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The Big Technology Trends of 2019

As an astute purveyor of technology, it is my job to share with you the upcoming tech trends of 2019.

Some might be easily discernable and some might be a headscratcher, but all must be tabbed up and considered in the current tech outlook that is unpredictable and fluctuating, to say the least.

Part of the moody tech sentiment has been influenced by a changeable macro landscape - the tech sector’s winter freeze was woefully volatile and unfairly capsized good companies with the bad.

There is no means to get around it – the administration's delicate situation as it relates to Beijing and the American tech sector is front and center, and any movement of tech stocks must carefully absorb the ongoings from this complicated relationship.

The number of obstacles that confront this sensitive situation means that the 90-day window granted to solve the trade quagmires appear too brief of a timeframe to really knock out every single disagreement on the table.

The uncertainty over trade policy has really ruffled some of tech’s strongest feathers such as America’s pride and joy Apple (AAPL).

Apple is a great long-term story, but it does not preside over many short-term positive catalysts that can resuscitate the stock.

Analysts' downgrade after downgrade has been most harrowing for the chip components that make up Apple and other consumer electronic devices such as televisions and tablets.

This scenario is expected to extend into 2019 with Bank of America Merrill Lynch (BAC) slashing their price target by nearly 30% on electronics retailer Best Buy (BBY) then sticking the fork in them by downgrading it to underperform.

The premise behind this downgrade was that Best Buy carved out 25% of revenue from television sales and even though Adobe (ADBE) analytics has calculated record online sales in the holiday season, the follow-through has largely been without television sales participating in the seasonal bonanza.

Piggybacking on this trope, I believe electronic device sales could be hard-pressed to eke out growth next year and are set up for a rude awakening.

Therefore, it is sensible to extrapolate this idea out and assume that smart hardware competing against the big boys such as smart speaker firm Sonos (SONO), who I urged readers to stay away at $16 in September, is set up for a painstaking 2019.

To reread the story, please click here.

The stock is now trading at $11 and a mix of weakening consumer device demand layered with the domination that is the Amazon Alexa has pushed up this company’s risk-reward levels to untold heights.

Rounding out the negatives is that content streaming platform Roku has also debuted its own version of a smart speaker.

Roku (ROKU) is one of my favorite long-time tech plays but has been dragged down by the broader trade war because a portion of its revenue is still captured by hardware such as the new speakers and Roku OTT boxes.

Differing from Apple, Roku earns most of their revenue from targeted ads on their proprietary platform, and this is its reason why most investors are in this stock that is set to capture a secular migratory wave of cord-cutters traversing to online streaming.

However, Roku TVs made by Chinese company TCL still draw in small portion of revenue and even though the China revenue is not as high on a relative basis as Apple’s 20%, the stock has floundered in the short-term.

If disruptors such as Roku can get hit savagely with a small portion of revenues from China, then I am convinced that any tech investor going into 2019 should stay away from hardware and hardware that is made in China.

The consensus is that the drawn-out trade war could become the X-factor in the 2020 election because the Chinese are willing to wait for the next guy on the carousel searching for a better deal.

If you thought Chinese supply chains had a tough time of it in 2018, then 2019 is poised to be even more treacherous.

What 2018 convincingly demonstrated was that the late economic price action is getting into later and later stages boding negative for tech stocks.

To construct a healthy tech portfolio going into 2019, the change in the tech partiality has made the pivot towards software much more important.

Investors need to mitigate Chinese supply chain risk and seek out domestic software plays.

That should be the playbook as tech investors are on pins and needles going into the new year.

The domestic economy is robust and tech investors should be attracted to top-quality cloud-based enterprise stocks that are profitable.

The FANG story collapsing in our face signaled to investors that it is time to cautiously consider whether to invest heavily into deep loss-maker tech growth stories.

A healthy rotation to premium quality tech with superior cash flow is one way to lock up stocks and slyly deflect the external factors shaking up the tech momentum.

PayPal (PYPL) is a stock that has large international exposure mainly in Europe, but none in China whose 3-year EPS growth rate is 26% and still driving sequential sales in the mid-20% range.

This is just one example of a stock that has the correct make-up in a harsh and brutal tech environment planted with invisible booby traps.

