Global Market Comments
April 3, 2020
Fiat Lux
Featured Trade:
(THE CODER BOOM)
(HOW TO EXECUTE A VERTICAL BULL CALL SPREAD)
(AAPL)
Posts
Global Market Comments
March 24, 2020
Fiat Lux
Featured Trade:
(TEN SIGNS THE MARKET IS BOTTOMING),
(FXI), (BRK/A), (BA), (DAL), (SPX),
(INDU), (UUP), (VIX), (VXX), (AAPL)
I spent the morning calling some big hedge fund friends asking what they are looking for to indicate the market may be bottoming. I’ll give you a warning right now. None of the traditional fundamental or technical measures have any validity in this market.
Markets will need to see at least one, and maybe all of these before they launch into a sustainable recovery. The good news is that several have already happened and are flashing green.
1) Watch New Corona Cases in China
The pandemic started in China and it will end in China (FXI). The president of China, Xi Jinping, has already announced that the epidemic is over and that the country is returning to normal. The country is donating thousands of respirators and millions of masks to Europe and poor countries all over the world. China was able to enforce a quarantine far more severe than possible in the West, such as using the army to surround 60 million people for a month. So, the results in the Middle Kingdom may not be immediately transferable to the US.
If we do get an actual fall in the number of cases in China, that could indicate the end is near. To keep track, click here.
2) Watch Corona Cases in Italy
Italy quarantined two weeks before California so we should get an earlier answer there. The numbers are reliable, but we don’t know the true extent of their quarantine. After all, this is Italy. Also, Italy has a much older population than the US (that Mediterranean diet keeps Italians alive forever), so they will naturally suffer a higher death rate. However, a decline in cases there will be proof that a western-style shelter-in-place order will work. To keep track, click here.
3) Watch Corona Cases in California
The Golden State was the first to quarantine ten days ago, so it will be the first American state to see cases top out. On Monday, we were at 1,733 cases and 27 deaths, or one in 1.5 million. However, it is a partial quarantine at best, with maybe half of the 20 million workforce staying home. When our cases top out, which should be the week of April 13, it could be an indication that the epidemic is flagging. To keep track, click here.
4) Watch Washington
Passage of a Corona Economic Recovery Bill could take place as early as Friday and could be worth $2 trillion. Add in the massive stimulus provided by the Federal Reserve, a large multiple of the 2008-2009 efforts, and $10 trillion is about to hit the economy. Warning: don’t be short an economy that is about to be hit with $10 trillion worth of stimulus.
5) Watch the Technicals.
Yes, technicals may be worthless now but someday in the future, they won’t be. The stock market has traded 20% below the 200-day moving average only four times in the last century. The Dow Average (INDU) was 32% below the 200-day moving average at the Monday low. The next rip-your-face off short-covering rally is imminent and may initially target that down 20% level at $21,496, or 18% above the Monday low.
6) Watch for the Big Buy
Value players are back in the market for the first time in six years, the last time the S&P 500 (SPX) traded at a discount to its historical 15.5X earnings multiple and are circling targets like hungry sharks. Watch for Warren Buffet of Berkshire Hathaway (BRK/A) to buy a large part of a trophy property, like a major bank or airline. He’s already stepped up his ownership in Delta Airlines (DAL). I’m sure he’s going over the books of Boeing (BA). Warren might even buy back his own stock at a discount to net asset value, down 31.4% in a month. Any move by Warren will signal confidence to the rest of the markets.
7) Watch the US Dollar
With US overnight interest rates having crashed by 1.5% in recent weeks, the US dollar (UUP) should be the weakest currency in the world. The greenback overnight became a zero-yielding currency. Instead, it has been the strongest, rocketing on a gigantic global flight to safety bid. When the foreign exchange rates return to rationality, the buck should weaken, as it has already started to do after last week’s super spike. A weak dollar will be good for American companies and their stocks.
8) Watch the (VIX)
We now know that the Volatility Index (VIX), (VXX) was artificially boosted last week by hundreds of short players covering positions with gigantic losses and going bust. Now that this is washed out, I expect volatility to decline for the rest of 2020. It has already fallen from $80 to $49 in days. This is a precursor to a strong stock market.
9) Watch the Absolute Value of the Market
There could be a magic number beyond which prices can’t fall anymore. That could be yesterday’s 18,000, 17,000, or 15,000. Some 80% of all US stocks are owned by long term holders who never sell, like pension funds, corporate crossholdings, or individuals who have owned them for decades and don’t want to pay the capital gains tax. When the ownership of that 20% is shifted to the 80%, the market runs out of sellers and stocks can’t fall anymore. That may have already happened. Similarly, a final capitulation selloff of market leaders, like Apple (AAPL) may also be a sign that the bear market is ending. (AAPL) is off 34.40% since February.
10) Watch John Thomas
I am watching all of the above 24/7. So rather than chase down all these data points every day, just watch for my next trade alert. I am confined to my home office for the duration, probably for months, so I have nothing else to do. No trips to Switzerland, the Taj Mahal, or the Great Pyramids of Egypt for me this year. It will just be nose to the grindstone.
Stay Healthy and we’ll back a killing on the back nine.
John Thomas
It will be inevitable – the 5G shift in 2020 will be delayed.
