January 2018 Newsletter, Part I

Let's Get the Macro & Market Melt-Up RIGHT Again for 2018

 

aaron-mello-528855.jpg

 

The Global Markets Melt-Up Accelerated TOO FAR TOO FAST: it’s Time to Start Some De-Risking and Build Some Cash as Volatility is Coming as Market HAS to Take a Rest!!!

Part 1 of this months double issue is the macro-economic assement and to set our 2018 strategy. Part II will be review of ALL our portfolio and pruning of positions to make room for new opportunities. 

Reality Check: With our 5X our money NVDA options profits and overall portfolio plus dividends received in January, we are up over 20% in just the month of JANUARY...and I HAVE to make sure you understand this rate of appreciation and short term trading profits is of course NOT sustainable. This is 2 YEARS of gains in one month. 

This week's 1.4% decline has been very orderly on normal volume and while the VIX volatility index moved to 14 from around 9...this much needed pullback comes from exhaustion and undoubtedly some large pension re-balancing as their norma 60-40 equities to bond balance HAS to have gone upside down with stocks UP 7% and longer dated bonds down 8%. 

Look...I  am HIGHLY confident and earnings season rolls out our amazing performing Transformity Investor stocks and leveraged ETFs will continue to BEAT Revenue BEAT Earnings Per Share and RAISE 2018 guidance (See LRCX )

BUT If they don’t follow through it's time to cut them and move on...there are too many BEAT BEAT RAISE secular growth opportunities.

Take Lam Research...it Beat top line Beat bottom line and Raised its 2018 guidance. 8 analysts UPPED their forecasts to $250-$270...and yet it could not hold $200. That is clear sign semi-equipment leaders are tired and new buyers want a better price. LRCX IS holding its 100-day or 20 week support well....so it's a HOLD at this point. 

1.png

 

Advanced Micro Devices (AMD) beat on top line and bottom line:

Advanced Micro Devices (NASDAQ:AMD): Q4 EPS of $0.08 beats by $0.03. Revenue of $1.48B (+33.3% Y/Y) beats by $70M but shares are trading slightly down it the aftermarket. We are up over 25% in 2018 on these shares...and 200%+ since our two purchases...but again the entire chip and chip equipment space minus our beloved Nvidia seems to have run out of steam even on Beat, Beat and Raise Guidance earnings call. 

Again semiconductor chips and equipment are trading as we used to say on my trading desk "heavy."

I am highly confident that we are 12-18 months away from the point where the Central Banks feel they HAVE to “tap on the GDP brakes” harder than the 4 raises this year and 2 next year. In a tightening cycle the FED only applies extra-ordinary monetary policy (aka 'removing the punchbowl) when real economy aggregate demand for goods and services start to exceed our capacity to build/manufacture/provide them...and that of course means a cyclical bout of serious price inflation. The Goldilocks expansion looks solid for now for the simple reason is the impact of Corporate Tax reform (from 21%-to-9% effective avg corporate tax rate) has not yet begun to get implemented. 

BUT...we have every classic sign of growing level of civilian investor euphoria. RECORD news accounts opened at self-directed Schwab and Ameritrade in January...record inflows came into ETF index funds. More people humble bragging on social media about their $1 million+ 401-k balances...Millennials are buying zero revenue or profit crypto and pot stocks like dot.com stocks in 1998 and cryptocurrency just had another $500 million loss/hack of cryptocurrency in Japan and subsequent mini-crash.  

IN SHORT: Too much too fast means we need the euphoria to cool T##$^#$^ down!

2.jpg
3.jpg

Key Point: WE ARE MOST definitely in the final euphoria stage of this 9 year bull market. The too far too fast melt-up this month HAS TO correct in order for the health of the bull market. THE Euphoria stage can last a year or more...the last one aka the dot.com boom...lasted 24 months until March 12 2000 announcement of massively restated MicroStrategy earnings and Microsoft's disappointing Q1 2000 earnings pre-announcement started the snowball rolling downhill and the the bubble burst (what did I care? I was skiing in Courchevel and scarfing fois gras while checking my $4 million of tech stocks...nothing to worry about :)).

IN memory of my $million ski vacation...let's buy a 3-month out of the money PUT OPTION on the TQQQ the $145 April 20 PUT at $6 or better. 

