Sunday, December 17, 2023

"Most of the change we think we see in life is due to truths being in and out of favor." --Robert Lee Frost

Busting Hedge Funds

BUSTING HEDGE FUNDS (December 17, 2023): I had worked at Thomson Reuters for 16-1/2 years; the person sitting next to me had the responsibility of tracking hedge funds and reporting on their behavior. After doing this job for a couple of decades, he pointed out to me how the vast majority of hedge funds which had shown little correlation in their investing behavior through the early 1990s had become increasingly alike by the second decade of this century. The proliferation of hedge-fund conferences where they discussed their "best ideas," combined with nearly identical computer algorithms and momentum strategies becoming increasingly much more popular, almost totally displaced former tendencies toward value investing and identifying compelling bargains.


Although there remain key exceptions including money managed by Seth Klarman, Marc Faber, Jim Rogers, Howard Marks, Ray Dalio, and some others where it is unlikely that you will be able to have them handle your accounts, more than 90% of hedge funds are crowding into identical concepts at any given time. This herd following is especially prevalent at key extremes and has almost certainly caused many of those extremes to become much more exaggerated than they would have been if they hadn't existed. It is also increasingly the case that hedge funds as a group are doing almost exactly the opposite of top corporate insiders and commercials. Thus, tracking insider behavior and the traders' commitments has demonstrated repeated multi-decade extremes where the insiders and commercials are heavily on one side while hedge funds have been piling even more aggressively the other way.


Doing the same as insiders and commercials and the opposite of hedge funds has become an increasingly available and profitable investing strategy which I have been doing more consistently as the 21st century has progressed.


As a result, the most consistently successful strategy in the 21st century has been to do whatever the insiders and commercials are doing at any rare extreme, while going against the hedge funds. During the past year we have already seen several examples of this behavior with hedge funds establishing an all-time record short position in U.S. Treasuries in October 2023. This was followed by the biggest Treasury rally in four decades which intensified during the past week as hedge funds rushed to close out their shorts ahead of all the other hedge funds, and were not particularly successful in doing so. TLT had traded at 81.92 in the pre-market session on October 23, 2022, and less than two months later was trading above 99.


Hedge funds piling into the AI bubble is their latest extremely overcrowded trade, while the top corporate insiders of these companies have done all-time record selling of their shares.


The latest overcrowding by hedge funds has been in being long AI stocks. While most U.S. and global stocks and their funds including IWM have been in bear markets since they had topped out in November 2021, funds which are concentrated in the biggest and most popular megacaps which have generated the most investor excitement in this year's AI bubble have dramatically outperformed in spite of their unimpressive profit growth. QQQ has almost regained its all-time top, while XLK and SMH are among those funds which have experienced the greatest percentage gains during the past year and have achieved new record highs. The top insiders of these companies have never sold more aggressively than they have done during the past few years, while the only time hedge funds had been more committed to any concept was when they had been massively short U.S. Treasuries in October 2023.


This chart, just updated, highlights the amazing recent overcrowding by hedge funds into QQQ and Nasdaq 100 futures which has achieved an overwhelmingly lopsided extreme by a large factor even when compared with 2021 or 2022:



Less historically extreme but still massive overcrowding has created other 2023 situations ripe for busting.


Hedge funds, as is evidenced by the official exchange data at cftc.gov, had never demonstrated a higher ratio of shorts to longs for palladium, thereby leading to PALL plummeting to 85.25 at 12:06 p.m. on December 5, 2023. Since then it has rebounded above 100. Hedge funds piled massively into gold on Sunday evening, December 3, 2023 to reach a spot price of 2137.50 U.S. dollars per troy ounce for the first time in history. Given how hedge fund crowding leads to huge reversals, gold bullion is likely to drop to around 1750 during the next several months before enjoying its next strong rally. The traders' commitments for gold as of December 5, 2023 showed commercials (who are those that own physical gold, such as miners, jewelers, and fabricators) long 103,193 contracts and short 330,138 which is more than 3:1 short to long. Not surprisingly, almost all of those on the other side of this trade were hedge funds and related managed money organizations which the commodity exchange calls "large speculators."


Silver's commitments the same week showed commercials long 40,974 and short 92,988 which was clearly also bearish for silver. Hedge funds were thus aggressively long gold and silver and even more aggressively short palladium. Palladium commercials that week were long 12,814 and short 1,537 which is more than 8:1 long to short.


Hedge funds had done all-time record crowding into shorting the Japanese yen, enabling the yen to fall to its lowest point since July-August 1990. Since then the yen, which trades as an exchange-traded fund via FXY, has experienced its strongest short-term rebound since the Bretton Woods agreement was terminated over a half century ago.


Hedge funds formed a lesser bubble by massively overcrowding into energy commodities and their shares two months ago.


Several times since November 2022 including around the middle of September 2023, hedge funds massively crowded into anything relating to energy while energy insiders sold shares at their most intense pace ever recorded. This was an especially notable reversal for top energy executives who in 2020 were their most aggressive in buying their own shares in their entire history. Starting on September 14, 2023, when XLE reached an all-time dividend-adjusted zenith of 93.685, energy shares and their funds including XLE have been among the biggest losers of all unleveraged exchange-traded funds in any sector.


The media often encourage ordinary investors to do as the hedge funds are doing, which is not surprising since they get a lot of their information from hedge funds which are naturally trying to get others to follow whatever will benefit their own portfolios.


Why have the media suddenly been talking about a "Fed pivot?" It's not because financial journalists have suddenly discovered how to interpret whatever the Fed has been doing. It is because they receive a lot of their data and even more of their interpretation of that data from hedge funds which naturally want to get retail investors to pile into their largest positions. In addition, whenever any asset is especially popular or depressed, the media will seek out stories which will allegedly explain "why" U.S. Treasury yields will keep climbing even when they are at their highest levels since 2000 (as in October 2023) or why AI stocks will keep rising regardless of how overpriced they are (as in December 2023). If you follow the media then you will repeatedly buy near each top and sell near each bottom.


The current U.S. equity bear market is following its usual sequence of sector bottoms.


The Russell 2000 and nearly all related funds such as IWM, along with most stocks worldwide which are unrelated to the AI bubble, have been in notable bear markets since their November 2021 tops, on average losing about 20% of their value during the past 25 months. Before any U.S. equity bear market intensifies, as the current one will almost certainly do soon, we have a sequence of historic sector bottoms which are completed in the following order: 1) U.S. Treasuries which probably completed their nadirs in October 2023 and are in major uptrends; 2) gold mining and silver mining shares which I expect will bottom around the spring of 2024 before initiating powerful rebounds; 3) emerging-market stocks and bonds which will perhaps bottom around the summer of 2024 with Chinese shares notably underpriced and which could thereby become compelling bargains at that time; 4) non-precious commodity producers which might also gain by substantial percentages after they bottom later in 2024; 5) special situations which vary from one bear market to another. In this case, the sectors which could approach multi-year lows in 2024 and thereafter rally strongly might include currently unpopular biotech shares and their funds like XBI along with airline shares and their funds including JETS.


I also plan to be open-minded about other sectors becoming worthwhile for purchase sometime during 2024.


The ultimate bottoms for most AI shares won't occur until 2025 or 2026.


As a general rule, those shares which achieve historic bubbles tend to lose over 80% of their value and to take two to three years to complete their total downtrends. After QQQ had topped out on March 10, 2000, it lost 83.6% of its value by the time it bottomed exactly 31 months later on October 10, 2002 (see stockcharts.com which includes all reinvested dividends by default). If QQQ loses 83.6% of its recent high of 406.5, which could potentially go even higher in the short run, then this would mean an eventual QQQ bottom of 66.666 which looks to me like a very lucky number indeed.


The bottom line: An increasingly profitable strategy during the 21st century capitalizes on the tendency of the vast majority of hedge funds to use momentum methods and to thereby overcrowd massively into various positions. Top corporate insiders and commercials throughout various points in 2023 have been doing almost exactly the opposite of those hedge funds near all key extremes for a wide variety of assets including AI stocks in December (QQQ,SLK,SMH), U.S. Treasuries in October (TLT), the Japanese yen in November (FXY), large-cap energy shares in September (XLE), and all precious metals in early December including palladium (PALL), gold (GLD), and silver (SLV). You can therefore consistently make money, although not always immediately, by following the insiders and commercials and doing the exact opposite of the most overcrowded hedge-fund concentrations during the next several years.


Disclosure of current holdings:


Below is my current asset allocation as of 4:00 p.m. on Friday, December 22, 2023. Each position is listed as its percentage of my total liquid net worth.