Last year, 5G was available on only about 1% of phones sold in 2019 and demand has cratered this year because of exogenous variables.
Up to just recently, Apple (AAPL) was the bellwether of the success of tech with wildly appreciating shares due to the expected ramp-up to a new 5G phone later this year.
Well, things are more complicated now.
I will be the first one to say it - the new Apple 5G iPhone will be delayed until 2021 – the project has been thrown into doubt because of a demand drop off and headaches with the supply chain in China.
The phenomenon of 5G cannot blossom until consumers can upgrade to 5G devices.
Concerning all the media print of China Inc. going back to work, don’t believe a word of it.
People of the Middle Kingdom are sitting at home just like you and me by navigating around top-down government edicts.
Instead of the perilous commute in a country of 1.4 billion people, Chinese workers are fabricating attendance figures per my sources.
Overall data is grim - global smartphone shipments dropped 38% year-over-year during February from 99.2 million devices to 61.8 million - the largest fall ever in the history of the smartphone market and that is just the tip of the iceberg.
The new data point underscores the magnitude of how the coronavirus is sucking the vitality out of the tech ecosystem in China and thus the end market for global consumer electronics.
The statistic also foreshadows imminent trouble in the smartphone market as other regions have now shut down not only in China but the manufacturing hubs of South East Asia.
The outbreak squeezes both supply and demand.
Factories in Asia are unable to manufacture phones as usual because of obligatory government shutdowns and complexities securing critical components from the supply chain.
5G has been hyped up as the great leap forward for wireless technology that will usher in unprecedented new use cases supercharging global GDP — from driverless transport to robotic automation to smart football stadiums.
And coronavirus is just that Godzilla destroying 5G momentum down.
Mass quarantines, social distancing, remote work, and schooling have been instituted in American cities, meaning that the current network carriers are swamped and overloaded with a surge in data usage.
The Verizon’s (VZ) and the AT&T (T) Broadbands of America are currently focused on maintaining their current core customers, adding extra broadband to handle the increased load, and making sure the health of the network stays intact.
This is a poor climate to upsell products to beleaguered Americans who have just lost income and possibly their house because they cannot pay mortgages.
Services such as YouTube and Netflix (NFLX) have even decreased the quality of streaming on their platforms to handle the dramatic spike in extra usage in Europe with the whole continent locked down.
The Chinese consumer was the Darkhorse catalyst to ramp up the global economic expansion during the last economic crisis, picking up world spending in 2009.
On the contrary, this group of super spenders is less inclined to save the global economy this time around because they are saddled with domestic debt.
Just as unhelpful to Silicon Valley revenues, the technology relationship at the top of the governments are poised to worsen because of the health scare.
The U.S. administration has already banned the use of Chinese components in the U.S. 5G network amid suspicions the devices would be used for espionage.
Back stateside, I believe the U.S. telecoms will explicitly detail a sudden slowdown in the 5G network rollout during their next earnings report.
The telecom companies have been able to successfully handle the extra incremental load, but it has had to allocate resources to service the extra volume.
In the meantime, companies will shift to doing infrastructure and site preparation in anticipation of the re-build up to 5G, but that could be next to be put on ice if crisis management moves to the forefront.
Considering every 5G base station is being manufactured in Asia, one must be naïve in believing all is well and they will probably need to do what the 2020 Tokyo Olympics will shortly do – postpone it.
It’s not business as usual anymore.
This time it’s different.
The world just isn’t ready to digest such a shift in global business as 5G until the fallout of the coronavirus is in the rear-view mirror.
The 5G phenomenon underlying effect is to supercharge globalization into smaller networks of interconnectivity and that is not possible during a black swan event like the coronavirus which is the antithesis of globalization and interconnected business.
Just take the situation across the Atlantic Ocean in Europe, UBS Group AG, and Credit Suisse Group AG required clients to post additional collateral, and money managers in New York are preparing term sheets for ultra-rich Americans to urgently meet margin calls.
Many people are scurrying back to their doomsday’s shelter and that does not scream global business.
If you thought gold was the safe haven – wrong again – it experienced back-to-back weekly losses as margin pressures force fire sales of gold to raise cash.
Another glaring example are the assets of Eldorado Resorts Inc., controlled by the founding Carano family, which burned $28.7 million of stock in the casino entity to meet a margin call to satisfy a bank loan.
Things are that bad now!
Sure, telecom players might argue that a sudden influx of workers from home necessitates more investment in 5G, but if they have no income, all bets are off.
The capacity of 4G home broadband has proved it is good enough for today’s demands and it means the last stage of 4G will be a high data consumption longer phase before business lethargically pivots to 5G in 2021.
Verizon’s CEO Hans Vestberg said last year that half the U.S. will have access to 5G by the end of 2020, and I will say that is now impossible.
This sets up a generational buy in the Silicon Valley chip names involved in 5G after coronavirus troubles peak such as Nvdia (NVDA), Xilinx (XLNX), Qorvo (QRVO), and QUALCOMM Incorporated (QCOM).
Followers of the Global Trading Dispatch have the good fortune to own a deep in-the-money options position that expires on Friday, and I just want to explain to the newbies how to best maximize their profits on that March 20 expiration.