And the most tell-tale sign that the American economy is in for an all-out software frenzy is the number of head-spinning investments from big tech companies looking to expand their footprint into new talent spots around the country.

First, the farcical Amazon beauty pageant came to an end with the e-commerce giant announcing a three-part package deploying new operations in New York, Washington D.C., and Nashville as the next phase of digital growth ramps up.

Google (GOOGL) followed that up by plopping a software office in New York City devouring a huge chunk of the Chelsea neighborhood aimed at doubling the 7,000 employees already there.

Then it was Apple’s turn choreographing a significant investment in Austin, Texas that will cost them $1 billion along with juicing up operations in Seattle, San Diego, and Los Angeles.

They weren’t finished there and promised to double down its presence in Pittsburgh, New York and Boulder, Colorado over the next three years.

It’s clear that big tech has finally understood that it’s not invincible and milking the China supply chain for all its worth is now a taboo business practice that has bipartisan support firmly against it.

Like I said before, the trade war came 1-2 years too early for Apple, and these headline-grabbing talent investments in data centers and its staff underscore the sense of urgency to fully and comprehensively pivot towards a software and services company.

The transition has certainly been an excruciating process exposing the weak spots at a brilliant company at the worst possible time.

I blame CEO of Apple Tim Cook who is the operations expert in the building grappling with Apple overextending themselves in the Middle Kingdom that has come back to haunt him at night.

You would have thought that with the troves of big data on their hands, Apple’s consultants might have found a country allied with America to invest in such a massive supply chain.

This leads me to communicate with conviction that Microsoft (MSFT) is my favorite tech stock going into 2019 because it is the purest, scalable, high-quality software name with minimal hardware drag devoid of weak spots in its armor.

That was what the investment in GitHub for $7.5 billion was about, highlighting the value of owning the meeting place for coders, literally buying up a stash of over 28 million users and 57 million coding repositories in which 28 million are public.

Microsoft has also bought up six video game studios in 2018 attempting to capture a bigger piece of the pie for the video game market that has been throttled by Fortnite.

If the Microsoft baby gets thrown out with the bathwater, then the tech bear market is upon us in full force.

If you didn’t really believe content is king in 2018, then you will really feel the phenomenon further embedded into the economy and society in 2019.

Next year, almost all tech investments will result in more data centers and software engineers in the hope of pumping out the best content and data, whether it’s enterprise software, video games, or pure data storage.

In 2019, I am bullish on companies with a cloud-based bedrock able to grind out the best content in the world, backed by a strong balance sheet that dovetails nicely with a lack of China-based revenue exposure.

The uber-growth models could be taking a rest boding negatively for Uber, Lyft, and Airbnb who must convince a more skeptical tech audience with tighter purse strings as they inject yet another unique dimension into the tech world next year.

December 17, 2018

Diary, Newsletter, Summary

Global Market Comments
December 17, 2018
Fiat Lux

Featured Trade:

(THE MARKET OUTLOOK FOR THE WEEK AHEAD, or THERE’S NO SANTA CLAUS IN CHINA)
($INDU), (SPY), (TLT), (AAPL), (AMZN), (NVDA), (PYPL), (NFLX)

The Market Outlook for the Week Ahead, or There’s No Santa Claus in China

Diary, Newsletter

On Friday, five serious hedge fund managers separately called me out of the blue and all had the same thing to say. They had never seen the market so negative before in the wake of the worst quarter in seven years. Therefore, it had to be a “BUY”.

I, on the other hand, am a little more cautious. I have four 10% positions left that expire on Friday, in four trading days, and on that day I am going 100% into cash. At that point, I will be up 3.5% for the month of December, up 31.34% on the year, and will have generated positive return for one of the worst quarters in market history.

I’m therefore going to call it a win and head for the High Sierras for a well-earned Christmas vacation. After that, I am going to wait for the market to tell me what to do. If it collapses, I’ll buy it. If it rockets, I’ll sell short. And I’ll tell you why.

These are not the trading conditions you would expect when the economy is humming along at a 2.8% annual rate, unemployment is running at a half-century low, and earnings are growing a 26% year on year. You can’t find a parking spot in a shopping mall anywhere.

