I had the great pleasure of having breakfast the other morning with my longtime friend, Mohamed El-Erian, former the co-CEO of the bond giant, PIMCO.
Mohamed argues that there has been a major loss of liquidity in the financial markets in recent decades that will eventually come home to haunt us all, and sooner than we think.
The result will be a structural increase in market volatility and wild gyrations in the prices of financial assets that will become commonplace.
We have already seen a few of these. Look no further than superstar NVIDIA (NVDA), which announced earnings in line with expectations in November but nevertheless responded with a 50% decline. It was a classic “Buy the rumor, sell the news” type move.
The worst is yet to come.
It is a problem that has been evolving for years.
When I started on Wall Street during the early 1980s, the model was very simple. You had a few big brokers servicing millions of small individual customers at fixed, non-negotiable commissions.
The big houses made so much money they could spend some dough facilitating counter cycle customers trades. This means they would step up to bid in falling markets and make offers in rising ones.
In any case, volatility was so low then that this never cost all that much, except on those rare occasions, such as the 1987 crash (we at Morgan Stanley lost $75 million in a day! Ouch!).
Competitive, meaning falling, commissions rates wiped out this business model. There were no longer profits to subsidize losses on the trading side, so the large firms quit risking their capital to help out customers altogether.
Now you have a larger number of brokers selling to a greatly shrunken number of end buyers, as financial assets in the US have become concentrated at the top.
Assets have also become institutionalized as they are piled into big hedge funds and a handful of very large index mutual funds and ETFs. These assets are managed by people who are also much smarter too.
The small individual investor on which the industry was originally built has almost become an extinct species.
There is no more “dumb money” left in the market, at least until this month.
Now those placing large orders were at the complete mercy of the market, often with egregious results.
Enter volatility. Lot’s of it.
What is particularly disturbing is that the disappearance of liquidity is coming now, just as the 35-year bull market in bonds is ending.
An entire generation of bond fund managers, almost two generations worth, have only seen prices rise, save for the occasional hickey that never lasted for more than a few months. They have no idea how to manage risk on the downside whatsoever.
I am willing to bet money that you or your clients have at least some, if not a lot of your money tied up in precisely these kinds of funds. All I can say is, “Watch out below.”
When the flash fire hits the movie theater, you are unlikely to be the one guy who gets out alive.
You hear a lot about when the Federal Reserve finally gets around to raising interest rates in earnest this year. They say it will make no difference as rates are coming off such a low base.
You know what? It may make a difference, maybe a big one.
This is because it will signify a major trend change, the first one for fixed income in more than three decades. Almost all of these guys really understand are trends and the next one will have a big fat “SELL” pasted on it for the fixed income world.
El-Erian has one of the best 90,000-foot views out there. A US citizen with an Egyptian father, he started out life at the old Salomon Smith Barney in London and went on to spend 15 years at the International Monetary Fund.
He joined PIMCO in 1999 and then moved on to manage the Harvard endowment fund.
He regularly makes the list of the world’s top thinkers. A lightweight Mohamed is not.
His final piece of advice? Engage in “constructive paranoia” and structure your portfolio to take advantage of these changes, rather than fall victim to them.
See the Long Term “Head and Shoulders” Top in the (TLT)?
https://www.madhedgefundtrader.com/wp-content/uploads/2015/05/Mohamed-El-Erian-e1431024366379.jpg400347DougDhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngDougD2019-02-14 02:07:052019-07-09 04:07:43The Liquidity Crisis Coming to a Market Near You
I am once again writing this report from a first-class sleeping cabin on Amtrak’s legendary California Zephyr.
By day, I have two comfortable seats facing each other next to a panoramic window. At night, they fold into two bunk beds, a single and a double. There is a shower, but only Houdini could get to navigate it.
I am not Houdini, so I go downstairs to use the larger public hot showers. They are divine.
We are now pulling away from Chicago’s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American exceptionalism.
I am headed for Emeryville, California, just across the bay from San Francisco, some 2,121.6 miles away. 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. Microsoft’s Spellchecker can catch most of the mistakes, but not all of them.
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied Internet searches during stops at major stations along the way to Google search obscure data points and download the latest charts.
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 so much about our country 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 10x.
After making the rounds with strategists, portfolio managers, and hedge fund traders in the run-up to this trip, I can confirm that 2018 was one of the most brutal to trade for careers lasting 30, 40, or 50 years. This was the year that EVERYTHING went down, the first time that has happened since 1972. Comparisons with 1929, 1987, and 2008 were frequently made.
While my own 23.56% return for last year is the most modest in a decade, it beats the pants off of the Dow Average plunge of 8% and 99.9% of the other managers out there. That is a mere shadow of the spectacular 57.91% profit I took in during 2017. This keeps my ten-year average annualized return at 34.20%.
Our entire fourth-quarter loss came from a single trade, a far too early bet that the Volatility Index would fall from the high of the year at $30.
For a decade, all you had to do was throw a dart at the stock page of the Wall Street Journal and you made money, as long as it didn’t end on retail. No more.
For the first time in years, the passive index funds lost out to the better active managers. The Golden Age of the active manager is over. Most hedge funds did horribly, leveraged long technology stocks and oil and short bonds. None of it worked.
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:
The Nine Key Variables for 2019
1) Will the Fed raise rates one, two, or three times, or not at all?
2) Will there be a recession this year or will we have to wait for 2020?
3) Is the tax bill fully priced into the economy or is there more stimulus to come?
4) Will the Middle East drag us into a new war?
5) Will technology stocks regain market leadership or will it be replaced by other sectors?
6) Will gold and other commodities finally make a long-awaited comeback?
7) Will rising interest rates (positive) or deficits (negative) drive the US dollar this year?
8) Will oil prices recover in 2019?
9) Will bitcoin ever recover?
Here are your answers to the above: 1) Two, 2) 2020, 3) Yes, 4) No, 5) Both, 6) Yes, 7) Yes, 8) Yes, 9) No.
There you go! That’s all the research you have to do for the coming year. Everything else is a piece of cake. You can go back to your vacation.
The Twelve Highlights of 2018
1) Stocks will finish lower in 2019. However, we aren’t going to collapse from here. We will take one more rush at the all-time highs that will take us up 10% to 15% from current levels, and then fail. That will set up the perfect “head and shoulders” top on the long-term charts that will finally bring to an end this ten-year bull market. This is when you want to sell everything. The May 10, 2019 end to the bull market forecast I made a year ago is looking pretty good.
I think there is a lot to learn from the 1987 example when stocks crashed 20% in a single day, and 42% from their 1987 high, and then rallied for 28 more months until the next S&L crisis-induced recession in 1991.
Investors have just been put through a meat grinder. From here on, its all about trying to get out at a better price, except for the longest-term investors.
2) Stocks will rally from here because they are STILL receiving the greatest amount of stimulus in history. Energy prices have dropped by half, taxes are low, inflation is non-existent, and interest rates are still well below long term averages.
Corporate earnings will grow at a 6% rate, not the 26% we saw in 2018. But growing they are. At current prices, the stock market is assuming that companies will generate big losses in 2019, which they won’t. Just try to find a parking space at a shopping mall anywhere and you’ll see what I mean.
3) Technology stocks will lead any recovery. Love them or hate them, big tech accounts for 25% of stock market capitalization but 50% of US profits. That is where the money is. However, in 2019 they will be joined by biotech and health care companies as market leaders.