This involves the:
Apple (AAPL) March 2020 $220-$230 in-the-money vertical BULL CALL spread
Microsoft (MSFT) March 2020 $120-$125 in-the-money vertical BULL CALL spread
Amazon (AMZN) March 2020 $1,350-$1,400 in-the-money vertical BULL CALL spread
Provided that we don’t have another 3,000 point move down in the market this week, these positions should expire at their maximum profit points. So far, so good.
I’ll do the math for you on the Apple (AAPL) position. Your profit can be calculated as follows:
Profit: $10.00 - $8.80 = $1.20
(11 contracts X 100 contracts per option X $1.20 profit per options)
= $1,320 or 13.63% in 7 trading days.
Many of you have already emailed me asking what to do with these winning positions.
The answer is very simple. You take your left hand, grab your right wrist, pull it behind your neck, and pat yourself on the back for a job well done.
You don’t have to do anything.
Your broker (are they still called that?) will automatically use your long position to cover your short position, canceling out the total holdings.
The entire profit will be credited to your account on Monday morning March 23 and the margin freed up.
Some firms charge you a modest $10 or $15 fee for performing this service.
If you don’t see the cash show up in your account on Monday, get on the blower immediately and find it.
Although the expiration process is now supposed to be fully automated, occasionally mistakes do occur. Better to sort out any confusion before losses ensue.
If you want to wimp out and close the options position before the March 20 expiration, it may be expensive to do so. You can probably unload them pennies below their maximum expiration value.
Keep in mind that the liquidity in the options market disappears and the spreads substantially widen when a security has only hours, or minutes until expiration on Friday. So, if you plan to exit, do so well before the final expiration at the Friday market close.
This is known in the trade as the “expiration risk.”
One way or the other, I’m sure you’ll do OK, as long as I am looking over your shoulder, as I will be, always. Think of me as your trading guardian angel.
I am going to hang back and wait for good entry points before jumping back in. It’s all about keeping that “Buy low, sell high” thing going.
I’m looking to cherry-pick my new positions going into the next quarter end.
Take your winnings and go out and buy yourself a well-earned dinner. Or use it to put a down payment on a long cruise.
Well done and on to the next trade.
This Market Can Be Very Tricky
I just drove from Carmel, California to San Francisco on scenic Highway 1. I was virtually the only one on the road.
The parking lot at Sam’s Chowder House was empty for the first time in its history. The Pie Ranch had a big sign in front saying “Shut”. The Roadhouse saw lights out. It was like the end of the world.
The panic is on.
The economy has ground to a juddering halt. Most US schools are closed, sports activities banned, and travel of any kind cancelled. All ski resorts in the US are shut down as are all restaurants, bars, and clubs in California. Virtually all public events of any kind have been barred for the next two months. Apple (AAPL) and Nike (NIKE) have closed all their US stores.
The moment I returned from my trip, I learned that the Federal Reserve has cut interest rates by a mind-boggling 1.00% on the heels of last week’s 0.50% haircut. This is unprecedented in history. S&P Futures responded immediately by going limit down for the third time in a week.
The most pessimistic worst-case scenario I outlined a week ago came true in days. The (SPX) is now trading at 2,500. Goldman Sachs just put out a downside target at 2,000, off 41% in three weeks.
That takes the market multiple down from 20X three weeks ago to 14X, and the 2020 earnings forecast to crater from $165 to $143. These are numbers considered unimaginable only a week ago.
You can blame it all on the Coronavirus. Global cases shot above 160,000 yesterday, while deaths exceeded 5,800. In the US, we are above 3,000 cases with 60 deaths. The pandemic is growing by at least 10% a day. All international borders are effectively closed.
The stock market has effectively impeached Donald Trump, unwinding all stock market gains since his election. At the Thursday lows, the Dow Average ticked below 20,000, less than when he was elected. Economic growth may be about to do the same, wiping out the 7% in economic growth that has taken place during the same time.
Leadership from the top has gone missing in action. The president has told us that the pandemic “amounts to nothing”, is “no big deal”, and a Democratic “hoax.” There is no Fed effort to build a website to operate as a central clearing house for Corona information. In the meantime, the number of American deaths has been doubling every three days.
There have only been 13,500 tests completed in the US so far and they are completely unavailable in my area. The bold action to stem the virus has come from governors of the states of all political parties.
The good news is that all this extreme action will work. If you shut down the economy growth, the virus will do the same. In two weeks, all carriers will become obvious. Then you simply quarantine them. Any dilution of the self-quarantine strategy simply stitches out the process and the market decline.
The hope now is that the recession, which we certainly are now in, will be sharp but short. “An ounce of prevention is worth a pound of cure” is certainly in control now.
When we come out the other side of this, we will be perfectly poised to launch into my new American Golden Age, or the next Roaring Twenties. With interest rates at zero, oil at $25 a barrel, and many stocks down by half, there will be no reason not to.
Oil (USO) crashed, taking Texas tea down an incredible $22 overnight. OPEC collapsed as Saudi Arabia took on Russia in a price war, flooding the market. All American fracking companies with substantial debt have just been rendered worthless. I told you to stay away from MLPs! It’s amazing to see how the effect of one million new electric cars can have on the oil market. Blame it all on Elon Musk.