However, the lead stocks like Apple (AAPL), Amazon (AMZN), and Netflix (NFLX) have plunged by 30%-60%. Price earnings multiples dropped by a stunning 27.5% from 20X to 14.5X in a mere ten weeks. Half of the S&P 500 (SPY) is in a bear market, although the index itself isn’t there yet. I would rather be buying markets on their way up than to try and catch a falling knife.

There is only one catalyst for that apparent yawning contradiction: The President of the United States.

Trump has created a global trade war solely on his own authority. Only he can end it. As a result, asset classes of every description are beset with uncertainty, confusion, and doubt about the future. Analysts are shaving 2019 growth forecasts as fast as they can, businesses are postponing capital spending plans, and investors are running for the sidelines in droves. Business confidence is falling like a rock

To paraphrase a saying they used to teach you in Marine Corps flight school, “It’s better to be in cash wishing you were fully invested than to be fully invested wishing you were in cash.”

The Chinese have absolutely no interest in caving into Trump’s wishes. They read the New York Times, see the midterm election result and the opinion polls, and are willing to bet that they can get a much better deal from a future president in two years.

I have been dealing personally with both Trump and the Chinese government for four decades. The Middle Kingdom measures history in Millenia. The president lives from tweet to tweet. The Chinese government can take pain by simply ordering its people to take it. We have elections every two years with immediate consequences.

The best we can hope for is that the president folds, declares victory, and then retreats from his personal war. This can happen at any time, or it may not happen at all. No one has an advantage in predicting what will happen with any certainty. Not even the president knows what he is going to do from minute to minute.

It is the possibility of trade peace at any time that has kept me out of the short side of the stock market in this severe downturn. That robs a real hedge fund manager of half his potential income. Trade peace could be worth an instant rally of 10% in the stock market. Even a lesser move, like the firing of trade advisor Peter Navarro, would accomplish the same.

The market was long overdue for a correction like the one we have just had. Investors were getting overconfident, cocky, and excessively leveraged. In October, we really needed the tide to go out to see who was swimming without a swimsuit. But if the tide goes out too far, we will all appear naked.

Thanks to some very artful trading, my year to date return recovered to +27.54% boosting my trailing one-year return back up to 27.54%. I covered an aggressive short position in the bond market (TLT) for a welcome 14.4% profit. I also took profits with an instant winner in PayPal (PYPL). On the debit side, I stopped out of an Apple call spread for a minimal loss.

December is showing a very modest loss at -0.26%. The market has become virtually untradeable now, with tweets and China rumors roiling markets for 500 points at a pop. And this is against a Dow Average that is down a miserable -2.8% so far in 2018. I should have listened to my mother when she wanted me to become a doctor.

My nine-year return nudged up to +304.01. The average annualized return revived to +33.77.

The upcoming week is all about housing data, with the big focus on the Fed’s interest rate hike on Wednesday.

Monday, December 17 at 10:00 AM EST, the November Homebuilders Index is out.

On Tuesday, December 18 at 8:30 AM, November Housing Starts are published.

On Wednesday, December 19 at 10:00 AM EST, November Existing Home Sales are released.

At 10:30 AM EST the Energy Information Administration announces oil inventory figures with its Petroleum Status Report.

At 2:00 PM the Federal Reserve Open Market Committee announces a 25 basis point rise in interest rates, taking the overnight rate to 2.25% to 2.50%. An important press conference with governor Jay Powell follows.

Thursday, December 20 at 8:30 AM EST, we get Weekly Jobless Claims.

On Friday, December 21, at 8:30 AM EST, we learn the latest revision to Q3 GDP which now stands at 2.8%.

The Baker-Hughes Rig Count follows at 1:00 PM.

As for me, I’ll be battling snow storms driving up to Lake Tahoe where I’ll be camping out for the next two weeks. Mistletoe, eggnog, and endless games of Monopoly and Scrabble await me.

Good luck and good trading!

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

December 13, 2018

Diary, Newsletter, Summary

Global Market Comments
December 13, 2018
Fiat Lux

Featured Trade:

(WHAT’S THE MATTER WITH APPLE?),
(AAPL), (MSFT), (KO), (AMZN), (CLX), (NFLX),
(WHY YOUR OTHER INVESTMENT NEWSLETTER IS SO DANGEROUS)

What’s the Matter With Apple?

