Research Archives

Market Outlook for the Week Ahead, or The Week That Washington Finally Mattered

After ignoring the constant chaos in Washington for 17 months, it finally mattered to the stock market.

Guess what was at the top of the list of retaliatory Chinese import duties announced last week?

California wine!

The great irony here is that half of the Napa Valley wineries are now owned by Chinese investors looking for a bolt-hole from their own government. Billionaires in China have been known to disappear into thin air.

And after years of trying, we were just getting Chinese consumers interested in tasting our fine chardonnays, merlots, and cabernet sauvignons.

It will be a slap in the face for our impoverished farmworkers who actually pick the grapes, who have just been getting back on their feet after last fall's hellacious fires.

Do you suppose they will call the homeless housing camps "Trumpvilles?"

California is on the front line of the new trade war with China.

Not only is the Middle Kingdom the largest foreign buyer of the Golden State's grapes, almonds, raisins, and nuts, it also is the biggest foreign investor, plowing some $16 billion in investments back here in 2016.

Down 1,700 Dow points on the week and a breathtaking 1,400 points in two days. It was the worst week for the markets in two years. And the technology and financial stocks suffered the worst spanking - the two market leaders. The most widely owned stocks are seeing the worst declines.

We certainly are paying the piper for our easy money made last year. The Dow Average is now a loser in 2018, off 4.1% and back to November levels.

The Dow 600 point "flash crash" we saw in the final two hours of trading on Friday was almost an exact repeat of the February 9 swoon that took us to the exact same levels.

There was no institutional selling. It was simply a matter of algorithms gone wild. The news flow that day was actually quite good.

Our favorite stock, Micron Technology (MU) announced blockbuster earnings and high target (for more depth, please read the Mad Hedge Technology Letter).

Dropbox (DBX) went public, and immediately saw its shares soar by 50% in the aftermarket. The president signed an emergency funding bill to keep the government open, despite repeated threats not to do so.

Which means the market fell not because of a fundamental change in the US economy. It is a market event, pure and simple.

I therefore expect a similar outcome. Only this time, we don't have an $8 billion unwind of the short volatility trade ($VIX) to deal with, as we did in February. That's why I thought markets would bottom at higher levels this time around.

There is only one problem with this theory.

The chaos, turmoil, and uncertainty in Washington is finally starting to exact a steep price on shareholders. Uncertain markets commend lower price earnings multiples than safer ones.

As a result, multiples are now 15% lower than the January high at 19.5X, and much more for individual stocks. And multiples have been falling even though earnings have been rising, quite substantially so. Such is the price of chaos.

Will markets bottom out here on a valuation basis as they did last time? Or will the continued destruction of our democracy command a higher price? We will find out soon.

Clearly the S&P 500 200-day moving average at $255.95 is crying out for a revisit, which we probably will see first thing Monday morning. Allow more shorts to get sucked in, and then you probably have a decent entry point to buy stocks for the rest of 2018.

Indeed, it was a week when the black swans alighted every day. First, the twin hits from Facebook (FB), followed by the worst trade war in eight decades. Then came the Chinese retaliation.

While the damage suffered so far has been limited, investors are worried about what is coming next.

One of the last supervising adults left the White House, my friend and comrade in arms, National Security Advisor H.R. McMaster. His replacement is Fox News talk show host John Bolton, who is openly advocating that the US launch a pre-emptive nuclear strike against North Korea.

Bolton has quite a track record. He is the guy who talked President Bush into invading Iraq. Now, that would trigger a new bear market in the extreme!

As I did not predict five black swans in five days, the Mad Hedge Trade Alert Service took a hit this week, backing off of fresh all-time highs.

The trailing 12-month return fell to 46.49%, the 8-year return to 284.01%, bringing the annualized average return down to only 34.08%.

Given all of the above, economic data points for the coming holiday shorted trading week seem almost quaintly irrelevant. But I'll give them to you anyway.

On Monday, March 26, at 10:30 AM, we get the February Dallas Fed Manufacturing Survey.

On Tuesday, March 27, at 9:00 AM, we receive an update on the all-important CoreLogic Case-Shiller National Home Price NSA Index for January. A 3-month lagging housing indicator.

On Wednesday, March 28, at 8:30 AM EST, the second read of Q1 GDP comes out.

Thursday, March 29, leads with the Weekly Jobless Claims at 8:30 AM EST, which hit a new 49-year low last week at an amazing 210,000. At 9:45 AM, we get the February Chicago Purchasing Managers Index. At 1:00 PM, we receive the Baker-Hughes Rig Count, which saw a small rise of three last week.

On Friday, March 30, the markets are closed for Good Friday.

As for me, I'll be doing my Christmas shopping early this year before the new Chinese import tariffs jack up the price for everything by 15% to 25%.

I'll be doing all of this courtesy of Amazon (AMZN), of course. Since I arrived here at Lake Tahoe, it has snowed 6 feet in two days in a storm of truly biblical proportions. We got a total of 18 feet of snow in March. By the time I dig out, it will be time to go home.

Good luck and good trading.

John Thomas

The Value Case for Facebook

Diary, Newsletter, Research

When it rains, it pours.

That is how Facebook founder Mark Zuckerberg must feel after suffering two black swans in two days.

First came the disclosures that a client, Cambridge Analytica, used the information from 50 million Facebook users to help the Russians influence the 2016 presidential election.

Today, we learned that the company is being investigated by the Federal Trade Commission for failure to keep customer information private.

As a result, the company has lost all of its 2018 year-to-date stock performance, and is now taking a big bite out of 2017.

