has been buying all those drinks has suddenly become stuck in the bathroom for an extended period of time.

That makes the biggest buyers of their own stock like Apple (AAPL), Cisco Systems (CSCO), Amazon (AMZN), and Amgen (AMGN) particularly interesting.

The shackles come off Apple’s buybacks when the Q3 earnings are announced after the close on November 1, a mere 14 trading days away. Apple CEO Tim Cook has committed to buying $100 billion worth of Apple shares.

Finally, my Mad Hedge Market Timing Index, which has been worth its weight in gold, just hit its all-time low at 4 and is flashing an extreme “BUY”. The last time this happened was at the February 8 capitulation low.

Of course, we will probably still see some heart-stopping volatility in the run up to the election. But after that, I still expect a burst to new all-time highs. If my 3,000 S&P 500 target is hit, that means there is a potential 9.5% gain from today’s low.

Investors raced to unload winners in the run up to yearend. Now that many of those winners have become losers, the selling should abate. Oh, and that bond collapse? Bonds have actually gone up since the big stock selling started two days ago, taking yields down from 3.25% to 3.13%. At some point, someone will notice.

Unfortunately, making money in the market is no longer the cakewalk that it used to be. There’s no more loading the boat, and then going on a long cruise. From now on, we are going to have to work for our money.

We may see a bottom this morning when banks announce their Q3 earnings. JP Morgan’s Jamie Diamond starts his conference call at 8:30 AM EST and the entire investment industry will be listening with baited breath.

Mad Hedge Market Timing Index

Correction? What Correction?

Reaching Peak Technology Stocks

Diary, Newsletter, Research

I drove into San Francisco for a client dinner last night and had to wait an hour at the Bay Bridge toll gate. When I finally got into town, the parking attendant demanded $50. Dinner for two at Morton’s steakhouse? How about $400.

Which all underlines the fact that we have reached “Peak” San Francisco. San Francisco just isn’t fun anymore.

The problem for you is that if the City by the Bay has peaked, have its much-loved big cap technology stocks, like Facebook (FB), Alphabet (GOOGL), and Netflix (NFLX) peaked as well?

To quote the late manager of the New York Yankees baseball team, Yogi Berra, “Nobody goes there anymore because it’s too crowded.”

What city was the number one creator of technology jobs in 2017?

If you picked San Francisco, you would have missed by a mile. Anyone would be nuts to start up a new business here as rents and labor are through the roof.

Competition against the tech giants for senior staff is fierce. What, no fussball table, free cafeteria, or on-call masseuses? You must be joking!

You would be much better off launching your new startup in Detroit, Michigan. Better yet, hyper-connected low-waged Estonia where the entire government has gone digital.

In fact, Toronto, Canada is the top job creator in tech now, creating an impressive 50,000 jobs last year. Miami, FL and Austin, TX followed. Silicon Valley was at the bottom of the heap.

It’s been a long time since peach orchards dominated the Valley.

Signs that the Bay Area economy is peaking are everywhere. Residential real estate is rolling over now that the harsh reality of no more local tax deductions on federal tax returns is sinking in.

To qualify for a home loan to buy the $1.2 million median home in San Francisco, you have to be a member of the 1%, earning $360,000 a year or better.

Two-bedroom one bath ramshackle turn of the century fixer uppers are going for $1 million in the rapidly gentrifying nearby city of Oakland, only one BART stop from Frisco.

Most school districts have frozen inter-district transfers because they are all chock-a-block with students. And good luck getting your kid into a private school like University or Branson. There are five applicants for every place at $40,000 a year each.

The freeways have become so crowded that no one goes out anymore. It’s rush hour from 6:00 AM to 8:00 PM every day.

When you do drive it’s dangerous. The packed roads have turned drivers into hyper-aggressive predators, constantly weaving in and out of traffic, attempting to cut seconds off their commutes. And there is no drivers ed in China.

I took my kids to the city the other day for a Halloween “Ghost Tour” of posh Pacific Heights. It was lovely spending the evening strolling the neighborhood’s imposing Victorian mansions.

