Global Market Comments
April 6, 2020
Fiat Lux
Featured Trade:
(MARKET OUTLOOK FOR THE WEEK AHEAD, or MAD HEDGE GOES POSITIVE ON THE YEAR)
(INDU), (SPY), (VIX), (VXX), (AMZN), (MSFT), (BAC), (JPM)
Posts
Global Market Comments
April 2, 2020
Fiat Lux
Featured Trade:
(THE DEATH OF PASSIVE INVESTING)
(SPY), (SPX), (INDU)
(NOTICE TO MILITARY SUBSCRIBERS)
Global Market Comments
March 23, 2020
Fiat Lux
Featured Trade:
(MARKET OUTLOOK FOR THE WEEK AHEAD, or WELCOME TO THE GREAT DEPRESSION),
(INDU), (SPY), (GS), (MS), (FXI), (USO), (TSLA)
The neighborhood is alive with power tools.
These are the implements that were given as Christmas presents to dads years ago. But to afford life in the San Francisco Bay Area said dads have to work 12 hours a day and weekends. Now, suddenly they have all the free time in the world and those ancient gifts are coming out of decade-old original packaging.
I’ve noticed something else about my neighborhood. People have suddenly started to turn gray. Beauty salon appointments have been banned for weeks, not designated essential businesses.
The GDP forecasts released by Goldman Sachs (MS) last week have been turning a lot of other people gray as well. Q1 is thought to show a -6% annualized shrinkage and Q2 is expected to come in at -24%. The unemployment rate will peak at 9%. Not to be outdone, Morgan Stanley (MS) cut their Q2 forecast to -30%.
That means America’s GDP will shrink to the 2016 level of $18.62 trillion, down enormously from today’s $21.5 trillion. Yes, three years of economic growth will be gone in a puff of smoke. These are far worse than the last Great Recession when the worst two quarters came in at -2% and -8%. That’s double the worst figures of the Great Recession.
In the meantime, vast swaths of the American economy are moving online, never to return.
The good news is that growth will return at a historic 12% rate in Q3. That sets up an exaggerated “V” for the stock market. How soon should you start buying stocks if this economic scenario plays out? Probably a month, if not weeks, but only if you have the courage to do so.
The numbers from China (FXI) this week are very encouraging, showing no increase in new cases. In February, they enacted the kind of severe lockdown which California enacted a week ago.
Hopefully, that means we will get the Chinese results in a month or two. But the problem is that these are Chinese numbers that may be intended more to please the government than shed light on the truth.
The first real look we get at the effectiveness of lockdown may be in Italy in a few weeks, which has been quarantined since February.
In the US, the states have abandoned all hope of help from Washington and are leading the charge with the most aggressive measures. In California, it is now illegal for 40 million people to go outside unless it is a trip to the grocery store, the pharmacy, or the doctor.
The Golden State is now on a WWII footing. Tesla (TSLA) is switching production to ventilators. The state national guard is setting up field hospitals in parks. I am growing my own victory garden in the back yard.
The state is seeking to double the number of hospital beds to 20,000 within weeks. It just bought an entire hospital in Oakland, Seton Hospital. It went bankrupt last year and the administrators couldn’t give it away. The state i taking control of abandoned college dormitories and leasing empty hotels and cruise ships.
I expect food rationing to hit in a month. The distribution system is strained but working now. It may start to fail in April or May when large numbers of workers get sick.
The good news is that shelter in place should work, possibly by May. Kids are out of school until August.
With Trump refusing to put the entire country on lockdown that raises the specter of those in red states dying, while those in blue ones live. The big blue states of New York, California, New Jersey, Connecticut, and Illinois were the first to order shelter-in-place and will certainly see lower and sooner peaks in disease and fatalities.
