Monthly Archives: November 2017

Acquired Optimism

Are you an optimist or a pessimist? Few questions are as basic or as revealing about our fundamental outlook on life and the world around us. Today I’d put myself in the “optimist” column albeit with some qualifications. To my family and friends that may come as a surprise. Indeed, my outlook has evolved over the years — today I’m an optimist by choice rather than disposition.

Happiness and Optimism

Culturally we tend to view those who warn us of impending doom as idiosyncratic thinkers, prescient iconoclasts, or even misunderstood geniuses — if not in those exact terms, at lease imbued with superior intellect. Consider this article, Are Happy People Dumb? from no less a paragon of thought leadership than the Harvard Business Review. Just in case the title equivocates, it opens thusly:

Happy people are not the smart people.

I felt the author dealt with happiness in a narrow sense of our immediate reaction to life circumstances. The article actually went on to make a different point (it’s worth a read so I won’t spoil it for you). But the sentiment reflected in its opening sentence is not uncommon. Happiness, some thought, is only reserved for the oblivious masses, the happy-go-lucky man-on-the-street, or worse yet, the dumb-as-a-door-knob brother-in-law. A person moderately read, traveled, and spent five minutes thinking about the future can see that wealth polarization is worsening, ideological differences are getting more entrenched, middle class is going nowhere, white collar jobs are being displaced by AI, our international allies are abandoning us, China is taking over the Pacific, war is brewing everywhere, OH MY FXXXING GOD THE WORLD IS COMING TO AN END!!! I was like that, a worrier by nature. I was taught to plan for the worst and hope for the best. But somehow I was preoccupied with the plan part and never allowed myself the hope part.

There have been claims of a “happiness gene”, although I find the evidence a little wanting. Certainly much of our immediate mental responses to external events are deeply rooted in our psyche, they’re called “gut reactions” for good reason. We know that when speedy decisions are needed, out mind apply certain heuristics, i.e. short-cuts borne from experience, rather than lengthy deliberation. As a result of our evolution, the heuristics tend to highlight signs of danger because of the risk/reward asymmetry — our ancestors were much better off assuming the rustling of leaves was from a mountain lion beneath than an errand gust. It’s quite possible for the tendencies of these heuristics have a genetic or neurochemical basis that also spills over to longer term decision making. Therefore, we need to overcome our innate dwelling on the negative, in order to make an accurate forecast by assessing the probabilities and consequences of potential outcomes; it may even be an acquired skill. The history of stock markets has shown optimism of this sort, a positive, thoughtful outlook on the future, to be by far the more profitable orientation.

Market and Economic Outlook

As a PM investor since 2002, I’ve lost count of the dire warnings I’ve read on websites like SafeHaven, DailyReckoning, FinancialSense, GoldSeek, Gold-Eagle, 321Gold, and last-but-not-least, ZeroHedge. Pessimism sells — I’m proof: fifteen years ago I bought into the doomsday thesis hook, line and sinker. I bought into, and lost money in, both David Tice’s and John Hussman’s funds. It took me a long time to come around to the other side which was an intellectual process. To start, there was one fatal flaw with the bearish thesis: it didn’t work for investors. Note I didn’t say it’s wrong because that’s a rabbit hole of theories about manipulation and what should have, would have happened. Instead, it’s an incontrovertible fact that the bearish thesis has made its believers poorer.

It’s a truism that the market goes up most of the time, but that is too simplistic an answer to why the bearish thesis did not panned out. I can think of two reasons why.

  1. One favorite line of attack on the “phoniness” of the stock market’s recovery is to point out that the recovery has left much of the middle and working class behind. Much of the gloomy picture is accurate, although I take issue with some interpretation of the data, such as the stagnant wage growth by noting that average wage is highly age dependent such that a typical worker is still getting more pay as his career advances. It’s undeniable that some are left behind by the digital divide, and unequal wealth distribution is both a humanitarian concern as well as a social ticking bomb. However, looking at it unemotionally, unequal wealth distribution is evidence for both the compounding effects of the knowledge economy and the diminishing economic footprint of the disaffected. Unevenness of recovery does not mean it’s false, but rather it’s early and has legs. Conversely, the top is not far away when everything everywhere is booming.
  2. The biggest mistake the bears made was to underestimate the resiliency of the system, by which I mean the policy tools the central bankers and governments around the world were willing to adopt. Sacred classic economic principles turned out to have its basic assumptions abrogated. Fore example, many was sure the expanding money supply was going to lead to inflation. Nine years later they say, oops the velocity of money collapsed. Oops indeed, that was one expensive mistake. I see the China bears making the same kind of mistakes again.

