Strategies for today’s crazy markets

I have to admit, I’ve been tempted to buy a bit faster than I should in this market. Here’s my last post compared with this one:

Date of holdings:             10 days ago      Today

Unallocated Cash:                 54%                46%

Gold Mining Stocks:             30%                33%

Defensive dividend payers: 16%              21%

I went through 8% in a bit over a week.  That would give me at least 2 months of buying power if the downturn lasted that long.  Still, I think it’s a bit early to call.  There’s no telling how far this market dump will go, so I need to be more patient and plan this out.

Here’s how I think this will play out…

Right now the coronavirus is the major economic story.  No one knows how long it will be shutting down cities and factories, causing a collapse in travel and tourism, and otherwise crimping economic activity.  The spread over the last week has been considerable and the problem is still growing.  Risks are against you and you can expect serious market pressure.

At some point, the coronavirus story will stabilize improve.  We don’t know whether it will take a couple weeks or a few months, we just know it’s a very difficult outbreak to contain.  Don’t expect it to stabilize overnight though – this will take weeks at the very least.

Once it stabilizes and starts to reverse, you’ll probably have a number of central banks interested in providing more money to juice the markets.  The federal reserve is the big one because a lot of the world has trouble when the US dollar strengthens, so many other countries follow the lead of the federal reserve on an easing cycle.  This is an election year which makes it more likely that the federal reserve and the US government will want to juice markets up as soon as possible.  That means a V-shaped stock market recovery just like the one from Dec 2018-Apr 2019.

Under this scenario I need to do the following:

1. Cap the amount I purchase just because prices got “better”, possibly at 2% in a given week.  I should have a significant amount of money on the sidelines when the market turn is obvious if I’m doing this correctly.

2. Don’t chase in a market like this – I should buy in small amounts, and only at incrementally lower prices.  Limit orders on a day scale are good for this – but don’t use them overnight at a time when markets can dump.

3. Stick with the safe havens.  Staples, utilities, health care, etc with high dividend yields are a good bet.  Right now they’re going down with everything else, but they are going to be the first to rally when the market turns.  There are a lot of funds out there – pensions and such – that need to invest everything and need to get a steady return.  If they are spooked about the markets, interest rates are low, and defensive stocks are paying 6-8% dividend yields then that’s where they’ll jump first.

I hate to admit it, but I have more than enough gold exposure in my portfolio.  Gold miners went down a good bit today – my gut says screaming buy, but it simply doesn’t fit my overall allocation strategy.  I have to throw my emotions aside and be patient.


Speaking of emotions, someone asked me today about how to play the presidential election.  My advice is simple:  Don’t.

The stock market moves on two things – relative valuations (fundamental analysis, are earnings rising in one place better than others) and liquidity (technical analysis, is money rotating in or out of the sector, are cash flows towards investment assets increasing or decreasing).  Follow these methodically and you’ll do fine.

If you’re a trader, you’ve heard it a million times – your emotions work against you.  You want to buy in at the top when everyone’s making money but you and you want to sell out at the bottom before you lose everything.  Our emotions cripple our ability to predict the future accurately, leading only to fears and fantasies.

Nothing is more emotionally charged than a presidential election.  Many were convinced that the stock market would tank if Trump got elected, and our country may even fall apart.  Many are similarly convinced that if Bernie gets elected the market will dump and we’ll fall into a Venezuela-style chaos.  To me the reason is obvious – both are political outsiders in a country where political interests control the mainstream passive media (cable news is the worst) for their own ends.  The reality is that our system has checks and balances, and that scary “extremists” like Trump and Bernie aren’t nearly as extreme as the candidates of most other countries, even in Europe.  In short, if you bet on an election you’ll find you’re really betting emotionally based on whether or not you support the candidate.  The election effect produces nothing more then a short-term blip which quickly disappears as the realities of earnings and cash flows move the markets forward.

Anyway, the world is not ending, but the market correction is not over either.  Watch the signals and be patient … it is better to jump in late and miss the bottom than to jump in early and fall to it.