4.png

With organic earnings growth of 8%ish another 5-10% from corporate income tax gains and 100% capex write-offs in year one, the "Beat Beat Raise" game from big cap leaders will continue through Q1 2018 reporting season. We have MOST of the "Game-Over dominator FAANG tech giants reporting this week...Apple, Facebook, Google....Netflix already crushed the quarter. THESE RESULTS ARE CRUCIAL.

Actions to Take NOW: CLOSE Apple X phone exposure. We have multiple sourced reports that Phone sales at $1200 average have already peaked. Apple Inc. is slashing planned production of the iPhone X for the three-month period ending March 31 in a sign of weaker-than-expected demand for the pricey handset. Apple plans to make about 20 million iPhone X handsets in the first quarter, down from roughly 40 million initially planned, according to one person with knowledge of Apple’s production goals. Other people familiar with the iPhone supply chain said Apple had cut orders for components used in the iPhone X by 60%. PS...Apple has broken its 200-day moving average pretty badly...IF they don't crush numbers Thursday...they dive (but are really oversold here so I would not expect a 10%+ drop...but who knows as everyone who wants to own Apple already owns it. )

5.png

WE are closing out Apple leveraged positions LITE FNSR TQQQ 2X Leveraged Naz 100 positions
We are closing Cavium CAVM (buyout from Marvell closing)
HOLD OLED...we will see if it holds 100-day moving average...that is the line in the sand.  

Key Risk: Weak Dollar is depreciating the value of 10-year bond for foreign holders and its on track to LOSE 10% more in value/yield rise to 3% ..risk off returns.
HOLD Leveraged Mortgage REITS MORL...

The BIG Macroeconomic Picture: There is SO MUCH that has gone on and is going on from a macro economic sense that has NEVER happened before in the US and global economy we need to understand and analyse a set of “knowns and unknown knowns.”

Let's use a mental picture. I want you to think of the total available capacity for US industrial and services or economic capacity aka "supply side" of the US or Euro Region as a big truck driving down the road at 70 MPH. Now think of our the demand  side or aggregate demand for goods and services as another truck that is 2009 was WAY behind the the economic production/capacity truck.

Since 2010 via the Central Bank actions around the world aka “QE” they have pumped “gas” aka capital into the demand and capital investment side of the economy so that demand would race ahead and to eventually  catch up with our total economic capacity.

Imagine the total production capacity truck is going 70 but the overall economy is travelling at 80 MPH...eventually the demand truck catches up with the capacity truck. NOW...when aggregate demand for goods or services exceeds total economic capacity, price inflation spikes (more $$ and demand for goods and services than capacity in ANYTHING means rising prices.) Econ 101 says price at the end of the day allocates limited resources based on capacity limits. For example with fixed supply and excess demand, crappy motel rooms 15 miles away from the Super Bowl venue in Minneapolis are going for $800 reportedly.

Key Point: We are clearly in the 7-8th innings of this 10 year expansion and probably 12-18 months from where the demand for goods and services could catch total production capacity/supply. Especially since the US Dollar hit a 3 year LOW against the rest of the world's currencies, demand for U.S. exports is 7-10% higher with the US dollar now that the 20% lower against the Euro. THAT higher export demand soaks up US capacity which serves to drive the demand truck even faster to reaching and then exceeding total capacity.

NOTE: Our "Beggar they Neighbor" economic policies are lighting the fuse for major retalliation from our biggest trading partners and THAT is the biggest risk to the American economy that only a few are talking about! Anyone with HALF a brain or understanding of macroeconomics agrees with me that the cavalier Treasury Secretary Mnuchin comments yesterday at World Economic Conference was the first BIG GAFFE of Trumpist economics. 

My old CNBC buddy Greg Valliere, the chief strategist at Horizon Investments, agreed that Mnuchin's comments marked a low point in the Trump administration's economic policy. "The first serious economic misstep by the Trump Administration is the inexplicable decision to talk the dollar even lower," Valliere said in a note to clients on Thursday. "Combined with new trade tariffs — with more to come — an element of uncertainty has been injected into the global markets: why purchase U.S. assets if those investments may lose value because of a weaker dollar?"

