parts of an email from yesterday

I guess you’ve seen all the stuff about huge buying of options on individual tech stocks, both by Bar Stool-style traders and by Softbank, driving tech stocks up.  My guess is that has ended for now.  If so, it will probably take a week or so for trading in the big tech names to settle down.

I’ve read that when the Tokyo market found out what Son had been up to, and had made $4 billion on speculative options trading, Softbank dropped by 8% (?), losing shareholders $20 billion in market value.  That’s because what he did is bet-the-company crazy.

One of the things I’ve noticed is that some second-line names are doing much better (meaning falling more slowly) than what must be Robinhood-ish favorites.


It’s never clear what triggers a market selloff.  In this case, though, it’s doing a healthy thing by readjusting relative values among different groups of stocks–something I’ve thought would happen by a temporary reversal of leadership in an uptrend.

I think the fact that at zero interest rates stocks are the only game in town means stocks will drop to some longer-term trend line, stabilize, and then begin to move up again.  A hope, not a belief–at the close today NASDAQ seems to have hit the bottom of a channel it’s been in since April.  (It’s also about 25% above its March high, which says these are not bargain-basement levels.)


Over the past 5 trading days, NASDAQ is down by -9.2%, the S&P by -5.5%, and the Russell by -4.7%, so there is outperformance of a sort by the R2000.
Very often after a big selloff, market leadership changes.  That didn’t really happen in March, although afterwards the R2000 began to keep up more with the S&P for several months.  My sense is that the market wants to broaden out to find non-tech stocks that will do well over the next year or two.  This is why consumer discretionary names have been doing well recently.  But because some kinds of tech are going to be long-term winners, the move has to be based on finding consumer names that have good growth prospects, not just that they’re in another sector. 

The market hasn’t gotten conviction yet with this idea, probably in large part because Trumponomics gets loonier by the day.  The near-term economic outlook in the US had already been deteriorating before his latest China ideas, and won’t have a chance to be better unless he’s defeated in November.

Then there’s the human side of things. Who’d have thought we’d see George Wallace reincarnated, or the Waffen SS recreated, or scary abuse of power in the Justice Department–or that the Joint Chiefs would feel the need to say they would not obey any Trump orders to use troops to deny Americans their civil rights.

 
The last two paragraphs both bear on stocks like NWL.  Arguably, NWL is a true “value” name.  That is, all the bad stuff–and more–that could reasonably be expected to happen has already taken place and been factored into the stock price.  So it has some downside protection. It’s also economically sensitive and non-tech; and maybe if management can use the company’s assets competently, good things will happen. 

Another way of putting this is that in a world where TSLA can be down 30% in a week maybe the value formula of dead money for now with the hope of upside later on isn’t so bad to have as part of a portfolio.

I’m raising a little cash

why not to do this

One of the earliest lessons I learned as a portfolio manager is not to raise cash. How so?

–it’s much harder to figure out whether stock A or stock B is cheap or expensive in absolute terms than it is to figure out that A is cheaper than B. This means the easiest way to beat the stock market is to keep fully invested and spend all of your time trying to find more As and eliminate any Bs

–the penalty for having a large cash balance and being wrong can be severe. One of my former work colleagues, running a high-profile value-oriented portfolio for pension clients, decided one day that the stock market was overvalued and that he would be a hero to clients by raising 40% cash. This is like professional suicide. He did it anyway. For the following two years the market went straight up. Nothing he did could offset the negative effect of that dead-weight cash. And after a short while he was so deep in the hole that he felt he couldn’t admit his mistake and reinvest the cash. It took a huge market downturn to give him an opportunity to buy in again. But all that did was more or less recoup the performance losses he had sustained by raising cash in the first place. Then he was fired.

–personally, I’m very bad at judging market tops. I’m pretty good at bottoms, I think. But I tend to think that the good times can go on longer than they actually can

why I’m doing it anyway

To be clear, I’m only selling about 10% of my portfolio, mostly paring back individual positions by that amount. That’s not enough to fundamentally change my portfolio composition–in other words, the gains/losses from this move may end up only as a rounding error in performance attribution. So it’s more security blanket than anything else.

