Why I?m Covering My Stock Shorts

I?ll take the home run, thank you very much. Ten handles in the (SPY) on the downside in ten days totally works for me. We have milked this trade for all it?s worth, so it?s hasta la vista baby! Thank you Vladimir Putin!

This is not a bad place to de-risk on the short side in stocks. Take a look at the charts below, and you will see a convergence of 100 day and 200 day support levels across several asset classes.

Check out the rock solid support level in the (SPY) at $191, and all of a sudden, buying back shorts here at $191.50 looks like a stroke of brilliance.

It is also interesting to see the suddenly despised junk bond ETF (HYG) hold at the 200 day moving average. Stocks and junk bond price movements are very highly correlated. It makes sense that after showing the most bubbleicious price action, high yield corporate debt led the change on the downside.

By the way, this could also mean that Treasury bonds are about to take a big dump off this morning?s 2.43% yield for the ten year, which is why I?m hanging on to all my short positions there.
We could still see more pain in risk assets. My favorite downside target in the (SPY) is the 200 day moving average at $186. That would give us a top to bottom correction of 6.5% in this cycle, in line with the pullback we saw earlier this year.

That?s where you want to load the boat one more time. When the BSD?s come back from their summer vacations in the Hamptons, Cannes or Portofino, they are going to quickly realize that stocks have been falling, while earnings have been rising.

That means they are going to be cheaper than they have been at any time in 2014. In a world where there is little else to buy, that is a big deal.

We have just entered a period when the seasonals strongly favor investment in equities. That sets up a yearend rally in the indexes that will not be as big as the melt up we saw in 2013, but will be just as welcome. My 2014 (SPY) target of $210, or $2,100 in the (SPX), may not be so Mad after all.

Yes, I know that geopolitics is still a factor. But it looks like both sides in the Gaza conflict have depleted their stockpiles of stupidity for the time being, so things are about to go quiet there.

Vladimir Putin is also likely to back down in the Ukraine because of that throbbing he is increasingly feeling in his pocketbook. The growing leverage and rising costs in the Russian oil industry mean that the recent $11, or 10%, drop in the price of crude cuts Russia?s revenues by 25%. The recession this will eventually bring could be bad enough to lose a future election.

In the end, that is what this is really all about.

I am already starting to draw up short lists to buy on the next turnaround. I?ll shoot out the Trade Alerts when I think the time is right.

Jim Parker! Get your ass back from Rome, per favore! The gelato can?t be that good!

RUT 8-6-14

HYG 8-6-14

SPX 8-6-14

PutinThank You Mr. Putin

What Could Derail the Coming Golden Age?

Regular readers of this letter are well familiar with my ?Golden Age? scenario for the decade starting in 2020. That?s when US economic growth, assisted by a huge demographic tailwind, doubles from 2% to 4% a year, sending all asset prices soaring.

Is this a sure thing? A done deal? Should I be betting the ranch now on such an outcome, even though it is still five years off? Most importantly, what could derail this hyper bullish scenario? What would cause the wheels to fall off?

What makes this a particularly vexing question now is that the traditional causes of recessions are nowhere on the horizon. With technological innovation accelerating, the chances are that wage growth remains low to non-existent, possibly for the rest of this century.

The 19th century was another one of those zero inflation centuries. That is when the Industrial Revolution unleashed a technology explosion that kept inflation perennially low.

I know because I like to collect 19th century defaulted bonds (especially those with really cool graphics). You know? Those issued by the Russian Trans Siberian and Chinese railroads?

What stands out is how universally low the coupons are on these bonds, often 3% or 4%, even for high-risk junk American railroad bonds (not sovereign backed). Remember, that Downton Abbey?s patriarch, the Earl of Grantham, lost the family fortune in a supposedly ?safe? investment in the shares of a Canadian railroad!

The other major cause of recessions for the past 60 years has been oil shocks. However, with America about to become a net energy exporter, it is likely that we will benefit from the next disruption in global supplies, not suffer.

It could well set up a trade where US suppliers sell outrageously expensive energy to Europe and Asia, both huge importers, while their domestic costs remain unchanged, or even fall.

This is a dream scenario for the domestic American energy industry, as it would lead to a massive increase in both volumes and margins. This may be why their shares have been one of the top performers this year.

Indeed, the first exports of distillates in nearly 50 years left the US for South Korea just last week.

That still leaves us with the conundrum of what will cause rain to fall on the parade expected for the next decade.

