Wednesday, December 21, 2016

“Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen. ” --Seth Klarman

DOLLAR SHMOLLAR (December 21, 2016): Whenever anything is repeated frequently enough, most people will end up believing it even if it is a preposterous concept. In early 2009, investors were bombarded with "experts" telling them why the U.S. economy and stock market would remain depressed for many more years because we had never experienced a subprime mortgage collapse before. Instead, we enjoyed one of the most powerful short-term rebounds in history and subsequent huge gains for U.S. equity indices. In 2011, analysts kept insisting that inflation would keep rising, commodities would soar, and emerging-market shares would remain the biggest percentage winners; all of those were the opposite of what actually happened between April 2011 and January 20, 2016. Recently, it's all about how the U.S. dollar is allegedly going to keep setting historic peaks and gaining against nearly all other world currencies. However, this is just as misguided as the other examples. The U.S. dollar has likely already begun a vital bear market.

Tiny gains are trumpeted as allegedly being huge historic events.

If you scan media headlines about the U.S. dollar, they emphasize how the U.S. dollar index has reached a new 14-year high, how the greenback hasn't been so elevated against most global currencies since December 2002, and why these increases will continue for many more years. While the first two statements are both technically true, they are misleading, while the inevitable conclusion of a perpetually-rising U.S. dollar is the opposite of what is going to happen during the next two or three years. First, let's look at the claim that the U.S. dollar is at a 14-year high. Against most currencies, this is correct; however, the total increase during the past couple of years has been tiny. On March 13, 2015, the U.S. dollar index achieved a peak of 100.39 which was slightly surpassed near the end of last year when it reached 100.51 on December 2, 2015. The recent top for the U.S. dollar index was 103.65 at 7:40 a.m. on Tuesday, December 20, 2016. If you do the math you can see that this is an increase of less than 3.25% over a period of more than 21 months, or about the same total gain as a U.S. Treasury note. If you look at currencies of commodity-producing countries including Australia, Canada, Brazil, and Russia, then they have not fallen to multi-decade lows but have been forming several higher lows from their bottoms which had mostly occurred in January 2016. Recent currency losses have mostly been confined to developed-market currencies such as the Japanese yen, the Swiss franc, the euro, and the British pound. As a result, the last four have all become incredibly disliked by investors while just about all speculators have been crowding into the U.S. dollar.

Thus, while frequent media stories about "new 14-year highs for the U.S. dollar" are technically accurate, they create the illusion among most investors that these have gained 30%-40% in recent years rather than just 3%-4%, while a modest pullback would wipe out all of the gains since March 2015.

Quantitative evidence supports the concept of a wildly overvalued U.S. dollar.

On Thursday, December 15, 2016, 96% of professional futures traders surveyed by Daily Sentiment Index, which has been conducting such surveys for decades, were bullish toward the U.S. dollar index. On the same day, only 4% of such traders were bullish on gold and only 6% were bullish on silver. There were 7% bulls toward the Japanese yen and the euro and only 9% who were bullish on the Swiss franc. Interestingly, there were only 9% bulls on U.S. Treasury bonds (10-30 years to maturity) and 8% bulls on U.S. Treasury notes (2-10 years to maturity), indicating that oversold and widely-detested bonds are likely to rebound during the next several months along with a retreat for the U.S. dollar. Even non-financial web sites have been hyping the strength in the greenback, assuming that it will continue indefinitely. Travel channels on cable TV are telling you why U.S. residents should go overseas during the next few years to capitalize upon the strong U.S. dollar, while programs about cooking and leisure will frequently make comments such as "due to a continued climb for the U.S. dollar, such-and-such will likely become even more affordable." When non-financial commentators start taking a rising U.S. dollar for granted, you know that its rally has become very mature and is likely set for a major reversal of fortune.

If the U.S. dollar is really going to plummet instead of surging, then your investment allocations will have to be entirely different.

Weakness for the greenback will mean that recent all-time record inflows into U.S. industrial-related and other highly popular equities are likely to be badly misguided. A drop for the greenback will likely also help to ease pressure on interest rates, thereby causing yields to decline and prices to rebound for most bonds including U.S. Treasuries, emerging-market government bonds, and corporate bonds of companies which will be helped by a weaker greenback. Instead of betting on a stronger U.S. dollar and higher U.S. interest rates, investors should be doing the opposite.

Gold mining and silver mining shares have been among the biggest winners of all sectors in 2016, and will likely achieve even greater percentage gains in 2017.

Gold mining and silver mining shares in particular have been hard hit by expectations of continued gains for the U.S. dollar. After having collapsed by 80%-90% from their April 2011 tops to their multi-decade bottoms of January 20, 2016, gold mining and silver mining shares and their funds including GDXJ and SIL generally more than tripled by August 11 or 12 before thereafter suffering significant downside corrections. While they remain far above their January nadirs, they once again represent compelling values and are likely to more than triple again during the next year or so. In addition to GDXJ and SIL, funds in this sector include the relatively speculative SILJ, SLVP, SGDJ, and GOEX, along with somewhat less volatile large-cap alternatives including GDX, RING, SGDM, and PSAU. Even if a fund like GDXJ tripled in value from its current price, it would still be only about half its historic top from April 2011.

Emerging-market bond funds are strongly out of favor, pay high yields, are not nearly as volatile as equity funds, and have been making higher lows since January 20, 2016.

Emerging-market bond funds including ELD, LEMB, PCY, and EMLC are barely known by most investors. At least with funds like GDXJ and GDX there are huge daily volumes even if most investors swing emotionally from loving to hating them based upon their recent performance. With emerging-market bond funds, hardly anyone knows of their existence. Their yields are usually in the 6%-7% range on average, while prices have been forming several higher lows since January 20, 2016 as is characteristic of a meaningful bull market. Each of the above funds has the additional advantage of being commission-free with one or more major U.S. brokers. The strong U.S. dollar has discouraged investors from participating in emerging-market securities of all kinds, even though a weak Brazilian real means lower wages in U.S. dollar terms for Brazilian workers and thus higher profit margins--thereby explaining why Brazilian equities have been among the biggest winners of all exchange-traded funds (not just emerging markets) in 2016 with Russian equities similarly enjoying outsized gains. As a group, emerging-market equities are roughly 30% underpriced relative to U.S. equities, thereby providing an additional motive for value investors to accumulate them into weakness. As investors progressively move out of overpriced U.S. equities into emerging-market stocks and bonds, emerging-market government bonds are an excellent and less volatile way of participating in this transition.

Several emerging-market equity funds are once again worthwhile for purchase at higher lows.

For those who are willing to accept greater risks, many emerging-market equity bourses have become compelling bargains. Most prices are above their multi-decade bottoms of January 20, 2016, but EWW (Mexico) has become especially cheap due to overblown fears about Trump's frequent negative public comments about that country. A depreciated Mexican peso means that Mexican companies are paying wages in much lower U.S. dollars, thereby leading to wider profit margins which will soon be evident in rising corporate earnings. TUR (Turkey) with numerous political scandals and VNM (Vietnam) primarily out of unpopularity have also become worthwhile bargains for purchase. Whenever there is geopolitical upheaval or some kind of scandal in any emerging market, its stocks will often plummet even though such events rarely have any impact on corporate profit growth. A good rule is to buy on fear and uncertainty and to sell into excitement. Track the fund flows: huge inflows tend to precede market tops and lead to declines, while record outflows usually occur prior to major bull markets.

The most popular sectors since Trump's election are not ideal for purchase, including most base metal producers and steel manufacturers.

Following the election of Donald J. Trump as U.S. President, some commodity-related assets have surged including funds of base-metal producers like COPX (copper mining) and SLX (steel manufacturers). Therefore, I have stopped buying these, although I haven't sold them because they remain generally undervalued on a long-term basis. In general, it makes sense to purchase whichever assets are currently the least popular, which have the heaviest insider buying, which have suffered recent historic outflows, which are wildly unpopular in the media, and which have especially bearish sentiment. If you only buy such securities, while selling whatever has become trendiest with the heaviest inflows, the most positive media coverage, and the most intense insider selling, then your portfolio will perform impressively in the long run.

Investors become irrationally obsessed with myths like interest-rate differentials.

Two years ago, the highest interest rates in the world were almost entirely in emerging-market countries including Russia and Brazil. If investors had purchased those currencies with the highest interest rates, then those would have been among the worst currency performers in 2015. I am not sure why the myth persists about investors seeking out the highest yields when making currency trading decisions, but it has no basis in the historical record. U.S. interest rates are currently above those in most developed countries, which is used by many analysts and brokerages as an excuse for anticipating a higher U.S. dollar. However, following their recommendations would be a major error. The most successful currency investors look at relative valuation which has no correlation with interest rates. I will now explain a simple method of computing such relative valuation.

The Big Mac tells the truth.

One well-known but little-used indicator to determine which global currencies are too high or too low is the Big Mac indicator. This was discovered by some clever person several decades ago. A Big Mac contains almost identical ingredients no matter where in the world it is made or consumed. If the price of a Big Mac sandwich at a number of McDonald's restaurants in any given country is significantly higher or lower than it is somewhere else, then it usually indicates that the country with the higher price has an overvalued currency while the cheapest Big Mac sandwiches can be found in the countries with the most underpriced currencies. Today, you can get good bargains on a Big Mac in countries including Japan, the U.K., most of the EU, and Switzerland. This is not usually the case. Among the highest Big Mac prices are those in the United States, which is also not typically true. In 2011, a Big Mac was unusually costly in cities including Sao Paulo and Moscow, which contradicted most analysts' expectations of continued gains for overpriced emerging-market currencies and led to some of the biggest losses for these currencies in their entire histories between April 2011 and January 2016. Today's Big Mac message is that the U.S. dollar will retreat while the currencies of nearly all developed markets will rebound.