And guess who has a one-month supply of Chloroquine, along with antibiotics widely believed to be a cure for the Coronavirus? That would be me, who bought them to fight off malaria for my trip to Guadalcanal six weeks ago. I was planning on going back in June to collect more dog tags for the Marine Corps, so I have an extra supply. As long as you can read, I’ll still be writing.
There is one more unexpected aspect of the pandemic and the shelter-in-place orders. I expect a baby boom to ensue in about nine months, thanks to all this enforced togetherness. The US birth rate has been falling for decades and is now well below the replacement rate. It’s about time we found a way to turn it around. Just don’t count me in on this one. I already have five kids.
So, you’re still asking for a market bottom.
The futures in Asia are limit down as I write this, just above the Dow Average 17,000 handle (INDU), thanks to the Senate failure to pass a virus rescue bill. Near 15,000 seems within range, down 49% from the February high. Modern history is no longer relevant here. We have to go back to 1929 to see numbers this extreme. I’ll be doing the research on that in the coming days.
The 1987 crash was already revisited a week ago, with a 3,000-point plunge in the Dow Average, or 12%. Some 33 years ago, we saw a 20% single day haircut, which I remember too well. This is with the Federal Reserve throwing everything at the stock market but the kitchen sink. I never thought I’d live long enough to see another one of these.
The Fed took interest rates to zero to stave off a depression, but the stock market crashes in overnight trading anyway. That brings the total to 150 basis points in cuts in five days. The Treasury is to buy an eye-popping $700 billion in mortgage securities to clear out the refi market for the first time in a decade. The Fed has just fired its last bullets to save stocks.
Goldman Sachs is targeting 2,000 in the (SPX), down 10% from here and 41% from the top. That is a 14X multiple on a 2020 S&P 500 earnings decline from $165 to $143. Yes, it’s just a guess. Investors could care less now about fundamentals or technicals. Cash is king.
Oil (USO) is headed for the teens. Saudi Arabia is ramping up production to a record 13 million barrels a day. The recession is collapsing US demand from 20 to 15 million b/d, half of which is consumed by transportation.
Russian national income has just collapsed by 75%. Will there by a second Russian Revolution? The 3% of the US market capitalization accounted for by energy stocks will drop below 1%. Fill her up! Avoid energy, even though some are going for pennies on the dollar.
The only data point that counts now is the daily real-time Corona tally of cases and deaths from Johns Hopkins, (click here). All other economic data is now irrelevant. Right now we are at 335,997 cases worldwide and 14,641 deaths. The US is at a frightening 33,276 cases as of writing.
Insider buying is exploding, with CEOs picking up their own stocks at 50%-70% discounts. Charles Scarf, president of Wells Fargo, just bought $5 million worth of (WFC) down 52% from the recent top. This is a legendary indicator that we may be within weeks of a market bottom.
The New York Stock Exchange closes its floor trading operations last week after several members tested positive for the Corona virus. Online trading will continue, where 95% of the business migrated years ago. It’s really just a TV stage now.
It’s all about hedge funds, triggering the massive volatility of the past month. They have been unwinding massive positions with up to 13X leverage in illiquid markets that can’t handle the massive volume.
When the last hedge fund is liquidated, the market will go up and the (VIX) will collapse. They may have started and the (VIX) plunged an incredible 25 points in hours.
Trump asked states to keep unemployment data secret to minimize market impact. Just what we need, less information, not more. The Weekly Jobless Claims were a bombshell, adding 70,000 to 271,000, the sharpest increase in a decade. Look for far worse to come in coming weeks as whole industries are shut down, and state unemployment computers explode from the weight of applications. Jobless Claims over 2 million are imminent!
Existing Home Sales soared by a stunning 6.5% in February, a 13-year high. The West saw an amazing 17% increase. The median home price jumped by 8% YOY. While the data is great, it’s all pre-Corona. It is illegal for people to go out to look at homes in many states, and no one wants to sell to keep strangers out of the house.
