Research Archives - Mad Hedge Fund Trader

The End of the Iran Nuclear Deal and Your Portfolio

My first contact with Iran was during the horrific 1980-88 Iran-Iraq war. I was a war correspondent for The Economist magazine living in the Kuwait Hilton.

Early every morning, hotel staff hurried down to the beach to clean up the remains of shark-eaten bodies that had washed up from the pitched battles overnight. It was essentially a replay of WWI. More than 1 million died, and poison gas was a regular feature of the conflict.

You are either getting killed yourself, or are having a fabulous day today because of the end of the U.S. participation in the Iran Nuclear Deal, depending on your sector exposure.

If you own energy producers, like the oil majors we have been bullish on for several months, including ExxonMobil (XOM), Occidental Petroleum (OXY), and Chevron (CVX), you are sitting pretty.

If you own energy consumers, such as Delta Airlines (DAL), and Consumer Staples (XLP), which we have been dissing to the nth degree, you are taking it in the shorts.

But what happens beyond today?

For the short term, you can expect nothing to result from the American abrogation of the treaty, which even the administration's own Secretary of Defense, Marine Corps General James Mattis, strongly advised against.

Three years into the agreement, very little trade between Iran and the U.S. actually took place. The big Boeing (BA) aircraft order never showed. American oil companies were gearing up to bid on the reconstruction of Iran's oil infrastructure. But so far it has been all talk and no do.

If you were looking forward to getting a great deal on a new Persian carpet you're out of luck. But there is an ample supply of used ones on the market.

At the end of the day, the Iranians would rather do business with Europe, treaty, or not. It is the natural trading partner, is close, and most of the Iranian leadership was educated at continental universities.

The European Economic Community (EEC) offers far larger export subsidies than the U.S. ever would. Remember, Iran was once a quasi-British colony. And let's face it, Iran never trusted the U.S., given our coddling of the previous Shah.

It is most likely Europe, Russia, and China; the other signatories will continue with the treaty in its current form. China will take all the oil Iran can produce, no questions asked. Russian interests are the same as Iran's, higher oil prices.

Yes, the U.S. has threatened to blacklist any bank financing trade with Iran going forward. There is absolutely no way this will work, unless the U.S. wants to ban American trade with Europe, its largest foreign customer.

If they try it, Fortune 500 companies will land on Washington like a ton of bricks, which earns up to 70% of their earnings from foreign sales. In the end all this will do is cut the U.S. out of the global economy.

Longer term, geopolitical risks will undoubtably rise. Iran will almost certainly ramp up its attempts to overthrow the government of Saudi Arabia, still the largest single source of American oil imports. It also has no cost of continuing mischief in Yemen and Syria. Iran already has a dominant influence in Shiite Iraq, which we fought a war to hand over to them.

Of course, the big winner in all of this is Russia, as it has been with almost everything else recently. Moscow loves higher oil prices, enabling Putin to deliver the higher standard of living he promised in last month's presidential election. It also gives him another opportunity to stick a thumb in America's eye, which he apparently loves to do.

Trump can threaten war all he wants, but the Iranians know this is nothing but a bluff. After 17 years of war in Afghanistan, the U.S. his little appetite for another one. Even though we are officially out of Iraq, it is still a massive drain on the U.S. budget. And we still haven't paid for the last one, unless the Chinese want to lend us more money.

In the end it will depend on how long oil will stay this high. The end of the treaty is worth at least $20 in higher oil prices. If oil continues to appreciate then it brings forward the next recession, possibly by years. Energy is a major component in the inflation calculation, which should now speed up smartly and crush the bond market, bringing higher interest rates.

Rising oil prices, inflation, and interest rates with a flagging global economy? Not good, not good.

While U.S. fracking production is rising, it can't increase fast enough to head off the current oil price spike. Production can't be ramped up faster because the U.S., with production now more than 10 million barrels a day, is oil infrastructure constrained, and much of the new infrastructure that has been added is aimed at increased oil exports, not domestic consumption. It makes a big difference.

And why are we focusing on the country that has zero nuclear weapons, primitive technology, and an economy in free fall, while ignoring the one that has more than 7,000 (Russia)? Will someone please explain that to me? Remember, Iran is a country that still relies on camels and donkeys as a major mode of transportation.

So you can take your nuclear treaty and toss it in the ash can of history. The problem is that it may cost you and your portfolio a lot more than you think.

Meet Your New Earnings Driver

Reminding You Why You Should Be Selling in May

Diary, Newsletter, Research

Followers of my Trade Alert service have watched me shrink my book, reduce risk, and cut positions to a rare 100% cash position.

No, I am not having a nervous breakdown, a midlife crisis, nor have I just received a dementia diagnosis.

It's because I am a big fan of buying straw hats in the dead of winter and umbrellas in the sizzling heat of the summer.

I even load up on Christmas ornaments every January when they go on sale for 10 cents on the dollar.

There is a method to my madness.

If I had a nickel for every time that I heard the term "Sell in May and go away," I could retire.

Oops, I already am retired!

In any case, I thought that I would dig out the hard numbers and see how true this old trading adage is.

