February 2019 Newsletter: It's ALL Played Out as Expected
The problem is what's next? We need to separate the best 21st Century Winners from the pack!
Apologies for the late newsletter. We sorta bomb-barded every one during the crazy last days of December and January with updates and activities. In the end, our decision that a tradable bottom was hit in the last week of December was right, our decision to double down into the late December flash crash on our favorite Ultra Income investments in MIC MORL MRRL BDCL NRZ and to hold our 2X AMD and Nvidia positions.
There has been no rush to rush new positions--there was too much news flow to come AND I wanted to see our favorite Q4 Software-as-a-Service companies report so we were confident we have ANOTHER winner like Chegg CHGG with we initiated under $28, got around $26 and it now trades at $39. There ARE some big profits ahead in SaaS plays that have dominant share of the key enterprise, small businessand consumer SaaS platforms--Chegg is a great example of owning a fast growing high demand amazing value proposition (save 90% of your college books!) with international "total addressed markets" or TAM untapped.
I also admit to a deadline crunch on two manuscripts I owed my publisher Diversion Books--one of the books is "The Transformity Principle" which explains in great detail the philosophy, strategy and tactics that we have used since my ChangeWave Research days in 2000-2010 but vastly improved in the last 7 years of Transformity Investor PRO with our 54.1% annual returns (realized profits, dividends and non-realized equity gains/losses) since 2013.
Speaking of amazing returns, in a world where the stock market has returned on average 5.8% a year since 1989, we are off to a smashing start for 2019. Our portfolio is up 21% including dividends so far--10.5% a month is NOT sustainable ok? We also have locked in via our prodigious monthly and quarterly dividends another 20% just for doing nothing but collecting dividend checks. Here are the updated portfolio returns
Jan/FEB 2019 Transformity PRO Performance
|Position||2/28 Return + Div||Buy Under||Target|
Ok, so what have we done lately for you?
Glad you asked. Next week will have some more dumpster diving--disruptive secular growth companies that got smashed in the flash crash. Also some long term options on Xilinx ( YES I regret taking profits at $88--but really no--I never regret taking profits if a stock gets to 5% of our target.) Xlynx has come on a real 5G chip play like our favorite 5G play Cavium that was bought by Marvel at a 70% profit of us in 8 months.
We are doing final work on new "Platformity Dominators" aka as the B2B SaaS companies that, like B2C Chegg, have a killer value proposition that is growing 25% a year for next few years, has $5+ billion TAM, whose subscription renewal rate is OVER 100% and is not priced for absolute perfection. A word on SaaS renewal rates. The REALLY big attraction to B2B and SB2B (small biz) is when they get >100% renewal conversions. How do they do that?Well what happens is the add-on additional SaaS services to the original subscription and/or they add more people and move up to unlimited nodes (ie., users on the service). This is how Salesforce and Adobe -the mega "Martech" meaning marketing technology companies have evolved.
They are now mega-cap stocks that if you own them, you are good--but we are looking for WAY higher returns (see CHGG) in the SaaS space. Our leading prospects are down to:
The Pick-Axe to Technology’s Crown Jewel—Highly Targeted Omnichannel Digital Ads
Finally—let me share some very interesting work from my friends at Business Insider PRIME. They allowed me to share this with you because, well, I am a long fan and friend of the founder Henry Blodgett from his Internet gogo days. They have assembled I think the best issues for my team and you to consider as we enter the 10th year of economic expansion.
We still hold the mild recession 2nd half 2020 forecast. Now, remember--recessions hurt business investment and consumer spending at the margin. That means because growth is slowing, business cuts back on new employees and capital expenditures--at the margin. Consumers tighten their monthly budgets where they can. Recessions are NOT Depressions where substantial economic activity is wiped out.
The Most Important Charts for The REAL Global Economy & Comments (ALL of which we are watching as we get research from most of these sell-side strategists and economists:
Gary Shilling: There's a "two-thirds probability" of a recession this year.
Despite the plunge in the headline unemployment rate from 10% to 3.9% in December, inflation remains below the central bank's 2% target. Globalization, declining unionization, robots, Amazon, Uber, government pressure on drug costs, the competitive race to zero in financial fees, the strong dollar and consumer and business resistance to price hikes are all at work.
"The likelihood of a recession starting this year, which I rate at two-thirds probability, is also deflationary. That would end and reverse the Fed credit tightening campaign that started in December 2015."
