October 3 Post

Hi Again,

Take a look at our scorecard! During the past 21 months, our Bank of America holding has gone up by 91.39% and during the past 25 months, Alcoa holding has gone up by 94.98%! Those two were very unpopular with most analysts 2 years ago. On Schlumberger, last week, our gain was at 0.87% and at end of September 2017, the gain was at 10.37%; and that means that if you purchased some of this stock on 8/31/17(for the same number of stocks given here), you could have gained about 9% in 30 days on one of the best companies of America! Even though this is one of the longest running bull markets with the least amount of volatility (see below for more details), from time to time, there has been a ‘sector rotation’. In other words, corrections do not take place for the whole market but corrections take place by industry or by sectors. Information is power! Using that bit of information, when stocks in our portfolio, except for Twitter, go down, it is safe to assume that it is a buying opportunity. Using that theory, as of 10/1/17, Glaxo Smith Kline (GSK) holding is down 0.66%. The dividend yield as of 10/1/17 is at 4.89%-which is fantastic! Let us assume GSK share price go down by 50% to $20.30 and there is no change in the dividend payout ($1.99 per share), then the dividend yield as a percentage will be at 9.80%!!  Just a cautionary note-if a dividend yield of a stock is over 5%, be extra careful as that is usually a red flag as it could indicate that many bad things could happen to that company in the future. Extra research is needed in such cases.

In my last newsletter, I mentioned that our market (as well as the South Korean market) was ignoring all danger signs and kept moving up which is a bad sign. That is unhealthy. For decades, I have heard that a healthy market ‘climbs a wall of worry”. I also stated that I placed an order to buy a put option on the South Korean ETF, “EWY” (which mirrors the South Korean market). I wrote my last newsletter on 9/1/17 evening, and on the next business day (after Labor Day), on 9/4/17, the day began with the South Korean ETF (EWY) which mirrors the South Korean market down 2% and the put option I was trying to buy was up 50% (one business day to another)! Therefore my order did not get filled. This clearly shows the power of put options as a hedge against a market crash.

Data released last week showed that August 2017 US margin debt (a measure of much borrowed money investors used to buy equities) reached a record high of $551 Billion (over half a trillion dollars!). Since 1959, nearly 25% monthly margin debt readings were record highs, and over the span, the difference between average S&P500 index performance 6 months after record months and 6 months after non-record months is minimal. (Bespoke Investment Group/Barron’s, Market Week, 10/1/17). What does this mean for us? First, this is another indication that we are in a bubble. Second, bubbles always end in crashes. Thirdly, it is never possible to predict an end to a bubble to proceed with caution!

According to CNBC, in 2017, the most market corrected was 3%; and that is the least amount corrected since 1914. This does not mean that a correction is around the corner but that would be healthy for the market. We had the same kind of situation around 1994 and then we had less volatility and more bullishness for the next 5 years or so which ended in a crash. In 2002 we had about 200 ETFs and now we have about 1800 ETFS. In 2002, S&P500 Index Vanguard fund had assets worth about $12B and now their cash inflows come to about $6B per day. These days most of the money is invested per quantitative analysis (mostly computer driven). As it always happen, when global trends change with little or no notice, we could see a multi-million trillion dollar loss in the global equity market. On 9/21/17, CNBC Halftime Report announces that this is the lowest volatility period in the market since 1896; even with all bad news coming from all quarters! This is bad! When all people are bullish, it is a huge bubble! On 9/20/17, Nightly Business Report commented that bullishness in the country is at a 17 year low and Warren Buffet predicted that in 100 years, the Dow will be at 1,000,000; as a contrarian, this is another sign of a bubble. The old bull market reached a new milestone by 9/15/17, the silver medal for endurance. 9/15/17 close of 2500, the S&P 500 index made a new all-time high and also capped its second strongest rise in history, up nearly 270% eclipsing the 1949-1956 bull market’s 267% rise, says the Bespoke Investment Group. The current rally which began on 3/9/2009 had already pulled in to second place for longevity in April 2016, and has now lasted 3,112 days without a bear market, defined as a 20% group. But first place is a long way off; the famous 1987-2001 rally logged 4,494 days and a 582% rise. Still, just because a bull is old doesn’t mean it can’t charge ahead. For the past year, the stock market has been the least volatile since 1965, and investors seem complacent. (Barron’s 9/18/17).  “The biggest thing we have to fear is the lack of fear itself; Something investors aren’t even contemplating will ultimately make volatility great again” (Steven Sosnick, Timber Hill, 9/17/17).

On the other hand, to make an argument for the longevity (9+ years) of this bull market, I have noticed that under the surface (which you cannot see by market index S&P500), there have been many major industry rotations over the past 9 years. Just take our portfolio for example; a few months ago, our oil stocks were doing very well and then a couple of months ago, they fell sharply and now they are rising again. Biotechs, Chips, Airlines, Banks are some other sectors that have been fluctuating between bull and bear markets.