The rise of passive investing and its implications

When I completed my MBA back in 2011, in Finance and Entrepreneurship, almost everyone talked about fundamental analysis and value investing.  They taught things like the “efficient market hypothesis,” where the market mechanism would efficiently reflect all available information into the most recent stock price.  This was all part of the old order – value investing Warren Buffet style – which lead to ideas such as mark-to-market accounting and praised the construction of GAAP.  Mark-to-market was abandoned in March 2009, which helped set the low for the US stock market and sent it back upward.  GAAP (Generally Accepted Accounting Principles) was abandoned later on for the much more flexible IFRS (International Financial Reporting Standards).  This flexibility allows companies to report better earnings metrics, making it easier to reclassify expenses as one-time costs for example.

Despite this change helping to buoy reported earnings, traditional investers have been totally baffled by the changes in the investment landscape.  You have an inverted yield curve and a manufacturing slowdown – the S&P marches higher.  The Coronovirus shuts down major cities in China which is the world’s second largest economy by GDP and a world-wide manufacturing hub – the S&P continues to reach all time highs.  How can the efficient market hypothesis have any bearing at a time when Apple – one of the biggest companies by market cap – doubles its valuation in a year?  It’s easy to get baffled and throw in the towel because nothing makes sense based on the old rules.  But don’t get discouraged – the market can be reasoned when you start to acknowledge the enormous functional changes over the last decade.

The following article mentions another game-changer in the last decade.  The gist of it is that the SEC changed the rules in March 2008 in a way that made it a lot easier to create ETFs (Exchange traded funds).  These funds exploded onto the market and became wildly popular, making it relatively easy for ordinary investors to buy into a big basket of stocks such as the S&P 500 or the NASDAQ.  The idea of safety through diversification began to replace any need for investment research or fundamental analysis.

Passive investing through ETFs (Exchange Traded Funds) is the biggest game changer in investing in the last decade.  They sell on their low management fees – they don’t need professional research or oversight – and their performance has simply trounced that of active investment funds over the last decade.  Many are calling for the end of active management as passive investing can replace it entirely – but can it?  I encourage everyone to take a look under the surface to see how this new machine works, and why it has such a tremendous track record.

Here are some of the important mechanics and requirements for passive investing through ETF’s…

  • Most passive ETF’s are limited to the universe of highly traded large cap stocks.  This is simply because they have to purchase or sell large amounts of stocks at a moment’s notice.  If you try this with a small stock you end up paying too much to buy and getting too little back to sell … so they stick to large stocks.
  • The most viewed indexes, such as the S&P 500 and the Dow Jones Industrial Average, are weighted by market cap.  This means the higher the price, the higher the weighting in the index.  As a result, funds tracking these will end up purchasing more of a stock simply because it’s share price rises.
  • The FAANG stocks (Facebook, Apple, Amazon, Netflix & Google) make up 15% of the S&P 500.  They are also in a number of popular index funds that track the NASDAQ, technology and growth for example.  As a result, any money entering any of these funds leads to large purchases of these 5 stocks, and this is amplified as the S&P responds by increasing their weights.

If you think about it, the structure above explains some of the curious behavior in stocks over the past decade.  Value stocks and smaller stocks have underperformed while large blue chips have been marching relentlessly higher and a small number of the most highly valued stocks went up enormously.

Here’s how I picture the stock market moving over the past decade.

1. Large passive index funds start to gain popularity.  There low fee structure is aimed primarily at attracting money from actively managed funds with higher fees.

2. Actively managed funds have to reduce their portfolios to accommodate the shift to passive investing.  They tend to be weighted a lot more heavily in stocks that they consider underpriced, such as value stocks and small caps with promising growth.  This relentless selling pressure causes the performance of these assets to lag.

3. Passively managed funds grow in leaps and bounds.  This money is split according to simple rules, such as purchasing stocks with the same rough weighting as the S&P 500.  This is done without regard to valuation, creating relentless buying pressure at any price, and causing the underlying holdings to outperform.

