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? 

    Friday, June 17, 2016

    “The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.” --Seth Klarman

    NEARLY ALL ASSETS ARE EITHER ABSURDLY OVERVALUED OR WORTHWHILE BARGAINS (June 17, 2016): It has been considerably less trendy to discuss the concept of fair value in recent years. Investors have been obsessed about the political situation and how that will impact the financial markets, or what is the latest trendy sector, or what will happen with Brexit, and many considerations which have nothing to do with whether something is overvalued or undervalued. If you analyze thousands of assets, both liquid and otherwise, you will soon discover that these fit into one of two categories. Either they are at or near their highest levels in history, both in absolute and relative terms, or else they had slumped to multi-decade bottoms during the first several weeks of 2016 and have since been moderately rebounding while remaining far below their tops from the past decade. Not surprisingly, most investors remain eager to buy the most overpriced assets, while remaining indifferent to accumulating true bargains.

    Most people today are following the dangerous path of stretching for yield.

    Many investors think to themselves or say to their financial advisors something like this: "I need income in order to meet my living expenses. I used to get 3% or 4% from my savings accounts, but now they pay less than one percent. So I want to invest in whichever are the safest and most reliable assets which will give me an income of three or four percent each year." If only a few people thought this way, then there wouldn't be a problem. However, since perhaps a billion people suffer from this exact situation and are approaching it in the same way, it has created an extremely dangerous form of herding in which assets like utilities (XLU), consumer staples (FXG, XLP), and real estate investment trusts or REITs (IYR, RWR) have become so popular that they are trading on average for about twice their usual historic ratios of prices to profits, prices to dividends, and other classic measures of valuation. Some investors have purchased commercial or residential real estate where rental yields are similarly 3% or 4%, believing they are getting a worthwhile rate of return on their capital because it is considerably more than they would receive in a money market fund. U.S. Treasuries (TLT, IEF, IEI) are also exaggeratedly overvalued as those who don't trust corporations believe the government will always pay on time. The chance of default is essentially zero, but you can still lose a huge percentage of your money from Treasury yields moving higher especially when such an outcome seems impossible to most participants. I will go way out on a limb and forecast that the yield on the 10-year U.S. Treasury bond will exceed 3% in 2017, which almost surely seems absurd to most people because we have become irrationally accustomed to a much lower yield range in recent years.

    Regardless of how well-intentioned or intelligent its participants may be, any heavily overcrowded trade will always lose badly in the end.

    Whenever any trade becomes incredibly crowded, there will inevitably be a subsequent severe shakeout. It's not different this time, and within a few years it is likely that those who are investing in the above assets will be severely disappointed. I expect all of the above, including listed securities and actual houses, to mostly end up losing half or more of their current valuations by the time their respective bear markets terminate in 2018 or 2019, and perhaps a year or two later for physical real estate. About a dozen people have contacted me to say they didn't personally buy these assets in order to be like everyone else, but for completely different reasons. The problem is that if you are swimming with great white sharks then it doesn't matter if you're only in the ocean to get your daily exercise; you have to deal with your fellow swimming companions. If you have been purchasing high-dividend shares for years for any reason, and all of a sudden everyone else is doing likewise, then you have to do something different until your method becomes unpopular again. The result will end up the same as it did for those who were crowding into internet shares in 1999-2000 and mortgage-backed securities in 2007. I could have also listed railroad shares in 1872 or canal companies' shares in 1836; the world may change through the centuries but the financial markets are always the same. If you own what everyone else also owns, regardless of your reasons or their reasons, you will all end up losing money together.

    Commodity producers have been the biggest winners for five months, with emerging markets second.

    If you were to ask most investors which assets have been the biggest percentage gainers of 2016, very few would know that commodity producers led by gold and silver mining shares have gained the most especially when compared with their intraday bottoms of January 20, 2016, while many emerging-market funds have also outperformed the broad U.S. equity market. The sole exception among the top several dozen is a lone fund of zero-coupon Treasuries. Out of all non-leveraged non-ETN funds which invest in stocks or bonds, according to xtf.com, the biggest year-to-date winners of 2016 in order are SILJ, GLDX, SLVP, GDXJ, SIL, RING, SGDJ, SGDM, GDX, and PSAU, which all invest in gold and/or silver mining shares. Next are XME (metals mining), EPU (Peru), CNDA (Canada), RSXJ (Russia), SLX (steel), KOL (coal mining), NANR (natural resources), EWZ, EWZS, BRAQ, BRAZ, BRF (the last 5 all Brazil), DBS, SIVR, SLV (the last 3 all physical silver), COPX (copper mining), LIT (lithium mining), TPYP (energy pipelines), REMX (rare earth mining), and at long last ZROZ which is a fund of zero-coupon long-dated U.S. Treasuries.

    While many are aware of the persistent strength of high-dividend assets in recent years, very few people are aware of how well commodity producers have been doing during the past five months. These had mostly suffered dramatic bear markets from April 2011 through January 20, 2016, and thus became extremely out of favor with nearly all investors including institutions, advisors, and analysts. Their powerful rebounds haven't encouraged very many people to jump aboard the bandwagon, at least so far. It is rare to see someone dressed in a fancy suit on cable TV extolling the virtues of energy producers or mining companies, and just as uncommon to see someone telling you why you should invest in South America, Africa, Australia, or just about anywhere outside of the best-known developed equity markets. Just five years ago, you couldn't avoid hearing analysts tell you why you should have your money in the BRICs, and which mining companies were superior to others, and which energy subsector was likely to be the biggest winner in the upcoming year.

    Investors love owning whatever has been climbing for years, and shun whatever has been in an extended bear market.