Transformity MacroMarket Index: 16.2--2% chance of recession in the next 4-6 months
Comment: Gary was right about the Great Recession--but he was calling for it by 2005, 2006, 2007...
Marko Kolanovic: Stock-market liquidity and volatility have an increasingly dangerous relationship.
"There's a strong and non-linear relationship between S&P 500 futures market depth (a measure of liquidity) and volatility; market depth declines exponentially as the VIX rises, and this relationship has been getting stronger in recent years. An increase in volatility also typically results in selling by systematic investors, as many of these strategies effectively embed a 'stop-loss.' TRUE
"Given this systematic selling happens in an environment of reduced liquidity, it causes their flows to have an outsized price impact. This liquidity-volatility-flows feedback loop creates market fragility and increases the risk of tail events."
Comment: This is what happened in December--a Flash Crash created by negative automated selling with no one home to deliver enough liquidity.
David Rosenberg: "We have as much as an 80% chance of a recession."
"Global liquidity conditions have tightened dramatically on the back of either tighter or less accommodative central bank policies. This will hit the world economy with a lag, and history suggests we have as much as an 80% chance of a recession as a result of this tourniquet."
Comment: David's timing is also about 24-30 months early.
Rick Rieder: The Fed is doing the appropriate thing.
"Between the lines of the Fed's mandate is the need to keep borrowing costs for consumers and enterprises in-line with potential growth: if rates are too low (the return on capital is too high relative to the cost of capital), credit bubbles can form, but if rates are too high (the return on capital is too low relative to the cost of capital) constrained credit can weigh on economic activity. Today, we see credit yields as roughly neutral relative to potential growth; hence, we believe interest rate policy has normalized and the Fed policy rate pause we long argued for should support sound economic growth and healthy financial markets. Still, while increased rates could threaten economic activity at this stage, and the Fed should remain patient and cautious, a policy rate hike later in 2019 isn't off the table if economic data improves."
Byron Wien: 'America First' has big implications for investors.
"After the Social Security Administration and the Federal Reserve, China and Japan are the biggest holders of US Treasurys. We know that US America First trade policies have caused serious concern in these countries. If Japan and China buy fewer US government securities when we are borrowing more than ever, the impact could be significant."
Comment: True but both Japan and China HAVE TO BUY US Treasuries to when they sell their currencies to keep export prices low.
Liz Ann Sonders: This usually forebodes a recession.
"Consumer confidence has rolled over, with a notable drop in the expectations component. There is now a near-record spread between present conditions and future expectations. Troughs in this spread have historically represented near-term recession warnings."
Comment: True but the Fed watches consumer confidence closely.
Michelle Meyer: American manufacturing is in danger of a slowdown.
"Global manufacturing PMIs have weakened of late after running above the breakeven level for all of last year.
"To achieve a cleaner comparison, we look at the standardized level of both the China and US manufacturing PMI. The two series trend closely, showing the linkage between the two economies. "The latest weakening in the data has been particularly acute for China which could portend further softness ahead for the US, akin to the early 2016 episode."
Comment: THIS IS WHY the US/China deal has to go through
Dubravko Lakos-Bujas: This is one of the biggest sources of stock-market volatility.
"Of the many macro uncertainties that pushed market volatility higher in 2H2018, trade war andmonetary policy error have weighed the most."With [the] Fed turning more dovish and constructive, US-China trade discussion is center-stage and should be watched carefully. A satisfactory resolution of the issue would have positive consequences for global growth and may prolong the current business cycle."
Comment: 100% agree
Lori Heinel: Geopolitical risk is surging.
Scott Minerd: The gap between the president's approval rating among Republicans and Democrats is at a historic high.
"The US political climate has become more polarized under President Trump than at any point in the post-war period, continuing a longstanding trend. This can be seen in the spread between the president's approval rating with his own party relative to opposition party voters.
Comment: Everyone knows this Scott!
George Pearkes: Fed business contacts suggest a growth slowdown — but no recession yet.
"While the economy is not likely to enter a recession near-term, leading indicators suggest that the US is experiencing another intra-cycle slowdown of growth similar to 2011 or 2016. Using natural language processing, our Beige Book Index captures the sentiment in each release (twice per quarter) of the Fed's Beige Book, a compilation of qualitative economic data from each Fed district.
