Mad Hedge Technology Letter
October 8, 2018
Fiat Lux
Featured Trade:
(A LONG-AWAITED BREATHER IN TECHNOLOGY),
(AMZN), (TGT), (NVDA), (SQ), (AMD), (TLT)
Posts
Taking profits - it was finally time.
The Nasdaq has been hit in the mouth the last few days and rightly so.
It was the best quarter in equities for five years, and a quarter that saw tech comprise up to a quarter of the S&P demonstrating searing strength.
It would be an understatement to say that tech did its part to drive stocks higher.
Tech shares have pretty much gone up in a straight line this year aside from the February meltdown.
Even that blip only caused Amazon (AMZN) to slide around 10%.
After all the terrible macro news thrown on the market in spades – tech stocks held their own.
Not even a global trade war with the second biggest economy in the world which is critical to exporting products to America was able to knock tech shares off their perch.
At some point, 26% earnings growth cannot sustain itself, and even though the tech narrative is still intact, investors need to breathe.
Let’s get this straight – tech companies are doing great.
They benefit from a secular tailwind with every business pivoting to mobile and software services.
All that new business has infused and invigorated total revenue.
The negative reaction by technology stocks was based on two pieces of news.
Interest rates (TLT) surging to over 3.2% was the first piece of news.
The increase in rates reinforces that the economy is humming along at a breakneck speed.
Yields are going up for the right reasons and this economy is not a sick one indeed.
As rates rise, other asset classes become more attractive such as CD’s and bonds.
The whole world is looking at the pace of rate rises because this will affect the ability for tech behemoths to borrow money to invest in their expensive well-oiled machines.
Three things are certain - the economy is hot, the smart money is buying on the dip now, and Amazon will still take over your home.
Even in a rising rate environment, Amazon is fully positioned to outperform.
The second catalyst to this correction was Amazon’s decision to hike its minimum wage to $15 per hour.
This could lay the path for workers around the country to demand higher pay.
The move was a misnomer as it will eliminate stock awards and monthly bonuses lessening the burden that Amazon actually has to dole out.
Call this a push – the rise in expenses won’t be material and realistically, Amazon can afford to push the wage bill by another order of magnitude, even though they will not.
This was also a way for Amazon founder Jeff Bezos to keep Washington off his back for a few months, and his generous decision was praised by government officials.
The wage hike underscores the strength of the ebullient American economy, and the consumer will benefit by recycling their wages back into Amazon and the wider economy.
Amazon makes up 50% of American e-commerce sales, and when workers are buying goods online, a good chance its coming from Amazon.
In an environment of full employment, the natural direction of wages is up, and this was due to happen.
You can also look at wage inflation as employees gaining at the expense of the corporation.
However, the massive deflationary trends of technology will also make this wage hike quite irrelevant over time as Amazon will automate more of their supply chain to make up for any wage hike that could damage revenue.
Amazon’s economies of scale give the Seattle-based company enough levers and buttons to push and pull to dilute expenses to make this a non-issue.
Each earnings call usually involves CFO of Amazon Brian Olsavsky explaining the acceleration of efficiencies in fulfilment centers bolstering the bottom line.
The stellar innovation in operational expertise moves up a level each quarter if not two levels.
Ultimately, though expensive on the surface, this won’t affect Amazon’s numbers at all, but more critically please the lower tier of workers who fight and scratch for their daily crust of bread.
This win-win scenario casts a positive image of Bezos in the public eye at a crucial time when he plans to recruit another legion of Amazon workers, as Amazon will shortly announce the location of their second American-based headquarter.
In fact, this turns the screws on the smaller retailers who must match the $15 per hour wage or confront a potential disaster of an entire workforce walking out and joining Amazon.
The mysterious Amazon-effect works in many shapes and sizes.
Big retailers like Target (TGT) have griped that it’s near impossible to find seasonal workers for the upcoming holiday season.
Moreover, if inflation remains moderate but contained – technology will power on.
And it will take more than a few prints of rising inflation to impress the Fed enough to expedite the raising of rates.
But it is safe to say that investors cannot expect the 100% up moves like in Amazon and Advanced Micro Devices (AMD) in one calendar year moving forward.
Technology has a plate full of challenges facing its share price as we move into the latter part of the fiscal year.
The challenges are two-fold - mid-term elections and navigating a smooth year-end.
Earnings should be good which is already baked into the pie, and the benefits of the tax cut have already worked itself through the system.
