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Carl Icahn Is At It Again

Many ascribe Monday?s 312 point plunge in the Dow Average to an informational webinar posted by legendary corporate raider and hedge fund manager, Carl Icahn.

I have known Carl for 30 years, and I once owned and apartment in his building on the Upper East Side of Manhattan, near Sutton Place (which I later sold for a quick double).

Even then, he was opinionated, cantankerous, and never hesitated to make the bold move. Wall Street hated him.

At 79, he is nothing less than a force of nature. Whenever I see Carl, I say I want to be like him when I grow up.

I just watched the controversial video, entitled ?Danger Ahead ? A Message From Carl Icahn?, which has ruffled more than a few feathers in the establishment. But that has always been Carl?s strong suite.

Here are the high-points:

1) We should end the ?carried interest? treatment of hedge fund profits, which lets billionaire managers get off scot-free, while sticking a big tax bill with the little guy.

2) Foreign profits of US multinationals, some $2.2 trillion, should be brought home, taxed, and put to work.

3) Corporate inversions, whereby American companies reincorporate overseas to beat taxes, should be banned.

4) Corporate share buybacks, which amount to 4.5% of the outstanding float per year, are a short-term fix for company share prices only at the long-term price of a weaker balance sheets.

5) Some $4.5 trillion in borrowing by the Federal Reserve has crowded out the little guy. On this one, I disagree with Carl. With overnight rates at zero and ten year Treasury bonds yielding 2.06%, nobody is getting crowded out from anything.

6) Artificially low interest rates are fueling an unwarranted takeover boom and encouraging risky financial engineering.

7) Junk bonds (HYG), (JNK) are a bubble begging to pop. They are the result of a runaway Wall Street selling machine that saw big firms selling short their own issues to unwary customers.

Carl sums up by saying that while the Fed saved the US economy during 2008-09, they created the problem in the first place with Greenspan?s excessive easing in 2002-03.

He believes that the candidacy of outsider Donald Trump is a natural reaction to peoples? dissatisfaction with Washington and Wall Street.

I have to admit that Carl has brought up some serious points here. I agree with all, except the above-mentioned ?crowding out? issue. Combined, they are a detrimental tax on the long-term economic health of America.

Could this be an attempt by Carl to throw his hat into the political ring? Treasury Secretary in a future Trump administration was mentioned in later media interviews.

But at his age, even for Carl, that would be a reach.

While Icahn has been ringing the alarm bell on the stock market and junk bonds all year, he has been aggressively acquiring major stakes in in the energy and commodities sectors all year, while they are trading at generational lows.

He has zeroed in on two of my own favorite trades, Freeport McMoRan (FCX) and Cheniere Energy (LNG).

Carl is also holding a major position in Apple (AAPL), which he acquired two years ago just after I jumped in at $395. He believes the shares are absurdly cheap.

To watch the 15 minute video in full, please click: http://carlicahn.com.

Good for you, Carl Icahn!

HYG 9-29-15

FCS 9-29-15

LNG 9-29-15

AAPL 9-29-15

Carl Icahn

 

2015 Annual Asset Class Review

Zephyr

I am once again writing this report from a first class sleeping cabin on Amtrak?s California Zephyr. By day, I have two comfortable seats facing each other next to a broad window. At night, they fold into bunk beds, a single and a double. There is a shower, but only Houdini could get in and out of it.

We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I am headed for Emeryville, California, just across the bay from San Francisco. That gives me only 56 hours to complete this report.

I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure, and to keep me up to date with the onboard gossip.

The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Spellchecker can catch most of the mistakes, but not all of them. Thank goodness for small algorithms.

 

station

As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied searches during stops at major stations along the way to chase down data points.

You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS. Who knew that 95% of America is off the grid? That explains a lot about our politics today. I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone.

After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2014 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Yet again, the stay at home index players have defeated the best and the brightest.

With the Dow gaining a modest 8% in 2014, and S&P 500 up a more virile 14.2%, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for seven boring consecutive months. Most hedge funds lagged the index by miles.

My Trade Alert Service, hauled in an astounding 30.3% profit, at the high was up 42.7%, and has become the talk of the hedge fund industry. That was double the S&P 500 index gain.

If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:

 

JT & conductor

The Ten Highlights of 2015

1) Stocks will finish 2015 higher, almost certainly more than the previous year, somewhere in the 10-15% range. Cheap energy, ultra low interest rates, and 3-4% GDP growth, will expand multiples. It?s Goldilocks with a turbocharger.

2) Performance this year will be back-end loaded into the fourth quarter, as it was in 2014. The path forward became so clear, that some of 2015?s performance was pulled forward into November, 2014.

3) The Treasury bond market will modestly grind down, anticipating the inevitable rate rise from the Federal Reserve.

4) The yen will lose another 10%-20% against the dollar.

5) The Euro will fall another 10%, doing its best to hit parity with the greenback, with the assistance of beleaguered continental governments.

6) Oil stays in a $50-$80 range, showering the economy with hundreds of billions of dollars worth of de facto tax cuts.

7) Gold finally bottoms at $1,000 after one more final flush, then rallies (My jeweler was right, again).

8) Commodities finally bottom out, thanks to new found strength in the global economy, and begin a modest recovery.

9) Residential real estate has made its big recovery, and will grind up slowly from here.

10) After a tumultuous 2014, international political surprises disappear, the primary instigators of trouble becalmed by collapsed oil revenues.

 

windmills

The Thumbnail Portfolio

Equities – Long. A rising but low volatility year takes the S&P 500 up to 2,350. This year we really will get another 10% correction. Technology, biotech, energy, solar, and financials lead.

Bonds – Short. Down for the entire year with long periods of stagnation.

Foreign Currencies – Short. The US dollar maintains its bull trend, especially against the Yen and the Euro.

Commodities – Long. A China recovery takes them up eventually.

Precious Metals – Stand aside. We get the final capitulation selloff, then a rally.

Agriculture – Long. Up, because we can?t keep getting perfect weather forever.

Real estate – Long. Multifamily up, commercial up, single family homes sideways to up small.

 

farmland

1) The Economy – Fortress America

This year, it?s all about oil, whether it stays low, shoots back up, or falls lower. The global crude market is so big, so diverse, and subject to so many variables, that it is essentially unpredictable.

No one has an edge, not the major producers, consumers, or the myriad middlemen. For proof, look at how the crash hit so many ?experts? out of the blue.

This means that most economic forecasts for the coming year are on the low side, as they tend to be insular and only examine their own back yard, with most predictions still carrying a 2% handle.

I think the US will come in at the 3%-4% range, and the global recovery spawns a cross leveraged, hockey stick effect to the upside. This will be the best performance in a decade. Most company earnings forecasts are low as well.

There is one big positive that we can count on in the New Year. Corporate earnings will probably come in at $130 a share for the S&P 500, a gain of 10% over the previous year. During the last five years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.

This is set to continue. Furthermore, this growth will be front end loaded into Q1. The ?tell? was the blistering 5% growth rate we saw in Q3, 2014.

Cost cutting through layoffs is reaching an end, as there is no one left to fire. That leaves hyper accelerating technology and dramatically lower energy costs the remaining sources of margin increases, which will continue their inexorable improvements. Think of more machines and software replacing people.

You know all of those hundreds of billions raised from technology IPO?s in 2014. Most of that is getting plowed right back into new start ups, accelerating the rate of technology improvements even further, and the productivity gains that come with it.

You can count on demographics to be a major drag on this economy for the rest of the decade. Big spenders, those in the 46-50 age group, don?t return in large numbers until 2022.

