Boy, did we have a great run in emerging markets during the 2000s!
A global commodity boom caused many of these markets to rise tenfold or more.
Go back to the earliest newsletters published by the Diary of a Mad Hedge Fund Trader in 2008, and you will find them chock full of recommendations to buy hard assets, emerging market ETFs, debt, and currencies.
As former colonies, many of these countries still base their economies on production of the precious and base metals, energy, and foodstuffs they once supplied the motherland.
And as a former correspondent for The Economist magazine covering this territory, I knew them well.
Then in 2011, the party abruptly ended, and a vicious five-year bear market ensued.
Oil peaked first, eventually nosediving some 82.5%, from $149 to $26.
Remember Dr. Copper, the only commodity with a PhD in economics? He gave up 57.9%.
And gold, that ultimate store of value for Armageddonists and conspiracy theorists everywhere? It plunged by 48.2%.
There are still a lot of unhappy American gold eagles sitting in bank deposit boxes around the country gathering dust, thanks to those ridiculous theories.
It didn?t help that a raging bull market in developed market government bonds sucked even more money out of these beleaguered countries.
The Emerging market debt ETF (ELD), collapsed by 32%. The emerging market currency ETF (CEW) dropped by 35.5%.
My long-term subscribers can already see where this is going.
The wonderful thing about all of these cross asset class declines is that they have a leveraged effect on each other.
So while the ishares MSCI Emerging Market ETF (EEM) fell by 38.9%, in dollar terms it declined by more than half.
Then a funny thing happened during the second week of January 2016.
Gold took off like a rocket.
It was closely followed by silver, oil copper, palladium, platinum, and iron ore. Only the ags failed to participate.
The bull market was back!
Portfolio managers were given a simple choice.
Should they chase developed market assets trading at all time highs with yields approaching zero. Or should they load up on emerging assets at decade lows with yields approaching 12%?
Yields that high can cover up a lot of mistakes and preserve principal.
If you voted for the latter, you deserve a brass ring.
Here we are some eight months later, and the emerging bull market is alive and well. In fact, it is about to take another substantial new leg upwards.
My money is on emerging market handily beating the major US stock indexes for the rest of 2016.
The reasons for this are many and complex.
For a start, the iShares MSCI Emerging Market ETF (EEM) is still cheap.
It has to rise by 21.6% just to get back up to its 2011 highs. As a laggard play, it is beyond reproach.
In emerging market debt, the positive carry is enormous.
The Wisdom Tree Emerging Market Local Debt Fund (ELD) is yielding 5.46%, some 390 basis points high than the ten year Treasury bond (TLT).
And if you want to go with individual rifle shots in single countries, you can earn as much as 11.90% in Brazil.
The ?lower for longer? philosophy of the Fed just shines a giant great spotlight on this paper.
And guess what happened while you weren?t looking?
Emerging market debt has ?emerged.?
Five years of balance sheet repair means their credit quality has improved.
Local credit markets have grown up too.
Once dominated by huge inflows and outflows from foreign investors, markets are now much more in balance, thanks to the rise of? local institutional investors and pension funds.
The fundamentals of these countries have been steadily improving.
Falling currencies gave them a competitive advantage that allowed? trade surpluses to dramatically improve.
Political stability is improving. During my journalist days, you used to be able to count on one good coup d??tat or revolution in the area a year. No more.
Many business friendly, pro trade governments have come into power, such as in Argentina, India and Peru.
Emerging market GDP growth rates are still double those found in developed markets.
Markets themselves are improving. Spreads for stocks and bonds are now much tighter in emerging markets and liquidity has improved. They are ?roach motel? markets no more, where you can check in, but you can?t check out.
Get this one right, and the cross asset class hockey stick effect we saw on the downside will work just as well on the upside.
In short, there is a lot more to the emerging market dollar than there used to be. It is just a matter of time before financial markets figure this out.
I am once again writing this report from a first class sleeping cabin on Amtrak?s California Zephyr.
By day, I have two comfortable seats facing each other next to a panoramic window. At night, they fold into bunk beds, a single and a double. There is a shower, but only Houdini could get in and out of it.
I am not Houdini, so I go downstairs to use the larger public showers.
We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American accomplishment.
I am headed for Emeryville, California, just across the bay from San Francisco. That gives me only 56 hours to complete this report.
I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure, and to keep me up to date with the onboard gossip.
The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Spellchecker can catch most of the mistakes, but not all of them.
Thank goodness for small algorithms.
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied searches during stops at major stations along the way to chase down data points.
You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS.
Who knew that 95% of America is off the grid? That explains a lot about our country today. I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone 6.
After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2015 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Even the stay-at-home index players had their heads handed to them.
With the Dow gaining 3.1% in 2015, and S&P 500 almost dead unchanged, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for eight boring consecutive months before spiking repeatedly many times to as high as 52%. Most hedge funds lagged the index by miles.
My Trade Alert Service, hauled in an astounding 38.8% profit, at the high was up 48.7%, and has become the talk of the hedge fund industry.
If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:
The Four Key Variables for 2016
1) Will the Fed raise interest rates more or not?
2) Will China?s emerging economy see a hard or soft landing?
3) Will Japanese and European quantitative easing increase, or remain the same?
4) Will oil bottom and stay low, or bounce hard?
Here are your answers to the above: no, soft, more later, bounce hard later.
There you go! That?s all the research you have to do for the coming year. Everything else is a piece of cake.
The Ten Highlights of 2015
1) Stocks will finish higher in 2016, almost certainly more than the previous year, somewhere in the 5% range and 7% with dividends. Cheap energy, a recovering global economy, and 2-3% GDP growth, will be the drivers. However, this year we have a headwind of rising interest rates and falling multiples.
2) Expect stocks to take a 15% dive. That gives us a -15% to +5% trading range for the year. Volatility will remain permanently higher, with several large spikes up. That means you are going to have to pedal harder to earn your crust of bread in 2016.
3) The Treasury bond market will modestly grind down, anticipating the next 25 basis point rate rise from the Federal Reserve, and then the next one after that.
4) The yen will lose another 5% against the dollar.
5) The Euro will fall another 5%, doing its best to hit parity with the greenback, with the assistance of beleaguered continental governments.
6) Oil stays in a $30-$60 range, showering the economy with hundreds of billions of dollars worth of de facto tax cuts.
7) Gold finally bottoms at $1,000 after one more final flush, then rallies $250. (My jeweler was right, again).
8) Commodities finally bottom out, thanks to new found strength in the global economy, and begin a modest recovery.
9) Residential real estate has made its big recovery, and will grind up slowly from here for years.
10) The 2016 presidential election will eat up immense amounts of media and research time, but will have absolutely no impact on financial markets. Give your money to charity instead.
The Thumbnail Portfolio
Equities - Long. A rising but high volatility year takes the S&P 500 up to 2,200. Technology, biotech, energy, solar, consumer discretionary, and financials lead. Energy should find its bottom, but later than sooner.
Bonds - Short. Down for the entire year, but not by much, with long periods of stagnation.
Foreign Currencies - Short. The US dollar maintains its bull trend, especially against the Yen and the Euro, but won't gain nearly as much as in 2015.
Commodities - Long. A China recovery takes them up eventually.
Precious Metals - Buy as close to $1,000 as you can. We are overdue for a trading rally.
Agriculture - Long. El Nino in the north and droughts in Latin American should add up to higher prices.
Real estate - Long. Multifamily up, commercial up, single family homes up small.
1) The Economy - Fortress America
I think real US economic growth will come in at the 2.5%-3% range.
With a generational demographic drag continuing for five more years, don?t expect more than that. Big spenders, those in the 46-50 age group, don?t return in larger numbers until 2022.
But this negative will be offset by a plethora of positives, like hyper-accelerating technology, global expansion, and the lingering effects of the Fed?s massive five year quantitative easing.
US corporate profits will keep pushing to new all time highs. But this year we won?t be held back by the collapsing economies of Europe, China, and Japan, which subtracted about 0.5% from American economic growth, nor weak energy.
US Corporate earnings will probably come in at $130 a share for the S&P 500, a gain of 10% over the previous year. During the last six years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.
Technology and dramatically lower energy costs are the principal sources of profit increases, which will continue their inexorable improvements. Think of more machines and software replacing people.
You know all of those hundreds of billions raised from technology IPO?s in 2015? Most of that is getting plowed right back into new start ups, increasing the rate of technology improvements even further, and the productivity gains that come with it.
We no longer have the free lunch of zero interest rates. But the cost of money will rise so slowly that it will barely impact profits. Deflation is here to stay. Watch the headline jobless rate fall below 5% to a full employment economy.
Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read as to whether the financial markets will head in a ?RISK ON? or ?RISK OFF? direction.
For the first time in seven years, earnings multiples are going to fall, but not by much. That is the only possible outcome in a world with rising interest rates, however modestly.