    The reason for the unpopularity is entirely emotional. Following the 2007-2009 bear market for U.S. equity indices in which the S&P 500 plummeted 57.7% and the Russell 2000 slumped 60.0%, no one in early 2009 wanted to hear about the latest index fund or which high-yielding securities were the best bargains. Since the bear markets for nearly all commodity-related and emerging-market assets had lasted for nearly five years, investors have emotionally concluded that they are hopeless and aren't interested regardless of the fundamentals. On the other hand, since high-dividend shares have been rallying for more than seven years while real estate in most parts of the world has surged since 2011, these assets psychologically appear to be superior and investors feel highly confident of additional increases. Paradoxically, when risk is lowest and upside potential is highest, most people are indifferent or are afraid to participate, while the situations of lowest additional upside and greatest risk of price collapse are usually greeted with sunny optimism and complacency about potential losses.

    Almost nothing is trading close to its fair value.

    At their intraday lows on January 20, 2016, many shares of commodity producers and emerging-market securities had traded at their lowest points since the previous century, in some cases going all the way back to the 1970s. They are almost all less glaringly underpriced today, but they remain at just one third to one half their average prices of recent decades. Thus, considerable additional upside remains in their rallies. Many people will finally discover these strong uptrends at the beginning of 2017 when they look at lists of the top-performing securities of 2016 and are surprised to see which names appear. While global equity and corporate bond markets are unlikely to collapse during the next twelve months or so, there will likely be significant declines for the most overcrowded sectors including especially the high-yielding ones mentioned near the beginning of this essay. Ironically, as investors at first gradually and later in a panic rush to get out of high-dividend assets, they will end up piling irrationally into commodity producers and emerging markets which have the potential of creating their own overvaluations perhaps in 2017. This could end up creating a situation roughly a year from now in which it will be necessary to sell commodity-related and emerging-market assets because far too many people will have jumped aboard these bandwagons. That would be especially true if investor excitement is accompanied by notable insider selling by top executives of these companies as there had previously been in years including 2008 and 2011. However, that is something to worry about next year. This year, gradually accumulate whichever undervalued assets are currently the least desired.

    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. From my largest to my smallest position, I currently own GDXJ, SIL, KOL, GDX, XME, COPX, EWZ, HDGE, RSX, GLDX, REMX, VGPMX, URA, ELD, GXG, IDX, ECH, BGEIX, NGE (some new), FCG, VNM, SEA (some new), RSXJ, EPU, RGLD, SLW, SAND, GREK, NORW (new), PGAL, TUR, SILJ, SOIL, 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.

    Friday, May 20, 2016

    "We don't have to be smarter than the rest. We have to be more disciplined than the rest." --Warren Buffett


    WHEN BUYING ASSETS, SELECT OLD BEARS AND YOUNG BULLS (May 20, 2016): There are many criteria which investors use in making buying and selling decisions. Unfortunately, the vast majority of these decisions are emotional rather than rational. People buy assets which appear to be superior, without realizing that this perceived excellence is actually due almost entirely to outperformance in recent years. Similarly, investors will tend to sell assets which they believe are inferior, without understanding that if something has been in a severe extended downtrend then it will almost always appear to be hopeless when it could be ready for a powerful rally. In other words, most investors subconsciously project the action during the past several years into the next several years, thereby nearly always ending up buying assets which will soon begin bear markets and selling assets which are about to enjoy spectacular percentage gains.

    A tale of two outperformers: commodity producers and emerging markets versus high-dividend favorites.

    The top sectors of 2016 have fallen into two completely different categories. The best performers have been gold and silver mining shares (GDXJ, GDX, GLDX, SIL, SILJ), with other commodity producers in mining (COPX, REMX) and energy (OIH, KOL) along with emerging-market assets in numerous countries (EWZ, GXG, RSX, NGE). Not far behind are high-dividend sectors, especially utilities (XLU), real estate investment trusts (IYR), and consumer staples (FXG, XLP). This is somewhat surprising, since both groups of securities behave very differently. Commodity producers and emerging markets normally love rising global inflationary expectations and worldwide GDP growth, while high-dividend shares tend to perform best when deflation reigns and there are fears of an economic contraction. Which of these two is likely to persist in its powerful uptrend?

    With most commodity producers and emerging-market assets having approached two- and three-decade bottoms on January 20, 2016 and/or February 11, 2016, their bull markets have been in existence for only four months on average. In most cases, their bear markets had begun following major tops in April 2011, and had suffered total declines averaging 70%-90%. A young bull market following a historic washout often leaves huge remaining upside, since even if these shares merely return to their highs of 2014 or 2013 then they could double or triple from their current levels; some of them have already more than doubled since their respective January 20, 2016 nadirs. Almost anyone who wanted to sell shares of commodity producers or emerging markets had plenty of opportunities to do so, as is evidenced by all-time record outflows from many funds in these sectors during the second half of 2015 and the first few weeks of 2016.

    In sharp contrast, most high-dividend shares had bottomed either during the fourth quarter of 2008 or during the first quarter of 2009, and thereafter enjoyed bull markets which lasted for more than seven years. A seven-year bull market is like a 100-year-old person running the marathon: you are quite impressed, but you know he or she won't be running many more marathons. It is possible and perhaps even likely that most high-dividend shares have already begun bear markets, although this won't be known for sure until after significantly greater losses have occurred. One major drawback to owning shares which pay 3% or 4% yields is that far too many investors have become disenchanted with bank deposits paying 1% interest or less, and have therefore crowded into high-yielding assets in a desperate attempt to achieve a modest income. There have been all-time record inflows into many high-dividend sectors in recent months. When too many people are pursuing the same concepts, regardless of their reasons for doing so, such assets become dangerously overpriced. On average, high-yielding assets have price-earnings ratios which exceed the overall price-earnings ratios for the S&P 500 Index and the Russell 2000. Utilities, real estate investment trusts, and consumer staples overall have never been more overvalued in their entire history, even when compared with major past bull-market peaks.

