Tether all the way down, Weekly Wrap 1/21-27/2018

Macro and Markets

Investors were undeterred (encouraged?) by the turmoil in bond and currency markets and continue to bid up stocks. There are signs that we have entered a parabolic phase which if continue unabated will reach S&P 3500 in April.

To be clear, this early a blow-off top is NOT the scenario I had been expecting. I established my options position in two large tranches, first in Jun-Aug, and then Oct-Nov of last year. All were Jan’19 expiry LEAPs with the hope of realizing long term capital gains from the long call side. Peaking in April is too far from the 1-year anniversary that it’s uneconomical to try to use protective puts to tie me over. So I’m mentally preparing to take the gains early if necessary. It won’t be the first time. It’s exactly what I did with cryptos. I had wanted to wait till March but the price action didn’t allow that luxury.

That said signs of excessive optimism are everywhere. One example is the equity put/call ratio being at extreme lows. The most recent Epsilon Theory letter also covered this topic.

I’m still holding the $UVXY calls. VIX was flat on the week even as stocks made new highs, indicating a degree of nervousness out there. Everyone is looking to the FOMC meeting for some direction. The $UVXY calls are a very small position as I’m expecting only a minor pull-back.

Muni CEFs sold off this week while the interest rate hedged multi strategy CEFs held steady — no surprise there. I’ve made the decision not to make any changes on the fixed-income side until a clear sign that the credit cycle has turned; however the discount in $NAC is looking mighty enticing. In general I expect money coming out of bonds into stocks should further fuel this rally.

Cryptocurrencies

The chatter around Tether is growing louder. The sub-Reddit (/r/Tether) is becoming a hang-out for concerned people. YouTube is another source (search Tether). I bought a few puts on Overstock ($OSTK, Mar 60), a crypto proxy. In December I made some quick money in its calls.

I actually quite like Overstock’s idiosyncratic CEO, Patrick Byrne, but this is not about personal likability. $OSTK was at mid 70’s this week, still up a hefty amount from mid teens back in August when it announced keeping the cryptos that its customers paid, and later establishing its own cryptocurrency. I’d say there is still plenty of “fluff” in that stock price should the whole cryto complex implode.

The supposed defense that Bitfinex/Tether put out actually implied egregious accounting misconduct: at a minimum co-mingling of funds belonging to separate legal entities even if the principles are the same. I suspect Tether is “printed” to purchase BTC which should have been sold for USD to back Tether but was not. Were I to feel generous, I’d assume that Bitfinex hands Tether fiat for that BTC. At any rate, Bitfinex/Tether is probably holding a massive amount of BTC giving them further incentive to prop up its price. But should BTC continue to fall, e.g. breaking $10k again, they will be under pressure to liquidate and it’ll be like a dam bursting. Trading has been unusually calm in the last couple of days. It’s hard to tell real vs. wash trades to give volume analysis any confidence.

History tells that when one has a weak hand and everyone else knows about it, the outcome seldom goes one’s way. A recent example was Amaranth when every hedge fund went against its position; Long Term Capital was a more distant example. Everyone who holds crypto will be affected when this thing implodes. You are forewarned.

Portfolio

Oh how I wish I held onto $LABU a little longer, that was another 15-20% that I missed. I’m still short $XBI puts so still have exposure there. Other trades this week were to move up strike prices on the short put positions. I also continued to add to PM miners.

Current portfolio composition is as follows: PMs 11.2%; equities 51.6%; FI, 22.0%; cash equivalent, 5.8%; and other, 9.5%. The “other” category is composed of 3X ETFs, 0.4% and options, 9.1%. Effective exposure from options is equal to 95.9% of total portfolio value for a leverage ratio of 10.6X. The portfolio is 147.5% long equities (not beta-adjusted). Options value and effective exposure both increased along with that of the underlying. Gamma remains positive. Options had and will continue to have outsized returns as long as this bull market continues.

YTD the active account is up 20.04% and the total portfolio 13.59%, vs. 7.39% for SPY and 4.08% for 60/40. About 2/3 of the gains have come from options, i.e. about +4.5% from everything else.

Good Reads

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

Hedging with UVXY Calls, Weekly Wrap 1/14-20/2018

Macro and Markets

While most people are celebrating yet another week of records in the stock market, I’m increasingly concerned with the short-term froth. “There is now almost $4 in long funds for every $1 in inverse funds, a record exposure level.” reports SentimenTrader.

The ProShares Ultra BIX Short-Term Futures ETF ($UVXY) has been called the worst instrument devised by men due to its continuous erosion of value from the VIX term structure (contango). But it works fine as a short-term hedging instrument since every time the S&P dips the volatility jumps and it spikes higher.

On Friday, I picked up some $UVXY calls. This is part of a new VIX related strategy I’m exploring this year — seeing that crypto is no longer a profit center. This particular play is based on sentiment measures, not the US government shut down, although the latter may provide an excuse for the market to correct. Speaking of which, I was at lunch with a group of colleagues last week, one of them remarked it was like “the mother-in-law threatening to leave” which brought a chuckle.

As discussed in the previous post, a quick pull-back (3%? one can only hope for so much in this environment) is definitely healthy at this point, and may even be necessary for the durability of this bull market. This trade with $UVXY calls was meant as an experiment since the size was tiny compared with my total exposure.

Cryptocurrencies

I thought I wasn’t going to write about cryptos for a while but the issue with Tether got me riled up. I provided links to two Reddit threads in the previous post. Also check out Tether’s marketcap from CoinMarketCap and see the jump after April’17. This link shows $100 million worth have been created for each of the last six days (as well as the millions before). I’ll let the readers draw their own conclusions.

