Author Archives: NoRegret

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.

The Next Bear Market

My current bullish market outlook notwithstanding, I want to look ahead to the inevitable next bear market. To give some context, I have written about a “post-August moonshot” and a “12-18 months” maniacal phase leading to a target of 10,000 on the NDX and about 3500 on the S&P. Together these projections should provide enough contour of an anticipated top. I like to think ahead so as not to get caught unprepared when changes occur. Being early also gives me a claim to some originality of thought then the time does come.

Readers should know I’m a habitual violator of the cardinal rule of making predictions on the stock market: target price or time but not both. It’s a luxury reserved for a no-name blogger with zero reputation to lose. On the other hand, I have my own money on the line and disclose the transactions and results every week and every month. When real money is involved, doubt, conviction, hope and regret have nowhere to hide. It is not sufficient to make correct projections, there also has to be enough conviction to capitalize on them. In the end, the only arbiter is the balance in the account.

Big Picture

In terms of the big picture, the view that most resonates with me is that of of Chris Ciovacco. He has a YouTube channel and here is a clear enunciation of his views: we have broken out of a 17 year consolidation box and is embarking on a decade plus journey higher.

Another key understanding relates to the length of the current bull market which many put at over 8 years counting from the Mar’09 low. Putting aside the argument that a bull market does not start until the previous high is exceeded, cases can be made for both May-Oct’11 and Aug’15-Jan’16 being bear markets (source), which resets the clock on the current bull to less than 2 years.

The Next Bear Market

The model I follow does not have a good record of predicting bear market bottoms which tend to overshoot the model prediction (I don’t plan on giving details of this model on this blog). My current interpretation is for a regular bear of a decline of 20-30% in the S&P for a duration of 12-18 months. In (very) rough round numbers, that’s from 3500 back down to 2500 on the S&P. The important take-away is that I don’t expect it to be the comeuppance that many doom-and-gloomers are calling for. The 50+% decline of the GFC has scarred a generation which paradoxically means it won’t happen again until the memory fades.

Defensive Measures

Execution is what separates a practitioner from a prognosticator. With a 30% decline that may take 1-2 years to recover, both holding tight and some defensive maneuvering are viable strategies. In a blog post as far back as May’17, I discussed my defensive asset allocation for the passive accounts: 40% equities, 45% fixed income and 15% PMs. Within equities I removed REITs, small tilt and EM. The FI allocation is modified to include bonds, treasury in particular instead of stable value exclusively. Most of the passive accounts are in 401K or Roth so there is no tax consequence for making these adjustments. The exact allocation will depend on the availability of funds in each account but there has been no change in the overall direction.

In the active accounts, the consideration is more complex. It’s reasonable to expect a deeper drawdown in tech which is the vessel of the current bubble. That said, given the taxes (includes CA taxes for me) and uncertainty in timing, selling then re-buy in taxable accounts is not a slam-dunk proposition. It’s much more advisable to hedge especially if one believes the overall technology trends are still intact and the bear market is just a reset of expectations. There are several workable option strategies for both individual stocks and indexes that are similar to the inverse of what I’m using for the current bull market.

At this moment, I expect both treasuries and PMs to be bid during the next bear market. Treasuries may be something to “re-balance into” when the 10-year yield gets above 3%, while PMs will likely be the next bubble where gold gets up to $3500-5000/oz. In short, there will be plenty of sources of return to keep the portfolio growing during this phase.

Impact of the Passive Investors

In Some of You Will Sell or the Achilles Heel of the Arithmetic of Active Management I discussed two type of passive indexers: type A who buys no matter what and holds through the bottoms and type B who sells at the wrong time. Since emotions have been shown to conspire against investors the assumption is that on net passive indexers will achieve less than market returns due to poor timing of type B indexers. From the large number of type B indexers we can expect a sharp decline. Conversely, type A indexers will temper the depth of the market bottom and set the tone for a gradual recovery. This understanding should inform the profile of the hedges to be put on. Moreover, the P/E at the next market bottom should be elevated vs. historical averages which will prevent many from recognizing it until much later.

I remain convinced that active to passive is a secular shift that won’t abate in the next bear market. It’s not obvious that the average active mutual fund can out-perform in a bear market. The trend will continue until easy-to-exploit inefficiencies appear. Will it be some float based mechanism? Who knows. The deeper question is what happens to market returns in the mean time.

