Global Market Comments
December 8, 2016
Fiat Lux
Featured Trade:
(WHAT TO DO ABOUT MUNICIPAL BONDS),
(MUB), (TBT),
(THE MARKETS ARE NOT RIGGED)
iShares National Muni Bond (MUB)
ProShares UltraShort 20+ Year Treasury (TBT)
While the entire fixed income space is getting decimated by Trump?s plans to vastly expand government deficit spending, there is one particular sector that is coming in for extra abuse.
That would be tax-free municipal bonds.
This is a big deal, because about one third of the readers of the Diary of a Mad Hedge Fund Trader are professional financial advisors.
The field was one of a few in which advisors could add value for clients, because the idiosyncrasies of these securities often limit tax exemptions to residents of a single state, county, city, or utility or bridge district.
Advisors working at big firms also get special access to new issues unique to their clients? residential requirements.
The end result of a 30-year bull market in bonds is that many of them have saddled their clients with very heavy weightings in munis. Some have even distilled their businesses purely into municipal bond practices.
This was a great strategy going into November 8th. Not so good the day after.
The reasons are very simple.
During a time of raising taxes, such as during the past eight years, muni bonds traded at premiums, and the tax aspect of the securities becomes over valued.
During time of falling taxes, the tax free character of munis is less attractive, and they become undervalued.
On the morning of November 9th, about 2:00 AM the entire $3.7 trillion municipal bond market flipped from undervalued to overvalued.
That was when is became clear that Trump would capture the state of Pennsylvania, making it impossible for Hillary Clinton to win the presidential election.
The prospects of future tax increases under a Clinton administration thus went up in smoke.
The iShares National Muni Bond ETF (MUB) gave up all of its 2016 gains in a matter of days, and then some. It is now off a staggering 7.0% since its July high. Lesser-rated issues have fallen by much more than that.
Approximately $259 billion in muni bond market value has been wiped out in the past month.
These are the sharpest moves down in munis since analyst Meredith Whitney made her fateful prediction on CBS 60 Minutes in 2010 that some 2,000 muni bond issuers would default on their bonds during the coming year.
In the end I think only two actually did it.
The next day, the Mad Hedge Fund Trader put out a long term ?BUY? on muni bonds, especially those issued by the State of California, and they have been stellar performers ever since.
Until now.
This is a massive move for this normally sedentary corner of the financial markets.
Beleaguered financial advisors have been besieged by calls from clients asking what to do about their substantial muni bond holdings.
As I have been through this cycle a few times before during my half century in the markets, it is time for me to hand out some sage advice on what to do. Here are some options:
1) Panic and Sell Everything. This is usually a terrible idea. While coupon interest payments are tax exempt, the capital gains incurred if you sell aren?t.
If you have been holding your paper for any amount of time, like decades, the taxable gain could be enormous.
If you absolutely HAVE to sell for cash flow or other reasons, at least wait until next year, when capital gains taxes will almost certainly be cut.? At least then you won?t have to pay the taxes for 16 months instead of 4 ?.
2) Do Nothing. This is almost always the best option for long term, risk averse investors.
By launching a huge jobs program with jobless claims at a 43 year low and unleashing the demons of inflation, Trump has unwittingly planted the seeds of the next recession.
That will be caused by a severe interest rate spike that could happen in as soon as three years.
Then rates will crash, possibly making your muni bonds more valuable than they are today. And in the intervening three years you can keep happily clipping your coupons for tax-free income.
3) Hedge. Those who have the facility to do so may want to hedge the interest rate risk in their muni bond trades to reduce the volatility of their portfolio.
The easiest way to do this is to buy the ProShares Ultra Short 20+ Year Treasury Bond Fund (TBT), a 2X ETF that rises at roughly 1.5 times the rates that US Treasury bonds fall.
Look at the charts below, and you see that the 7% decline in the (MUB) since July was matched by a commensurate 42% rise in the (TBT). So the natural market neutral hedging ratio here will be about 6:1.
These are rough figures only, as they fail to account for differences in management fees and expenses.
The turmoil seen in the municipal bond market is going on in all asset classes at the same time as a result of the presidential election.
