(LAST CHANCE TO BUY THE NEW MAD HEDGE BIOTECH AND HEALTH CARE LETTER AT THE FOUNDERS PRICE) (SEPTEMBER 18 BIWEEKLY STRATEGY WEBINAR Q&A), (SPY), (VIX), (USO), (ROKU), (TLT), (BA), (INDU), (GM), (FXI), (FB), (SCHW), (IWM), (AMTD)
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Below please find subscribers’ Q&A for the Mad Hedge Fund Trader October 2Global Strategy Webinar broadcast from Silicon Valley, CA with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!
Q: Would you do the S&P 500 (SPY) bull call spread if you didn’t have time to enter the short leg yesterday?
A: I would, because once again, once the Volatility Index (VIX) gets over $20, picking these call spreads is like shooting fish in a barrel. I think the long position I put on the (SPY) this morning is so far in the money that you will be sufficiently safe on a 12-day and really a 2-week view. There is just too much cash on the sidelines and interest rates are too low to see a major December 2018 type crash from here.
Q: I could not come out of the United States Oil Fund (USO) short position—should I keep it to expiration?
A: Yes, at this point we’re so close to expiration and so far in the money that you’d need a 30% move in oil to lose money on this. So, run it into expiration and avoid the execution costs.
Q: How do you see TD Ameritrade (AMTD) short term?
A: Well, it was down approximately 25% yesterday, so I would buy some cheap calls and go way out of the money so as not to risk much capital—on the assumption that maybe next week into the China trade talks, we get some kind of rally in the market and see a dramatic rise. 25% does seem extreme for a one-day move just because one broker was cutting his commissions to zero. By the way, I have been predicting that rates would go to zero for something like 30 years; that’s one of the reasons I got out of the business in 1989.
Q: Would you consider buying Roku (ROKU) at the present level?
A: Down 1/3 from the top is very tempting; however, I’m not in a rush to buy anything here that doesn’t have a large hedge on it. What you might consider doing on Roku is something like a $60-$70 or $70-$80 long-dated call spread. That is hedged, and it’s also lower risk. Sure, it won’t make as much money as an outright call option but at least you won’t be catching a falling knife.
Q: Will we see a yearend rally in the stocks?
A: Probably, yes. I think this quarter will clear out all the nervous money for the short term, and once we find a true bottom, we might find a 5-10% rally by yearend—and I’m going to try to be positioned to catch just that.
Q: At which price level do you go 100% long position?
A: If we somehow get to last December lows, that’s where you add the 100% long position. And there is a chance, while unlikely, that we get down to about 22,000 in the Dow Average (INDU), and that’s where you bet the ranch. Coming down from 29,000 to 22,000, you’re essentially discounting an entire recession with that kind of pullback. But we’re going to try to trade this thing shorter term; the market has so far been rewarding us to do so.
Q: The United States Treasury Bond Fund (TLT) looks like it’s about to break out. How do you see buying for the November $145 calls targeting $148?
A: We are actually somewhat in the middle of the range for the (TLT), so it’s a bit late to chase. We did play from the long side from the high $130s and took a quick profit on that, but now is a little bit late to play on the long side. We go for the low-risk, high-return trades, and $145 is a bit of a high-risk trade at this point. I would look to sell the next spike in the (TLT) rather than buy the middle where we are now.
Q: Will Boeing (BA) get recertified this year?
A: Probably, yes—now that we have an actual pilot as the head of the FAA—and that will be a great play. But if the entire economy is falling into a recession, nothing is a good play and you want to go into cash if you can’t do shorts. That would give us a chance to buy Boeing back closer to the $320 level, which was the great entry point in August.
Q: Do you expect General Motors (GM) shares to bounce if they settle with the union on their strike?
A: Maybe for a day or two, but that’s it. The whole car industry is in recession already. The union picked the worst time to strike because GM has a very high 45-day inventory of unsold cars which they would love to get rid of.
Q: What are the chances of a deal with China (FXI)?
A: Zero. How hard do the Chinese really want to work to get Trump reelected? My guess is not at all. We may get the announcement of a fake deal that resumes Chinese agricultural purchases, but no actual substance on intellectual property theft or changing any Chinese laws.
Q: Will they impeach Trump?
A: Impeach yes, convict no; and it’s going to take about 6 months, which will be a cloud hanging over the market. The market’s dropped about 1,000 points since the impeachment inquiry has started.
Q: What about the dollar?
A: I’m staying out of the dollar due to too many conflicting indicators and too much contra-historical action going on. The dollar seems high to me, but I’ve been wrong all year.
Q: E*Trade (ETFC) just announced free stock trading—what are your thoughts?