The furious pace of share buybacks will eventually subside too.
Management might finally bring out the spin doctors claiming the stronger dollar and worsening trade war is the reason to guide down.
At least tech companies doing business in China might follow this playbook.
Either way, tech shares are demonstrably sensitive right now and while the market needs tech to lead the way, the sector is exhausted from the burden of carrying the bulk of the load.
Freak-outs on rate surges have been a common experience for those old hands presiding over markets for decades.
These are all the staples of a 9th year bull market.
Typical late stage topping action is normal in economic cycles.
After the dust settles, the overreaction will give way to great buying opportunities at great prices, albeit it in the higher quality names.
The chip sector is still one to avoid unless the names are Advanced Micro Devices or Nvidia (NVDA).
Legacy companies have always been a no-go.
If you want hyper-growth, fin-tech name Square (SQ) would be an ideal candidate.
If buy and hold is your cup of tea, any 10% discount would be a great entry point in any of these quality companies.
Global Market Comments
October 5, 2018
Fiat Lux
Featured Trade:
(WEDNESDAY OCTOBER 17 HOUSTON STRATEGY LUNCHEON INVITATION),
(OCTOBER 3 BIWEEKLY STRATEGY WEBINAR Q&A)
(SPY), (VIX), (VXX), (MU), (LRCX), (NVDA), (AAPL), (GOOG), (XLV), (USO), (TLT), (AMD), (LMT), (ACB), (TLRY), (WEED)
Below please find subscribers’ Q&A for the Mad Hedge Fund Trader October 3 Global Strategy Webinar with my guest and co-host Bill Davis of the Mad Day Trader.
As usual, every asset class long and short was covered. You are certainly an inquisitive lot, and keep those questions coming!
Q: Will the market keep increasing for the rest of the year?
A: We haven’t had the pullback yet, so the short answer is yes. My yearend target of and S&P 500 (SPY) for the end of 2018 still stands. You can’t argue with the immediate price action. That said, the market is wildly overbought for the medium term and is approaching valuation levels we haven’t seen since the Dotcom peak in 2000. That why I am running a 70% cash trading book now.
Q: Should I be buying the Volatility Index (VIX) here?
A: Look at the bottom where we broke back in August, if we go down there and sit for a couple of days, then go out and buy the March 2019 $40 iPath S&P 500 VIX Short-Term Futures ETN (VXX) calls—way out of the money, way far in the future—and that way if you get any bounce in the (VIX) in the next 6 months, you’ll make a ton of money on that. You can buy them today for 50 cents. Plus, we could get one of these situations where there’s a major selloff once we’re into the new year, so a 6-month (VXX) call option would hedge that.
Q: Given the choice of Apple (AAPL) or Google (GOOG), which would you buy?
A: If you’re a conservative, old lady, widow and orphan type, you’d probably want to buy Apple— it’s almost turned into a utility, it’s so reliably safe, going up and has a nice dividend. If you want to be aggressive, swinging for the fences young stud and are looking for a double, I would go with Google—much higher growth pattern, pays no dividend and has had a 3-month consolidation going sideways. The only thing that could hurt this company would be government regulation, but with the Democrats possibly taking control of Congress in November, the prospect of government regulation of the entire technology sector could rapidly fade away.
Q: When should I get into Health Care (XLV)?
A: I think you have to wait at this point. To me, it’s tremendously overbought at the moment, but is still enjoying a long-term bull move. This is one of my two favorite sectors in the entire market. It has been rising for four months now, even though the Trump threat of price cuts are constantly overhanging the market.
Q: Is oil (USO) going to 100?
A: Because of the disruptions caused by the Iran sanctions and the tearing up of the Iran Nuclear Treaty, Trump has created a short squeeze in oil prices. He is threatening to boycott any country that buys oil from Iran, so Iran is shipping their oil through China, which is already under sanctions itself. However, that is easier said than done. The oil business is much more complicated than people realize. For China to take Iranian oil, they literally have to build new refineries from scratch to process the crude from Iran; no two crudes are alike. When you build a major supply, you have to build refineries to match that, and you have to get it there. This market will eventually stabilize, but in the meantime, there is a big short squeeze going on in Europe.
Q: Do you see the economy going strong into the end of the year?
A: Yes, I do—we still have the tax cuts, global liquidity, and deregulation kicking in, and those things will all work until the end of the year. I think we close at the highs of the year, and after that we’re going to have to start to work hard for our money once again in 2019. The US economy is like a supertanker; it takes a long time to turn it around.