In a LinkedIn post on Thursday, Ray Dalio, the founder of Bridgewater Associates, took issue with Mnuchin's comments as well. "Regarding Treasury Secretary Mnuchin's comments about the administration's weak dollar policy, I want to make sure that you understand what having currency weakness means—most importantly, it is a hidden tax on people who are holding dollar-denominated assets and a benefit to those who have dollar-denominated liabilities," Dalio wrote.

Here is what Mr. Dalio means. Remember the truck analogy; IF the aggregate demand side of the economy catches up too quickly with the output capacity side of the economy, the US economy becomes a massive version of the motel rooms price inflation in Minneapolis St. Paul-- and THAT MAKES the Federal Reserve hit the economic brakes HARDER i.e,. raising short term rates (which in turn drive long term risk free rates and bank lending rates skyrocketing). 

More precisely, here is what a continued crash in the already weak US Dollar or ANY weak currency does vis-a-vis our economy and the global economy::

  1. Reduces the currency holder’s buying power in the rest of the world (e.g. dollar weakness reduces Americans’ buying power relative to foreigners’ buying power) and makes foreign goods MORE expensive
  2. Benefits those who hold dollar denominated liabilities and non-dollar denominated currencies. 
  3. Makes commodities that trade in dollars MORE expensive for buyers who have to buy oil in dollars and less expensive for buyers with appreciating currency to the depreciating dollar
  4. Devalues the debt denominated in the weakening currency, which hurts the foreign holder of that debt
  5. Raises the country’s inflation rate via increased production of exports eating up spare capacity and increasing the cost of imports

KEY Point: None of this is what the U.S. economy needs now. On Thursday, Mnuchin tried to reverse course of his basic "beggar thy neighbor" narrative. FYI--In economics, the term "beggar thy neighbor" aka a beggar-thy-neighbour policy is an economic policy through which one country attempts to remedy ITS economic problems by means (#1 currency devaluation, #2 trade tariffs and #3 corporate income tax rates) that tend to worsen the economic problems of OTHER countriesThe term started in the 30's when Herbert Hoover caved into post WWI excess production of agriculture products in Europe which had sunk agricultural commodity prices by enacting 20-40% tariffs on imports from Europe on 300 food items aka the Smoot Hawley tariffs. That move then exploded to 14,000 items after the other industry lobbyists got a hold of Congress from steel to panty hose.

Europe and other nations retaliated of course. In just ONE year US exports and imports dropped by almost two-thirds and the Great Depression was in full swing. 

PS I LOVE this tidbit: "It is perhaps slightly different than previous Treasury secretaries who in recent times have just commented on strong dollar, strong dollar," Mnuchin said. "We suspect Mnuchin and other Trump officials got an earful yesterday from Wall Street types who worry about retaliation from countries alarmed at a 'beggar thy neighbor' dollar strategy along with tariffs," Valliere wrote. "Perhaps Mnuchin will walk back his comments, but the message seems clear — this is what President Trump thinks and wants."

Our Market Strategy for the Next 12 Months: Takes Profits and Use Options to Reduce Risk
SO--to stay with the truck metaphor...we are going to RIDE this runaway stock market for all we can over the next 12-18 months. BUT...we are NOT going to chase super expensive stocks and ultimately...when the Federal Reserve starts to “tap the brakes” on the U.S. economy...when short term rates exceed 10 year rates...THAT is going to be the signal for us to switch from offense to defense. I can’t tell you exactly when that day happens...it's 12-18 months away (unless our economically insane beggar-thy-neighbor trade policy starts real trade wars in the next 6 months).

I can tell you this: the current stock market melt-up in value is bringing forward a LOT of the real economy increased revenues and earnings into stock prices.Plus...as 5-10 year interest rates rise due to inflation expectations those earnings will GET DISCOUNTED with a higher discount rate.

Exploding stock values WAY ahead of their underlying fundamentals and higher borrowing costs and interest rates (i.e,, lower bond prices) for zero risk 10-year bonds on the other end of the risk spectrum is NOT a long term recipe for equity appreciation. 

What we DO have for the next 60-days is an earnings season that mostly beating expectations everyday...that is going to pump up the prices targets and exaggerate the lynching of stocks that do NOT bang the BEAT BEAT RAISE  drum. 