4. Central banks around the world engage in new and extreme policies of zero to negative interest rates and large balance sheet expansions known as quantitative easing.  This creates a large pool of money that pools into whatever assets the central banks favor – such as bonds – and drastically reduces the potential returns for bond investors.  Many of these investors – such as pension funds – are pushed into other markets such as stocks and private equity funds in order to get returns on investment.

5. The economy and labor market slowly recovers from the “great recession,” increasing the number of employees regularly putting money into widely used 401k plans, most of which heavily favored stocks.

6. The money going into 401k’s is considerably accelerated as large swaths of the well-paid boomer generation save like crazy as to prepare for a rapidly approaching retirement.

7. Stock buybacks began to be not only allowed in massive amounts, but often encouraged by the US government.  Companies such as Apple, GE and Boeing have spent enormous sums of money in buying back their own shares, often issuing corporate debt to do so.

7. A relentless supply of money was provided to the stock market because of 4, 5, 6 & 7 causing an enormous bull market in stocks.

This chart will help you visualize this trend:

Passive Fraction

By March 2019, passive funds already controlled over 45% of the US stock market.


We are at a time where baby boomers are retiring en masse as their average age hits 65.  After this time, they will stop adding to their 401k’s and begin drawing from them.  The following Gen-X is a much smaller generation and they typically earn significantly less.  They won’t offset the buying pressure that the boomers had.  Neither will the regular investments of the larger millennial generation, as they are all in adulthood but their pay and benefits are much smaller than that of their elders.

At this time, an enormous amount of money has been blindly crowded into a relatively small number of large stocks due to passive investing.  These investors don’t even realize it, as they believe that their passive funds offer safety through diversification.  As cash flows continue to go into stocks, particularly into passive funds, this doesn’t seem to matter as the market relentlessly climbs.

However, these flows are destined to reverse at some point – and then the question becomes who will buy and at what price.

The market correction in Oct-Dec 2018 was caused by a reverse of funds as the federal reserve reduced the size of its balance sheet and raised rates, shrinking the amount of money going into investable assets.  It turned sharply with the 2019 Powell pivot but began to peter out mid-year, until the federal reserve bumped its balance sheet higher at a rapid pace from October 2019 through January 2020.  The Coronavirus ironically helped the US stock market considerably as the financial easing in China designed to “stabilize markets” created a new wave of money, some of which rushed to the safety of US stocks.

With the worldwide manufacturing slowdown becoming more apparent and exacerbated by the growing economic affects of the coronavirus (cities shut down, reductions in trade and travel, etc), we may be destined for a significant correction here.  I wouldn’t bet short though, as I expect the US president, the federal reserve, and central banks around the world to respond to any significant decline.

I’ve been accumulating gold mining stocks in significant amounts lately and they now comprise 30% of my portfolio.  54% is sitting in cash on the sidelines in case of opportunities arising from an overdone pullback, and the remainder is primarily in defensive sectors with high dividend yields, such as consumer staples.  The technicals on both Gold and the Gold miners have been extremely bullish, and they seem set to benefit tremendously from central bank intervention.  I feel I have enough allocated there at this time however, as better buying opportunities may come ahead in other areas.

Right now I don’t think we have seen the top of this decade-long bull market in US stocks, though the chances of hitting that tipping point will increase considerably in the next few years.  I also don’t think we have seen the top of the passive investing trend … that continues to gain steam which means the overpriced FAANG stocks will probably go up even more over the next year.  I won’t bet on those though because the risks are too high for me to sleep comfortably with them in my portfolio.

Remember this … fundamental valuation does not drive stock prices.  The famous Dutch tulip mania did not happen because of any increase in tangible value or usefulness.  Valuation is driven by cash flows, and long-term outperformance comes when your understanding of the trends driving those cash flows allows you to position properly.

Happy trading, and may the odds be ever in your favor.








Midweek market thoughts

This market is certainly an interesting one.

The coronavirus caused a major demand gap, particularly in commodities, and it’s full effect is not known yet.

Economic data had been weakening for a while in cyclicals, and now we see the first signs of weakening in services & employment (Job openings in JOLTS plunge: )

The US stock market is at all-time highs. Everyone knows it’s driven by central bank liquidity.