The oil crash is all about the US. American fracking has added 4 million barrels a day of supply over the last five years and 8 million b/d during the last ten. Saudi Arabia and Russia would love to wipe out the entire US industry.
Even if they do, the private equity boys are lining up to buy assets at ten cents on the dollar and bring in a new generation of equity investors. The wells may not even stop pumping. How do you say “Creative Destruction” in Arabic and Russian? We do it better than anyone else.
Gold (GLD) soared above $1,700, on a massive flight to safety bid bringing the old $1,927 high within easy reach.
Bond yields (TLT) plunged to 0.31% as recession fears exploded. Looks like we are headed to 0% interest rates in this cycle. Corona cases top 4,000 in the US and fatalities are rising sharply. Malls, parking lots, and restaurants are all empty.
Trump triggered a market crash, with a totally nonsensical Corona plan. Banning foreigners from the US will NOT stop the epidemic but WILL cause an instant recession, which the stock market is now hurriedly discounting. This is an American virus now, not a foreign one or a Chinese one. The market has totally lost faith in the president, who did everything he could to duck responsibility. The US is short 100,000 ICU beds to deal with the coming surge in cases. No one has any test kits at the local level. We could already have 1 million cases and not know it.
The US could lose two million people, according to forecasts by some scientists. At 100 million cases with a 5% fatality rate, get you there in three months. That could cause this bear market to take a 50% hit. The US is now following the Italian model, doing too little too late, where bodies are piling up at hospitals faster than they can be buried.
Stocks are back to their January 2017 lows, down 1,000 (SPX) points and 9,500 Dow points (INDU) in three weeks. Yikes! Unfortunately, I lived long enough to see this. We’ve seen 14 consecutive days of 1,000-point moves. The speed of the decline is unprecedented in financial history.
The Recession is on. Look for a short, sharp recession of only two quarters. JP Morgan is calling for a 2% GDP loss in Q2 and a 3% hit in Q3. The good news is that the stock market has already almost fully discounted this. The only way to beat Corona is to close down the economy for weeks.
A two-week national holiday is being discussed, or the grounding of all US commercial aircraft. Warren Buffet has cancelled Berkshire Hathaway’s legendary annual meeting. All San Francisco schools are closed, events and meetings cancelled. The acceleration to the new online-only economy is happening at light speed.
Municipal bonds crashed, down ten points in three days to a one-year low. If you thought that you parked your money in a safe place, think again. Municipalities are seeing tax and fee incomes collapse in the face of the Coronavirus. Brokers are in panic dumping inventories to meet margin calls. There is truly no place to hide in this crisis but cash, which is ALWAYS the best hedge. I would start buying (MUB) around here.
Bitcoin collapsed 50% in two days, to an eye-popping $4,000. So much for the protective value of crypto currencies. I told you to stay away. No Fed help here.
My Global Trading Dispatch performance has gone through a meat grinder, pulling back by -10.36% in March, taking my 2020 YTD return down to -13.28%. That compares to an incredible loss for the Dow Average of -32% at the Friday low. My trailing one-year return was pared back to 35.31%. My ten-year average annualized profit shrank to +33.84%.
I have been fighting a battle for the ages on a daily basis to limit my losses. My goal here is to make it back big time when the market comes roaring back in the second half.
My short volatility positions have been hammering me. I shorted the (VXX) when the Volatility Index (VIX) was at $35. It then went to an unbelievable $76. I was saved by only trading in very long maturity, very deep out-of-the-money (VXX) put options where time value will maintain a lot of their value. These will all come good well before their one-year expiration.
I also took profits in four short position at the market lows in Apple (AAPL) and the three short positions in Corona-related stocks, (CCL), (WYNN), and (UAL), which cratered, picking up an 8% profit there.
At the slightest sign of a break in the pandemic, the economy and shares should come roaring back. As things stand, I can handle a 3,000 point in the Dow Average from here and still have all of my existing positions expire at their maximum profit point with the Friday options expiration.
On Monday, March 16 at 7:30 AM, the New York Empire State Manufacturing Index is out.
On Tuesday, March 17 at 5:00 AM, the Retail Sales for February is released.
On Wednesday, March 18, at 7:30 AM, the Housing Starts for February is printed.
On Thursday, March 19 at 8:30 AM, Weekly Jobless Claims are announced.
On Friday, March 20 at 9:00 AM, the February Existing Home Sales is published. The Baker Hughes Rig Count follows at 2:00 PM.
As for me, I went down to Carmel, California to hole up in a hotel near the most perfect beach in the state and do some serious writing. This is the city where beachfront homes go for $10 million and up, mostly owned by foreign investors and tech billionaires from San Francisco. Locals decamped from here ages ago because it became too expensive to live in.
This is also where my parents honeymooned in 1949, borrowing my grandfather’s 1947 Ford.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Below please find subscribers’ Q&A for the Mad Hedge Fund Trader March 11 Global Strategy Webinar broadcast from Silicon Valley, CA with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!
Q: What is the worst-case scenario for this bear market?
A: The average earnings loss for a recession is 13%. Last year, we earned $165 a share for the S&P 500. So, a recession would take us down to $143 a share. Multiply that by the 15.5X hundred-year average earnings multiple, where we are now, and that would take the (SPX) down to 2,200. However, if we get 100 million cases and 5 million deaths, as some scientists are predicting, we could get a 2008 repeat and a 50% crash in the (SPX) to 1,700. With the administration asleep at the switch, that is clearly a possibility. Nice knowing you all.