NOW the known economic unknowns.

#1 For one we have never cut corporate income taxes aka FISCAL economic stimulation of near 50% in the late 7-8th inning of an EXPANDING GDP cycle. Normally we get this fiscal “Keynesian” government stimulation at the beginning of a NEW business cycle expansion. Will this fiscal stimulation run out of steam in next 24 months or be a secular macroeconomic transformation? My numbers say 1-2 year boost and then return to 2% ish GDP. GDP is a function of # of people working (labor force size) and total population X number of hours worked x services and product output per hour of labor (i.e, productivity gains). in a 70% services economy its hard to boost productivity needle...but very easy to accomplish in the "stuff" economy. ALL capex investments for industrial companies will go into advanced manufacturing (less workers), transportation will be more efficient transportation equipment & autonomous technology (less operators) so clearly the productivity rise will come from the Stuff Economy not the service economy or government. 

#2 Usually the US Dollar is going down in value when the Federal Reserve is LOWERING short term rate...now the dollar has dropped 15% against the Euro while the Fed is raising interest rates. Yes the dollar decent is mostly about the REST of the world now growing again--an upswing in everything from stocks to oil means global investors are selling their dollars to buy Euros and Yen and Krona to buy assets with. But with highly liquid 2 year Treasuries above 2%...and major foreign 2 years paying 75% less, foreign buyers should be BUYING dollars to by the much higher yields from similar rated T-bills...but they aren't.  

Now the Fed Vice Chairman Stanley Fischer recently said the Fed trade model shows just a 10% fall in the trade-weighted dollar index (remember WE now have a 20% fall) can boost real exports by 7% over three years and contribute 1.5% to gross domestic product if there’s no monetary policy offset. The monetary offset from the Fed is slow but the fiscal stimulation is right now.  

Key Point: By the Fed model calculation, we have already had enough dollar weakness to boost GDP by 1% through the end of Donald Trump’s first term—an amount that far exceeds the impact of the tax overhaul!

In short we are in macroeconomic nowhere land...the compass of economic history is not useful. But we just increased the “speed of the aggregate demand truck” 2X with fiscal and dollar depreciation-- I’ve been a macroeconomics student and analyst for a long time and I can’t REMEMBER a time like this.

THE RISK: Obviously if the aggregate demand stimulus makes the "truck" catch up too quickly to total production capacity truck the Fed will HAVE to tap the economic brakes harder than they and we forecast.

Our Action Plan: 1) When one of our stocks BEAT BEAT RAISES guidance and does NOT trade up the next day...WE ARE GOING TO SELL THEM.  That is the market telling us it’s valuation climb is EXHAUSTED and it needs a 10-20% pull back ala Nvidia and chip stocks in general in  December.

2) IF one of our stocks or ETFs (ex-MORL and BDCL--we are still BUYERs under $15 EVERY TIME) breaks its standard deviation trading range on higher than average volume, we are going to SELL it.  Take OLED for instance as it is right on that cusp--we are waiting for announcement of their new contract with Samsung...they just announced a big new deal with BOE of China...and stock sold off today on NO news. This one day sell-off could of course be for many reasons starting with someone trimming a big position with a big market order that beat down the stock all day.

But sometimes a picture of the trading range  linear regression chart with volume bars tells a big story.

7.png

Look at the sales volume for no apparent reason.

3) IF one of our above higher P/E positions breaks down technically we will sell it too.

Reality: We are now firmly in an an earnings and stock price momentum market. Missed earnings and down guidance are 10-20% melt-downs...as the momentum/algo investors become marginal sellers (more on that in a moment).

The next bear market for stocks will come:

  1. 4-6 months ahead of a Fed monetary tightening that makes short term rates higher than long term 10 year rates (aka "the inverted yield curve")

  2. The bursting of the fear-of-missing-out aka FOMO bubble in equities driven by late-to-the party retail investors stuffing ETF index funds and “hot momentum” cult stocks to the skyhigh unsustainable fundamental valuations and going from marginal stock buyers to marginal stock sellers.