According to the wall street sentiment survey were at 17% bulls and 75% bears:

Rauol Pal says to bet on bond yields declining ( but I’ve tried with TLT before, fortunately with a stop loss at 5% down, and I’m reluctant to try again. Gold seems a good bet … it should be okay if everything falls and it should go up if the central banks continue to juice the markets. I’ve been increasing a bit to my portfolio of gold miners lately.

I’m definitely nervous about the FANG stocks … Every passive investor is highly invested in each of those without realizing it, and they could all try to exit at once, just as blindly as they entered. However, I sure as heck wouldn’t short them – a bit more easy money going into passives and they’ll inevitably go up.

I still like high yield defensives. And I still want to keep a good bit of money on the sidelines in case of a pullback.

What next… I guess we’ll have to wait and see. You can’t avoid the market (and neither can anyone else) because you need to get the returns from somewhere. They can’t be found in bonds. Buy and hold is a horrible idea when the valuations are crazy high and demographics are against you. You have to be vigilant and nimble.

In this modern market, the vast majority of investment is coming from passive ETF’s which don’t even consider price. On the one hand I should be able to outsmart that system, on the other it means fundamentals don’t work at all – it’s all about cash flows. Whatever that money enters will rocket up in value and whatever it leaves will plummet. There are not enough returns for everyone, and you can’t just wait it out.

In an environment like this, you can run into a winning trade that’s obvious. It’s only obvious if you’re looking, and it’s usually because of a forced sale, too many funds trying to exit at once, that sort of thing. That’s why I like keeping some cash on the side – these trades don’t happen often but it’s very rewarding if you’re ready when they do. Timing is certainly everything. It will be an interesting year.

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Why I am voting for Andrew Yang

I try not to get too heavy into politics, but primaries are upon us and I feel inspired. So here goes.

Yang doesn’t have a chance of winning the primaries, I understand that. However, that is not the entire reason he’s running. You may have seen him as a bit of a one-issue speaker in his debates – because he is. Back in the Clinton-Bush-Perot elections, Clinton won with the statement “It’s the economy, stupid!” That is the one message that Yang pushes. He’s there to remind both parties that they can’t forget the population that lives and works around the median wage.

Here are a number of messages that Yang’s economic policies bring up:

  • Headline GDP growth is not the only measure of a society’s growth and well being, nor is it necessarily the best. There are a lot of assumptions that go into the GDP calculation and even more that go into an inflation rate calculation used to correct to “real GDP.”
  • Welfare reform is both important and possible. In our current system, any type of government support is designed to keep you out of the labor force. We need to be able to provide assistance to the bottom in a way that encourages, or at least allows, people to rejoin the working class without losing all of their security and benefits.
  • There is real structural change going on in our economy and we can’t ignore it! The advent of the computer age and the gig-economy age is as disruptive as the industrial revolution on a much faster scale. We need to think seriously about how to keep people who are displaced economically linked into our system. You can’t tell people to just “learn to code” – it doesn’t work. Most of the coding jobs go to places like India anyways – places with high technical expertise combined with low cost of living. Local jobs in high cost countries like the US mainly exist because they require people on site. You can’t outsource an uber driver or a grocery store clerk, which only increases the drive to replace those workers with technology.
  • We live in a two-tier economy, where some think times have never been better while an ever-growing number are struggling.
    • Inflation: The upper class continually points out that we seem stuck with low inflation. Those around the median income increasingly complain about a rising cost of living as rents, health premiums, food, and gasoline (due to taxes) continue to rise. Autos are another interesting example … there is no headline inflation because of “hedonic adjustments” for quality improvements, yet median workers see the cost of owning a vehicle rising.
    • Growth: Much of modern growth comes from central banks pushing up asset prices. While the wealthy see their stocks and inner-city property values at all time highs, they feel like it’s a major boom. Workers see little to no wage pressure and greatly increasing costs of living. Many see no path to advancement whatsoever as higher cost employees are simply laid off.