I computed the exact totals for each position and grouped these according to sector.


The order is as follows: 1) U.S. government bonds; 2) shorts; 3) bear funds; 4) gold/silver mining; 5) coins; 6) miscellaneous securities.


VMFXX/TIAA(Traditional)bank CDs/FZDXX/FZFXX/SPRXX/SPAXX/Savings/Checking long: 36.32%;


26-Week/17-Week/52-Week/13-Week/2-Year/8-Week/3-Year/5,10-Year TIPS/4-Week/42-Day long: 21.66%;


TLT long: 11.67%;


I Bonds long: 10.54%;


PMM long: 0.01%;


XLK short (all shorts once again unhedged): 28.39%;


QQQ short: 17.23%;


XLE short: 5.15%;


XLI short: 2.77%;


XLV short: 1.69%;


SMH short: 1.01%;


AAPL short: 0.02%;


SARK long: 0.90%;


PSQ long: 0.03%;


PALL long: 0.20%;


GDXJ long: 0.14% (fully hedged with out-of-the-money covered calls);


Gold/silver/platinum coins: 6.28%;


FXY long: 0.17%;


PAK long: 0.03%.

Sunday, November 12, 2023

"The near absence of bargains works as a reverse indicator for us. When we find there is little worth buying, we find there is probably much worth selling." --Seth A. Klarman

Budding Bursting Bubbles

BUDDING BURSTING BUBBLES (November 12, 2023): Investors are easily impressed by large percentage moves, while barely noticing important asset behavior. Therefore, since the total losses so far for major U.S. large-cap equity indices including the S&P 500, Nasdaq, and QQQ have been modest so far, most people aren't concerned about whether or not we are in a primary bear market. The total declines overall are generally less than 10% from their peaks in November 2021 or early January 2022. U.S. real estate overall also has mostly single-digit percentage declines. Therefore, the fact that most of the above and other indices have experienced numerous lower highs over the past two years isn't appreciated even with the bearish implications of this activity in prior decades. Small- and mid-cap U.S. equity indices and funds have almost all suffered larger percentage losses, but hardly anyone pays attention to the Russell 2000 and similar benchmarks.


Therefore, even though the U.S. equity bear market is roughly half over timewise, and is probably entering its most dangerous downside phases, most investors are blissfully complacent. This is evident from VIX closing at 14.17 on Friday, November 10, 2023, an astonishingly low level two years into a bear market. Hardly anyone thinks they need protection or hedging against potential upcoming losses. Boglehead myths are widely prevalent with many such investors convinced that they have a divine right to come out ahead in the long run no matter how overvalued the assets are which they own.


Investors can get 5.5% guaranteed by the U.S. government with zero state and local income taxes, making the U.S. stock market much more overpriced than it had been two years ago.


One plausible reason for U.S. equities reaching all-time record overvaluations in November 2021 was that the 26-week U.S. Treasury bill had been yielding less than 0.1%. Currently it is yielding just about exactly 5.5%. This means that investors can obtain this kind of annualized gain with zero risk. Especially with the spread between the 13-week and the 10-year U.S. Treasuries reaching an all-time record going back to 1789, this makes U.S. stocks even more dangerously overpriced relative to U.S. Treasury bills and with far greater downside risk. Investors are so concerned about "missing out" on potential upside that they're unaware of the likelihood of losing more than half of their money. No one can say how far any asset will decline during a bear market, but if QQQ declines as much in 2023-2025 as it had done from its March 10, 2000 zenith to its October 10, 2002 nadir then those who currently hold QQQ and similar assets will lose more than 80% of their current valuation. This includes reinvested dividends and is even without adjusting for inflation.


There are two major consequences of the longest-ever U.S. equity bull market.


The U.S. equity bull market which began in March 2009 lasted longer than any other bull market in U.S. history. Whenever anything persists for such a lengthy period of time, investors psychologically don't believe that anything which had happened in prior decades has any significance. It has been so long since we had suffered the previous severe bear market that hardly anyone can imagine a significant percentage decline. This is similar to how hardly anyone two years ago thought that inflation could reoccur, since it had been such a long time since we had experienced surging inflation. Paradoxically, if some investors think about selling and then prices climb even higher, they congratulate themselves for not selling "too soon" and become even less likely to sell the higher that prices are rising. Insiders are an important exception, demonstrating their highest-ever overall ratios of insider selling to insider buying since early 2021 and only behaving otherwise during the final four months of 2022.


Besides investors being emotionally far too distant from the previous two true bear markets of 2000-2002 and 2007-2009 to believe that a third such decline could be underway, the duration of any bear market tends to be proportional to the bull market which precedes it. In general, a bear market will last roughly one-third as long as its prior bull market. Since the U.S. equity bull market which started in March 6-9, 2009 lasted for almost thirteen years, the current U.S. equity bear market will probably last for roughly four years which means that it won't likely be completed until around the end of 2025. This relatively leisurely pace has fooled many investors into believing either that the bear market "is over" or that we might experience one more moderate correction, rather than the far greater likelihood of two upcoming crushing down years which overall become progressively more dramatic.


The biggest losses will generally be suffered by the best-known shares.


U.S. equity overvaluations are far more pronounced and out of line with corporate profit growth for the best-known and largest U.S. companies, especially those which had generated a high level of excitement from the AI bubble and excitement over other modern technology. Nearly all of the 2023 gains for major U.S. large-cap equity indices were achieved by a surprisingly small number of trendy stocks. A company with an annualized profit growth averaging about 10% cannot maintain a price-earnings ratio near 40 regardless of what is happening with the economy, how inverted the U.S. Treasury curve happens to be, or what is occurring with the U.S. dollar. Momentum can sometimes seem to prevail for awhile, but eventually a regression toward the mean and beyond to a nearly opposite extreme of undervaluation must happen sooner or later.


The strongest proof of the unsustainability of the current situation is the irrationality of investors' attitudes toward any given company.


Perhaps you are thinking to yourself: maybe it makes sense for a company like Microsoft to have a price-earnings ratio which is four times its profit growth, since AI will allegedly cause its profits to quadruple. You can believe in such foolish fantasies, but consider that the corporate bonds of the most popular large-cap companies have been among the biggest losers over the past few years while the stocks of the same companies have been among the biggest winners. If a particular company is really going to outperform with its fundamentals then its bonds should also be outperforming along with its stocks. What is really happening is that investors have been crowding more and more aggressively into the biggest percentage winners while piling out of the biggest percentage losers, regardless of their merit. This has caused closed-end bond funds including "boring" municipal bonds to experience some of their highest-ever historic discounts, while anything related to AI has enjoyed some of the biggest gains regardless of whether new technology will ever get around to increasing these companies' profitability.


The U.S. economy is behaving like a trip on the planet Mercury.


Unlike Earth, the planet Mercury doesn't rotate. It maintains the same side toward the sun at all times. This side is incredibly hot, while the dark side which faces away from the sun is incredibly cold. If you are on the planet and you decide to pass from the scorching to the frigid side, you will briefly pass through a region where the temperature is just about right for human habitation. This is similar to what is happening with the U.S. economy: it is going from an overheated state with very low unemployment and bloated inflation, just like 1929-1930, 1972-1973, 1999-2000, and 2007-2008, to a period of serious recession, high unemployment, sharply diminished inflation, and depressed asset prices. 2025 is going to be very similar to 1932, 1974, 2002, and 2008, with stocks bottoming during or shortly after each of those years and real estate following roughly one year later.


Real U.S. equity bear markets always end with sizable undervaluations, heavy net investor outflows, intense insider buying by top executives, and pervasive media gloom. We are nowhere near any of the above.


At the end of any bear market, whether for stocks or real estate, we usually have an average of a 20% discount to fair value for real estate and a 40% discount to fair value for the U.S. stock market. We will have a multi-decade high for insider buying, exaggerated ratios of insider buying relative to insider selling, all-time record net outflows by investors who are finally panicking after losing more than half of their money, and day after day of negative media commentary about the economy and the markets. Until all of the above actually happen we can be certain that much greater downside for the U.S. stock market lies ahead.


The excuses change through the ages but the results are identical.


During the 1800s investors said that because of progress, canals, or railroads, the old valuation rules were no longer relevant. In the 1900s industrialization, computers, and at the turn of the century the invention of the internet convinced many that price-earnings and price-to-book measures were no longer relevant in the "modern age." Today you hear a lot about how AI has "permanently" changed the situation or how the Fed will ensure that valuations remain far above average indefinitely.


It's not different this time.