If multiples fall by 5%, from the current 18X to 17.1X, profits increase by 10%, and you throw in a 2% dividend, you should net out a 7% return by the end of the year.
S&P 500 earnings fell by 6% in 2015, but take out oil and they grew by 5.6%. In 2016, energy will be a lesser drag, or not at all. That makes my 10% target doable.
That is not much of a return with which to take on a lot of risk. But remember, in a near zero interest rate world, there is nothing else to buy.
This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years.
The market currently trades around fair value, and no market in history ever peaked out here. An overshoot to the upside, often a big one, is mandatory. Yet, that is years off.
After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not? Borrowing money at close to zero and investing in 2% dividend paying stocks has become the world?s largest carry trade.
Rising interest rates will have one additional worrying impact on stock prices. They will pare back mergers and acquisitions and corporate buy backs in 2016.
Together these were the sources of all new net buying of stocks in 2015, some $5.5 trillion worth. Call it financial engineering, but the market loves it.
Although energy looks terrible now, it could well be the top-performing sector by the end of the year, to be followed by commodities.
Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year expansion of leverage in the industry, it is ripe for a cleanout.
Solar stocks will continue on a tear, now that the 30% federal investment tax subsidy has been extended by five more years. Look at Solar City (SCTY), First Solar (FSLR), and the solar basket ETF (TAN). Revenues are rocketing and costs are falling.
After spending a year in the penalty box, look for small cap stocks to outperform. These are the biggest beneficiaries of cheap energy and low interest rates.
Share prices will deliver anything but a straight-line move. Expect a couple more 10% plus corrections in 2015, and for the Volatility Index (VIX) to revisit $30 multiple times. The higher prices rise, the more common these will become.
Amtrak needs to fill every seat in the dining car, so you never know who you will get paired with for breakfast, lunch, and dinner.
There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate to get out of Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.
A retired British couple was circumnavigating the entire US in a month on a ?See America Pass.? Mennonites returning home by train because their religion forbade airplanes.
I have to confess that I am leaning towards the ?one and done? school of thought with regards to the Fed?s interest rate policy. We may see a second 25 basis point rise in June, but only if the economy takes off like a rocket and international concerns disappear, an unlikely probability.
If you told me that US GDP growth was 2.5%, unemployment was at a ten year low at 5.0%, and energy prices had just plunged by 68%, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.25%.
We clearly are seeing a brave new world.
Global QE added to a US profit glut has created more money than the fixed income markets can absorb.
Virtually every hedge fund manager and institutional investor got bonds wrong last year, expecting rates to rise. I was among them, but that is no excuse.
Fixed income turned out to be a winner for me in 2015, as I sold short every bond price spike from the summer onward. It worked like a charm.
You might as well take your traditional economic books and throw them in the trash. Apologies to John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson.
The reasons for the debacle are myriad, but global deflation is the big one. With ten year German bunds yielding a paltry 62 basis points, and Japanese bonds paying a paltry 26 basis points, US Treasuries are looking like a steal.
To this, you can add the greater institutional bond holding requirements of Dodd-Frank, a balancing US budget deficit, a virile US dollar, the commodity price collapse, and an enormous embedded preference for investors to keep buying whatever worked yesterday.
For more depth on the perennial strength of bonds, please click here for ?Ten Reasons Why I?m Wrong on Bonds?.
Bond investors today get an unbelievable bad deal. If they hang on to the longer maturities, they will get back only 80 cents worth of purchasing power at maturity for every dollar they invest a decade down the road.
But institutions and individuals will grudgingly lock in these appalling returns because they believe that the potential losses in any other asset class will be worse.
The problem is that driving eighty miles per hour while only looking in the rear view mirror can be hazardous to your financial health.
While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite.
A 2% handle on the ten-year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough.
There is another factor supporting bonds that no one is looking at. The concentration of wealth with the 1% has a side effect of pouring money into bonds and keeping it there. Their goal is asset protection and nothing else.
These people never sell for tax reasons, so the money stays there for generations. It is not recycled into the rest of the economy, as conservative economists insist. As this class controls the bulk of investable assets, this forestalls any real bond market crash, at lest for the near term.
So what will 2016 bring us? I think that the erroneous forecast of higher yields I made last year will finally occur this year, and we will start to chip away at the bond market bubble?s granite edifice.
I am not looking for a free fall in price and a spike up in rates, just a move to a new higher trading range.
We could ratchet back up to a 3% yield, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2015 performance, taking it from $46 back up to $60.
You might have to wait for your grandchildren to start trading before we see a return of 12% Treasuries, last seen in the early eighties. I probably won?t live that long.
Reaching for yield suddenly went out of fashion for many investors, which is typical at market tops. As a result, junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (AMLP) are showing their first value in five years.
There is also emerging market sovereign debt to consider (PCY). If oil and commodities finally bottom, these high yielding bonds should take off on a tear.
This asset class was hammered last year, so we are now facing a rare entry point.
There is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase tax-free muni values.
The collapse of the junk bond market suddenly made credit quality a big deal last year. What is better than lending to the government, unless you happen to live in Puerto Rico or Illinois.
So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way, and mark to markets could be shocking.
Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits.
One question I always get asked at lunches, conferences, and lectures is what is going to happen to the budget deficit?
The short answer is that it disappears in 2018 with no change in current law, thanks to steady growth in tax revenues and no big new wars.
And Social Security? It will be fully funded by 2030, thanks to a huge demographic tailwind provided by the addition of 86 million Millennials to the tax rolls.
A bump up in US GDP growth from 2% to 4% during the 2020?s will also be a huge help, again, provided we don?t start any more wars.
It looks like I am going to be able to collect after all.
Without much movement in interest rates in 2016, you can expect the same for foreign currencies.
Last year, we saw never ending expectations of aggressive quantitative easing by foreign central banks, which never really showed. What we did get, was always disappointing.
The decade long bull market in the greenback continues, but not by much. You can forget about those dramatic double digit gains the dollar made against the Euro at the beginning of last year, which we absolutely nailed.
The fundamental play for the Japanese yen is still from the short side. But don?t expect movement until we see another new leg of quantitative easing from the Bank of Japan. It could be a long wait.
The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate.
The dramatic sell off we saw in the Japanese currency since December, 2012 is the beginning of what I believe will be a multi decade, move down. Look for ?130 to the dollar sometime in 2016, and ?150 further down the road.
I have many friends in Japan looking for an overshoot to ?200. Take every 3% pullback in the greenback as a gift to sell again.
With the US having the world?s strongest major economy, its central bank is, therefore, most likely to continue raising rates the fastest.
That translates into a strong dollar, as interest rate differentials are far and away the biggest decider of the direction in currencies. So the dollar will remain strong against the Australian and Canadian dollars as well.
For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book. Now that the Yuan is an IMF reserve currency, it has attained new respectability.
But don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth in order to keep its appreciation modest to maintain their crucial export competitiveness.
There isn?t a strategist out there not giving thanks for not loading up on commodities in 2015, the preeminent investment disaster of the year. Those who did are now looking for jobs on Craig?s List.
It was another year of overwhelming supply meeting flagging demand, both in Europe and Asia. Blame China, the one big swing factor in the global commodity.
The Middle Kingdom is currently changing drivers of its economy, from foreign exports to domestic consumption. This will be a multi decade process, and they have $3.5 trillion in reserves to finance it.
It will still demand prodigious amounts of imported commodities, especially, oil, copper, iron ore, and coal, all of which we sell. But not as much as in the past. This trend ran head on into a decade long expansion of capacity by the industry.
The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE), have all taken an absolute pasting.
The food commodities were certainly the asset class to forget about in 2015, as perfect weather conditions and over planting produced record crops for the second year in a row, demolishing prices. The associated equity plays took the swan dive with them.
Not even the arrival of one of the biggest El Nino events in history could bail them out.
However, the ags are still a tremendous long term Malthusian play. The harsh reality here is that the world is making people faster than the food to feed them, the global population jumping from 7 billion to 9 billion by 2050.
Half of that increase comes in countries unable to feed themselves today, largely in the Middle East. The idea here is to use any substantial weakness, as we are seeing now, to build long positions that will double again if global warming returns in the summer, or if the Chinese get hungry.
The easy entry points here are with the corn (CORN), wheat (WEAT), and soybean (SOYB) ETF?s. You can also play through (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU).
The grain ETF (JJG) is another handy fund. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cakewalk. You can participate in this most liquid of assets with the ETF?s (PHO) and (FIW).
You are now an oil trader, even if you didn?t realize it. Yikes!
The short-term direction of the price of Texas tea will be the principal driver for the prices of all asset classes, as it was for the 2015.
The smartest thing I did in 2015 was to ignore the professional traders, who called the bottom in oil monthly, based on key technical levels.
Instead, I hung on every word uttered by my old drilling buddies in the Barnett Shale, who only saw endless supply.
Guess whom I?ll be paying attention to this year?
I expect oil to bottom in 2016, and then launch a ferocious short covering rally. But when and where is anyone?s guess.