Q: Do you think we’re still setting up for another roaring 20s?
A: Yes, absolutely. We could not have a roaring 20s unless we got a major selloff and clearing out of old positions like we're getting now. That flushes out all the old capital and positions and paves the way for people to set up brand new positions at really bargain prices. If you missed the 2009 bottom, here's another chance.
Q: Will the fiscal stimulus help defeat the coronavirus?
A: No, viruses are immune to money. They don’t take PayPal or American Express (AXP). The president has been able to buy his way out of all his other problems until now; there’s no way to buy his way out of this one.
Q: Is JP Morgan’s (JPM) Jamie Dimon getting a heart attack related to the financial crisis?
A: Probably, yes. In a normal time, the pressure of a CEO in these big banks is enormous. All of a sudden half of your small customers are looking at bankruptcy—the pressure has to be immense. You've got customers screaming for short term loan facilities, you’ve got risk managers asking for margin extensions. And you certainly don't want to buy the banks here. I think this may be the final selloff with legacy banks, from which they never recover. The banks will disappear and come back online.
Q: What would you do with a $45,000-dollar portfolio right now? I don’t do options.
A: Look at my story on Ten Leaps to Buy at Market Bottom. Use those names—Microsoft (MSFT), Apple (AAPL), NVIDIA (NVDA), etc.—and just buy the stocks. Buy half now and a half in a month. This is a time to dollar cost average. And you’re looking at doubles at a minimum 3 years down the road—at the end of this year if you’re lucky. Once the virus burns out, it will only take a couple months to do that. Then it will be off to the races once again.
Q: Since the 2018 low was never tested, what do you think of 2400/2450?
A: I think that’s great. And you can get a half dozen different analyses that all come up with numbers around 2400, 2500, 2600. That’s where the final low will be—where you get a convergence of multiple support lines and opinions.
Q: Will buybacks come back or are they over for now?
A: They will come back once markets bottom. Companies aren’t stupid; they don’t like buying their own stocks at all-time highs, but they certainly will come in with major amounts of buying when they see their stocks down 20% or 30%. That's certainly what Apple is going to do.
Q: Will luxury retail shares get killed in the current market?
A: Yes, especially stocks like (LVMH), the old Louis Vuitton Moet Hennessey. They’re already down 37% this year. When it becomes clear that we are in an actual recession, these luxury names across the board will get completely abandoned. By the way, I worked with the son of the founder of this company when I was at Morgan Stanley. We called him “Bubbles.”
Q: Are there any similarities to 2008?
A: Yes; it’s worse because the market is dropping much faster than it ever has before. The 52% selloff in 2008 was spread out over the course of 18 months. Here, it’s taken only 14 trading days to see half of the damage done back then. It’s truly unbelievable.
Q: What do you think about gold (GLD)?
A: Even though gold is going up, gold miners (GDX) are doing terribly because they are stocks. They get tarred with the same brush blackening all other stocks. This is exactly what happened during the 2008-2009 crash. Fundamentals go out the window in these kinds of trading conditions, but they always come back.
Q: Is Europe in recession?
A: Absolutely, yes. I saw an interview with the Adidas CEO (ADDYY) this morning on TV and they said sales are off 90% on a month-on-month basis. Their stock is down 49% this year. You can bet that every other consumer company in Europe is suffering similar declines.
Q: What will real estate do in the next 3 months?
A: It's impossible to price real estate so finely because it's so illiquid. However, I expect it to hold up here because of super low interest rates, and then keep rising over the long term. We’re not going to get anything like the crashes we saw in 2008-2009 because all the excess leverage is not in the real estate market now, it’s in the stock market, where we are getting a much-deserved crash. If anything, I’d be buying rental properties here in low cost cities.
Q: What if the Dow Average (INDU) reaches the 300-day moving average?
A: It’s a nice theory, but technicals are meaningless in the face of panic selling. You don't want to get too fancy looking at these charts. When you have a billion shares to go at market, the 200 or 300 day moving average means nothing.
Good Luck and Good Trading. And stay healthy.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Today, we saw the largest point loss in market history, the first use of modern circuit breakers, and individual stocks down up to 40%. Ten-year US Treasury bond yields cratered to 0.39%. Virtually the entire energy and banking sectors vaporized.
What did I do? I did what I always do during major stock market crashes.
I took my Tesla out to get detailed. When I got home, I washed the dishes and did some laundry. And for good measure, I mowed the lawn, even though it is early March and it didn’t need it.
That’s because I was totally relaxed about how my portfolio would perform.
There is a method to my madness, although I understand that some new subscribers may need some convincing.
I always run hedged portfolio, with hedges within hedges within hedges, although many of you may not realize it. I run long calls and puts against short calls and puts, balance off “RISK ON” positions with “RISK OFF” ones, and always keep a sharp eye on multi-asset class exposures, options implied volatilities, and my own Mad Hedge Market Timing Index.
While all of this costs me some profits in rising markets, it provides a ton of protection in falling ones, especially the kind we are seeing now. So, while many hedge funds are blowing up and newsletters wiping out their readers, I am so relaxed that I could fall asleep at any minute.
