What the Next Recession Will Look Like

The probability of a recession taking place over the next 12 months is now ranging as high as 40%. If the trade war with China escalates, you can mark that up to 100%.

And here’s the scary part. Bear markets front-run recessions by 6-12 months, i.e. now. The bear case is now more persuasive than at any time in the last decade.

We’ll get a better read when the Chinese announce their retaliation for the last American escalation of tariffs on September 1, or in eight trading days. The timing couldn’t be worse. The bad news will come over the US three-day Labor Day weekend, allowing market volatility (VIX) to bunch up, setting up an explosive Tuesday, September 3 opening.

So, it’s time to start asking the question of what the next recession will look like. Are we in for another 2008-2009 meltdown, when friends and relatives lost homes, jobs, and their entire net worth? Or can we look forward to a mild pullback that only economists and data junkies like myself will notice?

I’ll paraphrase one of my favorite Russian authors, Fyodor Dostoevsky, who in Anna Karenina might have said, “all economic expansions are all alike, while recessions are all miserable in their own way.”

Let’s look at some major pillars in the economy. A hallmark of the last recession was the near collapse of the financial system, where the ATMs were probably within a week of shutting down nationally. The government had to step in with the TARP, and mandatory 5% equity ownership in the country’s 20 largest banks.

Back then, banks were leveraged 40:1 in the case of Morgan Stanley (MS) and Goldman Sachs (GS), while Lehman Brothers and Bear Stearns were leveraged 100:1. In that case, the most heavily borrowed companies only needed markets to move 1% against them to wipe out their entire capital. That’s exactly what happened. (MS) and (GS) came within a hair’s breadth of going the same way.

Thanks to the Dodd Frank financial regulation bill, banks cannot leverage themselves more than 10:1. They have spent a decade rebuilding balance sheets and reserves. They are now among the healthiest in the world, having become low margin, very low-risk utilities. It is now European and Chinese banks that are going down the tubes.

How about real estate, another major cause of angst in the last recession? The market couldn’t be any more different today. There is a structural shortage of housing, especially at entry-level affordable prices. While liar loans and house flipping are starting to make a comeback, they are nowhere near as prevalent a decade ago. And the mis-rating of mortgage-backed securities from single “C” to triple “A” is now a distant memory. (I still can’t believe no one ever went to jail for that!).

And interest rates? We went into the last recession with a 6% overnight rate and 7% 30-year fixed rate mortgage. Now, overnight rates are at 2.25% and the 30-year is at 3.6% with both falling like a stone. It’s hard to imagine a real estate crisis with rates at zero and a shortage of supply.

The auto industry has been in a mild recession for the past two years, with annual production stalling at 16.8 million units, versus a 2009 low of 9 million units. In any case, the challenges to the industry are now more structural than cyclical, with new buyers decamping en masse to electric vehicles made on the west coast.

Of far greater concern are industries that are already in recession now. Energy has been flagging since oil prices peaked seven years ago, despite massive tax subsidies. It is suffering from a structural over supply and falling demand.

Retailers have been in a Great Depression for five years, squeezed on one side by Amazon and the other by China. A decade into store closings and the US is STILL over stored. However, many of these shares are already so close to zero that the marginal impact on the major indexes will be small.

Financials and legacy banks are also facing a double squeeze from Fintech innovation and collapsing interest rates. There isn’t much margin in a loan where the customer is paying only 3.6%, and 2% in a year. All of those expensive national networks with branches on every street corner will be gone in the 2020s.

And no matter how bad the coming recession gets, technology, now 26% of the S&P 500, will keep powering on. Combined revenues of the four FANGs in Q2 came in at $118.7 billion and earnings were at $26.5 billion. That leaves a mighty big cushion for any slowdown. That’s a lot more than the “eyeballs” and market shares they possessed of a decade ago.

So, netting all this out, how bad will the next recession be? Not bad at all. I’m looking at a couple of quarters small negative numbers. Then the end of the China trade war, which can’t last any more than 18 months, and ultra-low interest rates, will enable recovery and probably another decade of decent US growth.

The stock market, however, is another kettle of fish. While the economy may slow from a 2.2% annual rate to -0.1% or -0.2%, the major indexes could fall much more than that, say 30% to 40%. Don’t forget, we already saw a horrendous 20% swan dive in the run-up to last December.

Earnings multiples are still at a 17X high compared to a 9X low in 2009. Shares would have to drop 47% just to match the last low, and earnings are already falling. Equity weightings in portfolios are high. Money is pouring out of stock funds into bond ones.

Corporations buying back their own shares have been the principal prop from the market for the past three years. Some large companies, like Kohls (KSS), have retired as much as 50% of their outstanding equity in ten years.

So get used to the high market volatility (VIX) we have seen in August. It could be only the trailer for the main show.





The Next Bear Market is Not Far Off

Welcome to the Deflationary Century

Ignore the lessons of history, and the cost to your portfolio will be great. Especially if you are a bond trader!

Meet deflation, upfront and ugly.