4) The next big rally in the market will be triggered by the end of the trade war with China. Don’t expect the US to get much out of the deal. It turns out that the Chinese can handle a 20% plunge in the stock market much better than we can.
5) The Treasury bond market will finally get the next leg down in its new 10-year bear market, but don’t expect Armageddon. The ten-year Treasury yield should hit at least 3.50%, and possibly 4.0%.
6) With slowing, US interest rate rises, the US dollar will have the wind knocked out of it. It’s already begun. The Euro and the Japanese yen will both gain about 10% against the greenback.
7) Political instability is a new unknown factor in making market predictions which most of us have not had to deal with since the Watergate crisis in 1974. It’s hard to imagine the upcoming Mueller Report not generating a large market impact, and presidential tweets are already giving us Dow 1,000-point range days. These are all out of the blue and totally unpredictable.
8) Oil at $42.50 a barrel has also fully discounted a full-on recession. So, if the economic slowdown doesn’t show, we can make it back up to $64 quickly, a 50% gain.
9) Gold continues its slow-motion bull market, gaining another 10% since the August low. It barely delivered in 2018 as a bear market hedge. But once inflation starts to pick up a head of steam, so should the price of the barbarous relic.
10) Commodities had a horrific year, pulled under by the trade war, rising rates, and strong dollar. Reverse all that and they should do better.
11) Residential real estate has been in a bear market since March. You’ll find out for sure if you try to sell your home. Rising interest rates and a slowing economy are not what housing bull markets are made of. However, prices will drop only slightly, like 10%, as there is still a structural shortage of housing in the US.
12) The new tax bill came and went with barely an impact on the economy. At best we got two-quarters of above-average growth and slightly higher capital spending before it returned to a 2%-2.5% mean. Unfortunately, it will cost us $4 trillion in new government debt to achieve this. It was probably the worst value for money spent in American history.
Dow Average 1987-90
The Thumbnail Portfolio
Equities - Go Long. The tenth year of the bull market takes the S&P 500 up 13% from $2,500 to $2,800 during the first half, and then down by more than that in the second half. This sets up the perfect “head and shoulders” top to the entire decade-long move that I have been talking about since the summer.
Technology, Pharmaceuticals, Healthcare, and Biotech will lead on the up moves and now is a great entry point for all of these. Buy low, sell high. Everyone talks about it but few ever actually execute like this.
Bonds - Sell Short. Down for the entire year big time. Sell short every five-point rally in the ten-year Treasury bond. Did I mention that bonds have just had a ten-point rally? That’s why I am doubled up on the short side.
Foreign Currencies - Buy. The US dollar has just ended its five-year bull trend. Any pause in the Fed’s rate rising schedule will send the buck on a swan dive, and it’s looking like we may be about to get a six-month break.
Commodities - Go Long. Global synchronized recovery continues the new bull market.
Precious Metals - Buy. Emerging market central bank demand, accelerating inflation, and a pause in interest rate rises will keep the yellow slowly rising.
Real Estate – Stand Aside. Prices are falling but not enough to make it worth selling your home and buying one back later. A multi-decade demographic tailwind is just starting, and it is just a matter of time before prices come roaring back.
1) The Economy-Slowing
A major $1.5 trillion fiscal stimulus was a terrible idea in the ninth year of an economic recovery with employment at a decade high. Nevertheless, that’s what we got.
The certainty going forward is that the gains provided by lower taxes will be entirely offset by higher interest rates, higher labor costs, and rising commodity and oil prices.
Since most of the benefits accrued to the top 1% of income earners, the proceeds of these breaks entirely ended up share buybacks and the bond market. This is why interest rates are still so incredibly low, even though the Fed has been tightening for 4 ½ years (remember the 2014 taper tantrum?) and raising rates for three years.
And every corporate management views these cuts as temporary so don’t expect any major capital investment or hiring binges based on them.
The trade wars have shifted the global economy from a synchronized recovery to a US only recovery, to a globally-showing one. It turns out that damaging the economies of your biggest economies is bad for your own business. They are also a major weight on US growth. CEOs would rather wait to see how things play out before making ANY long-term decisions.
As a result, I expect real US economic growth will retreat from the 3.0% level of 2018 to a much more modest 1.5%-2.0% range in 2019.
The government shutdown, now in its third week (and second year), will also start to impact 2019 growth estimates. For every two weeks of closure, you can subtract 0.1% in annual growth.
Twenty weeks would cut a full 1%. And if you only have 2% growth to start with that means you don’t have much to throw away until you end up in a full-on recession.
Hyper-accelerating and cross-fertilizing technology will remain a long term and underestimated positive. But you have to live here next to Silicon Valley to realize that.
S&P 500 earnings will grow from the current $170 to $180 at a price earnings multiple at the current 14X, a gain of 6%. Unfortunately, these will start to fade in the second half from the weight of rising interest rates, inflation, and political certainty. Loss of confidence will be a big influence in valuing shares in 2019.
Whatever happened to the $2.5 trillion in offshore funds held by American companies expected to be repatriated back to the US? That was supposed to be a huge market stimulus last year. It’s still sitting out there. It turns out companies still won’t bring the money home even with a lowly 10% tax rate. They’d rather keep it abroad to finance growth there or borrow against it in the US.
Here is the one big impact of the tax bill that everyone is still missing. The 57% of the home-owning population are about to find out how much their loss of local tax deductions and mortgage deductions is going to cost them when they file their 2018 returns in April. They happen to be the country’s biggest spenders. That’s another immeasurable negative for the economy.
Take money out of the pockets of the spenders and give it to the savers and you can’t have anything but a weakening on the economy.
All in all, it will be one of the worst years of the decade for the economy. Maybe that’s what the nightmarish fourth quarter crash was trying to tell us.
The final move of a decade long bull market is upon us.
Corporate earnings are at record levels and are climbing at 6% a year. Cash on the balance sheet is at an all-time high as are profit margins. Interest rates are still near historic lows.
Yet, there is not a whiff of inflation anywhere except in now fading home costs and paper asset prices. Almost all other asset classes offer pitiful alternatives.
The golden age of passive index investing is over. This year, portfolio managers are going to have to earn their crust of bread through perfect market timing, sector selection, and individual name-picking. Good luck with that. But then, that’s why you read this newsletter.
I expect an inverse “V”, or Greek lambda type of year. Stocks will rally first, driven by delayed rate rises, a China war settlement, and the end of the government shut down. That will give the Fed the confidence to start raising rates again by mid-year because inflation is finally starting to show. This will deliver another gut-punching market selloff in the second half giving us a negative stock market return for the second year in a row. That hasn’t happened since the Dotcom Bust of 2001-2002.
How much money will I make this year? A lot more than last year’s middling 23.56% because now we have some reliable short selling opportunities for the first time in a decade. Short positions performed dreadfully when global liquidity is expanding. They do much better when it is shrinking, as it is now.
Amtrak needs to fill every seat in the dining car to get everyone fed, so you never know who you will share a table with for breakfast, lunch, and dinner.
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 fleeing 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 automobiles or airplanes.
This year is simply a numbers game for the bond market. The budget deficit should come in at a record $1.2 trillion. The Fed will take out another $600 billion through quantitative tightening. Some $1.8 trillion will be far too much for the bond market to soak up, meaning prices can only fall.
Except that this year is different for the following reasons.
1) The US government is now at war with the world’s largest bond buyer, the Chinese government.