The question now arises, what should you do about all of this as the educated investor?

Facebook is one of the most widely owned companies in the world, right after Apple (AAPL). It often is the largest single position of many major institutional investors. And there isn't one that isn't salivating at adding to its position at fire-sale prices.

For the first time in ages, Facebook is now selling at a screaming discount to the main market, with a PE multiple of only 16.5X at today's low, compared to 19X, and 14.5X if you strip out cash on the balance sheet. Facebook has in effect become another Apple (AAPL) in valuation terms.

Fundamentals have not changed. Some 66% of advertisers say they will increase their spend over the next year.

Regulatory fear is overdone, and it is difficult to imagine in what form that such regulation would take. What, an (FB) friend tax on your account? I would go broke.

If anything, more regulation could be a net positive for (FB), as it creates a deeper moat with which it can protect and grow its business. For more depth on this topic please read today's issue of the Mad Hedge Technology Letter.

The barriers to entry for new competitors, already huge, are about to become insurmountable.

The worst case is that founder Mark Zuckerberg may have to undergo an unpleasant appearance in front of the technophobes in congress.

The company is growing at a compound 30% annual rate and is far and away the dominant player in a deeply moated space. In other words, it is still a company whose shares you should die for.

We'll know for sure when the company gives its Q1, 2018 earnings report after the market close on May 2.

In Q4, 2017 it announced an earnings per share of $2.21, a beat of 26% over analyst expectations. Revenues rose by an eye-popping 47.2% to $12.97 billion for the quarter YOY, a beat of $420 million.

Full year 2017 free cash flow came to $17 billion. Q4 operating income came to $7.4 billion representing a 53% profit margin.

Some 89% of the company's ad revenues came through mobile phones.

There are now 2.1 billion people using Facebook, and 1.1 billion on a daily basis. Some 700 million come to the site daily to buy and sell things through Facebook market.

Its WhatsApp subsidiary has 1.5 billion users who transmit 60 billion messages a day.

Its Oculus Rift entry in the virtual reality gaming space, to which my own kids are hopelessly addicted, is the front-runner in the field.

You might want to wait for the smoke to clear and the dust to settle. However, right here right now at $162 a share it would be perfect for your long-term "buy and forget" portfolio, not only for you and your kids, but for your grandkids as well.

I'm Willing to Bet on the Zuk

What Almonds Say About the Global Economy

Diary, Newsletter, Research

Yes, that's right, you read it correctly, almonds.

By now, many of you have figured out that I like calling my paid subscribers to find out how they find the service. I always ask for suggestions for improvements. Then I ask what they do besides trade the markets.

I get an amazing array of answers. One reader flew helicopters in Alaska to inspect oil pipelines, executing trades on his cell phone in between flights. Another ran a Russian hedge fund in Moscow.

The sheep farmer in Australia relied on me as his connection with the rest of the world. The family office in Spain valued my American view of the world.

Then I called a subscriber in Modesto, Calif., who said he was in the almond business.

My interest piqued, so I proceeded to grill him. And with that, I obtained a fascinating insight into an obscure corner of the global economy.

If you thought marijuana, estimated by the Drug Enforcement Administration to be at $6 billion a year, was California's largest cash crop, you'd be wrong.

Grapes used to be our largest legal crop, at $5 billion a year. But almonds will beat all this year, possibly reaching as high at $8 billion.

You can blame the six-year California drought, which was then followed by a year of flooding of biblical proportions.

This has driven the price of almonds from $1/pound a few years ago to as much as $4/pound today.

The price spike has ignited fierce water wars across the state, with increasingly desperate farmers battling over an ever-diminishing commodity.

Those located in the eastern half of the Central Valley (which you will remember from your freshman English class in The Grapes of Wrath) are sitting pretty.

They have long-term contracts to buy water from federal public works projects at subsidized prices that date back to the Great Depression.

These rights can make or break the value of a farm, and are passed down from one generation to the next.

The eastern half of the valley is another story. When construction of Interstate 5 was completed in 1979, most of it was still barren desert, a rain shadow effect of the state's coastal mountain range.

Only the oil industry was there in force, especially around the Elk Hills oil find (watch the Daniel Day Lewis movie, There Will Be Blood). I know because my grandfather worked there for Standard Oil during the 1920s.

So when large-scale farming developed there during the 80s, they had to buy water on the spot market.

The problem is that during a drought, there is very little water for sale. So parched farmers have turned to drilling to irrigate their fields.

This has led to an even bigger headache. In the 19^th century, you could drill 100 feet and find all the water you wanted.

Today, they have to go as deep as 1,200 feet, and even these ancient deep aquifers are drying up. And that's assuming you have the $1 million it costs to drill such a well.

Indeed, the elevation of the Central Valley has fallen by 10 feet over the past century because of the underground water that has been withdrawn so far.

Destruction of rural buildings through catastrophic subsidence is becoming widespread.

The only alternative is to let your crops die. You see this in abundance while making the drive from San Francisco to Los Angeles, withered trees frozen in tortured and grotesque death throes.

Also plentiful are irate billboards attacking the government for depriving local farmers of their cheap water.

Even if you have plenty of water, it is still not smooth sailing in the almond business these days.

China is the world's largest buyer of almonds. The demand there has been so great that the Chinese have become major buyers of almond farms throughout the state, at premium prices.

However, the Middle Kingdom's recent anticorruption campaign is starting to take a big bite out of sales.

In years past, individuals would buy dozens of boxes of almond cookies to pass out to friends, customers, employers, government officials and regulators during the Lunar New Year celebrations.