When we come out on the other side of this, we will be perfectly poised to launch into my new American Golden Age, or the next Roaring Twenties. With interest rates at zero, oil at $20 a barrel, and many stocks down by three quarters, there will be no reason not to.
My Global Trading Dispatch performance has had a great week, thanks to the collapse in market volatility, pulling back by -8.22% in March, taking my 2020 YTD return down to -11.14%. That compares to an incredible loss for the Dow Average of -37% at the Friday low. My trailing one-year return was pared back to 31.68%. My ten-year average annualized profit shrank to +33.56%.
I have been fighting a battle for the ages on a daily basis to limit my losses. My goal here is to make it back big time when the market comes roaring back in the second half.
My short volatility positions have largely recovered. I shorted the (VXX) when the Volatility Index (VIX) was at $35. It then went to an unbelievable $80 before falling back to $55. I was saved by only trading in very long maturity, very deep out-of-the-money (VXX) put options where time value will maintain a lot of their value. Now, we have time decay working in our favor. These will all come good well before their one-year expiration.
At the slightest sign of a break in the pandemic, the economy and shares should come roaring back. Right now, I have a 70% cash position.
On Monday, March 23 at 7:30 AM, the Chicago Fed National Activity Index is out.
On Tuesday, March 24 at 9:00 AM, the New Home Sales for February are released.
On Wednesday, March 25, at 7:30 AM, US Durable Goods for February are published.
On Thursday, March 26 at 7:30 AM, Weekly Jobless Claims are announced. The number could top 1,000,000. The final read on Q4 GDP is announced, although it is ancient history.
On Friday, March 27 at 9:00 AM, the US Personal Income for February is printed. The Baker Hughes Rig Count follows at 2:00 PM.
As for me, I will be in training doing daily ten-mile hikes with a 50-pound backpack. I will be leading the Boy Scouts on a 50-mile hike at Philmont in New Mexico. I expect the epidemic to peak well before then and normalcy to return.
Shelter in place will work. Please stay healthy.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Going Shopping
Global Market Comments
March 19, 2020
Fiat Lux
Featured Trade:
(INVESTING ON THE OTHER SIDE OF THE CORONA VIRUS),
(SPY), (INDU), (FXE), (FXY), (UNG),
(EEM), (USO), (TLT), (TSLA)
The Coronavirus has just set up the investment opportunity of the century.
In a matter of three weeks, stocks have gone from wildly overbought to ridiculously cheap. Price earnings multiples have plunged from 20X to 13X, well below the 15.5X long term historical average. The Dow Average is now 5% lower than when Donald Trump assumed the presidency more than three years ago. The world of investing after Coronavirus is looking pretty good.
I believe that as a result of this meltdown, the global economy is setting up for a new Golden Age reminiscent of the one the United States enjoyed during the 1950s, and which I still remember fondly. In other words, when it comes to investing after Coronavirus, we are on the cusp of a new “Roaring Twenties.”
This is not some pie in the sky prediction.
It simply assumes a continuation of existing trends in demographics, technology, politics, and economics. The implications for your investment portfolio will be huge.
For a start, medical science is about to compress 5-10 years of advancement into a matter of months. The traditional FDA approval process has been dumped in the trash. Any company can bring any medicine, vaccine, or anti-viral they want to the market, government be damned. You and I will benefit enormously, but a few people may die along the way.
What I call “intergenerational arbitrage” will be the principal impetus. The main reason that we are now enduring two “lost decades” of economic growth is that 80 million baby boomers are retiring to be followed by only 65 million “Gen Xer’s”.
When the majority of the population is in retirement mode, it means that there are fewer buyers of real estate, home appliances, and “RISK ON” assets like equities, and more buyers of assisted living facilities, healthcare, and “RISK OFF” assets like bonds.
The net result of this is slower economic growth, higher budget deficits, a weak currency, and registered investment advisors who have distilled their practices down to only municipal bond sales.