2) A declining US dollar will frighten off foreign buyers to a large degree.
3) The tax cuts have come and gone with no real net benefit to the average American. Probably half of the country saw an actual tax increase from this tax cut, especially me.
All are HUGELY bond negative.
It all adds up to a massive crowding out of individual and corporate borrowers by the federal government, which will be forced to bid up for funds. You are already seeing this in exploding credit spreads. This will be a global problem. There are going to be a heck of a lot of government bonds out there for sale.
That 2.54% yield for the ten-year Treasury bond you saw on your screen in early January? You will laugh at that figure in a year as it hits 3.50% to 4.0%.
Bond investors today get an unbelievably bad deal. If they hang on to the longer maturities, they will get back only 90 cents worth of purchasing power at maturity for every dollar they invest a decade down the road at best.
The only short-term positive for bonds was Fed governor Jay Powell’s statement last week that our central bank will be sensitive to the level of the stock market when considering rate rises. That translates into the reality that rates won’t go up AT ALL as long as markets are in crash mode.
It all means that we are now only two and a half years into a bear market that could last for ten or twenty years.
The IShares 20+ Year Treasury Bond ETF (TLT) trading today at $123 could drop below $100. The 2X ProShares 20+ Short Treasury Bond Fund (TBT) now at $31 is headed for $50 or more.
Junk Bonds (HYG) are already reading the writing on the wall taking a shellacking during the Q4 stock market meltdown. This lackluster return ALWAYS presages an inverted yield curve by a year where short term interest rates are higher than long term ones. This in turn reliably predicts a full-scale recession by 2020 at the latest.
I have pounded away at you for years that interest rate differentials are far and away the biggest decider of the direction in currencies.
This year will prove that concept once again.
With overnight rates now at 2.50% and ten-year Treasury bonds at 2.54%, the US now has the highest interest rates of any major industrialized economy.
However, pause interest rate rises for six months or a year and the dollar loses its mojo very quickly.
Compounding the problem is that a weak dollar begets selling from foreign investors. They are in a mood to do so anyway, as they see rising political instability in the US a burgeoning threat to the value of the greenback.
So the dollar will turn weak against all major currencies, especially the Japanese yen (FXY), and the Australian (FXA) and Canadian (FXC) dollars.
A global synchronized economic slowdown can mean only one thing and that is sustainably lower commodity prices.
Industrial commodities, like copper, iron ore, performed abysmally in 2018, dope slapped by the twin evils of a strong dollar and the China trade war.
We aren’t returning to the heady days of the last commodity bubble top anytime soon. Investors are already front running that move now.
However, once this sector gets the whiff of a weak dollar or higher inflation, it will take off like a scalded chimp.
Now that their infrastructure is largely built out, the Middle Kingdom will change drivers of its economy. This is world-changing.
The shift will be from foreign exports to domestic consumption. This will be a multi-decade process, and they have $3.1 trillion in foreign exchange reserves to finance it.
It will still demand prodigious amounts of imported commodities but not as much as in the past.
This trend ran head-on into a decade-long expansion of capacity by the commodities industry, delivering the five-year bear market that we are only just crawling out of.
The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE) have all been some of the best-performing assets of 2017.
If you expect a trade war-induced global economic slowdown, the last thing in the world you want to own is an energy investment.
And so it was in Q4 when the price of oil got hammered doing a swan dive from $68 to $42 a barrel, an incredible 38% hickey.
All eyes will be focused on OPEC production looking for new evidence of quota cheating which is slated to expire at the end of 2018. Their latest production cut looked great on paper but proved awful in practice. Welcome to the Middle East.
The only saving grace is that with crude at these subterranean levels, new investment in fracking production has virtually ceased. No matter, US pipelines are operating at full capacity anyway.
OPEC production versus American frackers will create the constant tension in the marketplace for all of 2019.
My argument in favor of commodities and emerging markets applies to Texas tea as well. A weaker US dollar, trade war end, interest rate halt are all big positives for any oil investment. The cure for low oil prices is low prices.
That makes energy Master Limited Partnerships, now yielding 6-10%, especially interesting in this low yield world. Since no one in the industry knows which issuers are going bankrupt, you have to take a basket approach and buy all of them.
The Alerian MLP ETF (AMLP) does this for you in an ETF format. 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, spanking 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 railroad.
We are also seeing relentless improvements on the energy conservation front with more electric vehicles, high mileage conventional cars, and newly efficient building.
Anyone of these inputs is miniscule on its own. But add them all together and you have a game changer.
As is always the case, the cure for low prices is low prices. But we may never see $100/barrel crude again. In fact, the coming peak in oil prices may be the last one we ever see. The word is that leasing companies will stop offering five-year leases in five years because cars with internal combustion engines will become worthless in ten.
Add to your long-term portfolio (DIG), ExxonMobile (XOM), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY). But date these stocks, don’t marry them.
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, like the rest of our lives.
It is a basic law of economics that cheaper prices bring greater demand and growing volumes which have to be transported. Any increase in fracking creates more supply of natural gas.
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 19th century gold mines and the broken-down wooden trestles leading to them, relics of previous precious metals booms. So, it is timely here to speak about the future of precious metals.
Gold (GLD) lost money in 2018, off 2.4%. More volatile silver (SLV) shed 12%.
This was expected, as non-yielding assets like precious metals do terribly during times of rising interest rates.
In 2019, gold will finally be coming out of a long dark age. As long as the world was clamoring for paper assets like stocks, gold was just another shiny rock. After all, who needs an insurance policy if you are going to live forever?
But the long-term bull case is still there. Gold is not dead; it is just resting.
If you forgot to buy gold at $35, $300, or $800, another entry point here up for those who, so far, have missed the gravy train.
To a certain extent, the belief that high-interest rates are bad for gold is a myth. Wealth creation is a far bigger driver. To see what I mean, take a look at a gold chart for the 1970s when interest rates were rising sharply.
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. China and India emerged as major buyers of gold in the final quarters of 2018.
They were joined by Russia which was looking for non-dollar investments to dodge US economic and banking sanctions.
That means it’s just a matter of time before gold breaks out to a new multiyear high above $1,300 an ounce. 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 rise from the present $14 and hit $50 once more, and eventually $100.
The turbocharger for gold will hit sometime in 2019 with the return of inflation. Hello stagflation, it’s been a long time.
Would You Believe This is a Purple State?
8) Real Estate (ITB), (LEN),
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 in advance to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving bands 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.
Passing by shantytowns and the forlorn communities of the high desert, I am prompted to comment on the state of the US real estate market.
There is no doubt a long-term bull market in real estate is taking a major break. If you didn’t sell your house by March last year you’re screwed and stuck for the duration.
And you’re doubly screwed if you’re trying to sell your home now during the government shutdown. With the IRS closed, tax return transcripts are unobtainable making any loan approval impossible. And no one at Fannie Mae or Freddie Mac, the ultimate buyers of 70% of US home loans, has answered their phone this year.
The good news is that we will not see a 2008 repeat when home values cratered by 50%-70%. There is just not enough leverage in the system to do any real damage. That has gone elsewhere, like in exchange-traded funds. You can thank Dodd/Frank for that which imposed capital rules so strict that it is almost impossible for banks to commit suicide.
And no matter how dire conditions may appear now, you are not going to see serious damage in a market where there is a generational structural shortage of supply.