If you looked at a chart for data from the United States, consumer prices are showing a feeble 1.6% YOY price gain. This is below the Federal Reserve’s own 2.0% annual inflation target, with most of the recent gains coming from rising oil prices.

And here’s the rub. Wage growth, which accounts for 70% of the inflation calculation, has been practically nil. So, don’t expect inflation to rise much from here despite an unemployment rate at a 50-year low.

We are not just having a deflationary year or decade. We may be having a deflationary century.

If so, it will not be the first one.

The 19th century saw continuously falling prices as well. Read the financial history of the United States, and it is beset with continuous stock market crashes, economic crisis, and liquidity shortages.

The union movement sprung largely from the need to put a break on falling wages created by perennial labor oversupply and sub living wages.

Enjoy riding the New York subway? Workers paid 10 cents an hour built it 120 years ago. It couldn’t be constructed today, as other more modern cities have discovered. The cost would be wildly prohibitive.

The causes of 19th-century price collapse were easy to discern. A technology boom sparked an industrial revolution that reduced the labor content of end products by ten to a hundredfold.

Instead of employing 100 women for a day to make 100 spools of thread, a single man operating a machine could do the job in an hour.

The dramatic productivity gains swept through the developing economies like a hurricane. The jump from steam to electric power during the last quarter of the century took manufacturing gains a quantum leap forward.

If any of this sounds familiar, it is because we are now seeing a repeat of the exact same impact of accelerating technology. Machines and software are replacing human workers faster than their ability to retrain for new professions.

This is why there has been no net gain in middle class wages for the past 30 years. It is the cause of the structural high U-6 “discouraged workers” employment rate as well as the millions of millennials still living in parents’ basements.

To the above, add the huge advances now being made in healthcare, biotechnology, genetic engineering, DNA-based computing, and big data solutions to problems.

If all the major diseases in the world were wiped out, a probability within 10 years, how many healthcare jobs would that destroy?

Probably tens of millions.

So the deflation that we have been suffering in recent years isn’t likely to end any time soon. If fact, it is just getting started.

Why am I interested in this issue? Of course, I always enjoy analyzing and predicting the far future using the unfolding of the last half-century as my guide. Then I have to live long enough to see if I’m right.

I did nail the rise of eight-track tapes over six-track ones, the victory of VHS over Betamax, the ascendance of Microsoft (MSFT) operating systems over OS2, and then the conquest of Apple (AAPL) over Microsoft. So, I have a pretty good track record on this front.

For bond traders especially, there are far-reaching consequences of a deflationary century. It means that there will be no bond market crash, as many are predicting, just a slow grind up in long-term bond prices instead.

Amazingly, the top in rates in this cycle only reach the bottom of past cycles at 3.25% for ten-year Treasury bonds (TLT), (TBT).

The soonest that we could possibly see real wage rises will be when a generational demographic labor shortage kicks in during the 2020s. That could be a decade off.

I say this not as a casual observer but as a trader who is constantly active in an entire range of debt instruments.




Yup, This Will Be a Real Job Killer

The Secret Fed Plan to Buy Gold

The recent appointment of my old acquaintance, Judy Shelton, to the Fed places a monetary policy once considered impossible solidly on the table. For your see, Judy has long advocated that the US return to the gold standard.

If the American economy moves into the next recession with interest rates already near zero, the markets will take the rates for all interest-bearing securities well into negative numbers. This has already happened in Japan and Germany.

At that point, our central bank’s primary tool for stimulating US businesses will become utterly useless, ineffective, and impotent.

What else is in the tool bag?

How about large-scale purchases of Gold (GLD)?

You are probably as shocked as I am with this possibility. But there is a rock-solid logic to the plan. As solid as the vault at Fort Knox.

The idea is to create asset price inflation that will spread to the rest of the economy. It already did this with great success from 2009-2014 with quantitative easing, whereby almost every class of debt securities were Hoovered up by the government.

“QE on steroids”, to be implemented only after overnight rates go negative, would involve large scale purchases of not only gold, but stocks, government bonds, and exchange-traded funds as well.

If you think I’ve been smoking California’s largest cash export (it’s not the raisins), you would be in error. I should point out that the Japanese government is already pursuing QE to this extent, at least in terms of equity type investments and ETFs and already owns a substantial part of the Japanese stock market.

And, as the history buff that I am, I can tell you that it has been done in the US as well, with tremendous results.

If you thought that president Obama had it rough when he came into office in 2009 with the Great Recession on, it was nothing compared to what Franklin Delano Roosevelt inherited.

The country was in its fourth year of the Great Depression. US GDP had cratered by 43%, consumer prices crashed by 24%, the unemployment rate was 25%, and stock prices vaporized by 90%. Mass starvation loomed.

Drastic measures were called for.

FDR issued Executive Order 6102 banning private ownership of gold, ordering them to sell their holdings to the US Treasury at a lowly $20.67 an ounce.

He then urged congress to pass the Gold Reserve Act of 1934, which instantly revalued the government’s holdings at $35.00, an increase of 69.32%. These and other measures caused the value of America’s gold holdings to leap from $4 to $12 billion. That’s a lot of money in 1934 dollars, about $208 billion in today’s money.