I have been gradually adjusting my mix of assets as I always do in order to respond to changing circumstances and multi-decade extremes, and I have general plans for the next several months.


As TLT and the actual 20-year U.S. Treasury both fell to their lowest valuations since 2004, I had been gradually purchasing them into weakness through October 2023. Related assets including closed-end bond funds like PMM slid to even deeper average bargains which hadn't been experienced generally since 2000, so I had gradually bought them also. More recently I have been adding to my short position in QQQ and related shares as they complete additional lower highs and haven't dropped much overall from their respective peaks from November 2021. I had been selling short large-cap energy shares and their funds including XLE at each of their peaks since November 2022 including September 2023. The Japanese yen slid to its lowest point since July-August 1990 making FXY a worthwhile bargain.


During the next several months I expect to be covering some or all of my short positions whenever QQQ experiences dramatic weakness such as a loss of about half from its current price. The next major purchase I think will be likely will be buying gold mining and silver mining shares through funds including GDXJ, although the traders' commitments demonstrate clearly that it is still too early to be doing so. Most likely gold bullion will drop below 1800 U.S. dollars per troy ounce sooner or later to provide the next buying opportunity in this sector.


The following charts highlight recent multi-decade extremes:






The bottom line: We have numerous nearly simultaneous multi-decade extremes in the global financial markets which sooner or later will all regress toward the mean and beyond to nearly opposite extremes within two or three years. This is likely to lead to an additional loss of 80% for QQQ and AI bubble stocks, roughly double the current valuations for TLT and the 20-year U.S. Treasury bond, much higher valuations for most closed-end government bond funds and the Japanese yen, and losses of about half on average for real estate around the world. The alternative is a simple one: put your money into U.S. Treasuries which mature within a couple of years and are paying up to 5.5% with both interest and principal guaranteed along with being exempt from state and local income taxes.


Disclosure of current holdings:


Below is my current asset allocation as of 4:00 p.m. on Friday, November 10, 2023. Each position is listed as its percentage of my total liquid net worth.


I computed the exact totals for each position and grouped these according to sector.


The order is as follows: 1) U.S. government bonds; 2) shorts; 3) bear funds; 4) gold/silver mining; 5) coins; 6) miscellaneous securities.


VMFXX/TIAA(Traditional)bank CDs/FZDXX/FZFXX/SPRXX/SPAXX/Savings/Checking long: 35.67%;


26-Week/17-Week/52-Week/13-Week/2-Year/8-Week/3-Year/5,10-Year TIPS/4-Week/42-Day long: 19.28%;


TLT long: 10.35%;


I Bonds long: 9.88%;


PMM long: 0.01%;


XLK short (all shorts once again unhedged): 26.54%;


QQQ short: 14.17%;


XLE short: 5.06%;


XLI short: 2.51%;


XLV short: 1.58%;


SMH short: 0.92%;


AAPL short: 0.02%;


SARK long: 1.22%;


PSQ long: 0.02%;


GDXJ long: 0.53% (fully hedged with out-of-the-money covered calls);


GDX long: 0.24%;


PALL long: 0.15%;


ASA long: 0.09%;


Gold/silver/platinum coins: 5.92%;


FXY long: 0.15%;


PAK long: 0.03%.

Monday, September 4, 2023

"When all feels calm and prices surge, the markets may feel safe; but, in fact, they are dangerous because few investors are focusing on risk." --Seth A. Klarman

Long Treasuries, Short Stocks

LONG TREASURIES, SHORT STOCKS (September 4, 2023): In the entire history of the U.S. financial markets there has rarely been an opportunity where U.S. Treasuries were such compelling investments relative to U.S. stocks. The 6-month U.S. Treasury bill is yielding just about exactly 5.5% while the S&P 500 Index is yielding less than 1.6%, one of the greatest spreads ever recorded.


The U.S. Treasury yield curve is at all-time record inversion, meaning that the short-term U.S. Treasury bills of several months to maturity have their widest-ever spreads over longer-term U.S. Treasuries. This chart shows the spread between the 3-month and 10-year U.S. Treasuries going back to 1982:



Here is a chart showing the extreme relative outperformance of the S&P 500 Index relative to the 10-year U.S. Treasury since 1993:



The 10-year U.S. Treasury hasn't underperformed so dramatically since it was first introduced by Alexander Hamilton in 1789, the year before the 1790 debut of equities trading on the Philadelphia Stock Exchange:



Commercials in U.S. Treasuries, analogous to top corporate insiders for individual companies, have a total net long position which is roughly twice their previous all-time record going back to 1990. The maroon bars represent the commercials in the 10-year U.S. Treasury, meaning those who trade it as a necessary part of their career rather than for the purpose of speculation (special thanks to Software North):



The U.S. money supply, measured by M2, has never contracted as sharply as it has done recently, as you can see from this chart dating back to 1965:



We have also experienced the lowest prices for one-year index put options since these valuations started to be tabulated in 2008:



Investors love call options and hate put options at market peaks, while chasing after puts during all bottoming patterns. Meanwhile, most people were so excited about megacap U.S. tech shares in 2021 that total fund inflows exceeded those of 2001 through 2020 combined [not a misprint], but this record was far exceeded by the AI bubble eagerness in 2023:



U.S. equity overvaluations have never been more glaring than they were near their 2021, 2022, and 2023 peaks including July 2023:



The prices of the most popular technology companies have soared far out of line with their actual earnings:



Not all global stock markets are overpriced. U.S. gold mining and silver mining shares and their funds are moving toward undervaluations which could become compelling later in 2023, although silver's traders' commitments warn that it's too early to buy as you can see by comparing the current maroon bars with those from the leftmost part of the following graph in September 2022 which was the last excellent purchase opportunity for precious metals and the shares of their producers:



Much-hated Chinese stocks have suffered recent record net outflows and will likely be worth buying sometime during the next several months after U.S. stocks have already been in more pronounced downtrends:



The bottom line: In 2000, 2007, and 2023, we experienced the highest U.S. Treasury yields of each decade when investors were far more eager to own U.S. stocks than they were to be long "boring" U.S. Treasuries. This was followed by losses of more than half for most U.S. equities while those who had bought U.S. Treasuries were rewarded by locking in yields just before they had dropped steeply after both 2000 and 2007. It is more likely that this will occur again this time, rather than less likely, because we have a far greater degree of commercial accumulation of U.S. Treasuries now than we have experienced at any time since 1990. We also have all-time record extremes of U.S. equity call buying, the most undervalued put options, all-time record net equity fund inflows, and the lowest-ever total U.S. dollar amount of insider buying ever recorded during the past three months:


Disclosure of current holdings:


Below is my current asset allocation as of 4:00 p.m. on Monday, August 28, 2023. Each position is listed as its percentage of my total liquid net worth.


I computed the exact totals for each position and grouped these according to sector.


The order is as follows: 1) U.S. government bonds; 2) shorts; 3) bear funds; 4) gold/silver mining; 5) coins; 6) miscellaneous securities.


VMFXX/TIAA(Traditional)bank CDs/FZDXX/FZFXX/SPRXX/SPAXX/Savings/Checking long: 31.83%;


26-Week/17-Week/52-Week/13-Week/2-Year/8-Week/3-Year/5,10-Year TIPS/4-Week/42-Day long: 17.24%;


TLT long: 9.92%;


I Bonds long: 9.53%;


XLK short (all shorts unhedged): 25.15%;


QQQ short: 12.48%;


XLE short: 5.04%;


XLI short: 2.55%;


XLV short: 1.67%;


SMH short: 0.88%;


AAPL short: 0.02%;


SARK long: 1.20%;


PSQ long: 0.01%;


ASA long: 1.26%;


GDXJ long: 0.57%;


GDX long: 0.25%;


BGEIX long: 0.00%;


Gold/silver/platinum coins: 5.69%;


PAK long: 0.03%.

Sunday, July 16, 2023

"Consistency and patience are crucial. Most investors are their own worst enemies. Endurance enables compounding." --Seth A. Klarman

Down, Up, DOWN, UP

Down, Up, DOWN, UP (July 16, 2023): It isn't widely appreciated that bear markets feature not only substantial percentage losses but dramatic rebounds which exceed the percentage gains achieved during bull markets and also happen more quickly. Therefore, it is necessary to keep switching from being net long, to net short, to net long, over and over again, gradually buying into the most extended pullbacks and progressively selling into the most extended uptrends.


Down, Up, DOWN, UP.