Like it or not, central bank and government intervention in the economy is likely to stay or even expand (see the recent Felix Zulauf interview). I choose to take advantage of the situation rather than make my portfolio a statement of what I believe things should be. As Keynes once said, “When the facts change, I change my mind. What do you do, Sir?” It was nice to have read Fredrick Hayek, Milton Friedman and Ayn Rand, but one can’t make money with Austrian economics and sound money principles. I too see nobility in the suffering of a starving artist — the operative word being “starving”.

Today I still have a substantial allocation to PMs based on their portfolio diversification characteristics, but I don’t expect a near or even medium-term monetary collapse. Readers are no doubt aware that my portfolio is currently leveraged long equities, from which some may surmise that I’m “optimistic” about the stock market. That’s not incorrect, but the whole picture is more nuanced. As always, the time frame plays a critical role.

  • As the title 1998 (relative to the dot com bubble) would suggest, my base case scenario doesn’t call for a top in the stock market until 2019.
  • The Next Bear market I anticipate to be a cyclical one within a secular bull market, for a decline of about 30% lasting 12-18 months.
  • Nonetheless, my 10-year equity return projection is under 4.3%. One way to get there is to round-trip in three years, then grow 6% for 7 years. That’s equivalent to 4.2% nominal for 10 years. In other words, I expect the current bubble to pull-forward a lot of the future returns. Based on this projection, the 4% rule for the Jan 2000 retiree is in jeopardy. Take a 70/30 initial allocation as an example, even if it were to make it to 2030, the portfolio would be too depleted to support the retiree much longer (see also).
  • I’m more hopeful after this next 10 years, and for the world as a whole. The technology trends of AI/ML etc. will take many decades to play out. Even if the US doesn’t grow as it did post WWII, the global economy just might.

I would consider this “tempered optimism”, no outright disaster, but the economic manipulation is not consequence-free either. What matters more, clearly, is what to do with this understanding.

Life in General

Looking back I believe I’ve made a case for not being an out-and-out pessimist, but probably not a strong one for being an optimist. For that we need to look outside the markets. In the larger picture, there is one and only one reason that makes me fundamentally optimistic about humanity: our knowledge is still expanding: in fact it’s being generated and disseminated at an unprecedented pace. Knowledge, once obtained, cannot be destroyed, but compounds for future generations. As long as humanity survives, and knowledge expands, there will be progress. Besides given me hope for humanity, this line of thinking has offered me clarity in the overall hierarchy of values.

On a more personal level, my optimism comes from my ability to think for myself, to adapt to change, and to raise a loving family. My active approach to investing as well as my appetite for risk are direct expressions of that optimism. I’d like to think that my path to where I’m today has not contradicted that belief. I have not always thought this way; I like this way much better.

May our future be brighter than the past.

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

Selling Discipline

Unless you’ve been living under a rock you knew bitcoin passed the magical $10K mark. I find the best form of greed/angst control is to sell a little: I sold a little BTC and BCH at BTC = $9980 on the way up. After passing the $10K mark, BTC got as high as $11.5K before dropping close to 20%. It’s been oscillating around that round number since (all basis Gdax).

Above is a record of my crypto accounts. Note “100” is a scaled number that represented about 0.6% of my total portfolio at the time — a sum I was willing to take a flier on. That was almost nine months ago. My risk appetite has not changed much, “100” is still about the max I’d be willing to risk on a gamble, but crypto prices have zoomed by. With the latest sale, I’m at 75% across the board of my max coin holdings (BTC/BCH/ETH/LTC). I’ve withdrawn 113% of the initial deposit and still left with coins 7.5 times that amount for an IRR of over 2500% (calculated at BTC=$9930). My bigger concern now is to limit the crypto allocation to no more than 5-6% if the futures listing doesn’t temper its volatility. It’s common for BTC to lose 40% in days and I want to limit the downside from any portfolio segment to no more than 2% in a month.

Frankly prices have advanced further than I had been expecting. Previously I had a target of around $25K, I may have to reconsider. There are more potential buyers out there since there still isn’t a convenient investment vehicle; however, signs of excesses are everywhere. I was on a flight recently, one of the first things I noticed a fellow passenger did after landing was opening his CoinBase app — I have to admit having done the same.

Below are two amazing charts I want to share. The first is from AllStarCharts, an update of a Fibonacci extension shared before. The second was posted to the EliteTrader forum, of unknown authorship but amazingly accurate in predicting the date of $10K BTC. Enjoy!


Remember, as great and important as the internet is, it led to the mal-investment, mis-pricing, and collapse of the dot com bubble. All the promises of blockchain from the most ardent devotees amount to a fraction of the impact of the internet. High crypto prices can create huge distortions in the world economy, not just in electricity consumption. If a tree can’t grow to the sky, then it won’t. This too shall pass. I’ll never catch the peak; I’ll never make as much money as I could have in theory; there are lots of people who make a lot more than me; and that’s all OK.