It turns out that it is far more powerful than I imagined.

According to the data in the Stock Trader's Almanac, $10,000 invested at the beginning of May and sold at the end of October every year since 1950 would be showing a loss today.

Amazingly, $10,000 invested on every November 1, and sold at the end of April would today be worth $702,000, giving you a compound annual return of 7.10%!

This is despite the fact that the Dow Average rocketed from $409 to $26,500 during the same time period, a gain of 64.79 times!

Since 2000, the seasonal Dow has managed a feeble return of only 4%, while the long winter/short summer strategy generated a stunning 64%.

Of the 68 years under study, the market was down in 25 May-October periods, but negative in only 13 of the November-April periods, and down only three times in the past 20 years!

There have been just three times when the "good 6 months" have lost more than 10% (1969, 1973 and 2008), but with the "bad six month" time period there have been 11 losing efforts of 10% or more.

Being a long-time student of the American and, indeed, the global economy, I have long had a theory behind the regularity of this cycle.

It's enough to base a pagan religion around, like the once practicing Druids at Stonehenge.

Up until the 1920s, we had an overwhelmingly agricultural economy.

Farmers were always at maximum financial distress in the fall, when their outlays for seed, fertilizer, and labor were the greatest, but they had yet to earn any income from the sale of their crops.

So, they had to borrow all at once, placing a large cash call on the financial system as a whole.

This is why we have seen so many stock market crashes in October. Once the system swallows this lump, it's nothing but green lights for six months.

After the cycle was set and easily identifiable by low-end computer algorithms, the trend became a self-fulfilling prophecy.

Yes, it may be disturbing to learn that we ardent stock market practitioners might in fact be the high priests of a strange set of beliefs. But hey, some people will do anything to outperform the market.

It is important to remember that this cyclicality is not 100% accurate, and you know the one time you bet the ranch, it won't work.

But you really have to wonder what investors are expecting when they buy stocks at these elevated levels, over $205 in the S&P 500 (SPY).

Will company earnings multiples further expand from 19X to 20X or 21X?

Will the GDP suddenly reaccelerate from a 2% rate to the 4% promised by the new administration, when the daily sentiment indicators are pointing the opposite direction?

I can't wait to see how this one plays out.

It's May!

Trading the U.S. Steel Fiasco

Diary, Newsletter, Research

Talk about unintended consequences. Tamper with the free market and it will usually blow up in your face.

You would have thought that U.S. Steel was going to announce blockbuster earnings in the wake of the new 25% steel tariff imposed by the administration, right?

Wrong.

Instead, it has triggered a disaster of epic proportions. The reasons why provide a crash course on how fast the modern economy is evolving.

Of course, the stock market didn't like it, the shares crashing some 17.1% since the announcement. U.S. Steel, far and away the biggest beneficiary of administration policies, is now down on the year.

You may recall that we made a fortune when we bought U.S. Steel last summer at $21 a share, well before the run up into the passage of the tax package. The shares gained a mind-blowing 127%.

Not only did the company deliver a shocking disappointment on Q1 earnings, bringing in net profits of only 10 cents a share, it guided lower for Q2. Expectations had been far higher. Still, that is far better than the $180 million loss it brought in a year ago.

The CEO, David Burritt, cited unexpected "operational volatility." Take that to mean the chaos created by the steel tariffs. There is also trouble with its Great Lakes factory.

Flat rolled steel used to manufacture cars swung from an $88 million loss to a $23 million profit. But tubular steel used for pipelines incurred a $23 million loss.

What is really amazing is that the company made only a dime per share off an increase in total steel shipments YOY of 15.6%. Clearly, there is trouble in Pittsburgh.

And here is what U.S. Steel didn't expect. Instead of paying the extra 25% for imported steel, many customers are simply designing steel out of their products to cut costs rather than shifting to (X).

Three decades ago, this might have taken years to achieve. Thanks to advanced software applications this can now be accomplished in weeks. Companies are vastly more sensitive to costs than they were only a few years ago, and mere pennies can make all the difference.

It's only a matter of time before the entire auto industry shifts to carbon fiber, which has four times the strength of steel at one fifth the weight. That gives you a 20X improvement in performance and safety. Cost and mass manufacturing are the only issues.

Tesla (TSLA) is planning to make the jump in a couple of years. Boeing (BA) and the U.S. Air Force already have.

Where is U.S. Steel in a carbon fiber world? Try Chapter 11.

In the meantime, U.S. Steel consumers are scrambling to get exemptions from the punitive tariffs, creating a bureaucratic nightmare for all involved.

Wilber Ross's Commerce Department has been flooded with some 3,500 requests, each one of which takes months to review. The agency has boosted staff, but it is still overwhelmed. It looks like the only new American jobs the tariff will create will be government ones.

It turns out that many types of high grade steel, such as for razor blades and specialized carbon steel parts, aren't made in the U.S.

To prove that I learn something new every day, I discovered that even France is an important steel supplier. And I thought it was all about wine, cheese, and those cute black berets.