We are probably seven years into a 17-year run at the next peak in 2028. What we are suffering now is a brief two-year pause to catch our breath. Those bidding wars were getting tiresome anyway.
There are only three numbers you need to know in the housing market for the next 20 years: there are 80 million baby boomers, 65 million Generation Xers who follow them, and 86 million in the generation after that, the Millennials.
The boomers have been unloading dwellings to the Gen Xers since prices peaked in 2007. But there is not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. That’s what caused the financial crisis.
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.” Imminent deregulation is about to deep-six that problem.
There is a happy ending to this story.
Millennials now aged 23-38 are already starting to kick in as the dominant buyers in the market. They are just starting to transition from 30% to 70% of all new buyers in this market.
The Great Millennial Migration to the suburbs has just begun.
As a result, the price of single-family homes should rocket tenfold during the 2020s as they did during the 1970s and the 1990s when similar demographic forces were at play.
This will happen in the context of a coming labor shortfall, soaring wages, and rising standards of living.
Rising rents are accelerating this trend. Renters now pay 35% of the gross income, compared to only 18% for owners, and less when multiple deductions and tax subsidies are taken into account.
Remember too that, by then, the US will not have built any new houses in large numbers in 12 years.
We are still operating at only a half of the peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.
That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with. And now that it is temporarily a buyer’s market, it is a good time to step in for investment purposes.
You will boast to your grandchildren how little you paid for your house as my grandparents once did to me ($3,000 for a four-bedroom brownstone in Brooklyn in 1922), or I do to my kids ($180,000 for an Upper East Side high rise in 1983).
That means the major homebuilders like Lennar (LEN), Pulte Homes (PHM), and KB Homes (KBH) may finally be a buy on the dip.
Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now.
If you borrow at a 4% 5/1 ARM rate, and the long-term inflation rate is 3%, then over time you will get your house nearly for free.
How hard is that to figure out?
Crossing 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 has made the ten-mile treck 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.
After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.
Well, that’s all for now. We’ve just passed the Pacific mothball fleet moored near the Benicia Bridge. The pressure increase caused by a 7,200-foot descent from Donner Pass has crushed my water bottle.
The Golden Gate Bridge and the soaring spire of Salesforce Tower 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 X, 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 ball drop in New York’s Times Square.
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 at a sweet spot on any of the dozens of trades described above.
https://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.png00Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2019-01-09 01:05:052019-01-08 21:01:382019 Annual Asset Class Review: A Global Vision
Not a day goes by without someone carping about the national debt to me which now stands at $21.6 trillion.
Since President Obama came into office on January 20, 2010, it skyrocketed.
Are we all going to hell in a handbasket? Eventually, yes.
While it is true that the national debt has increased by some $10 trillion over the past ten years, there is less than meets the eye.
Much less.
That includes the $4 trillion purchased by the Federal Reserve as part of its aggressive five-year monetary policy known as “quantitative easing”.
It also includes another $1 trillion of Treasury holdings by dozens of other federal agencies such as Fannie Mae, Freddie Mac, and Sallie Mae.
So, the net federal debt actually issued during Obama’s two terms is not $9 trillion, but $4 trillion.
That’s a big difference.
These numbers would make Obama one of the most fiscally conservative presidents in US history (see tables below).
And he pulled off this neat trick despite US tax revenues utterly collapsing in the aftermath of the Great Recession.
What the Treasury has in effect done is taken one dollar out of one pocket and put it in the other, 5 trillion times.
There has been no change in the nation’s true indebtedness or net worth as a result of these transactions.
In fact, these bonds were never even really issued. They only exist on a spreadsheet, on a server, on a mainframe, somewhere at 1500 Pennsylvania Avenue, NW, Washington DC.
And here is the real shocker.
The Treasury can cancel this debt at any time.
They can just decide to use one set of figures on the plus side of the balance sheet to offset an equal amount on the negative side, and poof, the debt is gone forever, and the national debt is suddenly only $16 trillion.
It wouldn’t even require an act of Congress. It could simply be carried out through a presidential order.
And we have seen a lot of those lately.
That would give America one of the lowest debt to GDP ratios in the industrialized world.
I actually recommended that the White House use this ploy to get around the last debt ceiling crisis.
All of this sounds nice in theory. But how would markets respond if this were the true state of affairs in the debt markets?
Ten-year US Treasury bond yields would stay stubbornly low around $3.10%.
Prices for marginal debt securities in emerging markets (ELD) would boom.
Am I ringing any bells here people? Do these sound like debt markets you know and love?
A half-century of trading has taught me to never argue with Mr. Market. He is always right.
By keeping its bonds, the Fed has a valuable tool to employ if it ever senses that real inflation is about to make a comeback without having to raise the overnight deposit rate.
It simply can raise bond market rates by selling some of its still considerable holdings.
“FED SELLS BOND HOARD.”
How do you think risk markets would take that headline? Not well, not well at all.
There are other reasons to keep the $5 trillion in phantom Treasury bonds around.
It assures that the secondary market maintains the breadth and depth to accommodate future large-scale borrowing demanded by another financial crisis, Great Recession, or war.
Yes, believe it or not, governments think like this.
I remember that these were the issues that were discussed the last time closing the bond market was considered.
That was at the end of the Clinton administration in 1999 when paying off the entire national debt was only a few years off.
But close down the bond market and fire the few hundred thousand people who work there, and it could take decades to restart.
This is what Japan learned in the 1960’s.
It took the Japanese nearly a half-century to build the bond infrastructure needed to accommodate their massive borrowings of today.
The Chinese are learning the same thing as they strive to construct modern debt markets from whole cloth. It is not an overnight job.
One of the most common questions I get from foreign governments, institutional investors, and wealthy individuals in my international travels is “What will come of America’s debt problem?”
The answer is easy. It will all go to debt heaven. It will disappear.
US government finances are now worsening at a pretty dramatic pace (see more charts and tables below).
The budget deficit has doubled from the Obama low of $450 billion to $900 billion in only two years. Debt has exceeded GDP for the first time since WWII. New government bond issuance is rocketing and will crush the market any day now.
However, there is a way out of the looming financial disaster.
A massive demographic tailwind kicks in during the 2020s as 85 million Millennials grow up to become big-time taxpayers.
In the meantime, the last of the benefit-hungry baby boomers finally die off, eliminating an enormous fiscal drag.
“Depends” and “Ensure” prices will crater.
The national debt should disappear by 2030, or 2035 at the latest. The same is true for the Social Security deficit. That’s when we next have to consider firing the entire bond market once more.
That is what happened to the gargantuan debt run up by the Great Depression, the Civil War, and the Revolutionary War.
Government debt always goes to debt Heaven either through repayment during the period of demographic expansion and economic strength, or via diminution of purchasing power caused by inflation.
That’s why we have governments to pull forward economic growth during the soft periods in order to even out economic growth and job creation over the very long term to accommodate population growth. Pulling forward growth during strong economies as the administration is now doing only ends in tears.
The French were the first to figure all this out in the 17th century. They were not the last.
History doesn’t repeat itself, but it certainly rhymes.
https://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.png00MHFTFhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMHFTF2018-10-31 01:07:002018-10-30 19:21:26What is America’s True National Debt?
I had the great pleasure of having breakfast the other morning with my long time friend, Mohamed El-Erian, former co-CEO of the bond giant, PIMCO.
Mohamed argues that there has been a major loss of liquidity in the financial markets in recent decades that will eventually come home to haunt us all.