What’s causing me to act is something I usually don’t like to talk about: performance.

performance

One of my early mentors told me he thought a good securities analyst could find a way to make a 20% yearly gain in almost any economic circumstances. In less folksy style, I’ve come to think of a good year as the market return (S&P 500) plus 5 – 8 percentage points; if the S&P 500 is up by 10%, I’d like to end up in the +15% – 20% range.

So far this year, however, my “capital flight” idea, envisioning the US today as like Mexico in the 1980s, has worked much better than I would have thought. That’s, unfortunately, because the Trump administration has been much more toxic than I could have dreamed. The result is that my portfolio is already many times ahead of my yearend relative performance target (I really dislike writing this last sentence. My experience is the minute you begin to pat yourself on the back, your performance begins to fall apart).

Still, I don’t think the epic wave I’ve been riding can go much farther. That’s probably my strongest belief right now. The only way I can see for present conditions to continue would be if we knew that Trump would be reelected. I don’t want to replace names I know with new ones that are basically the same thing. That’s just the anti-US pro-Trump bet all over again. But I don’t have a firm idea of where to go next.

Hence, 10% cash.

Trump underpins tech stocks …for now

The EU has a third more people than the US, has an older population and was in worse Covid shape than the US in early April. Today, however, US daily new cases are about 15x those in the EU; daily new deaths here are 7x those in the EU. The difference? The EU followed the recommendations of US medical scientists; Trump urged his supporters to ignore them.

The economic result for the US is a deeper, longer-lasting downturn than elsewhere in the OECD, huge amounts of Federal government assistance to keep the economy afloat–with a resulting budget deficit that could soon reach $6.0 trillion, vs. $0.6 trillion when he took office.

Rather than try to mitigate the suffering the US is going through, Trump appears to have decided to try to shift national attention away from his central role in creating this tragedy by creating a second, competing disaster. After the armed forces refused to help, Trump organized a gang of from other Federal agencies. Members wear identical camouflage combat gear and carry weapons. No identification on their bodies or vehicles, however. Not a thought about probable cause or excessive use of force, either. In other words, they’re shaped on the Gestapo/KGB/Stasi secret police model. Empowered by executive order and against the wishes of state and local officials, Trump envisions sending these groups into Democratic-leaning cities to instigate violence. Portland is his test case. News reports of the Navy veteran beaten in Portland (he decided to remind Trump’s minions they took an oath to defend the Constitution) show what’s going on. Kristallnacht in America is something no one would have believed possible four years ago. Talk about the banality of evil.

Relevance for the stock market? …a lot.

I’ve been writing for a while about the divergence between NASDAQ and the Russell 2000. The former is the part of the US stock market least tethered to the US by customers, revenues or physical assets; the latter represents the part most closely linked to domestic economic health. NASDAQ is up by about 55% since the beginning of 2018; the Russell 2000 is down by 4% over the same span. I read this 60 percentage point divergence as the stock market’s response to the ongoing economic damage Trump is doing to the US. The spread is very long in the tooth. It’s also so wide that it is begging for at least a temporary reversal of form. So far, however, every attempt at a counter-trend rally has been nipped in the bud.

How so? I think the pro-NASDAQ portfolio configuration has a second motivation. It is also the first step in capital flight from a country moving in the wrong direction.

Recently, coinciding with Trump’s more explicit white racist actions and the resurgence of Covid in the South and Midwest, we’ve begun to see a second aspect of capital flight–a 5%+ decline of the dollar vs. the euro over the past few weeks. The US currency has even lost ground to perennial weaklings sterling and the yen.

It’s hard to know how this all will play out. A Trump win in November is the easier case. I imagine it would create a seismic negative shift in global attitudes toward the US. That would result in a steady outflow of our most productive human and financial capital. The dollar would continue its decline. Maybe, government bonds would begin to sag, too. At some point, Washington would presumably close the border to outflows, a la Mexico 1982. NASDAQ would likely go up, led by firms announcing the relocation of intellectual property-creating operations abroad. Maybe dual listings in New York and China. China and the EU stand to be the big long-term winners.