A: All online brokers now pretty much have to announce free trading in order to stay in business, otherwise you end up with the dumbest customers. It’s bad for the industry, but it’s good for you. The fact that all of these companies are moving to zero shows how meaningless your commissions became to them because so much more money was being made on selling your order flow to high frequency traders or selling your data to people like Facebook (FB).
Q: What’s your take on the Canadian dollar (FXC)?
A: It will go nowhere to weak, as long as the US is on a very slow interest rate-cutting program. The second Canada starts raising rates or we start cutting more aggressively is when you want to buy the Loonie.
Q: Fast fashion retailer Forever 21 went bankrupt—is it too late to short the mall stocks?
A: No but be very disciplined; only short the rallies. Last week would have been a good chance to get shorts off in malls and retailers. You really need to sell into rallies because the further these things go down, the more volatility increases as the prices go low. Obviously, a $1 move on a $30 stock is only 3% but a $1 move on a $10 stock is 10%. If you’re the wrong way on that, it can cost you a lot of money, even though the thing’s going to zero.
Q: Comments on defense stocks such as Raytheon (RTN)?
A: This is a highly political sector. If Trump gets reelected, expect an expansion of defense spending and overseas sales to Saudi Arabia, which would be good for defense. If he doesn’t get reelected, that would be bad for defense because it would get cut, and sales to places like Saudi Arabia would get cut off. I stay out of them myself because it’s essentially a political play and we’re very late in the cycle.
Q: Mark Zuckerberg says presidential candidate Elizabeth Warren’s proposal is an existential threat. Do you agree with him and her policies? Will they crash the economy?
A: They would be bad for the economy; however, I think it’s highly unlikely Warren gets elected. The country’s looking for a moderate president, not a radical one, and she does not fit that description. If you did break up the Tech companies, they’d be worth more individually than they are in these great monolithic companies.
Q: Does the Russell 2000 (IWM) call spread look in danger to you?
A: It’s a higher risk trade, however we are hedged with that short S&P 500, so we can hang onto the long (IWM) position hedging it with your short S&P 500 (SPY) trade reducing your risk.
Q: What do you have to say about shrinking buybacks?
A: It’s another recession indicator, for one thing. Corporate buybacks have been driving the stock market for the last 2 years at around a trillion dollars a year. They have suddenly started to decline. Why is that happening? Because companies think they can buy their stocks back at lower levels. If companies don’t want to buy their stocks, you shouldn’t either.
Q: When is the time for Long Term Equity Anticipation Securities (LEAPS)?
A: We are not in LEAPS territory yet. Those are long term, more than one-year option plays. You really want to get those at the once-a-year horrendous selloffs like the ones in December and February. We’re not at that point yet, but when we get there, we’ll start pumping out trade alerts for LEAPS for tech stocks like crazy. Start doing your research and picking your names, start playing around with strikes, and then one day, the prices will be so out of whack it will be the perfect opportunity to go in and buy your LEAPS.
Q: Was it a Black Monday for brokerages when Charles Schwab (SCHW) cut their commission to zero?
A: Yes, but it’s been one of the most predicted Black Mondays in history.
Q: Will the Fed save the market?
A: I would think they have no ability to save the market because they really can’t cut interest rates any more than they already have. There really are no companies that need to borrow money right now, and any that does you don’t want to touch with a ten-foot pole. The economy is not starved for cash right now—we have a cash glut all over the world—therefore, lowering interest rates will have zero impact on the economy, but it does eliminate the most important tool in dealing with future recessions. You go into a recession with interest rates at zero, then you’re really looking at a great depression because there’s no way to get out of it. It’s the situation Europe and Japan have been in for years.
Good Luck and Good Trading John Thomas CEO $ Publisher The Diary of a Mad Hedge Fund Trader
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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
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I like roller coasters. The Giant Dipper at the Santa Cruz Boardwalk is tough to beat, the last operating wooden coaster in the United States. And I’ll always have fond memories of the Cyclone at Coney Island in New York.
I especially liked this week in the financial markets, which provided more profitable trading opportunities, both on the long and the short side, that any other week of the past decade.
Perhaps the highpoint was on Thursday when I was staring at my screens watching ten year US Treasury bond yields (TLT) bottom at a near historic 1.46%, and my own Mad Hedge Market Timing Index plunging to a lowly 19.
Impulsively, I covered the last of my short positions and started piling on longs in the FANGs. The next morning, the Dow Average opened up 300 points. But then, it’s easy to be bold and decisive when you’re up 30% on the year, compared to only 11% for the Dow Average.
And guess what? The best may be yet to come!
As long as the Volatility Index stays over $20, you will be able to print all the money you want with options spreads. I’m talking 10%-15% A MONTH!