    Begin with fair value, and tilt toward buying into the longest bear markets while selling into the longest bull markets.

    Before making any trading decision, it is important to calculate fair value for any asset which you plan to trade. If you believe that something is far below fair value, then ask yourself why this is the case. If something has been declining for several years, then many investors will tend to sell it regardless of fundamentals. They may be disappointed about its persistent underperformance, or they can't bear to miss out on chasing after something which has been climbing or which is mentioned frequently in the media, or they may hate to wake up and look at the securities in their portfolios which seem to keep going down, or they may actually believe that they can make money by following various momentum strategies. Generally, the best assets to purchase are those which are either in bear markets which have persisted for a very long time and have lost a dramatic percentage of their previous peak valuation, or else had recently fit into this category and have been choppily rebounding in recent weeks or months. There are pros and cons to buying into the most oversold points on the way down versus buying into higher lows as they are created on the way back up, which I will discuss in more detail in a future update.

    A key principle is to assiduously avoid buying anything which has been in a powerful extended uptrend for several years. Such assets will attract the attention of many investors who become enamored by its apparent invincibility, or who love to chase after recent outperformance, or who emotionally like to think they own winners even if they missed out on most of the gain to be enjoyed because they bought far too late, or because something which has been climbing for several years has usually received persistently optimistic media coverage which tells people why they should own such assets. Even if something is far above fair value, you will almost never read anything negative which will warn you against purchasing something which is clearly overpriced. You only see negative stories about something which has already suffered sharp declines, as analysts "explain" why those losses have occurred and tell you why they will get worse. It is easy to become brainwashed by these messages simply by hearing them repeated frequently.

    Prefer youthful bull markets following extended bear markets. Disfavor ancient bull markets.

    Even though you may wish to own anything which has been outperforming in 2016, stick with those assets which had suffered multi-year bear markets and have just been recovering for four months, rather than assets which are wildly overpriced and have been mostly in uptrends for more than seven years. The former group will continue to rally strongly because they remain intrinsically undervalued and are still unpopular, with most brokerages and analysts continuing to shun them and even to downgrade them in recent weeks. Some of these funds like GDX have continued to experience net outflows regardless of their spectacular gains since January 20, 2016. High-dividend shares have become so popular with amateurs, institutions including hedge funds, and just about everyone that they make excellent short positions. This is especially true for U.S. assets in these sectors which had enjoyed the massive global surge into U.S. stocks, bonds, real estate, the U.S. dollar, and just about everything else with a United States pedigree in recent years. Commodity producers located in emerging-market countries had been the world's most depressed and undervalued securities four months ago, and in spite of having doubled or tripled in some cases would have to double, triple, or quadruple again to finally surpass their April 2011 highs.

    Choose assets for which there is no reason to own them.

    The financial markets have always been a paradox. If there is a valid reason to own any asset, especially if that reason can be easily explained to others, then almost everyone else will have heard and believed the story and will have already purchased it. This will cause such assets to become dangerously overvalued. On the other hand, if there is no easy explanation for why you should own something, then very few people will be eager to participate, and the asset will tend to be substantially undervalued and thus an excellent bargain. Low bank interest rates give investors a perfect excuse for possessing high-dividend shares, and therefore you must avoid the temptation to own them along with everyone else. No one can easily comprehend why they should own shares of commodity producers or emerging-market securities, and therefore you should capitalize upon their unpopularity. Once you hear on a daily basis about why you should own these as an inflationary hedge, or because so-and-so genius has been buying them, or just because they're going up, then it will be getting close to the next selling opportunity.

    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 dangerously overvalued. As the extremely popular U.S. dollar stuns investors by suffering a bear market instead of continued gains as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. From my largest to my smallest position, I currently own GDXJ, KOL, SIL, XME, GDX, COPX, HDGE, REMX, EWZ, RSX, GLDX, VGPMX, URA, GXG, FCG, IDX, ECH, BGEIX, NGE, VNM, RSXJ, EPU, TUR, SILJ, SEA (new), SOIL, EPHE, and THD. Yes, HDGE is back on the list as of my previous update (see below) after having sold all of it just before it had peaked near 13. I have continued to increase my modest short positions in FXG and IYR, and I am also modestly short 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 as they have done 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 conservative investors deluded into believing that these are nearly as safe as government-guaranteed time deposits; these make excellent short positions and include consumer staples (FXG, XLP), real estate investment trusts (IYR), and utilities (XLU).

    Wednesday, April 20, 2016

    "Sometimes the bulls win; sometimes the bears win; but the hogs never win." --Anonymous

    IT IS TIME TO BE BEARISH TOWARD MOST U.S. ASSETS (April 20, 2016): It is fascinating how nearly all investors, analysts, advisors, and the media had been negative toward risk assets in January and early February 2016 and talked about "reducing risk," and now the same people have been talking about "getting back into the market" and what you should buy now. People will repeatedly buy high and sell low, because it is emotionally so difficult to do the opposite of the thundering herd. Therefore, having sold all of my HDGE shortly before it peaked near 13, which had represented roughly 8% of my total net worth, I began repurchasing it again during the past week into all pullbacks and plan to continue to buy it as long as it remains below 11 dollars per share. I also entered my first-ever short positions in FXG and IYR and plan to sell short XLU soon.