Since the US was still on the gold standard back then, this triggered an instant dollar devaluation of more than 50%. The high gold price sucked in massive amounts of the yellow metal from abroad creating, you guessed it, inflation.

The government then borrowed massively against this artificially created wealth to fund the landscape altering infrastructure projects of the New Deal.

It worked.

During the following three years, the GDP skyrocketed by 48%, inflation eked out a 2% gain, the unemployment rate dropped to 18%, and stocks jumped by 80%. Happy days were here again.

Monetary conditions are remarkably similar today to the those that prevailed during the last government gold buying binge.

There has been a de facto currency war underway since 2009. The Fed started when it launched QE, and Japan, Europe, and China have followed. Blue-collar unemployment and underpayment is at a decades high. The need for a national infrastructure program is overwhelming.

However, in the 21st century version of such a gold policy, it is highly unlikely that we would see another gold ownership ban.

Instead, the Fed would most likely move into the physical gold market, sitting on the bid for years, much like it recently did in the Treasury bond market for five years. Gold prices would increase by a multiple of current levels.

It would then borrow against its new gold holdings, plus the 4,176 metric tonnes worth $200 billion at today’s market prices already sitting in Fort Knox, to fund a multi trillion-dollar infrastructure-spending program.

Heaven knows we need it. Millions of blue-collar jobs would be created and inflation would come back from the dead.

Yes, this all sounds like a fantasy. But negative interest rates were considered an impossibility only years ago.

The Fed’s move on gold would be only one aspect of a multi-faceted package of desperate last ditch measures to extend economic growth into the future which I outlined in a previous research piece (click here for “What Happens When QE Fails” .

That’s assuming that the gold is still there. Treasury Secretary Stephen Mnuchin says he saw the gold himself during an inspection that took place of the last solar eclipse over Fort Knox in 2018. The door to the vault at Fort Knox had not been opened since September 23, 1974. But then Steve Mnuchin says a lot of things. Persistent urban legends and Internet rumors claim that the vault is actually empty or filled with fake steel bars painted gold.




The Next QE?

They’re Not Making Americans Anymore

You can count on a bear market hitting sometime in 2038, one falling by at least 25%.

Worse, there is almost a guarantee that a financial crisis, severe bear market, and possibly another Great Depression will take place no later than 2058 that would take the major indexes down by 50% or more.

No, I have not taken to using a Ouija board, reading tea leaves, nor examine animal entrails in order to predict the future. It’s much easier than that.

I simply read the data just released from the National Center for Health Statistics, a subsidiary of the federal Centers for Disease Control and Prevention (click here for their link).

The government agency reported that the US birth rate fell to a new all-time low for the second year in a row, to 60.2 births per 1,000 women of childbearing age. A birth rate of 125 per 1,000 is necessary for a population to break even. The absolute number of births is the lowest since 1987. In 2017, women had 500,000 fewer babies than in 2007.

These are the lowest number since WWII when 17 million men were away in the military, a crucial part of the equation.

Babies grow up, at least most of them do. In 20 years, they become consumers, earning wages, buying things, paying taxes, and generally contributing to economic growth.

In 45 years, they do so quite substantially, becoming the major drivers of the economy. When these numbers fall, recessions and bear markets occur with absolute certainty.

You have long heard me talk about the coming “Golden Age” of the 2020s. That’s when a two-decade long demographic tailwind ensues because the number of “peak spenders’ in the economy starts to balloon to generational highs. The last time this happened during the 1980s and 19990s, stocks rose 20-fold.

Right now, we are just coming out of two decades of demographic headwind when the number of big spenders in the economy reached a low ebb. This was the cause of the Great Recession, the stock market crash and the anemic 2% annual growth since then.

The reasons for the maternity ward slowdown are many. The great recession certainly blew a hole in the family plans of many Millennials. Falling incomes always lead to lower birth rates, with many Millennial couples delaying children by five years or more. Millennial mothers are now having children later than at any time in history.

Burgeoning student debt, which just topped $1.5 trillion, is another. Many prospective mothers would rather get out from under substantial debt before they add to the population.

The rising education of women is another drag on child bearing and is a global trend. When spouses become serious wage earners, families inevitably shrink. Husbands would rather take the money and improve their lifestyles than have more kids to feed.

Women are also delaying having children to postpone the “pay gaps” that always kicks in after they take maternity leave. Many are pegging income targets before they entertain starting families.

As a result of these trends, one in five children last year were born to women over the age of 35, a new high.

This is how Latin American moved from eight to two-child families in only one generation. The same is about to take place in Africa where standards of living are rising rapidly, thanks to the eradication of several serious diseases.

The sharpest falls in the US have been with minorities. Since 2017, the birthrates for Hispanics have dropped by 27% from a very high level, African Americans 11%, whites 5%, and Asian 4%.

Europe has long had the same problem with plunging growth rates but only much worse. Historically, the US has made up for the shortfall with immigration, but that is now falling, thanks the current administration policies. Restricting immigration now is a guaranty of slowing economic growth in the future. It’s just a numbers game.

