Sunday, June 30, 2024

"It's very hard to go against the crowd. Even if you've done it most of your life, it still jolts you." --David Dreman

Winter Follows Autumn

WINTER FOLLOWS AUTUMN (June 30, 2024): Many investors have embraced the mythical "soft landing" scenario. Every multi-year bull market in U.S. history, with steady growth and low inflation, eventually becomes overheated with above-average inflation, just as every moderate spring season is followed eventually by a hot humid summer. This overheating is followed by a choppy, dramatic slowdown during which inflation unevenly declines while GDP growth decelerates and eventually goes negative. It is similar to summer being followed by autumn. Then, just as autumn must lead into winter, negative GDP growth--also known as a recession--is accompanied by an equity bear market. As often as this scenario has repeated itself in the United States since the 1700s, many people today are convinced that we're going to magically transition from colorful falling leaves directly into blossoming flowers and warming temperatures.

The weather doesn't work that way and neither does the economy or the stock market. The Russell 2000 and many other consistently reliable leading indicators have been in bear markets since 2021, with numerous lower highs along the way. After the leaves have reached peak color in November, the next month isn't going to be April or May. Instead we get December, and usually an even colder January, and then a volatile February. Winter is approaching. You can dream of spring eventually returning, but to expect it to happen immediately after autumn is fantasy.

Top corporate insiders have been selling at an all-time record pace, not only in the popular AI shares but in numerous absurdly overpriced U.S. large-cap stocks.

We can spend hours or days debating whether or not Nvidia is overvalued, but let's instead look at a more clear and revealing instance of the current U.S. large-cap bubble. For four decades, Costco (COST) has been growing its profits at 10% or 11% per year, with its price-earnings ratio fluctuating from high single digits to low double digits. Recently Costco has sported a price-earnings ratio of 53.8. There are many possibilities about what the future might bring, but Costco growing its profits at a 50% annualized pace will never happen even if we are invaded from other galaxies and the invaders are eager to buy all of their supplies at Costco. If you didn't flunk kindergarten then you can calculate how much Costco's stock price has to drop to return to its long-term valuation.

Each time that analysts cheer allegedly "great" earnings from any company, the stock price usually immediately surges higher. Within a day or two the top executives usually make massive sales, taking advantage of the irrationally high valuations. Either 1) these insiders are correct by doing their heaviest selling in history by a wide margin, often selling years' worth of accumulated shares; or 2) the least-knowledgeable investors are correct by making all-time record inflows into the U.S. stock market. I know which side I'm betting on.

While top corporate insiders have done their heaviest selling in history during 2024, ordinary investors have done their most aggressive buying in history. Which group is right? History shows us the clear answer.

Ordinary households recently set a new all-time record allocation to the U.S. stock market, about four times their lows from the early 1980s and significantly higher than at the 2000 internet bubble top:

Overconfident investors have also set new records by piling into leveraged long U.S. equity funds, while bailing out of leveraged short funds in their certainty that a significant percentage loss for the U.S. stock market won't happen any time soon:

Other assets including residential real estate have become dangerously overpriced, although they are generally not as wildly overvalued as large-cap U.S. stocks.

Real estate worldwide had been reasonably priced for decades until 1997. Since then, we have experienced housing bubbles worldwide to varying degrees, with the U.S. reaching a bubble peak in 2005-2006 and an even higher bubble zenith in 2022-2024. Here is a chart of U.S. real residential housing prices from January 1976 through June 2024:

While U.S. houses are about twice as high relative to household incomes as compared with their long-term averages, Canadian real estate in early 2022 had reached triple fair value. Whenever any asset is fundamentally very under- or overvalued it must experience a volatile price adjustment in order to return to fair value.

The primary argument for owning any cryptocurrency is that a famous person also owns it and endorses it (and we would be shocked, shocked to hear that such a person is being paid for doing so).

With cryptocurrencies we don't even know what fair value is, because there is no proven history. Bitcoin is the oldest cryptocurrency which was invented in 2009, when the previous severe bear market was ending. Therefore, we have no clue as to how these will perform in another true bear market. It is like buying a rare tropical plant, putting it in your back yard in a place where it goes below freezing numerous times each winter, and assuming that it will thrive. It might be in wonderful shape by August or September, but it may not be in prime condition several months later. Why anyone would want to own such an unproven asset is beyond my limited ability of comprehension.

High-yield corporate bonds have mostly been approaching their lowest-ever spreads relative to U.S. Treasuries.