Not so today. The difference has led to the cancellation of a few shiploads of the prized nuts.

My friend kindly invited me to tour his roasting and packaging facilities the next time I was in the neighborhood.

I was left thinking, this really is a global economy that is so integrated that, when a butterfly flaps its wings in Brazil, it causes a typhoon in Japan.

It also is a great example of how information about one asset class can provide insights about all the others.

With that, I opened a fresh bag of healthy unprocessed Nut Up almonds that I picked up at Save Mart and grabbed a fresh handful. I hear they're going to sponsor a NASCAR driver soon to bring healthy food to the hinterlands.

Another Batch for China

America's Native Indian Economy

Diary, Newsletter, Research

When I was remodeling my 160-year-old London house years ago, the chimney was in desperate need of attention. After the chimney sweep crawled up the fireplace (yes, they still have them), he found a yellowed and somewhat singed envelope addressed to Santa Claus.

Thinking it was placed there by my kids, he handed it over to me. In it was a letter penned in a childlike scrawl, written with a quill and ink, dated Christmas, 1910, asking for a Red Indian suit.

Europeans have long had a fascination with our Native Americans. So, in preparation for my upcoming European strategy luncheon tour, I thought I would get myself up to date about our earliest North American residents.

Business is booming these days on Indian reservations, or it isn't, depending on where they live.

Of the country's 565 reservations, some 239 have moved into the casino business and the cash flow has followed.

In 2010, Indian gaming reaped some $26.7 billion in revenues, or some $9,275 per indigenous native. That is a stunning 44% of America's total casino revenues.

Some, like the Pequot tribe's massive Foxwoods operation just two hours from New York City, now the world's largest casino, once had money raining down upon it.

But the casino grew so large that it entirely occupied the diminutive Connecticut reservation allocated to it by an obscure 17^th century treaty.

During the salad days, the profits were so enormous that an annual $250,000 stipend was paid to each officially registered tribal member.

A poker boom helped. No surprise that the tribe grew from 167 to 665 members during the past 30 years.

Today, the operation is burdened with $2.5 billion in debt, thanks to some bad investments and an ill-timed expansion.

Casinos in more rural locations in the far west, distant from population centers, have fared less well.

Those that contracted out for professional management from Las Vegas and Atlantic City firms, such as Harrah's, MGM and Caesars, earn a modest living.

But the reservations attempting local management on their own fall victim to inefficiencies, incompetence, corruption, nepotism, over hiring of locals and outright theft.

Believe it or not, it is possible to lose money in the casino business, and some have had to shut down.

Overbuilding is another problem. In northern New Mexico you can find several casinos within five miles of each other competing for the same customers. Most of their clients (read losers) are in fact local tribal members, the same individuals these houses are intended to help.

The 326 tribes that avoided the casino industry do so at the cost of a big hit to their standard of living.

That explains why Native American median household income reaches only $35,062, compared to $50,046 for the US as a whole. Many, such as the numerous Hopi, shun it because of their religion.

Without gambling there are few economic opportunities on the reservations, which is why they were given the land in the first place.

The parched conditions of the west limit farming. Unemployment runs as high as 80% on some reservations, such as the White Mountain Apaches.

As a result, a high proportion of the country's 2.9 million Native Americans are wards of the federal government, living on food stamps and other government handouts.

That's not how it was supposed to be. The first modern reservation was set up for the Navajo tribe in 1851 at a baking hellhole on the Pecos River, with the intention of enforcing a primitive form of apartheid to ensure their survival.

The legendary scout Kit Carson was hired to herd the hapless Indians to their new home.

He did it by burning all the crops in their homelands and cutting down every tree.

Because they surrendered early rather than fight, today they are the most populous tribe, with 160,000, owning the largest reservation, at 24,000 square miles, mostly in Arizona.

Those who signed treaties early survived, which gave them status as an independent nation but ceded all matters regarding defense to the federal government.

In fact the Iroquois, Sioux, and the Chippewa separately declared war on Germany during WWII. Some even issued their own passports to attend the last Olympics. Those who didn't had to settle for much smaller reservations, or got wiped out.

In 1975, congress passed the Indian Self-Determination and Education Assistance Act, which devolved power from the government to the tribes.

Florida's Seminole tribe won the right in court to open a casino in 1981, which was confirmed by the Supreme Court in 1987. After that, it was off to the races, with Indian bingo parlors sprouting across the country.

During the 19^th century Indian wars when hundreds of thousands died, the practice was to attack a wagon train, kill all the men, marry the women and adopt the children.

As a result, I am descended from three different tribes, the Delaware, Sioux, and the Cherokee, as are about a quarter of native Californians my age. So I tried to cash in on government largess by applying for tribal scholarships to go to college.

It was to no avail. Only those who can trace their lineage to a 1941 Bureau of Indian Affairs census and are one-eighth Native American can qualify.

When whites married Indians 150 years ago, the common practice was to baptize them and give them western names, obliterating their true heritage.

They were also pretty casual with marriage records in the Wild West. Jumping over a broom doesn't exactly make it into the county records. But we still have many of the wedding photos, and it's clear who they are.

I never did find out if that little boy got his Red Indian suit for Christmas, but I hope he did.

So, Should I Double Down?

Notice to Military Subscribers

Diary, Newsletter, Research

To the dozens of subscribers in Afghanistan and the surrounding ships at sea, thank you for your service!

I think it is very wise to use your free time to read my letter and learn about financial markets in preparation for an entry into the financial services when you muster out.