At 40 years old, entering mid-life, I am right on the cusp between gen-x and millennial. There is an enormous gap of misunderstanding between the two, often fed by the propaganda coming from both Fox and CNN. Here are some examples of the misunderstandings I see:

  • Increasing homelessness, depression, and drug-related deaths are seen. I hear all too often that these people are lazy, mentally ill, on drugs, etc. and if they’d get off their butt and work they’d be fine. Anything to blame the victim and ignore the structural change going on. This is a real problem, a growing problem, and it needs to be addressed.
  • The younger generation has lower homeownership rates and pushes off raising a family longer. I hear all too often that these young people are stupid for not buying because home ownership has been the primary source of wealth accumulation for the older generation. Younger people often can’t because their jobs aren’t as reliable and don’t pay as much. Affordable housing is a real issue and should not be ignored.
  • Healthcare is a very contentious generational issue. Just think about one thing though … right now there are programs for the non-working poor and elderly to get support. The corporate employees and government employees tend to get coverage through work. Does it make any sense to strap the median wage workers with the highest healthcare premiums for the lowest service and outright deny healthcare to the large number of below-median-wage workers who clearly can’t afford it?
  • Socialism is extremely misunderstood between the generations. The older generation tends to lump anything having to do with higher minimum wages, unions, worker rights, and adjusting the tax system to favor the rich less as outright communism which will turn us into the old USSR or even Venezuela. Communist countries are not worker’s paradises – they are places dominated by centralized control. Centralized control can come as easily through corporate monopolization (like Nazi Germany) as it can through outright government ownership (like the USSR). Both are bad – and we need absolutely need to empower smaller businesses and employees over these modern corporate behemoths.

As a final note, I’ll say again – I’m not expecting Yang to win. He is a one-issue candidate, and I’m just hoping that he shows enough support to make the big players pay some attention to that issue. Remember the words of Bill Clinton: “It’s the economy, stupid!”

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Hope is not a strategy

Sometimes certain events cannot be ignored and really make you re-think your portfolio.  In my last post I was interested in the re-flation theme of easing into big high-yield oil companies, perhaps looking at fall as the best time to buy.  However, a couple of warning signals triggered.  First, the dollar strengthened considerably against the Euro and I  reduced some of the oil plays I had.  Then oil stockpiles were much higher than expected.  Then to top it off we had the coronavirus.

Whether or not it turns out to be a major deadly force, it has already been shown to be a major economic force in a number of ways.  Lots of airplanes are grounded, major cities in China are effectively shut down, and millions of people will cancel travel plans.  Jet fuel is one of the most profitable uses of oil.  I wouldn’t want to be in sectors related to travel right now either.

I sold off the last of the oil companies I held last Thursday. The big oil companies all have high dividend payout ratios, typically paying more in dividends than they make in net profits.  If profits are subdued longer than expected and they cut dividends, these stocks will go down considerably – so it’s just not worth the risk.  You can get a rough idea of dividend safety measures for free here:


As you can see from this chart of the S&P 500, we are at the beginnings of a pullback.  Whether it is fairly minor like the one in September, a bit bigger like the one in May, or as big as the one in late 2018 remains to be seen.

I do expect this to be a pullback rather then a market top however, and here’s why.  Stock prices are driven by two things –

  1. Liquidity, or the supply of money ready to invest
  2. Sentiment, or the willingness of investors to put that money at risk

Liquidity: Back in 2018, we had major doubts about liquidity because Powell was tightening by increasing the federal interest rates (making money more expensive for investment firms and banks to borrow) and decreasing the size of the Fed balance sheet (removing money from investment supply).  Powell was even saying that a significant market correction would have no bearing on his policy decisions.  He reversed that in 2019 and showed that the famous Fed Put, originally started under Greenspan, was still in effect.  Interest rates came down a bit, then the fed balance sheet shot right back up.  Currently, it seems more likely than not that the federal reserve will act to increase the money supply if the drop in the S&P is significant.  However, there is a minor risk that he slows the rate of increase giving a result similar to the “taper tantrums” of the early to mid-2010’s which involved small pullbacks in an overall strong utrend.