I will continue to hammer away in the Diary of a Mad Hedge Fund Trader ?at the short and long term implications for each one as soon as I figure them out.
Wow! Look at Those Muni Bonds Fall!
I recently read? ?Flash Boys?, Michael Lewis?s bestseller about high frequency trading.
In it, Lewis claims the markets are ?rigged? for the ordinary investor, and they are getting ripped off, in effect, paying a giant ?tax? to Wall Street to get their trades done.
Nothing could be further from the truth.
I have known Michael for 25 years, back when he was a wet behind the ears bond salesman at the former Salomon Brothers (now owned by Citigroup).
When he published an autobiographical recitation of his year there in 1989, a lot of people thought that I was him publishing under a pseudonym. It was only after he started making media appearances that this misunderstanding was resolved (he is a lot shorter than me).
Michael is first and foremost a storyteller. His previous books were about baseball (Moneyball), fatherhood (Home Game), and Silicon Valley (The New New Thing), as well as an assortment of financial topics, all entertaining endeavors.
The important thing is that these are stories intended to entertain. They are not documentaries. ?Flash Boys? has a coherent story line, a timeline, a good guy, lots of bad guys, and even a happy ending. Michael has certainly honed his craft over the decades.
The hero, Canadian Brad Katsuyama of RBC, embarks on a crusade to discover the truth behind HF trading. He discovers a viper?s nest of greedy, dishonest, and often foreign programmers lining their pockets at the public?s expense.
He comes to the revelation that if he created his own exchange where everyone was honest, victimized customers would flock to it in droves. He does, they do, and the angels sing. The Investor?s Exchange becomes a runaway success. Bring on the closing credits.
I calculate that Lewis should earn about $22.5 million pretax on this venture (5 million books X $30 X 15%), which explains why he has such a nice home next door to me in the Berkeley Hills.
If you want to learn about high frequency trading, you will pick up a few salacious details.
You will learn that a company backed by Netscape founder Jim Barksdale spent $300 million to lay a fiber optic cable from Chicago to New York just to shave a few milliseconds off order execution times.
One HF firm hasn?t had a losing trade in five years. Oh, and they tend to say F*** a lot on Wall Street. Big revelation!
But you will gain anything but the history, the broader picture, or how HF trading actually works. There are far better books around that do that, such as ?Dark Pools?, by Scott Patterson. But it?s a boring read.
In fact, the stock markets are miles away from being rigged. The Wall Street tax is the smallest it has ever been. When I first started in the business in the early seventies, it cost 25 cents to get one share done.
Today the cost is infinitesimally small. It was the collapse of order execution costs that made services like the Diary of a Mad Hedge Fund Trader possible. My strategies don?t work with the big-ticket commissions of yore.
Wall Street has been shrinking dramatically for the past eight years, faster than almost any other American industry, except for maybe newspapers and coal. The profits are just not there to support the enormous staffs of the past.
If you don?t believe me, just try to get your kid a job in the industry. No one will touch them without five years of experience.
Notice that the brokers don?t have the yachts anymore. Today, they are all owned by hedge fund managers and private equity guys, and the boats are a lot bigger.
I think the whole HF thing has been wildly exaggerated by the media. It was a slow news day when the book came out, and the networks were desperate to say anything. Vladimir Putin invading another country is not exactly new news.
No one really knows how much these people make. The current rumored figure for the bunch is anywhere from $1-$10 billion a year. This compares to the present market capitalization of American equities at $23 trillion.
In other words, it?s peanuts. We?re really looking at a tempest in a tea cup here.
There are no public firms where we can dig into financials, and the big banks hide all their HF income under a ?miscellaneous? item in their income statements (I looked). Who knows what goes on in dark pools? That's the point.
If these firms were really the printing presses they claim, where are all the listed companies? Wouldn?t owners want to claim the IPO premium and sell out for a high multiple of book value?
Virtu Financial was just about to go public, but the deal was postponed when the market fell apart.
I was offered an opportunity to back a start up that was a precursor to HF in the nineties. Back then, they were exploiting trapdoors in the exchange execution software that had been inadvertently left open by the original designers. I studied the business model carefully.