Nobody is going to call you a baby killer and shun you, as they did when I returned from Southeast Asia four decades ago. In fact, employers have been given fantastic tax breaks and other incentives to hire you.

I have but one request. No more subscriptions with .mil addresses, please. The Defense Department, the CIA, the NSA, Homeland Security, and the FBI do not look kindly on private newsletters entering the military network, even the investment kind.

If you think civilian spam filters are tough, watch out for the military kind! And no, I promise that there are no secret messages embedded with stock tips. "BUY" really does mean "BUY." "Sel" means "Sell" too.

If I did not know the higher ups at these agencies, as well as the Joint Chiefs of Staff, I might be bouncing off the walls in a cell at Guantanamo by now wearing an orange jumpsuit.

It also helps that many of the mid-level officers at these organizations have made a fortune with their meager government retirement funds following my advice. All I can say is that if the Baghdad Stock Exchange ever becomes liquid, I'm going to own it.

Where would you guess the greatest concentration of readers of The Diary of a Mad Hedge Fund Trader is found? New York? Nope. London? Wrong. Chicago? Not even close. Try a ten-mile radius centered around Langley, Virginia, by a large margin.

The funny thing is, half of the subscribing names coming in are Russian. I haven't quite figured that one out yet. Did we hire the entire KGB at the end of the cold war? If we did, it was a great move. Those guys were good. That includes you, Yuri.

So keep up the good work, and fight the good fight. But please, only subscribe to my letter with personal Gmail, Yahoo, or Hotmail addresses. That way my life can become a lot more boring.

Oh, and by the way, Langley, you're behind on your bill. Please pay up, pronto, and I don't want to hear whining about any damn budget cuts!

I Want My Mad Hedge Fund Trader!

Short Selling School 101

Diary, Newsletter, Research

With the stock market falling for the next few weeks, or even months, it's time to rehash how to profit from falling markets one more time.

There is nothing worse than closing the barn door after the horses have bolted.

No doubt, you will receive a wealth of short selling and hedging ideas from your other research sources and the media at the next market bottom. That is always how it seems to play out.

So I am going to get you out ahead of the curve, putting you through a refresher course on how to best trade falling markets now.

Market's could be down 10% by the time this is all over.

THAT IS MY LINE IN THE SAND!

There is nothing worse than fumbling around in the dark looking for the matches after a storm has knocked the power out.

I'm not saying that you should sell short the market right here. But there will come a time when you will need to do so. Watch my Trade Alerts for the best market timing. So here are the best ways to profit from declining stock prices, broken down by security type:

Bear ETFs

Of course the granddaddy of them all is the ProShares Short S&P 500 Fund (SH), a non leveraged bear ETF that is supposed to match the fall in the S&P 500 point for point on the downside. Hence, a 10% decline in the (SPY) is supposed to generate a 10% gain the in the (SH).

In actual practice, it doesn't work out like that. The ETF has to pay management operating fees and expenses, which can be substantial. After all, nobody works for free.

There is also the "cost of carry," whereby owners have to pay the price for borrowing and selling short shares. They are also liable for paying the quarterly dividends for the shares they have borrowed, around 2% a year. And then you have to pay the commissions and spread for buying the ETF.

Still individuals can protect themselves from downside exposure in their core portfolios through buying the (SH) against it (click here for the prospectus). Short selling is not cheap. But it's better than watching your gains of the last seven years go up in smoke.

Virtually all equity indexes now have bear ETF's. Some of the favorites include the (PSQ), a short Play on the NASDAQ (click here for the prospectus), and the (DOG), which profits from a plunging Dow Average (click here for the prospectus).

My favorite is the (RWM) a short play on the Russell 2000, which falls 1.5X faster than the big cap indexes in bear markets (click here for the prospectus).

Leveraged Bear ETFs

My favorite is the ProShares Ultra Short S&P 500 (SDS), a 2X leveraged ETF (click here for the prospectus). A 10% decline in the (SPY) generates a 20% profit, maybe.

Keep in mind that by shorting double the market, you are liable for double the cost of shorting, which can total 5% a year or more. This shows up over time in the tracking error against the underlying index. Therefore, you should date, not marry, this ETF or you might be disappointed.

3X Leveraged Bear ETFs

The 3X bear ETFs, like the UltraPro Short S&P 500 (SPXU), are to be avoided like the plague (click here for the prospectus).

First, you have to be pretty good to cover the 8% cost of carry embedded in this fund. They also reset the amount of index they are short at the end of each day, creating an enormous tracking error.

Eventually, they all go to zero, and have to be periodically redenominated to keep from doing so. Dealing spreads can be very wide, further added to costs.

Yes, I know the charts can be tempting. Leave these for the professional hedge fund intra day traders they are meant for.

Buying Put Options

For a small amount of capital, you can buy a ton of downside protection. For example, the April (SPY) $182 puts I bought for $4,872 allowed me to sell short $145,600 worth of large cap stocks at $182 (8 X 100 X $6.09).

Go for distant maturities out several months to minimize time decay and damp down daily price volatility. Your market timing better be good with these, because when the market goes against you, put options can go poof, and disappear pretty quickly.

That's why you read this newsletter.

Selling Call Options

One of the lowest risk ways to coin it in a market heading south is to engage in "buy writes." This involves selling short call options against stock you already own, but may not want to sell for tax or other reasons.

If the market goes sideways, or falls, and the options expire worthless, then the average cost of your shares is effectively lowered. If the shares rise substantially they get called away, but at a higher price, so you make more money. Then you just buy them back on the next dip. It is a win-win-win.