So watch that growth rate. When it starts to tick up again, it’s time to buy….in about 20 years. I’ll be there to remind you with this newsletter.

As for me, I’ve been doing my part. I have five kids aged 14-34, and my life is only half over. Where did you say they keep the Pampers?

The Death of the Financial Advisor

About one-third of my readers are professional financial advisors who earn their crust of bread telling clients how to invest their retirement assets for a fixed fee.

They used to earn a share of the brokerage fees they generated. After stock commissions went to near zero, they started charging a flat 1.25% a year on the assets they oversaw.

So it is with some sadness that I have watched this troubled industry enter a long-term secular decline which seems to be worsening by the day.

The final nail in the coffin may be the new regulations announced by the Department of Labor at the end of the Obama administration that controls this business.

Brokers, insurance agents, and financial planners were already held to a standard of suitability by the government based on a client’s financial situation, tax status, investment objectives, risk tolerance, and time horizon.

The DOL proposed raising this bar to the level already required of Registered Investment Advisors, as spelled out by the Investment Company Act of 1940.

This would have required advisors to act only in the best interests of their clients, irrespective of all other factors, including the advisor’s compensation or conflicts of interest.

What this does is increase the costs while also greatly expanding advisor liability. In fact, the cost of malpractice insurance has already started to rise. All in all, it makes the financial advisor industry a much less fun place to be.

As is always the case with new regulations, they were inspired by a tiny handful of bad actors.

Some miscreants steered clients into securities solely based on the commissions they earned, which could reach 8% or more, whether it made any investment sense or not. Some of the instruments they recommended were nothing more than blatant rip-offs.

The DOL thought that the new regulations will save consumers $15 billion a year in excess commissions.

Legal action by industry associations has put the DOL proposals in limbo. Unless it appeals, it is unlikely to become law. So, there will be a respite, at least until the next administration.

Knowing hundreds of financial advisors personally, I can tell you that virtually all are hardworking professionals who go the extra mile to safeguard customer assets while earning incremental positive returns.

That is no easy task given the exponential speed with which the global economy is evolving. Yesterday’s “window and orphans” safe bets can transform overnight into today’s reckless adventure.

Look no further than coal, energy, and the auto industry. Once a mainstay of conservative portfolios, all of these sectors have, or came close to filing for bankruptcy.

Even my own local power utility, Pacific Gas & Electric Company (PGE), filed for chapter 11 in 2001 because they couldn’t game the electric power markets as well as Enron.

Some advisors even go the extent of scouring the Internet for a trade mentoring service that can ease their burden, like the Diary of a Mad Hedge Fund Trader, to get their clients that extra edge.

Traditional financial managers have been under siege for decades.

Commissions have been cut, expenses increased, and mysterious “fees” have started showing up on customer statements.

Those who work for big firms, like UBS, Morgan Stanley, Goldman Sacks, Merrill Lynch, and Charles Schwab, have seen health insurance coverage cut back and deductibles raised.

The safety of custody with big firms has always been a myth. Remember, all of these guys would have gone under during the 2008-09 financial crash if they hadn’t been bailed out by the government. It will happen again.

The quality of the research has taken a nosedive, with sectors like small caps no longer covered.

What remains offers nothing but waffle and indecision. Many analysts are afraid to commit to a real recommendation for fear of getting sued, or worse, scaring away lucrative investment banking business.

And have you noticed that after Dodd-Frank, two-thirds of a brokerage report is made up of disclosures?

Many advisors have, in fact, evolved over the decades from money managers to asset gatherers and relationship managers.

Their job is now to steer investors into “safe” funds managed by third parties that have to carry all of the liability for bad decisions (buying energy plays in 2014?).

The firms have effectively become toll-takers, charging a commission for anything that moves.

They have become so risk-averse that they have banned participation in anything exotic, like options, option spreads, (VIX) trading, any 2X leveraged ETF’s, or inverse ETFs of any kind. When dealing in esoterica is permitted, the commissions are doubled.

Even my own newsletter has to get compliance review before it is distributed to clients, often provided by third parties to smaller firms.

“Every year, they try to chip away at something”, one beleaguered advisor confided to me with despair.

Big brokers often hype their own services with expensive advertising campaigns that unrealistically elevate client expectations.

Modern media doesn’t help either.

I can’t tell you how many times I have had to convince advisors not to dump all their stocks at a market bottom because of something they heard on TV, saw on the Internet, or read in a competing newsletter warning that financial Armageddon was imminent.

Customers are force-fed the same misinformation. One of my main jobs is to provide advisors with the fodder they need to refute the many “end of the world” scenarios that seem to be in continuous circulation.

In fact, a sudden wave of such calls has proven to be a great “bottoming” indicator for me.

Personally, I don’t expect to see another major financial crisis until 2032 at the earliest, and by then, I’ll probably be dead.

Because of all of the above, about half of my financial advisor readers have confided in me a desire to go independent in the near future, if they are not already.

Sure, they won’t be ducking all these bullets. But at least they will have an independent business they can either sell at a future date, or pass on to a succeeding generation.

Overheads are far easier to control when you own your own business, and the tax advantages can be substantial.