  3. A trade war started by leader of the world economy risking another Smoot-Hawley trade war

The Biggest Short Term Risk: Investor Euphoria and FOMO

Without a doubt the biggest worry and problem I see in this market melt-up from basically September to today is NOT the Fed over-tightening; its the almost drooling levels of optimism/bullish sentiment.  You can see it in stock index charts, in bull/bear sentiment numbers and in the cash flows into ETF index funds and private brokerage accounts (and yes the cryptocurrency mania but when compared to the near $100 trillion world equity market cap crypto is a microbe).

Our Known Knowns Today

Let me be real her: our system of identifying the highest magnitude secular sector transformations and buying the intellectual property owners driving that secular change has outperformed the overall market by about 5X since 2013...hurray for us!

But that has not happened in a vacuum. In addition to a transformational change research firm I am macroeconomic analyst too, and with the majority of the global bond market still delivering NEGATIVE after inflation returns and $14 trillion of world Central Bank stimulus, the goal of world’s major central banks to make world asset values rise because the alternative investment aka buying risk free bonds was guaranteed to LOSE you money WORKED.

And until recently in our 2 ish growth world, the real after inflation earnings growth was in energy 2010-2014 and transformational technology enablers really basically from 2010 onward. We were heavy into energy until the Saudis declared cold war on US oil frackers in 2014 and obviously long technology since we started this service in 2013. 

Today the Central Banks are slowly and methodically removing that stimulus every day...but at snail’s pace. They remember with trepidation the great Bond Market “Taper Tantrum” of June 2013 when the Fed said they were going to start raising rates at the end of 2013 and gave the bond market the now famous “Dot Chart” of projected rate increases . . . and the bond market shit the bed.

Already the Fed is NOT reinvesting it bond dividends in new bonds. IF Fed sees a trend reversal of US inflation of course (call it two quarters) they will increase the rate of their bond portfolio reduction and that will take the benchmark 10-year bond into a 3% range. What is the bond market telling us? Well a 3% 10-Year bond is still no big whoop (relative to inflation and historical trends) in a 3%ish GDP growth expansion (it's about 2% TOO low actually) It will take a spike in so called “chain-weighted inflation” (price inflation adjusted for substitution) to increase the rate of monetary tightening.

RIGHT NOW  our 45 part macro-market index is tell us ALL CLEAR for the stock market.

Transformity Research Macro-Market Index: 18.4--ALL CLEAR for the bull market. 2% risk of recession in next 4-6 months.

TR Latest Q4 GDP NOWCAST: 3.6 percent — January 18, 2018

The Atlanta Fed’s GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2017 is 3.4 percent on January 18, up from 3.3 percent on January 12. The New York Fed’s Q4 GDP forecast is 3.9%The fourth-quarter forecast of real consumer spending growth increased from 3.8 percent to 4.0 percent after Wednesday's industrial production release from the Federal Reserve Board of Governors.

8.gif

Realty Check #2: Our TRI System is Designed to MISS "Reversion to the Mean"
Since  the average return of the S&P 500 since 1924 is 9.8% (including dividends) which makes our 236% gain in stocks and ETFs/ETNs since 2013 23 years of stock market returns in just 4 years.

The 128% we have earned (capital appreciation, dividends and short term option gains) since 2016 is literally 12 YEARS of investment returns in 24 MONTHS. 

I have been around Wall Street, run a mutual fund and hedge fund, published and edited investment newsletters for nearly 40 years (GASP!!!) and I know one thing: When you outperform the overall stock market 5-6X, you are NOT Stock Market Jesus. Our system was designed to double your portfolio every  2.57 years in bull and bear markets. It has outperformed that ambitious goal with now over 55% average annual returns. If our portfolio was a hedge fund I’d be typing this newsletter from the private jet strip of my private island.

BUT...the key to KEEPING our ridiculous profits and wealth gains is to NOT repeat NOT become complacent and believe our own bullshit and fecal matter does not smell.
Key Point: When you as an investor DO feel “this is easy--I can do 5X the 90 years of average stock market returns forever”...you are headed for a great fall like 2000. If I have learned ANYTHING from earning $millions in stock market and options wealth its that it doesn’t mean a thing unless you KEEP IT.