Diary, Newsletter, Research

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

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

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

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

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

What a difference three months make!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Time for a Nibble?

The Real Story About Apple

Tech Letter

If you can’t handle the heat, then get out of the kitchen.

Well, the kitchen is getting a little bit toasty right now.

Apple (AAPL) was handed down a demonstrably negative verdict when a regional Chinese court ruled that they infringed on two patents belonging to Qualcomm (QCOM).

The Qualcomm chips were connected to photo editing and another to swiping on a touch-screen device.

This means that Apple won’t be able to sell legacy iPhone models in China which is a damaging blow to revenue prospects because older iPhone models in China offer attractive price points to wallet-light Chinese.

And when you add this all up, the ban includes over half of the iPhones on sale in China.

In general, less affordable, sleeker, fresher iterations price out many Chinese who want a piece of the Apple dream.

Even though this was a nice victory for Qualcomm, it spells trouble for the broader tech sector.

Apple’s myriad of chip suppliers who have grappled with a torrent stream of woeful news this year relating to Apple’s supply of iPhones and supply forecast of iPhones are first on the chopping block.

It’s also an excruciating blow to American business in China and this could potentially rule out any American management taking future business trips to China.

Apple looks set to join its chip company compadres on the sidelines as a stock to avoid like the plague at the moment.

Apple is a great company and a perfect hold to eternity stock, but this is not the time to jump in and out of it.

Let me explain why.

The trade war centered on future technological hegemony is directly connected to the domination of current technology in artificial intelligence, chip development, and 5G.

China has been furiously catching up to American tech the last two decades through its vast program of foreign technological forced transfers and outright intellectual property theft.

I remember testing my first shoddy Chinese smartphone from the Chinese company Coolpad to gauge a sample of the burgeoning Chinese consumer device market on a blistering hot day in Beijing in the summer of 2010.

It was one of the first iterations of Chinese smartphones on the local market and the 3G smartphone was simply terrible.

The hardware was iffy, software was untenable, design was hodgepodge and it ceased working after 3 painstaking months of testing.

I breathed a sigh of relief because I knew it would be years before Chinese tech could ever produce something material.

Since then, China and the love given to its tech sector through the state protecting its homegrown companies have come a long way since those teething years filled with shabby products and inferior expertise of yesteryear.

Chinese cell phones are now comparable to iPhones for a fraction of the cost especially the new Huawei and Xiaomi models and the companies want recognition for their success.

I have interviewed scores of Huawei engineers who describe a life of grinding out a modest existence in mega-cities dotted around China.

They lament the 12-hour back-breaking work days, suffocating authoritarian management style, and the 3am on-call staff meetings, but they rejoice in the accomplishment of collecting that down payment for a standard Chinese apartment in a subpar constructed building.

They earn 30% of what Apple engineers make per year just to seize an average life in a second-tier Chinese city.

They don’t complain and accept it as a consequence of cut-throat competition in a country of 1.3 billion trying to hustle the best they can.

These unbearable timelines and the crunch to develop the national brand of Huawei and its other protected tech behemoths is how China rose up from the ashes of irrelevancy to become arguably competitive with the American tech machine that is Silicon Valley.

Even through all of the local hyper-growth, there was one unwritten rule that allowed one squeaky clean American company from Cupertino to evade all of the fractious competition and make an absolute killing in China.

Apple was protected in China before until now that is.

I find it dubious that the timing of the court verdict was the first business day after the arrest of CFO of Huawei Meng Wanzhou.

By connecting the dots, this appears as if it was an indirect ruling from the higher-ups signaling that Apple won’t be handed a free pass anymore and a warning shot fired to Washington.

Even worse, the Chinese regulatory environment is opaque at best-giving discretion to Chinese authorities to do as they see fit.

The opaque nature of Chinese regulation can draw out cases for years potentially drowning out the sales of iPhones and banishing Apple and its products in China to the history books.

That is the worst-case scenario that probably won’t happen.