There are times when U.S. high-yield corporate bonds are at incredibly undervalued levels, such as they had been in years including 1932-1933 and 2008-2009, and there are periods like 2024 when their spreads to U.S. Treasuries have approached or set all-time record lows. Investors love to buy near all-time highs because they perceive elevated prices as proof of any asset's superiority, whereas they end up selling in disappointment near multi-year bottoms since all they hear about is how prices will keep on dropping.

A surprisingly diverse range of assets have quietly become absurdly undervalued, including some major emerging-market equity bourses.

While the price surges for stocks, real estate, cryptocurrencies, and high-yield corporate bonds have resulted in unsustainably overpriced levels being achieved, there are numerous assets which are trading well below fair value. Most emerging-market securities have been trading near their lowest relative valuations in years or decades, with stocks in countries including Brazil, China, Indonesia, and the Philippines being especially worthwhile bargains. Because the early stages of any severe bear market tend to be accompanied by a high degree of correlation, these bargains will probably become even better bargains during the upcoming year which makes it important to be patient before jumping in too soon.

Several less-heralded assets have been or will soon be completing multi-decade bottoms.

Other assets have become cheap enough to be worth purchasing immediately without waiting for lower prices. During the past several months we have had repeated downward spikes for assets as diverse as long-dated U.S. Treasuries (TLT), palladium (PALL), and the Japanese yen (FXY). U.S. Treasuries and their funds including TLT probably completed two-decade bottoms in October 2003 and added key higher lows in April 2024, while PALL may have bottomed in February 2024 at 78.50 and recently slid almost all the way back to higher lows just above 80. The most recent in this group to make new lows has been the Japanese yen, which during the past week touched its lowest level versus the U.S. dollar since 1986.

Funds of precious metals shares including GDX and GDXJ will eventually become compelling buying opportunities, but history and the traders' commitments tell us clearly that we must wait several months or longer before taking action.

QQQ dropped 83.6% from its peak on March 10, 2000 to its bottom on October 10, 2002. Meanwhile, HUI, an index of gold mining shares, completed a key bottom on November 15-16, 2000 and before the end of 2003 was worth more than seven times as much. Therefore, wait several months after QQQ has begun a major bear market and then get ready to aggressively purchase gold mining and silver mining shares. Be patient and don't act too soon.

One way we can be certain that it is too early to buy GDX or GDXJ is that the traders' commitments are especially bearish for gold, silver, and platinum. Commercials (see such as miners, fabricators, and jewelers who own physical gold are long 86,551 and short 358,039 contracts which is more than 4:1 short to long. Non-commercials (primarily hedge funds) are long 284,885 and short 38,656 which is more than 7:1 long to short. Regardless of how much gold China's central bank does or doesn't buy, these are unsustainable speculative longs which will be dramatically flushed out over the next several months. Gold bullion will drop below two thousand U.S. dollars per troy ounce and could eventually fall below 1800 before powerfully rebounding afterward.

The bottom line: it's not different this time. Don't fall victim to the soft-landing myth. As well-known stocks including Apple (AAPL) and Costco (COST) have been have been trading for roughly five times their long-term average price-earnings ratios, the only realistic possibility will be massive percentage losses for large-cap U.S. stocks during the next few years. Following bubble peaks, stocks don't just retreat from overvalued levels to fair value and stop dropping; they usually end up with undervaluations of 35% to 60% as we had previously experienced frequently including 2008-2009 and 2002-2003. U.S. Treasury yields have been close to their highest levels in more than two decades and will serve as an irresistible magnet once U.S. stocks have fallen enough to make some investors nervous about continuing to be so heavily overinvested in the most popular big U.S. companies.

Disclosure of current holdings:

Below is my current asset allocation as of 4:00 p.m. on Friday, June 28, 2024. 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/BPRXX/Savings/Checking long: 37.24%;

17-Week/52-Week/26-Week/13-Week/2-Year/8-Week/3-Year/5,10-Year TIPS/4-Week/42-Day long/20-Year: 22.91%;

I Bonds long: 11.01%;

TLT long: 10.75%;

PMM long: 0.01%;

XLK short (all shorts are once again unhedged): 34.84%;

QQQ short: 23.78%;

SMH short: 1.61%;

AAPL short: 0.12%;

SARK long: 1.00%;

PSQ long: 0.04%;

PALL long: 1.10%;

Gold/silver/platinum coins: 7.12%;

FXY long: 0.58%.