The Other Side of The Next Bear Market

In Diversification, Adaptation, and Stock Market Valuation, Jesse Livermore (pseudonym) at PhilosophicalEconomics poses a fundamental question about the equity risk premium. If buy-and-hold stocks is such an EASY way to achieve superior returns (remember the next bear market will be shallower and briefer than most doom-and-gloomer will have you believe), then why should it offer superior returns in the first place? If the equity risk premium should decrease or disappear, we should expect the baseline P/E level to increase and future returns to be commensurately diminished.

My current projection of the 10-year equity return is under 4.5% nominal. Coupled with 10-year bond yield under 2.5%, things do not look good for current and recent retirees. Based on these numbers, I predict that the 4% rule will fail for the Jan 2000 cohort, see the 2000-2016 case study at EarlyRetiremenNow. This is preventing me from fully embracing the optimistic views of Chris Ciovacco. It’s possible that the current QE fueled bubble is pulling forward some future returns, further suppressed by higher future baseline P/Es.

Popularity sows the seed of its own demise in financial markets even for a high-capacity strategy like market cap indexing. If too many people try to make a living from market returns, then there won’t be enough to go around. The democratization of investing may distribute equity returns more fairly but at the expense of making them anemic for everyone. One can argue that economic expansion and productivity gains will save us but I’m not so sanguine given demographics and the move from DB to DC retirement plans. Let’s hope an answer emerges soon. In the mean time, there’s an exciting and hopefully profitable ride ahead of us.

Semis, Weekly Wrap 10/29-11/4 /2017

Macro and Markets

Another week, another set of records in the major indexes. Wall Street got its preferred Fed Chair nominee in J. Powell, the status quo candidate. Economic numbers were mostly mildly positive or unremarkable. Earnings from Apple and FaceBook were solid but a repeat of last Thursday/Friday was not in the cards. So the market grinds higher, relentlessly. The S&P still has a good chance of hitting my year-end goal of 2700, less than 5% away.

The leak on Friday that Broadcom ($AVGO) was making a go at Qualcomm ($QCOM) kicked the semis into a higher gear — I didn’t know that was even possible. It was the eighth weekly advance of the ^SOX index which looks to be challenging the all time high of 1347.94 on Mar 10, 2000. I’ve been in the 3x ETF $SOXL since mid September. Qualcomm was the poster child of the dot com era and famously split 2:1 then 4:1 in one year. More recently it has been embroiled in a bitter legal battle with Apple in addition to having trouble closing the $NXPI deal. Both Broadcom and Qualcomm stocks reacted positively to the news.

Gold

I closed out $DUST earlier in the week and re-entered $JDST on Friday. Medium term outlook is unchanged from two weeks ago.

Portfolio

There were a flurry of trading activities this week. I was short $63.5 puts in Activision Blizzard ($ATVI) expiring Friday; they closed 30 cents in the money. Since I was planning on acquiring more it didn’t even occur to me to close out the puts that had been rolled twice already. I’ll be happy to be assigned. Last week, I highlighted the extreme ratio of the energy sector ETF ($XLE) to crude. Both $XLE and crude had a strong week. Refiners continue to do well but Exxon ($XOM) and Chevron ($CVX) started rolling over which finally convinced me to sell. I added to Eli Lily ($LLY) and BYD ($BYDDF) to bring them closer to the average weight among my individual stocks. Elsewhere, losses were taken in Kimberly Clark ($KMB) and Philip Morris ($PM). That brought the number of stocks to 27 and left a hole in the Consumer Staples sector. I didn’t find any good candidates at current prices so will continue to monitor this space.

Both pharma and biotech had been weak for several weeks. I tried to catch a falling knife in the biotech ETF ($XBI options) and left bits of finger on the floor. Nonetheless, bull markets are forgiving with poor timing, biotech looks to finally have turned the corner this week. On the other hand, the NDX remains strong which allowed me to continue moving up the strike of the short QQQ puts and add to calls. Across all speculative option positions, the leverage ratio declined to 34X due to increased option market values.

Good Reads

Edit: 11/6/2017 Qualcomm splits

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