The result will be a structural increase in market volatility, and wild gyrations in the prices of financial assets that will become commonplace.
We have already seen a few of these in recent weeks. German ten-year bund yields jumped from 0.01% to 0.20% in a mere two weeks, a gap once thought unimaginable. The Euro has popped from $1.08 to $1.03.
Since July, we have watched in awe as the ten-year Treasury yield ratcheted up from 1.23% to 2.40%.
The worst is yet to come.
It is a problem that has been evolving for years.
When I started on Wall Street during the early 1980s, the model was very simple. You have a few big brokers servicing millions of small individual customers at fixed, non-negotiable commissions.
The big houses made so much money they could spend some money facilitating counter cycle customers trades. This means they would step up to bid in falling markets, and make offers in rising ones.
In any case, volatility was so low then that this never cost all that much, except on those rare occasions, such as the 1987 crash (we lost $75 million in a day! Ouch!).
Competitive, meaning falling, commissions rates wiped out this business model. There were no longer the profits to subsidize losses on the trading side, so the large firms quit risking their capital to help out customers altogether.
Now you have a larger numbers of brokers selling to a greatly shrunken number of end buyers, as financial assets in the US have become concentrated at the top.
Assets have also become institutionalized as they are piled into big hedge funds, and a handful of big index mutual funds, and ETFs. These assets are managed by people who are also much smarter too.
The small, individual investor on which the industry was originally built has almost become an extinct species.
There is no more ?dumb money? left in the market.
Now those placing large orders are at the complete mercy of the market, often with egregious results.
Enter volatility. Lots of it.
What is particularly disturbing is that the disappearance of liquidity is coming now, just as the 35 year bull market in bonds is ending.
An entire generation of bond fund managers, and almost two generations of investors, have only seen prices rise, save for the occasional hickey that never lasted for more than a few months. They have no idea how to manage risk on the downside whatsoever.
I am willing to bet money that you or your clients have at least some, if not a lot of your/their? money tied up in precisely these funds. All I can say is, ?Watch out below.?
When the flash fire hits the movie theater, you are unlikely to be the one guy who finds the exit.
We're hearing a lot about when the Federal Reserve finally gets around to raising interest rates next month that it will make no difference, as rates are coming off such a low base.
You know what? It may make a difference, possibly a big one.
This is because it will signify a major trend change, the first one for fixed income in more than three decades. That?s all most of these guys really understand are trends, and the next one will have a big fat ?SELL? pasted on it for the fixed income world.
El-Erian has one of the best 90,000-foot views out there. A US citizen with an Egyptian father, he started out life at the old Salomon Smith Barney in London and went on to spend 15 years at the International Monetary Fund.
He joined PIMCO in 1999, and then moved on to manage the Harvard endowment fund. His book, When Markets Collide, was voted by The Economist magazine as the best business book of 2008.
He regularly makes the list of the world?s top thinkers. A lightweight Mohamed is not.
His final piece of advice? Engage in ?constructive paranoia? and structure your portfolio to take advantage of these changes, rather than fall victim to them.
https://www.madhedgefundtrader.com/wp-content/uploads/2015/05/Mohamed-El-Erian-e1431024366379.jpg400347Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2016-11-29 01:07:052016-11-29 01:07:05The Liquidity Crisis Coming to a Market Near You
With the bond market confounding forecasters and prognosticators once again, I thought I?d delve into one of the more mysterious reasons why the bond market keeps going from strength to strength.
To a man, hedge fund traders expected bond prices to take a dive in 2014 and 2015 and for yields to soar. Isn?t that what?s supposed to happen in recovering economies?
Instead, we got the opposite, and yields have plunged, from 3.05% for the ten-year Treasury to as low as 2.80% this week.
There are many important lessons to be learned here. This is not your father?s bond market.
The internal dynamics of the fixed income markets have changed so much in the last three decades that it has become unrecognizable to long term practitioners, like myself.
A big factor has been the takeover of the bond market by the 1%, the richest segment of the US population and, indeed, the global economy. As wealth concentrates at the top, its character changes.
Let me stop here and tell you that the ultra rich are different from you and me, and not just because they have more money.
I have learned this after nearly half-century-long relationships with the planet?s wealthiest families, including the Rockefellers, Rothschilds, DuPonts, Morgans, and Pritzkers, first as important contacts of mine at The Economist, then as clients of mine at Morgan Stanley, then as investors in my hedge fund, and now as subscribers to The Diary of a Mad Hedge Fund Trader.
The wealthier families become the more conservative they get in their investment choices. Their goal shifts from capital appreciation to asset protection.
They lose interest in return on capital and become obsessed with return of capital. This is how the rich stay rich, sometimes for centuries. I have even noticed this among my newly minted billionaire hedge fund buddies.
What this means for the bond market is that they never sell. When they buy a 30-year Treasury bond, it is with the expectation of keeping it for the full 30 years until maturity.
That way they can avoid capital gains taxes and only have to pay taxes on the coupon interest. When they die, spouses get the step up in the cost basis, and then the wealth passes from one generation to the next. Taxes are never paid.
Back in the 1980s, when wealth was more evenly distributed, the top 1% only accounted for 1% of Treasury bond ownership. Today, that figure is closer to 25%.
Add this to the 50% of our national debt that is owned by foreign investors, primarily central banks, who also tend to hold paper for its full life. Central banks don?t pay taxes either.
China and Japan are the biggest holders with around $1 trillion each. This means that 75% or more of bonds are owned by investors who won?t sell. What does that mean for the rest of us? Bond prices that never go down.
With bonds very close to 30-year highs, keeping your bonds has been the right thing to do. I can?t tell you how many investment advisors I know who have distilled their practices down to managing fixed income instruments only.
This involves the entire coupon clipping space, including municipal bonds (MUB), corporates (LQD), junk (JNK), and even emerging market debt (ELD).
This is driven by customer demand, the 1%ers, not from any great insights or epiphanies they achieved on their own.
Of course, there is a certain amount of "driving with your eyes firmly fixed on the rear view mirror" going on here. Maybe the rich will finally sell their bonds once prices fall hard, stay down and then go down some more.
Inflation rearing its ugly head might also do the trick since it is always bad for bond prices as it reduces the purchasing power of money. Selling is certainly what they were doing in the early eighties, when the ten-year yield hit 12%.
Again, the rear view mirror effect, when bond were called ?certificates of wealth confiscation.?
There are other matters to consider with the 1% owning so much of the bond market and keeping it there.
This money is not getting invested in new start ups and creating jobs. It is money that is not being used to engender new economic growth. One of the fantasies of the last election was the claim that the 1% were creating so many jobs. They weren?t, not as long as their money was parked in a risk free bond market.
Instead, it is just stagnating. This is one reason why economic growth is so flaccid this decade and will remain so. This is fine for the 1%, but not so good for the rest of us.
The bottom line here is that while bonds are overbought and due for a pullback, they are not by any means going to crash. We could be living in the 2.60%-3.50% range for the 30-year for quite some time, maybe for years.
That is if the new Federal Reserve governor and my friend, ultra dove Janet Yellen, has anything to say about it. She has only just started and could be with us for another eight years.
Personally, I don?t foresee any appreciable rise in interest rates until we get well into the 2020s, when real inflation finally returns from the dead.
That is when bonds will become the asset class you don?t want to know, whether you?re in the 1% or not.