But this negative will be offset by a plethora of positives, like technology, global expansion, and the lingering effects of Ben Bernanke?s massive five year quantitative easing. A time to pay the piper for all of this largess will come. But it could be a decade off.

I believe that the US has entered a period of long-term structural unemployment similar to what Germany saw in the 1990?s. Yes, we may grind down to 5%, but no lower than that. Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read as to whether the financial markets will head in a ?RISK ON? or ?RISK OFF? direction.

Most of the disaster scenarios predicted for the economy this year were based on the one off black swans that never amounted to anything, like the Ebola virus, ISIS, and the Ukraine.

Being continually afraid is expensive.

 

Moose on Snowy MountainA Rocky Mountain Moose Family

 

2) Equities (SPX), (QQQ), (AAPL), (XLF), (BAC), (EEM),(EWZ), (RSX), (PIN), (FXI), (TUR), (EWY), (EWT), (IDX)

With the economy going gangbusters, and corporate earnings reaching $130 a share, those with a traditional ?buy and hold? approach to the stock market will do alright, provided they are willing to sleep through some gut churning volatility. A Costco sized bottle of Jack Daniels and some tranquillizers might help too.

Earnings multiples will increase as well, as much as 10%, from the current 17X to 18.5X, thanks to a prolonged zero interest rate regime from the Fed, a massive tax cut in the form of cheap oil, unemployment at a ten year low, and a paucity of attractive alternative investments.

This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years. If anything, it is amazing how low multiples are, given the strong tailwinds the economy is enjoying.

The market currently trades around fair value, and no market in history ever peaked out here. An overshoot to the upside, often a big one, is mandatory.
After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not?

This is how the S&P 500 will claw its way up to 2,350 by yearend, a gain of about 12.2% from here. Throw in dividends, and you should pick up 14.2% on your stock investments in 2015.

This does not represent a new view for me. It is simply a continuation of the strategy I outlined again in October, 2014 (click here for ?Why US Stocks Are Dirt Cheap?).

Technology will be the top-performing sector once again this year. They will be joined by consumer cyclicals (XLV), industrials (XLI), and financials (XLF).

The new members in the ?Stocks of the Month Club? will come from newly discounted and now high yielding stocks in the energy sector (XLE).

There is also a rare opportunity to buy solar stocks on the cheap after they have been unfairly dragged down by cheap oil like Solar City (SCTY) and the solar basket ETF (TAN). Revenues are rocketing and costs are falling.

After spending a year in the penalty box, look for small cap stocks to outperform. These are the biggest beneficiaries of cheap energy and low interest rates, and also have minimal exposure to the weak European and Asian markets.

Share prices will deliver anything but a straight-line move. We finally got our 10% correction in 2014, after a three-year hiatus. Expect a couple more in 2015. The higher prices rise, the more common these will become.

We will start with a grinding, protesting rally that takes us up to new highs, as the market climbs the proverbial wall of worry. Then we will suffer a heart stopping summer selloff, followed by another aggressive yearend rally.

Cheap money creates a huge incentive for companies to buy back their own stock. They divert money from their $3 trillion cash hoard, which earns nothing, retire shares paying dividends of 3% or more, and boost earnings per share without creating any new business. Call it financial engineering, but the market loves it.

Companies are also retiring stock through takeovers, some $2 trillion worth last year. Expect more of this to continue in the New Year, with a major focus on energy. Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year bull market in energy, the industry is ripe for a cleanout.

This is happening in the face of both an individual and institutional base that is woefully underweight equities.

The net net of all of this is to create a systemic shortage of US equities. That makes possible simultaneous rising prices and earnings multiples that have taken us to investor heaven.

 

SPX 12-31-14

QQQ 12-31-14

IWM 12-31-14

XLE 12-31-14

snowy hillsFrozen Headwaters of the Colorado River

 

3) Bonds ?(TLT), (TBT), (JNK), (PHB), (HYG), (PCY), (MUB), (HCP), (KMP), (LINE)

Amtrak needs to fill every seat in the dining car, so you never know who you will get paired with.

There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate to get out of Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.

A retired British couple was circumnavigating the entire US in a month on a ?See America Pass.? Mennonites returning home by train because their religion forbade airplanes.

If you told me that US GDP growth was 5%, unemployment was at a ten year low at 5.8%, and energy prices had just halved, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.10%.

Virtually every hedge fund manager and institutional investor got bonds wrong last year, expecting rates to rise. I was among them, but that is no excuse. At least I have good company.

You might as well take your traditional economic books and throw them in the trash. Apologies to John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson.

The reasons for the debacle are myriad, but global deflation is the big one. With ten year German bunds yielding a paltry 50 basis points, and Japanese bonds paying a paltry 30 basis points, US Treasuries are looking like a bargain.

To this, you can add the greater institutional bond holding requirements of Dodd-Frank, a balancing US budget deficit, a virile US dollar, the commodity price collapse, and an enormous embedded preference for investors to keep buying whatever worked yesterday.

For more depth on the perennial strength of bonds, please click here for ?Ten Reasons Why I?m Wrong on Bonds?.

Bond investors today get an unbelievable bad deal. If they hang on to the longer maturities, they will get back only 80 cents worth of purchasing power at maturity for every dollar they invest.

But institutions and individuals will grudgingly lock in these appalling returns because they believe that the potential losses in any other asset class will be worse. The problem is that driving eighty miles per hour while only looking in the rear view mirror can be hazardous to your financial health.

While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite. A 2%, ten-year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough.

There is another factor supporting bonds that no one is looking at. The concentration of wealth with the 1% has a side effect of pouring money into bonds and keeping it there. Their goal is asset protection and nothing else.

These people never sell for tax reasons, so the money stays there for generations. It is not recycled into the rest of the economy, as conservative economists insist. As this class controls the bulk of investable assets, this forestalls any real bond market crash, possibly for decades.

So what will 2015 bring us? I think that the erroneous forecast of higher yields I made last year will finally occur this year, and we will start to chip away at the bond market bubble?s granite edifice. I am not looking for a free fall in price and a spike up in rates, just a move to a new higher trading range.

The high and low for ten year paper for the past nine months has been 1.86% to 3.05%. We could ratchet back up to the top end of that range, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2014 performance, taking it from $46 back up to $76.

You might have to wait for your grandchildren to start trading before we see a return of 12% Treasuries, last seen in the early eighties. I probably won?t live that long.

Reaching for yield will continue to be a popular strategy among many investors, which is typical at market tops. That focuses buying on junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (KMP), (LINE).

There is also emerging market sovereign debt to consider (PCY). At least there, you have the tailwinds of long term strong economies, little outstanding debt, appreciating currencies, and higher interest rates than those found at home. This asset class was hammered last year, so we are now facing a rare entry point. However, keep in mind, that if you reach too far, your fingers get chopped off.

There is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase tax free muni values. So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way, and mark to markets could be shocking. Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits.

 

TLT 12-31-14

TBT 12-31-14

MennonitesA Visit to the 19th Century

 

4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)

There are only three things you need to know about trading foreign currencies in 2015: the dollar, the dollar, and the dollar. The decade long bull market in the greenback continues.

The chip shot here is still to play the Japanese yen from the short side. Japan?s Ministry of Finance is now, far and away, the most ambitious central bank hell bent on crushing the yen to rescue its dying economy.

The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate.

The dramatic sell off we saw in the Japanese currency since December, 2012 is the beginning of what I believe will be a multi decade, move down. Look for ?125 to the dollar sometime in 2015, and ?150 further down the road. I have many friends in Japan looking for and overshoot to ?200. Take every 3% pullback in the greenback as a gift to sell again.

