Category Archives: Model Prediction

Predictions Update and Outlook for 2018

About This Blog and My Portfolio

This blog is different from most personal finance blogs out there, even those that focus on investing, in a number of ways. First and foremost, this is a digital trading journal for myself. Many bloggers claim writing a blog keeps them “accountable to themselves”. While I have no reason to doubt them, it is the PRIMARY justification for me. Fortunately given my portfolio size, I don’t need much extra to cover the annual hosting cost. The forced discipline of organizing and enunciating my thoughts as well as understanding the performance drivers in my portfolio have helped far more than that. This blog is not monetized and I intend to keep it that way. Since I’m not interested in growing a large following, I write about topics of interest to me and pertinent to my portfolio, not what may appeal to the largest number of potential readers.

Passive, low-cost indexing is the investment orthodoxy in PF blogosphere, while Dividend Growth Investing (DGI) is a sizable and tolerated minority. Still others find their niche in real estate in multiple forms. Universally though, market timing and speculation are reviled like the plague, the terms thrown around like schoolyard insults. Here on this blog however, both are openly embraced. It’s important to me to keep an open mind, receptive to multiple doctrines and practices. In quantum mechanics, a time-independent Hamiltonian is a special case of a time-dependent one. In the same vein, a static asset allocation is a special case of a dynamic one. The axiom of investing is “buy low, sell high”, although some finds fault in that it gives license to “speculation”, which only proves that their definition (typically a long-term, value-oriented) is too narrow.

I practice what I preach. My portfolio is set up to employ both passive and active strategies. The passive account, with the exception of PM bullions, rivals anything you see on Bogleheads. The active account, containing multiple sub-strategies, is on the more complex side among the real-life portfolios being shared openly. However, the complexity is not for its own sake. The primary motivation is the non-correlation between multiple sub-strategies (individual stocks, cryptos, and leveraged CEFs, etc.) while each is optimized independently. Secondly, each sub-strategy is subject to its own timing-overlay, which essentially means technical analysis is used for risk management with both capital and risk transfered between different strategies. A recent example is my exit from the crypto space and transferring part of the proceeds to PMs.

One often-heard objection to holding individual stocks is “what happens if you own GE, Kodak, or IBM (substitute any blue-chip that has fallen from grace)?” Well, if the investor is unable, or unwilling to learn to perform any fundamental or technical analysis, nor possesses any basic selling discipline, then indeed passive holding of low-cost index funds would be the recommended course of action. But if he is, there is no logical inconsistency for holding individual stocks. For the record, I used to own GE and sold it in March’17 at $29.81, realizing a small loss. GE closed today at $16.26. The same goes for taking advantage of an obviously-in-a-bubble asset like bitcoin. My ability and willingness to speculate allowed me to make 15 times the initial stake in 10 months. More fundamentally, I have a different perspective of “bubbles” (see here) that is propelling me to have a much higher equity exposure as we speak.

Studies I have read say only about 1% of traders are consistently profitable. To be the top 1% at in any field or craft deserves respect. Knowledge, analysis, judgment, empathy, and nerves are ALL required to make trading successful. So why are “market timing” and “speculation” held in such low regard? I can only suspect that the interlocutor has neither understanding nor aptitude in said art.

Making Predictions

Readers should know that I’m a habitual violator of the cardinal rule of making predictions (i.e. forecasting) on the stock market: don’t do it — I mean the other one: target price or time but not both. It’s a luxury reserved for a no-name blogger with zero reputation to lose. There is a well-known saying in statistics,

All models are wrong but some are useful.

The same may be said about predictions, but it hasn’t stopped people from making predictions in all matters of life, from macro-economy to business planning, to personal finance. There are those who forswear predictions and forecasting about the markets, but I wonder how they determine how much to save for retirement and how big a nest egg they’ll need?! Perhaps they’re dissuaded by people that spew numbers willy nilly. That’s not how things are done here. Although not every step is explicitly posted on this blog, I try to follow this process:

  1. Pick a subject (index, stock, rate, economic indicator), set a numerical target. The difference between the current and target value implies the direction. Sometimes, the initial call is about a trend. As the trend unfolds, a numerical target can be zeroed in later.
  2. Set a time frame for reaching the target value.
  3. Select a tradable instrument in accordance with the prediction, have a plan for entry, execute said plan.
  4. Have guide posts along the way, i.e., interim tests of whether the course is unfolding as predicted.
  5. Have an exit plan, whether at the final target or mid-course.
  6. Review how well the prediction played out.