Whenever I change my positions, the market makes a major move or reaches a key crossroads, I look to stress test my portfolio by inflicting various extreme scenarios upon it and analyzing the outcome.
This is second nature for most hedge fund managers. In fact, the larger ones will use top of the line mainframes powered by $100 million worth of in-house custom programming to produce a real-time snapshot of their thousands of positions in all imaginable scenarios at all times.
If you want to invest with these guys feel free to do so. They require a $10-$25 million initial slug of capital, a one-year lock-up, charge a fixed management fee of 2% and a performance bonus of 20% or more.
You have to show minimum liquid assets of $2 million and sign 50 pages of disclosure documents. If you have ever sued a previous manager, forget it. The door slams shut. And, oh yes, the best performing funds are closed and have a ten-year waiting list to get in. Unless you are a major pension fund, they don’t want to hear from you.
Individual investors are not so sophisticated, and it clearly shows in their performance, which usually mirrors the indexes less a large haircut. So, I am going to let you in on my own, vastly simplified, dumbed-down, seat of the pants, down and dirty style of risk management, scenario analysis, and stress testing that replicates 95% of the results of my vastly more expensive competitors.
There is no management fee, performance bonus, disclosure document, lock up, or upfront cash requirement. There’s just my token $3,000 a year subscription fee and that’s it. And I’m not choosy. I’ll take anyone whose credit card doesn’t get declined.
To make this even easier, you can perform your own analysis in the excel spreadsheet I post every day in the paid-up members section of Global Trading Dispatch. You can just download it and play around with it whenever you want, constructing your own best-case and worst-case scenarios. To make this easy, I have posted this spreadsheet on my website for you to download by clicking here. You have to be logged in to access and download the spreadsheet.
Since this is a “for dummies” explanation, I’ll keep this as simple as possible. No offense, we all started out as dummies, even me.
I’ll take Mad Hedge Model Trading Portfolio at the close of March 9, 2020, the date of a horrific 2,000 down day in the Dow Average. This was the day when margin clerks were running rampant, brokers were jumping out of windows, and talking heads were predicting the end of the world.
I projected my portfolio returns in three possible scenarios: (1) The market collapses an additional 5.3% by the March 20 option expiration, some 8 trading days away, (2) the S&P 500 (SPX) rises 10% by March 20, and (3) the S&P 500 trades in a narrow range and remains around the then-current level of $2,746.
Scenario 1 – The S&P 500 Falls Another 5.3% to the 2018 Low
A 5.3% loss would take the (SPX) down to $2,600, to the 2018 low, and off an astonishing 800 points, or 23.5% down from the recent peak in a mere three weeks. In that situation the Volatility Index (VIX) would rise maybe to $60, the (VXX) would add another point, but all of our four short positions (AAPL), (UAL), (CCL), and (WYNN) would expire at maximum profit points.
In that case, March will end up down -3.58%, and my 2020 year-to-date performance would decline to -6.60%, a pittance really compared to a 23.5% plunge in the Dow Average. Most people would take that all day long. We live to buy another day. Better yet, we live to buy long term LEAPs at a three-year market low with my Mad Hedge Market Timing Index at only 3, a historic low.
Also, when the market eventually settles down, volatility will collapse, and the value of my (VXX) positions double.
Scenario 2 – S&P 500 rises 10%
The impact of a 10% rise in the market is easy to calculate. All my short positions expire at their maximum profit point because they are all so far in the money, some 20%-40%. It would be a monster home run. I would go back in the green on the (VXX) because of time decay. That would recover my March performance to +1.50% and my year-to-date to only -1.42%
Scenario 3 – S&P 500 Remains Unchanged
Again, we do great, given the circumstances. All the shorts expire at max profits and we see a smaller increase in the value of the (VXX). I’ll take that all day long, even though it cost me money. When running hedge funds, you are judged on how you manage your losses, not your gains, which are easy.
Keep in mind that these are only estimates, not guarantees, nor are they set in stone. Future levels of securities, like index ETFs, are easy to estimate. For other positions, it is more of an educated guess. This analysis is only as good as its assumptions. As we used to say in the computer world, garbage in equals garbage out.
Professionals who may want to take this out a few iterations can make further assumptions about market volatility, options implied volatility or the future course of interest rates. And let’s face it, politics is a major influence this year. Thanks Joe Biden for that one day 1,000 point rally to sell into, when I established most of my shorts and dumped a few longs.
Keep the number of positions small to keep your workload under control. Imagine being Goldman Sachs and doing this for several thousand positions a day across all asset classes.
Once you get the hang of this, you can start projecting the effect on your portfolio of all kinds of outlying events. What if a major world leader is assassinated? Piece of cake. How about another 9/11? No problem. Oil at $10 a barrel? That’s a gimme.
What if there is an American attack on Iranian nuclear facilities to distract us from the Coronavirus and stock market carnage? That might take you all two minutes to figure out. The Federal Reserve launches a surprise QE5 out of the blue? I think you already know the answer.
Now that you know how to make money in the options market, thanks to my Trade Alert service, I am going to teach you how to hang on to it.
There is no point in being clever and executing profitable trades only to lose your profits through some simple, careless mistakes.