They needed $15 million in up front capital, and an additional annual operating budget of another $15 million. There was a risk that the anomaly they were exploiting could disappear at any time. The regulators could declare their activities illegal.
Congress could tax them out of existence if they attracted too much attention, as they did in Japan. The Internet could go down, trapping them in losing positions. Or someone could just accidentally kick the plug for the computer out of the wall socket.
Having lived through multiple technology collapses here in Silicon Valley, I can tell you that used high-end computers fetch about 20 cents on the dollar. Used desks fetch about 5 cents. The safety net is a long ways down.
All of this to earn 0.1 cent on a trade? If I have the ability to earn 100% on a single trade, which I do, then why commit enormous amounts of capital and weather unknown risks just to make 0.00001%?
In the end, I decided that you would only want to engage in HF trading if you couldn?t do anything else to make money in the markets.
I passed.
The bottom line here is that high frequency trading carries far more risk than is portrayed to the public, and than they may even understand themselves.
Just ask the former owners of Knight Capital, who lost $442 million in a single day due to a software glitch and had to be diluted out of existence to keep from going under. That?s a lot of tenths of cents.
A software glitch! When I have a software glitch, my TiVo doesn?t work or my alarm clock doesn?t go off on time. I don?t lose well into 11 figures, get financially wiped out, and threaten the stability of the financial markets!
The sad thing here is that when the big exchanges went public in 2006 their focus shifted from serving the public to satisfying their own shareholders. The interest of the little guy got tossed out the window. There really is no one looking after the welfare of the general public in the marketplace today.
It?s every man for himself.
To buy??Flash Boys: A Wall Street Revolt??at Amazon, please click here.
?The best thing in life is to have a piece of work worth doing, and then to do it well.? said America?s 23rd president, Theodore Roosevelt.
Global Market Comments
December 7, 2016
Fiat Lux
Featured Trade:
(THE DECLINING AMERICA MYTH),
(AAPL), (MSFT), (BA), (WMT), (MCD), (GM), (F)
Apple Inc. (AAPL)
Microsoft Corporation (MSFT)
The Boeing Company (BA)
Wal-Mart Stores, Inc. (WMT)
McDonald's Corporation (MCD)
General Motors Company (GM)
Ford Motor Company (F)
Seems it has become fashionable to bash America these days. As I travel around the country hosting my strategy luncheons, I hear a lament that has become all too familiar.
America has peaked as a civilization, the story goes, and will follow the British, French, Roman, and even the Egyptian empires into the dustbin of history.?
Our standard of living is falling, technological prowess is fading, and military strength is weakening.
It will be just another generation before the Chinese take over the world and we will all be forced to learn Mandarin in high school, or somebody worse will take their place.
Such bouts of doubt, angst, and self-loathing occur every generation in America.
I received a big dose after the US withdrew from Vietnam in 1972. My dad felt the same after Pearl Harbor was attacked in 1941. So did my grandfather when the Lusitania was sunk in 1917.
The outbreak of the Civil War in 1861 was considered the country?s darkest day. And then there was the British burning of Washington in 1812. I remember it like it was yesterday.
I say horse feathers, bullpucky, and balderdash to all this talk.
When speaking to foreign governments, military leaders, and central bankers during my global travels I keep hearing a recurring theme.
The United States is still the great shining example on the hill. We are dominant in technology and increasing our lead at an accelerating rate. All I hear about are our country?s strengths.
Our economy can evolve faster than anywhere else on the planet. This is because no one can beat us at creative destruction.
Some 26 years into Japan?s stock market crash, they are still maintaining companies on life support at enormous expense, some 20% of their stock market capitalization. We cleansed our system in about six months.
And try downsizing outdated unions in Germany. We have cut the union share of labor from 35% to 15% in 30 years. Where else can someone with no money, but good ideas, become a billionaire in a couple of years?
Since I am a numbers guy, let me throw a few out there just to make my case. With a $16.8 trillion GDP, ours is triple that of contenders number two and three at $5 trillion, respectively China and Japan.
We are nearly four times Germany?s size at $4 trillion. Our per capita GDP is a staggering twelve times China?s. That means it takes 12 Chinese workers to produce an hour of output compared to our one.