With the US having the world?s strongest major economy, its central bank is, therefore, most likely to raise interest rates first. That translates into a strong dollar, as interest rate differentials are far and away the biggest decider of the direction in currencies. So the dollar will remain strong against the Australian and Canadian dollars as well.

The Euro looks almost as bad. While European Central Bank president, Mario Draghi, has talked a lot about monetary easing, he now appears on the verge of taking decisive action.

Recurring financial crisis on the continent is forcing him into a massive round of Fed style quantitative easing through the buying of bonds issued by countless European entities. The eventual goal is to push the Euro down to parity with the buck and beyond.

For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book, but don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth in order to keep its appreciation modest to maintain their crucial export competitiveness.

 

FXY 1-2-15

FXE 1-5-15

CYB 1-2-15

mountains

5) Commodities (FCX), (VALE), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (PHO), (FIW), (CORN), (WEAT), (SOYB), (JJG)

There isn?t a strategist out there not giving thanks for not loading up on commodities in 2014, the preeminent investment disaster of 2015. Those who did are now looking for jobs on Craig?s List.

2014 was the year that overwhelming supply met flagging demand, both in Europe and Asia. Blame China, the big swing factor in the global commodity.

The Middle Kingdom is currently changing drivers of its economy, from foreign exports to domestic consumption. This will be a multi decade process, and they have $4 trillion in reserves to finance it.

It will still demand prodigious amounts of imported commodities, especially, oil, copper, iron ore, and coal, all of which we sell. But not as much as in the past. The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE), have all taken an absolute pasting.

The food commodities were certainly the asset class to forget about in 2014, as perfect weather conditions and over planting produced record crops for the second year in a row, demolishing prices. The associated equity plays took the swan dive with them.

However, the ags are still a tremendous long term Malthusian play. The harsh reality here is that the world is making people faster than the food to feed them, the global population jumping from 7 billion to 9 billion by 2050.

Half of that increase comes in countries unable to feed themselves today, largely in the Middle East. The idea here is to use any substantial weakness, as we are seeing now, to build long positions that will double again if global warming returns in the summer, or if the Chinese get hungry.

The easy entry points here are with the corn (CORN), wheat (WEAT), and soybeans (SOYB) ETF?s. You can also play through (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU).

The grain ETF (JJG) is another handy fund. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cakewalk. You can participate in this most liquid of assets with the ETF?s (PHO) and (FIW).

 

CORN 1-2-15

DBA 1-2-15

PHO 1-2-15

JT snow angelSnow Angel on the Continental Divide

 

6) Energy (DIG), (RIG), (USO), (DUG), (DIG), (UNG), (USO), (OXY), (XLE), (X)

Yikes! What a disaster! Energy in 2014 suffered price drops of biblical proportions. Oil lost the $30 risk premium it has enjoyed for the last ten years. Natural gas got hammered. Coal disappeared down a black hole.

Energy prices did this in the face of an American economy that is absolutely rampaging, its largest consumer.

Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system. Three Burlington Northern engines are heaving to pull over 100 black, brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.

There is another tank car train right behind it. No wonder Warren Buffett tap dances to work every day, as he owns the road. US Steel (X) also does the two-step, since they provide immense amounts of steel to build these massive cars.

The US energy boom sparked by fracking will be the biggest factor altering the American economic landscape for the next two decades. It will flip us from a net energy importer to an exporter within two years, allowing a faster than expected reduction in military spending in the Middle East.

Cheaper energy will bestow new found competitiveness on US companies that will enable them to claw back millions of jobs from China in dozens of industries. This will end our structural unemployment faster than demographic realities would otherwise permit.

We have a major new factor this year in considering the price of energy. Peace in the Middle East, especially with Iran, always threatened to chop $30 off the price of Texas tea. But it was a pie-in-the-sky hope. Now there are active negotiations underway in Geneva for Iran to curtail or end its nuclear program. This could be one of the black swans of 2015, and would be hugely positive for risk assets everywhere.

Enjoy cheap oil while it lasts because it won?t last forever. American rig counts are already falling off a cliff and will eventually engineer a price recovery.

Add the energies of oil (DIG), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY). Skip natural gas (UNG) price plays and only go after volume plays, because the discovery of a new 100-year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time.

It is a basic law of economics that cheaper prices bring greater demand and growing volumes, which have to be transported. However, major reforms are required in Washington before use of this molecule goes mainstream.

These could be your big trades of 2015, but expect to endure some pain first.

 

Baker Hughes Rig Count

WTIC 1-2-15

UNG 1-2-15

OXY 1-2-15

Train

7) Precious Metals (GLD), (DGP), (SLV), (PPTL), (PALL)

The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.

On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders. The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.

In the snow filled canyons we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It?s a good omen for the coming year. We also see countless abandoned gold mines and the broken down wooden trestles leading to them, so it is timely here to speak about precious metals.

As long as the world is clamoring for paper assets like stocks and bonds, gold is just another shiny rock. After all, who needs an insurance policy if you are going to live forever?

We have already broken $1,200 once, and a test of $1,000 seems in the cards before a turnaround ensues. There are more hedge fund redemptions and stop losses to go. The bear case has the barbarous relic plunging all the way down to $700.

But the long-term bull case is still there. Someday, we are going to have to pay the piper for the $4.5 trillion expansion in the Fed?s balance sheet over the past five years, and inflation will return. Gold is not dead; it is just resting. I believe that the monetary expansion arguments to buy gold prompted by massive quantitative easing are still valid.

If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. The precious metals have to work off a severely, decade old overbought condition before we make substantial new highs. Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.

If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all-time high, or more.

This is why emerging market central banks step in as large buyers every time we probe lower prices. For me, that pegs the range for 2015 at $1,000-$1,400. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).

I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal, silver (SLV), which I think could hit $50 once more, and eventually $100.

What will be the metals to own in 2015? Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf, would be something to consider on a dip. With US auto production at 17 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.

 

GOLD 1-2-15

SILVER 1-2-15

sunsetWould You Believe This is a Blue State?

8) Real Estate (ITB)

The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write. My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.

It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.

There is no doubt that there is a long-term recovery in real estate underway. We are probably 8 years into an 18-year run at the next peak in 2024.

But the big money has been made here over the past two years, with some red hot markets, like San Francisco, soaring. If you live within commuting distance of Apple (AAPL), Google (GOOG), or Facebook (FB) headquarters in California, you are looking at multiple offers, bidding wars, and prices at all time highs.

From here on, I expect a slow grind up well into the 2020?s. If you live in the rest of the country, we are talking about small, single digit gains. The consequence of pernicious deflation is that home prices appreciate at a glacial pace. At least, it has stopped going down, which has been great news for the financial industry.

There are only three numbers you need to know in the housing market: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 85 million in the generation after that, the Millennials.

The boomers have been unloading dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made.

If they have prospered, banks won?t lend to them. Brokers used to say that their market was all about ?location, location, location?. Now it is ?financing, financing, financing?. Banks have gone back to the old standard of only lending money to people who don?t need it.

Consider the coming changes that will affect this market. The home mortgage deduction is unlikely to survive any real attempt to balance the budget. And why should renters be subsidizing homeowners anyway? Nor is the government likely to spend billions keeping Fannie Mae and Freddie Mac alive, which now account for 95% of home mortgages.

That means the home loan market will be privatized, leading to mortgage rates higher than today. It is already bereft of government subsidies, so loans of this size are priced at premiums. This also means that the fixed rate 30-year loan will go the way of the dodo, as banks seek to offload duration risk to consumers. This happened long ago in the rest of the developed world.

There is a happy ending to this story. By 2022 the Millennials will start to kick in as the dominant buyers in the market. Some 85 million Millennials will be chasing the homes of only 65 Gen Xer?s, causing housing shortages and rising prices.