The net result for consumers has been uncertainty in the extreme. That purgatory has just been extended with the government's 30-day postponement of the tariffs announced yesterday.

If companies wait long enough the tariffs will simply disappear. They will certainly be declared illegal by the World Trade Organization.

The national security rationale for the steel tariffs was always completely bogus and will be laughed out of court. If steel really were a national security issue the Defense Department would have its own steel mill, as it already does with semiconductors.

The chips in U.S. weapons systems are 100% made in the USA to keep foreign back doors out of the design process.

Wars of the future will be bought with software, not M1 Abrams tanks or battleships. If fact, they already are.

As for the shares of U.S. Steel, I'm not touching them here. If the economic data continues to weaken as it has, you don't want to be anywhere near this sector.

The stock market already has reached that conclusion.

On the USS Missouri; Made in the USA

Anatomy of a Great Trade

Diary, Newsletter, Research

So, I'm sitting here agonizing over whether I should sell short the US Treasury bond market (TLT) once again.

Thanks to the bombshell Israel announced today alleging the existence of a secret Iranian nuclear missile program, oil has rallied by 2%, the US dollar has soared, and stocks have been crushed.

The (TLT) has popped smartly, some $2.5 points off of last week's low, taking yields down from a four-year high at 3.03% down to 2.93%.

The report is probably based on false intelligence, which is becoming a regular thing in the Middle East. Suffice it to say that the presenter, Prime Minister Benjamin "Bibi" Netanyahu, may soon be indicted on corruption charges. Clearly, they are going "American" in the Holy Land.

But for today, the market believes it.

You can understand me chomping at the bit, as selling short US government bonds has been my new rich uncle since the market last peaked in July 2017.

I just ran my Trade Alert history over the past nine months and here is what I found.

I sent you 38 Trade Alerts to sell short bonds generating 18 round trips, AND EVERY SINGLE ONE WAS PROFITABLE! In total these Alerts generated a trading profit of 216%, or 21.62% of my total portfolio return.

That means 35% of my profits over the past year came from selling short Treasuries.

You should do the same.

Falling Treasury prices have been one of the few sustainable trends in financial markets during the past year.

Stock rallied, then gave up a chunk. Gold (GLD) has gone nowhere. Only oil has surpassed as a sustainable trade, thanks to successful OPEC production quotas, which have been extended multiple times.

Texas tea is up an admirable 67% since the June $42 low. And who was loading up on crude way down there?

Absolutely no one.

Of course, I have an unfair advantage as a bond trader, as I have been doing this for nearly 50 years.

I caught the big inflation driven fixed income collapse during the 1970s, which had a major assist then from a rapidly devaluing US dollar.

That's when they brought out zero-coupon bonds, effectively increasing our leverage by 500% for virtually no cost. Principal only strips followed, another license to bring money on the short side.

The big lesson from trading this market for a half century is that trends last for a really long time. The bull market in bonds that started in 1982, when 10-year yields hit 14%, lasted for 33 years.

As we are less than three years into the current bear market the opportunities are rife. We are very early into the new game. This one could last for the rest of my life.

The reasons are quite simple. The fundamentals demand it.

1) The Global Synchronized Recovery is accelerating.

2) The Fed will start dropping on the bond market in the very near future $6 billion a month, or $200 million a day, worth of paper in its QE unwind.

3) Tax cuts will provide further stimulus for the US economy.

4) With the foreign exchange markets now laser-focused on America's exploding deficits, a weak US dollar has triggered a capital flight out of the US.

5) We also now have evidence that China has started to dump its massive $1 trillion in US Treasury bond holdings.

All are HUGELY bond negative.

All of this should take bonds down to new 2018 lows. What we could be seeing here is the setting up for the perfect head and shoulders top of the (TLT) for 2018.

As for that next Trade Alert, I think I'll hold out for a better price to sell again. What's the point in spoiling a perforce record?

Time to Stick to Your Guns

Why It's a "Sell the News" Market

Diary, Newsletter, Research

It could have been the 3.0% print on the yield for the US 10-year Treasury bond yield (TLT).

It could have been the president's warlike comments on Iran.

It could even have been rocketing commodity prices that are driving consumer staple stocks out of business.

No, none of these are the reason why the stock market melted down 700 points intraday yesterday.

The real reason is that we have had too much fun for too long.

Some nine years and 400% into this bull market, investors are starting to take some money off the table.

Not a lot mind you, but enough to make a big difference on a single day.

The Fed was seen carrying off the punch bowl, and the neighbors have called the police. Clearly, the party is over. At least for now.

If you had to point to a single cause of the Tuesday rout in share prices it had to be Caterpillar's (CAT) rather incautious prediction that its earning peaked for this business cycle in Q1, and it was downward from here.

Traders, being the Einstein's that they are, extrapolated that to mean that ALL companies saw earnings peak in Q1, and you get an instant 700-point collapse.

I think they're wrong, but I have never been one to argue with Mr. Market. You might as well argue with the tides not to rise.

In a heartbeat, investors shifted from a "sell earnings on the news" to "sell NOW, earnings be damned."