Q: Will the interest rate spike kill the market?
You think? Investors are so used to ultra-low interest rates that a transition to normal rates will be traumatic. Next Friday, we get Core CPI, and if that comes in hot we could see another spike to 3.35% in the ten-year US Treasury bond (TLT). There are now a ton of people desperate to get out of their bond holdings at last week’s prices. This is why I have been selling short the bond market for the past three years and selling as recently as Monday. The next leg down in a 30-year bear market has begun.
Q: Advanced Micro Devices (AMD) has shot over $30—would you sell it?
A: We love the company long term but short term it is just way overdone; take the double and run, and then buy back on the next dip.
Q: Are you still bearish on the chip company?
A: Short term yes, long term no. This sector is now totally driven by the trade war with China. This includes NVIDIA (NVDA), Micron Technology (MU) and LAM Research (LRCX). Lam is particularly exposed because they had ordered to sell ten entire chip factories to China which is now on hold. That said, the day the trade way ends these stocks will all start a 50% run up. If China gets the same free pass and symbolic treaty that Canada did, that could happen sooner than later. If you can’t sleep at night until then, cut your position in half. If you still can’t sleep, cut it again.
Q: Do you think Lockheed Martin (LMT) is a buy Here at $350?
A: No, there is a double top risk for the stock right here. And if the Democrats get control of congress, the whole Trump trade could unwind. That would give the opposition the purse strings and the first thing they’ll do is cut defense spending, which Trump bumped up by $50 billion.
Q: Do you have any views on pot stocks like Aurora Cannabis (ACB), Tilray (TLRY) and (WEED)?
Stay away in droves. They’re this year’s bitcoin stocks. It’s still illegal. That’s why these companies are all based in Canada. And after all it’s a weed. How hard is it to grow? The barriers to entry are zero.
Global Market Comments
October 4, 2018
Fiat Lux
Featured Trade:
(TUESDAY OCTOBER 16 MIAMI GLOBAL STRATEGY LUNCHEON),
(BONDS FINALLY BREAK TWO-YEAR RANGE),
(TLT), (TBT), ($TNX)
I love executing one day wonders.
Since we sold short the US Treasury bond market on Monday, it has plunged a stunning 3 points. Bond yields just performed a rare 10 basis point move up to 3.18%. You usually only see that during a major “RISK OFF” geopolitical event or financial crisis.
You could see all of the key support levels failing like a hot knife for butter. The next support for the United States Treasury Bond Fund (TLT) is now at $111, or some 2.5 points down from here, pointing to a 3.25% yield for the ten-year bond.
My yearend forecast of a ten-year yield of 3.25% and a one-year target of 4.0% is alive and well.
The break marks an important departure from a stubborn two-year trading range….to the downside.
As with major breaks there is not a single a data point that broke the camel’s back. It could have been the agreement to NAFTA 2.0 on Monday or the blistering hot ISM Services print at a 21-year high on Wednesday.
Rather, it has been a steady death by a thousand cuts spread over several points that did it. It was just a matter of time before a 4.2% GDP growth rate crushed the fixed income market.
If I had to point to one single thing that triggered this debacle, it would be Amazon’s (AMZN) decision to give a 25% raise to its 250,000 US employees to $15 an hour.
If Wal-Mart (WMT), McDonald’s (MCD), or Target (TGT) have to resort to the same, you could have a serious outbreak of inflation on 2019. Imagine that, a bidding war for minimum wage workers.
ALL of those costs will be passed on to us, which is highly inflationary, and bonds absolutely HATE inflation.
Other than giving us boasting rights, the bond market move carries several important messages for us.
Money is about to start transferring from borrowers to savers in a major way. You won’t hear about seniors unable to live off of their savings anymore, a common refrain of the past decade.
Cash is now offering a serious competitor to bond and equity investments. And the next recession and bear market have just been moved closer.
The rocketing US budget deficit is starting to bear its bitter fruit as the government is starting to crowd out private sector borrowers. The budget deficit should be running at a $1 trillion annualized rate by the end of this year.
All of you celebrating your windfall tax cuts are getting a sharp reminder that the money has been entirely borrowed, some 40% from foreign bond investors we have been attacking. It will have to be paid back some time.