If energy legends John Hamm, John Arnold, and T. Boone Pickens have no idea where the absolute low will be, who am I to second-guess them?
When that happens, a trillion dollars will pour out of the sidelines into this troubled sector. Energy shares should be top-performers in 2016.
That makes energy Master Limited Partnerships, now yielding 10%-15%, especially interesting in this low yield world. Since no one in the industry knows which issuers are going bankrupt, you have to take a basket approach and buy all of them.
The Alerian MLP ETF (AMLP) does this for you in an ETF format (click here for details). At its low this fund was down by 41% this year. The last printed annualized yield I saw was 10%. That kind of return will cover up a lot of sins. Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system. Three Burlington Northern engines are heaving to pull over 100 black, brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.
There is another tank car train right behind it. No wonder Warren Buffet tap dances to work every day, as he owns the railroad.
Who knew that a new, younger Saudi king would ramp up production to once unimaginable levels and crush prices, turning the energy world upside down?
They aren?t targeting American frackers, who at 1 million barrels a day in a 92 million barrel a day demand world barely move the needle. Their goal is to destroy the economies of enemies Iran, Yemen, Russia, and of course ISIS, which need high prices to stay in business.
So far, so good.
Cheaper energy will bestow new found competitiveness on US companies that will enable them to claw back millions of jobs from China in dozens of industries.
At current prices, the energy savings works out to an eye popping $550 per American driver per year!
This will end our structural unemployment faster than demographic realities would otherwise permit.
We have a major new factor this year in considering the price of energy. The nuclear deal with Iran promises to add 500,000 to 1 million barrels a day to an already glutted global market. Iraq is ramping up production as well.
We are also seeing relentless improvements on the energy conservation front with more electric vehicles, high mileage conventional cars, and newly efficient building. Anyone of these inputs is miniscule on its own. But add them all together and you have a game changer.
Enjoy cheap oil while it lasts because it won?t last forever. American rig counts are already falling off a cliff and will eventually engineer a price recovery.
As is always the case, the cure for low prices is low prices. But we may never see $100/barrel crude again.
Add to your long term portfolio (DIG), Exxon Mobil (XOM), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY).
Skip natural gas (UNG) price plays and only go after volume plays, because the discovery of a new 100-year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time.
It is a basic law of economics that cheaper prices bring greater demand and growing volumes, which have to be transported. However, major reforms are required in Washington before use of this molecule goes mainstream.
These could be your big trades of 2016, but expect to endure some pain first, nor to get much sleep at night.
The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.
On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders. The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.
In the snow filled canyons we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It?s a good omen for the coming year.
We also see countless abandoned 19th century gold mines and the broken down wooden trestles leading to them, relics of previous precious metals busts. So it is timely here to speak about precious metals.
As long as the world is clamoring for paper assets like stocks and bonds, gold is just another shiny rock. After all, who needs an insurance policy if you are going to live forever?
We have already broken $1,040 once, and a test of $1,000 seems in the cards before a turnaround ensues. There are more hedge fund redemptions and stop losses to go. The bear case has the barbarous relic plunging all the way down to $700.
But the long-term bull case is still there. Gold is not dead; it is just resting.
If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. The precious metals have to work off a severely, decade old overbought condition before we make substantial new highs.
Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.
If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all-time high, or more.
This is why emerging market central banks step in as large buyers every time we probe lower prices. China and India emerged as major buyers of gold in the final quarter of 2015.
They were joined by Russia, which was looking for non-dollar investments to dodge US economic and banking sanctions.
For me, that pegs the range for 2016 at $1,000-$1,250. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).
I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal, silver (SLV), which I think could hit $50 once more, and eventually $100.
What will be the metals to own in 2015? Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf, would be something to consider on a dip.
With US auto production at 18 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.
Would You Believe This is a Blue State?
8) Real Estate (ITB)
The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write.
My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.
There is no doubt that there is a long-term recovery in real estate underway. We are probably 5 years into a 17-year run at the next peak in 2028.
But the big money has been made here over the past two years, with some red hot markets, like San Francisco, soaring. If you live within commuting distance of Apple (AAPL), Google (GOOG), or Facebook (FB) headquarters in California, you are looking at multiple offers, bidding wars, and prices at all time highs.
While the sales figures have recently been weak, it is a shortage of supply that is the cause. You can?t sell what you don?t have, at least in the real estate business.
From here on, I expect a slow grind up well into the 2020?s. If you live in the rest of the country, we are talking about small, single digit gains. The consequence of pernicious deflation is that home prices appreciate at a glacial pace.
At least, it has stopped going down, which has been great news for the financial industry.
There are only three numbers you need to know in the housing market for the next 20 years: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 86 million in the generation after that, the Millennials.
The boomers have been unloading dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. That's what caused the financial crisis.
If they have prospered, banks won?t lend to them. Brokers used to say that their market was all about ?location, location, location?. Now it is ?financing, financing, financing?.
Banks have gone back to the old standard of only lending money to people who don?t need it. But expect to put up your first-born child as collateral, and bring in your entire extended family in as cosigners if you want to get a bank loan.?
There is a happy ending to this story. Millennials, now aged 21-37 are already starting to kick in as the dominant buyers in the market. They are just starting to transition from 30% to 70% of all new buyers in this market. The Great Millennial Migration to the suburbs has begun.
As a result, the price of single family homes should rocket tenfold during the 2020?s, as they did during the 1970?s and the 1990?s, when similar demographic influences were at play.
This will happen in the context of a coming labor shortfall and rising standards of living. Inflation returns.
Rising rents are accelerating this trend. Renters now pay 35% of the gross income, compared to only 18% for owners, and less when multiple deductions and tax subsidies are taken into account.
Remember too, that by then, the US will not have built any new houses in large numbers in 10 years. We are still operating at only a quarter of the peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.
That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with.
You will boast to your grandchildren how little you paid for your house, as my grandparents once did to me ($18,000 for a four bedroom brownstone in Brooklyn in 1922).
Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now.
If you borrow at a 3% 5/1 ARM rate, and the long-term inflation rate is 3%, then over time you will get your house for free.
How hard is that to figure out?
Crossing the Bridge to Home Sweet Home
9) Postscript
We have pulled into the station at Truckee in the midst of a howling blizzard.
My loyal staff have made the 20 mile trek from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.
After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.
Well, that?s all for now. We?ve just passed the Pacific mothball fleet moored in the Sacramento River Delta and we?re crossing the Benicia Bridge. The pressure increase caused by an 8,200 foot descent from Donner Pass has crushed my water bottle.
The Golden Gate Bridge and the soaring spire of the Transamerica Building are just around the next bend across San Francisco Bay.
A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my Macbook Pro and iPhone 6, pick up my various adapters, and pack up.
We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten mile night hike up Grizzly Peak and still get home in time to watch the opener for Downton Abbey's final season.
I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.
I?ll shoot you a Trade Alert whenever I see a window open on any of the trades above.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/01/JT-at-work.jpg478635Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2016-01-05 01:05:382016-01-05 01:05:382016 Annual Asset Class Review
One of the oldest games in the foreign exchange market is to always buy the currencies of strong countries that are growing and to sell short the currencies of the weak countries that are shrinking.
Any doubts that China?s Yuan is a huge screaming buy should have been dispelled when news came out that exports have once again started to surge, thanks to the recovery of its largest customer, Europe.
China?s surging exports of electrical machinery, power generation equipment, clothes and steel were a major contributor.
Interest rate rises for the Yuan and a constant snugging of bank reserve requirements by the People?s Bank of China, have stiffened the backbone of the Middle Kingdom?s currency even further.
That is the price of allowing the Federal Reserve to set China?s monetary policy via a semi fixed Yuan exchange rate.
The last really big currency realignment was a series of devaluations that took the Yuan down from a high of 1.50 to the dollar in 1980. By the mid-nineties, it had depreciated by 84%. The goal was to make exports more competitive. The Chinese succeeded beyond their wildest dreams.
There is absolutely no way that the fixed rate regime can continue and there are only two possible outcomes. An artificially low Yuan has to eventually cause the country?s inflation rate to explode. Or a future global economic recovery causes Chinese exports to balloon to politically intolerable levels. Either case forces a revaluation.
Of course timing is everything. It?s tough to know how many sticks it takes to break a camel?s back. Talk to senior officials at the People?s Bank of China and they?ll tell you they still need a weak currency to develop their impoverished economy. Per capita income is still at only $6,000, less than a tenth of that of the US. But that is up a lot from a mere $100 in 1978.
Talk to senior US Treasury officials and they?ll tell you they are amazed that the Chinese peg has lasted this long. How many exports will it take to break it? $1.5 trillion, $2 trillion, $2.5 trillion? It?s anyone?s guess.
One thing is certain. A free floating Yuan would be at least 50% higher than it is today, and possibly 100%. In fact, the desire to prevent foreign hedge funds from making a killing in the market is not a small element in Beijing?s thinking.