How long will these reversals persist?

Since January 20, 2016, most funds of commodity producers and emerging-market equities have been among the top-performing winners from their respective 52-week lows out of all exchange-traded funds. This pattern will likely continue in 2017, but it won't persist forever. Eventually, heavy insider buying of these securities will become transformed into substantial insider selling, just as has occurred recently with twice the usual ratio of insider selling to insider buying for overall U.S. equities. The media will change their tune and will invent a new series of meaningless myths--just as they did in the first half of both 2008 and 2011--which everyone will believe about commodities and emerging markets continuing to climb forever. This will encourage all-time record inflows into most funds of commodity producers and emerging-market securities. Such a dramatic transformation probably can't happen soon, but it could occur by the first half of 2018.

Aging bulls lead to fewer and fewer stocks remaining in bull markets.

One consistent pattern is that as U.S. equity indices try to extend their longest-ever bull markets, fewer and fewer stocks will continue to climb while others gradually begin bear markets. Whenever such a transition occurs from a major bull market to a major bear market for U.S. equity indices, most investors are reluctant to embrace a bearish thesis. Instead, they will crowd more and more frenetically into whichever sectors and shares are the biggest percentage winners. So far, hardly anyone has been pouring into most of the top gainers of 2016, but this will likely happen at some point during 2017-2018. Therefore, whatever continues to climb next year will likely enjoy far more positive investor attention than usual, especially as rising shares face less and less competition. This kind of narrowing reached its all-time extreme in January 1973 when only about 75 shares (known popularly as the "Nifty Fifty") were continuing to climb while thousands of U.S. equities had already begun major bear markets. Eventually, from January 1973 through December 1974, we experienced the most crushing bear market since the Great Depression with the Nifty Fifty stocks being among the greatest percentage losers.

It is likely that before we enter the next global recession we will have a final surge for whichever assets are continuing to set new 52-week highs several months or a year from now, and perhaps also into the early months of 2018. At that time it will probably be essential to sell all risk assets, because a very undervalued and pummeled U.S. dollar in 2018 could be setting the stage for its next powerful bull market. Just when everyone will have concluded that the greenback will keep slumping, it will probably enjoy even greater gains than it has achieved in the current cycle.

Disclosure of current holdings:

Whenever they have appeared to be especially irrationally depressed, I have been purchasing the shares of funds which invest either in the shares of commodity producers or emerging-market stocks and bonds, since I believe these remain the two most undervalued sectors in that order. In a world where real estate and U.S. high-dividend securities have finally begun major bear markets from ridiculous overvaluations and all-time record inflows, these irrational favorites of recent years and the brief post-election love affair with overpriced industrial shares will transition to a completely new set of investors' darlings. As the greenback surprises most investors by accelerating its bear market, with the U.S. dollar index moving below 80 within 1-1/2 years instead of continuing to rally to new 14-year peaks as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. The election of Donald J. Trump as U.S. President means "yuge" U.S. government spending and modestly lower taxes which is a combination for a massive rise in the deficit. The latest illogical pullback for most gold mining and silver mining shares, along with undervalued emerging-market bonds, has created some compelling buying opportunities, so be sure to seize them before they disappear. From my largest to my smallest position, I currently am long GDXJ (many new), SIL (some new), KOL, GDX (some new), XME, COPX, EWZ, RSX, GOEX, URA, REMX, VGPMX, ELD (some new), HDGE (some new), GXG, IDX, NGE, BGEIX, ECH, FCG, SEA, VNM (some new), NORW, BCS, EWW (some new), PGAL, GREK, EPOL, RBS, TUR (some new), RSXJ, RGLD, SLW, SAND, SILJ, EPU, FTAG, SOIL, EWI, EPHE, and THD. I have short positions in IYR, XLU, FXG, and SPHD, in that order, largest to smallest. I recently sold DXJ because I believe the uptrend for Japanese equities and the downtrend for the Japanese yen have both been overdone.

I expect the S&P 500 to eventually lose two thirds of its value from its all-time top, whether that level has or hasn't already been reached, with its next bear-market bottom perhaps occurring near the end of 2018 or in early 2019. As with all bear markets, the biggest losses will likely occur in its final months, and won't even be acknowledged as a bear market until it is nearly over--just as most investors in August 2008 didn't realize that we were well into the crushing 2007-2009 bear market. The current U.S. equity index bull market is already the longest on record; expecting several more years of gains is like anticipating that a 100-year-old marathon runner will continue to run marathons for a few more decades. While the media have been quick to trumpet new all-time highs for many U.S. equity indices throughout 2016, almost no one has noticed that fewer and fewer individual shares have set new 52-week highs especially as compared with previous peaks including June 2015, and with generally reduced overall participation. While many investors expect the surge following the election of Donald J. Trump as U.S. President to usher in four or eight more years of a bull market, nearly all of those gains have likely already occurred. Following the election of Narendra Modi in India on May 16, 2014, many analysts expected a bull market to continue for a full decade. The fund SCIF of a hundred small-cap Indian equities actually peaked on June 9, 2014 which was 24 days later; it has made a series of lower highs since then. IWM, a fund of the two thousand companies in the Russell 2000, had been outperforming the S&P 500 by roughly 3:2 from the nadir in March 2009 through March 2014, but thereafter has gained less than the S&P 500 and many other large-cap indices. The most recent high for IWM occurred on December 9, 2016, making the total post-Trump rally less than 31 days. At least you can say that it lasted a week longer than India's "decade-long" bull market. There is a little-known megaphone formation in which the S&P 500 has been making higher highs and lower lows since 1996, so it shouldn't be a shock to investors if the current or upcoming bear market for U.S. equity indices results in the S&P 500 approaching or sliding below its March 6, 2009 nadir of 666.79.

Sunday, November 13, 2016

“Trump is about to make inflation great again.” --Luke Kawa and Sid Verma

TRUMP WON'T TRUMP ENTRENCHED TRENDS (November 13, 2016): There has been a "yuge" amount of chatter on the internet and in the media about the alleged impact of Donald J. Trump as the next U.S. President. As with most simplistic theories, there is a kernel of truth and a pile of confusion. It is important to figure out what makes sense logically, and especially not to be overly influenced by the short-term reaction by the financial markets which will often be the opposite of what will happen over the next year or two.

The long-term trend is your friend.

In the financial markets, trends which are in place tend to remain in place for years no matter what happens with news events, because these trends are based upon economic cycles which have existed for decades or centuries and are only modestly affected by whatever happens along the way. In 2016, there are two primary trends which will continue at least for several more months and probably much longer: 1) On January 20, 2016, nearly all shares of commodity producers and emerging-market securities completed bear markets which had mostly begun in April 2011 and initiated major bull markets. Because of the extended and severe nature of their previous declines, including all-time record outflows in the months prior to their final bottoms, most investors psychologically have not yet accepted the fact that these assets are in powerful uptrends. 2) In July and early August 2016, high-dividend and low-volatility shares which had been in bull markets since October 4, 2011 and had enjoyed all-time record inflows for any sector in history transitioned to major bear markets. Because these assets had become so popular in the media, and because investors embraced these investments since it gave them 3%-4% dividends which banks and mutual funds were no longer paying on money market savings accounts, investors have been reluctant to acknowledge that these have switched to severe downtrends.

Enter Donald Trump. What has changed?

While the election of Donald J. Trump as U.S. President was a dramatic and unexpected event, even the most dramatic and unexpected events in the past have had little impact on the financial markets in the long run. On 9/11, the worst terrorist attack in U.S. history had occurred while U.S. equity indices were in the middle of bear markets since March 2000 which was 1-1/2 years earlier. Following 9/11, there was a one-week slump for U.S. stocks followed by a rebound into early January 2002. However, the bear market then resumed in full force until it bottomed on October 10, 2002. Similarly, gold had been in a bull market since April 1, 2001. The events of 9/11 caused a brief upward spike, then a retreat, then sideways movement into the middle of December 2001. Gold's bull market then continued in full force. Thus, even something like 9/11, after a brief interruption, merely delayed two major financial trends by a few months.

Thus, while Donald J. Trump is likely to lead to new policies and other changes, with some expected and some surprises, the two primary trends for inflation-loving and deflation-loving assets listed above are not going to be meaningfully altered. These trends exist due to long-term cyclical behavior in the global financial markets. The trajectory of these trends will be somewhat impacted, which I will discuss in this essay. However, do not believe analyses which tell you that everything is going to be entirely different, because patterns which have been established for centuries or longer will always repeat themselves with minor variations.

Be careful not to reach false cause-and-effect conclusions.