Of course, we all knew this was coming. It is no accident that the most capital-intensive industries in the country, also the heaviest borrowers, have seen the worst stock performance of 2018 including real estate, REITS, steel, and autos. Their profit margins have all just been seriously chopped.
So, what to do about the bond market now that we have begun the next leg in a 30-year bear market? For a start, don’t sell. Rather, wait for the next rally back up to the old support level at $116. It should revisit the old support level at least once.
When it does, SELL WITH BOTH HANDS.
I Just Love That 25% Wage Hike
Global Market Comments
September 28, 2018
Fiat Lux
Featured Trade:
(WHAT WILL TRIGGER THE NEXT BEAR MARKET?)
(JPM), (SNE), (TLT), (ELD), (AMZN),
(WEDNESDAY, OCTOBER 17, 2018, HOUSTON
GLOBAL STRATEGY LUNCHEON)
To paraphrase Leo Tolstoy in Anna Karenina, all bull markets are alike; each bear market takes place for its own particular reasons.
Now that the wreckage of the past financial crises is firmly in our rearview mirror, it is time for us to start pondering the causes of the next one. I’ll give you a hint: It will all boil down to excessive debt…again.
Global quantitative easing has been going on for a decade now, keeping interest rates far too low for too long. The unintended consequences will be legion, and the day of atonement may be a lot closer than you think.
The 1991 bear market was prompted by the Savings & Loan Crisis, where too many unsophisticated financial institutions in a newly unregulated world dreadfully mismatched asset and liabilities.
Every time I drive by a former Home Savings and Loan branch, with its unmistakable quilt decorations and accents, I remember those frightful days. Back then, when I looked at buying a home in San Francisco, the seller burst into tears when the price I offered would have generated a negative equity bill due for him.
The 2000 Dotcom crash can easily be explained by the monstrous amounts of debt provided to stock speculators. The 2008 crash was produced by massive, unregulated, and largely unknown lending to the housing sector through complex derivatives that virtually no one understood, especially the buyers.
So, here we are in 2018 nearly a decade out of the last crisis. Potential disasters are lurking everywhere under the surface while blinder constrained investors blithely power ahead. Once they metastasize, they rapidly feed into each other, creating a domino effect. They always do.
Emerging Market Debt
Lacking domestic capital markets with any real depth, companies in emerging economies prefer to borrow in U.S. dollars. When the dollar is weak that’s great because it means liabilities on the balance sheet shrink when brought back into the home currency. When the greenback is strong, the opposite happens. Dollar debt can grow so large that it can wipe out a company’s total equity.
This is already happening in a major way in Turkey, where the lira has plunged 50% in the past year, effectively doubling their debt. And once it starts, a global contagion kicks in as all emerging companies become suspect. This is not a small problem. Emerging market debt has rocketed from 55% to 105% of GDP since 2008.
The Rise of Junk Borrowers
In recent years there has been a massive expansion in borrowing by marginal credits. This is taking place because fixed income investors are willing to accept a large increase in the amount of risk for only a small marginal rise in interest rates.
There is now $1.4 trillion in low grade BBB bonds outstanding, with one-third of this one downgrade away from junk. There has also been a dramatic rise in “covenant lite” issuance, which minimizes the rights of bond holders in the event of default. When the next round of trouble arrives, you can expect this market to shut down completely, as it did in 2008.
Student Loans
These have been the sharpest rising form of borrowing over the past decade, doubling to $1.5 trillion. Some 10% are now in default. This acts as a major drag on the economy as heavily indebted students don’t borrow, buy homes or cars, or really participate in the economy in any way, banned by lowly FICO scores. This is why millennials in general have been slow to enter the housing market for the first time.
Shadow Banking
Would you like to know today’s equivalent of subprime the lending that took the financial system down in 2008? That would be shadow banking, or off the books, unreported lending by hedge funds, private equity funds, and mortgage companies. Again, this is all in pursuit of high interest rates in a low interest rate world.
Yes, liars’ loans are back, just not to the extent we saw 10 years ago…yet. I’m waiting for my cleaning lady to get offered a great refi package again, just as she was in the run-up to the last crisis. How many of these loans are out there? No one has any idea, especially the Fed. As a result, nearly 50% of all mortgage lending is now from unregulated nonbank sources.
The Outlier
Remember when Sony (SNE) was almost put out of business by a hack attack from North Korea? What if they had done this to JP Morgan (JPM)? That would have created a chain reaction of defaults throughout the financial system that would have been impossible to stop. When this happened in 2008, it took the Fed three months to reopen markets such as commercial paper. If big bankers need a reason to lie awake at night, this is it.