For Apple to even appeal this ruling offers Steve Jobs' brainchild a rare dose of reality in China, and the bruised Apple brand will go back to the drawing board after receiving severe harm to its previous image of an ultra-luxury brand on the Chinese mainland.

For other American companies, there is no way to flush out additional clarity, and they will get stonewalled if they want more details regarding the path forward and that in itself will damage the price action of stocks tilted towards China because of the wave of uncertainty.

At the extreme minimum, this escalation of pressure will make it arduous to maneuver to some sort of trade agreement let alone in the abbreviated 90-day window agreed on in Buenos Aires.

The Chinese national psyche cares a great deal about saving face and this dig at its national prize will be hard to forget.

And China has a habit at looking at these types of events as inclusive actions tallied up broadly inside a comprehensive portfolio labeled and pigeonholed as America, Canada, and so on.

This conspicuous move has pushed forward Canada into the forefront of the firing line which could become the silver lining to this quagmire because Canada will have more incentive to join in on the China rebukes with America if they get blacklisted by Beijing.

Uniting together as one pan-North American and the European task force would be the best method to combat China’s stealthy business acumen whose capital and influence are far-flung and hard to quantify because of its various gateways to global western pressure points.

I can tell you right now that after doing a quick jaunt of Belarus, the Ukraine, and Hungary this winter, China’s deep pockets and nationals have completely taken over Central and Eastern Europe.

Chinese companies and products are plastered all over the place in each Russified city center and cityscapes built in the Soviet era.

Chinese students and workers have flooded these markets as they line up around the fringes of the Western world armed with gobs of capital and a land-grab mentality that borders Amazon’s ambition.

The Budapest property market has been cornered by Chinese citizens looking for the cheapest entry point to permanent residence in the Eurozone.

If you want to rent a flat in Budapest, odds are a Chinese owner will be glad to accept your monthly rent payments.

China believes that to truly have its tentacles deep inside the Western apparatus, they must initially corner the peripheries of the Western World that thirst for capital to build up local economies to match the power and stature of the Western big boys.

This has all added up to the Chinese government having an influential voice in European affairs because they have direct sway with conservative Prime Minister of Hungary Viktor Orban who has accepted Chinese capital.

US executives are praying to the celestial heavens that Meng is not extradited to America and made the scapegoat of the broader trade war.

This would be a bitter pill to swallow for Huawei’s founder Ren Zheng Fei whose family is considered royalty inside the upper-level Chinese establishment.

I assume that Ren will not back down quietly and is pushing and pulling the behind-the-scenes levers to do what he can for his daughter.

What does this all mean?

Headline risk has shot through the roof and investors could hear any day of the rumblings to the next chapter of the trade saga that is enveloping more and more corporate collateral damage.

Apple’s next quarter’s earnings are also on the line, and CEO of Apple Tim Cook could conveniently use it as a throwaway quarter hyping its progression as a new software and subscriptions company which is indeed in the works.

I figure this is the base case for Apple especially if there is no quick solution to this new iPhone ban.

The transition has been dramatically painful and happened a year or two too early for Apple’s liking.

Consequently, Apple reigning in its expectations has crushed the stock recently.

Certain global banks could set to be punished after the Wall Street Journal reported that HSBC and Standard Chartered facilitated the illegal payments for Huawei.

The British bank problems don’t stop there with Britain as a country barreling towards a complete ban of Huawei products after New Zealand just announced their own ban.

The three biggest Japanese telecommunication companies dumped fuel on Huawei’s bonfire citing security issues for excluding Huawei products from Japanese 5G development.

The roller-coaster action could also give impetus to Chairman Xi to execute a power grab on Chinese domestic technology sector gifting him additional control over tech behemoths in the name of national security fortifying his multiplying power in China.

He did the same with the People Liberation’s Army and I see no reason why he wouldn’t do the same with the Chinese tech sector especially if western countries avoid Huawei products.

The Chinese regulatory presence has already reared its ugly head banning new video game licenses to Tencent slashing revenue streams in 2018.

That is why Tencent shares have grossly underperformed this year.

Theoretically, Xi could use this moment as a springboard to seize the reigns of Huawei citing illegal payments to Iran which would calm the trade tensions but beef up his clout in the tech community, a net negative for Silicon Valley.