This is why America?s per capita GDP stands at $53,041, compared to only $6,807 in the Middle Kingdom, and many Chinese have to work a 70 hour week to take that home.? They are supposed to be overtaking us? Even the Chinese laugh when I tell them this.
Some 18 of the world?s 50 largest companies are still US based, like Amazon (AMZN), Facebook (FB), Apple (AAPL), and Boeing (BA). But this understates the true picture.
Ours occupy far and away the highest end of the value added chain. Many of the rest scrape by copying or pirating our products. You never get ahead that way. Look no further than Apple which pays workers a minimal $15/day to build US designed products for sale at home with enormous profit margins.
It?s hard to find a strategic industry that we don?t dominate. US companies invented ?fracking? which has untapped vast new energy supplies, making the Middle East irrelevant. Saudi princes come here for their health care, not England or Japan. ?Globalization? has in fact become the polite word for ?Americanization?.
I was standing at Piccadilly Circus in London this summer when a bus stopped and unloaded 50 gorgeous high school girls. I couldn?t for the life of me figure out their nationality. They could have come from anywhere.
The teacher had a big rear end so I though maybe they were American. Then a kid lit up a cigarette and no one cared. Aha! French. They turned out to be the winners of a national English language essay-writing contest and the prize was a trip to the Olympics.
Let me just toss a few more tidbits out there:
*The biggest selling luxury car in China is a General Motors (GM) Buick
* iPhones, Ford Mustangs, and Katy Perry songs are pouring into a newly freed Libya
*Cubans and Iranians are erecting illegal satellite dishes so they can watch Law and Order
*Travel around Eastern Europe and all you see are blue jeans
*Over 70% of the drinkers of Coca-Cola are outside the US
*McDonald?s (MCD) has 10,000 hamburger stands abroad
*Microsoft?s (MSFT) Windows operating system runs 90% of the world?s computers
*London has 19,000 people a month joining Match.com
*100,000 readers a day pirate The Diary of a Mad Hedge Fund Trader, and even record a Mandarin version on YouTube
While the US has run big trade deficits for 50 years, we have a perennial surplus in services that goes unnoticed.
We remain the force to reckon with in banking and finance, thanks to the reserve currency status of the dollar. Transfer dollars from the UK to Japan and it has to go through New York. This isn?t changing in my lifetime.
The world?s wealthy and well connected have long sent their children to American universities. Six out of ten of the world?s best schools are here, matched only by Oxford, Cambridge, Tokyo University, and Beijing University.
You may be concerned about our rising level of national debt. Aren?t we under saving and over spending?
The credit markets beg to differ with you. With 30-year Treasury bond rates at 3.08%, the world is literally throwing money at us as fast as they can. With the long-term inflation rate probably at 2%, this means that our government can borrow money nearly for free!
Foreign individuals and institutions regularly take down more than half of our monthly government debt issues. With Europe in trouble, this trend is accelerating.
You have heard me talk a lot about demographics over the years. The US still has a modestly positive slope to its demographic pyramid which is the best in the developed world.
This means that we can expect an ever larger number of young consumers to drive economic growth, largely driven by immigration. This will lead to a new Golden Age for America in the 2020s which I believe will be a repeat of the 1950s.
Japan, Russia, and Europe suffer from a diabolical demographic outlook. China doesn?t look so hot either, thanks to its abandoned ?One Child? policy. They?re just not making young people anymore.
Since I am also an old and grizzled Marine combat veteran and stay well connected with the military establishment, let me tell you a few harsh realities.
Our military technology is the most advanced in human history, unbeatable, deeply feared, and is improving at breakneck speed. The American soldier is the best trained and most lethal ever deployed into the field.
Did you know that no Air Force fighter pilot has been shot down in 25 years, despite being almost continuously at war during this entire time? The next generation of US fighters won?t even have pilots, with drones carrying much of the heavy lifting in today?s combat.
The US now provides for the active defense of about half of the landmass of the world, double that protected by the British Empire at its 1914 peak.
Two decades after the end of the Cold War, the United States has no enemies of any real consequence.