1) A Global Pandemic

As a former scientist, I can put a global pandemic right at the top of the list of potential threats to our prosperity. If 2% of the world?s population suddenly die in a flu epidemic, as happened in 1918 (I lost two great aunts), you can quickly consign any optimistic scenario to the graveyard.

International travel and trade would grind to a halt as nations seek to protect their populations from serious infection. Asset prices would crash.

Scientists in several countries now are computer modeling potential future mutations of the flu virus, trying to anticipate the next new super bug. They are then synthesizing antidotes in advance.

The problem with this strategy is what happens if these laboratories made viruses escape? To produce enough vaccine to protect a population takes a year. If you want to see what this would be like in practice, watch the well thought out and researched science fiction movie 2011 Contagion.

For more depth on this topic, please refer to my recent piece ?Will Synbio Save or Destroy the World??.?

2) The Internet Goes Down

There is another possible cause of economic collapse that has recently gained media attention.

Computer power is doubling every year, meaning that your laptop (if they still exist) and cell phone will have 2,048 times more power than they do today, and probably will be available at a tenth of the current price. This is happening globally, with an exponentially growing number of machines.

What happens if the Internet becomes so sophisticated that it develops an opinion? It could just simply go on strike or shut down. Or it could selectively close certain industries it deems unnecessary, such as politics or financial services.

We have already become so dependent on the net that losing it, even for a few minutes, can be catastrophic. ATM?s would run out of cash, the food supply would grind to a halt, and water would no longer come out of your tap. This does not exactly auger well for assets of any type.

You may think these are way out there, far in the future risks. They were 30 years ago, but they?re not now. No lesser minds than those of Tesla founder, Elon Musk, and Google Head of Engineering, Ray Kurzweil, have been publicly warning of such a potential outcome.

They are proposing the creation of new types of antivirus software and other safeguards to head off just such a digital apocalypse. For more background on this issue, please read ?Peaking into the Future with Ray Kurzweil?.

There is an offshoot to this category of threat. What if a hacker, either an individual or a nationally sponsored team is able to take down the Internet and hold it for ransom? If China could selectively close down the US military or the entire US, while leaving allies or the rest of the world online, would they do it?

In a heartbeat. This is why the Joint Chiefs of Staff are waging a campaign in Washington to boost budgets for cyber warfare at the expense of Cold War, heavy metal, useless ones.

For more flavor on what this may look like, I again refer you to Hollywood. Take a look at the recently released flick, Transcendence, where Johnny Depp migrates on to the net, a Kurzweil favorite (but not until 2100). And then there are the cult favorites, Terminators I, II, and III. (I dated the stunt double for Kristanna Loken, the robot terminatrix in III).

3) Politics

There is a third way in which the prospects for an endless bull market in the 2020?s get utterly smashed. Politicians get involved.

Let?s say that someone gets elected President of the United States who launches discretionary wars around the world. Ideologically committed to cutting taxes, the US Treasury borrows the money from China and Japan. The economic collapse these policies bring cause financial assets to crater.

Do you think this is more science fiction? That is exactly what happened in the last decade, when the Dow plunged 50% and NASDAQ 60%.

Fortunately, this prospect is more unlikely than it was in the past. First, we have our own recent, hard earned experience to go by. America has lost its taste for war and debt.

In any case, the Chinese and Japanese are no longer willing to lend us any more money, not at these subterranean interest rates.

Hillary Clinton is the overwhelming favorite for president until she reaches the end of her second term in 2024, and she is clearly headed in the opposite direction in regards to foreign policy. She is so far ahead in the polls that no Democratic Party challenger has come forward, because they are unable to raise any money.

But after that, you can?t rule out debt-financed wars as an impediment for investment.

Americans will have to decide whether they prefer the prosperity that a Golden Age can then bring, or otherwise. Personally, I prefer the former.

Of course, all three of these scenarios are unlikely outliers, possibly extreme ones. But it is a useful ?thought experiment,? as Albert Einstein would call it. There isn?t a financial advisor out there who isn?t constantly asked by his clients, ?What could go wrong??

When they do, just refer them to this piece.

Pandemic - BurialsWill it be This?

 

TerminatorOr This?

 

Hillary ClintonOr This?

Russian Sanctions Crush European Yields

When a rogue element of Ukrainian separatists used a heavy antiaircraft battery supplied by the Russians to shoot down Malaysian Airlines flight 17, who knew that it would send the European bond market into turmoil?

Yet, that is exactly what happened.