In any case, there is substantial amount of uncertainty permeating the heart of the technology movement that could potentially splinter off violently into an American tech and Chinese tech world.

This hard landing would deprive China-based revenue and kill supply chains for American technology that have spent decades procuring these intricate systems.

For Chinese technology, they could be cut off from the important components required to develop the technology and chips they need to achieve its “Made in China 2025” state-subsidized targets aimed at rapidly expanding its high-tech sectors and developing its advanced manufacturing base.

The next few months will reshape the 2019 Silicon Valley landscape and certain companies are hoping their business models aren’t fully destroyed.

I can’t lie but I saw this coming when I became aware of the complicated relationship between foreign tech companies and its precious Chinese revenue, and I also never bought another Coolpad smartphone.

The Market Outlook for the Week Ahead, or Where is Santa Claus?

Diary, Newsletter

The only good thing to be said about last week is that it only lasted four days. If it had been open a fifth, the Dow Average (INDU) might have fallen another 800 points.

This is the first time since 1972 that every single asset class lost money for the year, and we were in the heat of an oil shock back then.

To earn money to pay for college, I was running a handy little business buying junk heap Volkswagen Beetles in California, getting them repainted in Mexico, and then selling them for huge profits in Los Angeles. That’s me, ever the entrepreneur.

As it was, three consecutive 800-point drops are the sharpest selloff we have seen since the 1987 crash. But despite all the violence and handwringing, the market is exactly where it was nearly two months, six months, ten months, and one year ago.

Talk on the street is rife of hedge funds blowing up, fat finger trades, and algorithms run wild. This could be the first stock market correction untouched by human hands.

What we have seen is some of the most extreme volatility in history with no net movement. And you wonder why institutions are so relaxed.

Let’s face it, we have all had it way too easy way too long. Who makes an average annualized return of 33.87% for 10 years? Oops, that’s me.

What happens next? One more dive to truly flush out the last of the nervous leveraged longs and then the long-promised Christmas rally.

Remember, markets will always do what they have to do to screw the most people, and that would be stopping traders out of their positions and then closing the year at multi-month highs.

Apple (AAPL) in particular was pummeled mercilessly, besieged by analyst downgrades almost every day. Steve Jobs’ creation is now down a stunning $65, or $27.9%. It dropped 40% when Steve died. I’m sure both Apple and Warren Buffet are in there soaking up stock every day with the shares at a half-decade earnings multiple low and laughing all the way to the bank.

But here’s the problem with that logic. Fundamentals can be very dangerous in an out-and-out panic. As my friend John Maynard Keynes used to say, “Markets can remain irrational longer than you can remain liquid.” Apple and Warren Buffet can wait out this correction, but can you, especially if you are a trader? If the stock falls further, they’ll just buy more.

The week started with such promise in the euphoria and afterglow of the G-20 Summit in Buenos Aires. It only lasted 24 hours when we discovered that nothing the administration said was true, all refuted by the Chinese when they got home to Beijing.

On Thursday, we learned that while the president’s team was negotiating, they arrested of the scion of one of China’s top tech companies while changing planes in Canada for a vacation in Mexico. It was equal to arresting the number two at Apple.

That little tidbit alone was worth a drop of 1,600 Dow points. As a result, half of all senior executive visit to the Middle Kingdom were instantly cancelled. Who wants to have “Hostage” listed on their resume?

If that were the only thing to worry about, the market would have bounced back sharply the next day and we would all be back in the Christmas mood.

But it’s not. Recession forecasts are starting to multiply like rabbits.

The Fed is growing cautious with 4 of 12 districts reporting slowing growth, said the Wednesday Beige Book report. The word “tariffs” is mentioned 39 times and is cited as a major reason for the lack of business clarity, and therefore capital investment for 2019.

The bond market is calling for a recession as “inversion” become the word of the year. The 2 year-10 years spread has shrunk to 12 basis points, an 11-year low, while the 3 year-5 year is already inverted. Massive short covering of bonds by hedge fund has ensued.

The ensuing bond melt-up was the most extreme in years as heavily short hedge funds ran for the sidelines. Now that they’re out, it’s safe to sell short again.