According to the CIA, Al Qaida has been worn down to a mere 200 active members. The futility of their efforts, confining explosives to shoes and underwear show
how badly things have gone for them.
We have been doing this with ever declining amounts of money. The military share of US GDP has plunged from 50% in 1943 to 6% at the end of the Cold War in 1992 to 4.7% today.
Cyber warfare and drones are much cheaper than carrier groups and advanced fighters. If we spend less on weapons, the rest of the world will too. In a year, expect to start hearing about this a lot on your dinnertime news.
What about China you may ask?
They have had the blueprints of our most advanced defensive systems for many years now. But having a picture of a weapon is a long way from building one. They lack the technical expertise and the machinery even to copy what we already have.
In any case, everyone knows China is indefensible. Torpedo one foreign grain ship, and the country will be starving in six months. China will never pose a threat as long as they can?t live without us and we have all of their money.
The next time I hear we have the world?s highest tax rate I am going to scream!
I moved a company here from Europe 20 years ago because the actual taxes paid are low to non-existent. Just ask General Electric (GE) which pays a 3% tax rate. But hey, if this was easy, it would pay minimum wage, not ten figures, so I?ll take things as they are.
And the next time someone tells you that the US is history, consider that person a great short.
It is they who are headed for the dustbin.
Things Aren?t That Bad!
?We?re all just one trade away from humility, Bud.? said a stockbroker in the classic film, Wall Street.
Global Market Comments
December 6, 2016
Fiat Lux
Featured Trade:
(DECEMBER 7TH LIVE GLOBAL STRATEGY WEBINAR),
(THE ONE STOCK YOU HAVE TO ABSOLUTELY BEG, BORROW, OR STEAL),
(NVDA),
(TESTIMONIAL)
NVIDIA Corporation (NVDA)
Nvidia (NVDA) is a stock that you should beg, borrow, or steal your way into any way you can.
Fortunately for you, the recent presidential election just gave you an opportunity to steal it.
By making instant pariahs out of the technology sector, and their globalization-based models, the? President-Elect is forcing portfolio managers to throw babies out with their bathwater.
That includes Nvidia, which gave up 10.52% from its high during last week?s tech wreck.
I first recommended Nvidia on November 2nd, (read more about ?The Great Artificial Intelligence Stock You?ve Never Heard Of?).
In the piece I argued that the shares could double over the next three years.
I lied.
They rocketed by a stunning 43.93% in the following three weeks!
And after what I heard at an exclusive Silicon Valley dinner party last week, I now believe that my doubling call is ultra conservative.
Leaks are emerging that Nvidia is about to make public its SATURN V supercomputer, so named after the NASA rocket that took astronauts to the moon during the 1960s and 1970s.
It is a cluster of 124 DGX-1s super computers, known as Nvidia's "AI in a Box". It delivers 9.46 gigaflops per watt, a 42 percent improvement from the 6.67 gigaflops per watt delivered by the most efficient machine on the Top 500 list released only last June.
This is a big step towards exascale computing, or one completing quintillion floating-point operations per second.
In addition, (NVDA) wants to combine AI and supercomputing, unlocking the power of AI for large-scale problems like autonomous vehicles, modeling fusion reactors, and a plethora of breakthroughs where deep learning would be a good fit for the problem at hand.
I have been covering Silicon Valley since it was a verdant, sun-kissed peach orchard in Northern California.
I have to say that in the half century that I have followed the technology industry, I have never seen the principals, gurus, and visionaries so excited about a major new trend.
That would be artificial intelligence or AI.
Asking if AI is relevant now is like pondering the future of Thomas Edison?s new electricity in 1890.
If you think AI still belongs in the realm of science fiction, you obviously didn?t get the memo. It is all around us all the time, 24/7. You just don?t know it yet.
And here?s the rub.
It is impossible to invest purely in AI.
All new AI startups comprise small teams of experts from labs and universities financed by big venture capital firms like Sequoia Capital, Kleiner Perkins, and Andreeson Horowitz.
After developing software for a year or two, they are sold on to major technology firms at huge premiums. They never see the light of day in the form of a public offering.