Sentiment: Investors simply haven’t forgotten about 2008.  I see bearish calls all over the place (bullish as well, but that’s not my point).  At market tops, it’s much more common that sentiment is almost all bullish: There’s nowhere to go but up, and many people who aren’t usually interested in stocks are excited about them.

Buying the dips in an overall bull market tends to be a winning strategy.  However, we still don’t know how far down this correction will go … look back at the S&P chart above and consider that you wouldn’t want to go all in at the first red candle in October 2018.  Now keep in mind that most people like to be 100% invested all the time – I just don’t play that way.  I like to have cash on the side in case of pullbacks and investments as well in case there are none, adjusting the cash position based on my own determination about the odds of a pullback.

Anyway, here’s how I’m planning to play it… let’s start with my current allocation.

55% Cash, 19% Gold miners, 9% US dividend stocks, 3% EU dividend stocks, 3% Brazil dividend stocks, 8% long stocks, 3% bonds.

This is significantly different from my last post, as I sold a bunch of things like oil stocks but I also bought a number of things (some of them on Friday’s pullback) such as long stocks (bigger names include CVS, ACVI, DIS – either helped or not hurt by the coronavirus scare), and dividend stocks (bigger names include MO, AABV & KHC).  As we get more big down-days I will buy a bit more, so that if we have a small pullback like in May 2019 I’ll have some gains to show afterwards … but I’ll likely keep a sizeable cash position, at least 45%, if that’s all the pullback there is.  If we get an abnormally high volume selloff followed by a minor up-day like the one in late 2018, I might get as bullish as only a 25% cash position.  If we get a pullback like that followed by a fed speech about increasing liquidity and/or some signs of higher fed balance sheets, I’ll go all in and possibly include some margin.

Note that I recently got a margin account so that I can put more chips on the table if I see the right opportunity.  These do come along, but not very often so you have to be patient.  I still remember some of those “mutual fund pukings” back in late 2008 as they were all dumping high quality names cheap because of record fund withdrawals, and even more so that massive margin call on the CEO of CPK when I was already 100% invested.  Those no-brainer opportunities are always driven by forced sales.

Remember this link – it is important:


Anyway, I hope this gives you some food for thought.  Happy trading!






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Wall of worry

It is said that bull markets in stocks climb a wall of worry; they top out and turn when you can no longer see a problem on the horizon.

I have read and heard a number of bearish predictions lately. They aren’t without merit; the market has moved with the fed balance sheet and you can easily have another blow-off top. The correction at the end of 2018 was quite steep, and the buying opportunity that followed was quite rewarding- as tends to be the case with bull market corrections.

The most famous and brutal bull-market correction was back in October 1987, when the S&P was cut in half and the V-shaped recovery took two years to make new highs. That is very possible. Back then, the new stop-losses triggered like crazy and the market tanked. Now, the new computer-based trading could easily set off another flash crash. There is a lot of fake liquidity today, where high frequency trading makes it look like a lot of cash is changing hands, implying a large and ready market for all affected stocks, yet these strategies stop buying the moment any genuine selling begins.

So what do you do here? You don’t want to be caught in a brutal correction from all-time highs, nor do you want to sit on the sidelines in what appears to be a cyclical bull period. There are a number of narratives here that I’m watching…

1. The re-flation trade. After a worldwide slowdown and a long bear marker for anything related to industrial commodities or oil, they could be ready to move higher. This would gain traction as government spending programs in the US, Europe, and elsewhere gain political traction.

I did buy some oil stocks – big dividend payers only like shell, Exxon, ConocoPhillips and the like though. I think we’re likely at least a year early for a real uptick in these sectors.

What to watch: The dollar vs the euro. They have been consolidating and If the dollar breaks higher, abandon this trade. Note that the dollar already strengthened considerably mid-Friday. If this continues and oil doesn’t move much from the Libya story I’ll seriously consider closing out this trade. The one thing that gives me pause is that for my particular picks the earnings aren’t bad and the dividends are decent. If the market corrects and the fed intervenes, big dividend payers will have a tailwind from lower interest rates.