All of this vindicates my call that markets would remained trapped in a wide trading range until the November congressional elections.

This has been further confirmed by the three-year chart of my Mad Hedge Market Timing Index.

For the second time this year, the Index peaked in the 40s, instead of the 80s, which is what you normally get in a bull market. The new trading strategy for the Index is to buy in the single digits and sell in the low 40s.

This is why I have been aggressively taking profits on long positions and slapping on short positions as hedges for the remaining longs. The Global Trading Dispatch model portfolio went into this week net short.

My Mad Hedge Technology Letter has only one 10% position left, in Microsoft (MSFT).

While a 3% 10-year is neither here nor there, the rapidly inverting yield curve is. The two-year/10-year spread is now a miniscule 53 basis points.

The 10-year/30-year spread is at a paper thin 18 basis points. To show you how insane this is, it means investors are accepting only an 18-basis point premium for lending money to the US government for an extra 20 years!

This is a function of the US Treasury focusing its new gargantuan trillion dollar borrowing requirements at the short end of the curve. This is the exact opposite of what they should be doing with yields still close to generational lows.

What this does is create a small short-term budgetary advantage at a very high long-term cost. This is constant with the government's other backward-looking Alice in Wonderland economic policies.

When the yield curve inverts, watch out below, because it means a recession is near.

If the stock market continues to trade like this, as I expect it will, you can expect the next stock market rally to start in two months when we ramp up into the Q2 earnings reports.

Until then, we will probably just chop around. Enjoy your summer.

Why Indexers Are Toast

Diary, Newsletter, Research

Hardly a day goes by without some market expert predicting that it's only a matter of time before machines completely take over the stock market.

Humans are about to be tossed into the dustbin of history.

Recently, money management giant BlackRock, with a staggering $5.4 trillion in assets under management, announced that algorithms would take over a much larger share of the investment decision-making process.

Exchange Traded Funds (ETFs) are adding fuel to the fire.

By moving capital out of single stocks and into baskets, you are also sucking the volatility, and the vitality out of the market.

This is true whether money is moving into the $237 billion S&P 500 (SPY), or the miniscule $1 billion PureFunds ISE Cyber Security ETF (HACK), which holds only 30 individual names.

The problem is being greatly exacerbated by the recent explosive growth of the ETF industry.

In the past five years, the total amount of capital committed to ETFs has doubled to more than $3 trillion, while the number of ETFs has soared to well over 2,000.

In fact, there is now more money committed to ETFs than publicly listed single stocks!

While many individual investors say they are moving into ETFs to save on commissions and expenses, in fact, the opposite is true.

You just don't see them.

They are buried away in wide-dealing spreads and operating expenses buried deeply in prospectuses.

The net effect of the ETF industry is to greatly enhance Wall Street's take from their brokerage business, i.e., from YOU.

Every wonder why the shares of the big banks are REALLY trading at new multi-year highs?

I hate to say this, but I've seen this movie before.

Whenever a strategy becomes popular, it carries with it the seeds of its own destruction.

The most famous scare was the "Portfolio Insurance" of the 1980s, a proprietary formula sold to institutional investors that allegedly protected them by automatically selling in down markets.

Of course, once everyone was in the boat, the end result was the 1987 crash, which saw the Dow Average plunge 20% in one day.

The net effect was to maximize everyone's short positions at absolute market bottoms.

A lot of former portfolio managers started driving Yellow Cabs after that one!

I'll give you another example.

Until 2007, every computer model in the financial industry said that real estate prices only went up.

Trillions of dollars of derivative securities were sold based on this assumption.

However, all of these models relied on only 50 years' worth of data dating back to the immediate postwar era.

Hello subprime crisis!

If their data had gone back 70 years, it would have included the Great Depression.

The superior models would have added one extra proviso - that real estate can collapse by 90% at any time, without warning, and then stay down for a decade.

The derivate securities based on THIS more accurate assumption would have been priced much, much more expensively.

And here is the basic problem.

As soon as money enters a strategy, it changes the behavior of that strategy.

The more money that enters, the more that strategy changes, to the point where it produces the opposite of the promised outcome.

Strategies that attract only $10 million market-wide can make 50% a year returns or better.

But try and execute with $1 billion, and the identical strategies lose money. Guess what happens at $1 trillion?

This is why high frequency traders can't grow beyond their current small size on a capitalized basis, even though they account for 70% of all trading.

I speak from experience.

During the 1980s I used a strategy called "Japanese Equity Warrant Arbitrage," which generated a risk-free return of 30% a year or more.

This was back when overnight Japanese yen interest rates were at 6%, and you could buy Japanese equity warrants at parity with 5:1 leverage (5 X 6 = 30).

When there were only a tiny handful of us trading these arcane securities, we all made fortunes. Every other East End London kid was driving a new Ferrari (yes, David, that's you!).

At its peak in 1989, the strategy probably employed 10,000 people to execute and clear in London, Tokyo, and New York.

However, once the Japanese stock market crash began in earnest, liquidity in the necessary instruments vaporized, and the strategy became a huge loser.