In the financial markets, if a particular news event occurs and there is a sharp market reaction afterward, then far too many investors will conclude that the event caused the reaction. Almost always there is a very different kind of behavior which is occurring. Consider how gold, which can be measured by the exchange-traded funds GLD and IAU, acted around the U.S. election. Gold has been in an uptrend with periodic corrections since December 14, 2015, two days before the U.S. Federal Reserve made their first rate hike. Gold is likely to remain in a bull market until almost exactly the time when the Fed decides to begin cutting rates again--which perhaps will be in early 2018, although it is too early to say with any accuracy. However, there was a lot of media hype about how Hillary Clinton was allegedly bearish for gold while Donald J. Trump was supposedly bullish. Therefore, gold had been retreating in price for a few months leading up to the U.S. election. It then rallied sharply on Tuesday night until around midnight when the initial surprise of a Trump victory became increasingly probable. After ascending rapidly to 1338.30 U.S. dollars per troy ounce, gold thereafter plummeted to 1218.70 at 1:35 p.m. on Friday, November 11, 2016. This is a drop of almost exactly 120 dollars which even for a volatile year like 2016 is a significant percentage loss.

A simplistic conclusion would be that Trump is actually "bad for gold."

Many investors therefore revised their initial opinion of Trump to conclude that since he was elected, and gold subsequently slumped, then Trump must be bearish for gold. Since he will be around for either four or eight years, this encouraged panic selling in the assumption that this three-day trend would continue indefinitely. As a result, there have been massive outflows in recent days from funds of precious metals and the shares of their producers including GDX, GDXJ, SIL, and related assets. This is a dangerous example of what is known as outcome bias. If a particular event is followed by a particular form of behavior, then we tend to believe that the event caused the outcome. However, it is far more likely that when gold moved above 1300, there were many technical buyers who jumped in just as they did after Brexit when gold made a similar upward spike. The financial markets will always defeat any large group of participants, and did so by knocking out these new buyers with a subsequent pullback below 1300 to trigger their sell stops. When other investors saw this decline, they falsely concluded that gold was in a new bear market.

The 200-day moving averages were broken to the downside for GDXJ, SIL, and similar securities.

When the 200-day moving averages were broken to the downside for many gold and silver mining shares, this encouraged additional selling by technical traders--as well as those who were disappointed that Trump's victory didn't lead to higher gold prices and sold for emotional reasons. As a result, most assets in this sector plummeted to their lowest levels since early June or late May 2016. However, the fundamental reality of being in a Fed rate hike cycle which had begun at the end of 2015 hasn't changed. All the reasons for being bullish on gold prior to Trump's election are just as true today, and more so because of the likely magnified pro-inflation slant.

Increased government spending and lower taxes are a recipe for rising inflationary expectations.

The shares of all commodity producers including gold and silver mining shares are helped whenever inflation expectations are climbing most rapidly. Similarly, high-dividend shares such as utilities (XLU, VPU, FXU), REITs (VNQ, IYR, RWR), consumer staples (XLP, VDC, FXG), and low-volatility favorites (SPHD, USMV, EFAV) are harmed proportionately by such behavior, since their yields then have to compete with higher yields on other investments including complete safe bank accounts and certificates of deposit (CDs). The downtrends for high-dividend and low-volatility assets have been accelerating in recent weeks, well before Trump's election, and have continued after the election. Clearly it doesn't make sense that rising inflation would be bearish for high-dividend shares but not bullish for commodity producers.

There are also divergences within assets which favor rising inflation.

There are also divergences within assets which love the prospect of rising inflation. The shares of copper producers and their funds including COPX, along with other base-metal producers, have been mostly accelerating their uptrends in November 2016. Financial shares including banks which had suffered huge negative effects from deflation have been rebounding sharply in the expectation of rising inflation and steepening yield curves. At the same time, as mentioned earlier, gold and silver mining shares have recently slumped. Since these assets have a strong positive correlation with rising inflationary expectations, those which are diverging will eventually have to get back in line with the others. It is like kids who are friends on a playground during recess; one or two might split off from the group to check out the sandbox or some interesting game, but eventually they will go back to their group of friends. Acting differently is anomalous and inconsistent with centuries of history. Birds of a feather flock together.

If something seems to be illogical than it usually is.

There is a famous test, repeated in various forms, in which participants are given a list of facts and asked to reach a conclusion about what will happen next. Usually they reach the correct conclusion. In a variation, some participants are given exactly the same facts, but are given one of four possible outcomes. They are told that a particular outcome actually occurred, and then asked like the first group to give a cause-and-effect explanation. When told what the correct outcome has been, the explanations are completely altered from those of the first group to reflect the known result. What the participants don't realize is that each of four test groups is told a different final outcome. Regardless of the twisted logic required to incorporate actual events with what makes sense, people will consistently alter their explanations dramatically to fit what they believe to be the actual behavior. When investors observe what has recently been happening with asset valuations, such price changes cause most people to entirely alter their previous expectations--even when their original conclusions had been valid.

The financial media are experts at repeatedly rewriting history to try to fit the latest facts. I have frequently seen news stories which tell you in the morning why a particular government news report was bullish for a certain asset which has since moved higher; if this asset slumps later the same day, they will unashamedly tell you why the same government report was allegedly bearish for that asset.

If logic enables you to reach a reasonable conclusion, do not allow yourself to be swayed by recent contradictory behavior.

As a result, if most people observe that gold has plummeted after the election of Donald J. Trump, then it doesn't matter if they had correctly reasoned that Trump's victory would mean greater spending, lower taxes, much higher deficits, rising inflation, and thus significantly higher prices for precious metals and the shares of their producers. Investors are discarding those clearly accurate conclusions and allowing the short-term price movement to override their logical thinking.

The same kind of false reasoning happens repeatedly in the financial markets.

A useful example would be when U.S. housing prices had peaked near the end of 2006 and then began to slump in 2007. Many observers in the media and on the internet correctly concluded that if housing prices were falling, especially when combined with the prevalence of subprime mortgages and other dangerous lending tactics, it would lead to a recession and much lower stock prices. However, after an initial pullback, U.S. equity indices climbed and then surged through October 2007--even as housing prices continued to retreat and mortgage defaults skyrocketed. Thus, investors concluded based upon the market behavior that there was nothing to worry about after all; the climb in the S&P 500 "proved" that the stock market wouldn't be negatively affected by the housing collapse. Afterward, of course, we experienced the most crushing bear market since the Great Depression. Investors' and analysts' original conclusions about the negative effect of the housing bubble were accurate, but the market's interim rally caused almost all of them to foolishly change their minds.

The U.S. dollar index is a useful and much-maligned barometer.

In 2015, the U.S. dollar index completed a March peak at 100.39 and a slightly higher December 2, 2015 top of 100.51 which had marked its highest point in 12-2/3 years. Throughout 2016, most people think that the U.S. dollar index has remained in an uptrend, but it may have begun an important bear market which will eventually accelerate to the downside. In typical fashion, it has been making several last-gasp efforts to move higher, with three moves during the past month above 99. Instead of climbing to 110 or 120 as most analysts are anticipating in upcoming years, it is far more likely that the U.S. dollar index will instead retreat below 90 and will eventually trade below 80 probably within 1-1/2 years. The U.S. dollar index dropped below 80 for at least part of each year from 2007 through 2014, so this would merely be a return to its normal historic behavior.

The bull markets for mining and energy shares have been in place since January 20, 2016, and will eventually accelerate.

The bear markets for high-dividend shares since July 2016 and the bull markets for commodity producers and emerging-market securities since January 20, 2016 will remain intact at least through much of 2017 and perhaps considerably longer. These trends are an inevitable result of the end of the deflationary monetary stimulus cycle and the beginning of the inflationary fiscal stimulus cycle. With the end of gridlock, higher government spending, and lower taxes, these trends won't be fundamentally changed but they will likely become more intense and could perhaps last longer than they would have with a Hillary Clinton victory. Whatever is diverging in the short run from this pattern is therefore providing a trading opportunity. Whichever deflation-anticipating assets are rallying should be sold or sold short, while whichever inflation-anticipating assets including gold and silver mining shares which have been irrationally retreating should be purchased. The only reason investors aren't doing so is because recent market behavior seems to "prove" the opposite, which will end up being a false signal just like the rally for the S&P 500 in 2007.

Mexican equities and their funds including EWW make excellent investments for classic contrarian reasons.

Think back one year ago to when the Brazilian real and the Russian ruble were collapsing. Investors concluded that their weak currencies and political uncertainty would lead to lower equity prices. However, a weak currency led to increased exports and much lower wages when measured in U.S. dollar terms, while they were selling the same goods in U.S. dollars in world markets. Thus, their profit margins soared and, after an initial slump, Brazilian and Russian stocks have been the top two emerging markets in 2016. Following Brexit, the British stock market similarly plummeted on June 27, 2016 out of fears that a lower British pound would lead to a long-term economic slowdown in that country. Instead, the cheap British pound has led to British stocks being among the top-performing global bourses since then.

While Donald J. Trump is seen as allegedly negative for Mexico, that country is likely to be among the biggest beneficiaries of increased U.S. government spending and lower taxes.

The identical pattern can be seen in the recently plunging Mexican peso and a dramatic loss for Mexican equities and their funds including EWW. Far from being negative, the undervalued Mexican peso is making wages lower in U.S. dollars while increasing the total amount of exports given currency competitiveness. This will lead to much higher profit margins and Mexican stocks being among the top-performing emerging markets during the upcoming year. It is the exact same pattern as the above examples, and as with nearly all similar circumstances going back decades or longer.