A secular trend away from non-discretionary to discretionary account management is a decisive move in this direction.

There seems to be a great separating of the wheat from the chaff going on in the financial advisory industry.

Those who can stay ahead of the curve, both with the markets and their own business models, are soaking up all the assets. Those that can’t are unable to hold on to enough money to keep their businesses going.

Let’s face it, in the modern age, every industry is being put through a meat grinder. Thanks to hyper accelerating technology, business models are changing by the day.

Just be happy you’re not a doctor trying to figure out Obamacare.

Those individuals who can reinvent themselves quickly will succeed. Those that won’t, will quickly be confined to the dustbin of history.


It’s Not As Easy As It Looks

Take a Leap Into Leaps

I am repeating this story because this is the best strategy with which to cash in on the gigantic market swoons, which have become a regular feature of our markets.

Since the advent of the spectacular market volatility, I have been asked one question.

What do you think about LEAPS?

LEAPS, or Long Term Equity Participation Securities, are just a fancy name for a stock option with a maturity of more than one year.

You execute orders for these securities on your options online trading platform, pay options commissions, and endure option like volatility.

Another way of describing LEAPS is that they offer a way to rent stocks instead of buying them, with the prospect of enjoying many years’ worth of stock gains for a fraction of the price.

While these are highly leveraged instruments, you can’t lose any more money than you put into them. Your risk is well defined.

And there are many companies in the market where LEAPS are a very good idea, especially on those gut-wrenching 1,000-point down days.


Currently, LEAPS are listed all the way out until June 2021.

However, the further expiration dates will have far less liquidity than near month options, so they are not a great short-term trading vehicle. That is why limit orders in LEAPS, as opposed to market orders, are crucial.

These are really for your buy-and-forget investment portfolio, defined benefit plan, 401k, or IRA.

Because of the long maturities, premiums can be enormous. However, there is more than one way to skin a cat, and the profit opportunities here can be astronomical.

Like all options contracts, a LEAP gives its owner the right to “exercise” the option to buy or sell 100 shares of stock at a set price for a given time.

LEAPS have been around since 1990, and trade on the Chicago Board Options Exchange (CBOE).

To participate, you need an options account with a brokerage house, an easy process that mainly involves acknowledging the risk disclosures that no one ever reads.

If a LEAP expires “out-of-the-money” – when exercising, you can lose all the money that was spent on the premium to buy it. There’s no toughing it out waiting for a recovery, as with actual shares of stock. Poof, and your money is gone.

LEAPS are also offered on exchange-traded funds (ETFs) that track indices like the Standard & Poor’s 500 index (SPY) and the Dow Jones Industrial Average (INDU), so you could bet on up or down moves of the broad market.

Not all stocks have options, and not all stocks with ordinary options also offer LEAPS. Note that a LEAPS owner does not vote proxies or receive dividends because the underlying stock is owned by the seller, or “writer,” of the LEAP contract until the LEAP owner exercises.

Despite the Wild West image of options, LEAPS are actually ideal for the right type of conservative investor.

They offer more margin and more efficient use of capital than traditional broker margin accounts. And you don’t have to pay the usurious interest rates that margin accounts usually charge.

And for a moderate increase in risk, they present outsized profit opportunities.

For the right investor, they are the ideal instrument.

Let me go through some examples to show you their inner beauty.

By now, you should all know what vertical bull call spreads are. If you don’t, then please click here for a quick video tutorial at (you must be logged in to your account).

Let’s go back to February 9, 2018 when the Dow Average plunged to its 23,800 low for the year. I then begged you to buy the Apple (AAPL) June 2018 $130-$140 call spread at $8.10, which most of you did. A month later, that position is worth $9.40, up some 16.04%. Not bad.

Now let’s say that instead of buying a spread four months out, you went for the full year and three months, to June 2019.

That identical (AAPL) $130-$140 would have cost $5.50 on February 9. The spread would be worth $9.40 today, up 70.90%, and worth $10 on June 21, 2019, up 81.81%.

So, by holding a 15 month to expiration position for only a month you get to collect 86.67% of the maximum potential profit of the position.

So, now you know why we leap into LEAPS.

When the meltdown comes, and that could be as soon as today, use this strategy to jump into longer-term positions in the names we have been recommending and you should be able to retire early.


Time to Leap Into LEAPS

The Mad Hedge Dictionary of Trading Slang

The Diary of a Mad Hedge Fund Trader is read in 140 counties. About a quarter of our readers run the letter through Google Translate before reading.

That has created a problem.

Stock trading is probably the most slang- and acronym-ridden profession on the planet, second only to the United States Marine Corps. (Semper Fi).

And guess what? Google Translate has never worked on the floor of a major stock exchange.

That means its translations often come out as gobbledygook or complete nonsense. So, the customers email me asking what the heck I am talking about in my daily newsletters, eating up a portion of my day.

I am therefore enclosing The Mad Hedge Fund Trader’s Dictionary of Traders’ Slang” below.

To keep this a PG-rated publication, I have left some terms undefined, but you can make a good guess as to their true meaning. It turns out that most traders never went to finishing school, and many are not even gentlemen.