Step 3, aka “putting money where your mouth is”, is what separates a “talking head” from a practitioner. Worse yet, most what one reads on blogs or comment sections go no further than step 1. It’s only when real money is on the line that doubt/conviction, hope/regret all come to the fore. Execution, especially when things don’t go as planned, becomes paramount and account balance the final arbiter on the usefulness of the whole endeavor.

Past Predictions and 2018 Outlook

The final step in the above list is critical to our growth as investors. Below I’ll review what I think are the most critical predictions made on this blog. Often, the most important calls are about major trends lasting years, even decades. Several of the major trends are still on-going, hence I’ll weave in my 2018 outlook as part of the discussion.

Equities

By far the most critical predictions I made, as measured by the amount of capital committed and potential gains, were centered around the current bull market in stocks. I’m guided by a long-term equity pricing model — I took something that was out there, after a few modifications made it my own.

  • The initial prediction was made in November’16 with a target of S&P 3400 in Q4’18.
  • A follow-up in March’17 pushed back the top into 2019 and was the first mention of “S&P to end the year with a 27 handle” when it was around 2350. The 2700 level was actually crossed on the 2nd trading day of this year — I’ll give myself a pass here.
  • In the first half of August, I started writing about a post-August moon-shot. The prediction was updated to “S&P to 3300-3500 and the NDX to 10K in 12-18 months”. Early September was the last time the S&P launched off the 50 day SMA. We have been going up every since, with signs of further acceleration in the last two weeks.
  • The most recent update was made in early November where I called for NDX to reach 7792 by April. We are still seeing how this one is going to turn out.
  • Conviction: very high
  • Implementation: 100% Vanguard growth index in 529s since early 2017; raised equity allocation to 55% in passive AA since March/April 2017; QQQ options etc. since late June 2017

The bull market in stocks is still unfolding, which I expect to last into 2019. The main danger to that scenario is a premature parabolic phase into a top this year. For this reason, I view the more recent up-tick in investor sentiment with alarm. My model calls for a small correction in January/February, more serious ones in May/June then October. A pull-back in the immediate future is definitely healthy for the longer term sustainability of this bull.

I don’t have an end-of-year target in S&P since unlike in early 2017, mainstream analysts are sufficiently bullish. The top end of Wall Street estimate at 3100 was from the highly respected Ed Yardeni. Recently, Jeremy Grantham from GMO published a newsletter on “melt-up” that made the rounds. The chart below depicts the range of possibilities he saw:

Compared with my S&P target of 3300-3500 (closer to top of that range now), there is remarkably good agreement. My current timing range is in 2019, while the original one was Q4’18. For now this timing difference is of no consequence, but as we progress further into 2018, more precise handling is required. In due time I’ll disclose the 3-months timing window that my model has given since March’17. On the other side of the peak Grantham sees a drop of 50%, whereas I forecast “only” a 30% drop in The Next Bear Market last November. My 10-year projection was: starting from September’17, S&P does a round trip of 2500 – 3500 – 2500 in three years, followed by 6% nominal annually for 7 years for a combined 4.16% nominal annualized over 10 years.

Precious Metals

  • Big picture I believe gold will be the next bubble after stocks and has the potential to reach $3500-5000/oz. However, I’m hazy on the timing. The 8-year cycle bottomed at the end of 2015 and the current cycle should be right translated i.e. peaks between 2020-2024. The last gold peak in 2011 was 3-4 years after the peak in equities and more than 2 years after its bottom. We’ll have to see how similar this cycle is.
  • On a shorter time scale, in mid October I tried to forecast the trajectory of the intermediate cycle by naming two potential dates in December and January. I was leaning towards January but was open to clues from the COT. The confirmation came mid December and I have been increasing my PM allocation since. Note gold price stayed above the July low, never touching the lower triangle line.
  • Conviction: medium high
  • Implementation: re-balanced 15% allocation in passive account already; also adding to active account

Given the weakness in the dollar, gold should do well this year, in a sense, tagging along the equity bull, ready to take over when equities falter. The waning dollar is likely to stoke inflation fears which is a segue into the next topic.