The entire business shut down within two years. Enter several thousand new Yellow Cab drivers.

All of this means that the current indexing fad is setting up for a giant fall.

Except that this time, many managers are going to have to become Uber drivers instead.

Computers are great at purely quantitative analysis based on historical data.

Throw emotion in there anywhere, and the quants are toast.

And, at the end of the day, markets are made up of high emotional human beings who want to get rich, brag to their friends, and argue with their spouses.

In fact, the demise has already started.

Look no further than investment performance so far in 2018.

The (SPY) is up a scant 0% this year.

Amazon (AAPL), on the other hand, one of the most widely owned stocks in the world, is up an eye-popping 30%.

If you DON'T own Amazon, you basically don't HAVE any performance to report for 2017.

I'll tell you my conclusion to all of this.

Use a combination of algorithms AND personal judgment, and you will come out a winner, as I do. It also helps to have 50 years of trading experience.

You have to know when to tell your algorithm a firm "NO."

While your algo may be telling you to "BUY" ahead of a monthly Nonfarm Payroll Report or a presidential election, you may not sleep at night if you do so.

This is how I have been able to triple my own trading performance since 2015, taking my 2017 year-to-date to an enviable 20%.

It's not as good as being 30% invested in Amazon.

But it beats the pants off of any passive index all day long.

Yup, This is a Passive Investor

The Market Outlook for the Week Ahead, or Here Comes The Four Horsemen of the Apocalypse

Diary, Newsletter, Research

Have you liked 2018 so far?

Good.

Because if you are an index player, you get to do it all over again. For the major stock indexes are now unchanged on the year. In effect, it is January 1 once more.

Unless of course you are a follower of the Mad Hedge Fund Trader. In that case, you are up an eye-popping 19.75% so far in 2018. But more on that later.

Last week we caught the first glimpse in this cycle of the investment Four Housemen of the Apocalypse. Interest rates are rising, the yield on the 10-year Treasury bond (TLT) reaching a four-year high at 2.96%. When we hit 3.00%, expect all hell to break loose.

The economic data is rolling over bit by bit, although it is more like a death by a thousand cuts than a major swoon. The heavy hand of major tariff increases for steel and aluminum is making itself felt. Chinese investment in the US is falling like a rock.

The duty on newsprint imports from Canada is about to put what's left of the newspaper business out of business. Gee, how did this industry get targeted above all others?

The dollar is weak (UUP), thanks to endless talk about trade wars.

Anecdotal evidence of inflation is everywhere. By this I mean that the price is rising for everything you have to buy, like your home, health care, college education, and website upgrades, while everything you want to sell, such as your own labor, is seeing the price fall.

We're not in a recession yet. Call this a pre-recession, which is a long-leading indicator of a stock market top. The real thing shouldn't show until late 2019 or 2020.

There was a kerfuffle over the outlook for Apple (AAPL) last week, which temporarily demolished the entire technology sector. iPhone sales estimates have been cut, and the parts pipeline has been drying up.

If you're a short-term trader, you should have sold your position in April 13 when I did. If you are a long-term investor, ignore it. You always get this kind of price action in between product cycles. I still see $200 a share in 2018. This too will pass.

This month, I have been busier than a one-armed paper hanger, sending out Trade Alerts across all asset classes almost every day.

Last week, I bought the Volatility Index (VXX) at the low, took profits in longs in gold (GLD), JP Morgan (JPM), Alphabet (GOOGL), and shorts in the US Treasury bond market (TLT), the S&P 500 (SPY), and the Volatility Index (VXX).

It is amazing how well that "buy low, sell high" thing works when you actually execute it. As a result, profits have been raining on the heads of Mad Hedge Trade Alert followers.

That brings April up to an amazing +12.99% profit, my 2018 year-to-date to +19.75%, my trailing one-year return to +56.09%, and my eight-year performance to a new all-time high of 296.22%. This brings my annualized return up to 35.55% since inception.

The last 14 consecutive Trade Alerts have been profitable. As for next week, I am going in with a net short position, with my stock longs in Alphabet (GOOGL) and Citigroup (C) fully hedged up.

And the best is yet to come!

I couldn't help but laugh when I heard that Republican House Speaker Paul Ryan announced his retirement in order to spend more time with his family. He must have the world's most unusual teenagers.

When I take my own teens out to lunch to visit with their friends, I have to sit on the opposite side of the restaurant, hide behind a newspaper, wear an oversized hat, and pretend I don't know them, even though the bill always mysteriously shows up on my table.

This will be FANG week on the earnings front, the most important of the quarter.

On Monday, April 23, at 10:00 AM, we get March Existing-Home Sales. Expect the Sohn Investment Conference in New York to suck up a lot of airtime. Alphabet (GOOGL) reports.

On Tuesday, April 24, at 8:30 AM EST, we receive the February S&P CoreLogic Case-Shiller Home Price Index, which may see prices accelerate from the last 6.3% annual rate. Caterpillar (CAT) and Coca Cola (KO) report.

On Wednesday, April 25, at 2:00 PM, the weekly EIA Petroleum Statistics are out. Facebook (FB), Advanced Micro Devices (AMD), and Boeing (BA) report.