This will happen in the context of a labor shortfall and rising standards of living. Remember too, that by then, the US will not have built any new houses in large numbers in 15 years.

The best-case scenario for residential real estate is that it gradually moves up for another decade, unless you live in Cupertino or Mountain View. We won?t see sustainable double-digit gains in home prices until America returns to the Golden Age in the 2020?s, when it goes hyperbolic.

But expect to put up your first-born child as collateral, and bring your entire extended family in as cosigners if you want to get a bank loan.

That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with. This is especially true if you lock up today?s giveaway interest rates with a 30 year fixed rate loan. At 3.3% this is less than the long-term inflation rate.

You will boast about it to your grandchildren, as my grandparents once did to me.

 

Case-Shiller Home Prices Indices

ITB 1-2-15

BridgeCrossing the Bridge to Home Sweet Home

9) Postscript

We have pulled into the station at Truckee in the midst of a howling blizzard.

My loyal staff have made the 20 mile trek from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.

Well, that?s all for now. We?ve just passed the Pacific mothball fleet moored in the Sacramento River Delta and we?re crossing the Benicia Bridge. The pressure increase caused by an 8,200 foot descent from Donner Pass has crushed my water bottle. The Golden Gate Bridge and the soaring spire of the Transamerica Building are just around the next bend across San Francisco Bay.

A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my Macbook Pro and iPhone 6, pick up my various adapters, and pack up.

We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten mile night hike up Grizzly Peak and still get home in time to watch the season opener for Downton Abbey season five. I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.

I?ll shoot you a Trade Alert whenever I see a window open on any of the trades above.

Good trading in 2015!

John Thomas
The Mad Hedge Fund Trader

 

JT at workThe Omens Are Good for 2015!

Why I?m Doubling Up My Shorts

I don?t double up short positions very often. I am too old to lose all my money and go back to work as an entry-level analyst at Morgan Stanley. Besides, they probably wouldn?t have me back anyway. It is a different company than it was 30 years ago, a lot different.

However, the dead cat, short covering bounce we got off this morning?s Hong Kong dump does allow me to get back into the short side of the (SPY) one more time.

We managed to gain 20 (SPX) points, or 2 entire (SPY) handles from the Monday morning capitulation, puke on your shoes low. Except this time, we are a weekend closer to expiration, only 14 trading days until October 15.

And waiting all the way until Friday for the September nonfarm payroll buys us a free week.

Does anyone really care what?s going on in Hong Kong, China, or anywhere else in the world, for that matter? Not really. It appears only day traders do, and those of us who have family members there, like me.

The beginning of October is usually the scariest two weeks of the year. So a bet that the (SPY) doesn?t blast up to new all time highs during this period looks like a pretty good idea.

Buying the S&P 500 (SPY) October, 2014 $202-$205 vertical in-the-money bear put spread with the volatility index (VIX) just short of the $17 handle, the highest print in six months, is also getting us the best short term spread prices this year. It?s almost like the good old days.

If the prospect of executing this trade causes the hair on the back of your neck to stand up, take a look at the charts below.

The Russell 2000 (IWM) broke through to a new low this morning, proving that a solid, three-month downtrend in the small caps is still alive and well.

The chart looks even worse for the iShares iBoxx High Yield Corporate Bond ETF (HYG), which has become a very important lead security for traders to keep a laser like focus on.

NASDAQ (QQQ) and the Dow Jones Average ($INDU) are sitting bang on crucial support lines. Alibaba is still sucking all the oxygen out of the technology sector, with major institutions selling everything else to take instant 5% stakes in the new issue. This is great news for the sector for the long term, but not so great for the short term.

Finally, I asked my ace Mad Day Trader, Jim Parker, his thoughtful take here. He believes that short term, markets are oversold and due for a rallyette. He wouldn?t be shorting stocks here with My money! But is the (SPY) going to a new all time high in 14 trading days? Absolutely no way!

There is another factor to consider here. We have recently clocked substantial profits with our short positions in the Euro (FXE) and the Russell 2000 (IWM).

So we can afford the luxury of getting aggressive here when everyone else is running and hiding. We are essentially now playing with the house?s money. The only question is whether we will next post a larger gain, or a smaller one. That is a position of strength, and a great place to trade from.

So I think the net net of all of this is that best case, the risk markets all keep trending downward, worse case, they flat line sideways, at least for the next 14 trading days. Either way, it is a win-win for me. That makes the S&P 500 (SPY) October, 2014 $202-$205 in-the-money bear put spread a winner in my book.

You can buy this spread anywhere in a $2.60-$2.75 range and have a reasonable expectation of making money on this trade.

This is a rare instance where there is no outright stock or ETF equivalent to this trade. If you sell short the stock market here, such as through purchasing the ProShares Ultra Short S&P 500 ETF (SDS), we could rally all the way up to, but just short of the all time high, and you would get your head handed to you.

If this happens with the S&P 500 (SPY) October, 2014 $202-$205 in-the-money bear put spread, you make your maximum profit of 1.30% of your total portfolio. This is why I play in the options market. So non options players are better to stand aside on this trade and just watch it for educational purposes.

 

SPY 9-29-14

DIA 9-29-14

QQQ 9-29-14

IWN 9-29-14

HYG 9-29-14

VIX 9-29-14

Headlines

Market Floor

Holder Retirement Could Send Bank of America Flying

Watching the market melt down today, I have been hurriedly compiling a shopping list of stocks to buy, and writing the Trade Alerts in advance for readers to execute.

If I am right about interest rates remaining flat or rising for the rest of the year, then financials have to be at the absolute top of such a list.

Bank of America (BAC) certainly was the chief whipping boy of the financial crisis. Since 2008, it has paid out more than $50 billion in fines and lawsuit settlements for every transgression under the sun.

After getting a bail out from the US Treasury, it was forced to cut its dividend payment to a token one cent. Do any Google search on the company and you are inundated with a flood of bad news.

All that is now ancient history. The entire banking industry is now moving into the sweet spot in the economic cycle. This is because rising interest rates mean that they will be able to charge more for loans, while their cost of funds (deposits and equity) remains low. These rising spreads fall straight to the bottom line.

Now with the bank?s Torturer-in-Chief, US Attorney General Eric Holder, announcing his retirement, the way is clear for better days ahead.

With the 30-year bull market in bonds now at an end, substantially higher rates in the near future are now included in virtually every economic forecast out there. Since the beginning of 2014 the ten-year Treasury yield has collapsed from 3.05% to as low as 2.32% at he end of August, pummeling bank shares.

What happens next? They go from 2.32% back up to 3.05%, possibly by yearend, then a lot more. Bank shares will ride on the back of this bull.

The jungle telegraph is now ringing with the prospect of a dividend hike by the company, currently at a lowly four cents. We may get the good news as soon as the next reporting period on October 14. The implications of such a move are broad.

If it pulls this off, it is only because of renewed confidence by the markets in the improved financial condition of the company. After several capital raises and the liquidation of the wreckage of the 2008 crash, US banks are now the healthiest in history, with balance sheets of bedrock stability.

Ahem, they are also too big to fail, again.

To get the dividend yield on the shares up to industry standard of 2.5%, the company really needs to raise its dividend to 42 cents. It certainly has the cash flow to do this. In 2013, (BAC) reported net income of $11.4 billion, more than four times to amount needed to cover such a payout.

Needless to say, this is all great news for the share price. The prospective return of increasing amounts of capital to shareholders should suck in new and wider classes of shareholders. It won?t be just about hedge fund punters anymore. Respectable, large and long term holding institutions will be in there as well.