If any of you out there have additional terms you would like to add, please email them to me at and put “DICTIONARY” in the subject line. I’ll use them in a future update. No doubt there are hundreds, if not thousands more.

Read, enjoy, and laugh.

Accelerated Time Decay: The increasing decline of the value of a stock option as it approaches its expiration date

Black Swan: A term made popular by Nassim Taleb that refers to a sudden, unexpected low probability event that has a disproportionately high impact on your portfolio

Boredom Trading: Reaching for marginally profitable trades during quiet markets because there is nothing else to do. Usually a bad idea.

Bottoming Process: When a market makes several failed attempts to make new lows, creating a medium-term bottom

Blow off Top: The top of a price spike upward usually associated with a volume spike as well

Bubble: Any assets class rising in price far above and beyond any rational valuation measures

Buy the Dip: BTD/BTFD/BTMFD – Buy the recent decline in prices.

Don’t Catch a Falling Knife: Don’t try and buy a stock in free fall

Don’t be a Hero: Keep positions small during volatile markets

“Be greedy when others are fearful, and fearful when others are greedy” is a classic Benjamin Graham quote which means “buy bottoms and sell top.”

Pigs Get Slaughtered: Buy a position that is too big for you and it will turn around and bite you

Bull Trap: A strong market move up that sucks in buyers and then dies as soon as the last one is in

Bear Trap: A strong market move down that sucks in lots of short sellers and turns around as soon as the last one sells

Buy When There is Blood in the Streets: Buy stocks at market bottoms

Capitulation Bottom: The last bull throws in the towel, gives up, and dumps all his stock, making the final bottom of a major move

Capitulation Top: The last bear throws in the towel, gives up, and jumps into the market late, making the final top of a major move

Choppy: Sudden and erratic price moves within a narrow range

Contrarian: One who trades against the general market consensus

Dead Cat Bounce: A brief rally in a stock that has just seen a sharp drop

Dialing for Dollars: Calling brokerage house customers to sell stocks for commissions

Don’t fight the Fed: Don’t expect markets to fall when interest rates are falling

Don’t Fight the Tape: Don’t trade against the market trend. Come for the paper ticker tapes that once transmitted stock prices by telegraph.

Dry Powder: Keeping cash in reserve for better trading opportunities

Dumb Money: What inexperienced retail investors are doing. Thanks to the Internet, they’re not as dumb as they used to be.

Get Filled: Your order is executed

The Greeks: Greek alphabet letters that refer to option valuation components, such as delta, theta, gamma, and vega

High-Frequency Traders (HFT): Firms using sophisticated computer programs to take positions for infinitesimally short periods of time taking microscopic profits in enormous volumes. They account for roughly 70% of the daily trading volume.

Holding the Bag: You are left holding stock in a falling market or short in a rising one

Honor Your Stops: Don’t make excuses for ignoring stop losses. This is where the really big hits come from.

Killing It: Making a series of successful trades

Locked Market: When the bid and offer are identical

Market Makers: Firms that provide market liquidity with two-sided bids and offers, now largely replaced by computers

Melt Up: A straight line move upward in shares with no pullbacks whatsoever, usually triggered by a news or earnings release

Momo: Momentum-based trading, buying rising markets and selling falling ones

Never Short a Dull Market: Quiet markets can often rally sharply because the selling is done

Noise: Random media reporting that has no true impact on the direction of stock prices

Pain Trade: The market is moving against the positions of the trading community

Permabear: A persona who is always bearish, usually driven by some bizarre, Armageddon-type ideology, or suffering from paranoia

Permabull: A person who is always bullish, despite deteriorating fundamental conditions

Picking Up Pennies in Front of a Steamroller: Sell short naked put options

Pump and Dump: Unethical brokers’ run of the prices of small illiquid stocks and then sell them to clients at market tops. The shares usually collapse afterward. See the movie The Wolf of Wall Street.

Resistance Level: A price on a stock chart offering technical resistance to further price appreciation

Sell in May and Go Away: The preference for selling shares ahead of a period of seasonal weakness

Sell the Rip: STR/STFR/STMFR

Short Squeeze: A sharp run-up in share prices that forces short seller to buy to avoid accelerating losses

Smart Money: What the best informed, most experienced investors are doing. Not as smart as they used to be.

Snakebit: A surprise news development that comes out of the blue and costs you money

Spoofing: Entering orders without any intention of executing them and canceling them before they can be executed. It is a common tactic of high-frequency traders.

Spoos: S&P 500 futures contracts

Squawk Box: A small loudspeaker on a desktop in a trading room constantly broadcasting news reports and large trades

Support Level: A price on a stock chart offering significant technical support

Stop Loss: A price at which when reached, a liquidation of the position is automatically triggered

The Trend is Your Friend: Trade with the market direction, not against it

Theta Burn: Time decay on options

Ticker Tape: A white 3/4-inch-wide paper tape used to transmit stock prices by telegraph at the rate of 500 characters a minute that was used until the 1950s to transmit stock prices. See ticker tape parade and delayed tape.