Thursday, April 26, leads with the Weekly Jobless Claims at 8:30 AM EST, which saw a fall of 9,000 last week. At the same time, we get March Durable Goods Orders. American Airlines (AAL), Raytheon (RTN), and KB Homes (KBH) report.

On Friday, April 27, at 8:30 AM EST, we get an early read on US Q1 GDP.

We get the Baker Hughes Rig Count at 1:00 PM EST. Last week brought an increase of 8. Chevron (CVX) reports.

As for me, I am going to take advantage of good weather in San Francisco and bike my way across the San Francisco-Oakland Bay Bridge to Treasure Island.

Good Luck and Good Trading.

Diving Back Into the (VIX)

Diary, Newsletter, Research

I think we are only days, at the most weeks, away from the next crisis coming out of Washington. It can come for any of a dozen different reasons.

Wars with Syria, Iran or North Korea. The next escalation of the trade war with China. The failure of the NAFTA renegotiation. Another sex scandal. The latest chapter of the Mueller investigation.

And then there's the totally unexpected, out of the blue black swan.

We are spoiled for choice.

For stock investors, it's like hiking on the top of Mount Whitney during a thunderstorm with a steel ice axe in hand.

So, I am going to buy some fire insurance here while it is on sale to protect my other long positions in technology and financial stocks.

Since April 1, the Volatility Index (VIX) has performed a swan dive from $26 to $15, a decline of 42.30%.

I have always been one to buy umbrellas during parched summers, and sun tan lotion during the frozen depths of winter. This is an opportunity to do exactly that.

Until the next disaster comes, I expect the (VXX) to trade sideways from here, and not plumb new lows. These days, a premium is paid for downside protection.

The year is playing out as I expected in my 2018 Annual Asset Class Review (Click here for the link.). Expect double the volatility with half the returns.

So far, so good.

If you don't do options buy the (VXX) outright for a quick trading pop.

You may know of the Volatility Index from the many clueless talking heads, beginners, and newbies who call (VIX) the "Fear Index."

For those of you who have a PhD in higher mathematics from MIT, the (VIX) is simply a weighted blend of prices for a range of options on the S&P 500 index.

The formula uses a kernel-smoothed estimator that takes as inputs the current market prices for all out-of-the-money calls and puts for the front month and second month expirations.

The (VIX) is the square root of the par variance swap rate for a 30-day term initiated today. To get into the pricing of the individual options, please go look up your handy-dandy and ever-useful Black-Scholes equation.

You will recall that this is the equation that derives from the Brownian motion of heat transference in metals. Got all that?

For the rest of you who do not possess a PhD in higher mathematics from MIT, and maybe scored a 450 on your math SAT test, or who don't know what an SAT test is, this is what you need to know.

When the market goes up, the (VIX) goes down. When the market goes down, the (VIX) goes up. Period.

End of story. Class dismissed.

The (VIX) is expressed in terms of the annualized movement in the S&P 500, which today is at $806.06.

So, for example, a (VIX) of $15.48 means that the market expects the index to move 4.47%, or 121.37 S&P 500 points, over the next 30 days.

You get this by calculating $15.48/3.46 = 4.47%, where the square root of 12 months is 3.46 months.

The volatility index doesn't really care which way the stock index moves. If the S&P 500 moves more than the projected 4.47%, you make a profit on your long (VIX) positions. As we know, the markets these tumultuous days can move 4.47% in a single day.

I am going into this detail because I always get a million questions whenever I raise this subject with volatility-deprived investors.

It gets better. Futures contracts began trading on the (VIX) in 2004, and options on the futures since 2006.

Since then, these instruments have provided a vital means through which hedge funds control risk in their portfolios, thus providing the "hedge" in hedge fund.

If you make money on your (VIX) trade, it will offset losses on other long positions. This is how the big funds most commonly use it.

If you lose money on your long (VIX) position, it is only because all your other long positions went up.

But then no one who buys fire insurance ever complains when their house doesn't burn down.

"Chance Favors the Prepared," said French scientist Louis Pasteur.

The Great American Jobs Mismatch

Diary, Newsletter, Research

With the Weekly Jobless Claims bouncing around a new 43-year low at 220,000, it's time to review the state of the US labor market.

Yes, I know this research piece isn't going to generate an instant Trade Alert for you.

But it is essential in your understanding of the big picture.

There are also thousands of students who read my website looking for career advice, and I have a moral obligation to read the riot act to them.

With a 4.1% headline unemployment rate, the US economy is now at its theoretical employment maximum. If you can't get a job now, you never will.

We may see a few more tenths of a percent decline in the rate from here, but no more. To get any lower than that you have to go all the way back to WWII.

Then there was even a shortage of one-armed, three-fingered, illiterate recruits with venereal disease, the minimum US Army recruitment standards of the day.

Speaking to readers across the country and perusing the Department of Labor data, I can tell you that not all is equal in the jobs market today.

You can blame America's halls of higher education, which are producing graduates totally out of sync with the nation's actual skills needs.