    The reasons for my being bearish are not primarily about price or timing, although it is true that many U.S. sectors have never been more overvalued in their entire history including years like 2007, 2000, 1972, and 1929. Among those sectors experiencing record overpricing are consumer staples (XLP, FXG), utilities (XLU), and real estate investment trusts or REITs (IYR). Consumer staples are extremely popular for two reasons: 1) they had enjoyed among the biggest percentage gains for all sectors outside of biotechnology during the past five years, in spite of mediocre profits for these companies; and 2) they have become the darlings of people who took their money out of bank accounts paying 1% or less in order to capture their modest dividends which have never been lower in percentage terms. Everyone loves a winner, so people have ignored the mediocre profit growth in consumer staples and concentrated instead on the stock price appreciation. Buying any sector with especially oversized gains and lackluster earnings is never a recipe for success, since this signifies a dangerous overvaluation. I have sold short FXG rather than the more popular XLP because it has a much higher expense ratio. IYR is also an excellent short position due to real estate having become even more overvalued in many parts of the world than it had been during the 2006 bubble. Utilities have also become the darlings of those chasing yield, making this sector more overvalued than at any time in its long history. There have been times when almost everyone was bearish toward utilities and I felt as though I was the only one in the world who was buying. Today, it is just about the exact opposite.

    There are many reasons why U.S. assets, other than commodity producers which mostly remain compelling bargains, became so overvalued in recent years. Persistent underperformance and price/earnings ratio collapses for emerging-market equities, combined with a generally climbing U.S. dollar, made U.S. stocks seem like the safest game in town. Recently, the greenback has been in a downtrend since the U.S. dollar index had peaked on December 2, 2015 at 100.51, thereby exposing the irrational overvaluation of U.S. equities, corporate bonds, and other assets relative to those in most other parts of the world. While the S&P 500 Index has more than tripled from its March 6, 2009 nadir of 666.79, many emerging-market equity bourses on January 20, 2016 were trading even lower than at their most depressed points of late 2008 and early 2009, and even compared with previous bear-market bottoms in 2002, 1998, 1994, and 1990. Whenever you can buy a basket of assets which are trading near 20- and 30-year bottoms, it is almost always a good idea to do so regardless of the alleged reasons for such undervaluation. Similarly, whenever you can sell something like a house in San Francisco or a basket of biotechnology shares which are trading at incredibly overpriced levels, you should accept the market's gift and take advantage of others' temporary folly.

    HDGE is the only exchange-traded fund which sells short directly instead of using various artificial preservatives for doing so. Therefore, it has a somewhat higher expense ratio. This should not be an obstacle to purchasing it, and if you hold it for more than a year you will achieve favorable U.S. federal long-term capital gains tax treatment. Selling short directly is a reasonable alternative, which is why I mentioned my favorite overvalued funds in earlier paragraphs. If you have money in general U.S. equity and corporate bond funds, then now is an excellent time to sell them to take advantage of valuations which are close to their all-time highs and are likely to drop by 60% or more.

    Many people don't believe that U.S. equities can decline by 60%, even though we have already experienced two severe bear markets since 2000. From March 10, 2000 through October 10, 2002, the Nasdaq plummeted 78.4%. In the 2007-2009 bear market, the S&P 500 lost 57.7% while the Russell 2000 declined by a total of 60.0%. I expect somewhat greater losses this time primarily because we had become more overvalued, so we have to drop by a greater percentage to roughly match the March 2009 lows. The Nasdaq is an especially glaring case of overpricing. As you can verify by going to http://finance.yahoo.com and entering ^IXIC, if the Nasdaq were to merely return to its October 31, 2007 top of 2861.51 then it would represent a plunge of 45.3% from its July 20, 2015 zenith of 5231.94. And this would be if it were to merely return to its previous bull market peak, not if it were to follow a much more likely route of approaching a previous major bottom. Biotechnology shares, which have been the biggest percentage winners of the past five years in spite of inconsistent earnings growth in this sector, have already been in downtrends along with many other equity sectors which had previous been leaders. When the former winners are pointing the way lower, that is an especially dangerous time to participate.

    We have also experienced many of the classic signs of a market top. The ratios of insider selling to insider buying have approached their unusually high levels from the middle of 2015 and are usually only seen just before a major bear market. Investor inflows into most U.S. stock and bond funds surpassed all-time records for thousands of such funds during the past two months. The media, which for part of January and early February had featured more bearish than bullish articles about risk assets, have recently stopped even asking about whether you should be a buyer and have instead focused on what you should buy now for the biggest gains. VIX dropped below 13 for the first time since October 2015, indicating that investors have lost nearly all their fear of lower valuations.

    I plan to remain long outperforming commodity producers and emerging-market assets. These will periodically suffer sharp short-term pullbacks, but have all begun powerful bull markets after having suffered extended, severe bear markets from April 2011 through January 20, 2016 when many of them registered multi-decade lows. Whenever other risk assets are attempting to rebound, mining and energy shares will continue to be among the biggest percentage gainers for approximately one more year until they become incredibly popular with investors, analysts, advisors, and the media. This is still a long way off: GDX, the most popularly traded fund in these sectors by average daily volume, has continued to experience outflows nearly every single day during the past several weeks in spite of being among the top-performing funds of 2016. As long as a bull market is greeted with intensified outflows instead of inflows, it will continue and will accelerate until disbelievers are finally converted into new buyers.