Ergo...the #1 lesson I learned in forty years of stock and option and venture capital investing is this: WHEN you earn 23 years of stock market profits in just 4 years you need to prepare NOW to PROTECT those outsized gains because  . . . because when the music stops (and the only certainty in life is bear market WILL come) and you are not prepared/hedged/build cash you will give back 50% of those gains or more--and that is NOT WHAT I developed our Transformity Investing system (or my ChangeWave Investing system either for you long time subscribers) to do.

Question: When is the BEST time to start to de risk your stock portfolio?

Answer: When EVERY FRIGGIN PERSON in the world is bullish on stocks. NEVER forget: the value of any liquid and tradeable asset is what the MARGINAL buyer is willing to pay for it. Up to this point the marginal buyer (which I define simply as the largest investor willing to buy a stock at its most current ask price) has been the static ETF major index funds and corporate buyback plans that sit on a constant bid for hours during the market day.

The day traders and market makers and trading desks all trade around the elephant in the room--the non-trading institutional marginal buyer of stocks. When the institutional buyers are getting $billions in new money every day, they are buying $billions of stocks in order of market cap automatically.

Here is the longest running retail investor sentiment survey the AAII. For context in 1999 it was running 75% Bullish...20% bearish. Today 51% are bullish and 25% bearish and 34% neutral. As you can see we are no where close to the level of dot.com euphoria.

Key Point: The Volatility Risk in the market is the next sharp correction.  As usual the FOMO “investors” who are the last marginal buyers INTO stocks will panic, they sell their index fund and then the ETF index funds turn into the “marginal seller” aka willing to SELL at the bid NOT the ask.

When the marginal retail stock buyer turns into the marginal seller, the next marginal sellers are the momentum hedge funds who buy stocks going up in a channel and when they break the channel they become the next marginal seller. Following them are the “sell stop” marginal sellers who have market order sell stops that get hit at 50-day and 100-day moving averages. 

YOU get my point: IN the next 10%+ correction panic selling cascades downward into a negative feedback loop aka a marginal seller meltdown following big marginal buyer melt-ups. We have had multiple large institutional marginal buyers for the stock market defined as the Wilshire 5000  index that represents ALL the NYSE and Nasdaq stocks (minus some small caps and ALL micro/nano caps). As of December 31, 2017, the index contained only 3,492 components.

Look at it’s chart: a “melt-up” is defined as any stock or index trading above it’s 10-day average for more that 20-trading days. The Wilshire 5000...ALL the 3492 stocks that actively trade, has been above it’s 10-day moving average since SEPTEMBER 2017! The was when we first talked about our forecast for a 2017 equities melt-up simply because the $5 trillion hedge fund returns were 50-80% BELOW the S&P 500 index. At the time I said “there are $trillions in bonus money NOT GOING to be paid in January 2018 UNLESS these traders and managers throw caution to the wind and buy OUR stocks” (at the time we were up 35% vs. 3-5% for the average hedge fund.)

Give this chart a look.

SEE the “green blob” to the far right? That is the MUCH followed indicator for an “overbought” and oversold” security. Here is a QUICK tutorial on RSI...the relative strength indicator (if you math nerds want the formula, here it is.) The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and rate of change of price movements. RSI oscillates between zero and 100. Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30.

Key point: The ENTIRE stock market has been “oversold” aka controlled by the two most powerful marginal buyers: momentum amd ETF index funds for 70 DAYS! Go to stockcharts.com and look up ANY index...they all look the same.
Now look at the Dow GLOBAL Index...take a deep breath. 92% RSI?

REALLY Key Point: WE ARE IN A GLOBAL EQUITIES MOMENTUM MELT-UP and we have to take a rest.

  The global market is now basically now a game of chicken. EVERY time one of the market leaders reports our beloved “Beat Top Line, Beat Bottom Line, Raised Guidance” or Beat/Beat/Raise the poor bastards who are still solvent and short the the stock get murdered and HAVE to cover their short positions by becoming...for 20-30 minutes or so...the NEW marginal stock buyer!!!