I think a Trump loss would much more complicated. There’s the issue of repairing the enormous economic, financial and cultural damage he has done to the country. There are also the former heavy industry areas, core sources of Trump strength, which have been ignored by both parties for decades at great national cost. A counter-trend rally might finally happen–maybe even pre-election if a pro-Biden outcome were clear. Would it have legs, if so?

it’s mostly about interest rates

There are three big categories of liquid investments: stocks, bonds and cash. Typically, the progression for individuals as they begin to save is: cash first, then bonds, then stocks.

There’s also an age-related progression, generally from riskier stocks to the steadier returns of government bonds. The old-fashioned formulation is that your age in years is the percentage of savings that should be in bonds, the remainder in stocks. A 30-year old, for example, would have 70% of savings in stocks, the rest in fixed income.

A strong tailwind has been aiding bond returns in the US since the early 1980s, since after the Fed raised short-term interest rates to 20%+ to choke off an inflation spiral spawned by too-loose money policy during the Seventies. The financial collapse of 2008 required another huge dose of money policy stimulus. Recently, Trump has been badgering the Federal Reserve to push short rates below zero to cover up the damage he has done to the domestic economy since being elected, in addition to the big hole he punched in the bottom of the boat this year by his pandemic denial.

No matter how we got here, however, and no matter how bad the negative long-term consequences of Trump’s bungling, the main thing to deal with, here and now, is that one-month T-bills yield 0.13%. 10-year notes yield 0.91%. That’s because during times of stress investors almost always shrink their horizons very substantially. They’re no longer interested in what may happen next year. They just want to get through today.

My sense is that we’re bouncing along the bottom for both short and long rates–and that we’re going to stay this way for a long time. If so, not only is income from Treasures of all maturities substantially below the 1.9% yield on stocks, a rise in interest rates toward a more normal 3% will result in a loss for today’s holders of any fixed income other than cash.

So for now at least, for investors it’s all stocks, all day long.

Looked at this another traditional way, the inverse of the yield on the long Treasury should be the PE on the stock market. If we take the 10-year as the benchmark, the PE on the stock market should be 111; if we take the 30-year (at 1.68%), the PE should be 59.5.

We have to go back to the gigantic bubble of 1980s Japan to see anything similar. If the comparison is valid, then bonds are already in full bubble mode; stocks are halfway there.

reopening rally back on?

That’s what it looks like from yesterday’s price action and today’s futures–both showing the US economy-centric Russell 2000 outperforming the much more international NASDAQ.  The latter, of course, has been the engine driving US stocks for the past 2 1/2 years.

The reason?   Trump continues to do substantial damage to the long-term prospects of the US.  That hasn’t changed.  Nor has the fact that his management incompetence has caused more American deaths that all the wars the US has been in since 1945.  But the performance differential between NASDAQ and the Russell 200 has become so massive that a significant countertrend rally is on the cards.

like a bad movie script…

That stopped in its tracks last week when Trump tweeted segregationist messages urging police to shoot/imprison demonstrators protesting the death of George Floyd at the hands of Minnesota police.  It’s not pretty to see a president eager to incite widespread domestic violence he can call out the army to suppress (something no sane person would want) simply to distract attention from the coronavirus deaths his incompetence is causing.

Suddenly the stock market was back late last week to “capital flight” mode (I’m using this term because, to me, the market has had the feel of Mexico in the early 1980s).

…swiftly tossed into the reject pile

The president basically can’t deploy federal troops into a state without local permission.  And Trump seems to have lost his P. T. Barnum-like persuasive power since wilting during the virus crisis.  Governors appear to have been appalled by his advocacy of violence during a recent conference call.

why is the market rising as this scary story unfolds?

I don’t know.  Nevertheless, this is what’s happening.

No matter what, I think internal market dynamics favor the R2000 over NASDAQ for the moment.

I think ultra-low interest rates favor stocks over fixed income or cash.

Where else would money go  …Japan?  …China?  …the EU?   …the UK?   …emerging markets?  All of these places have substantial warts, either in terms of their economies or their stock markets.  Because of this, the first step in Trump-driven capital flight, I think, would be portfolio concentration in names with global reach, dual listings or the ability to shift domicile away from the US, i.e., a shift away from R2000 and toward NASDAQ.

NASDAQ is now pulling the R2000 up with it.  I also don’t think the current situation would remain stable if Wall Street begins to consider the large damage to long-term economic prospects, to say nothing of civil liberties, were Trump to be reelected.