    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 dangerously overvalued. As the extremely popular U.S. dollar stuns investors by suffering a bear market instead of continued gains as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. From my largest to my smallest position, I currently own GDXJ, KOL, SIL, XME, COPX, GDX, HDGE, EWZ, RSX, REMX, GLDX, VGPMX, URA, GXG, FCG, IDX, ECH, BGEIX, NGE, VNM, RSXJ, EPU, TUR, SILJ, SOIL, EPHE, and THD. Yes, HDGE is back on the list; I just added very small short positions in FXG and IYR, and I am currently buying HDGE this week after having sold all of it just before it had peaked above 13. 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 as they have done 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 was withdrawn from safe bank accounts by conservative investors deluded into believing that these were nearly as safe as government-guaranteed time deposits. Excellent short positions include FXG, IYR, and XLU.

    Special note: if you enjoy theater and you would like to attend an evening of my original "true contrarian" playwriting, you are invited to join us at the end of the month:

  • Original Parodies of Corporate Life
  • Monday, April 4, 2016

    "No price is too low for a bear or too high for a bull." --Anonymous

    MOST INVESTORS MISUNDERSTAND BEAR MARKETS (April 4, 2016): If there is one defining characteristic of bear markets for U.S. equities, it is the failure of nearly all participants to recognize when they exist, to acknowledge that they require asset reallocation, and to make appropriate changes to their portfolios. If we look back at all of the past bear markets in U.S. history, then even when they had been underway for a year or more, the vast majority of investors continued to act as though nothing had changed. They continued to buy and sell as though we were still in the previous bull market. Finally, when the bear market was in its final stages, it was usually accompanied by a collapse which at long last awakened people with the realization that we weren't in a bull market anymore. By then, however, it had become far too late to sell at anything close to favorable prices. Once a collapse becomes particularly extended or severe, or both, investors will end up doing the exact opposite of intelligent reallocation by emotionally selling during a bottoming process instead of increasing their risk to accumulate compelling bargains.

    The bear market of 2007-2009 serves as a useful illustration of some of the above points. That bear market began, as so many do, with initial weakness for high-yielding securities including utilities and REITs. Soon afterward, high-yielding junk bonds completed their peaks and began underperforming. After June 1, 2007, small-cap U.S. equity indices notably underperformed their large-cap counterparts. By August 2008, nearly all U.S. equities and corporate bonds had been in downtrends marked by numerous lower highs, but most investors continued to behave as though we were still in a bull market. Whenever U.S. equity indices and their funds like QQQ would rebound from any intermediate-term low along the way, there would be significant inflows into equity funds because investors had learned during 2002-2007 to buy into rallies which followed all corrections. Of course they had finally learned the wrong lessons, and acted as they should have done five years earlier when legitimate bargains were easy to find but almost no one wanted to participate. Then we had September-November 2008, which finally achieved clarity when it was far too late to be able to sell at worthwhile high prices. Especially when the S&P 500 was down by more than half, investors ended up making their greatest outflows in history from most sectors, with these withdrawals even exceeding those which had occurred during the Great Depression. During the first quarter of 2009, when investors should have been buying left, right, and center, people mostly sold instead of making purchases at the lowest inflation-adjusted valuations since the early 1980s.

    In case you think that investors learned from their experience of 2007-2009, their behavior demonstrates that they are making the same mistakes again. From early March 2009 through early March 2014, small-cap U.S. equities outperformed large-cap counterparts by a ratio of roughly 3 to 2. During this five-year period, investors continued to mostly make net outflows instead of buying, partly because they were frightened by above-average volatility. From early March 2014 through May-June 2015, most U.S. equity indices continued to make higher highs, but the Russell 2000 (IWM) gained progressively less than the S&P 500 (SPY) in percentage terms. There have been all-time record inflows into most equity funds in recent years, with huge net deposits occurring during the past several weeks. Since the second quarter of 2015, nearly all U.S. equity indices have been in little-recognized and unappreciated bear markets. The financial media a month ago loudly trumpeted the alleged "seventh anniversary" of the bull market even though the uptrends for U.S. equity indices had nearly all ended the previous year.

    On December 15, 2006, VIX completed a historic bottom at 9.39 and thereafter formed several higher lows even as U.S. equity indices including the S&P 500 continued to climb for most of the following year. This was a valuable warning signal that we were getting set to transition from a major bull market to a severe bear market. When the bear market was in its final months, VIX topped out at 89.53 on October 24, 2008, and continued to make several lower highs even as the S&P 500 itself continued to grind to lower 12-1/2 year lows through its 666.79 nadir on March 6, 2009. This process has repeated in the current cycle, with VIX bottoming at a 7-1/2-year low of 10.28 on July 3, 2014. As in 2006-2009, VIX foreshadowed the end of the bull market by a little less than a year. On Friday, April 1, 2016, VIX slid to 13.00 as it is completing yet another higher low. Eventually, VIX will achieve some kind of elevated zenith and will begin to form a pattern of lower highs, thereby signaling that the current bear market--which by then will likely have intensified sharply--will be several months away from beginning its next strong bull market.

    However, instead of recognizing these cyclical patterns and acting upon them, most investors end up repeatedly and foolishly projecting the recent past into the indefinite future. This is partly because our brains are hardwired to do this as it served as a useful way for groups of humans to survive in prehistoric times. Thus, many investors today are eagerly crowding into utilities (XLU), real estate investment trusts or REITs (IYR), and consumer staples (XLP), even though all of these have never been more overvalued in history. Therefore, we are going to suffer especially large percentage declines for these sectors relative to the overall U.S. stock market which itself is perched precariously roughly 50% above fair value. In many global cities, real estate is at double or triple fair value. Paradoxically, most people will want to sell their stocks and corporate bonds two years from now when they should be aggressively buying, and will want to do no selling of real estate or stocks today when they could obtain highly favorable prices for both.