I'll give you a concrete example. Let's say you own 100 shares of Apple (AAPL), which closed on Friday at $95.13, worth $9,513. If you sell short 1 July, 2016 $100 call at $1.30 against them, you take in $130 in premium income ($1.30 X 100 because one call option contract is exercisable into 100 shares).

If Apple closes below $100 on the July 15, 2016 expiration date, the options expire worthless and you keep your stock and the premium. You are then free to repeat the strategy for the following month. If (AAPL) closes anywhere above $100 and your shares get called away, you still make money on the trade.

Selling Futures

This is what the pros do, as futures contracts trade on countless exchanges around the world for every conceivable stock index or commodity. It is easy to hedge out all of the risk for an entire portfolio of shares by simply selling short futures contracts for a stock index.

For example, let's say you have a portfolio of predominantly large cap stocks worth $100,000. If you sell short 1 June, 2016 contract for the S&P 500 against it, you will eliminate most of the potential losses for your portfolio in a falling market.

The margin requirement for one contract is only $5,000. However if you are short the futures and the market rises, then you have a big problem, and the losses can prove ruinous.

But most individuals are not set up to trade futures. The educational, financial, and disclosure requirements are beyond mom and pop investing for their retirement fund.

Most 401ks and IRAs don't permit the inclusion of futures contracts. Only 25% of the readers of this letter trade the futures market. Regulators do whatever they can to keep the uninitiated and untrained away from this instrument.

That said, get the futures markets right, and it is the quickest way to make a fortune, if your market direction is correct.

Buying Volatility

Volatility (VIX) is a mathematical construct derived from how much the S&P 500 moves over the next 30 days. You can gain exposure to it through buying the iPath S&P 500 VIX Short Term Futures ETN (VXX), or buying call and put options on the (VIX) itself.

If markets fall, volatility rises, and if markets rise, then volatility falls. You can therefore protect a stock portfolio from losses through buying the (VIX).

I have written endlessly about the (VIX) and its implications over the years. For my latest in-depth piece with all the bells and whistles, please read Buy Flood Insurance With the (VXX)by clicking here.

Selling Short IPO's

Another way to make money in a down market is to sell short recent initial public offerings. These tend to go down much faster than the main market. That's because many are held by hot hands, known as "flippers", and don't have a broad institutional shareholder base.

Many of the recent ones don't make money and are based on an, as yet, unproven business model. These are the ones that take the biggest hits.

Individual IPO stocks can be tough to follow to sell short. But one ETF has done the heavy lifting for you. This is the Renaissance IPO ETF (click here for the prospectus).

Buying Momentum

This is another mathematical creation based on the number of rising days over falling days. Rising markets bring increasing momentum, while falling markets produce falling momentum.

So selling short momentum produces additional protection during the early stages of a bear market. Blackrock has issued a tailor made ETF to capture just this kind of move through its iShares MSCI Momentum Factor ETF (MTUM). To learn more, please read the prospectus by clicking here .

Buying Beta

Beta, or the magnitude of share price movements, also declines in down markets. So selling short beta provides yet another form of indirect insurance. The PowerShares S&P 500 High Beta Portfolio ETF (SPHB) is another niche product that captures this relationship.

The Index is compiled, maintained and calculated by Standard & Poor's and consists of the 100 stocks from the (SPX) with the highest sensitivity to market movements, or beta, over the past 12 months.

The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November. To learn more, read the prospectus by clicking here.

Buying Bearish Hedge Funds

Another subsector that does well in plunging markets are publicly listed bearish hedge funds. There are a couple of these that are publicly listed and have already started to move.

One is the Advisor Shares Active Bear ETF (HDGE) (click here for the prospectus). Keep in mind that this is an actively managed fund, not an index or mathematical relationship, so the volatility could be large.

Oops, Forgot to Hedge

The Passive/Aggressive Portfolio

Diary, Newsletter, Research

What if you want to be a little more aggressive with your investment strategy, say twice as aggressive? What if markets don't deliver any year on year change?

Then you need a little more pizzazz in your portfolio, and some extra leverage to earn your crust of bread and secure your retirement.

It turns out that I have just the solution for you. This would be my "Passive/Aggressive Portfolio".

I call it passive in that you just purchase these positions and leave them alone and not trade them. I call it aggressive as it involves a basket of 2x leveraged ETF's issued by ProShares, based Bethesda, MD (click here for their link).

The volatility of this portfolio will be higher. But the returns will be double what you would get with an index fund, and possibly much more. It is a "Do not open until 2035" kind of investment strategy.

Here is the makeup of the portfolio:

(ROM) - ProShares Ultra Technology Fund - The three largest single stock holdings are Apple (AAPL), Microsoft (MSFT), and Facebook (FB). It was up 80.95% last year. For more details on the fund, please click here.

(UYG) - ProShares Ultra Financials Fund - The three largest single stock holdings are Wells Fargo (WFC), Berkshire Hathaway (BRK.B), and JP Morgan Chase (JPM). It was up 38.42% last year. For more details on the fund, please click here.

(UCC) - ProShares Ultra Consumer Services Fund - The three largest single stock holdings are Amazon (AMZN), Walt Disney (DIS), and Home Depot (HD). It was up 3.71% last year. For more details on the fund, please click here.

(DIG)- ProShares Ultra Oil & Gas Fund - The three largest single stock holdings are ExxonMobil (XOM), Chevron (CVX), and Schlumberger (SLB). It was DOWN 9.20% last year. For more details on the fund, please click here.

