August 6 Post

Hello Again,

For the past few months I have been saying that the US market is way overvalued and since we have gone for 8 years without a 10%+ correction, we really need a drastic correction for the long term health of the market. George Soros bets $1.1Billion on a US market crash! Soros without question has an undeniable track record of predicting such frightening events (“Money Morning, 7/20/15). He is known as "The Man Who Broke the Bank of England" because of his short sale of US$10 billion worth of pounds, giving him a profit of $1 billion during the 1992 Black Wednesday UK currency crisis. Soros is one of the 30 richest people in the world.(Wikipedia). Of course, like all other investors, Soros is known for making huge mistakes too(i.e. investments in Russia).  Bridgewater Associates believe that there would be bubbles exploding in equity as well as debt markets which will lead to a huge problem; most compare this to 2007.

From my perspective, money managers believe that with technical analysis and derivatives, they could avoid a big correction.  This can only go so far. Last year so many got taken to the cleaners when oil dropped like a lead balloon-WTI dropped from $110 per barrel in July 2014 to $45 (approx..) in March 2015. For example, Carl Icahn smartly made billions in 2014 with his investment in Apple but overall he lost billions because he was on the wrong side of the ‘oil trade’-as with all other investors.  On many fronts, we are in untested waters. Major market declines do not happen when most anticipate them. Right now the market breadth (the difference between the number of stocks going up to the number that is going down) is extremely bad. How can the market be healthy when most are going down? Most are making money by following trends of overvalued stocks. Now everyone’s darling Apple is at the 200-day average-which could be taken as a buy signal or as a warning of things yet to come.

The market could decline for many reasons- The US Feds raising interest rates, the contagion effect from other markets (i.e. Chinese), liquidity problems in the high yield market; to name a few. It seems like most analysts believe that the Feds will increase rates only slightly and maintain very low rates for a long time. They intend to raise rates as we are approaching the full employment rate as defined by economists. This is inflationary; and this what the Feds fear most. In order to avoid inflation, the Feds might increase rates to levels we have not seen for a long time. If that happens, it is going to shock most people. The counter argument is that we are currently witnessing a bear market in the commodity market –to the level we saw in 2007. This is mainly due to the slowdown in China. Also,due to the fact that the dollar has been rising against other currencies-so the value of Australian commodities in terms of US Dollars keep going down. Since commodity levels are at 2007 levels, it might be time to sell overvalued stocks and buy commodity stocks. So even if the demand goes up with lower unemployment,  prices need not go up to increase the supply side. In July 2015 when the major US banks (i.e. Wells Fargo) announced their earnings, they revealed that they swapped a substantial amount of  their balance sheet from floating in to fixed liabilities. If we are expecting an interest rate hike, this is not a good move.

In my opinion, it is better to buy an undervalued ‘investment’, hold it for a long time with patience and then sell at a profit than buy in to overvalued investments (i.e. Biotechs, Tesla, Netflix and so on).  As long as we are confident that the undervalued item will recover in the future, as the price drops, we can purchase more and cut the average cost of the investment.  It is extremely difficult to recover when an overvalued investment gets caught to a market crash-assuming that you can survive one. In the year 2000, if you bought Yahoo with a P/E of 1,000 or Intel, you are still licking your wounds. In the year 2000, I was telling everyone that they should buy Phillips Morris as the dividend rate was over 8% and they were selling at 40% of book value.  In 1999, someone told me that he was very disappointed in Berkshire Hathaway as it is losing money when the dot com stocks were skyrocketing. I told him that if that is so, that shows that the market is wrong and Warren Buffet is right. History shows that I was right. That is my investment philosophy in a nutshell. Go against the herd or else when the herd gets slaughtered, you get your head cut off, too!  In March, when oil (WTI) fell to $45, instead of purchasing oil company stocks as most were suggesting I purchased the ETF, “OIL” that reflects the price of oil (WTI) and I made a 25% profit in 3 months. I do not advise readers to follow suit as you do not get to hold any assets when you make a purchase on this ETF. In fact, if you try to purchase it through a broker, you will get the following warning, “ETNs are unsecured debt subject to the credit risk of the issuer. ETNs do not provide an ownership interest in any underlying asset”. I just invested a small amount in the ETF,”OIL” at a price of $8.80. Within a 2 year period, WTI could go back to $100 per barrel or more; however I wonder if this ETF would last that long. ETFs provide a nice way to invest but they also pose a huge risk due to liquidity problems as well as their impact on their underlying assets. For example, 18% of the ETF, “XLK” (technology) is in Apple. A drop in Apple would make XLK go down and if people start exiting XLK for that reason, it would bring down the stocks of Microsoft, Verizon, Facebook etc. when they had nothing to do with the fall of Apple.  Most analysts are bearish on the commodity oil. It is a demand/supply issue for them. More than WTI(mostly US), BRENT is at risk with Iran entering the world market.