Fast forward two years when the reverse happens and the baby boomers are out of the economy, worried about whether their diapers get changed on time or if their favorite flavor of Ensure is in stock at the nursing home.
That is when you have 65 million Gen Xer’s being chased by 85 million of the “millennial” generation trying to buy their assets.
By then, we will not have built new homes in appreciable numbers for 20 years and a severe scarcity of housing hits. Residential real estate prices will soar. Labor shortages will force wage hikes.
The middle-class standard of living will reverse a then 40-year decline. Annual GDP growth will return from the current subdued 2% rate to near the torrid 4% seen during the 1990s.
The stock market rockets in this scenario. And this pandemic has just given us a very low base from which to start, making investing after Coronavirus a promising prospect.
Once the virus is beaten, we could see the same fourfold return we saw from 2009 to 2020. That would take us from The Thursday low of 18,917 to 76,000 in only a few years.
If I’m wrong, it will hit 100,000 instead.
Emerging stock markets (EEM) with much higher growth rates do far better.
This is not just a demographic story. The next ten years should bring a fundamental restructuring of our energy infrastructure as well.
The 100-year supply of natural gas (UNG) we have recently discovered through the new “fracking” technology will finally make it to end users, replacing coal (KOL) and oil (USO), so this sort of energy investing after Coronavirus in particular is looking undoubtedly promising.
Fracking applied to oilfields is also unlocking vast new supplies.
Since 1995, the US Geological Survey estimate of recoverable reserves has ballooned from 150 million barrels to 8 billion. OPEC’s share of global reserves is collapsing.
This is all happening while the use of electric cars is exploding, from zero to 4% of the market over the past decade.
Mileage for the average US car has jumped from 23 to 24.9 miles per gallon in the last couple of years, and the administration is targeting 50 mpg by 2025. Total gasoline consumption is now at a five-year low and collapsing.
Alternative energy technologies will also contribute in an important way in states like California, which will see 100% of total electric power generation come from alternatives by 2030.
I now have an all-electric garage, with a Tesla Model 3 for local errands and a Tesla Model X (TSLA) for longer trips, allowing me to disappear from the gasoline market completely. Millions will follow. Both cars are powered by my rooftop solar system.
The net result of all of this is lower energy prices for everyone.
It will also flip the US from a net importer to an exporter of energy, with hugely positive implications for America’s balance of payments.
Eliminating our largest import and adding an important export is very dollar bullish for the long term.
That sets up a multiyear short for the world’s big energy-consuming currencies, especially the Japanese yen (FXY) and the Euro (FXE). A strong greenback further reinforces the bull case for stocks.
Accelerating technology will bring another continuing positive for investing after Coronavirus.
Of course, it’s great to have new toys to play with on the weekends, send out Facebook photos to the family, and edit your own home videos. But at the enterprise level, this is enabling speedy improvements in productivity that are filtering down to every business in the US, lower costs everywhere.
This is why corporate earnings have been outperforming the economy as a whole by a large margin.
Profit margins are at an all-time high.
Living near booming Silicon Valley, I can tell you that there are thousands of new technologies and business models that you have never heard of under development.
When the winners emerge, they will have a big cross-leveraged effect on the economy.
New healthcare breakthroughs, which are also being spearheaded in the San Francisco Bay area, will make serious disease a thing of the past.
This is because the Golden State thumbed its nose at the federal government 18 years ago when the stem cell research ban was implemented.
It raised $3 billion through a bond issue to fund its own research, even though it couldn’t afford it.
I tell my kids they will never be afflicted by my maladies. When they get cancer in 20 years, they will just go down to Wal-Mart and buy a bottle of cancer pills for $5, and it will be gone by Friday.
What is this worth to the global economy? Oh, about $2 trillion a year, or 4% of GDP. Who is overwhelmingly in the driver’s seat on these innovations? The USA.
There is a political element to the new Golden Age as well. Gridlock in Washington can’t last forever. Eventually, one side or another will prevail with a clear majority.