(BIB) - ProShares Ultra NASDAQ Biotechnology Fund - The three largest single stock holdings are Amgen (AMGN), Regeneron (REGN), and Gilead Sciences (GILD). It was up 40.49% last year, please click here.

You can play around with the sector mix at your own discretion. Just focus on the fastest growing sectors of the US economy, which the Mad Hedge Fund Trader does on a daily basis.

It is tempting to add more leveraged ETF's for sectors like gold (UGL), to act as an additional hedge.

There is also the 2X short Treasury bond fund (TBT), which I have been trading in and out of for years, a bet that long-term bonds will go down, interest rates rise.

There are a couple of provisos to mention here.

This is absolutely NOT a portfolio you want to own going into a recession. So, you will need to exercise some kind of market timing, however occasional.

The good news is that I make more money in bear markets than I do in bull markets because the volatility is so high. However, to benefit from this skill set, you have to keep reading the Diary of a Mad Hedge Fund Trader.

There is also a problem with leveraged ETF's in that management and other fees can be high, dealing spreads wide, and tracking error huge.

This is why I am limiting the portfolio to 2X ETF's, and avoiding their much more costly and inefficient 3X cousins, which are really only good for intraday trading. The 3X ETF's are really just a broker enrichment vehicle.

There are also going to be certain days when you might want to just go out and watch a long movie, like Gone With the Wind, with an all ETF portfolio, rather than monitor their performance, no matter how temporary it may be.

A good example was the flash crash, when the complete absence of liquidity drove all of these funds to huge discounts to their asset values.

Check out the long-term charts, and you can see the damage that was wrought by high frequency traders on that cataclysmic day, down -53% in the case of the (ROM). Notice that all of these discounts disappeared within hours. It was really just a function of the pricing mechanism being broken.

I have found the portfolio above quite useful when close friends and family members ask me for stock tips for their retirement funds.

It was perfect for my daughter, who won't be tapping her teacher's pension accounts for another 45 years, when I will be long gone. She mentions her blockbuster returns every time I see her, and she has only been in them for five years.

Imagine what technology, financial services, consumer discretionaries, biotechnology, and oil and gas will be worth then? It boggles the mind. My guess is up 100-fold from today's levels.

You won't want to put all of your money into a single portfolio like this. But it might be worth carving out 10% of your capital and just leaving it there.

That will certainly be a recommendation for financial advisors besieged with clients complaining about paying high fees for negative returns in a year that is unchanged, or up only 1%-2%. Virtually everyone has them right now.

Adding some spice, and a little leverage to their portfolios might be just the ticket for them.

It's Time to Spice Up Your Portfolio

China's Coming Demographic Nightmare

Diary, Newsletter, Research

Now that China has ended its "One Child" policy, it is time to assess its long-term costs.

Adopted 33 years ago, there are now 32 million more boys under the age of 20 than girls.

Large scale interference with the natural male:female ratio has been tracked with some fascination by demographers for years, and is constantly generating unintended consequences.

Until early in the last century, starving rural mothers abandoned unwanted female newborns in the hills to be taken away by "spirits."

Today, pregnant women resort to the modern-day equivalent by getting ultrasounds and undergoing abortions when they learn they are carrying girls.

Millions of children are "little emperors," spoiled male-only children who have been raised to expect the world to revolve around them.

The resulting shortage of women has led to an epidemic of "bride kidnapping" in surrounding countries. Stealing of male children is widespread in Vietnam, Cambodia, Laos, and Mongolia.

The end result has been a barbell shaped demographic curve unlike that seen in any other country. The Beijing government says the program has succeeded in bringing the fertility rate from 3.0 down to 1.8, well below the 2.1 replacement rate.

As a result, the Middle Kingdom's population today is only 1.3 billion instead of the 1.6 billion it would have been.

Political scientists have long speculated that an excess of young men would lead to more bellicose foreign policies by the Middle Kingdom. But so far the choice has been for commerce, to the detriment of America's trade balance and Internet security.

In practice, the one child policy has only been applied to those who live in cities or have government jobs. That is about two thirds of the population.

On my last trip to China I spent a weekend walking around Shenzhen city parks. The locals doted over their single children, while visitors from the countryside played games with their three, four, or five children. The contrast couldn't have been more bizarre.

Economists now wonder if the practice will also understate China's long-term growth rate. Parents with boys tend to be bigger savers, so they can help sons with the initial big-ticket items in life, like an education, homes, and even cars.

The end game for this policy has to be the Japan disease; a huge population of senior citizens with insufficient numbers of young workers to support them. The markets won't ignore this.

In the latest round of reforms announced by the Chinese government was the demise of the one child policy. But no matter how hard you try, you can't change the number of people born 30 years ago.

The boomerang effects of this policy could last for centuries.

Trading the Kennedy Assassination

Diary, Newsletter, Research

Passing through Dallas, Texas on the way to my Strategy luncheon, I couldn't help but remember the assassination of president John F. Kennedy, on November 22, 1963, over 50 years ago.

The tragedy offers valuable lessons for today's traders, although we have to travel a circuitous route to get there.

It was one of those epochal events, where people remember exactly what they were doing when they heard the news, like the 1942 Japanese attack on Pearl Harbor, and the 9/11 attacks on the World Trade Center.

During the middle of my 5^th grade class there was a school wide announcement that the president had been shot while campaigning in Dallas, Texas, but was still alive. Hours later, we were told he was dead. The teachers started crying, and we were all sent home.