You get the rhythm yet? NEW ETF funds deposited (and for the last 60 days its been a record net deposit) are the most powerful marginal stock buyer. THEN that momentum attracts the black box/algorithmic “trend buyers” who THEN become the most powerful marginal buyer. Finally...the individual FOMO stock buyer can’t stand the pain of missing out and buys the winning brand name stock he/she knows and we get to a 90+ RSI relative strength index on the world of stocks.
Look at our beloved Lam Research that just reported post-close this evening: BEAT BEAT RAISE baby!

  • Lam Research (NASDAQ:LRCX) shares are up 5.4% aftermarket following Q2 results that beat EPS and revenue estimates.  

  • Upside Q3 guidance: Shipments, $3.05B to $3.3B; revenue, $2.73B to $2.98B (consensus: $2.64B); gross margin, 46% +/- 1%; operating margin, 29% +/- 1%; EPS, $4.20 to $4.50 (consensus: $3.75).

  • Key Q2 results: Shipments, $2.63B (+11% Y/Y); non-GAAP gross margin, 47.6% (+40 bps); operating margin, 30.2% (+60 bps).

  But the stock did not hold...even at a forward 10 P/E! LIke I stated in the top of this newsletter...many of these stocks have almost literally run out of non-index buyers after going up for two straight years!. 

Final Point: My long time friends Tobias Levkovich now at Citibank and Tony Dwyer now at Canaccord Genuity bring some big time reality to how euphoric the market is at this juncture and why it’s time to take down some our risk (yet still have big upside exposure the current melt-up in equity prices from synchronized world GDP expansion and US corporate tax cuts that will lead to additional world corporate tax cuts in response).

  • Bullish U.S. trading threatened by overextended optimism

  • Volatility, drawdowns tend to follow extreme points in indexes

Optimism has peaked, according to two widely followed measures of U.S. economic sentiment. If history is any guide, bouts of equity volatility and plunging Treasury yields will soon follow. The U.S. Citi Economic Surprise index -- the rate at which data exceeds analyst expectations -- has started to fall after reaching a five-year high in December. Meanwhile, the Federal Reserve’s index of the public’s uncertainty about the outlook for monetary policy is climbing after reaching a three-year low in November.

Though the economy remains strong, unbounded enthusiasm has run too far, according to Tony Dwyer. Reality will catch up to interrupt the widespread investor optimism and strong bullish trends imbuing nearly every corner of financial markets, he said. “We are not suggesting the data is going to get weak, just that expectations have become overly aggressive relative to what is likely to come out,” het wrote in a note to clients this week.

December was only the fifth time since 2003 the economic-surprise index peaked above 75. From each peak to the corresponding trough, 10-year yields on average dropped 1.11 percentage points over the next seven months, according to data compiled by Canaccord. Bonds have yet to respond to recent disappointing data, as the 10-year approaches the 2.66 percent high watermark set in 2014.

 The Monetary Policy Uncertainty index -- which measures angst around the Fed’s moves as recorded in news articles -- has enjoyed consistent weak inflation readings that set the stage for reliably accommodative policy. In fact, there have only been four other times on record when the public was this confident in Fed policy.

Yet in the past, after similar lows came “periods that were associated with more volatility and drawdowns,” said Dwyer, who added that the effect was often temporary. When factoring in the consequences of tax cuts and increasingly hawkish policy from other central banks, uncertainty is likely to increase, fueling volatility in U.S. stocks, he said.

But all we are hearing from the Street is GO GO GO. Here is a sample of what I read everyday from Wall Street. “Everything is pointing to an acceleration in growth,” said Jim O’Sullivan, chief U.S. economist at High Frequency Economics and the 20-time winner of MarketWatch’s Forecaster of the Month contest in December. U.S. economic growth “will be stronger in the year ahead, the unemployment rate will keep falling, and it’s likely that wages will keep moving up,” he said. O’Sullivan is predicting that real gross domestic product will expand 2.8% in 2018 while the unemployment rate drops to 3.5% by the end of the year.

With the economy already at full employment, the tax cut and the coming increases in federal spending will goose the economy by about three-quarters of a percentage point this year, he said.

However, Jim is on the same page as me: “But the impact of the stimulus will fade quickly as the Federal Reserve steps up the pace of its rate hikes to keep the economy from overheating, he said. Boosting the supply side — increasing the capacity of the economy to produce more goods and services — won’t come easily.”