I first noticed this common pattern as a much younger investor when Pinochet gave way to a Democratic government in Chile. The two listed Chilean securities on the NYSE, a telephone company and a closed-end equity fund, both plummeted to multi-year lows on the exact date of the transition out of fear and uncertainty about the future. The Chilean stock market was thereafter among the world's biggest winners over the subsequent five- and ten-year period.

Bridge players make the best traders, because they understand the difference between method and results.

Some investment firms only hire competitive bridge players (i.e., the card game), and there is a good reason for this. I have played bridge at a high competitive level, and the top players who are far better than me consistently make decisions based upon the probability of success. Thus, while a beginning bridge player is likely to frequently take a finesse--an easily-learned play which has a 50% chance of victory--a more experienced player will use end plays, squeezes, and other complex strategies which in combination will have an 80%-90% chance of prevailing. Being a card game with some element of luck, the most experienced players can tell you a day's worth of tales about tournaments where the inferior play actually succeeded. However, expert bridge players won't alter their strategies based upon periodic unfortunate results. They know that they won't always win, but they also know that if they make consistently logical and superior decisions then they will come out far ahead in the long run. Emotional investing methods or chasing after technical trends will sometimes work, but sticking with rational conclusions regardless of what the market does in the short run is almost always a superior method which will produce far greater profits over any period of decades.

Assets in bull markets which slide below their 200-day moving averages almost always represent ideal buying opportunities.

The S&P 500 was in a bull market starting on March 6, 2009, and may still be in a bull market or may have transitioned to the early stages of a bear market. When was the best time to buy it, other than obviously at the exact bottom? It has been whenever the S&P 500 slumped below its 200-day simple moving average. In the beginning of October 2011, the S&P 500 made a brief plunge below that mark, and it was one of the most rewarding purchase points of the entire cycle. If you review the 35-year bull market for long-dated U.S. Treasuries, as measured by funds including VUSTX and TLT, these were also exceptionally good buys whenever they have dropped below their 200-day moving averages. Thus, funds like GDXJ and SIL, which even after their recent slumps remain among the top winners from their respective 52-week lows, are providing superior buying opportunities now that they have fallen below their respective 200-day moving averages. The selling by technical-minded traders and many disappointed investors when those levels were broken to the downside are providing even better discounts than would otherwise have been available.

Avoid succumbing to the outcome bias.

Do not allow yourself to be easily seduced into believing that assets which have made sharp moves following Trump's election are sending some kind of messages or indicating the "true" outcome--and especially be wary of concluding that the market behavior of the past few days will continue into the next several years. Following President Obama's initial election in November 2008, the shares of commodity producers slumped through November 20, 2008 and thereafter began powerful bull markets which persisted until April 2011. After Obama's re-election in November 2012, the S&P 500 and other U.S. equity indices slid for nearly two weeks and thereafter climbed strongly. The initial reaction can be either the "right" or the "wrong" one--or, more often, simply people chasing after what others have been doing in the frantic belief that doing something is better than doing nothing.

Trends which are intact will remain intact no matter what happens, because they are determined by events and cycles which unfold over periods of years or decades. The election of Donald J. Trump will eventually intensify and perhaps extend some of these trends, but don't expect any major changes in direction. Maintain your focus and gradually buy more of whatever has become irrationally undervalued while progressively selling whatever has become most overpriced.

Disclosure of current holdings:

Whenever they have appeared to be irrationally depressed, I have been buying the shares of funds which invest either in the shares of commodity producers or emerging-market stocks and bonds, since I believe these remain the two most undervalued sectors in that order. In a world where real estate and U.S. high-dividend securities have finally begun major bear markets from ridiculous overvaluations and all-time record inflows, these irrational favorites of recent years will transition to a completely new set of investors' darlings. As the greenback surprises most investors by accelerating its bear market, with the U.S. dollar index moving below 80 within 1-1/2 years instead of climbing above 100 as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. The election of Donald J. Trump as U.S. President means "yuge" U.S. government spending and modestly lower taxes, which is a combination for a massive increase in the deficit along with higher inflation and interest rates. The latest irrational pullback for many commodity producers has created some compelling buying opportunities, so be sure to seize them before they disappear. From my largest to my smallest position, I currently am long GDXJ (many new), SIL (some new), KOL, GDX (some new), XME, COPX, EWZ, RSX, GOEX, URA, REMX, VGPMX, HDGE, ELD, GXG (some new), IDX, NGE, BGEIX, ECH, FCG, SEA (some new), VNM (some new), NORW, DXJ, BCS, EWW (many new), PGAL, GREK, EPOL, RBS, TUR, RSXJ, RGLD, SLW, SAND, SILJ, EPU, FTAG, SOIL, EPHE, and THD. I have short positions in IYR, XLU, FXG, and SPHD, in that order, largest to smallest.

I expect the S&P 500 to eventually lose two thirds of its August 23, 2016 intraday top of 2193.81, with its next bear-market bottom perhaps occurring near the end of 2018. As with all bear markets, the biggest losses will likely occur in its final months, and won't even be acknowledged as a bear market until then. While the media have been quick to trumpet new all-time highs for many U.S. equity indices throughout 2016, almost no one has noticed that several broad-based sectors have failed to surpass their peaks of June 2015 including IWC, a fund of 1,377 micro-cap U.S. companies (i.e., with total market capitalizations which are less than 300 million U.S. dollars). IWM, a fund of the two thousand companies in the Russell 2000, had been outperforming the S&P 500 by roughly 3:2 from the nadir in March 2009 through March 2014, but has since been generally underperforming and has barely surpassed its June 2015 peak. The failure of small-cap indices to outpace their large-cap counterparts as a group has frequently signaled major bear markets in past decades including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes. The most overvalued sectors rely on the overhyped deflation trade and money which has been withdrawn from safe bank accounts by investors who begin with the premise that they want to generate income of 3%-4% and look for the most stable securities which can generate such yields. This popular and extraordinarily dangerous method of investing had created valuations in July 2016 at roughly double fair value for most consumer staples, real estate investment trusts, utilities, and low-volatility shares, all of which have been underperforming most other sectors since then and will eventually lose 60% or more of their peak valuations.

Monday, November 7, 2016

“There can be few fields of human endeavor in which history counts for so little as in the world of finance.” --John Kenneth Galbraith

COMMODITY-PRODUCERS' RALLIES DON'T GET NO RESPECT (November 7, 2016): If you sort all unleveraged exchange-traded funds based upon their percentage increases from their respective 52-week lows, then you will discover that the top 50 are all involved with commodity production or emerging markets. The top three funds consist of silver mining companies (SILJ, SLVP, SIL), followed by coal mining (KOL), then junior gold mining (GDXJ, GOEX, SGDJ), then general metals mining (XME), steel (SLX), gold mining (RING), Brazil and Russia (EWZS, EWZ, RSXJ, BRF), large-cap gold mining (GDX, SGDM), copper mining (COPX), Brazil again (BRAQ), gold mining again (PSAU), more Brazil (FBZ, BRAZ), Peru (EPU), base metals mining (PICK), Canadian commodity production (CNDA), and then a mix of commodity producers, master limited partnerships, and emerging-market equities including ILF, FCG, GML, PSCE, XOP, and ENY. However, most of these funds have continued to experience outflows whenever they are experiencing short-term corrections. Partly this is because they had been in bear markets from April 2011 through January 20, 2016, so most investors don't trust their 2016 rebounds. Partly it is because they remain highly volatile, so that after they surge for some period of time they will slump by 20% or 30% and discourage participants into believing that they are incapable of sustaining bull markets. Even those funds which have more than doubled from their January 20 nadirs have mostly suffered from periodic outflows and are almost never recommended in the mainstream financial media.

The longer that investors ignore the best-performing funds of 2016, the more extended their uptrends will become.

From September 2008 through December 2012, nearly all U.S. equity index funds based upon the S&P 500 or some other benchmark equity index continued to suffer more outflows than inflows. This was partly because many investors had lost more than half their money in these funds during the crushing 2007-2009 bear market, and partly because these securities remained highly volatile even after they had begun bull markets in early March 2009. The strongest percentage increases usually occur when investors don't trust recent gains and are unwilling to participate. So far, there are no clever acronyms for commodity producers, and the only well-known acronym for emerging markets is BRICs which have been out of favor for 5-1/2 years.

High-dividend shares have been in bear markets since July 2016.

In sharp contrast to the choppy fund flows for commodity producers and emerging-market securities, high-dividend and low-volatility funds had enjoyed all-time record inflows in recent years. These including IYR, XLU, FXG, and SPHD had become so popular that their total inflows in many cases had sent new all-time records for all sectors, even surpassing the huge inflows into technology shares in 1999-2000. Partly this is because normally conservative investors who for decades would put their money into bank accounts to get 3% or 4% couldn't accept getting only 1% or less from such time deposits, and decided to do the same as everyone else and pile into funds paying similar yields as dividends. These incredibly trendy funds have been underperforming since July 2016, experiencing mostly double-digit percentage declines. However, investors haven't yet figure out what to do with their money; they haven't made notable inflows into any major asset class during the second half of 2016. Selling has begat selling; even ordinary U.S. equity index funds have mostly experienced outflows in recent months. Investors are taking their money out of most stocks and bonds, but so far they haven't decided what to do with it. The money is mostly sitting in cash, waiting for a particular concept to become popular.

We have the ingredients for a perfect storm: plenty of buying power among investors, no conviction about what to do with it, and a compelling list of 2016 winners.