The Chinese government says it won?t entertain a revaluation for the foreseeable future. The Americans say they need it tomorrow. To me that means it?s coming.
Buy the Yuan ETF, the (CYB). Just think of it as an ETF with an attached lottery ticket. If the Chinese continue to stonewall, you will get the token 3%-4% annual revaluation they are thought to tolerate. Double that with margin, and your yield rises to 6%-10%, not bad in this low yielding world. Since the chance of the Chinese devaluing is nil, that beats the hell out of the zero interest rates you now get with T-bills.
If they cave, then you could be in for a home run.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/09/Girl-Chinese.jpg376284Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-07-09 01:03:512015-07-09 01:03:51Play China?s Yuan from the Long Side
So far in 2015 the Indian stock market has handily beaten that of the US, by 10.6% compared to 5.3%.
?The India election result is the biggest development to affect emerging markets over the last 30 years.? That is what retired chairman of Goldman Sachs Asset Management and originator of the ?BRIC? term, Jim O?Neal, told me last week.
Indeed, the stunning news has sent long term country specialists scampering. In my long term strategy lectures I have been titillating listeners for years with predictions that India was about to become the next China.
With half the per capita income of the Middle Kingdom, India was lacking the infrastructure needed to compete in the global marketplace. All that was needed was the trigger.
This is the trigger.
With a new party taking control of the government for the first time in 50 years, the way is now clear to carry out desperately needed sweeping political and economic reforms. At the top of the list is a clean sweep of corruption, long endemic to the subcontinent. I once spent four months traveling around India on the Indian railway system, and the demand for ?bakshish? was ever present.
A reviving and reborn India has massive implications for the global economy, which could see growth accelerate as much at 0.50% a year for the next 30 years. This will be great news for stocks everywhere. It will help offset flagging demand for commodities from China, like coal (KOL), iron ore (BHP), and the base metals (CU).
Demand for oil (USO) grows, as energy starved India is one of the world?s largest importers.
A strengthening Rupee, higher standards of living, and relaxed import duties should give a much needed boost for gold (GLD). India has always been the world?s largest buyer.
The world?s largest democracy certainly delivers the most unusual of elections, a blend of practices from today?.and a thousand years ago. It was carried out over five weeks, and a stunning 541 million voted, out of an eligible 815 million, a turnout of 66.4%. That is far higher than elections seen here in the United States.
Of the 552 members in the Lok Sabha, the lower house (or their House of Representatives), a specific number of seats are reserved for scheduled castes, scheduled tribes, and women. Gee, I wonder which one of these I would fit in?
Important issues during the campaign included rising prices, the economy, security, and infrastructure such as roads, electricity and water. About 14% of voters cited corruption as the main issue.
Some 12 political parties ran candidates. The winner was Hindu Nationalist Narendra Modi of the Bharatiya Janata Party (BJP), who led a diverse collection of lesser parties to take an overwhelming majority. For more details on this fascinating election, please click here at http://www.ndtv.com/elections.
It is still early days for the Bombay stock market, which has already rocketed by a stunning 20% since the election results became obvious last week.
This could be the beginning of a ten-bagger move over coming decades. Managers are hurriedly pawing through stacks of research on the subcontinent they have been ignoring for the past four years, the last time emerging markets peaked.
In the meantime, the action has spilled over into other emerging markets (EEM), their currencies (CEW), and their bonds (ELD), which have all punched through to new highs for the year.
I?ll be knocking out research o specific names when I find them. Until then, use any dip to pick up the Indian ETF?s (INP), (PIN), and (EPI).
https://www.madhedgefundtrader.com/wp-content/uploads/2014/05/India-Election-Results.jpg254477Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-02-24 01:03:152015-02-24 01:03:15The Game Changer in India
Investors around the world have been confused, befuddled and surprised by the persistent, ultra low level of long term interest rates in the United States.
At today?s close, the 30 year Treasury bond yielded a parsimonious 2.01%, the ten year, 2.62%, and the five year only 1.51%. The ten-year was threatening its all time low yield of 1.37% only two weeks ago, a return as rare as a dodo bird, last seen in August, 2012.
What?s more, yields across the entire fixed income spectrum have been plumbing new lows. Corporate bonds (LQD) have been fetching only 3.29%, tax-free municipal bonds (MUB) 2.89%, and junk (JNK) a pittance at 5.96%.
Spreads over Treasuries are approaching new all time lows. The spread for junk over of ten year Treasuries is now below an amazing 3.00%, a heady number not seen since the 2007 bubble top. ?Covenant light? in borrower terms is making a big comeback.
Are investors being rewarded for taking on the debt of companies that are on the edge of bankruptcy, a tiny 3.3% premium? I think not.
It is a global trend.
German bunds are now paying holders 0.35%, and JGB?s are at an eye popping 0.30%. The worst quality southern European paper has delivered the biggest rallies this year. Portuguese government paper is paying only 2.40%, and is rapidly closing in on US government yields.
Yikes!
These numbers indicate that there is a massive global capital glut. There is too much money chasing too few low risk investments everywhere. Has the world suddenly become risk averse? Is inflation gone forever? Will deflation become a permanent aspect of our investing lives? Does the reach for yield know no bounds?
It wasn?t supposed to be like this.
Almost to a man, hedge fund managers everywhere were unloading debt instruments in January. They were looking for a year of rising interest rates (TLT), accelerating stock prices (QQQ), falling commodities (DBA), and dying emerging markets (EEM). Surging capital inflows were supposed to prompt the dollar (UUP) to take off like a rocket.
It all ended up being almost a perfect mirror image portfolio of what actually transpired since then. As a result, almost all mutual funds are down so far in 2014. Many hedge fund managers are tearing their hair out, suffering their worst year in recent memory.
What is wrong with this picture?
Interest rates like these are hinting that the global economy is about to endure a serious nose dive, possibly even re-entering recession territory?or it isn?t.
To understand why not, we have to delve into deep structural issues, which are changing the nature of the debt markets beyond all recognition. This is not your father?s bond market.
I?ll start with what I call the ?1% effect.?
Rich people are different than you and I. Once they finally make their billions, they quickly evolve from being risk takers into wealth preservers. They don?t invest in start-ups, take fliers on stock tips, invest in the flavor of the day, or create jobs. In fact, many abandon shares completely, retreating to the safety of coupon clipping.
The problem for the rest of us is that this capital stagnates. It goes into the bond market where it stays forever. These people never sell, thus avoiding capital gains taxes and capturing a future step up in the cost basis whenever a spouse dies. Only the interest payments are taxable and that at a lowly 20% rate.
This is the lesson I learned from servicing generations of Rothschild?s, Du Ponts, Rockefellers, and Getty. Extremely wealthy families stay that way by becoming extremely conservative investors. Those that don?t, you?ve never heard of, because they all eventually went broke.
This didn?t used to mean much before 1980, back when the wealthy only owned 10% of the bond market, except to financial historians and private wealth specialists, of which I am one. Now they own a whopping 23%, and their behavior affects everyone.
Who has bee the largest buyer of Treasury bonds for the last 30 years? Foreign central banks and other governmental entities, which count them among their country?s foreign exchange reserves. They own 36% of our national debt, with China in the lead at 8% (the Bush tax cut that was borrowed), and Japan close behind with 7% (the Reagan tax cut that was borrowed). These days they purchase about 50% of every Treasury auction.
They never sell either, unless there is some kind of foreign exchange or balance of payments crisis, which is rare. If anything, these holdings are still growing.
Who else has been soaking up bonds, deaf to repeated cries that prices are about to plunge? The Federal Reserve, which thanks to QE1, 2, and 3, now owns 22% of our $17 trillion debt. Both the former Federal Reserve governor Ben Bernanke, and the present one, Janet Yellen, have made clear they have no plans to sell these bonds. They will run them to maturity instead, minimizing the market impact.
An assortment of other government entities possess a further 29% of US government bonds, first and foremost the Social Security Administration, with a 16% holding. And they ain?t selling either, baby.
So what you have here is the overwhelming majority of Treasury bond owners with no intention to sell. Only hedge funds have been selling this year, and they have already done so, in spades.
Which sets up a frightening possibility for them, now that we are at the very bottom of the past year?s range in yields. What happens if bond yields fall further? It will set off the mother of all short covering squeezes and could take ten-year yield down to match the 2012, 2.38% low.
Fasten your seat belts, batten the hatches, and down the Dramamine!
There are a few other reasons why rates will stay at subterranean levels for some time. If hyper accelerating technology keeps cutting costs for the rest of the century, deflation basically never goes away (click here?for ?Peeking into the Future with Ray Kurzweil?).
Hyper accelerating corporate profits will also create a global cash glut, further levitating bond prices. Companies are becoming so profitable they are throwing off more cash then they can reasonably use or pay out.