Take a look at this table of graduating majors to job offers, and you'll see what I am talking about:

Major - Job Offers Offered per Graduating Major

Computer Science - 21:1
Engineering - 15:1
Physical Sciences (oil) - 13:1
Humanities - 5:1
Business and accounting - 4:1
Economics - 4:1
Agriculture - 2:1
Education - 0.4:1
Health Sciences - 0.2:1

To clarify the above data, there are 21 companies attempting to hire each computer science graduate today, while there are five kids battling it out to get each job in Health Sciences.

To understand what's driving these massive jobs per applicant disparities, take a look at the next table nationally ranking graduating majors desired by corporations.

Graduating Majors Desired by Employers

81% - Business and Accounting
76% - Engineering
64% - Computer science
34% - Economics
21% - Physical Science
12% - Humanities
5% - Agriculture
2% - Health Science

There is something screamingly obvious about these numbers.

Colleges are not producing what employers want.

This is creating enormous imbalances in the jobs market.

It explains why computer science students are landing $150,000-a-year jobs straight out of school, complete with generous benefits and health care. Many employers in Silicon Valley are now offering to pay down student debt in order to get the most desirable candidates to sign a contract.

In the meantime, Health Sciences and Humanities graduates are lucky to land a $25,000-a-year posting at a nonprofit with no benefits and Obamacare. And there are no offers to pay down student debt, which can rise to as much as $200,000 for an Ivy League degree.

Agriculture grads usually go to work on a family farm, which they eventually inherit.

As a result of these dismal figures, the character of American education is radically changing.

With students now graduating with an average of $35,000 in debt, no one can afford to remain jobless upon graduation for long.

That's why the number of Humanities graduates has declined from 9% in 2012 to 6% today.

Colleges are getting the message. Since 1990, one-third of those with the words "liberal arts" in their name or prospectus have dropped the term.

Students who do stick with anthropology, philosophy, English literature, or history are learning a few tricks as well.

Add a minor in Accounting and Management and it will increase your first-year salary by $13,000. Toss in some Data Base Management skills, and the increase will be even greater.

And online marketing? The world is your oyster!

These realities have even come home to my own family.

I have a daughter working on a PhD in Education from the University of California, and the mathematics workload is enormous, especially in statistics.

It is all so she can qualify for government research grants upon graduation.

The students themselves are partly to blame for this mismatch.

While recruiters report an average of $45,000 a year as an average first year offer, the graduates themselves are expecting an average first-year income of $53,000.

Companies almost universally report that interviewees have a "bloated" sense of their own abilities, poor interviewing skills, and unrealistic pay expectations.

Some one-third of all applicants are unqualified for the jobs for which they are applying.

The good news is that everyone gets a job eventually. A National Association of Colleges and Employers survey says that companies plan to hire 5% more college graduates than last year.

And where do all of those Humanities grads eventually go.

A lot become financial advisors.

Just ask.

Sorry, STEM Students Only!

Why the Homebuilders Are Not Dead Yet

Diary, Newsletter, Research

It was as if someone had turned out the lights.

The homebuilders, after delivering one of the most prolific investment performance of any sector until the end of January, suddenly collapsed.

Since then, they have been dead as a door knob, flat on their backs, barely exhibiting a breath of life. While most of the market has since seen massive short covering rallies, the homebuilders have remained moribund.

The knee-jerk reaction has been to blame rising interest rates. But in fact, rates have barely moved since the homebuilders peaked, the 10-year US treasury yield remaining confined to an ultra-narrow tedious 2.72% to 2.95% yield.

The surprise Canadian limber import duty has definitely hurt, raising the price of a new home by an average of $3,000. But that is not enough to demolish the entire sector, especially given long lines at homebuilder model homes.

Are the homebuilders gone for good? Or are they just resting.

I vote for the later.

For years now, I have begged, pleaded, and beseeched readers to pour as much money as they can into residential real estate.

Investing in your own residence has generated far and away the largest returns on investment for the past five years, and this will continue for the next 10 to 15 years.

For we are still in the early innings of a major real estate boom.

A home you buy today could increase in value tenfold by 2030, and more if you do so on the high-growth coasts.

And while I have been preaching this view to followers for years, I have been assaulted by the slings and arrows of naysayers predicting that the next housing crash is just around the corner - only this time, it will be worse.

I have recently gained some important new firepower in my campaign.

My friends at alma mater UC Berkley (Go Bears!), specifically the Fisher Center for Real Estate and Urban Economics, have just published a report written by the Rosen Consulting Group that is blowing the socks off the entire real estate world.

The implications for markets, and indeed the nation as a whole, are nothing less than mind-blowing.

It's like having a Marine detachment of 155 mm howitzers suddenly come in on your side.

The big revelation is that only a few minor tweaks and massaging of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 could unleash a new tidal wave of home buyers that will send house prices, and the shares of homebuilders (ITB) ballistic.

The real estate industry would at last be restored to its former glory.

That's the happy ending. Now let's get down to the nitty gritty.

First, let's review the wreckage of the 2008 housing crash.