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

Amazon HQ2, Weekly Wrap 11/12-18/2017

I’m away on a family vacation, hence the delay in writing this post. Happy Thanksgiving to those in the US. I’m going to skip the weekly wrap post Thanksgiving.

Macro and Markets

Amazon’s HQ2 has been getting lots of press and rightfully so. I can’t offer any insight as far as predicting which city Amazon is likely to pick. Much has been written on the candidate cities’ work force, infrastructure, and culture — there are far more knowledgeable people than I on those matters. But I do have some thoughts about Amazon’s motives that I haven’t seen written elsewhere. First, I make the following observations:

  1. Amazon doesn’t need money, at least not the puny billions (if that) any city will be able to offer via tax incentives.
  2. Amazon can damn well hire any one it wants.
  3. If you look at the numbers given in the link above, Amazon can make/re-make whichever city it picks into whatever cultural environment it wants to.

What’s the biggest obstacle in Amazon’s growth trajectory? Political and popular backlash due to its growing clout. What did the military-industrial complex do to curry favor with politicians to get its projects and contracts? Putting factories in the key congressional districts. What can Amazon’s HQ2 accomplish? Transform, or should I say ingratiate itself with, an entire city, region, and state — and more than a few votes I would imagine. Is that the only consideration? Absolutely not, but to assume it’s not part of the consideration is equally naive.

Anyway, that was part of a wider reflection on the sustainability of the growth from AI/ML/IoT/robotics/blockchain/CRISPR/etc. There is more than enough to underwrite a new secular bull market and I’m sure Amazon will be part of it (disclosure: no position in AMZN as of now). Though the tricky part is to be able to take advantage of mispricing, both on the way up and down.

Back to the more immediate developments in the market this past week: there was a nice bounce on Thursday, though much was given back on Friday, at equal or larger volume to boot. It was the case for S&P, Dow and Nasdaq.

The CNN Money fear and greed index dropped below 40 and ended the week at 44. There may still be uncertainty surrounding the senate vote on tax reform but I don’t see anything that will derail this bull market. There is still an outside chance we’ll see 2700 on the S&P by the end of this year.

Portfolio

For someone convinced the bull market is intact this past week presented several buying opportunities. I added to QQQ calls and $LABU (I’m incorrigible), and most proudly: Pimco CEFs $PCI and $PDI before the reversal on Wednesday. The latest UNII report showed much better coverage ratios, likely from taking profits in swap positions. Once again it points to the folly of listening to someone who can’t tell interest rate swaps from the internal revenue service.

Current portfolio composition is as follows: PMs 9.9%; equities 56.4%; FI, 23.2%; cash equivalent, 5.1%; and other, 5.6%. The “other” category is composed of crypto, 3.3%; 3X ETFs, 0.35%; and options, 1.85%. Effective exposure from options is 67.2% of total portfolio value. The option leverage ratio is 36X. The total portfolio is over 130% long equities (before considering the beta of each position).

Good Reads

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

NDX Prediction, Weekly Wrap 11/5-11/2017

Macro and Markets

Two pieces of news cast doubt on the tax reform this week. While the POTUS was on his Asian tour, the GOP suffered resounding election defeats around the country. It was seen as a firm rejection of the President and his policies. In addition, the Senate’s version of tax reform plan had a one-year delay in corporate tax rate reduction. As far as the stock market is concerned, I remain as suspicious as ever that the tax reform is “priced in”, i.e. not much credence was given to passage, in the present form anyway. The real growth-inducing initiatives that I can see are the repatriation of off-shore profits and faster investment dispensing, both are front-loaded and one-shot deals. As far as the corporate rate that grabs the headlines, multinationals already have so many ways to reduce their taxes. Small caps may indeed benefit which is why the Russell is acting so poorly this year — evidence again that the market has NOT priced in the tax reform. As far as “trickle down corporate rate cuts” to raise labor compensation is concerned, I have a bridge in Brooklyn for sale if you actually believe that. While I stand to benefit as an investor, any wage increase will come from the tight labor market, not lower corporate tax rates.

Against that background, I view the drop on Thursday as nothing more than a natural fluctuation. We’re so used to low volatility that a 1% intra-day move was sufficient to take the CNN Money fear and greed index down to 54, squarely in the neutral range. I’m going out on a limb again to make a prediction on NDX. Below is its weekly chart. I think it has entered into a phase similar to end of Jun’13 to Feb’14 where the index stayed mostly above the 10 WMA and definitely above the 20 WMA for eight straight months. Timing wise it points to a top (not necessarily THE TOP) next April. Along the way, a test of the 20 WMA in early 2018 is to be expected. As a price objective — I’m using the 1.618 extension of the dot com era high (4816) or 7792, equivalent to $190 for the QQQ. This is a refinement of my current market view, so no immediate portfolio change is required.