2. Foreign market catchup. The US stock market has been on a tear the last 5 years while Europe has been flat and emerging markets moved weakly higher. If a cyclical manufacturing and commodities downturn is ending, there could be good upside here.

Again, watch the US dollar. A strengthening dollar gives problems to economies throughout the world – especially emerging markets – as they have more commodity income and significant US dollar denominated debt. I had been picking up big dividend payers in Europe and Brazil to gain some exposure while the dividends should help stabilize the exposure if the markets turn more bearish. Examples I’m holding include Brazilian telecom VIV, European staples DEO & UL, European pharmaceutical GSK, etc.

3. The Strong US consumer. This trade has been the biggest winner of the last 3 months, so it may be due for a pause. I would expect consolidation periods in a number of these names like NKE and ROST, while I’m long DIS because its been consolidating its big move since November. I also like ATVI where it is, I just haven’t gotten back in yet.

4. Gold and gold miners. These both have incredibly bullish charts which should not be ignored – especially given the tendency of gold-related trades to stay strong even as the rest of the market falls. I prefer the miners because they’ve rallied less and they’ll win if gold just holds its price longer, as they can roll their gold futures to higher prices later on.

5. Defensive dividend payers. I have a number of these – including KFT. They should benefit if nervous investors look for a relatively safe place to put money, and they have less downside in a potential correction.

I’m actually down to a 51% cash position now with 15% in gold miners, 7% oil-related, dividend payers, 6% European dividend payers, 5% Brazilian dividend payers, 6% US dividend payers, 5% bonds and 5% US consumer discretionary/tech/industrial stocks. You can see by the mix that I’m still worried about the market though I don’t want to miss out on gains.

In general, the biggest signal I’m watching is right here:

If the fed balance sheet stops rising, I’ll expect a correction and sell off. If a correction hits and markets are plummeting, I’ll wait until the Federal Reserve moves before I do – then I’ll get really bullish betting on a snap-back. I do think there’s merit to the idea that we’re only halfway through a cyclical bull market in stocks. After all, we still hear bearish arguments, investors still remember the 2007-2009 downturn, and we don’t hear everyone we meet talking about the stock market. Good luck on your strategies, whatever they may be.


Making sense of today’s stock prices

The stock market is at all time highs.  It has been on a tear for the past three months, and it didn’t even react to the escalation of tensions in the middle east.  What’s going on?

I’ve listened to and read about a number of different perspectives, so I’ll write a bit about each…

  1. The federal reserve driving the stock market.  The basic concept is that lower interest rates lead to higher stock prices, and that assets purchased by the federal reserve put more money into the markets which drives stock prices higher.

Federal reserve balance sheet:


The narrative here is that the stock market in 2017-2018 was driven higher following the tax cuts, as US companies “repatriated” a lot of money from overseas leading to record spending on corporate stock buybacks.  This pushed the stock market higher even as the federal reserve was increasing interest rates and reducing the size of its balance sheet.  This worked until October 2018, when a 20% correction began as wall street was worried about the fed over-tightening.  Most analysts expected the fed to continue increasing interest rates in 2019.  After the “Powel Pivot,” where the federal reserve announced a halt to rate hikes and stock analysts started anticipating rate cuts, the market jumped higher.  This worked until August, when the market became indecisive and choppy as liquidity was drying up.  In September, the overnight repo rates spiked as banks were no longer funding all the repurchase agreements offered (aka lending money based on US government and agency assets).  The federal reserve stepped in and funded these – as well as purchasing treasury notes – increasing the size of the balance sheet.  More money was added to markets leading to a significant move higher in the last 3 months.

The questions here are what happens now.  Will the fed allow it’s balance sheet to reduce in size by stepping aside from repo operations (basically overnight lending, which can be ended at any time) and encouraging banks to allocate more money there?  This would allow the market to falter again, and it could drop in quick bursts.  Will the federal reserve continue increasing repo operations and treasury note buybacks with no limit to the size of it’s balance sheet?  This would move markets higher as more money is continually available to go there.