Real estate probably suffered more than any other industry during the Great Recession.

After all, the banks received a federal bailout, and General Motors was taken over by the Feds. Remember Cash for Clunkers?

No such luck with politically unconnected real estate agents and homebuilders.

As a result, private homeownership in the US has cratered from 69.2% in 2006 to 63.4% in 2016, a 50-year low.

Homeownership for married couples was cut from 84.1% to 79.6%.

Among major cities, San Diego led the charge to the downside, an area where minority and immigrant participation in the market is particularly high, with homeownership shrinking from 65.7% to a lowly 51.8%.

Home price declines were worse in the major subprime cities of Las Vegas, Phoenix, and Miami.

There were a staggering 9.4 million foreclosures during 2007-2014, with adjustable rate loans accounting for two-thirds of the total.

Some 8.7 million jobs were lost from 2007-2010, while the unemployment rate soared from 5.0% to 10%. The collapse in disposable income that followed made a rapid recovery in home prices impossible.

As a result, real estate's contribution to US GDP growth fell from 17.9% of the total to only 15.6% in 2016.

That is a big hit for the economy and is a major reason why growth has remained stuck in recent years at a 2% annual rate.

While the ruins were still smoking, Congress passed Dodd-Frank in 2010. The bill succeeded in preventing any more large banks from going under, with massive recapitalization requirements.

As a result, US banks are now the strongest in the world (and also a great BUY at these levels).

But it also clipped the banks' wings with stringent new lending restrictions.

I recently refinanced my homes to lock in 3% interest rates for the long term, since inflation is returning, and I can't tell you what a nightmare it was.

I had to pay a year's worth of home insurance and county property taxes in advance, which were then kept in an impound account.

I was forced to supply two years worth of bank statements for five different accounts.

Handing over two years worth of federal tax returns wasn't good enough.

To prevent borrowers from ginning up their own on TurboTax, a common tactic for marginal borrowers before the last crash, they must be independently verified with a full IRS transcript.

Guess what? A budget constrained IRS is remarkably slow and inefficient at performing this task. Three attempts are common, while your loan sits in limbo.

(And don't even think of asking for Donald Trump's return when you do this. They have NO sense of humor at the IRS!)

Heaven help you if you have a FICO score under 700.

I had to hand over a dozen letters of explanation dealing with assorted anomalies in my finances. My life is complicated.

Their chief goal seemed to be to absolve the lender from any liability whatsoever.

And here's the real killer.

From 2014, banks were forced to require from borrowers a 43% debt service to income ratio. In other words, your monthly interest payment, property taxes, and real estate taxes can't exceed 43% of your monthly gross income.

This hurdle alone has been the death of a thousand loans.

It is no surprise then that the outstanding balance of home mortgages has seen its sharpest drop in history, from $11.3 trillion to $9.8 trillion during 2008-2014. It is down by a third since the 2007 peak.

Loans that DO get done have seen their average FICO scores jump from 707 to 760.

Rocketing home prices are making matters worse, by reducing affordability.

Only 56% of the population can now qualify to buy the mean American home priced at $224,000, which is up 7.7% YOY.

Residential fixed investment is now 32% lower than the 2005 peak.

Also weighing on the market was a student loan balance that rocketed by 400% to $1.3 trillion since 2003. This eliminated a principal source of first-time buyers from the market, a major source of new capital at the low end.

Now for the good news.

Keep Dodd-Frank's capital requirements, but ease up on the lending standards only slightly, and all of the trends that have been a drag on the market quickly reverse.

And yes, some 2.3% in missing US GDP comes back in a hurry, and then some. That's a whole year's worth of economic growth at current rates.

Rising incomes generated by a full employment economy increase loan approvals.

Foreclosure rates will fall.

More capital will pour into homebuilding, alleviating severely constrained supply.

More investment in homes as inflation hedges steps up from here.

The entry of Millennials into the market in a serious way for the first time further increases demand.

Promised individual tax cuts will add a turbocharger to this market.

There is one way the Trump administration could demolish this housing renaissance.

If the deductibility of home mortgage interest from taxable income on Form 1040 Schedule "A" is cut back or eliminated to pay for tax cuts for the wealthy, a proposal now being actively discussed in the White House, the whole party is canceled.

The average American will lose his biggest tax break, and the impact on housing will be huge.

A continued war on immigrants will also hurt, which accounted for one-third of all new households from 1994-2015.

You see, we let them in for a good reason.

Assuming this policy self-inflicted wound doesn't happen, the entire homebuilding sector is a screaming "BUY."

On the menu are Toll Brothers (TOL), DH Horton (DHI), and Pulte Homes (PHM).

You can also add the IShares US Home Construction ETF (ITB), a basket of the leading homebuilding names (For the prospectus, click here.)

To read the UC Berkeley report in its entirety, entitled Homeownership in Crisis: Where Are We Now? a must for any serious real estate professional or investor, please download the PDF file for free by clicking here.

The bottom line here is that after a three-month break, the stirrings of a recovery in homebuilders may be just beginning.

Where It's Hot

It's Always Better on the Coasts