For the rest of the week, we were transfixed by the tumultuous events on our black and white, rabbit eared television sets. Lyndon Johnson was sworn in as president on Air Force One. Lee Harvey Oswald was arrested. Then nightclub owner Jack Ruby shot him in a Dallas jail.

It was all so surreal, witnessing history unfold before you. I remember that my dad told me this all might be a prelude to a military coup d' etat, or a Soviet nuclear attack, and that we should be prepared for the worst.

Our stockpile of canned food to feed our family of nine from the previous year's Cuban Missile Crisis was still in its cases. So were the boxes of ammunition. Those were scary times.

It seemed like the country went to pieces after that. The Vietnam War ramped up, igniting huge national demonstrations. Some 60,000 of our guys died, including three from my high school graduating class.

Race riots followed, setting cities on fire. I got caught in the ones in Los Angeles and Detroit. Then came the Oil Crisis, Watergate, and the Iran Hostage Crisis.

Things didn't get back to normal until the 1980's, and guess what? The stock market started going up, and I got into the hedge fund business.

The Kennedy assassination sparked an entire industry of conspiracy theorists, armchair historians, and assorted nut jobs, whose mission was to debunk the conclusions of the Warren Report.

Thousands of books were published, and even more lectures delivered. It inspired us all to distrust our government.

After all, we were told that Oswald made an impossible shot, and only a "magic bullet" could achieve what the report claimed. Witnesses died like flies, against all actuarial probability. The old Italian rifle he used to commit the crime was impossibly flawed.

I tended to believe the version that was taught in California state textbooks as late as the 1990s, that Kennedy was the victim of either a CIA, Mafia, or Cuban plot. The Hollywood director, Oliver Stone, fanned the flames with his 1991 film, JFK.

Then one day during the late eighties, while visiting big oil clients for Morgan Stanley, I found myself with a couple of free hours to kill in Dallas, Texas. I took a taxi to the Texas School Book Depository on Elm Street, now a museum.

It was a weekday, and I was the only visitor. So I took the elevator up to the 6^th floor. There, at a corner window, cases of books were set up exactly as Oswald had placed them on that fateful day.

I looked around, saw no one else, and then deftly stepped over the rope that barred public access.

It turned out that I shared some personal history with Lee Harvey Oswald. We had both been in the Marine Corps, and obtained a marksman's rating, which earned you a few extra dollars a month.

He had also been stationed in Japan a few years before, at a base I knew well. So I had always been curious about Oswald's incredible shot.

I sat down in the exact spot that Oswald had and watched the traffic below. At 62 feet away, the cars were moving at 8 miles per hours, the same speed as the Kennedy motorcade. Then it hit me.

This was not an impossible shot. This was not even a hard shot. I could make this shot. In fact, half the Marines who went through basic training at Camp Pendleton could have made this shot on a bad day with a stiff wind.

It was a revelation.

It meant that the Warren Report was right. Oswald was the single shooter. It meant that all of the conspiracy theories I had heard about over the decades were lies.

Not only that, I also realized then that all conspiracy theories about everything were untrue, usually manufactured by people with ulterior motives, almost always driven by the desire to make money. The level of cooperation required between large numbers of people is far too improbable.

After that, theories about the Kennedy assassination started to unravel. During the 1990s, the investigative TV program, 60 minutes, got several professional marksmen to easily replicate Oswald's feat of getting off three shots with the same antiquated bolt action rifle in less than three seconds.

After a deal with congress in 1992, the government released 5 million pages of evidence on which the Warren Report conclusion was based, which had previously been secret (click here for the National Archives link).

We obtained hours of classified testimony from Marina Oswald, Lee Harvey's Russian wife, about how troubled the man was.

We discovered that a dozen people saw a man with a rifle in the window of the Book Depository minutes before Kennedy was due to pass by. They screamed at the police to intervene, but none could hear them over the noise.

The fourth shot from the "grassy knoll" recorded over a police radio with a broken microphone button turned out to be an echo off a building.

The FBI was aware that Oswald had taken a shot at the home of an army general only months before. A memo warning the Secret Service of the threat was found crumpled up in a Dallas agent's desk drawer.

The Kennedy assassination has become a favorite topic of modern risk analysts who advise hedge funds. The Secret Service was well aware of many assassination risks for the liberal, democratic president from Boston from a wide assortment of right wing fanatics in the Deep South, and they chased down many of them.

No one imagined that the actual attempt would come from the left, and they were blindsided. It is a valuable lesson that we trade and invest by today.

Finally, it was all put together is a 2007 book by Vincent Bugliosi, Reclaiming History: The Assassination of President John F. Kennedy.

I had the misfortune of working with Bugliosi while he was prosecuting cult mass murderer, Charles Manson (while working for the Los Angeles County Coroner, I had dug up some of his victims in the California desert, one with a missing head). I always found him a show boater and a tireless self-promoter.

However, in the book, Bugliosi does a masterful job of weaving together declassified evidence, testimony from missing witnesses, and the contribution of modern technology.

His conclusion: the Warren Report was dead right. As deranged as Oswald was, there was one thing he could do well, and that was to shoot straight. He then proceeds to expertly demolish every conspiracy theory out there, and uncover their promoters as the profit driven charlatans that they are.

Oliver Stone was a better storyteller than a historian.

It turns out that being perennially disbelieving of conspiracy theories is quite a useful philosophy to have as a trader. We are often asked by the media to believe in the conspiracies that underpin certain investment theses. Bet against them, and you'll win every time.

If we don't fight them in El Salvador, then we'll be fighting them in the streets of Los Angeles. Russia wants to take over the world, and when they finish their work in the Ukraine, we are next.

