August Newsletter
Murica: Last Market Standing
Dear Subscriber,
Many of you have been with us for years--we have all made a boatload of money riding these waves of transformational change since 2013. Why all the nostalgia? Because I now believe the world economic data and the market action and the bond market are telling us that the global monetary stimulus + negative interest rates are inching us closer and closer to the proverbial "pushing on a string" stall stage where, at the margin, the incremental buyer of stocks and bonds is coming down to institutions rebalancing their massive overweight bond portfolios to buy US equity index funds.
This means the marginal buyer of bonds will revert to the QE buying central banks and the US stock market is pushed by international stocks buyers.
Net Net: When the US stock market economy goes UP in value as the US real economy is withering down zero real growth (net of inflation), we are in that "last hurrah" or blow-off stage of the bull. In the last leg of the bull market crappy IPOs will be pushed through the window (can you say WeWorks, Uber, Lyft, Beyond Meat?). I swear the WeWorks IPO has more hair on it than a camel's back. My prediction if this insane valuation IPO gets pushed through it will be the peak for "technology" stocks (as if leasing office space and putting a beer keg a ping pong tables in the middle of office pods is "technology."
As I get into this remember: we are 5% off the market top. Building cash is psychological here: how are you sleeping? I am at 40% PFFA fund in most accounts waiting for that LAST BIG 30+ VIX fear meltdown and as I have said I have collared my AMD NVDA XLNX shares selling 10% out of the money calls and buying 10% out of the money put options.
The last hurrah of the 11-12 year bull market will, of course, be a tweet "WE have a DEAL with China--All tariffs removed!!" which Mr. Trump will, like any master performance artist, unveil at the most dramatic time when all economic indicators and public sentiment are crumbling, farmers are on the TV with "Trump Sucks" posters and whichever "Open Border Socialist" is leading him in the polls by 20-30 points starts pulling away.
We are in a binary market: worsening US economic data is "good bad news" as it gives the Fed cover to continue its "mid-cycle" "accommodation." When was 11 years into GDP growth "mid-cycle?"
Draconian threats via tweet take 600 points off the Dow. Positive tweets add 300 points--that math does not work. I never thought in my lifetime the POTUS would be both the antagonist and protagonist acting in a bizarre daily reality and social media TV show that moves stock markets more than the Fed.
But here we are--as investors we have to deal with it and have a strategy.
The Big Unwind: How and Why It Is Inevitable
There are really only three constants in investing; human psychology and confidence in the near future, entrepreneurs/academia and governments that create transformational technology, industries, products, services, and regulatory change, and the post-Bretton Woods international monetary order.
As such, I think at this point we all have to start to prepare for the "Great Unwind" that inevitably will come to the last man standing US macroeconomy and the global economy from the next "exogenous" i.e., unexpected financial system shock or the eventual reckoning that has come to the world and US economy from tariff wars (see Smoot Hawley tariffs in the early 1930's against European imports. FYI when we get to December tariff rise--we will have higher tariffs than Smoot Hawley in 1930) For example; US Consumer and PMI index and US Capital Expenditure confidence all just took the biggest hit in August since Agust 2008...you dig what I am saying here?
The uncertainty of the next 12-18 months is multiplied 100X by the Tweeter-in-Chief. When in doubt, sit on your hands--which is what I am advising we do here. September is historically the worst month for the stock market. Unless the heavens ring out a signal that "Tariffs are over" I see no reason for the volatility and uncertainty to reduce.
But the great unwind in the US is not happening tomorrow or most likely (unless tariff wars spiral out-of-control) in 2020. Yet with most secular growth stocks priced to perfection in a low-growth world, the algorithm price momentum funds the marginal buyer of stocks and pension funds the marginal buyer of investment-grade AAA sovereign debt and corporate debt (who must have high levels of instantly liquidatable bonds to meet pension fund risk parameters), the narrowing of 52-week highs in the US stock market to 4X more 52-week lows vs. Highs (which I have monitored and recorded every day since 2000) is filled with stock categories that are all bond proxies (with higher yields) and traditional recession sectors:
1) water and power utilities
2) preferred stocks
3) Some REITS (especially cell tower REITS)
4) A handful of winning 30%+ CAGR growing enterprise SaaS players (with many previous leaders getting schmeised aka killed if the lower growth guidance--our CHGG being one of the exceptions)
5) A handful of tech not hit hard by China tariffs or Huawei boycott (NVDA, AMD, Xlnyx still holds for now--out long term AMD call option is safe here)
5) Consumer staples
6) Consumer fast-food players (3% unemployment means less time to cook for middle and working-class homes)
7) Off-price retailers
8) Global P&C insurance brokers (P&C insurance premiums are rising aka "hard pricing environment" so profits up for the brokers paid a commission on the premium
9) High ROI Healthcare cost reduction services & technologies (which are paid for by Medicare/Medicaid/Private Insurance).