This will allow the government to push through needed long-term structural reforms, the solution of which everyone agrees on now but nobody wants to be blamed for.
That means raising the retirement age from 66 to 70 where it belongs and means-testing recipients. Billionaires don’t need the maximum $45,480 Social Security benefit. Nor do I.
The ending of our foreign wars and the elimination of extravagant unneeded weapons systems cut defense spending from $755 billion a year to $400 billion, or back to the 2000, pre-9/11 level. Guess what happens when we cut defense spending? So does everyone else.
I can tell you from personal experience that staying friendly with someone is far cheaper than blowing them up.
A Pax Americana would ensue.
That means China will have to defend its own oil supply, instead of relying on us to do it for them for free. That’s why they have recently bought a second used aircraft carrier. The Middle East is now their headache, not ours.
The national debt then comes under control, and we don’t end up like Greece.
The long-awaited Treasury bond (TLT) crash never happens.
The reality is that the global economy will soon spin off profits faster than it can find places to invest them, so the money ends up in bonds instead.
Sure, this is all very long-term, over the horizon stuff. You can expect the financial markets to start discounting a few years hence, even though the main drivers won’t kick in for another decade.
But some individual industries and companies will start to discount this rosy scenario now.
Perhaps this is what the nonstop rally in stocks since 2009 has been trying to tell us.
Needless to say, investing after Coronavirus runs it's course will be a welcome change for both individual investors and the economy as a whole.
Dow Average 100-Year Chart
Another American Golden Age is Coming
Global Market Comments
March 18, 2020
Fiat Lux
Featured Trade:
(LOOKING FOR LEVERAGED LONG PLAYS),
(SPY), (INDU), (SSO), (UPRO)
This is a time where everyone is wondering: what is the future of coronavirus and, in turn, the economy?
It is highly likely that the stock market will bottom out over the next few weeks and then begin a period of sideways chop in a wide range.
That range could be half the recent loss, a staggering 5,000 points in the Dow Average (INDU), or 500 S&P 500 points (SPX).
The math is quite simple.
With much of the country now on lockdown, Corona cases will keep climbing sharply in the US from the present 5,000 cases. They will keep doubling every three days for the next two weeks, the incubation time for the disease possibly reaching as high as 40,000 cases.
Just in the time it took me to write this piece, the number of cases worldwide jumped from 184,000 to 194,873 (click here for the link).
At that point, everyone who has the disease will become visible and can be isolated. The following week will bring a sharp falloff in the number of new cases, which many traders and investors will read as the end of the epidemic.
Shares will rocket.
The lockdowns and the “shelters in place” will come off. The economy will start to return to normal. Stock investors will pile in.
Then another spike in new cases will take place, prompting a secondary round of shutdowns and another run at the lows.
On top of this, the market will have to digest a coming set of economic numbers that will be the worst in history. All eyes will be on the Thursday Weekly Jobless Claims out at 8:30 AM, that will be our first look at the terrifying layoffs to come.
Our first look at economic growth comes at the end of April when the Q1 GDP is released. Since we had two months of growth before the crash and lockdown, it comes in as high as zero.
Not so with Q2, which could bring in a 5% or more shrinkage in the economy at an annualized rate. No doubt more 1,000 point down days are setting up when these figures are printed.
This is precisely what healthcare officials want to happen. That way, Corona cases can be spaced out over a year, keeping the national civilian and military hospital system from getting overwhelmed.
This is what the future of coronavirus will look like for the economy. Suffice it to say that there are some spectacular long side plays setting up. I’ll cover some of the best ways to play it.
One is the ProShares Ultra S&P 500 (SSO), a 2x long the underlying stock index. Since the all-time high four weeks ago, the (SSO) has cratered by 54.50%.
Another is the ProShares Ultra Pro S&P 500 (UPRO), a 3x long the underlying stock index. Since the all-time high four weeks ago, the (SSO) has cratered by an eye-popping 74.40%.