The Grantham Melt-Up over the next 12-24 Months

When one of the biggest BEARS on Wall Street turns bullish, beward. Jeremy Grantham, who is credited with calling the 2000 and 2008 downturns, warned investors Wednesday to be prepared for the possibility of a near-term “melt-up” that would likely set the stage for a burst bubble and a stock-market meltdown. In a 13-page note that he emphasized reflected “a very personal view,” the value investor and co-founder and chief investment strategist of Boston-based asset manager GMO compared the present market setup with the run-up to past bubbles, including the 2000 tech boom and the precursor to the 1929 crash.
  “I recognize on one hand that this is one of the highest-priced markets in U.S. history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market,” Grantham said.

He terms the current market run-up the “possible/probable bubble of 2018-19.”

In the note, Grantham emphasizes that bubble calls shouldn’t necessarily rely on price alone. Instead, he puts emphasis on price acceleration, which captures “the importance of a true psychological event of momentum increasing to a frenzy.” I agree 100%... it's the "rate of change OF the rate of change" (aka known as "the second derivitive" to you physics and math fans...and you know who you are!) that is important to navigating the melt-up and blow-off cycle in bull markets. 

Read his complete note here.

Grantham favorably cited an academic paper published last year that concluded that the strongest indicator of a bubble in U.S. and almost all global markets was price acceleration. As for the S&P 500 SPX, +0.70% Grantham says that “just recently, say the last six months, we have been showing a modest acceleration, the base camp, perhaps, for a final possible assault on the peak. Jeremy sees a S&P 500 3400 to 3700 as the classic bubble blow-off top. 

At this point of the cycle so do I. 

14.png

“Exhibit 4 (shown below) represents our quick effort at showing what level of acceleration it might take to make 2018 (and possibly 2019) look like a classic bubble,” he wrote. “A range of nine to 18 months from today and a price rise to around 3,400 to 3,700 on the S&P 500 would show the same 60% gain over 21 months as the least of the other classic bubble events.” Other bubble factors cited by Grantham include increasing concentration on certain stock market “winners,” the outperformance of quality and low-beta stocks in a rapidly rising market, “extreme overvaluation” and the role of the Federal Reserve.

Here’s Grantham’s summary of his guesses:

  •  “A melt-up or end-phase of a bubble within the next six months to two years is likely, i.e., over 50%.

  • ”If there is a melt-up, then the odds of a subsequent bubble break or meltdown are very, very high, i.e., over 90%.

  •  “If there is a market decline following a melt-up, it is quite likely to be a decline of some 50%( due to the forced unwind of money borrow against or to buy stocks) 

15.jpg
16.jpg

John Lynch, LPL’s firm’s chief investment strategist makes a very interesting point “ Being overbought may sound like a negative for markets, but the “historically super overbought level” that markets have recently been trading at hasn’t always been followed by declines in the past. Somewhat surprisingly, the future returns are actually stronger after such periods of overbought natures,” Lynch wrote. “For instance, a year after being overbought, the S&P 500 is up 12.8% on average versus the average gain of 8.8% and higher 12 out of 13 times, which suggests there may be a good chance for solid market returns next year.”

17.jpg

Chart courtesy LPL Financial


Final Point: The NEXT 12-18 Months Will Be the KEY PERIOD to Growing our Portfolio's and more important KEEPING THEM at 200-300% and more of the value we started out with in 2013. I hope you have made or exceeded this prosperity; out job now is to KEEP it rolling and growing but KEEP the wealth we've earned with risk assets. 

PART II: Buy/Sell/HOLD on our portfolio and the NEW Transformational Change OPPORTUNITIES We will invest in for 2018-2019 (can you say cobalt, emerging markets and more!)  
Final Chart; the NYSE Primary Index of ALL NYSE Listed Equities: IT NEEDS A REST! It's been running like a young puppy yet its 9 years old!

18.png

Please let us know if you or your subscribers have run into any issues with the new website! If so, contact:  Msmith@nbtgroupinc.com   (301) 520-9610

- Toby

Copyright © 2018 Transformity Media, Inc., All rights reserved.

Our mailing address is:
38689 North 104th Place Scottsdale AZ 85262
(301) 520-9610
tsmith@tranformityresearch.com

19.jpg
Tobin Smith