Portfolio

I got out of $SOXL on Monday with a good profit, but jumped into $LABU too soon and was stopped out. I’m out of $JDST as well. In fact, I’m out of all leveraged ETFs and just going to enjoy the bulk of my $SOXL profits for a while. In PMs, I still believe the intermediate trend is down and the low in January scenario is increasingly likely. It’s just a very difficult environment to trade so I will simply lay off for now.

This week I participated in an IPO. InteractiveBrokers was an underwriter for Sogou ($SOGO), a Chinese search engine. I requested 1000 shares and was allotted 100 @ $13. It closed the week at $13.85, not a blockbuster but I’m happy with any gains.

Current portfolio composition is as follows: PMs 9.8%; equities 56.8%; FI, 22.7%; cash equivalent, 6.2%; and other, 4.6%. The “other” category is composed of crypto, 2.7%, and options, 1.9%. Effective exposure from options is 64.6% of total portfolio value. The option leverage ratio decreased to 34X due to increases in option value. The total portfolio remains over 120% long equities (before considering the beta of each position).

Good Reads

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

Fixed Income, Nov 2017

In this post I’ll go over my fixed income (FI) allocation as well as sharing the outlook and plan for navigating the next bear market. Currently, FI occupies 22.3% of the total portfolio, not counting 5.6% in cash equivalent (3.6% of the 5.6% is the emergency fund in a CD ladder, the rest actual cash). It has fluctuated between 22 and 24% over the past year and I may deploy some cash by year-end to get closer to 24% again. Detailed breakdown is shown in the table below.

My general philosophy is to treat FI as another source of return, contrary to the Boglehead/Bernstein teaching of taking risk in equities only, but consistent with modern portfolio construction methods such as risk parity, max diversification, min correlation, etc. What I ended up with is a “bar-bell” in risk profile where stable value funds in passive is counter-weighed by leveraged CEFs in active.

The stable value funds are in the 401K’s and have a combined yield around 2.5%. $PCI/$PDI/$PFN are Pimco taxable multi-strategy CEFs, and $BGB is a Blackstone bank loan CEF. The current yields are 8.65%, 8.76%, 8.96% and 7.98%, respectively. These four are in tax-advantaged accounts. Pimco has paid a year-end special in the past but I’m not too hopeful this year. $NAC and $PCQ are two CA muni CEFs in taxable accounts, currently yielding 5.12% and 5.38%, respectively, federal and CA tax free (though $NAC has some AMT). The Pimco taxable CEFs in particular have had good capital appreciation with total returns exceeding that of S&P in 2016/17. When comparing with benchmarks, I expect greater out-performance from my FI vs. $AGG than individual stocks vs. $SPY.

Above is a correlation matrix between the total stock market ($VTI) and the CEFs from PortfolioVisualizer.com. My rule of thumb is to assume a 0.4 correlation between the Pimco taxable CEFs and stocks. The muni CEFs show near zero correlation to stocks but don’t quite provide the negative correlation during a crisis. Therein lies the rub: the CEFs provide excellent returns during bull markets but are likely to drop along with stocks in bear markets. This lends itself to market timing where CEFs are swapped with treasuries, which is my plan for the taxable CEFs. The Pimco CEFs are “unproven” in bear markets. Even if they navigate skillfully, investors may still punish them, leaving exploitable discounts. These are opportunities not available in open-ended mutual funds. As for the muni CEFs, trading may not be worthwhile if the bear market is as brief and shallow as I expect. The $TNX (10 year yield x 10) chart below was shown two weeks ago. I’d like to re-balance “into” treasuries rather than “out of” existing holdings. The yield won’t go up in a straight line, however I’m expecting 2.8% first and then above 3% during this bull market.

The PortfolioVisualizer table also shows the volatilities of the CEFs which are on par with that of $VTI. When correlations vanish risk parity degenerates into volatility parity; when the volatilities are equal it degenerates again into equal weight. So the data is suggestive of replacing the cash portion of a Permanent Portfolio with $PCQ. I’ll write about this in a future post.

Towards the end of The Next Bear Market, I painted a rather bleak picture of an investment landscape where the equity risk premium has either diminished or disappeared due to “over grazing” by investors enamored with stocks and the performance assurance from passive buy-and-hold. Fixed income, properly leveraged, may offer a ray of hope in this new world. After all, the FI universe is far greater than equities both in size and variety. It may be the last refuge of active managers.

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