    The following link highlights how investors were making significant outflows near the beginning of the year when stocks and corporate bonds were much lower than they are now, and have recently been eagerly pouring back into U.S. assets at overvalued prices:

  • Investors Pull $24 Billion from Equity Funds in January


  • Now is an excellent time to be a true contrarian. When everyone you know is eagerly "getting back into the market," progressively sell your U.S. stocks, bonds, and real estate. Put some money into cash or a government-guaranteed bank account, and slowly accumulate shares of the most undervalued assets in emerging markets along with the shares of commodity producers, especially as these are forming additional higher lows following their respective multi-decade bottoms which were mostly completed on or around January 20, 2016. Perhaps in a year or so it will make sense to gradually unload these holdings so you are almost entirely in cash, with the important exception of buying TLT and other long-dated U.S. Treasury securities if they should slump to multi-year lows. Almost no one expects TLT to drop to 120, much less a far lower target like 100, so if there is panic and gloom in the U.S. Treasury market then prepare to be a big buyer in another year when everyone else is telling you why you should be selling.

    Do not rely too heavily on the assumption which others will be making, which is that if we are in a true bear market then it will likely be a repeat of 2007-2009. That bear market lasted for only 17 months, so instinctively people will assume that the recent past will repeat itself. Most bear markets are longer, and it will take time to flush out millions of those investors who would usually have their money in bank accounts but who have foolishly concluded that it is almost as safe to have their money in various stock and bond sectors. Assuming that most U.S. equity indices had topped out in May or June 2015, the ultimate bear-market bottoms might occur during 2018. Each time we slide to a lower low and rebound sharply, many will proclaim that we had reached "the bottom" and will be eagerly buying. Within a few months or less, we will slump to another lower low. Eventually, almost everyone will be exhausted from making additional purchases and soon finding themselves deeper in the red, and will refuse to buy when a strong recovery is underway. This, combined with extreme gloom and doom in the media and by nearly all analysts and advisors recommending that their clients "take steps to reduce risk" will signal that the next powerful bull market is truly underway. If such a bull market begins around 2018 then it could persist until 2021-2023.

    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 dangerously overvalued. As the extremely popular U.S. dollar stuns investors by suffering a bear market instead of continued gains as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. From my largest to my smallest position, I currently own GDXJ, KOL, SIL, XME, COPX, GDX, EWZ, RSX, REMX, GLDX, URA, FCG, IDX, GXG, VGPMX, ECH, VNM, BGEIX, NGE, RSXJ, EPU, TUR, SILJ, SOIL, EPHE, and THD. I may end up buying HDGE which I had sold in its entirety during the third week of January 2016. 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 late 2017 or in 2018. 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, recently trading at their lowest levels in 2-1/2 years. Small-cap U.S. equities typically lead the entire U.S. equity market lower as they have done 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 was withdrawn from safe bank accounts by conservative investors deluded into believing that these were nearly as safe as government-guaranteed time deposits.

    Special note: if you enjoy theater and you would like to attend an evening of my original "true contrarian" playwriting, you are invited to join us at the end of the month:

  • Original Parodies of Corporate Life
  • Tuesday, February 23, 2016

    "Our party has been accused of fooling the public by calling tax increases ‘revenue enhancement’. Not so. No one was fooled." --Dan Quayle

    NUMEROUS NEW TRENDS HAVE QUIETLY BEGUN (February 23, 2016): One of the most underappreciated features of 2016 has been the number of trend reversals which are already underway but which have been ignored by most investors or dismissed as being temporary deviations which will soon return to their previous behavior. Because so few accept these new bull and bear markets as being significant, only the few who recognize their importance have been investing in the anticipation that these newer trends are likely to continue, with their usual backing and filling, until they eventually accelerate and force nearly all investors to acknowledge their existence. It is worthwhile to point out which of these trends have reversed direction after years of moving the other way, and what is likely to happen during the next year or so.


    Some of these trends have already been underway for a year or more. Small-cap U.S. equity indices and their funds, including IWM which tracks the Russell 2000, had been outperforming the S&P 500 and similar large-cap indices for five years. From early March 2009 through early March 2014, IWM tended to gain about 3 dollars for each 2-dollar increase in the S&P 500, thereby enabling it to approximately quadruple while the S&P 500 was tripling. However, since the first week of March 2014, IWM and other small-cap baskets have been notably underperforming the S&P 500, with most of them slumping to 2-1/2-year bottoms during January 2016. Whenever they are temporarily oversold and there is too much gloom and doom in the media, these indices will rebound for several weeks or so, but their primary trend remains firmly downward and will likely surprise everyone with the total percentage losses which they suffer by the time they complete their next bottoming patterns perhaps in 2018. IWM topped out in June 2015, and it has become increasingly likely that the S&P 500 reached its highest point of 2134.72 on May 20, 2015.


    Some assets began bear markets even earlier than the above well-known U.S. indices and funds. Most high-yielding shares including utilities (XLU), REITs (IYR), and U.S. Treasuries (TLT) were extremely popular in 2014 and completed important topping patterns in January 2015. Utilities and Treasuries have been outperforming the broader market in recent months, as they often do during a flight to defensive sectors, but all of the above sectors are likely to soon resume their downtrends even if general equities are able to enjoy a more sustained recovery during the next several weeks. These sectors tend to signal changes in inflationary expectations, so especially if they resume their downtrends and retreat to lower lows, it will signal that the widespread belief in deflation will eventually give way to the realization that inflation has been quietly rising worldwide.