Fixed Income and Rates

  • I believe that rates are going up, but will do so in a managed fashion and not in a straight line. I did NOT expect $AGG to gain 3.5% in 2017, but the bar-bell approach I took served me well.
  • I’m on record to expect the 10 year UST yield to reach 2.8% in the first half of 2018. It just crossed Jeff Gundlach’s 2.63% “line in the sand” this week. We shall see how it plays out.
  • Conviction: low
  • Implementation: stable value funds and leveraged FI CEFs

I expect FI CEFs to give me the most headache this year. I like that the Pimco CEFs are hedging their interest rate exposure. Indiscriminate selling from other investors are a blessing, but I may not be able to take advantage of that blessing due to my limited tax advantaged space. As for the muni CEFs, the premium in $PCQ is still high but my remaining lot has a tax handcuff. $NAC on the other hand, is seeing its discount widen as rates rise. Its coverage ratio has finally gotten over 100% after the most recent distribution cut. I consider it fairly valued as I don’t see rates moving violently higher.

One of the most crucial questions is whether UST will provide safety when the stock bubble pops, or whether UST implosion will actually be the proximate cause for the pop itself. For now I can only plan on keeping the duration short when the credit cycle turns and be ready to move out of the multi-strat funds. I may resign to simply holding the muni CEFs since I only expect an average bear not an apocalypse.

Cryptocurrency

  • The one unequivocal prediction I made was on Dec 5 where I suggested $60K as a BTC target with a time window of Jan 3 – 19. Well, that was proven wrong pretty fast. BTC reached $19.8K on GDAX on Dec 17; I’m inclined to think that was THE peak.
  • I explained in a later post some of the analysis behind that call. The total coin marketcap peaked on Jan 8th which was in my timing window. In early January I still held some ethereum but was out completely by the 16th.
  • As of the end of December’17, I believe cryptos have entered a long-term bear market.
  • Conviction: medium
  • Implementation: no crypto position, may short a stock proxy

Just today I read two Reddit threads on the potential fraud in tether (reddit 1, reddit 2) that really shook me; and I don’t even own any crypto anymore! It can easily take down the entire complex overnight. I was going to swear off them until BTC is something like several thousand, but now I may start looking to short a stock proxy!

So there you have it, a recap of my major predictions along with my 2018 outlook. I place less emphasis on whether a prediction turned out correct, more on the following execution. Remember, the account balance is always the final arbiter!

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

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.

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.

1998, Weekly wrap, 9/10-16/2017

Macro and Markets

What difference a week makes! The S&P finally made it over 2500 on Friday, brushing aside yet another NK missile test. While Amazon and Alphabet are still wallowing, the semiconductor index conclusively broke out of its triangle. Risk-off assets were sold: gold finally and bonds right after the yields were at resistance the previous week.

My first prediction for a final bubble phase of this market appeared in November 2016. In March 2017, I added that S&P will end the year with a “27 handle”. The words “post August moon-shot” appeared in the very first weekly wrap, where the target was set at “the S&P to 3300-3500 and the NDX to 10K in 12-18 months”, which, to be honest, were meant to be on the safe side. I didn’t really have to write all the preceding words to state my position since there is one number that that succinctly captures them all: 1998, as in the year 1998 in relation to the first tech bubble. E’nuf said.

Cryptocurrencies

Overnight BTC dipped below $3000, ETH to $200 and LTC was in the low $30’s. The sentiment was such that I’m willing to go out on a limb and call a bottom to this correction — or shall I say the conclusion to this particular bubble. I’m beginning to regard bitcoin as a series of bubbles each with a fresh group of hopefuls. Please note that I’m not a crypto trader and don’t take this as trading advice. Do check out the two bitcoin links below especially Charlie Bilello’s.