I’m not saying that markets can’t go higher before they go lower. In fact, I dove back into Amazon (AMZN) only this morning.
However, as an Australian farmer told me on my last trip down under, “Be careful when you cross the field, mate. Deadly snakes abound.” Add up all the above and it will turn into a giant headache for investors everywhere.
Global Market Comments
September 24, 2018
Fiat Lux
Featured Trade:
(THE MARKET OUTLOOK FOR THE WEEK AHEAD, or IT’S FED WEEK),
(SPY), (XLI), (XLV), (XLP), (XLY), (HD), (LOW), (GS), (MS), (TLT),
(UUP), (FXE), (FCX), (EEM), (VIX), (VXX), (UPS), (TGT)
(TEN TIPS FOR SURVIVING A DAY OFF WITH ME)
20/20 hindsight is a wonderful thing, especially when all of your predictions come true.
In February, I announced that markets would trade in broad ranges until the run-up to the midterm elections. That is what has happened to a tee, with the decisive upside breakout taking place last week. From here on. You’re trying to buy dips for a year-end run-up to higher highs.
For many months I was the sole voice in the darkness crying out that the bull market was still alive, it was just resting. Now quality laggards are taking the lead, such as in Industrials (XLI), Health Care (XLV), Consumer Staples (XLP), and Consumer Discretionary (XLY).
Home Depot (HD), which I recommended a month ago has taken off for the races, as has competitor Lowes (LOW), thanks to a twin hurricane boost. Even the long dead banks have recently showed a pulse (MS), (GS).
Technology stocks are taking a long-needed rest after a torrid two-and-a-half-year run. But they’ll be back. They always come back.
It’s not only stocks that have broken out of ranges, so has the bond market (TLT), the U.S. dollar (UUP), and foreign currencies (FXE). Will commodity companies like Freeport-McMoRan (FCX) and emerging markets (EEM) be the last to pick themselves off the mat, or do they really need to see the end of the trade wars first?
Markets are essentially acting like the trade war is over and we won. Why would traders believe this? That’s what a Volatility Index touching $11 tells you and is why I have been telling them to avoid buying it all week. Because the president told them so.
Another not insignificant positive is that multinationals have been slow to repatriate foreign funds, so there is a lot more still abroad to buy back their own stocks.
Weekly jobless claims hit another half century low at 201,000. Major U.S. companies such as UPS (UPS) and Target (TGT) are planning record levels of Christmas hiring. By the way, this is what economic peaks look like.
The Senate passes a mini spending bill that keeps the government from shutting down until December 7. The budget deficit keeps on soaring, but apparently, I am the only one who cares. Live through a debt crisis like we had during the early 1980s and you’d feel the same way.
The data for housing continues to be terrible, and we saw our first increase in inventories in three years.
Finally, with people camping out overnight and lines around the block, Apple’s CEO Tim Cook opens the doors to the Palo Alto, CA, store at 9:00 AM sharp on Friday to three new phones. But did the stock peak at $230, as it has in past release cycles?
Last week, the performance of the Mad Hedge Fund Trader Alert Service forged a new all-time high and then gave it up on one bad trade. September is now unchanged at -0.32%. My 2018 year-to-date performance has retreated to 26.69%, and my trailing one-year return stands at 38.23%.
My nine-year return appreciated to 303.16%. The average annualized Return stands at 34.32%. I hope you all feel like you’re getting your money’s worth.
This coming week is all about the Fed, plus a plethora of housing data.
On Monday, September 24, at 10:30 AM, we learn the August Dallas Fed Manufacturing Survey.
On Tuesday, September 25, at 9:00 AM, the new S&P Corelogic Case-Shiller National Home Price Index for July, a three-month lagging indicator.
On Wednesday September 26, at 10:00 AM, the August New Home Sales is published. At 2:00 the Fed Open Market Committee announced its decision to raise interest rates by 25 basis points.
Thursday, September 27 leads with the Weekly Jobless Claims at 8:30 AM EST, which dropped 3,000 last week to 201,000, a new 43-year low. At the same time an update on Q2 GDP is published.
On Friday, September 28, at 9:45 AM, we learn the August Chicago Purchasing Managers Index. The Baker Hughes Rig Count is announced at 1:00 PM EST.
As for me,
Good luck and good trading.