    While most investors continue to believe that the shares of commodity producers and emerging markets are continuing their bear markets which mostly began in April 2011, it is likely that most or all of these have reversed during the past several weeks. Some of the assets in these sectors have already rebounded dramatically, including gold and silver mining shares which have mostly gained more than 40% from their respective bottoms from the third week of January. It is common for gold and silver mining shares to lead energy and emerging-market assets both higher and lower, and it appears that although they remain very choppy in the short run, the shares of energy and emerging-market securities mostly bottomed in the second half of January or the first half of February 2016. Media coverage had been persistently negative toward the above assets, with most analysts and brokerages continuing to project aggressive downside targets as recently as a month ago. As the prices of commodity-related assets have been progressively rising, most of those in the media and financial industries have been very slow to adjust their previous forecasts and portfolios to reflect what could end up being a dramatic change of fortune. As is usually the case, the best-informed insiders and their wealthy friends have been among the first to make appropriate asset reallocations, while most investors won't do so until these trends have already become too powerful to ignore and more than half of the potential percentage profit from these opportunities will have already passed.


    After moving mostly sideways for roughly nine months, the U.S. dollar index has been forming a notable pattern of lower highs since it had finally surpassed its March 2015 peak to register a key top on December 2, 2015 at its highest point since April 2003. This pattern of lower highs is likely to continue for roughly another year and perhaps a few months longer than that. Throughout 2015 there had been an increasing number of speculative bets on a higher U.S. dollar along with more intensely bullish market commentary and analysts raising their upside targets for the greenback. As a rule, increasing excitement and optimism combined with flat prices is a dangerous combination. It will take time before investors recognize that this long-term pattern since 2011 has also reversed; when they are finally forced to acknowledge that life in 2016 is not the same as it had been in recent years, the downtrend for the U.S. dollar could accelerate. Even if it continues in leisurely fashion, it will exert a meaningful influence on all other assets.


    There hasn't been much discussion about real estate in recent months, although Tuesday morning's report on U.S. existing homes showed the 47th-consecutive month of year-over-year gains for U.S. housing prices. In most of the rest of the world, real estate has been climbing for a similarly extended period of time. As we have seen with many other trends described above, anything which lasts for four or five years tends to eventually be accepted as some kind of "permanent" situation whenever it is most likely to soon reverse. I expect that just as almost everyone is expecting housing prices to continue to climb indefinitely, we will experience massive losses in most parts of the world during the next four or five years. Instead of housing prices to household incomes demonstrating their normal historic ratios of 3:1 which have existed for centuries or millennia, and which had been lower than 1.5 to 1 in many regions in 2011, there are neighborhoods in cities including San Francisco, Vancouver, and Tel Aviv where ratios are greater than 10:1. Many other cities are more than double their normal levels, which creates a bubble which is just as dangerous as the one in 2005-2006 and which has been fueled mostly by borrowed money which tends to suddenly become scarce during an economic downturn.


    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 dangerously overvalued. As the extremely popular U.S. dollar stuns investors by suffering a bear market instead of continued gains as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. From my largest to my smallest position, I currently own GDXJ, KOL, SIL, XME, COPX, GDX, EWZ, RSX, REMX, GLDX, URA, FCG, IDX, GXG, VGPMX, ECH, VNM, BGEIX, NGE, RSXJ, EPU, TUR, SILJ, SOIL, EPHE, and THD. 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 late 2017 or in 2018. 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, recently trading at their lowest levels in 2-1/2 years. Small-cap U.S. equities typically lead the entire U.S. equity market lower as they have done 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. Confirmation of an impending end to the wildly popular deflation trade has been the notable decline for high-yielding shares since they had mostly achieved all-time peaks in January 2015, including utilities (XLU), REITs (IYR), and U.S. Treasuries (TLT).

    Tuesday, January 26, 2016

    "In the short run, the market is a voting machine, but in the long run it is a weighing machine." --Benjamin Graham

    ALL ASSETS WILL CONTINUE TO SWING TO IRRATIONAL EXTREMES (January 26, 2016): As Benjamin Graham notably stated in the above quote, in the short run the market is driven by investors who will be especially eager to purchase trendy assets near tops and to sell unpopular assets near bottoms. In the long run, the most undervalued assets will climb the most while the most overpriced ones will suffer the greatest percentage losses. This is evidenced by the all-time record outflows from U.S. equity index funds during the first quarter of 2009, and all-time record inflows into most of these funds during 2014-2015. Naturally, this means that most investors were selling the S&P 500 around 800 or below, while buying it near 2000 or above. This is true of virtually all sectors: you can see huge outflows from U.S. Treasury funds in late 2010 and early 2011 the last time they were completing a multi-year bottoming pattern, and all-time record inflows into the same funds in late 2014 and early 2015 when they were peaking. It will always be this way, because investors will always want to own whichever assets have already enjoyed the most extended uptrends and are thus maximally vulnerable to a significant drop to reach fair value, while they will flee those assets which have suffered the most severe and long-lasting bear markets and are thus the most likely to rebound strongly.

    If we look at the state of the global financial markets, we can see that there have already been tentative and not-so-tentative moves toward fair value for those securities which had been among the most popular investor favorites of 2015. Apparently "unstoppable" names including the "fang" four, Facebook (FB), Amazon (AMZN), Netflix (NFLX), and Google/Alphabet (GOOG) have been among the biggest losers. Even these have rebounded in recent days, indicating that investors aren't willing yet to give up on their darlings even if they are barely profitable and have irrationally high price-earnings ratios. Some of the most undervalued emerging markets around the world, including Russia (RSX) where price-earnings ratios had dropped to an average between four and five, were also affected by the selloff as many investors dumped everything which is easy to do on the internet, only questioning their rash decisions later. In the short run, panic usually leads to a partial recovery, but the U.S. equity markets aren't going to go back to new all-time highs. Small-cap shares had outperformed from March 2009 through March 2014 and have since notably underperformed their large-cap counterparts, which historically has almost always been followed by a severe bear market. 2016 isn't likely to be either the horrible year which some are anticipating for U.S. equity indices, nor is it likely to be flat like 2015. It will be a moderate down year, with the bear market accelerating as usual in its final months which will likely occur in 2017 or 2018 when we could go below the deep nadirs of March 2009.