Needless to say, the velocity of these instruments is enormous, and the bid offered spreads wide. If you want your “E-ticket” ride for the stock market, this is it. Trade these with extreme caution.
Get a piece of either one of these and the gains can be huge. The (SSO) has to jump by 120% to the old high, while the (UPRO) needs to soar by 290%.
Good Luck!
This Morning’s Traffic Report
The San Francisco Rush Hour
My Kind of Stockpile
I almost got to take a shower today.
However, whenever I got close to the bathroom, I'd get an urgent call from a concierge member, Marine buddy, Morgan Stanley retiree, fraternity brother from 50 years ago, or one of my kids asking me which stocks to buy at the bottom.
It’s been that kind of market.
I refer them to the research piece I sent out last week, “Ten Long Term LEAPs to Buy at the Bottom” for a quick and dirty way to get into the best names in a hurry (click here for the link).
I have been doing the same, and as a result, I have one of the largest trading portfolios in recent memory. When the Volatility Index is above $50, it is almost impossible to lose money as long as you remember to buy the 1,000 dips and sell the 1,000 point rallies.
In the run-up to every options expiration, which is the third Friday of every month, there is a possibility that any short options positions you have may get assigned or called away.
If that happens, there is only one thing to do: fall down on your knees and thank your lucky stars. You have just made the maximum possible profit for your position instantly.
Most of you have short option positions, although you may not realize it. For when you buy an in-the-money vertical option spread, it contains two elements: a long option and a short option.
The short options can get “assigned,” or “called away” at any time, as it is owned by a third party, the one you initially sold the put option to when you initiated the position. Whenever you have sold short an option, you run an assignment risk.
You have to be careful here because the inexperienced can blow their newfound windfall if they take the wrong action, so here’s how to handle it correctly.
Let’s say you get an email from your broker saying that your call options have been assigned away. I’ll use the example of the Microsoft (MSFT) December 2019 $134-$137 in-the-money vertical BULL CALL spread.
For what the broker had done in effect is allow you to get out of your call spread position at the maximum profit point 8 days before the December 20 expiration date. In other words, what you bought for $4.50 last week is now with $5.00!
All have to do is call your broker and instruct them to exercise your long position in your (MSFT) December 134 calls to close out your short position in the (MSFT) December $137 calls.
This is a perfectly hedged position, with both options having the same expiration date, the same amount of contracts in the same stock, so there is no risk. The name, number of shares, and number of contracts are all identical, so you have no exposure at all.
Calls are a right to buy shares at a fixed price before a fixed date, and one options contract is exercisable into 100 shares.
To say it another way, you bought the (MSFT) at $134 and sold it at $137, paid $2.60 for the right to do so, so your profit is 40 cents, or ($0.40 X 100 shares X 38 contracts) = $1,520. Not bad for an 18-day limited risk play.
Sounds like a good trade to me.
Weird stuff like this happens in the run-up to options expirations like we have coming.
A call owner may need to buy a long (MSFT) position after the close, and exercising his long December $134 call is the only way to execute it.
Adequate shares may not be available in the market, or maybe a limit order didn’t get done by the market close.
There are thousands of algorithms out there which may arrive at some twisted logic that the puts need to be exercised.
Many require a rebalancing of hedges at the close every day which can be achieved through option exercises.
And yes, options even get exercised by accident. There are still a few humans left in this market to blow it by writing shoddy algorithms.
And here’s another possible outcome in this process.
Your broker will call you to notify you of an option called away, and then give you the wrong advice on what to do about it. They’ll tell you to take delivery of your long stock and then most additional margin to cover the risk.
Either that, or you can just sell your shares on the following Monday and take on a ton of risk over the weekend. This generates a ton of commission for the brokers but impoverishes you.
There may not even be and evil motive behind the bad advice. Brokers are not investing a lot in training staff these days. It doesn’t pay. In fact, I think I’m the last one they really did train.