This is why these gigantic corporate cash hoards are piling up in Europe in tax free jurisdictions, now over $2 trillion. Is the US heading for Japanese style yields, or 0.39% for 10 year Treasuries?
If so, bonds are a steal here at 2.55%. If we really do enter a period of long term -2% a year deflation, that means the purchasing power of a dollar increases by 35% every decade in real terms.
The threat of a second Cold War is keeping the flight to safety bid alive, and keeping the bull market for bonds percolating. This could put a floor under bond prices for another decade, and Vladimir Putin?s current presidential run could last all the way under 2014.
All of this is why I?m out of the bond market for now, and will remain so for a while.
https://www.madhedgefundtrader.com/wp-content/uploads/2014/05/Orangutan.jpg346382Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-02-16 01:05:282015-02-16 01:05:28Why Are Bond Yields So Low?
I am once again writing this report from a first class sleeping cabin on Amtrak?s California Zephyr. By day, I have two comfortable seats facing each other next to a broad window. At night, they fold into bunk beds, a single and a double. There is a shower, but only Houdini could get in and out of it.
We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I am headed for Emeryville, California, just across the bay from San Francisco. That gives me only 56 hours to complete this report.
I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure, and to keep me up to date with the onboard gossip. The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Spellchecker can catch most of the mistakes, but not all of them. Thank goodness for small algorithms.
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied searches during stops at major stations along the way to chase down data points.
You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS. Who knew that 95% of America is off the grid? That explains a lot about our politics today. I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone.
After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2014 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Yet again, the stay at home index players have defeated the best and the brightest.
With the Dow gaining a modest 8% in 2014, and S&P 500 up a more virile 14.2%, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for seven boring consecutive months. Most hedge funds lagged the index by miles.
My Trade Alert Service, hauled in an astounding 30.3% profit, at the high was up 42.7%, and has become the talk of the hedge fund industry. That was double the S&P 500 index gain.
If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:
The Ten Highlights of 2015
1) Stocks will finish 2015 higher, almost certainly more than the previous year, somewhere in the 10-15% range. Cheap energy, ultra low interest rates, and 3-4% GDP growth, will expand multiples. It?s Goldilocks with a turbocharger.
2) Performance this year will be back-end loaded into the fourth quarter, as it was in 2014. The path forward became so clear, that some of 2015?s performance was pulled forward into November, 2014.
3) The Treasury bond market will modestly grind down, anticipating the inevitable rate rise from the Federal Reserve.
4) The yen will lose another 10%-20% against the dollar.
5) The Euro will fall another 10%, doing its best to hit parity with the greenback, with the assistance of beleaguered continental governments.
6) Oil stays in a $50-$80 range, showering the economy with hundreds of billions of dollars worth of de facto tax cuts.
7) Gold finally bottoms at $1,000 after one more final flush, then rallies (My jeweler was right, again).
8) Commodities finally bottom out, thanks to new found strength in the global economy, and begin a modest recovery.
9) Residential real estate has made its big recovery, and will grind up slowly from here.
10) After a tumultuous 2014, international political surprises disappear, the primary instigators of trouble becalmed by collapsed oil revenues.
The Thumbnail Portfolio
Equities - Long. A rising but low volatility year takes the S&P 500 up to 2,350. This year we really will get another 10% correction. Technology, biotech, energy, solar, and financials lead.
Bonds - Short. Down for the entire year with long periods of stagnation.
Foreign Currencies - Short. The US dollar maintains its bull trend, especially against the Yen and the Euro.
Commodities - Long. A China recovery takes them up eventually.
Precious Metals - Stand aside. We get the final capitulation selloff, then a rally.
Agriculture - Long. Up, because we can?t keep getting perfect weather forever.
Real estate - Long. Multifamily up, commercial up, single family homes sideways to up small.
1) The Economy - Fortress America
This year, it?s all about oil, whether it stays low, shoots back up, or falls lower. The global crude market is so big, so diverse, and subject to so many variables, that it is essentially unpredictable.
No one has an edge, not the major producers, consumers, or the myriad middlemen. For proof, look at how the crash hit so many ?experts? out of the blue.
This means that most economic forecasts for the coming year are on the low side, as they tend to be insular and only examine their own back yard, with most predictions still carrying a 2% handle.
I think the US will come in at the 3%-4% range, and the global recovery spawns a cross leveraged, hockey stick effect to the upside. This will be the best performance in a decade. Most company earnings forecasts are low as well.
There is one big positive that we can count on in the New Year. Corporate earnings will probably come in at $130 a share for the S&P 500, a gain of 10% over the previous year. During the last five years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.
This is set to continue. Furthermore, this growth will be front end loaded into Q1. The ?tell? was the blistering 5% growth rate we saw in Q3, 2014.
Cost cutting through layoffs is reaching an end, as there is no one left to fire. That leaves hyper accelerating technology and dramatically lower energy costs the remaining sources of margin increases, which will continue their inexorable improvements. Think of more machines and software replacing people.
You know all of those hundreds of billions raised from technology IPO?s in 2014. Most of that is getting plowed right back into new start ups, accelerating the rate of technology improvements even further, and the productivity gains that come with it.
You can count on demographics to be a major drag on this economy for the rest of the decade. Big spenders, those in the 46-50 age group, don?t return in large numbers until 2022.
But this negative will be offset by a plethora of positives, like technology, global expansion, and the lingering effects of Ben Bernanke?s massive five year quantitative easing. A time to pay the piper for all of this largess will come. But it could be a decade off.
I believe that the US has entered a period of long-term structural unemployment similar to what Germany saw in the 1990?s. Yes, we may grind down to 5%, but no lower than that. Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read as to whether the financial markets will head in a ?RISK ON? or ?RISK OFF? direction.
Most of the disaster scenarios predicted for the economy this year were based on the one off black swans that never amounted to anything, like the Ebola virus, ISIS, and the Ukraine.
With the economy going gangbusters, and corporate earnings reaching $130 a share, those with a traditional ?buy and hold? approach to the stock market will do alright, provided they are willing to sleep through some gut churning volatility. A Costco sized bottle of Jack Daniels and some tranquillizers might help too.
Earnings multiples will increase as well, as much as 10%, from the current 17X to 18.5X, thanks to a prolonged zero interest rate regime from the Fed, a massive tax cut in the form of cheap oil, unemployment at a ten year low, and a paucity of attractive alternative investments.
This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years. If anything, it is amazing how low multiples are, given the strong tailwinds the economy is enjoying.
The market currently trades around fair value, and no market in history ever peaked out here. An overshoot to the upside, often a big one, is mandatory. After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not?
This is how the S&P 500 will claw its way up to 2,350 by yearend, a gain of about 12.2% from here. Throw in dividends, and you should pick up 14.2% on your stock investments in 2015.
This does not represent a new view for me. It is simply a continuation of the strategy I outlined again in October, 2014 (click here for ?Why US Stocks Are Dirt Cheap?).
Technology will be the top-performing sector once again this year. They will be joined by consumer cyclicals (XLV), industrials (XLI), and financials (XLF).
The new members in the ?Stocks of the Month Club? will come from newly discounted and now high yielding stocks in the energy sector (XLE).
There is also a rare opportunity to buy solar stocks on the cheap after they have been unfairly dragged down by cheap oil like Solar City (SCTY) and the solar basket ETF (TAN). Revenues are rocketing and costs are falling.
After spending a year in the penalty box, look for small cap stocks to outperform. These are the biggest beneficiaries of cheap energy and low interest rates, and also have minimal exposure to the weak European and Asian markets.
Share prices will deliver anything but a straight-line move. We finally got our 10% correction in 2014, after a three-year hiatus. Expect a couple more in 2015. The higher prices rise, the more common these will become.
We will start with a grinding, protesting rally that takes us up to new highs, as the market climbs the proverbial wall of worry. Then we will suffer a heart stopping summer selloff, followed by another aggressive yearend rally.
Cheap money creates a huge incentive for companies to buy back their own stock. They divert money from their $3 trillion cash hoard, which earns nothing, retire shares paying dividends of 3% or more, and boost earnings per share without creating any new business. Call it financial engineering, but the market loves it.
Companies are also retiring stock through takeovers, some $2 trillion worth last year. Expect more of this to continue in the New Year, with a major focus on energy. Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year bull market in energy, the industry is ripe for a cleanout.
This is happening in the face of both an individual and institutional base that is woefully underweight equities.
The net net of all of this is to create a systemic shortage of US equities. That makes possible simultaneous rising prices and earnings multiples that have taken us to investor heaven.
Amtrak needs to fill every seat in the dining car, so you never know who you will get paired with.
There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate to get out of Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.
A retired British couple was circumnavigating the entire US in a month on a ?See America Pass.? Mennonites returning home by train because their religion forbade airplanes.
If you told me that US GDP growth was 5%, unemployment was at a ten year low at 5.8%, and energy prices had just halved, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.10%.
Virtually every hedge fund manager and institutional investor got bonds wrong last year, expecting rates to rise. I was among them, but that is no excuse. At least I have good company.