Bonds Will Stay Up Until Inflation Returns from the Dead
https://www.madhedgefundtrader.com/wp-content/uploads/2013/05/Dracula.jpg268337Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2016-01-20 01:06:342016-01-20 01:06:34The 1% and the Bond Market
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 panoramic 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.
I am not Houdini, so I go downstairs to use the larger public showers.
We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American accomplishment.
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.
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 country 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 6.
After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2015 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Even the stay-at-home index players had their heads handed to them.
With the Dow gaining 3.1% in 2015, and S&P 500 almost dead unchanged, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for eight boring consecutive months before spiking repeatedly many times to as high as 52%. Most hedge funds lagged the index by miles.
My Trade Alert Service, hauled in an astounding 38.8% profit, at the high was up 48.7%, and has become the talk of the hedge fund industry.
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:
The Four Key Variables for 2016
1) Will the Fed raise interest rates more or not?
2) Will China?s emerging economy see a hard or soft landing?
3) Will Japanese and European quantitative easing increase, or remain the same?
4) Will oil bottom and stay low, or bounce hard?
Here are your answers to the above: no, soft, more later, bounce hard later.
There you go! That?s all the research you have to do for the coming year. Everything else is a piece of cake.
The Ten Highlights of 2015
1) Stocks will finish higher in 2016, almost certainly more than the previous year, somewhere in the 5% range and 7% with dividends. Cheap energy, a recovering global economy, and 2-3% GDP growth, will be the drivers. However, this year we have a headwind of rising interest rates and falling multiples.
2) Expect stocks to take a 15% dive. That gives us a -15% to +5% trading range for the year. Volatility will remain permanently higher, with several large spikes up. That means you are going to have to pedal harder to earn your crust of bread in 2016.
3) The Treasury bond market will modestly grind down, anticipating the next 25 basis point rate rise from the Federal Reserve, and then the next one after that.
4) The yen will lose another 5% against the dollar.
5) The Euro will fall another 5%, doing its best to hit parity with the greenback, with the assistance of beleaguered continental governments.
6) Oil stays in a $30-$60 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 $250. (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 for years.
10) The 2016 presidential election will eat up immense amounts of media and research time, but will have absolutely no impact on financial markets. Give your money to charity instead.
The Thumbnail Portfolio
Equities - Long. A rising but high volatility year takes the S&P 500 up to 2,200. Technology, biotech, energy, solar, consumer discretionary, and financials lead. Energy should find its bottom, but later than sooner.
Bonds - Short. Down for the entire year, but not by much, with long periods of stagnation.
Foreign Currencies - Short. The US dollar maintains its bull trend, especially against the Yen and the Euro, but won't gain nearly as much as in 2015.
Commodities - Long. A China recovery takes them up eventually.
Precious Metals - Buy as close to $1,000 as you can. We are overdue for a trading rally.
Agriculture - Long. El Nino in the north and droughts in Latin American should add up to higher prices.
Real estate - Long. Multifamily up, commercial up, single family homes up small.
1) The Economy - Fortress America
I think real US economic growth will come in at the 2.5%-3% range.
With a generational demographic drag continuing for five more years, don?t expect more than that. Big spenders, those in the 46-50 age group, don?t return in larger numbers until 2022.
But this negative will be offset by a plethora of positives, like hyper-accelerating technology, global expansion, and the lingering effects of the Fed?s massive five year quantitative easing.
US corporate profits will keep pushing to new all time highs. But this year we won?t be held back by the collapsing economies of Europe, China, and Japan, which subtracted about 0.5% from American economic growth, nor weak energy.
US 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 six years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.
Technology and dramatically lower energy costs are the principal sources of profit 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 2015? Most of that is getting plowed right back into new start ups, increasing the rate of technology improvements even further, and the productivity gains that come with it.
We no longer have the free lunch of zero interest rates. But the cost of money will rise so slowly that it will barely impact profits. Deflation is here to stay. Watch the headline jobless rate fall below 5% to a full employment economy.
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.
For the first time in seven years, earnings multiples are going to fall, but not by much. That is the only possible outcome in a world with rising interest rates, however modestly.
If multiples fall by 5%, from the current 18X to 17.1X, profits increase by 10%, and you throw in a 2% dividend, you should net out a 7% return by the end of the year.
S&P 500 earnings fell by 6% in 2015, but take out oil and they grew by 5.6%. In 2016, energy will be a lesser drag, or not at all. That makes my 10% target doable.
That is not much of a return with which to take on a lot of risk. But remember, in a near zero interest rate world, there is nothing else to buy.
This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years.
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. Yet, that is years off.
After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not? Borrowing money at close to zero and investing in 2% dividend paying stocks has become the world?s largest carry trade.
Rising interest rates will have one additional worrying impact on stock prices. They will pare back mergers and acquisitions and corporate buy backs in 2016.
Together these were the sources of all new net buying of stocks in 2015, some $5.5 trillion worth. Call it financial engineering, but the market loves it.
Although energy looks terrible now, it could well be the top-performing sector by the end of the year, to be followed by commodities.
Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year expansion of leverage in the industry, it is ripe for a cleanout.
Solar stocks will continue on a tear, now that the 30% federal investment tax subsidy has been extended by five more years. Look at Solar City (SCTY), First Solar (FSLR), 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.
Share prices will deliver anything but a straight-line move. Expect a couple more 10% plus corrections in 2015, and for the Volatility Index (VIX) to revisit $30 multiple times. The higher prices rise, the more common these will become.
Amtrak needs to fill every seat in the dining car, so you never know who you will get paired with for breakfast, lunch, and dinner.
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.
I have to confess that I am leaning towards the ?one and done? school of thought with regards to the Fed?s interest rate policy. We may see a second 25 basis point rise in June, but only if the economy takes off like a rocket and international concerns disappear, an unlikely probability.
If you told me that US GDP growth was 2.5%, unemployment was at a ten year low at 5.0%, and energy prices had just plunged by 68%, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.25%.
We clearly are seeing a brave new world.
Global QE added to a US profit glut has created more money than the fixed income markets can absorb.
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.
Fixed income turned out to be a winner for me in 2015, as I sold short every bond price spike from the summer onward. It worked like a charm.
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 62 basis points, and Japanese bonds paying a paltry 26 basis points, US Treasuries are looking like a steal.
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 a decade down the road.
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% handle on the 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, at lest for the near term.
So what will 2016 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.
We could ratchet back up to a 3% yield, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2015 performance, taking it from $46 back up to $60.
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 suddenly went out of fashion for many investors, which is typical at market tops. As a result, junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (AMLP) are showing their first value in five years.
There is also emerging market sovereign debt to consider (PCY). If oil and commodities finally bottom, these high yielding bonds should take off on a tear.
This asset class was hammered last year, so we are now facing a rare entry point.
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.
The collapse of the junk bond market suddenly made credit quality a big deal last year. What is better than lending to the government, unless you happen to live in Puerto Rico or Illinois.
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.
One question I always get asked at lunches, conferences, and lectures is what is going to happen to the budget deficit?
The short answer is that it disappears in 2018 with no change in current law, thanks to steady growth in tax revenues and no big new wars.
And Social Security? It will be fully funded by 2030, thanks to a huge demographic tailwind provided by the addition of 86 million Millennials to the tax rolls.
A bump up in US GDP growth from 2% to 4% during the 2020?s will also be a huge help, again, provided we don?t start any more wars.
It looks like I am going to be able to collect after all.