    Among the least popular assets today are shares of companies which produce commodities or are located in emerging markets. Some shares fit into both categories and are unusually undervalued. Even the highest-quality names in these sectors have mostly been devastated, because investors have concluded that they only move in one direction which is lower. It is the opposite of a bubble, which interestingly has no word in the English language to express it precisely. The increasingly optimistic expectation of continued gains for the U.S. dollar, which had been especially strong until the middle of March 2015 and has mostly moved sideways since then, is probably misplaced partly because it is such a popular bet with a recent all-time record total of speculative bets on a higher greenback, along with unusually strong commercial accumulation of nearly all other global currencies. Commercials, or insiders who trade currencies for a living as part of their job, have been especially eager to buy the Canadian dollar, with aggressive accumulation of other currencies including the Australian dollar and the Mexican peso. It's not that they necessarily know something that others don't, but that they aren't nearly as easily swayed by media coverage of an "unstoppable" U.S. dollar and are much more concerned with the fundamental facts on the ground.

    One asset which has barely been discussed as being overvalued is real estate in many parts of the world. As recently as 2011, there were many neighborhoods in U.S. states including Florida, Arizona, and Nevada where the ratio of housing prices to household incomes was less than 1.5 to 1. Today, there are cities including San Francisco, Vancouver, Tel Aviv, and others where some neighborhoods have ratios which exceed 10 to 1. As with all other assets, real estate prices which appear extreme can become even more extreme, but eventually fair value will reign and prices will have to revert toward their normal levels of 3:1 which have prevailed at least since the time of Julius Caesar. The percentage declines implied by these losses will shock those who are residents of these and many other global cities. As with everything else in the financial world, until it has happened almost no one can imagine it occurring, and after it happens everyone will say how obvious it had been that prices would have to collapse. This is part of a human tendency to repeatedly project the recent past into the indefinite future, even when making such an assumption is inherently illogical.

    For the past two decades, perhaps because of the existence of the internet, the financial markets have swung to much more frequent extremes than they had done for the previous several decades. The internet allows people to get and to act upon information rapidly, which is both a blessing and a curse. For most people, it is unfortunate that they can find out everything so fast, because this causes their emotions to get ahead of their brains. If you hear a stream of bad news, you will be more likely to take an action which you wouldn't likely have done if you had more time to think it over. I know people who have literally sold everything in their brokerage accounts within minutes because they were able to do so and because they were responding to news reports or listening to financial TV radio or television. If it is March 6, 2009 and you hear an incredibly negative U.S. employment report, you are likely to place sell orders even before the market has opened, as many did on that day when the S&P 500 completed its historic bottom at 666.79. Throughout almost all of 2014 and 2015, you heard almost entirely optimistic forecasts of future U.S. stock market performance which encouraged many to buy near their most inflated levels and which dissuaded many from selling U.S. assets at clearly overpriced levels. The same will happen with real estate: people aren't going to consider seriously selling until after prices have already slumped and houses are trading well below their asking prices, instead of above their asking prices as is currently the case in the most popular areas.

    Prices which have strayed far from fair value, and then regress to fair value, rarely stop there. Whatever had been absurdly overvalued usually ends up becoming ridiculously undervalued and vice versa. This makes it emotionally difficult to sell, because you will be tempted to reduce your holdings when they reach a level you know is too high, and then if you don't sell you will see prices climb more and more and eventually you won't be able to sell at any price because you have received so much positive psychological feedback for doing nothing. Similarly, if you are considering buying something which is blatantly undervalued, but you do nothing and it gets even cheaper, then you won't be able to buy no matter how low it goes because you will have told yourself a dozen or more times how brilliant you were by waiting longer. This is a major reason why even the most experienced investors can rarely bring themselves to buy low or to sell high, because they were rewarded for not acting earlier.

    As usual, it makes sense to gradually buy a little of whatever is the most below fair value, while gradually selling whatever has surged far above fair value. In the short run you will almost always feel foolish as extreme trends tend to become even more extreme, but eventually everything will regress toward the mean and usually beyond the mean by an amount which is roughly proportional to the extent which it had been illogically pushed in the opposite direction. It is like a pendulum, which will move most violently away from a point which is the farthest away from equilibrium.

    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 dangerously overvalued. As the extremely popular U.S. dollar stuns investors by suffering a bear market instead of continued gains as almost everyone is expecting, this will lead to a major upward revision in global inflationary expectations. From my largest to my smallest position, I currently own GDXJ, KOL, SIL, XME, COPX, GDX, HDGE, EWZ, RSX, REMX, GLDX, URA, FCG, IDX, GXG, VGPMX, ECH, VNM, BGEIX, NGE, RSXJ, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. 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 late 2017 or early 2018. 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, recently trading at their lowest levels in 2-1/2-years. Small-cap U.S. equities typically lead the entire U.S. equity market lower as they have done 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. Confirmation of an impending end to the wildly popular deflation trade has been the notable decline for high-yielding shares since they had mostly achieved all-time peaks in January 2015, including utilities (XLU), REITs (IYR), and U.S. Treasuries (TLT).