Topping Process: Occurs when a market makes several failed attempts to make a new high, creating a medium-term top

Turnaround Tuesday: The tendency of markets to reverse direction after the markets digest weekend news on a Monday

Yellen Put: An assumption that the Fed will come to the rescue with a monetary easing on any substantial market sell-off


Short Selling School 101

With the markets recently incredibly volatile, and now that we are solidly into the high risk, low return time of the year, I thought it’s time to review how to make money when prices are falling.

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

No doubt, you will receive a wealth of short selling and hedging ideas from your other research sources and the media right at the next market bottom.

That is always how it seems to play out.

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

Markets could be down 10% by the time this is all over.


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

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

Bear ETFs

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

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

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

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

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

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

Leveraged Bear ETFs

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

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



3X Leveraged Bear ETF

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

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

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

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

Buying Put Options

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

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

That’s why you read this newsletter.

Selling Call Options

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

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



Selling Futures

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

For example, let’s say you have a portfolio of predominantly large-cap stocks worth $100,000. If you sell short 1 June 2019 contract for the S&P 500 against it, you will eliminate most of the potential losses for your portfolio in a falling market.

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

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

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

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

Buying Volatility

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

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

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




Selling Short IPOs

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

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

Individual IPO stocks can be tough to follow to sell short. But one ETF has done the heavy lifting for you. This is the Renaissance IPO ETF (click here for the prospectus). As you can tell from the chart below, (IPO) was warning that trouble was headed our way since the beginning of March. So far, a 6% drop in the main indexes has generated a 20% fall in (IPO).



Buying Momentum

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

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

Buying Beta

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

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

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


Buying Bearish Hedge Funds

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

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


Oops, Forgot to Hedge

Why You Missed the Technology Boom and What to Do About It Now

I often review the portfolios of new subscribers looking for fundamental flaws in their investment approach and it is not unusual for me to find some real disasters.

The Armageddon scenario was quite popular a decade ago. You know, the philosophy that said that the Dow ($INDU) was plunging to 3,000, the U.S. government would default on its debt (TLT), and gold (GLD) was rocketing to $50,000 an ounce.

Those who stuck with the deeply flawed analysis that justified those conclusions saw their retirement funds turn to ashes.

Traditional value investors also fell into a trap. By focusing only on stocks with bargain basement earnings multiples, low price to book values, and high visible cash flows, they shut themselves out of technology stocks, far and away the fastest growing sector of the economy.

If they are lucky they picked up shares in Apple a few years ago when the earnings multiple was still down at 10. But even the Giant of Cupertino hasn’t been that cheap for years.

And here is the problem. Tech stocks defy analysis because traditional valuation measures don’t apply to them.

Let’s start with the easiest metric of all, that of sales. How do you measure the value of sales when a company gives away most of its services for free?

Take Google (GOOGL) for example. I bet you all use it. How many of you have actually paid money to Google to use its search function? I would venture none. What would you pay Google for search if you had to? What is it worth to you to have an instant global search function? Probably at least $100 a year. With 70% of the global search market comprising 2 billion users that means $140 billion of potential Google revenues are invisible.

Yes, the company makes a chunk of this back by charging advertisers access to these search users, generating some $26.26 billion in revenues and $3.2 billion in net income in the most recent quarter. It would have been an $8.2 billion profit without the outrageous $5 billion fine from the European Community.

But much of the increased value of this company is passed on to shareholders not through rising profits or dividend payments but through an ever-rising share price. If you’re looking for dividends, Google doesn’t exist. It is also very convenient that unrealized capital gains are tax free until the shares are sold.

I’ll tell you another valuation measure that investors have completely missed, that of community. The most successful companies don’t have just customers who buy stuff, they have a community of members actively participating in a common vision, which is then monetized. There are countless communities out there now making fortunes, you just have to know how to spot them.

Facebook (FB) has created the largest community of people who are willing to share personal information. This permits the creation of affinity groups centered around specific interests, from your local kids’ school activities, to municipality emergency alerts, to your preferred political party.

This creates a gigantic network effect that increases the value of Facebook. Each person who joins (FB) makes it worth more, raising the value of the shares, even though they haven’t paid it a penny. Again, it’s advertisers who are footing your tab.

Tesla (TSLA) has 400,000 customers willing to lend it $400 billion for free in the form of deposits on future car purchases because they also share in the vision of a carbon free economy. When you add together the costs of initial purchase, fuel, and maintenance savings, a new Tesla Model 3 is now cheaper than a conventional gasoline powered car over its entire life.

REI, a privately held company, actively cultivates buyers of outdoor equipment, teaches them how to use it, then organizes trips. It will then pursue you to the ends of the earth with seasonal discount sales. Whole Foods (WFC), now owned by Amazon (AMZN), does the same in the healthy eating field.

If you spend a lot of your free time in these two stores, as I do, the United States is composed entirely of healthy, athletic, good-looking, and long-lived people.

There is another company you know well that has grown mightily thanks to the community effect. That would be the Diary of a Mad Hedge Fund Trader, one of the fastest-growing online financial services firms of the past decade. We have succeeded not because we are good at selling newsletters, but because we have built a global community of like-minded investors with a common shared vision around the world, that of making money through astute trading and investment.