One characteristic of any transition from a U.S. equity bull market to a bear market is that, as the months pass, fewer and fewer securities are setting new all-time or 52-week highs. This process of the narrowing of the equity base has been underway for almost 1-1/2 years. The Russell 2000, which can be measured by IWM, has never surpassed its June 2015 top even as the S&P 500 and most other well-known U.S. benchmark indices did so repeatedly during the first several months of 2016. This is how bear markets classically have always begun. Investors will ultimately gravitate toward the biggest winners, which in this case are nearly all commodity producers and emerging markets. With so much money sitting around looking for a home, sooner or later those investors who tend to act first will notice what is going on and act accordingly, with everyone else eventually climbing aboard the bandwagon. Many investors won't realize which funds are 2016's top performers until they see the lists of such funds when they become widely publicized around the beginning of 2017.

Both mining and energy producers have experienced multi-month corrections and are likely resuming their powerful uptrends.

Most shares of gold and silver mining companies had peaked on August 11 or 12, 2016 and slumped for several weeks, bottoming on or around October 6, 2016. GDXJ slid from 52.50 to 36.96 over this time period, which is a total loss of 29.6%. Such a steep pullback discouraged many recent buyers from remaining committed to these and related assets. Energy shares including URA, FCG, KOL, OIH, and TAN also suffered corrections, with the price of the December 2016 crude oil futures contract falling to 43.57 U.S. dollars per troy ounce on Friday, November 4, 2016 which was its lowest point since June 11, 2016. Between now and the end of 2016, the shares of commodity producers will likely improve both their relative and absolute positioning even further, so they end up as almost exclusively the biggest winners of the year when people are deciding how to make allocations for 2017. Emotionally, many people like to use the new calendar year as an impetus to changing their asset allocation and revamping their portfolios. This will probably result in even more money being withdrawn from retreating high-dividend and low-volatility shares, with some of it going into commodity producers and emerging-market stocks and bonds.

The greenback seems to have completed additional lower highs as it has been doing for nearly one year.

If you mention the U.S. dollar to most people, they will tell you that it is in an uptrend. As measured by the U.S. dollar index, a 12-2/3-year top of 100.51 was reached on December 2, 2015 and has been followed by a pattern of several lower highs. Two additional lower highs were just completed, with the U.S. dollar index touching 99.119 at 10:15 a.m. on October 25, 2016 and then another lower high of 99.026 at 12:40 p.m. on October 27, 2016. Since then, the greenback has continued its choppy descent, which will lead to additional lower highs and eventually a downside acceleration. Instead of climbing above 100 as most are anticipating, is much more likely that the U.S. dollar index will plummet below 80 within 1-1/2 years or less. While this probably sounds like an irrationally aggressive projection, the U.S. dollar index was below 80 at least part of each year from 2007 through 2014. As emerging markets went out of favor worldwide during 2011-2015, many currency traders crowded irrationally into the U.S. dollar, but that is unsustainable as emerging markets have been experiencing higher GDP growth rates along with stronger stock and bond gains than their U.S. counterparts for most of 2016. This pattern is likely to continue into 2017 and perhaps into early 2018, thereby encouraging investors to move progressively away from the safe haven of the greenback.

This will serve as a supportive factor for assets which correlate inversely with the U.S. dollar, including most shares of commodity producers and emerging-market securities.

There has been far too much media hype about how assets will allegedly "respond to" the U.S. Presidential election.

There is usually a brief, intense emotional reaction to any widely-broadcast news, and that will likely also be the case with Tuesday's November 8, 2016 U.S. elections for President, the Senate, and the House of Representatives. However, even the extreme post-Brexit excesses were mostly resolved relatively quickly, while any alleged post-election response has already been mostly factored into current asset valuations. If there is any activity which goes in the opposite direction of their established trends, such as unusual lows for commodity producers or strong rebounds for high-dividend shares, then these should be used as opportunities to buy whichever commodity producers become most oversold and to sell short whichever high-dividend assets bounce the most euphorically. In general, the more that any news event is believed to exert a "permanent" influence on asset valuations, the more likely that trends which were in place prior to these events will resume shortly thereafter. The strong bull markets for commodity producers and emerging markets which began on January 20, 2016 will probably continue for another year or more in spite of periodic sharp corrections, while the bear markets for high-dividend and low-volatility shares which mostly began in July 2016 will continue perhaps into 2019 with occasional upward bounces.

There was a fascinating academic study published recently about why most people make inferior investing decisions:

  • Irrational Tossers


  • Disclosure of current holdings:

    Whenever they have appeared to be irrationally depressed, I have been buying the shares of funds which invest either in the shares of commodity producers or emerging-market stocks and bonds, since I believe these remain the two most undervalued sectors in that order. In a world where real estate and U.S. high-dividend securities are wildly overvalued, these irrational favorites will accelerate their bear markets which aren't even recognized by most investors. As the greenback surprises most investors by accelerating its bear market, with the U.S. dollar index moving below 80 instead of climbing above 100 as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. The latest multi-month pullback for many commodity producers has created some compelling buying opportunities, so be sure to seize them before they disappear. I was a very heavy buyer on June 27, 2016 when I made my largest total purchases since October 4, 2011 to capitalize upon the ridiculous post-Brexit panic. From my largest to my smallest position, I currently am long GDXJ (some new including today at 39.99), SIL (some new), KOL, GDX (some new), XME (some new), COPX (some new), EWZ, RSX, GOEX, URA (many new), REMX, VGPMX, HDGE, ELD, GXG (some new), IDX, NGE, BGEIX, ECH, FCG (some new), SEA (some new), VNM (some new), NORW, DXJ, BCS, PGAL, GREK, EPOL, EWW, RBS, TUR, RSXJ, RGLD, SLW, SAND, SILJ, EPU, FTAG, SOIL, EPHE, and THD. I have short positions in IYR, XLU, FXG, and SPHD, in that order, largest to smallest.

    I expect the S&P 500 to eventually lose two thirds of its August 23, 2016 intraday top of 2193.81, with its next bear-market bottom perhaps occurring near the end of 2018. As with all bear markets, the biggest losses will likely occur in its final months, and won't even be acknowledged as a bear market until then. While the media have been quick to trumpet new all-time highs for the Dow Jones Industrial Average, the Nasdaq, and the S&P 500 Index, hardly anyone has pointed out that the Russell 2000 Index and its funds including IWM had handily outperformed the S&P 500 from March 2009 through March 2014, and have subsequently dramatically underperformed, trading at their lowest levels during January 2016 in 2-1/2 years. The top for the Russell 2000 had occurred in June 2015 and so far has not been surpassed in this cycle. The failure of small-cap indices to reach new all-time highs as a group has frequently signaled major bear markets in past decades including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes. The most overvalued sectors rely on the overhyped deflation trade and money which has been withdrawn from safe bank accounts by investors who begin with the premise that they want to generate income of 3%-4% and look for the most stable securities which can generate such yields. This popular and extraordinarily dangerous method of investing had created valuations in July 2016 at roughly double fair value for most consumer staples, real estate investment trusts, utilities, and low-volatility shares, all of which have been underperforming most other sectors since then and will eventually lose 60% or more of their peak valuations.

    Thoughts or concerns about your investments in the light of the election? Feel free to email sjkaplan@truecontrarian.com 

    Sunday, September 11, 2016

    “If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.” --Benjamin Graham

    STEP RIGHT UP TO THE THREE-RING CIRCUS (September 11, 2016): The global financial markets in 2016 have become a three-ring circus. The most popular sideshow by far has been high-dividend and low-volatility shares which had enjoyed all-time record inflows and overvaluations earlier this summer, and have since become the worst-performing sectors of the past several weeks. On the opposite side of the ring are commodity producers and emerging markets, which everyone hated at the start of the year and have been by far the biggest winners in powerful bull markets. Finally, ladies and gentlemen, in the center ring we have the U.S. dollar itself, beloved by everyone and believed to be rising, but which has actually been in an important bear market since December 2, 2015.

    As is true for every bubble throughout history, high-dividend and low-volatility sectors have begun what will become crushing bear markets.

    Whenever I argued in late 1999 and early 2000 that internet shares would become huge losers, as I often did, people were convinced that I had some serious mental instabilities. Today, if you tell someone that they are taking dangerous risks by purchasing high-dividend or low-volatility shares, most will insist that these shares have consistently behaved more steadily than the broader equity market for decades, and they have no choice anyway because they need income to pay their expenses. The inflows into these sectors during the past year are astonishing, far outpacing nearly all other all-time record one-year inflows for any asset at any time in history. Since banks were no longer paying anything close to the 3% or 3.5% yields that investors "needed" on their money, with other safe choices including U.S. Treasuries not providing sufficiently high returns, investors have wildly crowded into utility shares (XLU, FXU); real estate investment trusts (IYR, VNQ, REM, RWX); telecommunications companies (IYZ); tobacco producers; consumer staples (XLP, FXG, VDC); and similar sectors. As a result, many of these shares reached all-time record overvaluations and their lowest overall yields in history.