Many global markets are in bubble territory. Bitcoin market is definitely in a bubble. Per Stephen Weiss (Managing Partner, Short Hills Capital Partners, on CNBC, 9/5/17) , our bond market has been in bubble for the past 5 years.

Over long periods, Wall Street analysts give contrarian signal when they herd in to a single view of a stock, when that view is bullish or bearish. When every analyst is positive, it often pays to be wary on the stock, and vice versa. As of 8/28/17, the 50 (10%) of the S&P 500 Index Stocks with the highest aggregate analyst ratings have done the best, up to 15% in 2017, while 50 (10%) with the lowest ratings have performed the worst, down 7%. (Bespkoe Investment Group/Barrons Market Week, 9/11/17).

 Diversification is extremely important. A few months ago I applied for a job at Dexcom that boasted to be the number one supplier of diabetic supplies. One year ago, their share price was trading around $90. On 9/27/17, Abbot Labs announced that FDA approved their new device that does not need pricking of fingers to test blood sugar levels; and in one day the share price dropped by 50%!

I have been a big fan of stock options for the past 35+ years. I want to share something interesting that happened on 9/8/17. On 9/8/17, the credit bureau, Equifax, announced that they were hacked and 143 million accounts (half the US population) is at risk for identity theft. The hacking happened in July 2017, and they took so long to let the public know. The two Najarian brothers of the CNBC half time report that are the ultimate experts on options and who keep tabs on unusual trading in options noticed that a certain party purchased a massive amount of put options (as a short) on Equifax soon after the actual hacking in July. They were purchased at 40 cents per contract and on 9/8/17, they were sold at $16 per contract!  That is a whopping 3,900% profit in about 2 months! They were hinting that the authorities (SEC for insider trading, Justice Dept. etc. ) should look in to this trade. Later in the day, the New York attorney general announced that he was looking in to the whole Equifax hacking incident. This shows the power of options.

GE- On 9/7/17, JP Morgan rated GE as ‘underweight’ and stated, “Future of GE is going to be below what we expected”. Their current price target is $22. Many analysts do not believe that GE will maintain its current dividend yield. As of 9/7/17, 2 analysts have sell ratings and 8 have buy ratings on GE. Analysts who monitor stock option volumes states that there is heavy put buying on GE-which means many are pessimistic but this could turn out to be bullish for GE as this could lead to a ‘short squeeze’ in the future. If there are a lot of puts, it is safe to assume that a lot of people might be shorting GE too. If we get some positive news on GE and if it moves up, people who shorted, have to ‘cover their shorts’ which will move GE higher, sharply.

 Disney- On 9/7/17, Disney CEO Igor gave a profit warning for end of September 2017 stating that their profits will be at the same level as last year. For 9/7, Disney was the worst performer on the Dow. He blamed NBA costs and recent hurricanes. Immediate impact was a 3% decline. Analyst Rich Greenfield, who is the only analyst with a sell rating on Disney, stated that Disney should buy Twitter (due to their role in sports). He also stated that all media stocks are in trouble.  Other analysts are stating that Disney should purchase Netflix. This is good for us as Disney is close to our average cost. We buy for the long term and not for short term trading opportunities.

Alcoa- Alcoa (ticker: AA) could beat our third-quarter estimates on lower energy costs or higher energy sales. At our Laguna conference, we heard that the Warrick smelter restart could add about $60 million to Ebitda and the Rockdale land swap another $60 million, approximately. We hosted Chief Financial Officer Bill Oplinger at our Fifth Annual Laguna Industrials Conference last week. Our key takeaway was that the restart of the Warrick smelter gives the company about $60 million in synergies with downstream and if Alcoa can execute the land-swap plan at Rockdale, that could lower transformation costs by about $60 million. At a conservative five times multiple, we think both these initiatives can add about $3, or 7%, to the stock. Capital return could take some time. On the last earnings call, management said that they’ll look to renegotiate their revolver once they get a better credit rating. The revolver limits the company’s ability to pay out dividend and buy back stock. Moody’s recently upgraded the company’s debt. Our impression from the Laguna conference is that management will look to raise their debt rating above current levels before they renegotiate their revolver, but at the same time, Alcoa does not plan to be an investment-grade-rated company.(Sood and Alley, Hot Research/Barrons,9/20/17)

Apple- On 9/5/17, Nomura Securities raised the price target for Apple from $175 to $185. They referred to “confidence in the super cycle”. Shares have been up over 50% over the past 2 years. According to Piper, IPhone upgrade interest is low.

Till next month, have a great month!