We are likely to experience all of the following events, in order: 1) the biggest percentage pullback of the 2021-2025 bear market to date over the next several months, roughly 50% from top to bottom for QQQ; 2) a strong rebound for several months as about half of this loss is regained; 3) a much more severe and sustained decline for about one year ending sometime in 2025 at the lowest absolute valuations since 2013 even without adjusting for inflation; 4) an impressive multi-year value bull market similar to 2002-2008 or 1975-1980 which will favor commodities, emerging markets, smaller companies, and definitely not megacap tech shares.


We have experienced several multi-decade and all-time record extremes of net exchange-traded inflows, call volume, new participation, and many other signals of a multi-decade U.S. stock-market peak.


Recently we have achieved bubble extremes which have surpassed all previous records, including many which had been set less than two years ago in late 2021 and early 2022. While the S&P 500 Index, QQQ, the Russell 2000, and most other global equity indices haven't completely regained their all-time record overvaluations of November 2021 or January 2022, we have far exceeded the all-time record levels of net exchange-traded fund inflows, total call volume, number of first-time U.S. stock-market investors, and concentration into just seven shares (MSFT,AAPL,AMZN,NVDA,TSLA,GOOGL,META) which are responsible for the vast majority of the gains in market capitalization in 2023.


Investors had an excuse to make risky choices at the beginning of 2022 since safe U.S. Treasuries were yielding one quarter of one percent interest. 1-1/2 years later U.S. Treasury bills usually exceed 5.4% yields, so rationally risk should be less popular instead of at an all-time high of eagerness.


If the highest guaranteed return on your investment is 0.2% to 0.3%, as it had been at the start of 2022, then it is understandable why some investors would prefer to put their money into almost anything else. However, when you can get 5.4% or 5.5% with zero risk from U.S. Treasuries which mature in 8, 13, 17, 26, or 52 weeks, then why would anyone want to take a risk with other assets? You have to make 5.5% just to break even in relative terms, and that doesn't even count the fact that U.S. Treasury interest is free of state and local income taxes. Just as had been the case in 2000 and 2007, the last two times that U.S. Treasuries had sported similar yields, investors have become so eager to pile into stocks that they have stopped analyzing the fundamental trade-offs which are the core of how the financial markets work. The upcoming result will therefore be exactly the same as it had been after 2000 and 2007 with severe U.S. equity bear markets and dramatic declines for U.S. Treasury yields of all maturities.


Bear markets consistently experience the strongest rebounds.


At the beginning of 2022 I had recommended being heavily net short, but at the end of 2022 I had switched to being even more heavily net long. In 2023 I have progressively been closing out long positions, most recently selling gold mining and silver mining shares just in the past couple of days, while steadily adding to short positions in funds including QQQ and XLE whenever insiders were most aggressively selling and it was most timely to take action. I have therefore become heavily net short again, and will become even more net short if I continue to sell gold/silver mining shares in upcoming days as seems likely now that the U.S. dollar index has fallen below 100. Investors have recently become very bearish toward the U.S. dollar and also U.S. Treasuries just when they should be most aggressively accumulating them into weakness, thereby causing TLT to drop to 98.40 in the pre-market session on July 10, 2023 as well as the U.S. dollar index sliding below 100 in recent days.


It is useful to remind yourself about how much more strongly stocks will rebound during bear markets than they will during bull markets. In every bear markets, Bogleheads and others will tell you every time we have a sharp recovery that "the bear market is over" but then we have the next downward wave, at which point investors become too fearful and we get the next rebound, and so on. Here is a chart of how QQQ had behaved in 2000-2002, where you can see how many very strong percentage gains we had even as QQQ overall was busy dropping 83.6% from its March 10, 2000 peak to its October 10, 2002 bottom:


As a bear market matures, both the pullbacks and the recoveries become generally greater in percentage terms.


You probably heard a lot of people talk about the so-called Goldilocks economy in 2021. The problem with that analogy is that many people weren't paying attention in kindergarten when their teacher read the Goldilocks story: Goldilocks is always followed by three bears, known as Baby Bear, Mama Bear, and Papa Bear. We had Baby Bear in January-October 2022, where a modest pullback for the U.S. stock market had occurred, followed by a rebound. The recovery has been above average for a bear market in terms of duration and intensity, partly since we had a second bubble encouraged by AI hype.


We are about to experience Mama Bear. This will feature much greater percentage losses than we had experienced in 2022. Such a pullback will be followed by a strong bounce higher for several months, and then starting sometime in 2024 we will begin Papa Bear which will likely continue until some unknown point in 2025. Most investors aren't prepared for either of the bear parents to perform their inevitable starring roles, and have foolishly convinced themselves just as they had done in all previous bear markets that somehow we're in a "new bull market."


Pictures can be worth a thousand words or perhaps even ten thousand words. We have experienced numerous multi-decade extremes in recent weeks which are probably best shown through the actual data:





The bottom line: Look for down, up, DOWN, UP. Get ready for the following four major moves, in order: 1) the biggest percentage decline so far in the 2021-2025 bear market; 2) a strong multi-month rebound; 3) a much more intense collapse lasting roughly one year; and 4) a multi-year value bull market.


Disclosure of current holdings:


Below is my current asset allocation as of 4:00 p.m. on Friday, July 7, 2023. I have since added to my short position in QQQ while selling some GDX and GDXJ, which I will update soon.


I computed the exact totals for each position and grouped these according to sector.


The order is as follows: 1) U.S. government bonds; 2) shorts; 3) gold/silver mining; 4) coins; 5) individual securities.


TIAA(Traditional)/VMFXX/bank CDs/FZDXX/FZFXX/SPRXX/SPAXX/Savings/Checking long: 22.62%;


26-Week/17-Week/52-Week/13-Week/2-Year/8-Week/3-Year/5,10-Year TIPS/4-Week long: 13.86%;


I Bonds long: 9.48%;


TLT long: 9.43%;


XLK short (all shorts once again unhedged): 25.31%;


QQQ short: 12.17%;


XLE short: 4.58%;


XLI short: 2.60%;


XLV short: 1.62%;


SMH short: 0.89%;


AAPL short: 0.03%;


PSQ long: 0.01%;


GDXJ long: 10.75%;


ASA long: 6.79%;


GDX long: 2.98%;


BGEIX long: 1.44%;


Gold/silver/platinum coins: 5.88%;


HBI long: 0.29%;


PAK long: 0.03%.


The numbers add up to more than 100% because short positions only require 25% to 30% collateral in stocks/funds and only 4% to 6% in U.S. Treasuries (by SEC regulations; some brokers require more) to hold them with no margin required.

Wednesday, May 3, 2023

"At some price, an asset is a buy, at another it's a hold, and at another it's a sell." --Seth A. Klarman

2023 All-Time Danger

2023 ALL-TIME DANGER (May 3, 2023): In 2021 we achieved especially dangerous all-time record unprecedented investor behavior. In the U.S. we had greater net inflows into U.S. equity funds in 2021 than in 2001 through 2020 combined. We also experienced all of the following all-time record extremes from early 2021 through early 2022: 1) the ratio of the total dollar volume of insider selling divided by the total dollar volume of insider buying; 2) the ratio of the top 50 U.S. companies by market capitalization relative to the entire U.S. stock market; 3) the ratio of the total market capitalization of the top 50 U.S. companies relative to the total U.S. GDP; 4) the overall valuation of the top 50 U.S. companies relative to the total market capitalization of the the rest of the world; 5) the total volume of call buying; 6) the average daily net inflow into U.S. passive large-cap equity funds; 7) the divergence in behavior between the most-experienced investors who had never been heavier net sellers especially of the biggest U.S. company shares, versus the least-experienced participants who had never been more aggressive net buyers of U.S. equities.


This article on Bloomberg from November 25, 2021, which doesn't even include the huge net inflows from the past several weeks of that year, highlights how investors became far too heavily committed to U.S. stocks at the worst possible time in history:


2023 has smashed all previous U.S. large-cap stock-market extremes including those of 2021 and 2022.


It was truly amazing to have all of the previous extremes surpassed for all previous U.S. large-cap equity bubbles including 1837, 1873, 1929, 1973, and 2000. I was convinced that we might never see such overenthusiasm, overinvesting, and overcommitment to the biggest U.S. stocks for another century or more. However, it didn't take a century to revisit these all-time distortions, as every single one of the above all-time records from 2021-2022 was surpassed in 2023.