    What is the difference between participating in the internet bubble of 2000 and the high-dividend, low-volatility bubble of 2016? Other than the passage of sixteen years and somewhat smarter smartphones, not much has changed. In both cases, investors perceive that there is little risk in doing whatever everyone else is doing, as long as they have some rationalization for their actions. However, the financial markets have always punished those who invested the same way as most other investors, particularly when valuations reached all-time record overpricings. Not surprisingly, since they had completed all-time tops in July or early August, high-dividend and low-volatility securities have been among the biggest losers in percentage terms. While everyone seems to love owning these, whether for their yields or for any other reason, they can be comfortably sold short perhaps for as long as three years while providing annualized double-digit gains even after paying the dividends.

    Just because something is perceived to be safe doesn't make it so. If anything is trading near twice fair value, it runs a risk of dropping by more than half.

    Nearly everyone is underestimating the potential downside risk for high-dividend and low-volatility assets. Many of the above funds had gained 300% or 400% from their previous recession bottoms. They aren't likely to surrender all of their gains, but they could easily fall by more than half and still remain far above their previous bear-market nadirs. Usually, the most popular sectors become the most detested, which had happened with internet shares when they plummeted nearly 90% overall from March 2000 through October 2002, and with the overloved Nifty Fifty from January 1973 through December 1974 when they slid by roughly 75%. Just because investors perceive stocks with higher dividends and lower long-term volatilities to be "safe" doesn't mean that they are.

    Real estate is really another high-dividend, low-volatility asset which has begun a major bear market in most global cities.

    Real estate near all bubble peaks has been popularly perceived to be solid, but anything which reaches roughly double or especially triple fair value is always at risk of a dramatic subsequent decline. Many people have become aware of incredible, unsustainable gains for housing prices in cities including San Francisco, London, Tel Aviv, Vancouver, and New York, but very few people are aware that the total number of apartments available for rent has reached multi-decade or all-time highs in many of the above and similar well-known cities. Whenever prices are at double or triple fair value, regardless of the reasons (think of all the phony talk about "Chinese buying" and "unique local circumstances"), prices will inevitably regress toward the mean and beyond sooner or later.

    Previous bear markets are still perceived to be intact, even though commodity producers and emerging markets are by far the biggest winners of 2016.

    If you were to look at a list of the top-performing exchange-traded, open-end, and closed-end funds of 2016, very few investors would correctly guess which securities are to be found there. The strongest-performing sector of 2016 by far has been silver mining shares, followed closely by gold mining shares. In spite of their powerful bull markets, whenever these experience sharp corrections as both have done during the past several weeks, they mostly experience net outflows and gloomy media commentary along with negative sentiment. According to Daily Sentiment Index, only 23% of traders are currently bullish toward gold and only 22% are bullish on copper. The two previous best buying opportunities during the past several months had occurred on the mornings after the bullish sentiment for gold had slumped to 15% on May 30 and 18% on August 31. The best time to buy any asset is when it is in a powerful uptrend but most traders are staunchly bearish.

    A drop exceeding 20% is not necessarily a bear market. A bear market can exist with a decline of much less than 20%.

    Since many funds of gold mining shares had recently retreated more than 20% from their three-year highs, some commentators and technical analysts concluded that they were in bear markets. A bear market has nothing to do with the percentage drop from the previous high; it is defined by a sequence of lower highs from a multi-year top. Instead, most gold and silver mining shares had plunged to multi-decade bottoms on January 20, 2016, and have since formed several or more higher lows. Thus, they are in energetic bull markets when many think they are in bear markets. In addition, the previous bear markets for most commodity producers and emerging markets had become both severe and extended from April 2011 through January 20, 2016. Following such a sustained downtrend, it is emotionally difficult for most investors to accept that there has been a reversal. The longer that investors remain skeptical toward any new trend, the longer it will persist and intensify.

    Following silver and gold mining shares, the biggest winners of 2016 have been a variety of other commodity-related and emerging-market selections: base metal mining companies; Brazilian equities; coal mining shares; master limited energy partnerships; and other South American and Russian equity funds. If you had polled ten thousand traders at the beginning of the year, how many would have forecast that mining, energy, and South American/Russian stocks would be by far the biggest winners of the year? Especially now that previously outperforming high-dividend and low-volatility sectors have been among the biggest losers and have probably begun three-year bear markets, investors will progressively switch some of those trillions of dollars into other kinds of assets including commodity-related securities.

    Is the price of gasoline in a bear market? It had been in a multi-year downtrend since 2011, but it has increased substantially from its February 11, 2016 lows while notably retreating from highs set earlier in the year. Gasoline is still cheap, as the following photograph indicates, but it has been making several higher lows as is characteristic of a true bull market:

  • Cheap Sunset on September 11, 2016


  • Most people believe the greenback is still in a bull market, but after it achieved a 12-2/3-year top on December 2, 2015, the U.S. dollar index has made over a dozen lower highs.

    Unlike some of the mainstream financial media who foolishly believe that a 20% decline for an asset causes it to be in a bear market, very few investors realize that a sequence of a dozen or more lower highs following a multi-decade zenith means that an asset is suffering a true bear market. The U.S. dollar index has been doing exactly this for more than nine months, with very little media attention. The U.S. dollar is critical for all global investors, since it serves as the world's reserve currency and as the safe-haven asset of last resort. If people are piling into U.S. dollars, as they classically do during recessions or deflationary episodes, then it will discourage investing in most other currencies, in emerging markets, in commodity producers, and in assets including TIPs, I-Bonds, and other inflationary hedges.

    Be the first on your block to recognize that the greenback is in a bear market. Once you realize this, everything else fits into place. Other investors will eventually be forced to acknowledge this situation, but not until it is far too late to benefit from it. Before everyone else piles into assets which benefit from a slumping greenback, you can take advantage of prices which aren't as compelling as their multi-decade lows of January 20, 2016 but remain far below their historic averages and have mostly retreated moderately in recent weeks. Among the best choices are silver mining shares (SIL, SILJ, SLVP); gold mining shares (GDXJ, GLDX, RING); non-crude energy shares (URA, KOL, FCG, TAN); copper mining and other base metals shares (COPX, XME); and emerging-market equities (EWZ, RSX, GXG, NGE). It is no surprise that 1) all of the above are among the top-performing sectors of 2016; and 2) almost no one knows it.

    Here is a brilliant model of a three-ring circus on display at the Shelburne Museum in Vermont:

  • Three-Ring Circus Model, Shelburne Museum, Vermont


  • Disclosure of current holdings:

    Whenever they have appeared to be irrationally depressed, I have been buying the shares of funds which invest either in emerging-market assets or in the shares of commodity producers, since I believe these are among the two most undervalued sectors in a world where real estate and U.S. equity indices remain wildly overvalued. As the greenback surprises most investors by accelerating its bear market, with the U.S. dollar index moving below 80 instead of climbing back above 100 as almost everyone is still expecting, this will lead to a major upward revision in global inflationary expectations. The latest pullback for many commodity producers has created some compelling buying opportunities, so be sure to seize them before they disappear. I was a very heavy buyer on June 27, 2016 when I made my largest total purchases since October 4, 2011 to capitalize upon the ridiculous post-Brexit panic. From my largest to my smallest position, I currently own GDXJ (some new), SIL (some new), KOL, GDX, XME, COPX, EWZ, RSX, GLDX, REMX, URA (some new), VGPMX, HDGE (some new), ELD, GXG, IDX, NGE, BGEIX, ECH, FCG, SEA, VNM, NORW, DXJ, BCS, PGAL, GREK, EPOL, EWW, RBS, TUR, RSXJ, RGLD, SLW, SAND, SILJ, EPU, FTAG, SOIL, EPHE, and THD. I have recently increased my short positions in IYR, XLU, and FXG, in that order, largest to smallest.

    I expect the S&P 500 to eventually lose two thirds of its August 23, 2016 peak valuation of 2193.81, with its next bear-market bottom perhaps occurring near the end of 2018. As with all bear markets, the biggest losses will likely occur in its final months, and won't even be acknowledged as a bear market until then. While the media have been quick to trumpet new all-time highs for the Dow Jones Industrial Average, the Nasdaq, and the S&P 500 Index, hardly anyone has pointed out that the Russell 2000 Index and its funds including IWM had handily outperformed the S&P 500 from March 2009 through March 2014, and have subsequently dramatically underperformed, trading at their lowest levels during January 2016 in 2-1/2 years. The top for the Russell 2000 had occurred in June 2015 and so far has not been surpassed in this cycle. The failure of small-cap indices to reach new all-time highs as a group has frequently signaled major bear markets in past decades including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes. The most overvalued sectors rely on the overhyped deflation trade and money which has been withdrawn from safe bank accounts by investors who begin with the premise that they want to generate income of 3%-4% and look for the most stable securities which can generate such yields. This popular and extraordinarily dangerous method of investing had created valuations in July 2016 at roughly double fair value for most consumer staples, real estate investment trusts, and utilities, all of which have already begun to slump by half or more within three years or less.

    Tuesday, August 2, 2016


    THE FIRST AND THIRD SHALL BE FIRST, WHILE THE SECOND SHALL BE LAST (August 1, 2016): There is a fascinating pattern to the trading during the first seven months of 2016. The strongest sectors by far have exclusively been silver and gold mining shares, in that order, followed primarily by other commodity producers and mining-related emerging-market equities. The second-biggest percentage winners have mostly been high-dividend, low-volatility assets including consumer staples, utilities, REITs, tobacco shares, telecommunications companies, and long-dated U.S. Treasuries. The third-best performers of 2016 have been mostly energy companies and a variety of emerging-market stocks and bonds.