The November Nonfarm Payroll came in at a weak 155,000, but headline unemployment still hugs a half-century low. I saw the first really solid evidence of a recession when I drove by a high-end housing project in an upscale neighborhood and saw that it was abandoned with all equipment and tools removed. The developer obviously froze construction to get out of the way of a rapidly slowing economy.

In fact, things have gotten so bad that they may start getting good again. Instead of raising rate three times like clockwork in 2019, the Fed may adopt a “one and done” policy in December. That is where the bond market received its recent shot of adrenaline.

I doubt it as our nation’s central bank is a profoundly backward-looking organization. If the economy was hot a year ago, that means interest rates have to be raised today.

When will someone start spiking the eggnog? An awful lot of people are starting to discount a 2019 recession no matter what the administration says. If the Santa Claus rally doesn’t start this week, it will be too short to notice.

My year-to-date return recovered to +28.42%, boosting my trailing one-year return back up to 30.17%. December is showing a modest gain at +0.62%. That last leg down in the NASDAQ really hurt and was a once-in-18-year event. And this is against a Dow Average that is down a miserable -1.6% so far in 2018.

My nine-year return nudged up to +304.89. The average annualized return revived to +33.87.

The upcoming week is light on data after last week’s fireworks. The CPI is the big one, out Wednesday. Hopefully, that will give us all time to attend our holiday parties.

Monday, December 10 at 8:30 AM EST, the November Producer Price Index is out.

On Tuesday, December 11, November Producer Price Index is out.

On Wednesday, December 12 at 8:30 AM EST, the all-important November Consumer Price Index is released, the most important read we have on inflation.

At 10:30 AM EST, the Energy Information Administration announces oil inventory figures with its Petroleum Status Report.

Thursday, December 13 at 8:30 AM EST, we get the usual Weekly Jobless Claims.

On Friday, December 14, at 8:30 AM EST, we learn November Retail Sales.

The Baker-Hughes Rig Count follows at 1:00 PM.

As for me, I will be spending my weekend assembling the ski rack for my new Tesla model X P100D. I’ll be damned if I can get the pieces to fit together, and what is this extra bag of parts for? I hope the car is made better than this!

As for my VW trading business from 46 years ago, repair work done on US registered cars in Mexico was then subject to a 20% import duty. When the customs officer leaned against the car to ask if I had any work done recently, I fibbed. As he walked away I notice to my horror that the front of his pants was entirely covered with fresh green paint.

I never went back. Stocks looked like a better bet.

Good luck and good trading.

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

November 30, 2018

Diary, Newsletter, Summary

Global Market Comments
November 30, 2018
Fiat Lux

Featured Trade:

(NOVEMBER 28 BIWEEKLY STRATEGY WEBINAR Q&A),
(VXX), (VIX), (GE), (ROKU), (AAPL),
(MSFT), (SQ), (XLK), (SPLS), (EWZ), (EEM)

November 28 Biweekly Strategy Webinar Q&A

Diary, Newsletter

Below please find subscribers’ Q&A for the Mad Hedge Fund Trader November 28 Global Strategy Webinar with my guest and co-host Bill Davis of the Mad Day Trader.

Q: Is it time to get out of semiconductor stocks?

A: The time to get out is before it drops 60%, not afterwards. So, if you have semiconductor stocks, I would look for the next major rally to get out. I think we will get one of those rallies into December/January. We went negative on this sector in June, took all our profits, and didn’t go back in until last week.

Q: Is it time to buy semiconductor stocks?

A: No, that is the group you want to buy at the absolute bottom of the next recession which might be next year sometime. They lead on the downside, and they will lead on the upside as soon as they sniff a recovery in the economy.

Q: I held on to my position in Square (SQ). Should I sell now for a small profit?

A: Yes, in recessions, big companies prosper much more than small companies like Square; that’s why it had such a tremendous selloff; down 55% in six weeks. A small technology stock is not what you want to own in a recession. Big companies slow down, small ones die. At least that’s how conservative investors see it.

Q: What do you make of Fed comments this morning that asset prices are high?