Avarice could have been an explanation here but I think stupidity and poor training and low wages are much more likely.
Brokers have so many legal ways to steal money that they don’t need to resort to the illegal kind.
This exercise process is now fully automated at most brokers but it never hurts to follow up with a phone call if you get an exercise notice. Mistakes do happen.
Some may also send you a link to a video of what to do about all this.
If any of you are the slightest bit worried or confused by all of this, come out of your position RIGHT NOW at a small profit! You should never be worried or confused about any position tying up YOUR money.
Professionals do these things all day long and exercises become second nature, just another cost of doing business.
If you do this long enough, eventually you get hit. I bet you don’t.
Calling All Options
Today, we saw the largest point loss in market history, the first use of modern circuit breakers, and individual stocks down up to 40%. Ten-year US Treasury bond yields cratered to 0.39%. Virtually the entire energy and banking sectors vaporized.
What did I do? I did what I always do during major stock market crashes.
I took my Tesla out to get detailed. When I got home, I washed the dishes and did some laundry. And for good measure, I mowed the lawn, even though it is early March and it didn’t need it.
That’s because I was totally relaxed about how my portfolio would perform.
There is a method to my madness, although I understand that some new subscribers may need some convincing.
I always run hedged portfolio, with hedges within hedges within hedges, although many of you may not realize it. I run long calls and puts against short calls and puts, balance off “RISK ON” positions with “RISK OFF” ones, and always keep a sharp eye on multi-asset class exposures, options implied volatilities, and my own Mad Hedge Market Timing Index.
While all of this costs me some profits in rising markets, it provides a ton of protection in falling ones, especially the kind we are seeing now. So, while many hedge funds are blowing up and newsletters wiping out their readers, I am so relaxed that I could fall asleep at any minute.
Whenever I change my positions, the market makes a major move or reaches a key crossroads, I look to stress test my portfolio by inflicting various extreme scenarios upon it and analyzing the outcome.
This is second nature for most hedge fund managers. In fact, the larger ones will use top of the line mainframes powered by $100 million worth of in-house custom programming to produce a real-time snapshot of their thousands of positions in all imaginable scenarios at all times.
If you want to invest with these guys feel free to do so. They require a $10-$25 million initial slug of capital, a one-year lock-up, charge a fixed management fee of 2% and a performance bonus of 20% or more.
You have to show minimum liquid assets of $2 million and sign 50 pages of disclosure documents. If you have ever sued a previous manager, forget it. The door slams shut. And, oh yes, the best performing funds are closed and have a ten-year waiting list to get in. Unless you are a major pension fund, they don’t want to hear from you.
Individual investors are not so sophisticated, and it clearly shows in their performance, which usually mirrors the indexes less a large haircut. So, I am going to let you in on my own, vastly simplified, dumbed-down, seat of the pants, down and dirty style of risk management, scenario analysis, and stress testing that replicates 95% of the results of my vastly more expensive competitors.
There is no management fee, performance bonus, disclosure document, lock up, or upfront cash requirement. There’s just my token $3,000 a year subscription fee and that’s it. And I’m not choosy. I’ll take anyone whose credit card doesn’t get declined.
To make this even easier, you can perform your own analysis in the excel spreadsheet I post every day in the paid-up members section of Global Trading Dispatch. You can just download it and play around with it whenever you want, constructing your own best-case and worst-case scenarios. To make this easy, I have posted this spreadsheet on my website for you to download by clicking here. You have to be logged in to access and download the spreadsheet.
Since this is a “for dummies” explanation, I’ll keep this as simple as possible. No offense, we all started out as dummies, even me.
I’ll take Mad Hedge Model Trading Portfolio at the close of March 9, 2020, the date of a horrific 2,000 down day in the Dow Average. This was the day when margin clerks were running rampant, brokers were jumping out of windows, and talking heads were predicting the end of the world.