Portfolio

The Apple ($AAPL) puts were closed on Monday with a 50% gain. They would have expired today had I held but couldn’t take the chance over the iPhone X launch. I added to PM miner hedges on Monday such that I’m only 30% long. On Wednesday I sold puts on Activision Blizzard ($ATVI) as an attempt to acquire the stock cheaper. In addition, I swapped Qualcomm ($QCOM) for more Visa ($V) but regretted it almost instantly. I still have semi exposure elsewhere though.

Good Reads

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

Edit Oct 14, 2017: fixed link to “March 2017” post.

On Bubbles

Charlie Bilello from Pension Partners pointed out that the CAPE is now over 30. His piece is balanced and well written as always but it won’t prevent others from using the data to once again proclaim that the market is expensive and that we’re in a bubble, etc. So far so good and I might even agree. But if the implication is that there is impending doom then I have to beg to differ.

Many writers, the eminent Larry Swedroe among them, have argued that the historical context of the P/E ratio has evolved. I find no reason to doubt them, so let’s take the shorter term relative movement as an indication of multiple expansion or contraction. In 1921-29, the CAPE ratio went from 5 to 30, for a gain of 6X. In 1982-2000, the CAPE ratio went from about 7 to 44, another 6X. The CAPE low of 2009 was about 12.5. Now I’m not about to forecast a CAPE of 75 (although within the realm of possibility, cf. Japan 1990), but surely an increase of mere 2.5X can’t be the end of this bubble if it can be called such? If this is indeed the coming-home-to-roost of all the QE by all the central banks since the great financial crisis then we will have much, much further to go. To say otherwise is to say “this time is different”.

I have been saying on this blog since last November that we’re entering a generational bull market. Currently the model is seeing a consolidation low in July, flat in August, but a truly maniacal phase for 12-18 months thereafter.

Speaking of bubbles, the Collaborative Fund recently published The Reasonable Formation of Unreasonable Things. Here are a couple of gems:

The majority of your lifetime investment returns will be determined by decisions that take place during a small minority of the time.

Bubbles are not anomalies or mistakes. They are an unavoidable feature of markets where investors with different goals compete on the same field. they would occur even if everyone was a financial saint.

It’s a hallmark of thought-provocativeness that the readers may draw different conclusions from the ones the author intended. It reads to me that one of the article’s main purpose was to warn long-term investors of the dangers of irrational pricing during bubbles. Pointing out the difference in goals and time frames was a beautiful rebuttal to EMH which sometimes is used to justify “buy at any price”. But to me the greater take away was the importance of the bubbles — rational, inevitable, and the driver of long term returns that those smooth, monotonically uptrending curves from a fantasy land called Excel would have you overlook.

Two recent articles by Jason Zweig (here and here), speaks to the difficulty of riding a bubble: specifically, a money manager Samuel Lee and his experience with Ethereum. Except in this case, the final chapter, or more than likely the second act, has not yet been written. Jason Zweig is too good a writer and has too much understanding to express an opinion other than saying it’s really hard. So here I would like to give myself some pointers that I hope to follow:

  • Participate — showing up is half the battle, especially when others are calling it a bubble.
  • Don’t be greedy. Position size control is paramount. Set a volatility limit as well as a position limit.
  • Do not envy those in earlier with a lower cost basis, nor those in later with a larger position.
  • Take profits, often. It’s impossible to catch the exact bottom or top. Play with the house’s money.
  • Do not take positions to justify a point.
  • The majority of the portfolio should be in an allocation that one would have in the absence of bubbles.

The last point is an import one for me. My speculative positions are benchmarked against cash, not the 60/40 much less 100% stocks. Why would it be otherwise if the bubble is expected to be short lived? Taking profits, even partially, forces one to re-evaluate the whole position.

We live in interesting times. I see three bubbles in progress or developing that require very different treatments. In cryptocurrencies, I have taken a position and am simply content to sell a little bit as prices rise. In PMs I have a 15% baseline allocation but trade around the cycles. Exposure can be increased by being in silver, miners, 3x ETFs and options while maintaining the same nominal allocation. In stocks and Nadaq in particular, I’m willing to increase the overall allocation along with highly leveraged option positions. These are in contrast to their neutral allocations of 0%, 15% and 45% (for all equities), respectively.

The next year or two should be very interesting.