A: I agree with them. They were certainly overpriced with a P/E multiple of 20 that we saw in September; they’re moderately priced now with a P/E multiple of 14.9. I think real estate markets are the overpriced assets that the Fed is talking about though, far more than the stock market, and markets like San Francisco, Seattle, and Vancouver are still way too high.

Q: What are your comments on Apple (AAPL)?

A: There’s an interesting thing going on here; you’ve just had a massive move out of hardware stocks like Apple, which basically makes phones and computers, into software stocks like Microsoft (MSFT), which is growing their cloud business like crazy. You may see this as a long-term industry trend, out of hardware stocks into software stocks. It’s all about the cloud now. The future is in software and that is where Apple is going to with services like the cloud, iTunes, streaming, and advertising, although they are doing it slowly.

Q: Will Trump be able to persuade Fed Chair Powell to stop hiking interest rates?

A: He will not, Powell is one of the few principled people in the government. He’s going to stick to his discipline, only look at the data, and that is going to require him to keep raising interest rates. One of the big black swans for 2019 may be that Trump fires Powell and gets a friendly rent-a-Fed chair in there who lowers interest rates on command. If Trump can hold on for nine months though, even Powell will see the economy’s in trouble and will have to respond accordingly by capping or even lowering interest rates.

Q: Why are you not stopping out of Roku (ROKU)?

A: We haven't yet approached our upper strike price on the December $30-$35 vertical bull call spread. That’s usually where I bail out; I like to give stocks plenty of room to do the right thing. Stocks have to breathe and I pick strike prices to compensate for that. Otherwise, you’d be stopping out of every trade immediately.

Q: Should we close the iPath S&P 500 VIX Short Term Futures ETN (VXX) trade or leave it open?

A: I’m looking for a bit more of a rally in stocks and a drop in the Volatility Index (VIX); then we’ll try to grab whatever additional couple of pennies we can get out of that.

Q: What do you think of Brazil (EWZ)?

A: Avoid emerging markets (EEM) as long as the U.S. is raising interest rates and the dollar is strong. Rising dollar means rising debt for emerging markets and less ability to service that debt, all bad for business.

Q: Morgan Stanley (MS) says “buy emerging markets”; are they nuts?

A: For the short term yes, for the multi-year long term they are a screaming buy. They are at historical lows in terms of valuation and already have a recession priced into them. But jumping in too soon could be painful.

Q: What are your expectations for the yield curve?

A: I expect all levels of the fixed income market to drop in price and rise in yield with the sharpest move in overnight rates. This eventually leads to a very steep inverted yield curve which causes recessions and bear markets.

Q: Thoughts on Master Limited Partnerships?

A: They could be relatively safe now that oil is at $50. There have been big selloffs recently. The yield on these are high and there is going to be big infrastructure building for energy going forward. I would say don’t put all your eggs in one basket and diversify your risk. In the Great Recession, many of these went bankrupt. I would look at the Alerian MLP (AMLP), which has fallen 15% in six weeks.

Q: Should I be rotating out of the Tech (XLK) stocks on rallies into more defensive stocks like Staples (SPLS)?

A: That’s half right. You should be rotating out of Tech stocks and rotating into cash which yields up to 2-3% these days. Nothing does well in a real bear market except cash. Defensive stocks still go down, just at a slower rate.

Q: Is General Electric (GE) good for the long term?

A: Yes, if anyone can turn around GE it’s the current management. That said, it could be a long-term slog—that’s why I had a long-term leap in this thing before it collapsed. It could turn around and still go up but these are throwaway, chapter eleven level type prices that we’re getting now. And now they are going to have to do a turnaround going into a recession.

Q: Do you see GE as good for a long-term trade?

A: Long term and trade don’t belong in the same sentence; but I’d say for a long-term investment at these levels, probably yes. It certainly is a bargain from $30 down to $7.40 in a year.

Q: Is this webinar archived?

A: A: Yes, they are always posted on the website within two hours of recording. Just go to www.madhedgefundtrader.com/, login and then hover your cursor over “MY ACCOUNT” click on “GLOBAL TRADING DISPATCH,” “Mad Hedge Technology Letter” or “Newsletter” depending on your membership then click on the Webinars button. The last ten years of webinars should show up, with the most recent one at the top.

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