We are building and researching a new ideas list in a number of these categories. But everything we own is still a hold except for Bloom Energy (more in a bit on that fiasco).
Our strategy? DO ALMOST NOTHING. Take advantage of crazy dislocations like CLDR and others. COLLECT DIVIDENDS and reinvest them to build the income stream in the bear market (if you don't need them for everyday expenses). Stay out of the trade war victims for now. Hedge Xlnx AMD Nvidia selling calls 10-20% out of the money and buying puts 10% below the price. Take cash and plow into our preferred share superstar PFFA and wait for the for the next 600-1000 point Tweetsplosion! Yes, I made that word up--I own it!
The Big Tell
We are waiting for the next >30X fear sell-off that gets exploded by momentum algo robot trades on our favorite 20% CAGR secular growth sectors and companies. The trade war has replaced the Fed as risk by far--at least the FED does what they say or signal they are going to do (albeit not as fast or deep as they would like--but there is this guy screaming at them every day to which they are saying--"bite me"--were are not you bitch, bitch.)
My BEST advice is to sit on your hands here and remember one day's tweet that takes the overall market down 600 points is tomorrows tweet that takes the market up 600 points. We have no control over this--but we do know that in 100% of the times, The Donald talks draconian shit to the Chinese and then in his passive-aggressive mind he is blowing kisses a week later. Everyone knows his game except, of course, the Donald; in his mind, he is the master of the world puppeteer and its just too much fun not to jerk China up and down like a Chinese Pinocchio.
Why do I love sitting on 40% of my portfolio is high yield or PFFA?
This is why:
The First Big Unwind
But the biggest tell on the fragility and frayed nerves in the market today is the evisceration of the price momentum serial beat, beat, raise stocks that guide down and miss growth rates. The new poster child for this one-day 25-40 % once loved now scorned "momo" growth stocks is ULTA Beauty (ULTA). Thought to be Amazon-proof, Ulta guided lower last Friday and comp-store sales missed guidance--and a $350 stock on a week ago Thursday was a $200 stock on Friday. I can't remember a time since the dot com favorite Microstrategy (MSTR) tanked on March 13, 2000, when a $350 stock a week before turned into a $150 stock in one day. (Note: I built my first investment research company ChangeWave Research on my $10 recommendation of MSTR--a few of my employees retired on that stock. I made my first $1M on that stock. I was in Europe skiing on the day it wrote down earnings on revisions--I had put options on the small amount I had left--the life long lesson is NEVER EVER put a 3000% profit at risk--ever!).
This chart should make you remember that there is a reason we have not been ready to jump in on enterprise SaaS at these 15-30x times sales valuations for 30%+ CAGR growth (Chegg is a consumer SaaS service still a buy under $40) and wait for special situations like Cloudera (CLDR--Buy Under $6.50) which we are up 30+% from our entry. Carl Icahn did what I would have done if had a few $billion hanging around--the next logical step is to clean up the horrific merger, write-down assets and sell to a software private equity company to finish the clean-up and refloat.
I guarantee you that with the .com like a bubble in enterprise SaaS stocks, we are going to see more ULTA blow-ups with the exception of the best-of-breed plays like MSFT, CRM, Adobe and niche players like Chegg (still buy under $40), Hubspot, Avalara, Veeva (the Salesforce of pharma) and a few more.
But it is not just Ulta or other momo faves. Ollie's is a Jim Cramer favorite off-price player--the buy close-out stuff at huge discounts from retailers like Macy's at 70% discounts off of WHOLESALE. The announced a slow Q2 and revised down--mind you this is off-price space that other players like TJ Max have been gaining market share--and boom another $100 stocks just weeks ago a $50 blown-up disaster:
To Be Redundant, the US Market IS THE LAST MAN Standing
The market right now is hand-to-hand everyman for himself combat. But at the macroeconomic level, we have the inexorable business cycle that is not rescinded; it just been put on life support by the world's central banks in a new kind of QE + negative interest rates monetary shell game. New research by the IMF details how that, without borrowing the equivalent of the modern world's GDP every year, developed world GDP would be negative. Old and slow growth Japan and Italy would have negative 2% GDP aka shrinking without $trillions in annual borrowing.