All eyes are now on September 1 when the Chinese announce their own retaliation to our tariff increase. Will they target ag again? Or does the bond market (TLT) take the hit this time (the Chinese government owns $900 billion worth of our debt).
And now for the question that everyone is asking: How far will the stock market fall in this cycle. We have already plunged 10% from the highs on an intraday basis. Could we drop another 10% in this period of high anxiety? Certainly. However, I tend to think it will be less than that.
The initial market pop on Monday came when the new Chinese tariffs were delayed, from September 1 to December 15, on some items. Tell me who saw this one coming. The potential costs of the tariffs are hitting the US more than China. It was worth a 550-point rally in the Dow Average. In 50 years, I’ve never seen such blatant market manipulation.
Gold hit a new six-year high, with the collapse of the Argentine Peso a new factor. A poor election result drove the beleaguered currency down 15% in one day, a massive move.
Now you have to worry about what’s happening in China AND Argentina. For the first time in history, gold now has a positive yield versus the Europe and the Japanese Yen, which both offer negative interest rates.
Hong Kong is becoming a factor driving US markets down. If there is a repeat if the 1989 Tiananmen Square massacre where thousands died, global markets could collapse. The hit to growth will be more than it currently can stand in its present weakened state.
Inflation is taking off, with Core Consumer Inflation for July coming in at a red hot 0.3%, delivering the strongest two-month price burst since 2006. If it keeps up, you can kiss those future interest rate cuts goodbye.
Germany is in recession. That is the only conclusion possible when you see Q2 at -0.1% growth and the economy still in free fall. The ZEW’s figures regarding Germany yesterday were nothing short of horrific as the Economic Sentiment Index fell to -44. When you damage China’s economy, it puts the rest of the world into recession. The global economy has become so interlinked, it can’t become undone without another great recession.
Bonds rates bottomed yesterday, at least for the short term, the intraday low for the ten-year US Treasury yield hitting 1.46%. Welcome to inversion land, where long term interest rates are below short-term ones. Confidence in the economy is melting like an Alaskan glacier. But with three more 25 basis point rate cuts to come, an eventual break below 1.0% is inevitable. Watch for stocks to remake half their recent losses.
Consumer Sentiment cratered in August from 97.0 estimated to 92.1. And that was before the stock market sold off. Consumer spending remains strong. The last time it was this strong was at the market top in 2008, the market top in 1999, and the market top in 1987.
July Housing Starts plunged 4.0%, to 1.191 million units as homebuilders move into recession mode. Not even record low-interest rates can get them to stick their necks out this time. Those that did last time got wiped out.
It’s been pedal to the metal all month with the Mad Hedge Trade Alert Service, with no less than 31 Trade Alerts going out so far. Some 18 or the last 19 round trips have been profitable, generating one of the biggest performance jumps in our 12-year history.
Since July 12, we have clocked a blistering 15.15% in profits or $15,150 for the model $100,000 trading portfolio.
My Global Trading Dispatch has hit a new all-time high of 330.65% and my year-to-date shot up to +30.51%. My ten-year average annualized profit bobbed up to +34.20%.
I have coined a blockbuster 12.18% so far in August. All of you people who just subscribed in June and July are looking like geniuses. My staff and I have been working to the point of exhaustion, but it’s worth it if I can print these kinds of numbers.
The coming week will be a snore on the data front. Believe it or not, it could be quiet.
On Monday, August 19, nothing of note is released.
On Tuesday, August 20 at 10:30 AM, we get API Crude Oil Stocks.
On Wednesday, August 21, at 10:00 the Existing Home Sales are published for July.
On Thursday, August 22 at 8:30 AM, the Weekly Jobless Claims are printed. The Jackson Hole conference of global central bankers and economists begins.
On Friday, August 23 at 8:30 AM the July New Home Sales are announced.
The Baker Hughes Rig Count follows at 2:00 PM.
As for me, I will be attending the Pebble Beach Concourse d’Elegance vintage car show where I will be exhibiting my 1925 Rolls Royce Phantom I, the best car ever made.
I don’t mind the wooden brakes, but it’s too bad they didn’t make adjustable seats in those days to fit my 6’4” frame. However, its price appreciation has been better than Apple’s (AAPL) which I bought as a fixer upper in England during the 1980s for $20,000. My average cost on Apple is a split adjusted 25 cents.
My Rolls will be shown alongside James Bond’s 1964 Aston Martin which sold for $6.3 million, a 1939 Volkswagen Type 64 priced at more than $20 million, and a $13 million 1958 Ferrari 250 GT BBT.
And what am I doing next weekend? Taking the Boy Scouts to the Six Flags roller coaster farm in Vallejo.
Good luck and good trading.
John Thomas CEO & Publisher The Diary of a Mad Hedge Fund Trader
My Phantom I
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