Take a look at the charts below, and it is clear that such a move is underway. (BAC) broke out from the end of a classic triangle formation, which traditionally resolves itself to the upside. New post crash highs beckon.

You can find more dry powder in the chart for the Financials Select Sector SPDR ETF (XLF), which clearly rejected a complete breakdown at long-term trend support in early February.

Finally, take a gander at the chart for the S&P 500. New life from the financials will be the adrenaline shot this market needs to break it out of its current low volume sideways consolidation, taking it to new highs as well.

Finally, for those who are concerned that the bull market was killed off by last week?s massive Alibaba IPO (BABA), take a look at he chart below provided by my friends at Business Insider. Certainly, the collapse of the iShares iBoxx High Yield Corporate Bond ETF (HYG) has put the fear of God into traders.

The chart tracks long-lived bull markets in terms of their price earnings multiples. It shows that we have only reached half the length of the great 1987-2000 bull market. The implication is that this bull could live another five or more years.

This bull is not dead, it is just resting.

So far, the S&P 500 has declined by a feeble 2.8% off the $202 top. If we break the 50-day moving average here, we could make it down to the 200-day moving average at $1,880, a more substantial 7% pullback. Take that as a gift, and load the boat for the year-end rally.

I?ll send out the Trade Alert to buy (BAC) when I think the timing is ripe.

BAC 9-25-14

(XLF) Weekly

XLF 9-25-14

(XLF) Daily

XLF Daily - 9-25-14

SPY 9-25-14

HYG 9-25-14

Markets Charts of the Day - Bull Markets

Bank of America - ATMTime to Visit the ATM Again

 

BullThe Bull is Not Dead, It is Resting

Why I?m Covering My Stock Shorts

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

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

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

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

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

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

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

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

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

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

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

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

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

RUT 8-6-14

HYG 8-6-14

SPX 8-6-14

PutinThank You Mr. Putin

Why I?m Hammering the Bond Market

Those lucky traders who have been following my Trade Alert service are well aware that I have been hamming the bond market for the past week. These new positions were a major factor in adding an impressive 5% to my model trading portfolio P&L during a week when there was very little happening in the real world.

There is a method to my madness.

This was supposed to be the year of the ?Great Reallocation,? whereby long-term investors bailed on their fixed income portfolios in favor of stocks. The only problem was that it just didn?t happen.

Bonds fell alright, taking the ten year Treasury yield up to 3.0% by August 20. But what selling did occur up until then saw the proceeds moved largely into cash instead of equities.

What happened next surprised many industry experts. Bonds rallied strongly going into a September meeting at the Federal Reserve where they were supposed to announce a taper of its $85 billion a month in bond buying. That was supposed to crash the bond market, and the street piled on massive shorts.

The meeting came and went without a taper announcement, catching many traders wrong footed. That forced them to chase the market to cover shorts, taking the yen year yield all the way down to 2.47% by last week.

Then the rally abruptly died.

When you see disparate markets confirming major reversals within an asset class all at once, it usually signifies that something big is happening. Starting on Wednesday, the Treasury market peaked and began a rapid descent, taking yields up 17 basis points in dramatic fashion.

Corporate bonds also took a dive, with the High Grade Investable Bond ETF (LQD) giving back a few points. Junk bonds took a hit, with the high yield ETF (HYG) taking it on the kisser. Even emerging market debt (ELD) and the municipal bond market (MUB) were thrown out with the bathwater.

Only master limited partnerships continued to hold up well, my favorite pick in the sector, Linn Energy (LINE), blasting ten points to the upside. This is one of the few areas in the fixed income space where a double-digit yield pays you for your principal risk.

That prompted me to rush followers out of a 100% cash position into seven new positions in very quick succession. I was writing Trade Alerts so fast that I was busier than the proverbial one-handed paperhanger. So I was a day early. Take it out of my next paycheck!

What is the big thing that the market is trying to tell us here? I may be going deaf and blind in my old age, but I can see this one coming a mile off.

The ?Great Reallocation? scheduled for 2013 is actually going to happen in 2014. The sell off in bonds that ran for the first eight months of the year put the fear of god into investors and managers alike. It?s not for nothing that bond giant PIMCO?s Bill Gross says that he expects to get ?ashes in my stocking for Christmas this year.?

Having been warned once on the risks entailed in a market that is coming off a 60 year high, bond owners don?t need to be told twice to sit down when the music stops playing. They have started to lighten up in a hurry.

December is turning into a ?Great Front Run of 2014.? To reallocate out of bonds into stocks in 2014, you have to start selling your bonds now. That means that bonds could remain weak for the rest of 2013, possibly even taking the ten year yield all the way back up to 3.0% again. Hence, my aggressive selling.

If I am right about this scenario, the flipside for stocks could be even more important. It augurs for a narrow, low volume, sideways correcting stock market for a few more weeks, then a blast to the upside into year-end. A Standard and Poor?s 500 of 1,800 becomes a chip shot, and with two months to run, it could even make it as high as 1,850. There is a global synchronized recovery on the table for 2014 and everyone and his brother wants to participate.

My only concern here is that we are pulling forward performance from 2014 into this year that will ultimately make next year harder to trade.

TNX 11-1-13

LQD 10-31-13

HYG 10-31-13

LINE 11-4-13

Musical ChairsSo Who?s Selling Their Bonds First?

Be Careful What You Wish For

The wild whipsaw movements in the markets on Thursday reminded us once again how dependent they have become on monetary stimulus from central banks. As if we needed reminding. Almost simultaneously, officials from the US, Japan and the UK hinted at a coordinated move at this weekend?s G-20 meeting in Cabo San Lucas, Mexico.

Let?s hope for the sake of global financial stability that no one eats a bad taco down there. And say ?Hello? to Miguel for me at the notorious drinking establishment, The Giggling Marlin. Just make sure he doesn?t pick your pocket when he hangs you upside down by your ankles with a block and tackle to give you a tequila shot.

The rumors were enough to cause me to cover my sole remaining short position in the S&P 500 (SPY) and bat out some additional shorts in the Japanese yen, which would go into free fall in such a scenario. If the rumors are true, they will take the (SPX) up to 1,400 and I will make a killing on my hefty long positions in (AAPL), (HPQ), (JPM), (DIS) and shorts in (FXY) and (TLT). If not, then the large cap index will revisit 1,290 one more time and I will be left looking like a dummy while posting an embellished resume on Craig?s List.

To see how closely risk assets are correlated with quantitative easing, take a look at the chart produced below by my friend, Dennis Gartman of The Gartman Letter. It graphically presents the market response to QE1, QE2, and Operation Twist, which are highlighted in green. In fact, quantitative easing has become the on/off switch of the financial markets. Hence, we get ?RISK ON?/?RISK OFF? gyrations in spades.

While on the topic of monetary policy, let?s consider the implications of a Romney win in the November presidential election. The former Massachusetts governor and son of a Michigan governor has said that he would fire Federal Reserve Governor, Ben Bernanke, on his first day in office.

Well, he actually can?t do that, although it is great fodder for the faithful on the hustings. What he can do is appoint and anti QE, pro-austerity replacement when Ben?s second four year term is up on January 31, 2014. At the top of the list of replacements are Stanford University?s John Taylor of Taylor Rule fame and sitting non-voting board member, president of the Dallas Fed, and noted hawk, Richard Fisher.

How would the financial markets react? Much of the recent buying of stocks and other risk assets has been on the assumption that the ?Bernanke Put? would kick in on any serious selloff. No Bernanke means no Bernanke put. I can already hear portfolio managers thinking ?What, you mean there is risk in these things?? and heading for the exits as quickly as possible. The resulting market crash could make 2008-2009 look like a cakewalk. Your 401k would rapidly shrink to a 201k, and your IRA would become DOA. So be careful what you wish for.