How much can the world borrow--with now $17 trillion of negative bond yields (i.e., paying a higher price for the bond value thus a negative imputed yield--you are guaranteed to lose money unless bond yields go more negative.) One thing for sure--when something bad happens out-of-the-blue to the US or world economy, the Fed will go to negative rates and maybe buy stocks too. We are at that new place--the power of having the currency of the world trade and reserves IS why we are the last man standing. Don't forget it.
But for now, the wave is unstoppable and head spinning. Most institutional bond buyers HAVE to buy bonds because of national pension allocation laws. The global stock of negative-yielding debt is now in excess of $17 trillion as rising market volatility lends extra force to this year’s unprecedented bond rally. Thirty percent of all investment-grade securities now bear sub-zero yields, meaning that investors who acquire the guaranteed money-losing debt. Yet buyers are still piling in, seeking to benefit from further increases in bond prices and favorable cross-currency hedging rates (long dollar/short their currency)—or at least to avoid greater losses elsewhere particularly in non-US stocks.
But the nature of the business cycle without question has changed with the digitalization of business processes--especially inventories. The business cycle used to peak when businesses thought the good times would last forever. They loaded up on inventory and just as consumption cycle peaked, they had no clue because they had no system to measure actual supply and demand. By then they realized they over-ordered and stopped ordering/canceled from their suppliers. The suppliers, in turn, canceled intermediate goods and so on in a vicious negative feedback loop. High relative interest rates at the margin slowed auto sales and that supply chain collapses. Home sales turn negative and furniture and appliance sales drop--yada yada yada.
If you look carefully at the world markets--the United States and the King Dollar are the last men standing. And again, there is now a positive and negative economic feedback loop driving bond prices up and yields down. Since 60% of emerging markets debt is denominated in dollars, every 10 cents the dollar index goes up against EM currency index, the more expensive their debt is. The more expensive their debt becomes the lower profits. Vicious downward circle.
In the equity markets, where to go? Europe in recession and their banks are running a negative credit spreads. Brexit is a shit show and disrupts supply chains in both the UK and Europe. The 530 million in the Eurozone are retiring faster than the US (for example, Germans can retire at 56 at 75% of their last 5-year compensation. Pensions kick in for a high percentage of Europeans as well as Scandinavia. America? Not so much). China GDP growth lowest since 1990--South Korea and Japan are co-dependent economies that are now in disarray over the "comfort women" issue in WWII. Oil economies are flat to negative etc etc. Foreign money flooded into the US stock market index funds in August at a record pace--there is the theme gain--TINA--"there is no alternative" or my fave "the cleanest shirt in the dirty laundry bag."
So that is where we find ourselves on Labor Day: The American economy led by 97% employed consumer (with 7 million unfilled jobs--another record) chugs along as the strongest in the developed world. But look at the sectors that are literally uninvestable (off 20%+ YOY:
1) Traditional Mall based retail (except off-price retail getting Amazoned and e-commerced)
2) Transportation (biggest drop in long haul trucking since 2008 + the 737 MAX fiasco and Amazon logistics)
3) Energy and MLPs-- fracking brought 12 million barrels of light crude every day and nat gas over-supply--we flare as much gas in the Permian Basin as produced in the East Coast. Energy companies lose money on every BTU they send into the Texas pipelines.
4) Commodities & Materials--At the margin, steel, aluminum, copper, iron ore, food, livestock, paper etc etc..no pricing power and oversupply in most cases plus tariffs
5) Autos and Trucks and Auto Parts--young people are not getting driver's licenses or "first cars", millions of cars coming off the leases flooding used auto market. Used car dealer Carvana is interesting!
6) Home Builders-- lowest rates ever and home starts down and only
7) Financials: Stuck in a bear market for two years
8) Emerging Markets--obliterated
9) Consumer Discretionary --Dead in the water (with a few exceptions)
10) Microcaps--toast
What's left is infotech and healthcare high yield ETFs/ETNs sector and special situation companies with secular growth and not contracting growth--so that is what we are concentrating on.
US MacroMarket Index: 15.6 US expansion in-tact --less than 10% recession risk next 4-6 months (unless tariff trade war terms worsen)
Latest Atlanta Fed Nowcast forecast: 2.0 percent — August 30, 2019
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2019 is 2.0 percent on August 30, down from 2.3 percent on August 26. After yesterday's and this morning's releases from the U.S. Census Bureau and U.S. Bureau of Economic Analysis, the nowcasts of third-quarter real personal consumption expenditures growth and third-quarter real nonresidential equipment investment growth decreased from 3.4 percent and 4.4 percent, respectively, to 3.2 percent and -0.5 percent, respectively.