Practically every week we get a new all-time record or two: 1) the lowest VIX (15.53) during a bear market; 2) the longest rebound from an intermediate-term bottom during a bear market (nearly 7 months); 3) frequent record ratios of the biggest U.S. megacap shares relative to the rest of the S&P 500 or relative to other indices of small- and mid-cap U.S. shares. The last statistic is especially ominous, since the degree of overcrowding into the biggest U.S. companies has consistently been proportional to the subsequent total percentage losses for the best-known U.S. equity indices and funds. The following three charts highlight the astonishing enthusiasm for the biggest U.S. companies in recent weeks:





If U.S. Treasuries are paying over 5% guaranteed with the interest exempt from state and local income taxes, how can other investments compete?


The simple answer is that on a rational or analytical basis there is no reason to purchase U.S. stocks, real estate, art, collectibles, or anything else if you can get 5% or more on U.S. Treasury bills. Only emotional reasons would justify purchasing fluctuating assets, especially since so many of those are trading near all-time record overvaluations and as described earlier in this update have rarely been more popular.


The 17-week U.S. Treasury bill usually sports among the highest yields of all U.S. Treasuries since it has only existed since October 2022 and many institutions aren't aware of it. This is a far more intelligent choice than putting money into absurdly-overpriced U.S. large-cap equity funds including QQQ, XLK, and SPY.


The U.S. Federal Reserve is trying to slow the U.S. economy. Do you really think they'll fail in that pursuit?


The U.S. Federal Reserve has just raised both of its key overnight lending rates by a total of five percent over a relatively short time period in order to slow the U.S. economy. Regardless of whether there is a soft landing or not, current valuations especially for the largest U.S. stocks aren't compatible with contracting economic growth. We don't need to have a recession in order to have a stock-market crash, since merely returning to fair value will produce massive percentage losses. Moreover, bear markets almost always bottom at a 30% to 50% discount to fair value.


Gold mining and silver mining shares are often among the earliest assets to complete both tops and bottoms in any cycle. History always repeats itself with minor variations.


Even though the price of spot gold almost exactly revisited its all-time high from August 2020, the prices of gold mining and silver mining shares remained dramatically below their peaks from that month. This served as an important negative divergence to warn us that, even though this sector is traditionally one of the strongest bear-market performers, for some period of weeks or months we are going to experience a meaningful correction in this sector which has been underway since April 13, 2023.


Funds including GDXJ and GDX are likely to complete their bottoms ahead of nearly all other risk assets over the next several months. Gold has repeatedly failed to remain above 2050 U.S. dollars per troy ounce, including a failed attempt on Wednesday, May 3, 2023, and will likely drop below 1800 before resuming its long-term uptrend which has been in effect since the beginning of this century. After gold mining and silver mining shares complete their pullbacks and begin to rebound, the clock will be ticking for most other stocks which will fall to multi-year lows over the subsequent several weeks or months.


The biggest losses for U.S. stocks will be in 2024-2025, not in 2023. However, we are going to drop a lot more in 2023 than even many bearish analysts are anticipating.


In 2024-2025 U.S. stocks are likely to return to their levels of 2013 and perhaps even 2012. In 2023 we generally won't approach or drop below most of the March 2020 bottoms, because it's not yet timely for such an event to occur. Bear markets are like avalanches: they start out slowly and build up momentum on the way down. All pullbacks are followed by powerful recoveries, each of which convinces most investors that the bear market is over and we're in a new bull market. If you don't believe this then check how many times during the past 1-1/2 years Jim Cramer has insisted that the bear market has ended. Each time he and many other analysts became convinced that "the bear market is over", a renewed, ferocious downturn ensued.


A reasonable 2023 downside target for QQQ would be 200 or 190, and I think we will go lower than that before the end of this calendar year. This should be followed by a rebound of perhaps 40% over a period of several months, after which we will begin a much more severe downtrend.


U.S. equity indices keep making upward spikes as is characteristic of an intermediate-term topping pattern in a bear market.


QQQ briefly surged to intraday highs of 323.63 on May 1, 2023 and 322.47 on May 3, 2023. Topping patterns within bear markets feature repeated attempts to stage upside breakouts, just as bottoming patterns within bear markets are accompanied by repeated sharp downward moves. Investors tend to be easily fooled into believing that repeated upward intraday surges are bullish when they are profoundly bearish.


VIX fell to 15.53 at 11:02 and 11:03 a.m. on Monday, May 1, 2023 for the first time since November 5, 2021.


In past bear markets, multi-month low extremes for VIX were an important sell signal. Similarly, when VIX climbs to a multi-year high and then begins to form lower highs, as I think will be the case much later in 2023, this is a useful buy signal for U.S. equities and their funds.


Investors are repeating the same recency-bias mistake as the Fed had done in 2020.


Why did the Fed wait so long before starting to increase overnight lending rates? Didn't they notice that the U.S. stock market was approaching record bubble levels near the end of 2020? Of course they did, but the deciding factor in not raising rates at that time or in early 2021 was because we hadn't experienced a true inflationary binge since the early 1980s which was forty years earlier. If something hasn't happened for a long time, you start to believe that it's highly unlikely to reoccur even if it is by far the most probable outcome.


Investors are making the same serious mistake today. They're not putting most of their money into U.S. Treasury bills, in most cases not because they aren't aware how overpriced megacap U.S. shares are today (although some are simply ignorant), but because we haven't experienced a crushing bear market since early March 2009 which was more than 14 years ago. Anything which is that far in the past seems psychologically as though it can't happen again, even though it is by far the most likely outcome.


The U.S. dollar index has been making higher lows since early 2021. The correction from the last week of September 2022 essentially ended at the beginning of February 2023 and we have been experiencing higher lows in preparation for a dramatic move higher for the greenback over the next several months.


I keep reading about how I should invest in anticipation of a falling U.S. dollar. As with most media coverage this is badly misguided. One of the major risks to the global economy is that the U.S. dollar, which reached its highest point in September 2022 in more than twenty years, is likely to achieve a 40-year zenith within two or three years. Bet on a rising U.S. dollar, not a falling one.


Investors are overly concerned about commercial real estate and are not nearly concerned enough about residential real estate.


Work-at-home popularity in recent years, encouraging companies to lease significantly less office space, has become widely broadcast and Charlie Munger was recently featured as highlighting this point. This phenomenon is probably more than built into current valuations for commercial real estate and associated REITs. Investors are ignoring the far more dangerous all-time record ratios of residential real estate in most neighborhoods to the average household incomes in those neighborhoods. Eventually residential real estate, like all other assets, must regress to fair value as measured by the average long-term ratios of housing prices to household incomes. This implies a 50% average decline for houses in most U.S. cities over the next few years if you don't adjust for inflation. If U.S. stocks end up mostly completing historic nadirs in 2025 then real estate might complete its bottoming process in 2025-2027 as residential housing prices tend to retreat to important lows a year or two later than the equity market.


The bottom line: 2023 has experienced even more dangerous extremes than 2021 or 2022, and those had been among the most-overvalued episodes in U.S. history for large-cap U.S. equities.


We can debate how much lower QQQ, XLK, and similar assets are likely to drop over the next 1-1/2 to 2-1/2 years. I feel pretty confident that QQQ will eventually trade below 80 which would not even be as large a total percentage decline as its 83.6% collapse from its March 10, 2000 top to its October 10, 2002 bottom. This would represent a slide of 75% for QQQ from its current level. Other funds which are laden with heavy weightings in the largest U.S. companies will suffer proportional declines.


Disclosure of current holdings:


Below is my current asset allocation as of 4:00 p.m. on Monday, May 1, 2023.


The order is as follows: 1) U.S. government bonds; 2) shorts; 3) gold/silver mining; 4) coins; 5) individual securities.


TIAA(Traditional)/VMFXX/FZDXX/Savings/Checking long: 26.44%;


26-Week/17-Week/52-Week/2-Year/8-Week/3-Year/5,10-Year TIPS long: 13.02%;


I Bonds long: 9.35%;


TLT long: 9.04%;


XLK short (all shorts are currently unhedged): 21.45%;


QQQ short: 8.74%;


XLE short: 4.59%;


XLI short: 2.37%;


XLV short: 1.62%;


SMH short: 0.69%;


GDXJ long: 11.45%;


ASA long: 7.33%;


GDX long: 3.25%;


BGEIX long: 1.59%;


Gold/silver/platinum coins: 6.10%;


HBI long: 0.31%;


EWZ long: 0.20%;


EWZS long: 0.08%;


PAK long: 0.02%;


EGPT long: 0.01%.


The numbers add up to more than 100% because short positions only require 25% to 30% collateral in stocks/funds and less than that in U.S. Treasuries (by SEC regulations; some brokers require more) to hold them with no margin required.