Alphabet (GOOG) acquired Britain based, Deep Mind, in 2014. Later that year, Google?s AlphaGo program defeated the world?s top ranked Go player.
Last year, Microsoft (MSFT) purchased Equivio, a small firm that applies AI to advanced document searches on the Internet.
Amazon (AMZN) recently bought out Orbeus, a startup known for machine learning tools for image recognition.
Amazon?s Jeff Bezos now says that his Amazon Fresh home food delivery service is using AI to grade strawberries.
Really!
We?re not talking small potatoes here.
The global artificial intelligence market is expected to grow at an annual rate of 44.3% a year to $23.5 billion by 2025.
Nearly half of all applications now use some form of AI that by 2020 will earn businesses an extra $60 billion a year in profits.
And from what I have learned from speaking to the major players over the last few weeks, I am convinced that these numbers are low by an order of magnitude.
It gets better.
If you have, in any way, been involved in the stock market for the past five years, AI has invaded your life.
High frequency trading and hedge funds now account for 70% of the daily trading volume on the major stock exchanges, and almost all of this is AI driven.
Having spent my entire life trading stocks, I can confirm that in recent years the market?s character has dramatically changed and not for the better. Call it trading untouched by human hands.
Algorithms are trading against algorithms, and whoever wins the nuclear arms race brings home the big bucks.
You used to need degrees in Finance and Economics, or perhaps an MBA, to become a professional fund manger. Now it?s a PhD in Computer Science.
Remember the May, 2010 flash crash, when the Dow Average plunged 1,100 points in minutes, wiping out $4.1 billion in equity value? AI?s fingerprints were all over that.
And only weeks ago, the British pound lost 6% of its value in a mere two minutes, a move unprecedented in the history of foreign exchange markets. The culprit was AI.
Don?t expect the path forward to AI to be an easy or smooth one.
Indeed, the machines already have the power of life and death over all of us.
Since we aren?t venture capitalists, we can?t buy into pure AI firms in their early stages. And I?m too old to get a PhD in computer science.
We therefore have to be sneaky and get in through the back door via an indirect play which still has plenty of upside leverage.
What is the one medium sized, publicly listed company that most benefits from the AI explosion?
I have found exactly such a company (it was small at the beginning of the year) that represents the marrying of the four biggest trends in technology today: AI, self-driving cars, big data, and virtual reality.
That would be Nvidia (NVDA).
The Santa Clara, California based company manufactures graphics processing units (GPUs) for the gaming market as well as system-on-a-chip units (SOCs).
It is heavily involved in super computing and mobile computing, producing processors for tablets, iPhones, and vehicle navigation systems.
Nvidia, named after the Roman god, Nemesis, was founded in 1993. It was the original supplier of processors for the Microsoft Xbox and Sony?s (SNE) PlayStation 3.
In 2011, it demonstrated the first quad-core processor for mobile devices.
Nvidia has been on an acquisition tear over the past decade, picking up more than a dozen companies to expand its reach into the most advanced AI and manufacturing technologies, as well as picking up some first class talent.
Nvidia has more engineers working on AI than any other company, or institution, in the world.
Its integrated stack of imaginative chip designs is unmatched.
Its principal competitors are Advanced Micro Devices (AMD), Intel (INTC) and QUALCOM (QCOM).
To learn more about Nvidia, please visit their website at Nvidia
http://www.nvidia.com/content/global/global.php .
She?s Smarter Than You Think
Thanks for your very informative daily updates and stories. I subscribe to four daily investment advisors and yours are the only one I always read and almost always follow.
I followed your trades to the letter and most were successful. The problem was I was not trading live (always at least half a day late and sometimes a full day due to the time difference (US versus AUD), and my trade size was too small.
I am basically using your alerts as the trigger to place the trade as a CFD (entry via a stop just above previous day?s high ? for a long/call) and then manage them with a trailing stop loss using the daily charts (stop loss just below previous day?s low unless the day was an inside bar).
This seems to work much better and entry and exits from trades are far more successful at the price you want to trade at.
Looking forward to applying this strategy for 2017 and hopefully I will catch up with you next time you are in Australia.
Hope you have a great XMAS and New Year.
Regards,
David
Pullenvale, Australia