Investors with the above narrative like to focus on precious metals, which should gain if the federal reserve pumps more dollars into the system.  This brings us to gold…

2. Gold is a bit risky right now due to the record amount of commercial shorts and investor longs.

COT chart vs gold:—CMX-Futures-Only/088691/Commodity/156/26


The above chart is a bit hard to read, but here’s the gist of it… the commercial hedgers are gold miners, who tend to sell gold futures when they want to lock in a price, and then hold the bet to maturity.  They were basically at zero before the huge expansion in the gold price, while market speculators were short gold.  As the gold price goes up, the commercials will generally sell more futures to effectively lock in future prices so that they can better plan operations.  They are at record short positions now, but there won’t be a short squeeze because the commercial producers hold these contracts to maturity.  On the other side are the large and small speculators, who were short gold considerably near the bottoms and are at record long bets now.  These futures drive the price of gold rather than physical demand … it’s just the way the market works.  They are also leveraged bets of about 34x, so that $1 billion long futures controls $34 billion of actual gold.  Unlike commercials, these speculators are at high risk … the price can drop considerably if they take profits, and can snowball downward if they start losing money and panic selling.  There is a bit of a floor here as the commercials buy back the contracts when gold approaches their cost of production.  For the commercials, it doesn’t make sense to produce below the cost of production – they would be better off closing these trades, booking the gains, then slowing or halting physical production until it is again profitable.

Long story short … with the record long speculative open interest, gold can see a sharp pullback.  Other notes on gold… technical analysts see a number of positive formations on gold, including the latest break upward after a few months of consolidation from the September high.  The trend overall is upward even though a pullback is expected.

Also, the gold miners themselves show a bullish cup-and-handle formation:


3. The stock market may be only halfway through the long-term bullish cycle.


In this viewpoint, you should be increasing your risk toward cyclicals, because we have a ways upward to go before the next extended flat period.  In this perspective, you tend to have PE ratios bottom out in the orange periods and top out in the green ones.  Here’s what those look like:

PE Ratios.jpg

The current PE ratio of around 18 is not historically cheap.  However, they did move considerably higher after the 401k was introduced in the early 1980’s, putting investment money from millions of workers into the stock market year after year – a move which is likely permanent.

4. The effects of the manufacturing recession already cycled through the stock market

In this perspective, the US did not enter recession because it’s economy is over 70% services (financials, insurance, medical, legal, etc) which have been growing considerably while it is less than 20% manufacturing, which has been shrinking.  This manufacturing recession was felt much more strongly in many other parts of the world, such as Germany which was particularly affected by the slowdown in durable goods such as autos.  Because the cycle has gone through the pricing already, it is a good idea to have some investments in areas which are expected to recover after the worst of it, such as Europe and Brazil.

I’m going to break here and talk about my own allocations…

I actually sold almost everything off (I held the gold miners and bonds) on Dec 24 and decided to enjoy the new year with family before figuring out how to re-allocate.  Although DIS was a good ride for me (bought at $129 and sold at $151, then gave a little back on one Jan 150 call which is about to expire), my biggest winner was MO because I had a much bigger position.  I dipped in at $44, bought considerably more at $47, and sold it all at $51.  It was a good quarter.

I have been struggling with that a bit as the risks in the market are significant … What will the federal reserve do? How will the US election rhetoric affect sentiment? How can I get a halfway decent rate of return without considerable risk?  This last couple weeks – mainly last week – I started making some allocations.  Now I’m down to 67% cash, 15% gold miners, 4.5% US dividend payers, 5% EU dividend payers, 3.5% Brazilian dividend payers, 2% long cyclicals (tech & industrial) and 3% bonds.  I don’t want to allocate too much – especially into cyclicals – in one shot at all time S&P highs.  I’ll probably get more cyclicals, but I want to wait until I get some favorable chart formations.  For those, I prefer to enter after a decent pullback with a stop loss below resistance, then edge up the stop loss as they move higher.  Patience is key in these markets… I’m fine with a relatively high cash position because having extra capital available when an opportunity presents itself is worth a lot more than locking it up at a sub-2% annual yield.

Happy new year and happy new decade.



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