Wednesday, March 22, 2023

"Patience and discipline can make you look foolishly out of touch until they make you look prudent and even prescient." --Seth A. Klarman

Trapped Bogleheads

TRAPPED BOGLEHEADS (March 22, 2023): If it doesn't rain outside for several weeks in a row then you may stop taking an umbrella with you even when it's cloudy. As a result you'll get rained on sooner or later. Worse, if the lack of rain continues for years then you may start building houses without roofs. Then you'll have a catastrophe. Investors have been building portfolios in the same manner, ensuring that they'll be flooded and thoroughly ruined sooner or later. The water is already coming in and they're not even putting on plastic blue roofs.


We had such a lengthy bull market that, even with the overall mediocre 23-year performance for U.S. large-cap equity index funds since March 2000, investors who made foolish decisions were generally rewarded instead of punished. Those who used margin, or who kept piling blindly into U.S. equity growth funds in classic Boglehead style, or who simply purchased shares of the best-known big U.S. companies, generally outperformed those who used more scientific methods. Buying whatever was out of fashion or which was most undervalued often did more poorly than picking the popular names, especially in years like 2021. When inferior performance is rewarded and careful analysis is not, investors will naturally pile into whatever is "doing well" regardless of merit. Even assets with essentially zero value like cryptocurrencies became highly desired because they were going up.


Most investors have been piling into U.S. large-cap equity growth funds in 2023 at an even more intense pace than during 2021, which at that time had set a record for greater total net calendar year inflows than 2001 through 2020 combined.


2021 experienced by far the highest total net inflows into U.S. equity funds in history even if you adjust generously for inflation. 2022 would have been an all-time record except for 2021. Not learning anything from their mistakes, 2023 has shown greater average daily net inflows into U.S. stock funds than either 2021 or 2022. The following article highlights this astonishing phenomenon of supreme overconfidence at the worst possible time:



Many baby boomers know they didn't save nearly enough to enjoy a comfortable retirement. Now that these folks are mostly in their 60s and 70s, they have been hoping that the stock market's gains will magically compensate for their savings shortage.


Millions of baby boomers didn't save anywhere close to the amount they knew they would need to retire comfortably. They have adopted the Boglehead philosophy that they have a divine right to come out ahead, and have therefore ignored compelling alternatives. More importantly, far too many investors of all ages haven't been reducing risk by moving into guaranteed U.S. Treasury bills and similar insured time deposits. Most people have no idea why it matters that large-cap U.S. stocks are still mostly trading at more than double fair value based upon their future profitability.


Now that U.S. Treasuries have been paying close to 5% with zero risk and zero state and local income taxes, a small minority of investors have been intelligently accumulating these since last summer. Tragically, far more investors are actually more confident about the U.S. stock market after experiencing a losing year like 2022, because they figure that was the one bad year of the decade and they'll get even bigger gains from now on. The media have been encouraging this sort of behavior, reporting that something like 90% of all down years for U.S. stocks are followed by up years. The problem is that 100% of all the first years of bubble collapses are followed by down years, and since we had experienced all-time record overvaluations, net inflows, and insider selling in 2021, the current scenario cannot be anything other than a bubble collapse.


The longest bull markets are followed by the lengthiest bear markets in a simple case of Newton's Third Law applied to investing.


The longest bear market in U.S. history was from September 1929 through July 1932, or 34 months. This was preceded by a bull market from August 1921 through September 1929 which was over 8 years. The second-longest bear market in U.S. history of 31 months occurred from March 2000 through October 2002 when QQQ had plummeted 83.6%. This had been preceded by a bull market from October 1990 through March 2000 which lasted for more than nine years.


The most recent bull market extended from March 6, 2009, when the S&P 500 had slid to 666.79, followed by the final peak on January 4, 2022 when the S&P 500 topped out at 4818.62. This was nearly 13 years altogether. Therefore, the current bear market is going to be a lengthy and severe one, perhaps lasting into 2025, and with the S&P 500 Index likely losing more than 70% of its peak valuation.


History always repeats itself with minor variations.


In any true bear market the S&P 500 moves below its previous bull-market top. Prior to early 2022 the most recent bull-market top for the S&P 500 had been 1576.09 on October 11, 2007. Therefore this index will have to drop below such a level sooner or later, although there is no way in advance to know when or by how much.


You have to adjust intelligently to everything in life, not just investing.


Imagine that you are a frequent sailboat racer. You adopt the following approach in every single race: within seconds of the official start, you hoist the spinnaker to go full speed ahead in a straight line toward your target. You don't care how the winds are blowing, or what the other boats are doing, or anything about the capabilities and personalities of their crews. It's always a direct all-or-nothing rush toward the finish. You have concluded that tacking (playing defense in unfavorable or shifting wind conditions), observing what other sailors are doing, or anything other than a straight-ahead approach is an irrelevant distraction.


No serious sailor would do this except on rare occasions. Unless the wind is firmly at your back and everything should be full speed ahead, you have to keep adjusting your strategy depending upon the conditions, what the competitors are planning, what you know they're likely to do based upon their past history, and dozens of other considerations. You don't wear the same clothing on a sweltering day in July as you do during a blizzard in January. Therefore, why would you want to invest with blinders on and zero consideration for the prevailing conditions?


While the stock market's long-term upward direction is a meaningful force, mean regression from a rare extreme is a far more powerful force. Whenever any asset is dangerously overpriced it will inevitably collapse before it resumes its next rally.


A married couple I have known for many years love to tell me how they remain nearly fully invested in U.S. large-cap passive equity funds at all times, no matter what the market is doing, as though I'll reward them with bones for being such faithful dogs.


Whenever I meet a certain lovely couple whom I've known for many years, the first thing they tell me is how they're staying the course no matter what and refusing to alter their asset allocation. These are folks who know they're on the Titanic and they've hit an iceberg, and the ship is probably sinking, but they're going to refuse the lifeboats and keep singing bravely on into the unknown. They're already starting to take on water, but their foolish consistency and pride will always trump their common sense.


It's better to be confused than to be wrongly overconfident.


Those who are baffled when the market has been more volatile or disappointing than usual might sell some of their stocks and reduce their risk because they don't understand what's happening. Those who are supremely confident that they have to come out ahead in the long run will keep buying, and buying, and buying, and will eventually lose a lot more than their counterparts. Being unsure is far superior to a false certainty.


Top U.S. corporate insiders have been persistently selling into rallies for more than two years. Since February 2021, insiders set a new all-time record for insider selling relative to insider buying.


Just as average investors have never been more aggressively buying large-cap U.S. equity index funds, top corporate insiders have never demonstrated a higher ratio of selling to buying in U.S. dollar terms than they have done for more than two years. These are the same executives who made all-time record purchases near major market bottoms including 2002-2003 and 2008-2009, and who no doubt will eventually become even more aggressive in accumulating shares of their companies.


However, insiders haven't been making purchases in any notable way since their massive buying spree of March 2020, even near the lowest points of 2021-2023. Therefore, the U.S. stock market has a very long way to go to the downside. Once insiders become heavy buyers it will be time to buy also, but it would be absurd to want to front-run those who know the most about the financial markets.


U.S. Treasury bills provide nearly 5% risk-free interest which is free of state and local income taxes.


A month ago, most U.S. Treasury bills were yielding over 5%. Now that we had the U.S. bank crisis, some investors have taken their money out of banks to put into U.S. Treasuries which has pushed their yields below 5% across the board. These are still well worth buying and I participate in all auctions of 8, 17, 26, and 52 weeks as well as those of 2 and 3 years.


Here's a little secret with U.S. Treasuries: hardly anyone knows about the 17-week U.S. Treasury which was only introduced in October 2022 when the U.S. government needed to increase its net borrowing. Some brokers including TD Ameritrade don't even offer this maturity to its customers, while older computer systems haven't added it to its inventory. You will therefore often get a higher yield on the 17-week U.S. Treasury than on other maturities including 13-week and 26-week; the March 22, 2023 17-week U.S. Treasury auction yielded an investment rate of 4.964%.


TLT sounds like a boring fund of U.S. Treasuries, but I expect it to gain more than 50% including all monthly dividends over the next two years.


Longer-term U.S. Treasury bonds and their funds including TLT suffered substantial losses in 2022, followed by a moderate recovery since then. TLT became so undervalued that, even if you don't count its rebound from its 11-year bottom in October 2022 until today, it will likely gain another 50% or more (including all monthly dividends) over the next two years. Usually investors don't think of U.S. Treasuries as being so volatile, but they were by far the biggest winners of all sectors in 2008.


Precious metals will likely correct for several weeks or more, but will thereafter become among the top performers of the 2020s.