The first goal of risk control is to preserve whatever capital you have. I tell people that I am too old to lose all my money and start over again as a junior trader at Morgan Stanley. Therefore, I am pretty careful when it comes to risk control.
The other goal of risk control is the art of managing your portfolio to make sure it is profitable no matter what happens in the marketplace. Ideally, you want to be a winner whether the market moves up, down, or sideways. I do this on a regular basis.
Remember, we are not trying to beat an index here. Our goal is to make absolute returns, or real dollars, at all times, no matter what the market does. You can’t eat relative performance, nor can you use it to pay your bills.
So the second goal of every portfolio manager is to make it bomb-proof. You never know when a flock of black swans is going to come out of nowhere or another geopolitical shock occurs causing the market crash.
Below please find subscribers’ Q&A for the Mad Hedge Fund Trader February 26 Global Strategy Webinar broadcast from Silicon Valley, CA with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!
Q: There’s been a moderation of new coronavirus cases in China. Is this what the market needs to find a bottom?
A: Absolutely it is; of course, the next risk is that cases keep increasing overseas. The final bottom will come when overseas cases start to disappear, and that could be a month or two off.
Q: How low will interest rates go after the coronavirus?
A: Well, interest rates already hit new all-time lows before the virus became a stock market problem. The virus is just giving it a turbocharger. Our initial target of 1.32% for the ten-year US Treasury bond was surpassed yesterday, and we think it could eventually hit 1.00% this year.
Q: What is the best way to know when to buy the dip?
A: When the Volatility Index (VIX) starts to drop. If you can get the volatility index down to the mid-teens and stay there, then the market will stabilize and start to rise fairly sharply. A lot of the really high-quality stocks in the market, like United Airlines (UAL), Walt Disney (DIS), Apple (AAPL) and Amazon (AMZN), have really been crushed by this selloff. So those are the names people are going to look at for quality at a discount. That’s going to be your new investment theme, buying quality at a discount.
Q: Do recent events mean that Boeing (BA) is headed down to 200?
A: I wouldn't say $200, but $280 is certainly doable. And if you get to $280, then the $240/$250 call spread all of a sudden looks incredibly attractive.
Q: What does a Bernie Sanders presidency mean for the market?
A: Well, if he became president, we could be looking at like a 50-80% selloff—at least a repeat of the ‘09 crash. However, I doubt he will get elected, or if elected, he won’t have control of congress, so nothing substantial will get done.
Q: Is this the beginning of Chinese (FXI) bank failures that will cause an economic crisis in mainland China?
A: It could be, but the actual fact is that the Chinese government is doing everything they can to rescue troubled banks and companies of all types with short term emergency loans. It’s part of their QE emergency rescue package.
Q: Can you explain what lower energy prices mean for the global economy?
A: Well, if you’re an oil consumer (USO), it’s fantastic news because the price of gas is going down. If you’re an oil producer (XLE), like for people in the Middle East, Texas, Louisiana, Oklahoma, and North Dakota, it’s terrible news. And if you’re involved anywhere in the oil industry, or own energy stocks or MLPs, you’re looking at something like another great recession. I have been hugely negative on energy for years. I’ve seen telling people to sell short coal (KOL). It’s having a “going out of business” sale.
Q: Should I aggressively short Tesla (TSLA) here? Surely, they couldn’t go up anymore.
A: Actually, they could go up a lot more. I would just stay away from Tesla and watch in amazement—there’s no play here, long or short. It suffices to say that Tesla stock has generated the biggest short-selling losses in market history. I think we’re up to about $15 billion now in short losses. Much smarter people than us have lost fortunes trying in that game.
Q: Was that an Amazon trade or a Google trade?
A: I sent out both Amazon and an Apple trade alert this morning. You should have separate trade alerts for each one.
Q: Are chips a long term buy at today’s level?
A: Yes, but companies like NVIDIA (NVDA), Micron Technology (MU), and Advanced Micro Devices (AMD) may be better long-term buys if you wait a couple of weeks and we test the new lows that we’ve been talking about. Chips are the canary in the coal mine for the global economy, and we have not gotten an all-clear on the sector yet. If you’re really anxious to get into the sector, buy a half of a position here and another half 10% down, which might be later this week.
Q: When will Foxconn reopen, the big iPhone factory in China?
A: Probably in the next week or so. Workers are steadily moving back; some factories are saying they have anywhere from 60-80% of workers returning, so that’s positive news.
Q: Are bank stocks a sell because of lower interest rates?
A: Yes, absolutely. If you think the 10-year treasury is running to a 1.00% yield as I do, the banks will get absolutely slaughtered, and we hate the sector anyway on a long-term basis.
Q: What about future Fed rate cuts?
A: Futures markets are now pricing in possibly three more rate cuts this year after discounting no more rate cuts only a few weeks ago. So yes, we could get more interest rates. I think the government is going to pull all the stops out here to head off a corona-induced recession.
Q: Once your options expire, is it still affected by after-hours trading?
A: If you read the fine print on an options contract, they don’t actually expire until midnight on a Saturday night after options expiration day, even though the stock market stops trading on a Friday. I’ve never heard of a Saturday exercise, but you may have to get a batch of lawyers involved if you ever try that.
Q: What’s the worst-case scenario for this correction?