That is unless you are a reader of this letter and a subscriber to my Trade Alert Service. Such a market meltdown would be one of the great shorting opportunities of the century. But to follow the game you have to have a program.

 

 

 

 

 

 

Time for Another Shot of Monetary easing

2012 Annual Asset Class Review

I am writing this report from a first class cabin on Amtrak?s California Zephyr en route from Chicago to San Francisco. The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sage brush and salt flats of Northern Nevada outside my window, so there is nothing else to do but to write. My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca. It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.

After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2011 was the most hellacious in careers lasting 30, 40, or 50 years. With the S&P 500 up 0.4% 2011, following a roaring 0.04% decline in 2010, the average hedge fund was up a pitiful 1%, and thousands lost money.

It is said that those who ignore history are doomed to repeat it. I am sorry to tell you that we are about to endure 2011 all over again. You can count on another 12 months of high volatility, gap moves at the opening, tape bombs, a lot of buying of rumors and selling of news, promises and disappointments from governments, and American markets being held hostage to developments overseas.

If you lost money in 2011, you will probably do so again in 2012, and should consider changing your line of work. It takes a special kind of person to make money in markets like these; someone who thrives on raw data and ignores the hype and the spin, who invests based on facts and not beliefs, and who thinks all things can happen at all times.? In other words, you need somebody like me, as my 40% return last year will attest. Those who don?t think they are up to it might consider pursuing that long delayed ambition to open a trendy restaurant, the thoughtful antique store, or finally get their golf score down to 80.

If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:

*Long term structural issues will overwhelm short term positives.

*Corporate profits continue to grow, but at a much slower rate, reaching diminishing returns.

*2009 stimulus spending is a distant memory, and there will be no replays.

*Bush tax cuts expire, creating a 1% drag on GDP.

*An epochal downsizing continues by state and local governments, chopping another 2-3% off of GDP.

*A recession in Europe further reduces American growth by 1%.

*Expect an actual default out of the continent in 2012, certainly from Greece, possibly also from Portugal and Ireland.

*There will be no QE3, since QE2 never filtered down to the real economy. There is little the Fed can do to help us.

*Huge demographic headwinds bring another leg down in the residential real estate market.

*The first baby boomer hit 65 last year and it is now time to pay the piper on entitlements.

*The new hot button social issue will become ?senior homelessness,? as millions retire without a cent in the bank and are unable to find jobs.

*Falling home prices bring secondary banking crisis, but this time there will be no TARP and no bail outs

*Gridlock in Washington prevents any real government solution, and there is nothing they can do anyway.

*Candidates from both parties will attempt to convince us that their opponents are crooks, thieves, idiots, or ideologues, and largely succeed. That will leave the rest of us confused and puzzled, and less likely to invest or hire.

*Unemployment remains stuck at an 8-9% level, then ratchets up to 15%. The real, U-6 rate soars to 25%.

Now let me give you a list of possible surprise positives, which may mitigate the list of negatives above.

*American multinationals continue to squeeze more blood out of a turnip and post stellar earnings increases yet again.

*China successfully slams the breaks on the real estate market without cutting the rest of the economy off at the knees and engineers a soft landing with 7%-8% GDP growth.

*Europe somehow pulls a new treaty out of its hat that addresses its structural financial and monetary shortfalls a decade ahead of schedule.

*Through some miracle, the American consumer keeps spending at the expense of a declining savings rate. There is evidence that this has been going on since October.

The Election Will Not Be Good for Risk Assets

So, let me summarize what your 2012 will look like. The ?RISK ON? trade that started on October 4 will spill into the new year, driven by value players loading up on cheap multinationals, chased by frantically short covering hedge funds, hitting a peak sometime in Q1. The S&P 500 could reach 1,350. In Q2 and Q3 traders will have to deal with flocks of black swans, giving 4-7 months of the ?RISK OFF? trade. We should rally into Q4 as markets discount the end of the election cycle. It really makes no difference who wins. The mere disappearance of electioneering will be positive for risk takers.

I Said ?Black Swans,? Not Crows!

The Thumbnail Portfolio

Equities-A ?V? shaped year, up, down, then up again
Bonds-Treasuries grind towards new 60 year peaks, then an eventual collapse
Currencies-dollar up and Euro and Australian, Canadian and New Zealand dollars down
Commodities-Look to buy for a long term hold mid-year
Precious Metals-take a longer rest, then up again
Real estate-multifamily up, single family down, commercial sideways

1) The Economy-The Second Lost Decade Continues

I am sticking with a 2% growth forecast for 2012. I see the huge list of negatives above that add up to at least a 5% drag on the economy. There is only one positive that we can really count on. Corporate earnings will probably come in at $105 a share for the S&P 500 this year, a gain of 15% over the previous year, and a double off the 2008 lows. During the last three years we have seen the most dramatic increase in earnings in history, taking them to all-time highs, no matter how much management complains about over regulation.

Can the magic continue? I think not. Slowing economies in China and Europe will fail to deliver the stellar gains seen in 2011, which account for half the profits of many large multinationals.? A global economy that grew at 4.1% in 2010 and 2.5% in 2011 will probably eke out only a subdued 1.5% in 2012. A strong dollar will further eat into foreign revenues.

Cost cutting through layoffs is reaching an end as there is no one left to fire. Growing companies can?t delay new hires forever. That leaves technology as the sole remaining source of margin increases, which will continue its inexorable improvements. So corporate earnings will rise again in 2012, but possibly only by 5%-10%? to $105-$110 for the $S&P 500. Hint: technology will be the top performing sector in the market in 2012, with Apple (AAPL) taking the lead.

Deleveraging will remain a dominant factor affecting the economy for another 5-8 years. Much of the hyper growth we witnessed over the past 30 years, possibly half, was borrowed from the future through excessive credit, and it is now time to pay the piper. We are still at the beginning of a second lost decade. Don?t expect a robust GDP while governments, corporations, and individuals are sucking money out of the economy. This lines up nicely with my 2% target.

Forget about employment. The news will always be bad. I believe that the US has entered a period of long term structural unemployment similar to what Germany saw in the 1990?s. Yes, we may grind down to 8% before the election. But the next big move in this closely watched indicator is up, possible as high as 15%. Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read of the financial markets to head in a ?RISK ON? or ?RISK OFF? direction.

Equities: No Place for Old Men

2) Equities? (SPX), (QQQQ), (AAPL), (XLF), (BAC), (EEM),(EWZ), (RSX), (PIN), (FXI), (TUR), (EWY), (EWT), (IDX)

With a GDP growing at a feeble 2% in 2012, and corporate earnings topping out at $105-$110 a share, those with a traditional buy and old approach to the stock market will fare better taking this year off. While earnings are growing, multiples will shrink from 13 to 12, multiple? for the indexes unchanged. It is also possible that the economy will never meet the textbook definition of a recession, that of two back to back quarters of negative GDP numbers.? But the market will think the economy is going into recession and behave accordingly. ?Double dip? will get dusted off one again. Remember how ?Sell in May and Go Away? has worked so well for the past three years? This year you may want to sell in January.

I am looking for some new liquidity from value players and additional short covering to spill over into the New Year, possibly taking us up to 1,325-$1,350. If we get that high, take it as a gift, as the big hedge funds will be very happy to pile on the leveraged shorts at the top of a multiyear range.