    This is puzzling is because the first and third groups are inflation-loving assets, whereas the second group performs well when deflation reigns. How can the financial markets be both inflationary and deflationary?

    The deflation trade is nearly over, but it has remained in a bull market due to huge inflows from investors desperate for yield.

    High-dividend and low-volatility assets including FXG and XLP (consumer staples), IYR and RWR (REITs), XLU, IDU, FXU, and VPU (utilities), along with TLT and ZROZ (long-dated U.S. Treasuries) have been among the second-best performers of 2016. They have also been among the top winners of the past five years. Many of those who have retired or who need to pay their monthly expenses have become overly dependent upon income-producing investments to generate yield. That's fine as long as high-dividend assets are either bargains or reasonably priced, but it creates a dangerous situation when they are trading at all-time highs even compared with previous historic peaks. There have been all-time record inflows into high-dividend and low-volatility funds which have far outpaced their previous records. A person who has retired with a half million or a million dollars might perceive that he or she "needs income" in order to maintain a basic lifestyle, and most of these investors don't realize that if everyone goes to their financial advisors and wants the same level of "safe" income then they are all going to end up owning the exact same assets. What would be reasonable for a tiny minority of investors has become an inevitable catastrophe since millions of others are acting similarly without realizing the consequences of collectively being in such an overcrowded trade.

    The inflation trade has only been in a bull market since January 20, 2016, and has a long way to go to recover its losses since April 2011.

    Unlike most high-dividend assets which had bottomed in the first quarter of 2009, most commodity producers and emerging markets had been in severe downtrends from April 2011 through January 20, 2016, and even after their subsequent strong rebounds remain far below their previous peaks. Earlier this year, many of these assets completed multi-decade nadirs, with some of them touching levels not seen since the 1970s. Therefore, they remain substantially below fair value. Silver and gold mining shares including GDXJ, SIL, GLDX, SILJ, and GDX have tripled on average in just over a half year, and have thereby outpaced nearly all energy producers which had initially rallied but have gone out of favor along with most emerging-market equities during the past several weeks. This has created the best bargains for those assets which are in the process of completing important higher lows including URA (uranium), GXG (Colombia), FCG (natural gas), and FENY, a more diversified and less volatile fund of energy producers.

    The Daily Sentiment Index for crude oil, indicating the percentage of traders who are bullish toward any asset, plummeted to 10% at the close on Monday, August 1, 2016. This is an incredibly low level for anything which is in a primary bull market, as energy commodities have been since February 11, 2016. The shares of energy producers mostly approached or reached multi-decade bottoms on January 20, 2016. Whenever it is possible to buy at higher lows during a major uptrend, this is ideal because a sequence of several higher lows is often followed by an accelerated rally.

    The high-dividend and low-volatility bull markets are very stale and incredibly popular, while few know about the uptrends for commodity producers or emerging markets.

    Almost everyone knows that high-dividend shares have been the biggest winners of the past several years and are still eager to jump aboard the bandwagon, while few realize how overcrowded this bandwagon has become. Historically, the most wildly trendy and popular trades have always proven to be disappointing. Although it is rarely compared with the internet bubble of 1999-2000, the Nifty Fifty overvaluation of 1972-1973, or the blue-chip top of 1929, high-dividend and low-volatility names have become the bubble of the decade. The total assets in USMV, a frequently-touted low-volatility fund, have tripled in one year. Just as in 2000, almost no one who has invested in these securities realizes that they can lose half or more of their money. Almost no analysts, even those who know how overvalued these popular securities have become, can emotionally imagine them plummeting. They might know intellectually that it is possible, but they can't really imagine it happening any more than anyone at the beginning of the century could envision the Nasdaq plunging by more than 75% within three years. Alas, a similar fate awaits those who are participating in high-dividend and low-volatility shares and funds.

    Just because you're in the water to get exercise doesn't mean you can ignore the great white sharks.

    When I point out the dangerous of owning high-dividend and low-volatility shares, I often hear the refrain that "I'm not in these due to their extreme popularity" or "I only own these to generate the income I need to pay my expenses." The market won't treat you differently just because your motivations are allegedly pure. You might be the nicest person on your block, you might generously donate to charities, and you might frequently help old ladies to cross busy streets. Even if you're swimming in the water just to get your daily exercise, you're not magically exempt from being eaten by hungry great white sharks that are lurking nearby. If any given trade has become desperately overcrowded, then no matter why you're involved in it, you're going to be as badly hurt as the ignorant buyer who is doing it to keep up with his poorly-informed friends. As Warren Buffett has stated, when we strip off the clothing and pretense, we're all fully exposed underneath. When the U.S. housing bubble collapsed in 2006-2011, as it about to do again in 2016-2021, it won't spare those who are nice to animals or who do good deeds. I will discuss real estate in more detail in the near future.

    Disclosure of current holdings:

    Whenever they have appeared to be irrationally depressed, I have been buying the shares of funds which invest either in emerging-market assets or in the shares of commodity producers, since I believe these are among the two most undervalued sectors in a world where real estate and U.S. equity indices remain wildly overvalued. As the greenback surprises most investors by accelerating its bear market, with the U.S. dollar index moving below 80 instead of climbing back above 100 as almost everyone is still expecting, this will lead to a major upward revision in global inflationary expectations. The latest pullback for energy-related assets has created some compelling buying opportunities, so be sure to seize them before they disappear. I was a very heavy buyer on June 27, 2016 when I made my largest total purchases since October 4, 2011 to capitalize upon the ridiculous post-Brexit panic. From my largest to my smallest position, I currently own GDXJ, SIL, KOL, GDX, XME, COPX (some new post-Brexit), EWZ, RSX (some new post-Brexit), GLDX, REMX, URA (many new), VGPMX, HDGE (very new), ELD, GXG (many new), IDX, NGE (many new), BGEIX, ECH, FCG, SEA (some new post-Brexit), VNM, NORW (many new), DXJ (all new post-Brexit), BCS (all new post-Brexit), PGAL (mostly new post-Brexit), GREK (mostly new post-Brexit), EPOL (all new post-Brexit), EWW (all new post-Brexit), RBS (all new post-Brexit), TUR (mostly new post-coup), RSXJ, RGLD, SLW, SAND, SILJ, EPU, FTAG (previously PLTM), SOIL, EPHE, and THD. I have very recently increased my moderate short positions in FXG, IYR, and XLU, in that order, largest to smallest.

    I expect the S&P 500 to eventually lose roughly two thirds of its May 20, 2015 peak valuation of 2134.72, with its next bear-market bottom perhaps occurring near the end of 2018. As with all bear markets, the biggest losses will likely occur in its final months, and won't even be acknowledged as a bear market until then. While the media have been quick to trumpet new all-time highs for the Dow Jones Industrial Average and the S&P 500 Index, hardly anyone has pointed out that the Russell 2000 Index and its funds including IWM had handily outperformed the S&P 500 from March 2009 through March 2014, and have subsequently dramatically underperformed, trading at their lowest levels during January 2016 in 2-1/2 years. The top for the Russell 2000 had occurred in June 2015 and is not likely to be surpassed in this cycle. Small-cap U.S. equities typically lead the entire U.S. equity market lower whenever we are transitioning from a major bull market to a severe bear market. This has happened in past decades including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes. The most overvalued sectors rely on the overhyped deflation trade and money which has been withdrawn from safe bank accounts by investors who begin with the premise that they want to generate income of 3%-4% and look for the most stable securities which can generate such yields. This popular and extraordinarily dangerous method of investing has created valuations at roughly double fair value for most consumer staples (FXG, XLP), real estate investment trusts (IYR, RWR), and utilities (XLU), all of which will likely slump by half or more within three years or less.

    Tuesday, June 28, 2016

    “Generally, the greater the stigma or revulsion, the better the bargain.” --Seth Klarman

    WHO'S AFRAID OF A BIG BAD BREXIT? (June 28, 2016): It is amazing that after centuries of history which investors can peruse at their leisure to see how the global financial markets have behaved in past decades and centuries, people keep repeating the same mistakes and experiencing identical emotional reactions. In the U.K., the day after the Brexit vote, the most commonly googled question was "What is the EU?" The overall impact will be zero, as these kinds of news headlines usually are; the only difference is the degree to which it has been broadcast around the world and how many people are convinced that something has actually changed. If you believe that a vote by confused citizens in the U.K. will impact corporate profits in Mexico or Poland, to cite two countries whose equity markets have been most negatively affected by the panic in recent days, then you can ignore the rest of this essay. Otherwise, you can take advantage of some amazing bargains in assets which had already been in bull markets since January 20, 2016, and which are likely to soon experience accelerations in their uptrends due to the reality--rather than the fantasy--of a falling U.S. dollar and a significant asset reallocation into emerging markets and commodity producers which in hindsight will have been one of the key themes of 2016-2017.

    Brexit is one of a series of periodic panics which have no long-term impact and are totally forgotten afterward.

    It is interesting that Brexit was reported early on Friday, since that is the time of the week when news events tend to exert their greatest psychological impact on the markets. People begin to panic immediately, and then after a sharp drop on Friday they have the whole weekend to fret about how much worse things are going to be. This will consistently lead to a follow-through plunge on Monday, sometimes just during the first hour of trading, and on other occasions persisting throughout the trading day. Sometimes this will carry through further into Tuesday, as it had done during the October 1987 stock-market collapse and again at the beginning of October 2011, each of which were preceded by substantial gains. On other occasions, the panic ends at some point on Monday and is soon followed by an energetic recovery.