German and French ten-year bond yields have hit 300 year lows at around 1.12% and 1.50%. They achieved 500-year lows in the Netherlands, only because it has the longest record for publicly trading debt (the Dutch East India Company was a big borrower to colonize Asia).

Spanish government debt is now trading at higher prices than equivalent US debt. Perish the thought! Weren?t they supposed to be bankrupt?

Yet, the ultra low Japanese levels of interest rates now found on the continent are justified by the new pall cast upon the European economy.

The first round of sanctions imposed by the European Community on Russia a few months ago were little more than symbolic gestures. Close friends of Putin saw bank accounts frozen, and invitations to international gatherings rescinded. Putin could easily afford to laugh them off.

Not so with the second round, which officials have dubbed ?Sanctions 2.5?. The Europeans are taking the Malaysian Air incident personally, as the great majority of the 295 victims were theirs, primarily from Holland. Restricting access to the crash site has only made the pain greater and Russian obtuseness more offensive.

Russian banks have been barred from the European capital markets, greatly increasing their cost of funds. There is a new ban on military contracts, although existing deals are grandfathered, such as France?s sale of two ultra modern helicopter carriers for $4 billion.

Sitting in Europe as I write this, I am inundated by news of the adverse effects of the New Cold War on the European economy. Germany, alone, has 300,000 jobs dependent on trade with Russia, which is a major buyer of industrial machinery and automobiles.

Unfortunately, the timing for all of this couldn?t be worse. It is happening just as the economic data was showing glimmers of a nascent, but sustainable recovery. Look no further than the Euro (FXE), (EUO) which has greatly accelerated its collapse against the US dollar.

Europe has also become hugely dependent on Russia for energy, particularly natural gas. Putin has already used his energy weapon on the Europeans over a contract dispute, arbitrarily cutting off supplies during one of the coldest winters on record.

The problem is that this is not a challenge that can be dealt with easily. On paper, the US could supply a substantial portion of Europe?s energy needs with its newfound windfall from fracked natural gas (UNG).

However, anyone in the energy industry will tell you that installing the needed infrastructure is at least a 20-year job, and maybe ten years if you put it on a military footing.

The new sanctions were instrumental in the announcement of a major expansion of fracking in Europe, which until now has been held back by environmental concerns. The coal bearing areas of Germany, Poland, and France have the perfect geology for fracking, which will enable the continent to become energy independent.

But again, we are talking about very long timelines. This is another reason why US fracking stocks, like USA Compression Partners (USAS), Nuverra Environmental Solutions (NES), and US Silica Holdings (SLCA), have been on a tear.

The late President Ronald Reagan must be laughing in his grave. When I was a young White House correspondent, his administration fought the energy deals Europe was negotiating with Russia tooth and nail.

In the end, the Europeans ignored the ?Gipper,? wary of his conservative, saber rattling, Cold War rhetoric. The headache is that the EC is now in so deep with Russia, recently describing it as a ?strategic partner,? that it can only extricate itself at great cost.

The US cannot just sit back and laugh this off with a giant ?I told you so.? The collapse in bond yields has been a global affair, dragging our interest rates down to one year lows at 2.45% for ten year Treasury bonds, and 3.24% for the 30 year.

At the very least, it postpones a major switch by American investors out of bonds and into stocks that was imminent. It also hits American companies, that until recently have been cashing in on new trade with Russia. Who is the biggest casualty? Exxon (XOM), which has several ongoing projects to modernize Russian oil production.

Sanctions 3.0 could be worse, if Putin doesn?t get the message. The US Treasury is prepared to ban Russia from global US dollar clearing if it doesn?t back off from the Ukraine. Trying selling 10.5 million barrels a day of oil without using the greenback.

What could they accept in return other than the buck? Gold? North Korean Won? Chinese Renminbi? The collapse of the Russian economy would be total and absolute, not that anyone cares. Its GDP is only $2 trillion, 3% of the world total, and they have an even smaller share of international trade.

Fortunately, I have been able to dance between the raindrops with my Trade Alert service. I have been marginally caught out by premature short positions in the Treasury bond market (TLT), (TBT).

But so far, these losses have been offset by my aggressive shorts in the Euro, which has been cratering, thanks to ECB president Mario Draghi?s new found belief in quantitative easing. Breaking even when a flock of ?black swans? descends upon you is a ?win? in my book.

It?s a classic example of, ?The harder I work, the luckier I get.?

FXE 7-29-14

EUO 7-29-14

HEDJ 7-29-14TankerGrandfathered