Gold bullion recently briefly surpassed two thousand U.S. dollars per troy ounce. Historically moves above each exact multiple of one thousand have generated lots of excitement among the wrong investors, meaning those with the least experience who are most susceptible to chasing after trends which have already nearly fully matured. Therefore, I expect pullbacks for most assets related to precious metals until we reach some kind of important higher lows this spring or summer.


Over a longer-term basis, bubbles for large-cap U.S. equity growth shares are consistently followed by gains of hundreds of percent for gold mining and silver mining shares during subsequent years. There is a key parallel with the previous bubble peak for the S&P 500: in both cases, gold mining shares began to rally eight months after the top in the S&P 500. The March 2000 zenith was followed by a rally for gold/silver mining shares which started in November 2000; the January 2022 peak for the S&P 500 Index was similarly followed by September 2022 start for the long-term uptrends for GDXJ, GDX, ASA, and similar securities which had all lost more than half their value from their August 2020 peaks (a critical time to sell them) while retreating to 2-1/2-year lows.


VIX has continued to provide the most reliable signal telling us when to sell short during the current U.S. equity bear market.


Some market signals have an inconsistent record or send false messages, but fortunately VIX is spot on. Since 2021 VIX has told us precisely when to sell short QQQ and related large-cap passive U.S. equity growth funds. Whenever VIX is near 20 and especially whenever it is below 19, you get the green light for selling short large-cap passive U.S. equity funds including QQQ and XLK. The reason this works repeatedly is that a depressed level for VIX in a bear market tells us loudly and clearly that there exists a dangerous environment of complacency and a widespread misguided belief that, usually due to a recent extended stock-market rebound, the bear market is probably over. During the 2000-2003 and 2007-2009 U.S. equity bear markets we heard similar repeated pronouncements about the bear market being over, with some analysts making such a statement a dozen times or more within a few years and being wrong each time.


As has always been the case in past bear markets, whenever the downtrends for QQQ, the S&P 500, and similar funds and indices really are over, you won't be hearing about it in the media. Instead, almost everyone will be asking how much lower the market still has to go to the downside.


In recent months I had added to short positions in XLV, XLE, and XLI. More recently I have been adding to my short positions in QQQ and SMH whenever VIX is near 20 or lower.


Investors tend to be mesmerized by the "recency bias": whenever a given asset has been enjoying an extended uptrend most people take for granted that additional gains will follow, whereas protracted downturns cause people to conclude that additional losses will soon occur. This is where tracking VIX, insider activity, fund flows, and traders' commitments has a huge advantage. You will get reliable forecasts while most investors are overly reliant upon the recent past continuing into the indefinite future.


If you're not sure about whether or not we're in a U.S. equity bear market, check to see if women's clothing length has been extended to the feet--amazingly this signal has been accurate for over a century:



Here are some useful charts which illustrate the above points.


The following chart shows that for more than a century an unusually low spread between corporate bond yields and U.S. Treasury yields signals a major decline for the U.S. stock market, while an especially high spread precedes the biggest rallies in percentage terms:



We have also experienced unprecedented buying of call options in 2023 even when compared with previous all-time record speculative call buying in 2021 and parts of 2022:



The traders' commitments for all U.S. Treasuries, including the 30-year and 5-year maturities shown below, have demonstrated commercial accumulation (equivalent to insider buying for futures by those who are trading any given security as part of their career) which is near their highest percentiles ever recorded:




The bottom line: we have two crushing down years still ahead for U.S. assets including especially large-cap growth stocks, high-yield corporate bonds, real estate, art, and other collectibles.


Why did the Fed wait at least a year too long before raising the overnight lending rates? It was primarily due to the foolish conclusion that, since we hadn't experienced above-average inflation for decades, it couldn't reoccur. Don't make the mistake of thinking that, since we haven't suffered a severe U.S. equity bear market since March 2009, it is somehow less likely to happen. Exactly the opposite is true as this extended period without a real decline has psychologically caused most people to believe that it won't occur again at least in their lifetimes, thereby causing valuations for U.S. stocks and real estate to be near or above double fair value and higher than that for many large-cap U.S. growth shares.


Don't live in a house without a roof. Protecting against adversity is far more important than stretching for dangerous additional gains.


Disclosure of current holdings:


Here is my current asset allocation as of the close on Wednesday, March 22, 2023:


TIAA(Traditional)/VMFXX/FZDXX/FZFXX/SPRXX/Savings/Checking long: 33.63%;


XLK short (all shorts currently unhedged): 20.36%;


QQQ short: 7.70%;


XLE short: 4.29%;


XLI short: 2.28%;


XLV short: 1.51%;


SMH short: 0.67%;


GDXJ long: 10.74%;


ASA long: 6.64%;


GDX long: 2.95%;


BGEIX long: 1.45%;


2-Year/3-Year/52-Week/26-Week/13-Week/5,10-Year TIPS long: 12.56%;


TLT long: 9.33%;


I Bonds long: 9.31%;


Gold/silver/platinum coins: 5.86%;


HBI long: 0.27%;


EWZ long: 0.07%;


EWZS long: 0.04%;


PAK long: 0.01%;


EGPT long: 0.01%.


The numbers add up to more than 100% because short positions only require 30% collateral in stocks/funds and less than that in U.S. Treasuries (by SEC regulations; some brokers require more) to hold them with no margin required.

Tuesday, January 17, 2023

"In a world in which most investors appear interested in figuring out how to make money every second and chase the idea du jour, there's also something validating about the message that it's okay to do nothing and wait for opportunities to present themselves or to pay off. That's lonely and contrary a lot of the time, but reminding yourself that that's what it takes is quite helpful." --Seth A. Klarman

Caldron Bubble

CALDRON BUBBLE (January 17, 2023): We are in the second year of the collapse of the "everything bubble." Unless you are in your 90s or over 100 years old and you were trading during the Great Depression, or you're in kindergarten and you could be trading into the 22nd century, this will end up being the biggest bubble collapse of your lifetime.


U.S. stocks, high-yield corporate bonds, real estate, art, used autos, baseball cards, and of course cryptocurrencies are all declining almost the same way that they did following a similar bubble in Japan which had peaked at the end of 1989. As for the U.S. stock market, there are many parallels in 2022-2025 with 2000-2003 which we will discuss in more detail later in this essay.


The most important characteristics of bubbles is that regardless of how or why they form, they all collapse nearly identically. This was first chronicled in detail by Charles Mackay in his 1841 classic publication, "Extraordinary Popular Delusions and the Madness of Crowds."


2023 will likely have a very different shape from 2022 although it will also primarily be a bear-market year.


Bear markets for all assets usually feature the most sharp rebounds within the context of dramatic long-term declines.


The lion's share of the market's losses in 2022 occurring in the most overvalued shares. High-P/E large-cap technology shares in 2022, just as in 1973 and 2000, were among the biggest percentage losers. From its March 10, 2000 intraday top to its October 10, 2002 intraday bottom, QQQ, a fund of the top 100 Nasdaq companies, lost 83.6% of its value which is more than 5 dollars out of 6. It is likely that a similar percentage decline is in progress following QQQ's all-time zenith in November 2021, with the losses for QQQ ending up twice or thrice as much as many other U.S. equity index funds.


We could get a much higher VIX and a much deeper pullback for U.S. equities in 2023 as compared with 2022.


I expect the S&P 500 Index to probably drop below three thousand at some point during 2023. If this occurs around mid-year rather than near the end of the calendar year, and if it is accompanied by the highest level for VIX since March 2000, massive investor outflows, and heavy insider buying, then this could provide our first opportunity to actually close out short positions and go heavily net long many deeply-undervalued securities. This would not be because the bear market will be over, as 2024 will almost surely feature the greatest percentage losses of the entire bear market. However, it could be possible to make numerous diversified purchases of washed-out securities around the middle of 2023 which could be huge winners within several months at which time most of them should be sold.


Even in the most severe bear markets, you can often make more money by going long prior to the bounces following deeply-oversold bottoms than from going short into the declines themselves.


Remember your favorite kindergarten story: Goldilocks and the Three Bears.


If March 2020 through January 2022 was Goldilocks, then 2022-2025 will feature the inevitable starring roles for the Three Bears. Baby Bear is an apt description of 2022, with numerous equity pullbacks each followed by a sharp rebound. Mama Bear should be an apt description of 2023 with a much more severe parental punishment, followed by a motherly strong rebound. This still leaves Papa Bear's powerfully destructive grip for 2024, of which we will talk more in future updates.