We have to invade Iraq because Saddam Hussein is imminently going to use his weapons of mass destruction against us. And don't get me started on the Ebola Virus.

When gold hit $1,900 an ounce six years ago, I heard that the bars inside Fort Knox were made of lead and painted gold. When this was discovered, the price of the barbarous relic was supposed to soar to $50,000 an ounce. I sold gold short.

After Barack Obama was elected president in 2008, the Internet abounded with assumptions of a vast left wing conspiracy that pegged our new president as a socialist, was born in Kenya, was going to destroy corporate America, and take away all of our guns.

Those who bought the story sold all their stocks because the market bottom, unloaded their homes, and ditched all their bonds because the US government was going to default on its debt, ignite hyperinflation, and collapse the dollar. The advice was to put all your money into gold.

I didn't believe any of this for a second, and did the exact opposite of what the Armageddon crowd was urging on to followers.

I bought stocks, ultra high yielding junk bonds, MLP's, REITS, and every other risk asset out there while avoiding gold like the plague. I sold short the Japanese yen and the Euro against the US dollar. So did my subscribers. You know the rest of the story. Some of my picks rose tenfold.

I met Senator Ted Kennedy when he was running for president in 1982, and have kept in touch with his staff ever since. They told me he hit the deck whenever he heard a loud noise, be it a firecracker, a backfiring car, or even a slammed door. He lived a lifetime in constant fear of assassination.

Some scars never heal.

On my next trip to Tokyo I will be spending some time at the magnificent, white stucco edifice that has been the residence of US ambassadors there for nearly 100 years.

I will also give a briefing to our ex ambassador, Caroline Kennedy, the daughter of the late president, who served as the 29^th United States ambassador to Japan until January, 2017.

The National Archives will release the last of its files on the assassination 70 year after the event, on November 22, 2033.

I hope to live that long, for by then I'll be nearly 82. Then for me, the Kennedy story will come full circle.

Taking the Story Full Circle

A Tribute to a True Veteran

Diary, Newsletter, Research

Today is a good day to tell you the story of my Uncle Mitch.

I'll be putting on my faded Marine Corp fatigues, with gold railroad track bars on my shoulders, and leading the hometown's parade.

Since job prospects for high school graduates in rural Pennsylvania in 1936 were poor, Mitch walked 200 miles to the nearest Marine Corp recruiting station in Baltimore.

After basic training, he spent five years rotating between duty in China and the Philippines, manning the fabled gunboats up the Yangtze River.

When WWII broke out, he was a seasoned sergeant in charge of a machine gun platoon. That put him with the seventh regiment of the First Marine division at Guadalcanal in October, 1942.

When the Japanese counterattacked, Mitch was put in charge of four Browning .30 caliber water-cooled machine guns and 33 men, dug in at trenches on a ridge above Henderson Field.

The Japanese launched massive waves of suicide attackers in a pouring tropical rainstorm all night long, frequently breaking through the line and engaging in fierce hand-to-hand combat.

If the position fell, the flank would have been broken, leading to a loss of the airfield, and possibly the entire battle. WWII would have lasted two more years.

After the first hour, all of Mitch's men were either dead or severely wounded, shot or slashed with samurai swords.

So Mitch fired one gun until it was empty, then scurried over to the next, and then the next. In between human waves, he ran back and reloaded all the guns.

To more easily pitch hand grenades, he cut the arms off his herringbone fatigues. When the Japanese launched their final assault, and then retreated, he picked up a 40-pound Browning and ran down the hill after them, firing all the way, and burning all the skin off his left forearm.

Mitch's commanding officer, Col. Herman H. Hanneken, heard the guns firing all night from the field below.

He was shocked when he visited the position the next morning, finding Mitch alone in front of a twisted sea of 1,000 Japanese bodies, not a scratch on him.

Mitch was awarded the Congressional Medal of Honor in Australia a few months later.

Henderson's Ridge in 1942

After the war, Mitch, now a colonel, was handed the plum of all Marine Corp jobs, acting as the liaison officer with Hollywood. He provided the planes, ships, and beaches needed to make the great classic war films. He got to know stars like John Wayne, Lee Marvin, and yes, even Elvis Presley.

The iconic fictional hero in the 1949 film, Sands of Iwo Jima, Sergeant John M. Striker, was modeled after Mitch.

Tradition dictated that all military officers salute Mitch, even five star generals, and he was given a seat to attend every presidential inauguration from FDR on. Pacific countries issued stamps with his image, and Mattel sold a special GI Joe in his likeness.

When Mitch got older and infirm, I used my captain's rank to escort him on diplomatic missions overseas to attend important events, like the 40^th anniversary of D-Day in Normandy.

Whenever Mitch was in town, he would join me for lunch with some of my clients with a history bent, and a more humble and self-effacing guy you never met. Mitch passed away in 2003 while he was working as a technical consultant for the pre-production of the HBO series, The Pacific. The funeral in Riverside, California was marked by an eagle continuously circling overhead which, according to the Indian shaman present, only occurs at the services for great warriors.

When I got back from the parade, I took out the samurai sword Mitch captured on that fateful day, a 1692 Muneshige, the hilt still scarred with 30-caliber slugs, and gave it a ritual polishing in sesame oil and powdered deer horn, as samurai have done for millennia.

To learn more about the First Marine Division's campaign during the war, please read the excellent paperback, The Island: A History of the First Marine Division on Guadalcanal by Herbert Laing Merillat, which you can buy from Amazon by clicking on the title.