The Market is very concerned about the liquidity problem in the high yield market as well as the corporate bond market. Last week, when asked about this problem, Paul Volker said that he is not concerned as there is no liquidity problem with the Treasury market. I am short selling the high yield market with puts on HYG.  As for oil, the wild card is China. Even though they are expecting their demand to drop, they might make use of these low prices and increase their emergency reserves which could increase the price.  Other countries might do the same.

I rarely add new recommendations to this newsletter but today I am adding Twitter. I try my best to keep away from technology stocks; that is unless there is a special situation.  Warren Buffet was famous for staying away from technology stocks-even though he is a good friend of Bill Gates.  The 1980’s stock market God, Peter Lynch too avoided technology stocks and he called himself a ‘technophobe’.  When Facebook first came to the market, all the people in the world rushed to buy at inflated prices and then when everyone got negative and sold off, I purchased it at $18 and sold it at $23. It was a trade and not an investment.  On 7/31/15, Facebook (FB) closed at $94.01! With respect to Twitter, all analysts agree that it will eventually move up with monetization but the market did not like the fact that the interim CEO did not have a specific plan and a specific timetable. Wall Street’s impatience is our gain!

Given the fact that most stocks are overvalued and also that we have been in a 7+ year bull market, this is a good entry point. All analysts that came on CNBC were waiting for the price to drop further so that they could buy Twitter; to all of them, I have to share the words of wisdom expressed by the old man J P Morgan in the 1920s, when he was asked how he made money in the market, “ I never bought stocks at its lowest point and I never sold my stocks at its highest point”. If you try to maximize, you might not get the opportunity to take part in the deal at all! When the price dropped to $29.27, the volume skyrocketed; and that is a good sign. Pretty soon, hopefully, all those who are willing to sell will be done with their intentions. Within the next 4 weeks, if the market (Dow Jones IA) falls by 25% (Can’t I dream?!), I do not expect this to go below $20. However if that happens, assume Christmas came early and buy more!

As always keep 50% of your portfolio in cash to make use of a market correction. In my case, I periodically purchase put options on the market to protect me from a severe correction or a market crash.

Now to my favorite punching bag-the stock market in China. As I stated in my last newsletter, about 2 months ago when the Goldman Sachs guy in charge of China stated that it was a time to buy Chinese stocks and that there was no concern about a  severe correction, I purchased put options on the Chinese market to short sell that market through the ETF, “ASHR”. When I wrote the last newsletter, the Chinese market was down about 30% and my puts were up by 25%. I purchased out of money puts.

As soon as I wrote my newsletter, the Chinese government made the announcement, “We forbid the market to go down”. They ordered their Central Bank to work with their brokerage houses to buy stocks to stop the carnage. They banned trading on 1,400 stocks which accounted for 50% of the total market cap! In other words, prior to that day if all Chinese stocks accounted for 6 trillion dollars, the market cap (or value=current price*# of outstanding shares) of the 1,400 frozen stocks came to 3 trillion dollars. The market cap of these 1,400 stocks was equal to all the stocks traded in India. 

In population, India will overtake China in about 20 years. All the people, all the funds, all the companies, who needed to sell stocks, were not allowed to do so.  The Chinese Central Bank was supposed to put in $15Billion and stop the downdraft which already lost $4 trillion within a 2 month period.  At this time, some US analysts were suggesting not to short sell China and even start purchases and they used the term well known here as “Don’t fight the Fed”. From my perspective, that was all nonsense. The phrase, ”Don’t fight the fed” was coined by market guru Martin Zweig in the 1980s where he showed people to get in to the market when the Feds start lowering rates and getting out of the market when the Feds start to tighten.

Some were saying that if the US and Europe could intervene; there is no harm in the Chinese intervening in this manner. The Feds always intervene with Treasuries to lower rates for ‘Main Street’ and not for ‘wall street’. The Chinese were buying worthless stocks and it was like catching a falling knife. I did not listen to the pundits and I kept my ‘shorts’(puts). For 2 weeks, the Chinese market managed not to go down. Then in one day, their market fell another 8%. At that point, I sold 50% of my puts at a profit of 100% (which I gained in 2months). I kept the rest thinking that if their market goes up again, I will buy more puts as I do not think that massacre is over.  Over the past 12 months, when everyone expected the Chinese economy to slow down, their stock market went up by 150% ! The Chinese government is saying that hedge funds can buy but cannot sell for 6 to 12 months. When that ends, there will be a bloodbath. My puts expire in 2016 and 2017 so I have time. 

Some compare China to Japan prior to their 1990 market and economy crash:

·        Property bubble

·        Stock market bubble

·        Boasted of  a new model for capitalism

·        Heavy investments in the global economy

·        Making wrong moves to correct the bubble

Unlike with Japan, most westerners have doubts about the credibility of financials of Chinese companies as well as data reported by the Chinese government.  Some compare this Chinese crash to the 1929 US crash. I hope the Chinese will learn as much as we did from our 1929 crash. Market regulations (no pyramid schemes), FDIC, tight banking regulations came after that crash. Greenspan and Bernanke, being students of the 1929 crash, learned to add liquidity after market crashes.

 All markets are linked so beware of the contagion effect! Hold 50% of your portfolio in cash.

Until next time, I wish you all the best.