Portfolio

Other transactions include selling some puts in Diageo ($DEO), and swapping $JNUG for $LABU for my 3X leveraged ETF trade. I finally caught a 25% run in $LABU after everything $XBI related gave me nothing but pain.

Current portfolio composition is as follows: PMs 11.0%; equities 52.6%; FI, 23.1%; cash equivalent, 5.9%; and other, 7.3%. The “other” category is composed of 3X ETFs, 0.4% and options, 6.9%. Effective exposure from options is 85.2% of total portfolio value for a leverage ratio of 12.3X. The portfolio is 138% long equities (not beta-adjusted). Options value and effective exposure both increased along with that of the underlying. Gamma remains positive. Options had and will continue to have outsized returns as long as this bull market continues.

YTD the active account is up 12.26% and the total portfolio 8.43%, vs. 5.08% for SPY and 2.63% for 60/40.

Good Reads

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

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.

So Long, and Thanks for All the Fish

The title is borrowed from the fourth book of Douglas Adams’ Hitchhiker’s Guide to the Galaxy “trilogy”, where the dolphins leave earth before its imminent destruction.

This morning I sold the last of my ethereum. Later on GDAX, BTC dropped to as low as $9928, below the Dec 22 low of $10,400, while ethereum got to as low as $852. I have been calling $19.8K on Dec 17 THE peak in BTC since the end of December. The odds of that being right are better than 50/50.

I’ll show my crypto account activity one last time. In the last two weeks, I was able to add a little ethereum and then gradually got out between $1100 and $1400. Overall, I made 15 times my money — not bad for 10 month of “work”. Cryptos will surely go down in history as THE most outrageous collective delusion. I count my blessings that my investment philosophy allowed me to hitch a ride and make a decent profit. The words of George Soros ring true:

“When I see a bubble forming, I rush in to buy, adding fuel to the fire,” he said in 2009. “That is not irrational.”

If I’m right, a large part of the human drama is still to be played out. Many late-comers will lose a lot of money. There’s little that I can say to counsel them other than that in a bear market, bounces are to be sold.

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

Three Kings, Weekly Wrap 1/7-13/2018

Macro and Markets

I’m going to try hard NOT to talk about the rally in the equities. As a matter of fact, I hope we get a pull-back soon which is necessary for this bull market to extend its life into 2019. Instead, I find the drama in bond and currency markets far more entertaining. The year started with significant weakness in bonds, with 10 year yield touching 2.6% briefly.

  • On Tuesday the 9th, Bond King Bill Gross came out and said “Bond bear market confirmed today.” 25-year trendlines in 10-year and 5-year yields were broken.
  • The other Bond King, Jeff Gundlach wasted no time saying “Gross is early” in a presentation peppered with excellent charts. His line in the sand: 2.63% on the 10 Year.
  • Gross then came back with a rather cryptic Bonds, like men, are in a bear market”. Was he making a social commentary? Putting that aside, he was clear about this: “There are several significant reasons that should lead to a 2.70% + year end yield and a mild bear market total return of 0-1% for most bond portfolios.” OK, a mild bond bear market then.
  • The last bond king (at least in my mind), Pimco’s Dan Ivascyn, has been his usual quiet self. Note I have the majority of my FI CEF’s at Pimco, especially $PDI and $PCI which he manages with Alfred Murata. A recent thread on MorningStar discussed interest rate swaps in $PDI. The gist is that the fixed pay IRS should start to gain value (as well as net payments) as interest rate increases. It’s why reason most Pimco multi-strategy CEFs have had rather stable NAV in his environment.

The last time I tried to make sense of the 10-year yield, I concluded it was going to 2.8% this year and eventually over 3% before the end of the bull market in stocks. To me that is consistent with a yield that is “slowly rising but under control”. The market will probably be OK with that scenario. What will spooked the market, is a sudden uptick in inflation. Let’s hope we steer clear of that.

In the meantime, the USD has dropped below its September low and now sitting on the bottom rail of the bearish megaphone pattern. It may be puzzling that the dollar should be so weak despite interest rate and central bank policy differentials viz-a-viz ECB and BOJ. A guest on CNBC Asia (which I listen to on my evening commute) made the point that better growth prospects/stock market internationally is siphoning capital away, which I thought was a rather intriguing point. Whatever the reason for the dollar weakness, it’s definitely positive for gold.

Portfolio

I’ve already made my 2018 529 and backdoor Roth contributions and re-balanced the passive account. Other recent transactions on the active side include adding to PMs ($GDX/$GDXJ), adding to Aqua America ($WTR) after recent drop but still too early, selling some Ethereum, selling vested company RSU stock and then buying ATM calls to minimize regret, and finally continued maintenance of the short put positions by moving up the strike price as the underlying made nice gains.

Current portfolio composition is as follows: PMs 11.4%; equities 52.6%; FI, 23.6%; cash equivalent, 5.7%; and other, 6.7%. The “other” category is composed of crypto, 0.5%; 3X ETFs, 0.4%; and options, 5.8%. Effective exposure from options is 80.7% of total portfolio value for a leverage ratio of 13.9X. The total portfolio is 133% long equities (not beta-adjusted). Options value and effective exposure both gained along with that of the underlying. Gamma is positive. Options had and will continue to have outsized returns as long as this bull market continues.

The trend of strong performance in Q4 is continuing. YTD the active account is up 9.7% and the total portfolio 6.23%, vs. 4.14% for SPY and 2.27% for 60/40.

Good Reads

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