A continuing stream of positive economic data will also help. Since we don?t have the ?oomph? offered by the tax compromise and QE2 a year ago, look for equities to peak much earlier than the April 29 apex we saw in 2011. The trigger for this deluge could be a sudden spike in jobless claims as the temporary Christmas hires are fired combined with economic data that cools coming off a hot Q4.

Let me tell you why the value players up here don?t get it. A 2% growth rate doesn?t justify the 10-22 price earnings multiple range that we have enjoyed during the last 30 years. At best it can support an 8-16 range, or maybe even the 6-15 range that prevailed when I first started on Wall Street 40 years ago. That makes the current 13 multiple look cheap according to old models, but expensive in the new paradigm.

When the guys in the white coats show up to drag away the value managers, they will be screaming that ?They were cheap,? all the way to the insane asylum. What these hapless souls didn?t grasp was that we are only four years into a secular, decade long downtrend in PE multiples, the bottom for which is anyone?s guess.

After that, the way should be clear for a 25% swoon down to 1,000, which will happen sometime in Q2 or Q3. That will be caused by a ton of new short selling triggered by the break of the 2011 low at 1,070, which then get stopped out on the upside. The heating up of trouble with Iran is another unpredictable variable, which is really just a pretext for attacking Syria, their only ally. How will the market decline in the face of growing earnings? That is exactly what markets did in 2011, once the fear trade was posted on the mast for all to see?

Crash, we won?t, and this is what my Armageddon friends don?t get. To break to new lows, you need sellers, and lots of them. Those were in abundance in 2008, when the bear market caught many completely by surprise, everyone was leveraged to the hilt, and risk controls provided all the security of wet tissue paper.

This time around it?s different. Prime brokers now require a pound of flesh as collateral, especially in the wake of the MF Global Bankruptcy, and leverage as almost an extinct species. In the meantime, individuals have been decamping from stocks en masse, with equity mutual fund sales over the past three year hitting $400 billion, compared to $800 billion in bond fund purchases. That will leave hedge funds the only players at an (SPX) of 1,000, who will be loath to run big shorts at multiyear bottoms. You can?t have a crash if there is no one left to sell.

That gives us the juice to rally into Q4, just as the presidential election is coming to an end. It really makes no difference who wins, as long as one doesn?t get control all three branches of government. My money is on Obama, who has the highest approval rate in history with unemployment at 8.6%. The mere fact that the election is over will lift a cloud of uncertainty overhanging risk assets. It will be a real stretch to hope that stock markets will close unchanged in 2012, as we did in 2011. My expectation is for a single digit loss for 2012.

This Could? be the Big Trade of 2012

Equities will be no place for old men

3) Bonds?? (TBT), (JNK), (PHB), (HYG), (PCY)

The single worst call by myself and the hedge fund industry at large this year was that massive borrowing by the Federal government would cause the Treasury bond market to collapse. Not only did it fail to do so, it blasted through to new 60 year highs, sending ten year yields to 1.80%, which adjusted for inflation is a real negative yield of -1.5% a year.

Investors today will get back 80 cents worth of purchasing power at maturity for every dollar they invest. But institutions and individuals will grudgingly lock in these appalling returns because they believe that the losses in any other asset class will be much greater.

What I underestimated was the absolute perniciousness of today?s deflation. The price for everything you want to sell is continuing a relentless fall, including your home and your labor.? The cost of the things you need to buy, like food, energy, health care, and education, is rocketing. Globalization is the fat on the fire. I call this ?The New Inflation?. This goes a long way in explaining the causes behind a 30 year decline in the middle class standard of living.

The other thing I miscalculated on was how rapid contagion fears spread from Europe. When the world gets into trouble, everyone picks up their marbles and goes home. For the financial markets, that translates into massive buying of the core ?flight to safety? assets of the US dollar and Treasury bonds.

While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite. A 1.80%, ten year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough. Given the choice between what a politician wants me to believe and the harsh judgment of the marketplace, I will take the latter every time.

So what will 2012 bring us? More of the same. For a start, we have seen a substantial ?RISK ON? rally for the past three months where equities tacked on a virile 20% gain. Bond yields have ticked up barely 30 basis points from the lows, not believing in the longevity of this rally for one nanosecond. That tells me that the next equity sell off could see Treasury yields punch through to new lows, possibly down to 1.60%. Given even a modest recession, bond yields could touch 1%.

Surveying the rocky landscape that lies ahead of me, I expect to get five months of ?RISK ON? conditions and a turbulent and volatile seven months of ?RISK OFF?. This augers very well for a continuation of the bull market in Treasuries at least until August.

This scenario does not presage a good year for the riskiest corner of the fixed income asset class – junk bonds, whose default rates are not coming in anywhere near where they were predicted just a few months ago. Don?t get enticed by the siren song of high yields by the junk ETF?s, like (JNK), (PHB), and the (HYG). There will be better buying opportunities down the road.

As for municipal bonds, we are seeing only the opening act of a decade of fiscal woes by local government. Still, there is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase muni values. The continued bull market in Treasuries will do the same.

So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way. Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits. And thank Meredith Whitney for creating the greatest buying opportunity in history for muni bonds a year ago.

Perhaps the best place to live in bond world is in emerging market debt, where you can participate via the (PCY). At least there, you have the tailwinds of strong economies, little outstanding debt, appreciating currencies, and already high interest rates. But don?t buy here. This is something you want to pick up at the nadir of a ?RISK OFF? cycle, when the dollar and Treasury markets are peaking.

(FXC)

The Fat Lady Will Have to Wait to Sing for the Treasury Market

4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)

Any trader will tell you to never bet against the trend, and the overwhelming direction for the US dollar for the last 220 years has been down. The only question is how far, how fast. Going short the currency of the world?s largest borrower, running the greatest trade and current account deficits in history, with a diminishing long term growth rate is a no brainer.

But once it became every hedge fund trader?s free lunch, and positions became so lopsided against the buck, a reversal was inevitable. We seem to be solidly in one of those periodic bear market corrections, which began in March and could continue for several more months, or even years.

The big driver of the currency markets is interest rate differentials. With US interest rates safely at zero, and the rest of the world chopping theirs as fast as they can, this will provide a very strong tailwind for the greenback for much of 2012. Use rallies to sell short the Euro (FXE), (EUO), the Canadian dollar (FXC), the high beta Australian dollar (FXA), and the lagging New Zealand dollar (BNZ). Australians could see a print of 85 cents before the bloodletting is over, and should pay for their upcoming imports and foreign vacations now, while their currency is still dear.

The Euro presents a particular quandary for foreign exchange traders, with a never ending sovereign debt crisis causing its death through a thousand cuts. Just look at Greece, with a budget deficit of 13% of GDP against the 3% it promised on admission to the once exclusive club. But this is not exactly new news, and traders have already built shorts to all-time records. Still, the next crisis in confidence could easily take the Euro to $1.25, and new momentum driven shorts could take us to the $1.17?s.

As far as the Japanese yen is concerned, I am going to stay away. How the world?s worst economy has managed to maintain the planet?s strongest currency is beyond me. The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate. But until someone provides me with a convincing explanation, or until the yen decisively reverses, I?ll pass. Let hedge fund manager, Kyle Bass, figure this one out.

For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book, but don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth to in order to keep its appreciation modest to maintain their crucial export competitiveness.

Suddenly, Everyone Loves Uncle Buck

5) Commodities (FCX), (VALE), (DIG), (RIG), (JOY), (KOL), (CCJ), (FSLR), (USO), (DUG), (DIG), (UNG), (JJG), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (CCJ), (NLR), (PHO), (FIW), (CORN), (WEAT), (SOYB)

This is my favorite asset class for the next decade, as investors increasingly catch on to the secular move out of paper assets into hard ones. Don?t buy anything that can be manufactured with a printing press. Focus instead on assets that are in short supply, are enjoying an exponential growth in demand, and take five years to bring new supply online. The Malthusian argument on population growth also applies to commodities; hyperbolic demand inevitably overwhelms linear supply growth.

