Nagilum’s Market, 10 Year Yield, Weekly wrap, 9/3-9/2017

Nagilum is a powerful, immortal being from Star Trek: The Next Generation. Once it trapped the starship Enterprise and presented its crew with various apparitions to study their responses — all to satisfy its curiosity about the human race. I mentioned it because the stock market action of the past few weeks give the impression of traders “being played”, where listless see-sawing seemingly designed to frustrate and induce over-reactions. I won’t be surprised if it’s revealed at a later time that AI bots have taken over.

Below is a long term chart of the 10-year US treasury yield (X10) that got to as low as 2.03% this week. It’s pretty amazing to recall that early this year Bill Gross was drawing a line-in-sand at 2.6%, and Jeff Gundlach, making fun of “second-rate bond managers” had it a bit higher. Per my trend lines, we’re just above resistance (call it 2% flat, if broken 1.85% is the next stop); whether it holds will have major implications.

If you put aside the market timing element and just look at asset allocation and security selection, I expect (and have been getting) greater contribution from the fixed income side than the equity side compared with a 60/40 portfolio. In fact, with my individual stocks I’m happy to just match SPY. It is my fixed income allocation — currently at a 50/50 bar-bell of stable value funds and leveraged CEFs that’s been hitting it out-of-the-park, month after month. This is in stark contrast to most DIY investors who tend to have nearly all the portfolio risk exposure and return potential from equities. I’m aware of what William Bernstein said about where to take risks, I simply disagree. I want my fixed income space to deliver returns just like any other.

  • My baseline expectation is for rates to rise as indicated by the generally rising trend lines. I’m by no means married to my CEF positions. The critical timing decision is to catch the turning point in the credit cycle to swap CEFs with treasuries.
  • If rates continue to stay low, it might still be a good hedge to equities when the bubble pops. In fact, rates staying low will fuel the equity bubble even more.
  • The real concern is if both bonds and equities drop, or to be more precise a rout in bonds leading to a rout in equities. Sovereign default is a real possibility of course, but I expect it to start in Europe first. That said, there are scenarios in which US treasury is dumped (at which point a collapsing market may be only minor concern in the overall scheme of things). The question is whether there will be any safe-haven assets or whether the only right position is “short or fetal” to quote a Fast Money trader (I think it was Macke) during the GFC. This is a low probability event but must not be dismissed since the consequences are so dire.

These things will take a year or more to play out so there are no near-term implications on my portfolio. Though it’s good to be prepared.

The US dollar dropped further this week and gold went up some more. I have been expecting a short term turn since the end of last week. My PM miner positions have been slightly hedged to 60% net long while the bullion positions are long term holds. I would have liked to have better timing but I’m maintaining the small hedge since gold looks finally ready for a short term correction. $1300 will be the first target.

Cryptocurrencies

The correction that started at BTC/$5000 could have reached a bottom by now but the second announcement from China banning all exchanges may have changed the character of this correction. The furtherest I can see it running is into the potential November 1st bitcoin SegWit hard fork. Last time BCH rewarded all BTC holders with a free dividend and the bottom came two weeks before Aug 1st. These are not trading recommendations and there is no change to my “managed withdrawal”. FWIW, I’m planning to write a blog post to argue for continued bitcoin appreciation from a game theoretic perspective. Hopefully I can get it done this month.

Portfolio

Sold margin secured Apple ($AAPL) puts EOD Friday, meant to be a very short term trade.

Outlook

Frankly I’m not happy with the market action this week. I would have liked the June lows to be taken out, instead we stopped right at the intermediate trend line. We now have anemic action from that lack of catharsis. There are chatters about an October correction which even if true would likely be mild. Still I might tweak my stable of individual stocks that now number 31. I want to pare down the number but increase the dollar amount. In short each stock needs to be a high conviction idea. I have not avoided mentioning any individual names on this blog, but neither have I given a comprehensive list. I’ll consider publishing it once I’m done with adjustments.

Good Reads

  • Profit Margins, Bayes’ Theorem, and the Dangers of Overconfidence: anything by PhilosophicalEconomics gets an automatic mention but this is easily one of the top 5 posts there and that’s saying a lot. Excellent explanation of the Bayes’ theorem, the whole article is as close to a mathematical proof of “strong conviction, carried lightly” as they come.
  • Yet Again? Howard Marks memo covering all the topics near and dear to my heart: market and positioning (agree in principle but not timing), bitcoin, passive investing, and six ways to invest in a low return world (#6 here I come)

Edit 9/10/2017: added “10 year yield” to blog title

None of the above is investment advice, the standard disclaimer applies.