Without much movement in interest rates in 2016, you can expect the same for foreign currencies.
Last year, we saw never ending expectations of aggressive quantitative easing by foreign central banks, which never really showed. What we did get, was always disappointing.
The decade long bull market in the greenback continues, but not by much. You can forget about those dramatic double digit gains the dollar made against the Euro at the beginning of last year, which we absolutely nailed.
The fundamental play for the Japanese yen is still from the short side. But don?t expect movement until we see another new leg of quantitative easing from the Bank of Japan. It could be a long wait.
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 ?130 to the dollar sometime in 2016, and ?150 further down the road.
I have many friends in Japan looking for an 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 continue raising rates the fastest.
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.
For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book. Now that the Yuan is an IMF reserve currency, it has attained new respectability.
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.
There isn?t a strategist out there not giving thanks for not loading up on commodities in 2015, the preeminent investment disaster of the year. Those who did are now looking for jobs on Craig?s List.
It was another year of overwhelming supply meeting flagging demand, both in Europe and Asia. Blame China, the one 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 $3.5 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. This trend ran head on into a decade long expansion of capacity by the industry.
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 2015, 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.
Not even the arrival of one of the biggest El Nino events in history could bail them out.
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 soybean (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).
You are now an oil trader, even if you didn?t realize it. Yikes!
The short-term direction of the price of Texas tea will be the principal driver for the prices of all asset classes, as it was for the 2015.
The smartest thing I did in 2015 was to ignore the professional traders, who called the bottom in oil monthly, based on key technical levels.
Instead, I hung on every word uttered by my old drilling buddies in the Barnett Shale, who only saw endless supply.
Guess whom I?ll be paying attention to this year?
I expect oil to bottom in 2016, and then launch a ferocious short covering rally. But when and where is anyone?s guess.
If energy legends John Hamm, John Arnold, and T. Boone Pickens have no idea where the absolute low will be, who am I to second-guess them?
When that happens, a trillion dollars will pour out of the sidelines into this troubled sector. Energy shares should be top-performers in 2016.
That makes energy Master Limited Partnerships, now yielding 10%-15%, especially interesting in this low yield world. Since no one in the industry knows which issuers are going bankrupt, you have to take a basket approach and buy all of them.
The Alerian MLP ETF (AMLP) does this for you in an ETF format (click here for details). At its low this fund was down by 41% this year. The last printed annualized yield I saw was 10%. That kind of return will cover up a lot of sins. 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 Buffet tap dances to work every day, as he owns the railroad.
Who knew that a new, younger Saudi king would ramp up production to once unimaginable levels and crush prices, turning the energy world upside down?
They aren?t targeting American frackers, who at 1 million barrels a day in a 92 million barrel a day demand world barely move the needle. Their goal is to destroy the economies of enemies Iran, Yemen, Russia, and of course ISIS, which need high prices to stay in business.
So far, so good.
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.
At current prices, the energy savings works out to an eye popping $550 per American driver per year!
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. The nuclear deal with Iran promises to add 500,000 to 1 million barrels a day to an already glutted global market. Iraq is ramping up production as well.
We are also seeing relentless improvements on the energy conservation front with more electric vehicles, high mileage conventional cars, and newly efficient building. Anyone of these inputs is miniscule on its own. But add them all together and you have a game changer.
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.
As is always the case, the cure for low prices is low prices. But we may never see $100/barrel crude again.
Add to your long term portfolio (DIG), Exxon Mobil (XOM), 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 2016, but expect to endure some pain first, nor to get much sleep at night.
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 19th century gold mines and the broken down wooden trestles leading to them, relics of previous precious metals busts. 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 $1,040 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. Gold is not dead; it is just resting.
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. China and India emerged as major buyers of gold in the final quarter of 2015.
They were joined by Russia, which was looking for non-dollar investments to dodge US economic and banking sanctions.
For me, that pegs the range for 2016 at $1,000-$1,250. 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 18 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.
Would 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 5 years into a 17-year run at the next peak in 2028.
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.
While the sales figures have recently been weak, it is a shortage of supply that is the cause. You can?t sell what you don?t have, at least in the real estate business.
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 for the next 20 years: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 86 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. That's what caused the financial crisis.
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. 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.?
There is a happy ending to this story. Millennials, now aged 21-37 are already starting to kick in as the dominant buyers in the market. They are just starting to transition from 30% to 70% of all new buyers in this market. The Great Millennial Migration to the suburbs has begun.
As a result, the price of single family homes should rocket tenfold during the 2020?s, as they did during the 1970?s and the 1990?s, when similar demographic influences were at play.
This will happen in the context of a coming labor shortfall and rising standards of living. Inflation returns.
Rising rents are accelerating this trend. Renters now pay 35% of the gross income, compared to only 18% for owners, and less when multiple deductions and tax subsidies are taken into account.
Remember too, that by then, the US will not have built any new houses in large numbers in 10 years. We are still operating at only a quarter of the peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.
That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with.
You will boast to your grandchildren how little you paid for your house, as my grandparents once did to me ($18,000 for a four bedroom brownstone in Brooklyn in 1922).
Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now.
If you borrow at a 3% 5/1 ARM rate, and the long-term inflation rate is 3%, then over time you will get your house for free.
How hard is that to figure out?
Crossing 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.
After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.
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 opener for Downton Abbey's final season.
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.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/01/JT-at-work.jpg478635Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2016-01-05 01:05:382016-01-05 01:05:382016 Annual Asset Class Review
Investors around the world have been confused, befuddled and surprised by the persistent, ultra low level of long term interest rates in the United States.
At today?s close, the 30 year Treasury bond yielded a parsimonious 2.01%, the ten year, 2.62%, and the five year only 1.51%. The ten-year was threatening its all time low yield of 1.37% only two weeks ago, a return as rare as a dodo bird, last seen in August, 2012.
What?s more, yields across the entire fixed income spectrum have been plumbing new lows. Corporate bonds (LQD) have been fetching only 3.29%, tax-free municipal bonds (MUB) 2.89%, and junk (JNK) a pittance at 5.96%.
Spreads over Treasuries are approaching new all time lows. The spread for junk over of ten year Treasuries is now below an amazing 3.00%, a heady number not seen since the 2007 bubble top. ?Covenant light? in borrower terms is making a big comeback.
Are investors being rewarded for taking on the debt of companies that are on the edge of bankruptcy, a tiny 3.3% premium? I think not.
It is a global trend.
German bunds are now paying holders 0.35%, and JGB?s are at an eye popping 0.30%. The worst quality southern European paper has delivered the biggest rallies this year. Portuguese government paper is paying only 2.40%, and is rapidly closing in on US government yields.
Yikes!
These numbers indicate that there is a massive global capital glut. There is too much money chasing too few low risk investments everywhere. Has the world suddenly become risk averse? Is inflation gone forever? Will deflation become a permanent aspect of our investing lives? Does the reach for yield know no bounds?
It wasn?t supposed to be like this.
Almost to a man, hedge fund managers everywhere were unloading debt instruments in January. They were looking for a year of rising interest rates (TLT), accelerating stock prices (QQQ), falling commodities (DBA), and dying emerging markets (EEM). Surging capital inflows were supposed to prompt the dollar (UUP) to take off like a rocket.
It all ended up being almost a perfect mirror image portfolio of what actually transpired since then. As a result, almost all mutual funds are down so far in 2014. Many hedge fund managers are tearing their hair out, suffering their worst year in recent memory.