You might as well take your traditional economic books and throw them in the trash. Apologies to John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson.
The reasons for the debacle are myriad, but global deflation is the big one. With ten year German bunds yielding a paltry 50 basis points, and Japanese bonds paying a paltry 30 basis points, US Treasuries are looking like a bargain.
To this, you can add the greater institutional bond holding requirements of Dodd-Frank, a balancing US budget deficit, a virile US dollar, the commodity price collapse, and an enormous embedded preference for investors to keep buying whatever worked yesterday.
For more depth on the perennial strength of bonds, please click here for ?Ten Reasons Why I?m Wrong on Bonds?.
Bond investors today get an unbelievable bad deal. If they hang on to the longer maturities, they will get back only 80 cents worth of purchasing power at maturity for every dollar they invest.
But institutions and individuals will grudgingly lock in these appalling returns because they believe that the potential losses in any other asset class will be worse. The problem is that driving eighty miles per hour while only looking in the rear view mirror can be hazardous to your financial health.
While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite. A 2%, ten-year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough.
There is another factor supporting bonds that no one is looking at. The concentration of wealth with the 1% has a side effect of pouring money into bonds and keeping it there. Their goal is asset protection and nothing else.
These people never sell for tax reasons, so the money stays there for generations. It is not recycled into the rest of the economy, as conservative economists insist. As this class controls the bulk of investable assets, this forestalls any real bond market crash, possibly for decades.
So what will 2015 bring us? I think that the erroneous forecast of higher yields I made last year will finally occur this year, and we will start to chip away at the bond market bubble?s granite edifice. I am not looking for a free fall in price and a spike up in rates, just a move to a new higher trading range.
The high and low for ten year paper for the past nine months has been 1.86% to 3.05%. We could ratchet back up to the top end of that range, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2014 performance, taking it from $46 back up to $76.
You might have to wait for your grandchildren to start trading before we see a return of 12% Treasuries, last seen in the early eighties. I probably won?t live that long.
Reaching for yield will continue to be a popular strategy among many investors, which is typical at market tops. That focuses buying on junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (KMP), (LINE).
There is also emerging market sovereign debt to consider (PCY). At least there, you have the tailwinds of long term strong economies, little outstanding debt, appreciating currencies, and higher interest rates than those found at home. This asset class was hammered last year, so we are now facing a rare entry point. However, keep in mind, that if you reach too far, your fingers get chopped off.
There is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase tax free muni values. So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way, and mark to markets could be shocking. Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits.
There are only three things you need to know about trading foreign currencies in 2015: the dollar, the dollar, and the dollar. The decade long bull market in the greenback continues.
The chip shot here is still to play the Japanese yen from the short side. Japan?s Ministry of Finance is now, far and away, the most ambitious central bank hell bent on crushing the yen to rescue its dying economy.
The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate.
The dramatic sell off we saw in the Japanese currency since December, 2012 is the beginning of what I believe will be a multi decade, move down. Look for ?125 to the dollar sometime in 2015, and ?150 further down the road. I have many friends in Japan looking for and overshoot to ?200. Take every 3% pullback in the greenback as a gift to sell again.
With the US having the world?s strongest major economy, its central bank is, therefore, most likely to raise interest rates first. That translates into a strong dollar, as interest rate differentials are far and away the biggest decider of the direction in currencies. So the dollar will remain strong against the Australian and Canadian dollars as well.
The Euro looks almost as bad. While European Central Bank president, Mario Draghi, has talked a lot about monetary easing, he now appears on the verge of taking decisive action.
Recurring financial crisis on the continent is forcing him into a massive round of Fed style quantitative easing through the buying of bonds issued by countless European entities. The eventual goal is to push the Euro down to parity with the buck and beyond.
For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book, but don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth in order to keep its appreciation modest to maintain their crucial export competitiveness.
There isn?t a strategist out there not giving thanks for not loading up on commodities in 2014, the preeminent investment disaster of 2015. Those who did are now looking for jobs on Craig?s List.
2014 was the year that overwhelming supply met flagging demand, both in Europe and Asia. Blame China, the big swing factor in the global commodity.
The Middle Kingdom is currently changing drivers of its economy, from foreign exports to domestic consumption. This will be a multi decade process, and they have $4 trillion in reserves to finance it.
It will still demand prodigious amounts of imported commodities, especially, oil, copper, iron ore, and coal, all of which we sell. But not as much as in the past. The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE), have all taken an absolute pasting.
The food commodities were certainly the asset class to forget about in 2014, as perfect weather conditions and over planting produced record crops for the second year in a row, demolishing prices. The associated equity plays took the swan dive with them.
However, the ags are still a tremendous long term Malthusian play. The harsh reality here is that the world is making people faster than the food to feed them, the global population jumping from 7 billion to 9 billion by 2050.
Half of that increase comes in countries unable to feed themselves today, largely in the Middle East. The idea here is to use any substantial weakness, as we are seeing now, to build long positions that will double again if global warming returns in the summer, or if the Chinese get hungry.
The easy entry points here are with the corn (CORN), wheat (WEAT), and soybeans (SOYB) ETF?s. You can also play through (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU).
The grain ETF (JJG) is another handy fund. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cakewalk. You can participate in this most liquid of assets with the ETF?s (PHO) and (FIW).
Yikes! What a disaster! Energy in 2014 suffered price drops of biblical proportions. Oil lost the $30 risk premium it has enjoyed for the last ten years. Natural gas got hammered. Coal disappeared down a black hole.
Energy prices did this in the face of an American economy that is absolutely rampaging, its largest consumer. Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system. Three Burlington Northern engines are heaving to pull over 100 black, brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.
There is another tank car train right behind it. No wonder Warren Buffett tap dances to work every day, as he owns the road. US Steel (X) also does the two-step, since they provide immense amounts of steel to build these massive cars.
The US energy boom sparked by fracking will be the biggest factor altering the American economic landscape for the next two decades. It will flip us from a net energy importer to an exporter within two years, allowing a faster than expected reduction in military spending in the Middle East.
Cheaper energy will bestow new found competitiveness on US companies that will enable them to claw back millions of jobs from China in dozens of industries. This will end our structural unemployment faster than demographic realities would otherwise permit.
We have a major new factor this year in considering the price of energy. Peace in the Middle East, especially with Iran, always threatened to chop $30 off the price of Texas tea. But it was a pie-in-the-sky hope. Now there are active negotiations underway in Geneva for Iran to curtail or end its nuclear program. This could be one of the black swans of 2015, and would be hugely positive for risk assets everywhere.
Enjoy cheap oil while it lasts because it won?t last forever. American rig counts are already falling off a cliff and will eventually engineer a price recovery.
Add the energies of oil (DIG), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY). Skip natural gas (UNG) price plays and only go after volume plays, because the discovery of a new 100-year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time.
It is a basic law of economics that cheaper prices bring greater demand and growing volumes, which have to be transported. However, major reforms are required in Washington before use of this molecule goes mainstream.
These could be your big trades of 2015, but expect to endure some pain first.
The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.
On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders. The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.
In the snow filled canyons we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It?s a good omen for the coming year. We also see countless abandoned gold mines and the broken down wooden trestles leading to them, so it is timely here to speak about precious metals.
As long as the world is clamoring for paper assets like stocks and bonds, gold is just another shiny rock. After all, who needs an insurance policy if you are going to live forever?
We have already broken $1,200 once, and a test of $1,000 seems in the cards before a turnaround ensues. There are more hedge fund redemptions and stop losses to go. The bear case has the barbarous relic plunging all the way down to $700.
But the long-term bull case is still there. Someday, we are going to have to pay the piper for the $4.5 trillion expansion in the Fed?s balance sheet over the past five years, and inflation will return. Gold is not dead; it is just resting. I believe that the monetary expansion arguments to buy gold prompted by massive quantitative easing are still valid.
If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. The precious metals have to work off a severely, decade old overbought condition before we make substantial new highs. Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.
If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all-time high, or more.
This is why emerging market central banks step in as large buyers every time we probe lower prices. For me, that pegs the range for 2015 at $1,000-$1,400. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).
I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal, silver (SLV), which I think could hit $50 once more, and eventually $100.
What will be the metals to own in 2015? Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf, would be something to consider on a dip. With US auto production at 17 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.
Would You Believe This is a Blue State?
8) Real Estate (ITB)
The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write. My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.
There is no doubt that there is a long-term recovery in real estate underway. We are probably 8 years into an 18-year run at the next peak in 2024.
But the big money has been made here over the past two years, with some red hot markets, like San Francisco, soaring. If you live within commuting distance of Apple (AAPL), Google (GOOG), or Facebook (FB) headquarters in California, you are looking at multiple offers, bidding wars, and prices at all time highs.
From here on, I expect a slow grind up well into the 2020?s. If you live in the rest of the country, we are talking about small, single digit gains. The consequence of pernicious deflation is that home prices appreciate at a glacial pace. At least, it has stopped going down, which has been great news for the financial industry.