Of course, we?re already nine years into what is probably a 30 year secular bull market for commodities and these things are no longer as cheap as they once were. You?ll never buy copper again at 85 cents a pound, versus today?s $3.40. You are going to have to allow these things to breathe. Ultimately, this is a demographic play that cashes in on rising standards of living in the biggest and highest growth emerging markets. You can start with the traditional base commodities of copper and iron ore.

The derivative equity plays here are Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE). Add the energies of oil (DIG), coal (KOL), uranium (NLR), and the equities Transocean (RIG), Joy Global (JOY), and Cameco (CCJ).

As much as I love the long term case for hard commodities, I am not expecting any action in the immediate future. Commodities will remain a no go area until it is clear whether China?s economy will suffer a soft or a hard landing, or continues to remain airborne. Use this year?s big ?RISK OFF? trade to acquire serious positions. If markets rally into year end, you might catch a quick 50% gain in the more volatile securities.

Oil has in fact become the new global de facto currency, and probably $30 of the current $100 price reflects monetary demand, and another $30 representing a Middle Eastern risk premium. Strip out these factors, and oil should be trading at $40.? That will help it grind to $100 sometime in early 2012, and we could spike as high as $120. After that, the ?RISK OFF? trade could take it back down to the $75 we saw in September.

Skip natural gas (UNG), because the discovery of a new 100 year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time. Major reforms are required in Washington before use of this molecule goes mainstream.

The food commodities are also a great long term Malthusian play, with corn (CORN), wheat (WEAT), and soybeans (SOYB) coming off the back of great returns in 2010. These can be played through the futures or the ETF?s (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU). The grain ETF (JJG) is another handy play. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cake walk. You can participate in this most liquid of asset with the ETF?s (PHO) and (FIW).

Here is Your Lead Contract for ?RISK ON?

Meet Your New Currency

5) Precious Metals??? (GLD), (DGP), (SLV), (PTM), (PALL)

Let?s face it, gold is not a hard asset anymore, it?s a paper one. Since hedge funds and high frequency traders moved into this space, the barbarous relic has been tracking one for one with the S&P 500 and other risk assets.

The chip shot here is $1,500 on the downside, once the remaining hedge fund redemptions and other hot money are cleared out. If we have a real recession this year, $1,050 might be doable. Remember, the speculative frenzy is as great as it was in 1979, which saw the beginning of a 75% plunge in the yellow metal.

But the long term bull case is still there. Obama has not suddenly become a paragon of fiscal restraint. Bernanke has not morphed into a tightwad. When I pull a dollar bill out of my wallet, it?s as limp as ever.

If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. The precious metals have to work off a severely overbought condition before we make substantial new highs. Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.

If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all-time high, or more. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP). But you should only go into these as part of a broader ?RISK ON? move.

I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal,+ silver (SLV), which I think could hit $50 once more. Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf would also be something to consider on a dip.

Here?s a Nice Busted Bubble

6) Real Estate

There is no point in spending much time on this most unloved of asset classes, so I?ll keep it brief. There are only three numbers you need to know in the housing market: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 85 million in the generation after that, the Millennials.

The boomers have been desperately trying to unload dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of them, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. If they have prospered, banks won?t lend to them.

Now consider the coming changes that will affect this market. The home mortgage deduction is unlikely to survive any attempt to balance the budget. And why should renters be subsidizing homeowners anyway? Nor is the government likely to spend billions keeping Fannie Mae and Freddie Mac alive, which now account for 95% of home mortgages.

That means the home loan market will be privatized, leading to mortgages rates 200 basis points higher than today. If this sounds extreme, look no further than the jumbo market for proof. It is already bereft of government subsidy, and loans here are now priced at premiums of this size. This also means that the fixed rate 30 year loan will disappear, as banks seek to offload duration risk to consumers. This happened long ago in the rest of the developed world.

There is a happy ending to this story. By 2025 the Millennials will start to kick in as the dominant buyers in the market. Some 85 million Millennials will be chasing the homes of only 65 Gen Xer?s, causing housing shortages and rising prices. This will happen in the context of a labor shortfall and rising standards of living. In fact, the mid 2020?s could bring a repeat of our last golden age, the 1950?s.

The best case scenario for residential real estate is that it bounces along a bottom for another decade. The worst case is that it falls another 25% from here. Only buy a home if your wife is nagging you about living in that cardboard box under the freeway overpass. But expect to put up your first born child as collateral, and bring in your entire extended family in as cosigners if you want to get a bank loan. Then pray that the price starts to go up in 15 years. Rent, don?t buy.

Rent, Don?t Buy

Well, that?s all for now. We?ve just passed the Pacific mothball fleet and we?re crossing the Benicia Bridge, where the Sacramento River pours into San Francisco Bay. The pressure drop caused by an 8,000 foot descent from Donner Pass has crushed my water bottle. The Golden Gate and the soaring spire of the Transamerica building are just around the next bend. So it is time for me to unglug my laptop and pack up.

I?ll shoot you a trade alert whenever I see a window open on any of the trades above. Good trading in 2012!

Watch Out for the Bear Trap

The volatility index (VIX) is just not buying this sell off. Even with the Dow down over 300 today, the (VIX) has only managed a meager 3% gain on the day. With a move in equities of this magnitude, you would expect volatility to rise by 15% or more. If traders and investors really believed that the risk markets were really going to crash to new lows, they would be paying through the nose to buy downside protection, which would be clearly visible in a (VIX) spike. These figures prove they aren?t.

Let?s do a quickie cross asset class review here and look at what else on the table. The S&P 500 is precisely at the 50% retracement of the entire 200 point move up from October 4. It could hold this level and keep the bull move intact. While junk bonds (HYG) are down, they are nowhere near the levels suggesting that a financial collapse is imminent. Advance decline ratios are at all-time highs, not exactly an argument for a new bear market. Nor are Treasury bonds drinking the Kool-Aide. Sure they are up today, but not as much as they should be.

It all has the makings of an asymmetric trade for me. That means that the next piece of good news will deliver a larger move up than the next piece of bad news will bring a down one. So a tactical long here will bring an outsized returns. It could well be that the failure of the Super committee is fully in the price, and the mere passage of the deadline might bring a big rally. There are certainly a lot of hedge funds looking to chase yearend performance and value players happy to bottom fish to pull this off.

The bulls also have the calendar strongly in their favor. Not only is the November-December period the second strongest bimonthly period of the year, investors are massively underweight equities. As I never tire in explaining to my permabear friends, most investors can?t sell stock they don?t own. That?s why the Armageddon scenario never kicked in during September. That leaves hedge funds and high frequency trading alone to break the downside supports, something they have so far been unable to do alone.

Which girls will get invited to the next dance? The same ones taken to the last one: commodities, energy, rail, coal, and technology stocks, especially Apple, which is sitting bang on its 200 day moving average today.

Of course I could be wrong about all of this. Conditions in the markets are so uncertain here that there are no real high quality trades to be found. Almost everyone is posting negative returns this year, including some of the smartest people I know. That?s why I have pared back my own trading in order to preserve my own 42% year to date gain. But then, I am 75% in cash, so I can afford to take a relaxed view of things.

Only trade here if your wife is pestering you for a larger Christmas shopping budget. Don?t even think about opening up a new short here, because you have already missed the big, easy move. Then again, you could consider getting a new wife. It might be cheaper.