We produce a daily research service covering global financial markets, such as Global Trading Dispatch and the Mad Hedge Technology Letter. We teach you how to monetize this information with our books such as Stocks to Buy for the Coming Roaring Twenties and the Mad Hedge Options Training Course.

We then urge you to action with our Trade Alerts. If you want more hands-on support, you can upgrade to the Concierge Service. You can also meet me in person to discuss your personal portfolios at my Global Strategy Luncheons.

The luncheons are great because long-term Mad Hedge veterans trade notes on how best to use the service and inform me on where to make improvements. It’s a blast.

The letter is self-correcting. When we make a mistake, readers let us know in 60 seconds and we can shoot out a correction immediately. The services evolve on a daily basis.

It all comes together to enable customers to make 50% to 60% a year on their retirement funds. And guess what? The more money they make, the more products and services they buy from me. This is why I have so many followers who have been with me for a decade or more. And some of my best ideas come from my own subscribers.

So, if you missed technology now what should you do about it? Recognize what the new game is and get involved. Microsoft (MSFT) with the fastest-growing cloud business offers good value here. Amazon looks like it will hit my $2,000 target early. You want to be buying graphics card and A.I. company NVIDIA (NVDA) on every 10% dip.

You can buy the breakouts now to get involved, or patiently wait until the 10% sell-off that usually follows blowout quarterly earnings.

My guess is that tech stocks still have to double in value before their market capitalization of 26% matches their 50% share of U.S. profits. And the technologies are ever hyper-accelerating. That leaves a lot of upside even for the new entrants.






May I Show You to Your Table?

Cyber Security is Only Just Getting Started

It looks like the cyber security sector is about to take off like a rocket once again. There could be another 25%-50% in it this year.

The near destruction of Sony (SNE) by North Korean hackers last November has certainly put the fear of God into corporate America. Apparently, they have no sense of humor whatsoever north of the 38th parallel.

As a result, there is a generational upgrade in cyber security underway, with many potential targets boosting spending by multiples.

It?s not often that I get a stock recommendation from an army general. That is exactly what happened the other day when I was speaking to a three star about the long-term implications of the Iran peace deal.

He argued persuasively that the world will probably never again see large-scale armies fielded by major industrial nations. Wars of the future will be fought online, as they have been, silently and invisibly, over the past 15 years.

All of those trillions of dollars spent on big ticket, heavy metal weapons systems are pure pork designed by politicians to buy voters in marginal swing states.

The money would be far better spent where it is most needed, on the cyber warfare front. Needless to say, my friend shall remain anonymous.

The problem is that when wars become cheaper, you fight more of them, as is the case with online combat.

You probably don?t know this, but during the Bush administration, the Chinese military downloaded the entire contents of the Pentagon?s mainframe computers at least seven times.

This was a neat trick because these computers were in stand alone, siloed, electromagnetically shielded facilities not connected to the Internet in any way.

In the process, they obtained the designs of all of out most advanced weapons systems, including our best nukes. What have they done with this top-secret information?

Absolutely nothing.

Like many in senior levels of the US military, the Chinese have concluded that these weapons are a useless waste of valuable resources. Far better value for money are more hackers, coders and servers, which the Chinese have pursued with a vengeance.

You have seen this in the substantial tightening up of the Chinese Internet through the deployment of the Great Firewall, which blocks local access to most foreign websites.

Try sending an email to someone in the middle Kingdom with a gmail address. It is almost impossible. This is why Google (GOOG) closed their offices there years ago.

I know about these things because several Chinese readers are complaining that they are unable to open my Trade Alerts, or access their foreign online brokerage accounts.

As a member of the Joint Chiefs of Staff recently told me, ?The greatest threat to national defense is wasting money on national defense.?

Although my brass-hatted friend didn?t mention the company by name, the implication is that I need to go out and buy Palo Alto Networks (PANW) right now.

Palo Alto Networks, Inc. is an American network security company based in Santa Clara, California just across the water from my Bay Area office. The company?s core products are advanced firewalls designed to provide network security, visibility and granular control of network activity based on application, user, and content identification.

Palo Alto Networks competes in the unified threat management and network security industry against Cisco (CSCO), FireEye (FEYE), Fortinet (FTNT), Check Point (CHKP), Juniper Networks (JNPR), and Cyberoam, among others.

The really interesting thing about this industry is that there are no real losers. That?s because companies are taking a layered approach to cyber security, parceling out contracts to many of the leading firms at once, looking to hedge their bets.

To say that top management has no idea what these products really do would be a huge understatement. Therefore, they buy all of them.

This makes a basket approach to the industry more feasible than usual. You can do this through buying the $435 million capitalized PureFunds ISE Cyber Security ETF (HACK), which boasts Cyberark Software (CYBR), Infoblox (BLOX) and FireEye (FEYE) as its three largest positions. (HACK) has been a hedge fund favorite since the Sony attack.

For more information about (HACK), please click here:

And don?t forget to change your password.