There are only three numbers you need to know in the housing market: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 85 million in the generation after that, the Millennials.
The boomers have been unloading dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made.
If they have prospered, banks won?t lend to them. Brokers used to say that their market was all about ?location, location, location?. Now it is ?financing, financing, financing?. Banks have gone back to the old standard of only lending money to people who don?t need it.
Consider the coming changes that will affect this market. The home mortgage deduction is unlikely to survive any real attempt to balance the budget. And why should renters be subsidizing homeowners anyway? Nor is the government likely to spend billions keeping Fannie Mae and Freddie Mac alive, which now account for 95% of home mortgages.
That means the home loan market will be privatized, leading to mortgage rates higher than today. It is already bereft of government subsidies, so loans of this size are priced at premiums. This also means that the fixed rate 30-year loan will go the way of the dodo, as banks seek to offload duration risk to consumers. This happened long ago in the rest of the developed world.
There is a happy ending to this story. By 2022 the Millennials will start to kick in as the dominant buyers in the market. Some 85 million Millennials will be chasing the homes of only 65 Gen Xer?s, causing housing shortages and rising prices.
This will happen in the context of a labor shortfall and rising standards of living. Remember too, that by then, the US will not have built any new houses in large numbers in 15 years.
The best-case scenario for residential real estate is that it gradually moves up for another decade, unless you live in Cupertino or Mountain View. We won?t see sustainable double-digit gains in home prices until America returns to the Golden Age in the 2020?s, when it goes hyperbolic.
But expect to put up your first-born child as collateral, and bring your entire extended family in as cosigners if you want to get a bank loan.
That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with. This is especially true if you lock up today?s giveaway interest rates with a 30 year fixed rate loan. At 3.3% this is less than the long-term inflation rate.
You will boast about it to your grandchildren, as my grandparents once did to me.
Crossing the Bridge to Home Sweet Home
9) Postscript
We have pulled into the station at Truckee in the midst of a howling blizzard.
My loyal staff have made the 20 mile trek from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.
Well, that?s all for now. We?ve just passed the Pacific mothball fleet moored in the Sacramento River Delta and we?re crossing the Benicia Bridge. The pressure increase caused by an 8,200 foot descent from Donner Pass has crushed my water bottle. The Golden Gate Bridge and the soaring spire of the Transamerica Building are just around the next bend across San Francisco Bay.
A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my Macbook Pro and iPhone 6, pick up my various adapters, and pack up.
We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten mile night hike up Grizzly Peak and still get home in time to watch the season opener for Downton Abbey season five. I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.
I?ll shoot you a Trade Alert whenever I see a window open on any of the trades above.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/01/Zephyr.jpg342451Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-01-06 01:02:142015-01-06 01:02:142015 Annual Asset Class Review
For the last couple of nights, I have left my iPhone logged into the Argentina peso market, one of several troubled currencies igniting the emerging market contagion. Whenever the peso losses another handle to the US dollar, an alarm goes off. That gives me a head start on how American markets will behave the next day.
I have not been getting a lot of sleep lately. My poor phone has recently been sounding off like a winning slot machine at a Las Vegas casino.
Take a look at the long-term chart for the peso, and it?s clear that some traders have not gotten any sleep for five years, when the peso cratered 50% against the greenback. An imploding currency, soaring national debt, and sliding economy promise to send it lower.
Incompetent leadership doesn?t help either. You know that things are bad when your ships get seized by creditors when they land at foreign ports.
When I wrote my all asset class forecast for 2014, there was only one thing I knew for sure: this year would be harder than last. That has been my best prediction for 2014 so far.
The guaranteed shorts, those for the Japanese yen (FXY) and the Treasury bond market (TLT), have been rocketing to the upside since the opening bell rang on January 2. The no brainer longs, like financials (XLF) and consumer discretionaries (XLY), have been plummeting.
The heart wrenching 4.3% correction we saw for the S&P 500 (SPY), and the 5% hit for the Dow average this month, the worst weekly draw down in two years, has predictably brought the Armageddon crowd out of the closet once again. All of a sudden, a 10% correction best case, and Dow 3,000 worst case, are on the table once again. Do they have a leg to stand on?
Not really.
To achieve these big numbers on the downside, your really need a global systemic financial crisis. There isn?t one remotely on the horizon. Yes, there are difficulties in Argentina, the Ukraine, and Turkey. But they are locally confined.
Together, these countries account for less than 1% of global GDP. If they disappeared completely, they would barely make a blip in world GDP. They certainly are not important enough to panic you into emptying your ATM at the local mall on your next lunch break.
You also need excessive leverage. But that has been banned by prime brokers since the 2008 crash. An aggressive long today is 20% net long, not 200% as in the bad old days of yore. Nothing systemic there.
Sure, we aren?t getting the juice that we used to from the Federal Reserve. It is likely that they will further reduce the taper from $75 billion to $65 billion of bond buying per month at their 1:00 PM Wednesday press release.
If there were a one in a million chance that this would trigger a real market meltdown, my friend, Fed governor Janet Yellen, would run that release through the shredder as fast as you could say ?Go Bears?, sending markets flying.
Others are accusing a looming financial crisis in China as another culprit. Yes, the economic data has been soggy of late, to be sure. However, that is just the continuation of a four year old trend. You can safely forget about that one.
No country in history ever suffered a financial crisis with $4 trillion in foreign exchange reserves on hand, including over $1 trillion in US Treasury bonds close to all time highs in value. In fact many of the emerging markets said to be in trouble also boast large reserves, the product of running massive trade surpluses with a hyper consuming West for the past decade.
So if we can?t blame emerging markets or the taper for the downside, then what is causing the January swoon? You can blame it all on the hedge funds.
I have seen this time and again. Whenever too many people crowd into one end of a canoe, it rolls over. When the majority of funds have identical positions, they are guaranteed to fail. That is why we have had a looking glass market performance since the beginning of this year.
Except that this time we got a turbocharger. The peaking of concentration in the most popular trades perfectly coincided with the big New Year reallocation trade, taking prices to greater extremes. Much of the selling you are seeing down here is from latecomers who bought stock only three weeks ago and are now puking them out.
Of course, I saw all of this coming a country mile off. This is why I cut my net long from 100% 10 days ago to only 10%. It is why I am maintaining a year to date performance of +5.13%, compared to a Dow that is down -5%. It is one of my best gains relative to the index over a short period ever.
The same is true of my colleague, Mad Day Trader, Jim Parker. He is almost all in cash and is also well up on the year. He stuck his toe in the water with a small position in some calls on the (TBT) last week, but it got bit off by a shark almost immediately. So he quickly stopped out, as is his way. Of course, we have been comparing notes and sharing input throughout the selling. It appears that great minds think alike.
Jim?s proprietary in-house analysis predicts that the (SPX) will bottom out just above 1,730, the market close on the November 15 options expiration. If correct, that would give us a total start to finish correction of only 6.7%, which is in line with every other correction for the past two years. But the bottoming process could last a few weeks, and provide several more gut churning dumps. Fasten your seat belt.
When will this end? Watch for the parallel confirming cross market trends. The Treasury bond market is a big one, which appears to be peaking already, right at its 200 day moving average and the top of a six month trading range.? Announcement of the next taper could spark the selloff we need there. The Japanese yen is also important. A top here could signal a return to the carry trade and ?RISK ON?.
Since Emerging markets were the instigator of the crisis, look there as well for the first signs of a turnaround. Scrutinize the chart below, and you gain some heart.? It shows that we are a scant 70 cents from setting up a potential multiyear triple bottom at $37, and worst-case $36.
More specifically, you want to see Turkey (TUR), another instigator of this crisis, recoil from $39. Expect it to bounce hard there, as long as the world is really not ending.
Then it will be off to the races once more. I?ll be keeping my powder dry until then. Watch this space.
https://www.madhedgefundtrader.com/wp-content/uploads/2014/01/Gunpowder-barrel.jpg382381Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2014-01-28 09:25:562014-01-28 09:25:56What the Markets Will Do from Here
The Chinese government has announced the most revolutionary changes to its economy in nearly four decades. The implications for global stock markets are hugely positive, and until now, under appreciated. The Middle Kingdom?s state controlled media, never prone to hyperbole, are calling it ?a new historical starting point.?
Chinese stocks have rocketed since word of the broad ranging reforms leaked out last week, and appear to have much more to go. This brings to an end the 3 ? year Chinese growth recession, which saw GDP growth rates shrink from a white hot 13% annual rate, down to a more modest 7%. Until last week, Chinese capital markets were neglected, ignored, and left stranded on a back burner.
This is great news for all of us.
The sea of change promised by the events in the Middle Kingdom barely caught notice in the West, where investors were transfixed by the never ending rise of US equities and other risk assets. But my friends at the senior levels of the Chinese government have been gushing about the great things to come. They compare it to the 1978 revolution, when the ?Gang of Four? was thrown out, and Deng Xiaoping was named premier.