What is wrong with this picture?
Interest rates like these are hinting that the global economy is about to endure a serious nose dive, possibly even re-entering recession territory?or it isn?t.
To understand why not, we have to delve into deep structural issues, which are changing the nature of the debt markets beyond all recognition. This is not your father?s bond market.
I?ll start with what I call the ?1% effect.?
Rich people are different than you and I. Once they finally make their billions, they quickly evolve from being risk takers into wealth preservers. They don?t invest in start-ups, take fliers on stock tips, invest in the flavor of the day, or create jobs. In fact, many abandon shares completely, retreating to the safety of coupon clipping.
The problem for the rest of us is that this capital stagnates. It goes into the bond market where it stays forever. These people never sell, thus avoiding capital gains taxes and capturing a future step up in the cost basis whenever a spouse dies. Only the interest payments are taxable and that at a lowly 20% rate.
This is the lesson I learned from servicing generations of Rothschild?s, Du Ponts, Rockefellers, and Getty. Extremely wealthy families stay that way by becoming extremely conservative investors. Those that don?t, you?ve never heard of, because they all eventually went broke.
This didn?t used to mean much before 1980, back when the wealthy only owned 10% of the bond market, except to financial historians and private wealth specialists, of which I am one. Now they own a whopping 23%, and their behavior affects everyone.
Who has bee the largest buyer of Treasury bonds for the last 30 years? Foreign central banks and other governmental entities, which count them among their country?s foreign exchange reserves. They own 36% of our national debt, with China in the lead at 8% (the Bush tax cut that was borrowed), and Japan close behind with 7% (the Reagan tax cut that was borrowed). These days they purchase about 50% of every Treasury auction.
They never sell either, unless there is some kind of foreign exchange or balance of payments crisis, which is rare. If anything, these holdings are still growing.
Who else has been soaking up bonds, deaf to repeated cries that prices are about to plunge? The Federal Reserve, which thanks to QE1, 2, and 3, now owns 22% of our $17 trillion debt. Both the former Federal Reserve governor Ben Bernanke, and the present one, Janet Yellen, have made clear they have no plans to sell these bonds. They will run them to maturity instead, minimizing the market impact.
An assortment of other government entities possess a further 29% of US government bonds, first and foremost the Social Security Administration, with a 16% holding. And they ain?t selling either, baby.
So what you have here is the overwhelming majority of Treasury bond owners with no intention to sell. Only hedge funds have been selling this year, and they have already done so, in spades.
Which sets up a frightening possibility for them, now that we are at the very bottom of the past year?s range in yields. What happens if bond yields fall further? It will set off the mother of all short covering squeezes and could take ten-year yield down to match the 2012, 2.38% low.
Fasten your seat belts, batten the hatches, and down the Dramamine!
There are a few other reasons why rates will stay at subterranean levels for some time. If hyper accelerating technology keeps cutting costs for the rest of the century, deflation basically never goes away (click here?for ?Peeking into the Future with Ray Kurzweil?).
Hyper accelerating corporate profits will also create a global cash glut, further levitating bond prices. Companies are becoming so profitable they are throwing off more cash then they can reasonably use or pay out.
This is why these gigantic corporate cash hoards are piling up in Europe in tax free jurisdictions, now over $2 trillion. Is the US heading for Japanese style yields, or 0.39% for 10 year Treasuries?
If so, bonds are a steal here at 2.55%. If we really do enter a period of long term -2% a year deflation, that means the purchasing power of a dollar increases by 35% every decade in real terms.
The threat of a second Cold War is keeping the flight to safety bid alive, and keeping the bull market for bonds percolating. This could put a floor under bond prices for another decade, and Vladimir Putin?s current presidential run could last all the way under 2014.
All of this is why I?m out of the bond market for now, and will remain so for a while.
https://www.madhedgefundtrader.com/wp-content/uploads/2014/05/Orangutan.jpg346382Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-02-16 01:05:282015-02-16 01:05:28Why Are Bond Yields So Low?
Here are the long-winded, feeble bunch of excuses I promised you.
I have broken every rule in my trading book hanging on to my position in the (TBT) for the past four months. I ignored my own stop losses. I listened to the morons on TV saying interest rates were about to spike up. I took the pile of charts that were telling me there was no bottom in sight, and deliberately lost them behind the radiator.
I even listened to the Fed signaling me with an emergency flare gun that they would raise rates in June.
As a result, I have been punished. Not too severely though, for I did follow one cardinal rule: I kept the position small. I did not double, triple and quadruple up, as many in the hedge fund industry have done.
As a result, I am merely suffering a thrashing in the woodshed, the kind my grandfather used to give me when he caught me shooting out the lights with my .22 rifle on our ranch in Indio, California. This is not a beheading, nor even a water boarding, and not a scintilla of an existential threat.
Still, a $14, 25% loss on a single position is no laughing matter. It?s about as welcome as a slap in the face with a wet mackerel. This is all proof that after 45 years in this business, I can still make the mistakes of a first year intern that was only hired for her good looks, shapely figure and loose morals.
If you told me that US GDP growth was 5%, unemployment was at a ten year low at 5.6%, and energy prices had just halved, I would have pegged the ten-year Treasury bond yield at 6.0%. The US economy created 2.9 million jobs in 2014, the most since 1999. Full employment is now almost a gimme.
Yet here we are at 2.00%.
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. It is yet another indication that this market has an insatiable need to teach an old dog new tricks.
After turning a blind eye to the writing on the wall, it?s time for me to read it out to you loud and clear.
The collapse of the German bond market is the big deal here. With the European economy in free fall, and doubts remaining about the ability of quantitative easing to work there under any circumstances, investors are assuming the future demand for money on the beleaguered continent will be zero.
German 10 year bond yields at 0.45% and still falling make 10 year US Treasuries at 2.00% appear the bargain of the century. Governments and hedge funds alike can buy US paper, sell short European paper against it, hedge out the currency risk, and lock in a risk free 1.55% a year for ten years. Sounds like a deal to me.
Multiply this by trillions of dollars and you can see what the problem is.
The other big deal here is the price of oil. I will reiterate my belief that if Texas tea stays down at the $40 handle, it is worth not just a 10% gain in stocks, but a double. The flipside is that interest rates stay far lower for longer than anyone expects, even including the Fed.
People just don?t understand how far reaching the impact of oil prices is. This heralds an entire new leg in the deflation story, one that could continue for years. It completely rules out any chance of a hike in interest rates this year. It is also fantastic news for the US bond market, and terrible for the (TBT).
If you want to add a third strike against continuing with a short bond position, look no further than the string US dollar. Investors around the world are pouring money into the greenback for a host of reasons. What do they do with the dollars when they get here? Buy bonds.
For more depth on why I totally missed the boat on bonds, please click here for ?10 Reasons Why I Am Wrong on Bonds?.
There are also opportunistic issues to consider here.
With implied volatilities on options sky high here, I can slap on almost any other options position and make back my 2.5% loss on the (TBT) in a couple of weeks. So there is no point in tying up 10% of my portfolio in a position that is dying a death of a thousand cuts.
Also, If you have been short the Euro (FXE), (EUO) and the Japanese yen (FXY), (YCS) after the past seven months, as I begged you to do, you have already more than made back the money.
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Dow Average 1987-90
Frozen Headwaters of the Colorado River
Crossing the Bridge to Home Sweet Home