The ornate gingerbread and stained-glass buildings are stacked right against each other to keep from falling down in earthquakes. It works. The former abodes of gold and silver barons are now occupied by hoody-wearing tech titans driving new Teslas.

We learned of the young girl forced into a loveless marriage with an older wealthy stock broker in 1888. She bolted at the wedding and was never seen again.

However, the ghost of a young woman wearing a white wedding address has been seen ever since around the corner of Bush Street and Octavia Avenue. Doors slam, windows shut themselves, and buildings make weird creaking noises.

Then I came to a realization walking around Fisherman’s Wharf as I was nearly poked in the eye by a selfie stick-wielding visitor. The tourist areas on weekdays are just as crowded as they were on summer weekends 30 years ago, except that now the number of languages spoken has risen tenfold, as has the cost.

It started out to be a great year for technology stocks. Amazon (AMZN) alone managed to double off its February mini crash bottom, while others like Apple (AAPL) rocketed by 56%. But traders may have visited the trough once too often

The truth is that technology stocks have not performed since June, right when the Mad Hedge Fund Trader dumped its entire portfolio. Only Microsoft (MSFT) and Amazon (AMZN) have managed to eke out new all-time highs since then, and only just.

The rest of tech has been moving either sideways in the most desultory way possible, or suffered cataclysmic declines like Facebook (FB) and Micron Technology (MU).

Of course, the trade wars haven’t helped. It’s amazing that big tech hasn’t already been hit harder given their intensely global business models.

Nor has rising interest rates. Big cap tech companies have such enormous cash balances that they are all net creditors to the financial system and actually benefit from higher interest rates. But dear money does slow the US economy and that DOES hurt their earnings prospects.

No, I’m not worried about tech for the long term. There is no analog company that can compete with a digital company anywhere in the world.

Accounting for 26% of the stock market capitalization and 50% of its profits, it’s only a question of when we get a major new up leg in share prices, not if.

The only unknown now is whether this next leg will take place before or after the next recession. Given the rate at which interest rates and oil prices are rising in the face of a slowing global economy, it’s looking like the recession may win the race.

As our tour ended, who did we see having dinner in the front window of one of the city’s leading restaurants? A young woman wearing a white wedding dress.

Yikes! Maybe the recession is sooner than I thought.

The Bull Case for Tesla

Diary, Newsletter, Research

Talk about a bad news factory.

A short interest of 26% in Tesla (TSLA) stock has the tendency to manufacture bad news on a daily basis, whether it is true or not. It really has been a black swan a day.

This really is the most despised stock in the market. But you have to expect that when you are simultaneously disputing the auto, oil, dealer, and advertising industries, and doing it all union-free.

It also doesn’t help that Tesla is on the Department of Justice speed dial, undergoing no less than three investigations since the advent of the new administration. I can’t imagine why this is happening, given that the White House is now packed with oil industry executives.

That’s why I have been advising investors to buy the car and not the stock.

That is until now.

The truth is that all of this negativity is generating the best entry point for Tesla shares in two years.

In the meantime, the San Francisco Bay Area has become flooded with new Tesla 3’s. These are suddenly everywhere and soon will outnumber the ubiquitous Toyota Prius, until now the favorite of technology employees.

Q3 production of Tesla 3’s reached an eye-popping 55,840, up from 18,440 the previous quarter, taking Tesla’s total output to 80,000 including the model X.

That puts the company on target to reach 250,000 units in 2019. Tesla may be about to see something it has not witnessed in the company’s 15-year history: a real profit.

When I picked up my first Tesla 1 in 2010, chassis no. 125, I was all alone and treated like I was visiting royalty. The sales staff fawned all over me, offering me free hats, coffee mugs, and other tchotchke. Today, a staggering 200 people a day are gleefully driving their new wheels away from the Fremont factory, and another 200 getting them home-delivered by semis. Take a number and wait in line.

I have pinned down several of these drivers in parking lots, shopping malls, and trailheads to quiz them about their new ride and the answer is always the same. It’s a car from 20 years in the future, the best they have ever driven, and they will never buy another marque again.