Some 35 years of wildly successful modernization, westernization, and capitalization followed. Chinese per capita incomes skyrocketed, from $100 to $6,000 today. The current round of liberalizations could eventually bring Chinese standards of living to American levels. Give it another 35 years.
Of course, reading the statement issued by the 370 senior party members of the third plenum of the 18th Central Committee, you get no clue of the brave new world they promise. These are always written in obscure code words whose meaning can only be deciphered by tracking nuances, changes, and references over decades. I have been doing this since the early seventies, when Mao Zedong was calling the shots, longer than most Chinese. It was a lot harder then, or am I simply getting wiser in my old age?
The goal of the reforms is to move China from its current emerging status towards middle class. The one child policy was abandoned, which has cut the country?s population growth by 400 million over the last 30 years. This should add back in 400 million in population growth over the next 35 years. Not to do so would risk labor shortages looming in the 2020?s, and the runaway wage inflation that invariably follows.
Internal passports that restricted population movements were abolished. Private property rights are receiving a boost. The economy will become more market oriented. The Chinese gulag that imprisoned tens of thousands was sent to the dustbin of history. The strengthening of the country?s social safety net will free up domestic Chinese savings, which now at 30%, are among the highest in the world. This will bring a surge in consumer spending.
Financial reforms are expected to follow soon. These include a more aggressive path towards a free float of the Chinese Yuan, known locally as the ?renminbi,? or ?people?s currency.? The breadth and depth of domestically traded debt instruments will be greatly expanded. You can expect far more active investment of the country?s nearly $4 trillion foreign exchange hoard abroad, especially in trophy assets in safe havens like the US and the UK. They are already soaking up commercial property loans by the billions here in the San Francisco Bay area.
This will accelerate the evolution of the Chinese economy from an export oriented consuming one to one that is more oriented towards domestic consumption. This is big.
The net net of all this will be to enhance the productivity and profitability of Chinese companies. That is what the Chinese stock markets have been screaming at us since last week.
The prospects for the world economy have been much improved by this second Chinese modernization. Rising Chinese standards of living will produce hundreds of millions of new consumers of American and European goods. Emerging markets (EEM), many of which are indirect China plays, do pretty well in the new paradigm as well. All in all, this should add many percentage points of growth to the world economy in coming decades.
It certainly makes my own forecast of a global synchronized recovery 2014 look good as well. As for stock markets everywhere, think higher, and for longer. ?RISK ON? is ?ON.?
The no brainer here is to buy the iShares FTSE China 25 Index Fund ETF (FXI), which has to rise by 63% just to match its 2007 high. The Chinese economy has more than doubled in size since then, making today?s (FXI) level relatively much cheaper. During this time, Chinese earnings multiples have gone from a huge premium to US ones to a large discount, making them a great rotation play.
If you want to sleep at night, buy the Hong Kong ETF (EWH), where accounting and disclosure standards are on par with those of England, a legacy from its colonial days. You can expect to Chinese Yuan ETF (CYB) to continue its northward market, as I have been predicting for the past four years.
You can also go into single stock plays, like China Mobile (CHL), the world?s largest phone company. Something tells me there are a lot of new customers and upgrades in its future.
Looks like there is going to be a lot more dim sum in my future.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/11/Deng-Xiaoping.jpg372369Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-11-19 13:00:022013-11-19 13:00:02CHINESE REFORMS WILL SEND US STOCKS SKYWARD - Update
No asset class has been beaten more severely this year than emerging markets. Since the March, 2011 high, the iShares MSCI Emerging Market ETF (EEM) has plunged from $48 to $35.80, a loss of 25%. Individual markets have fared far worse. The Market Vectors Indonesia ETF (IDX) has taken a 39% haircut, while the Powershares India Portfolio ETF (PIN) has cratered by 46%.
It wasn?t supposed to be like this. These countries boast GDP growth rates of two to four times those found in the developed world. Many, like Chile (ECH) and Indonesia (IDX) are endowed with abundant natural resources. India (PIN) offers one of the world?s most attractive demographic pyramids, a precursor to stable long term growth.
The Philippines (EPHE) boasts a great, low waged, educated labor force. It is no accident that to subscribe to the San Francisco Chronicle your call gets directed to an obscure location 200 miles south of Manila, where call center workers live well on $2,000 a year.
You can blame China for starting the malaise. The Middle Kingdom is the largest customer for many of these countries, and successful efforts to throttle back the economy to control runaway home price inflation have spilled far beyond its borders. Since 2007, China?s economy has slowed from a near 14% annual growth rate to a probable 7%. This is a rate not to be sneezed at, but it is still quite a hit. Weak emerging economies then slow China further, creating a vicious negative feedback loop.
China isn?t the only problem. Most emerging nations are highly dependent on imported energy, and are in effect shorts on oil. So when Middle Eastern turmoil drives Texas tea up 28% over the past five months, as it has, balance of payments bleed. This has pummeled their currencies, boosting the local cost of fuel even further. In some countries gasoline costs have soared by more than 50% since the spring. This is terrible for their economies.
The big surprise is how much Ben Bernanke?s ?taper? thoughts are pounding the emerging markets. Much of the excess cash that the Federal Reserve has created over the past five years has poured into the emerging space, boosting share prices and ETF?s to heady heights. Cut off that supply, even by a piddling $5 billion a month, and everyone tries to leave the party at the same time. The price action has been reminiscent of the proverbial flash fire in the movie theater.
Excess liquidity has in fact turned the emerging markets into ?reach for yield? assets, much like master limited partnerships, sovereign debt, junk bonds, municipal bonds, and REIT?s. All of these asset classes have held hands jumping over the cliff since April, when the ?taper? talk began. When investors take inordinate risks for small, incremental improvements in returns, it always ends in tears.
Once emerging markets started going down, all the dirty laundry came out. Tales of corruption have always been endemic to the region. China has started arresting foreign drug company executives for bribery, a classic case of the pot calling the kettle black. The human rights records of several are less than sterling. Having spent time in jail in some of these places because of what I wrote, I more than sympathize.
What?s worse, some of the emerging fundamentals have deteriorated. Once, you bought these countries because they had little debt, a legacy of dismal credit ratings in the seventies and eighties. What did the Fed?s easy money policies accomplish here? Rising debt levels, both at the national and corporate level. Worst of all, some countries have been borrowing from abroad to subsidize fuel prices to lessen the recent price spike. That weakens national finances at an exponential rate.
It all adds up to a perfect storm for emerging markets. Think of them as a short oil/short dollar/long junk play. Ouch! With the way they have been trading, you?d think their largest export was venereal disease!
Which is all why I am starting to get interested. For many years, emerging market companies sold at large premiums to American ones. They now sell at a 35% discount. The long-term bull case is still valid. Watch the bond market. If it rallies hard in the wake of the Fed?s taper decision, as I expect, then it will be off to the races for emerging markets once again.
But it won?t be your father?s emerging bull market. Forget about the BRIC?s (Brazil, Russia, India, China), which are last year?s story. Just mindlessly buying the (EEM) won?t work anymore either. This is no longer an index play.
In the next cycle single country picks will be the name of the game. What?s on my short list? Mexico (EWW), South Africa (EZA), Indonesia (IDX), Thailand (THD), Malaysia (EWM), the Philippines (EPHE), Columbia (GXG), and Chile (ECH). Industry selection will also be important, with a move away from export industries towards domestic consumption called for.
Maybe it?s time to add Thailand to my short list of potential vacation destinations?
https://www.madhedgefundtrader.com/wp-content/uploads/2013/09/Thai-Dancer.jpg405268Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-09-09 07:54:182013-09-09 07:54:18The Emerging ?BUY? on Emerging Markets
As part of my never ending campaign to get you to move more money into emerging markets, please take a look at the chart below from Goldman Sachs. It shows that the global middle class will rise from 1.8 billion today to 4 billion by 2040, with the overwhelming portion of the increase occurring in emerging markets.
The chart defines middle class as those earning between $6,000 and $30,000 a year. Adding 2.2 billion new consumers in these countries is creating immense new demand for all things and the commodities needed to produce them. This explains why these countries will account for 90% of GDP growth for at least the next ten years. It's all a great argument for using this dip to boost your presence in ETF's for emerging markets (EEM), China (FXI), Brazil (EWZ), and India (PIN).
Of course, you don't want to rush out and buy these things today. Emerging markets have been one of the worst performing asset classes of the year. But the selloff off is creating a once in a generation opportunity to get into the highest growing sector of the global economy on the cheap. I'll let you know when it is time to pull the trigger.
In the meantime, store this chart in your data base so when people ask why your portfolio is packed with Mandarin, Portuguese, and Hindi names, you can just whip it out.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/06/World-Middle-Class1.jpg441515Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-06-20 10:42:522013-06-20 10:42:52The Future of Consumer Spending?
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