I projected my portfolio returns in three possible scenarios: (1) The market collapses an additional 5.3% by the March 20 option expiration, some 8 trading days away, (2) the S&P 500 (SPX) rises 10% by March 20, and (3) the S&P 500 trades in a narrow range and remains around the then-current level of $2,746.
Scenario 1 – The S&P 500 Falls Another 5.3% to the 2018 Low
A 5.3% loss would take the (SPX) down to $2,600, to the 2018 low, and off an astonishing 800 points, or 23.5% down from the recent peak in a mere three weeks. In that situation the Volatility Index (VIX) would rise maybe to $60, the (VXX) would add another point, but all of our four short positions (AAPL), (UAL), (CCL), and (WYNN) would expire at maximum profit points.
In that case, March will end up down -3.58%, and my 2020 year-to-date performance would decline to -6.60%, a pittance really compared to a 23.5% plunge in the Dow Average. Most people would take that all day long. We live to buy another day. Better yet, we live to buy long term LEAPs at a three-year market low with my Mad Hedge Market Timing Index at only 3, a historic low.
Also, when the market eventually settles down, volatility will collapse, and the value of my (VXX) positions double.
Scenario 2 – S&P 500 rises 10%
The impact of a 10% rise in the market is easy to calculate. All my short positions expire at their maximum profit point because they are all so far in the money, some 20%-40%. It would be a monster home run. I would go back in the green on the (VXX) because of time decay. That would recover my March performance to +1.50% and my year-to-date to only -1.42%
Scenario 3 – S&P 500 Remains Unchanged
Again, we do great, given the circumstances. All the shorts expire at max profits and we see a smaller increase in the value of the (VXX). I’ll take that all day long, even though it cost me money. When running hedge funds, you are judged on how you manage your losses, not your gains, which are easy.
Keep in mind that these are only estimates, not guarantees, nor are they set in stone. Future levels of securities, like index ETFs, are easy to estimate. For other positions, it is more of an educated guess. This analysis is only as good as its assumptions. As we used to say in the computer world, garbage in equals garbage out.
Professionals who may want to take this out a few iterations can make further assumptions about market volatility, options implied volatility or the future course of interest rates. And let’s face it, politics is a major influence this year. Thanks Joe Biden for that one day 1,000 point rally to sell into, when I established most of my shorts and dumped a few longs.
Keep the number of positions small to keep your workload under control. Imagine being Goldman Sachs and doing this for several thousand positions a day across all asset classes.
Once you get the hang of this, you can start projecting the effect on your portfolio of all kinds of outlying events. What if a major world leader is assassinated? Piece of cake. How about another 9/11? No problem. Oil at $10 a barrel? That’s a gimme.
What if there is an American attack on Iranian nuclear facilities to distract us from the Coronavirus and stock market carnage? That might take you all two minutes to figure out. The Federal Reserve launches a surprise QE5 out of the blue? I think you already know the answer.
Now that you know how to make money in the options market, thanks to my Trade Alert service, I am going to teach you how to hang on to it.
There is no point in being clever and executing profitable trades only to lose your profits through some simple, careless mistakes.
The first goal of risk control is to preserve whatever capital you have. I tell people that I am too old to lose all my money and start over again as a junior trader at Morgan Stanley. Therefore, I am pretty careful when it comes to risk control.
The other goal of risk control is the art of managing your portfolio to make sure it is profitable no matter what happens in the marketplace. Ideally, you want to be a winner whether the market moves up, down, or sideways. I do this on a regular basis.
Remember, we are not trying to beat an index here. Our goal is to make absolute returns, or real dollars, at all times, no matter what the market does. You can’t eat relative performance, nor can you use it to pay your bills.
So the second goal of every portfolio manager is to make it bomb-proof. You never know when a flock of black swans is going to come out of nowhere or another geopolitical shock occurs causing the market crash.