Investors on the equivalent of the Titanic prefer to upgrade their cabins rather than to head for the lifeboats.


In early 2001 investors had been migrating away from slumping large-cap tech shares and moving into energy, industrials, healthcare, and whatever else had been outperforming in 2000. Similar behavior has been occurring recently, with funds including XLI (industrials), XLV (healthcare), and XLF (financials) only modestly below their all-time tops. Last week XLI had the biggest net inflow of all exchange-traded funds. Just as in 2001, investors in early 2023 are unwilling to accept that we could be in a bear market and that they should therefore purchase something safe like 26-week U.S. Treasuries yielding between 4.8% and 4.9%. Instead, they think they are immune to losing money if they are in the "right" sectors.


As in all bear markets, most analysts are emphasizing "looking for quality" instead of diversifying into safer assets. The problem is that they're looking for quality in all the wrong places.


Bogleheads will be Bogleheads.


Near the end of 1999 I was working for a company in Manhattan which offered 401(k) options to its employees. Two of these choices were entirely invested in Nasdaq shares, one with large-caps and one which was more diversified but still highly speculative. The custodian of these assets sent a representative to "educate" (i.e., brainwash) employees on their options, failing to mention that these Nasdaq funds featured fees which were triple those of more conservative bond funds in the plan. They also did typical Boglehead tricks like showing charts of how these funds had performed--but going back to 1982 rather than some other year. I was upset enough to write a written complaint to the head of human resources and copy the CEO, and also to point out that they were subjecting themselves to potential legal action in a future year. They dismissed my complaints as being absurd.


In response, I organized a meeting of my co-workers in which I arranged to give a lecture about how the financial markets work. I was already teaching a class in the financial markets to new employees, so people were familiar with my experience. I gave one of my most eloquent explanations of how the Nasdaq and its funds were very dangerously overpriced. Many people commented that they had no plans to change their allocations since "the market always goes up in the long run" and this kind of commonly-heard nonsense, but over the next few years quite a few people came up to me privately and told me that they paid attention to my advice and reduced their risk.


The most reliable bear-market signals are ringing loudly of further losses.


VIX, an important signal of investor fear, hasn't even approached 40 so far in the current bear market. VIX slid to an intraday low of 18.01 on January 13, 2023, a one-year bottom. VVIX, also known as the VIX of VIX, has recently been rebounding from a multi-year nadir. We haven't had anywhere near the typical heavy net outflows that have characterized every bear-market bottom in history, nor the intense levels of buying by top corporate executives which had featured so prominently at major bottoms including March 2009 and March 2020 and were far more prevalent at minor bottoms such as December 2018. The failure by average investors to be worried about additional losses, and the indifference by insiders in accumulating shares near recent lows, are both clear signs that additional substantial losses still lie ahead.


In 2021 we had greater net exchange-traded fund inflows than during the entire twenty-year period from 2001 through 2020 combined. In 2022, even with notable declines for equity valuations, we had the second-highest total after 2021.



Fundamental valuations for most assets remain enormously above long-term historic averages.


QQQ and the S&P 500 have dropped from all-time record overvaluations a year ago but are still both trading at more than double their average ratios relative to the profits of their components. Real estate has fallen modestly from its all-time highs in recent months, but is about 75% overpriced on average in U.S. cities and more than that in many parts of the world. Assets in true bear markets don't just retreat somewhat and then resume their uptrends. They usually bottom well below fair value as we had seen for stocks in late 2002 and early 2003 as well as late 2008 and early 2009. For real estate we had many deeply undervalued neighborhoods at various points from 2010 through 2012.


After experiencing an extended correction since its September 28, 2022 two-decade high, the U.S. dollar index could be ready for its next multi-month uptrend.


Some undervalued assets including U.S. Treasuries have probably begun multi-year bull markets.


U.S. Treasuries, including their funds like TLT, fell to multi-decade lows in the autumn of 2022 and have begun forming several higher lows. Each week I have been buying 26-week U.S. Treasury bills along with other short-term Treasury securities as they have been enjoying their highest yields in 15-1/2 years. One consistent winner in bear markets going back to the late 1700s has been U.S. Treasuries of nearly all maturities.


Gold mining and silver mining shares likely resumed their bull markets in September 2022, right on schedule.


In March 2000 the S&P 500 completed its top and initiated a huge bear market which didn't end until October 2002. Gold mining and silver mining shares, as measured by $HUI and other reliable indices and funds, bottomed in mid-November 2000 which was eight months later. Fast forward to 2022. The S&P 500 completed its top on January 4, 2022 while GDXJ and related funds slid to multi-year lows (although remaining well above their March 2020 bottoms) in September 2022, once again eight months following the S&P 500 top. Looking back at 2000, gold/silver mining shares were among the top-performing sectors over the next three years and over the next decade. This is likely to be the case over the next several years also.


Gold mining and silver mining shares will dramatically outperform in the upcoming decade with periodic pullbacks of 15% to 25%. Only buy them after such pullbacks.


I have been maintaining my long positions in gold mining and silver mining funds including GDXJ, ASA, GDX, and BGEIX in that order. These consistently outperform following the collapse of U.S. growth bubbles, although they will periodically suffer moderate pullbacks of 15% to 25% just as they had done during November 2000 through December 2003.


I have been steadily adding to my short positions and reducing my long positions in preparation for the next downward trend for U.S. equities.


While I have been maintaining my short positions in XLK and QQQ, in recent months I have been adding to short positions in XLI, XLV, and SMH whenever VIX is below 20 and in XLE whenever insiders are heavily selling energy shares.


We had an all-time record level of insider selling of the largest global energy companies in recent months, so I began selling short XLE near 93 and 94 and have been continuing to add to this short position into its recent lower highs near 90 and 91. XLE has been one of the biggest outperformers since its March 2020 bottom and is therefore likely to be one of the biggest losers until insiders are once again heavy buyers. During several periods in 2020, including the spring and early autumn, we had the heaviest-ever insider buying of energy shares. Energy insiders seem to be especially astute in buying low and selling high.


Here are some useful charts which illustrate the above points.


The following chart highlights that the 2022 U.S. housing bubble surpassed the previous dangerous bubble peak of 2005-2006:



The Nasdaq in recent years has very closely tracked the Nikkei in the late 1980s as all true bubbles collapse identically:



The S&P 500 Index is its most overvalued in its entire history relative to risk-free U.S. government bonds:



Measured using price-to-sales, the S&P 500 has been far more overpriced recently than at any time in recent decades including 1999-2000:



Commercials, the equivalent of insiders for futures trading, have approached multi-year highs in accumulating the 30-year U.S. Treasury bond:



Lengthy bull markets from August 1921 through September 1929 and October 1990 through March 2000 were both followed by bear markets which lasted over 2-1/2 years apiece, therefore likely setting the stage for a repeat:



The bottom line: expect two more bear-market years through late 2024 or perhaps 2025.


Numerous analysts have declared that "the bear market is over" and use as "evidence" the hilarious proclamation that down years are followed by up years a large percentage of the time. This is like concluding that you don't need to take an umbrella when you go outside, since it will usually not be raining--except when it is. Checking the weather forecast or actually going outdoors to see for yourself is much more reliable than going by irrelevant long-term statistics, and there can be no doubt that stormy weather in the financial markets will be with us for roughly another two years. If you're very conservative then put all of your money in U.S. Treasury bills up to 52 weeks while emphasizing the weekly 26-week auctions. If you're willing to assume greater risk than gradually sell short the most-overvalued large-cap U.S. equity funds including XLI, XLE, XLV, and SMH.


Disclosure of current holdings:


Here is my current asset allocation as of the close on Tuesday, January 17, 2023:


TIAA(Traditional)/VMFXX/FZDXX/SPRXX/Savings/Checking long: 34.54%;


XLK short (all shorts currently unhedged): 17.52%;


QQQ short: 6.23%;


XLE short: 4.61%;


XLI short: 2.24%;


XLV short: 1.53%;


SMH short: 0.06%;


GDXJ long: 10.84%;


ASA long: 6.77%;


GDX long: 2.88%;


BGEIX long: 1.48%;


2-Year/3-Year/52-Week/26-Week/13-Week/5-Year TIPS long: 10.04%;


I Bonds long: 9.19%;


TLT long: 8.65%;


Gold/silver/platinum coins: 5.55%;


HBI long: 0.30%;


WBD long: 0.25%;


EWZ long: 0.08%;


EWZS long: 0.04%;


The numbers add up to more than 100% because short positions only require 30% collateral (by SEC regulations; some brokers require more) to hold them with no margin required.