Comment: Our data shows the same!
Tom Lee: 2019 looks a lot like 2009 for stocks.
"So far in 2019, the S&P 500 is tracking similar to prior instances of waterfall declines, particularly when the PMI>50 at time of completion of the 19% decline (within 60 days)."Notably, as shown above, equity markets post 12-month gains of 32% on average in the 12-months after waterfall declines (but PMI>50). 2019 falls into this case."
Comments: Your lips to God's ears Tom. But Tom also thought Bitcoin would be $25,000 by end of 2018!
Sam Bullard: Politics is putting investors and CEOs on high alert.
"Keynes stated that animal spirits are one of the key factors behind fluctuations in the economy and changes in the business cycle. Therefore, a quantitative measure of animal spirits may lead to a more accurate estimation of the potential effect that a change in animal spirits has on the economy.Animal spirits have fallen considerably, as recent market turmoil and political uncertainty have weighed on expectations for economic growth. Given the broad-based weakness, business leaders and investors are likely to remain cautious in the near term."
Note: "Animal spirits" is the term coined by legendary economist John Maynard Keynes to describe instincts, proclivities, and emotions that ostensibly influence and guide human behavior.
Comment: Fed knows this too!
Katie Nixon: Stay the course in risky assets.
"In the US and other global equity markets, there is no relationship between the performance in previous and subsequent quarters, or even from one year to the next. While short-term returns are unpredictable, longer-term (e.g., three to seven years) evidence suggests more predictability due to mean-reversion in risky assets, especially after periods of market stress.
"Staying the course with risky assets allows for recovery of lost value and helps earn the higher expected returns with time, which does not happen for investors who exit the market."
Comment: Long and strong for now.
Robert Tipp: The Fed has been very responsive to market twists and turns.
"The advent of the Fed 'collar' has been clear in retrospect over the last several years. In periods ofmarket turbulence have all seen the Fed quickly turn to caution. This was the case with the September 2015 meeting hike skip, as well as with the dovish twists of rhetoric and extended pause over much of 2016, and most recently with the post December 2018 rate hike policy reorientation from hikes to caution."
Comment: That is what I mean by managing market convexity--Fed has our back!
Binky Chadha: Wage growth doesn't necessarily hurt company margins.
Comment: Do higher wages mean lower margins? They haven't historically."
Joe LaVorgna: The Fed has tightened a lot more than you think.
"Economists at the Atlanta Fed created a shadow fed funds rate to measure the full effects of quantitative easing and forward guidance on the funds rate during and after the financial crisis. This rate provides a more accurate reading of the 'true' level of the fed funds rate given the zero bound. For example, at one stage of the economic recovery, the shadow rate was in sharply negative territory, while the official fed funds rate was slightly above zero. Since then, the shadow rate has meaningfully increased, and the cumulative amount of monetary tightening has been substantial."
Komal Sri-Kumar: Why the Fed has done a 180-degree turn.
"What is behind the 180 degree turn we saw from Fed Chair Jerome Powell on Wednesday [January 30, when the FOMC met]? Inflation numbers have been consistently below the Fed target of 2% but the central bank (under Bernanke, Yellen and Powell) kept insisting that there was an inflation threat. The Federal Funds rate has been increased nine times since December 2015 — four of which were implemented just last year — even as inflation remained relatively tame."
Ryan Detrick: Midterm-year sell-offs are typically followed by big comebacks.
Alicia Levine: Here's the "doom loop" chart for European banks.
"European banks own their own sovereign debt, held at par and it becomes part of the capital cushion. This is a fatal flaw in the European banking system — one that is silent until it is not. If sovereign credit comes under question and borrowing costs rise, then bank capital is also at risk, creating a 'doom loop' between sovereigns and their banks. Italy and Portugal show the greatest increase of sovereign debt held at the national banks."
With Bryan Besecker, Investment Strategist and Lale Akoner, Global Markets Strategist.
Cullen Roche: Fears of an imminent recession are overblown.
"[The Orcam US Recession Index] measures the current probability of a recession in the US.
Since most of the substantial bear markets coincide or precede US recessions this is an important indicator of the likelihood of a sustained bear market in the USA. Current levels are consistent with just a 25% probability of recession.
The index is an 'on/off' index so readings less than 100% tend to be highly unreliable. This is a positive sign for the domestic economy and markets."
That's all folks...look for new buys!!