    The most compelling choices for purchase had been in bear markets since April 2011, are historically undervalued, and have been in bull markets since January 20, 2016.

    I have recently been buying mostly funds of emerging markets and commodity producers which had been in severe extended bear markets since April 2011 which finally ended on or around January 20, 2016, and which had caused these securities to become dramatically undervalued and out of favor. Since then, many of them have made several or more higher lows which is characteristic of the early months of a bull market, while sentiment remains generally gloomy and had worsened considerably after Brexit. These include URA, a fund of uranium producers; COPX, a fund of copper mining companies; and the emerging-market funds GREK (Greece), EPOL (Poland), NORW (Norway), PGAL (Portugal), GXG (Colombia), and RSX (Russia). Most of the above, except perhaps for RSX, aren't even familiar to most investors and wouldn't be considered under most circumstances. Another fund which is rarely followed is SEA, a fund of sea shipping companies which has been almost entirely forgotten and is dramatically oversold. I purchased all of these on Monday (June 27, 2016) due to the likelihood that they are completing important higher lows in their bullish patterns of higher lows which had begun on January 20.

    Many British financial institutions have been incredibly punished merely for being headquartered in the U.K.

    As proof of the highly emotional nature of investors' response to Brexit, the companies which are best known and which are most closely associated with Great Britain have experienced the biggest losses. Everyone has heard of BCS (Barclays), Royal Bank of Scotland (RBS), and Lloyd's of London (LYG), so these have been unusually hard hit since the Brexit vote. There have been an astonishing number of brokerage, analyst, and advisor downgrades of these and similar companies, even though their corporate profits will likely be almost completely unaffected by the news. As usual, if the actual impact is one or two tenths of a percent, the market reaction is twenty or thirty percent (or more, in some cases), thereby providing an ideal buying opportunity in all of the above and in similar companies.

    The Brexit overreaction has been even greater than for events which actually impact corporate profits.

    Sometimes there is an event which will negatively impact a company's stock price and receives worldwide media coverage, such as the Exxon Valdez disaster or the British Petroleum catastrophe in the Gulf of Mexico. Other examples would include drug companies which don't receive approval for a particular drug, or which will have to pay money for widespread side effects. Even though Brexit is meaningless, it had roughly the same percentage effect on many companies as the above events which actually did affect corporate profits--although even in those cases the overreaction by investors was so severe that they presented worthwhile buying opportunities. A meaningless panic which is widely believed to be important is an even better buying opportunity than when there is something which will affect corporate profitability. In general, political events are treated with a much stronger emotional response than economic ones, and almost always have essentially zero impact on earnings growth. High-profile resignations, impeachments, elections, accusations of corruption, and similar news reports, especially when they are widely broadcast to the public, often provide the best opportunities to make money. In India, there was persistently negative political news in the summer of 2013 which created historic bargains, and then incredibly positive coverage of Modi's election in the spring of 2014 which caused most small-cap stocks in India to more than double in price within a year without anything actually changing for India's corporate profits.

    Ignore the hype and accumulate the most oversold securities.

    Most funds of emerging markets and commodity producers had been at or near multi-decade bottoms on January 20, 2016, and have since begun what will likely become major bull markets. It had appeared that the best buying opportunities had already passed and would not likely be seen again, but Brexit has provided an opportunity to purchase many of these at true bargain levels. There are exceptions such as gold and silver mining shares, which is only because some media types recommended buying gold bullion after having disparaged this idea for many months. GDXJ is a fund of junior gold and silver producers. From their respective intraday lows (1067 for gold bullion, 16.87 for GDXJ) on January 20, 2016 through the close on Thursday, June 23, 2016, GDXJ had gained over 7.5% for each 1.0% rise for gold bullion which can be measured by GLD or IAU. Since then, however, the post-Brexit behavior has shown roughly a 1:1 ratio, indicating that gold will soon slump below 1300 U.S. dollars per troy ounce and could retreat further in order to shake out recent buyers who acted totally out of emotion and have no commitment to this sector; they will be out of the market as soon as their sell stops are triggered near 1300 and perhaps in smaller numbers near 1275 or thereabouts. In general, whenever gold and silver mining shares far outperform gold bullion, a major uptrend is underway; the recent underperformance by the shares of the producers is thus a warning not to chase after this sector until the shares once again outperform bullion. This will likely happen as funds like GDXJ, SIL, GDX, GLDX, and SILJ repeatedly recover from early intraday selloffs during the next several trading days even as gold bullion continues to generally slump lower. Once the ratios of June 23 are restored, this sector will be ready to enjoy the next phase of its powerful uptrend.

    I closed out my position in HDGE, but retained and added to my short positions in high-dividend shares.

    I sold all my HDGE between 11.20 and 11.29 on Monday which I had purchased earlier in the month between 10.06 and 10.29. The intensity of the fear in the global financial markets made this action necessary, as I had similarly done when I sold all of my HDGE in early February 2016. There will be a better opportunity to repurchase HDGE at some point during the next several weeks or whenever VIX is near 13 again. I have continued to hold and to periodically add to my short positions in XLU (utilities), IYR (real estate investment trusts or REITs), and FXG (consumer staples), because these continue to be irrationally owned by millions who are desperate to achieve the 3%-4% yields they used to get from safe bank accounts and don't appreciate the extreme danger of participating in one of the world's most incredibly popular and therefore soon to be devastatingly money-losing trades. I am short FXG instead of XLP, a similar fund of consumer staples, because FXG has a much higher expense ratio.

    When in doubt, do the opposite of whatever you hear most frequently.

    In the early months of 2009, this was the most common refrain: "I sold all my stocks and I'm cutting back as much as I can with my spending, and I can't understand why the economy has become so bad." If you hear every day, several times a day, why the global economy won't recover for many years, you will do exactly the opposite of what you should be doing. If all you read about is how Brexit means that the sky is falling and the end of the world will soon arrive, then you're likely to sell in a panic rather than buying aggressively. Those who voted for Brexit mostly had no idea what they did, and if they had to vote again many of them would choose not to leave. Even if Britain does leave the EU, the only impact will be a complex series of negotiations which will last for years or decades and will have close to zero impact on corporate profits or the interrelationships between assets. It is puzzling why so few people are able to realize the obvious, but that just makes it better for those who understand reality because it has created compelling buying opportunities for many emerging-market securities, the shares of commodity producers, and numerous British-related securities--as well as anything else which has suddenly plummeted in price since Friday morning. June 27, 2016 was my single heaviest day of buying since October 4, 2011. Be sure to gradually accumulate the most worthwhile assets before everyone else gradually realizes that the world will continue and the sun will keep rising in the east even over the U.K.

    Since the reaction by many assets is even greater than it had been during World War II, 9/11, and some "real" news instead of this meaningless vote, the following song by Dame Vera Lynn should inspire you to do some buying:


  • Dame Vera Lynn: White Cliffs of Dover


  • Disclosure: Whenever they have appeared to be especially depressed, I have been buying the shares of funds which invest either in emerging-market assets or in the shares of commodity producers, since I believe these are among the two most undervalued sectors in a world where real estate and U.S. equity indices remain wildly overvalued. As the greenback surprises most investors by suffering a bear market, with the U.S. dollar index moving below 80 instead of climbing back above 100 as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. The latest Brexit panic has created a new set of compelling buying opportunities, so be sure to seize them before they disappear. From my largest to my smallest position, I currently own GDXJ, SIL, KOL, GDX, XME, COPX (some new), EWZ, RSX (some new), GLDX, REMX, VGPMX, URA (some new), ELD, GXG (some new), IDX, ECH, BGEIX, FCG, NGE (some new), SEA (some new), VNM, RSXJ, EPU, RGLD, SLW, SAND, GREK (some new), NORW (some new), PGAL (some new), EPOL (all new), TUR, SILJ, SOIL (some new), BCS (all new), EPHE, and THD. I have continued to increase my modest short positions in FXG, IYR, and XLU. I expect the S&P 500 to eventually lose roughly two thirds of its May 20, 2015 peak valuation of 2134.72, with its next bear-market bottom perhaps occurring in 2018. As with all bear markets, the biggest losses will likely occur in its final months, and won't even be acknowledged as a bear market until then--as is evidenced by the media falsely proclaiming in March 2016 that the bull market had celebrated its seventh birthday. The Russell 2000 Index and its funds including IWM had handily outperformed the S&P 500 from March 2009 through March 2014, and have subsequently dramatically underperformed, trading at their lowest levels during January 2016 in 2-1/2 years. Small-cap U.S. equities typically lead the entire U.S. equity market lower whenever we are transitioning from a major bull market to a severe bear market. This has happened in past decades including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes. The most overvalued sectors rely on the overhyped deflation trade and money which has been withdrawn from safe bank accounts by investors who begin with the premise that they want to generate income of 3%-4% and look for the most stable securities which can generate such yields. This popular and extraordinarily dangerous method of investing has created valuations at roughly double fair value for most consumer staples (FXG, XLP), real estate investment trusts (IYR), and utilities (XLU), all of which will likely slump by about half within three years or less.

    Question: What are the main implications you see Brexit having on the U.S. Economy?