A: Everything goes down to their 200-day moving averages, including Indexes and individual stocks. You’re talking about Apple dropping to $243 and Microsoft (MSFT) to $144, and NASDAQ (QQQ) to 8,387. That could tale the Dow Average (INDU) to maybe 24,000, giving up all the 2019 gains.
Good Luck and Good Trading
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Just as every cloud has a silver lining, every stock market crash offers generational opportunities.
In a month or two, there will be spectacular trades to be had with LEAPS. What are LEAPS, you may ask?
This is the best strategy with which to cash in on the gigantic market swoons, which have become a regular feature of our markets.
Since the advent of the recent incredible market volatility, I have been asked one question.
What do you think about LEAPS?
LEAPS, or Long Term Equity AnticiPation Securities, is just a fancy name for a stock option spread with a maturity of more than one year.
You execute orders for these securities on your options online trading platform, pay options commissions, and endure option like volatility.
Another way of describing LEAPS is that they offer a way to rent stocks instead of buying them, with the prospect of enjoying years’ worth of stock gains for a fraction of the price.
While these are highly leveraged instruments, you can’t lose any more money than you put into them. Your risk is well defined.
And there are many companies in the market where LEAPs are a very good idea, especially on those gut-wrenching 1,000-point down days.
Interested?
Currently, LEAPS are listed all the way out until January 2022, some 695 days away.
However, the further expiration dates will have far less liquidity than near month options, so they are not a great short-term trading vehicle. That is why limit orders in LEAPS, as opposed to market orders, are crucial.
These are really for your buy-and-forget investment portfolio, defined benefit plan, 401k, or IRA.
Because of the long maturities, premiums can be enormous. However, there is more than one way to skin a cat, and the profit opportunities here can be astronomical.
Like all options contracts, a LEAP gives its owner the right to "exercise" the option to buy or sell 100 shares of stock at a set price for a given time.
LEAPS have been around since 1990, and traded on the Chicago Board Options Exchange (CBOE).
To participate, you need an options account with a brokerage house, an easy process that mainly involves acknowledging the risk disclosures that no one ever reads.
If a LEAP expires "out-of-the-money" – when exercising, you can lose all the money that was spent on the premium to buy it. There's no toughing it out waiting for a recovery as with actual shares of stock. Poof, and your money is gone.
LEAPS are also offered on exchange-traded funds (ETFs) that track indices like the Standard & Poor's 500 index (SPY) and the Dow Jones Industrial Average (INDU), so you could bet on up or down moves of the broad market.
Not all stocks have options, and not all stocks with ordinary options also offer LEAPS.
Note that a LEAPS owner does not vote proxies or receive dividends because the underlying stock is owned by the seller, or "writer," of the LEAP contract until the LEAP owner exercises.
Despite the Wild West image of options, LEAPS are actually ideal for the right type of conservative investor.
They offer more margin and more efficient use of capital than traditional broker margin accounts. And you don’t have to pay the usurious interest rates that margin accounts usually charge.
And for a moderate increase in risk, they present outsized profit opportunities.
For the right investor, they are the ideal instrument.
Let me go through some examples to show you their inner beauty.
By now, you should all know what vertical bull call spreads are. If you don’t, then please click their link for a quickie video tutorial. You must be logged in to your account.
Let’s go back to February 9, 2018 when the Dow Average plunged to its 23,800 low for the year. I then begged you to buy the Apple (AAPL) June, 2018 $130-$140 call spread at $8.10, which most of you did. A month later, that position is worth $9.40, up some 16.04%. Not bad.
Now let’s say that instead buying a spread four months out, you went for the full year and three months, to June 2019.
That identical (AAPL) $130-$140 would have cost $5.50 on February 9. The spread would be worth $9.40 today, up 70.90%, and worth $10 on June 21, 2019, up 81.81%.
So, by holding a 15-month to expiration position for only a month, you get to collect 86.67% of the maximum potential profit of the position.
So, now you know why we leap into LEAPS.
When the meltdown comes, and that could be as soon as today, use this strategy to jump into longer-term positions in the names we have been recommending and you should be able to retire early.
What’s out there today? Take a look at Boeing (BA), one of the most undervalued companies in the market, thanks to their 737 MAX woes.
Today, (BA) shares were trading at a lowly $305. Let say that Boeing shares recover to $350 by the end of 2020. You can buy a January 2021 $340-$350 vertical bull call spread for $3.00. If Boeing makes it back up to $350 by the January 15, 2021 option expiration, the LEAP will expire worth $10, an increase of 233%.
It gets better. You can buy a (BA) January 2022 $370-$380 call spread for $2.15. If Boeing recovers to $380 by the January 21, 2022 expiration it will expire worth $10, giving you a gain of 365%!
What if you think that Boeing is overdue for a monster rally back to its old all-time high of $450?
You can buy a (BA) January 2022 $420-$430 calls spread for $0.90. If Boeing makes it all the way back to $430 by the January 21, 2022 expiration, it will expire worth $10, giving you a gain of 1,011%! Caution: If the shares only make it back up to $429, the position becomes worthless.
Now you know why I like LEAPS so much. Play around with the names and the numbers and I’m sure you will find something you like. But remember one thing. Buying LEAPS is only a trade to consider at long time market bottoms, not tops!
Time to Leap Into LEAPS