Sounds pretty good, doesn’t it?

So I perked up the other day when I heard my old pal, legendary value investor Ron Baron, make the bull case for Tesla.

Ron has never done things by halves. He expects Tesla’s market capitalization to soar from $43 billion today to $1 trillion by 2030, a mere 12 years away. By then, Tesla should be generating $150 billion a year in profits. That implies that a 23-fold increase in the share price to $5,570 is ahead of us.

Half of this will be generated by the auto sales, while the other half will be produced by a burgeoning battery business. Tesla will easily become the largest auto manufacturer in the world within a few years.

Tesla will sell 10-15 million cars a year by 2030, compared to the current 300,000 annual rate.

It already is the one American auto maker with the highest US parts content, nearly 100%. It has also been one of the largest creators of new jobs over the past decade, right behind Amazon (AMZN), at some 46,000.

It’s really all about the math. Today, Tesla is building its Tesla 3’s at a cost of $28,000 apiece and selling them for $62,000. That’s the high price they have been realizing with extra options like four-wheel drive, 300-mile extended range batteries, painted wheels, and all the other bells and whistles. That gives you a $34,000 profit per vehicle.

Tesla’s “cheap” cars, the stripped-down rear wheel drive Tesla 3’s that will sell for a modest but world-beating $35,000 won’t be available until early 2019.

At this rate, the entire company will become profitable when it hits a production rate of 10,000 units a week compared to the current 6,000 units. They should achieve that sometime in early 2019.

Much has been made of drone video footage showing vast parking lots in Fremont, CA chock-a-block with shiny new Tesla 3’s. This creates a false sense of poor sales.

The actual fact is that Tesla has no dealer network. All of those parked cars have been sold and are awaiting owners to pick them up. The months it takes from payment to actual delivery gives Tesla a free float on billions of dollars. That’s worth a lot in a world of steadily rising interest rates.

Oh, and those notorious tents? They could withstand a category 5 hurricane. However, like everything else the company does, they’re revolutionary. They enable bypassed permitting procedures and can be built very quickly and cheaply.

How are things going with the competition? Not so good. The traditional internal combustion car industry has hundreds of billions of dollars tied up in engine factories that will eventually become worthless. They really are the 21^st century equivalent of buggy whip makers.

General Motors (GM), Ford (F), and Chrysler are executing slow motion roll out of electric cars in order to squeeze a few more years of use out of these legacy plants. Electric cars don’t use engines. That is putting them ever further behind.

This is what the poor share performance of auto shares has been screaming at you all year despite one of the strongest economies and stock markets in history. Yes, “peak Auto” is at hand.

The high-end brands like Mercedes, BMW, Audi, and Porsche that just entered the all-electric market are a decade behind Tesla in autonomous software and manufacturing processes. They all have huge, expensive dealer networks.

Let’s see how sales go after they suffer their first fatal crash. In the meantime, Tesla has run up 200 million miles worth of driving data.

Factory insiders say a speed-up of new Tesla orders is in the works. Orders placed before December 31, 2018 are entitled to a $7,500 federal tax credit. That drops to $3,750 in the first half of 2019, only $1,750 in the second half, and zero in 2020.

In the meantime, the oil industry is still collecting $55 billion a year of federal oil depletion allowances. Go figure.

At the same time, many states like California, far and away Tesla’s largest market (Texas is no. 2), are either maintaining or expanding their own electric car subsidies or gas guzzler penalties. It is $2,500 per car in California.

Ron Baron is not alone in his admiration of Tesla. Macquarie Research has just initiated coverage with a strong “BUY” and a target of $430 a share, up 70% from today’s close.

Next in the works will be a Tesla Model Y, a small four-wheel drive based on the Tesla 3 chassis. A Roadster relaunch comes next in 2022, a $250,000 super car that will be doubtless aimed at Arab sheiks and billionaire car collectors.

By then the entire product line will spell SEXY. See! Elon Musk does have a sense of humor after all!