Tuesday, April 2, 2024

"The inability to hold cash and the pressure to be fully invested at all times meant that when the plug was pulled out of the tub, all boats dropped as the water rushed down the drain." --Seth A. Klarman

Nine Align; Benign? Nein!

NINE ALIGN; BENIGN? NEIN! (April 2, 2024): We have recently experienced several simultaneous extremes which investors are ignoring due largely to two key factors: 1) investors will almost always believe that whatever has occurred in recent months will continue over the next several months, regardless of the merits of such a momentum argument; and 2) the Goldilocks myth of a "soft landing" has become so widely prevalent that the vast majority of individual investors in their retirement plans and hedge funds have become dangerously overcrowded into the most popular U.S. stocks. Nearly 100% of equity valuations are at or near all-time record overpricings, while many reliable signals of upcoming market behavior have approached or surpassed all-time record extremes.

Many investors apparently weren't paying attention in kindergarten. They should have learned that Goldilocks is always followed by the three bears. Mama Bear is backstage now, already cued up and ready to make her dramatic entrance. Speaking of cue, the most overvalued assets including QQQ are likely to lose one-third or more of their recent peak valuations, which would imply QQQ dropping below 300 at least briefly during the next twelve months. In the final months of 2022, all forecasters of the U.S. economy insisted that there would be a U.S. recession. Now almost none of them expect a recession. They're going to be as wrong in 2024 as they had been in 2023.

Several reliable signals have been flashing bright red.

All of the following warnings are close to their most extreme levels ever recorded: 1) we have the lowest-ever put valuations and the lowest overall "skew" of put valuations relative to call valuations since options began trading on the CBOE at the start of 1973; 2) we have the longest-ever inverted U.S. Treasury yield curve and we had recently experienced the most-inverted Treasury curve in its entire history going all the way back to 1789; 3) the U.S. dollar amount of insider selling divided by the U.S. dollar amount of insider buying set a new all-time record during the first quarter of 2024; 4) investor inflows set several historic records including the largest-ever weekly inflow into U.S. exchange-traded equity funds during March 2024; 5) most measures of valuation which had been favored by classic value analysts including Benjamin Graham and Seth Klarman either approached or surpassed all-time records going back to 1790 when the Philadelphia Stock Exchange had its debut; 6) we have experienced the greatest-ever divergences between the most popular large-cap U.S. shares and just about everything else worldwide; 7) investor sentiment is close to multi-decade peaks; 8) perhaps most importantly, far more investors are concerned about missing out on future gains than they are about losing money in the financial markets.

No trigger has even been needed to begin either a massive collapse or a major rally. Follow the insiders whenever their trading is near a rare extreme in either direction.

Whenever someone asks me which event will trigger a massive percentage loss for QQQ and related assets, the answer is best encapsulated in the following question: what triggered the 83.6% drop for QQQ starting on March 10, 2000? What "caused" the even larger percentage losses beginning in September 1929? How about January 1973 or the 19th-century bubbles which had begun collapses in 1837 and 1873? In other words, the financial markets have never been and will never become cause-and-effect processes. Whenever valuations for any asset are either unusually high or low relative to fair value, anything can spontaneously initiate a regression toward the mean and beyond. I had to laugh when I saw the news articles on Tuesday about why U.S. stock futures were lower. All of them related to events which had occurred over the weekend or on Monday during market hours. Can't the market respond immediately? Investors tend to forget that during the subprime mortgage housing price bubble collapse of 2007, which had begun in January of that year, most equity sectors kept climbing at first. The S&P 500 didn't peak until October 11, 2007, long after the subprime news was already widely known. Other analysts pegged the collapse of Lehman Brothers as the trigger, even though that occurred in September 2008. Probably that helped to accelerate a much later phase of the downtrend but it had already been in place for a long time.

Top corporate executives are well aware of this principle. They don't waste time debating what could "trigger" any future event in the financial markets. The reason that top executives overall and especially in the most-overpriced sectors have been selling at their most intense pace in history is because they are close to being pure value investors. They know better than anyone what fair value is for the company which they are helping to run, and when current valuations have deviated the most from this level. That is why insiders consistently buy aggressively near bottoms and persistently sell near tops. They are often "wrong" in the short run but they are rarely off the mark in the long run.

The unusually lengthy interval since the last true bear market encourages investors to believe that the next bear market is emotionally far away, even as it is much more likely to happen.

Many people including myself remain puzzled why the U.S. Federal Reserve didn't immediately begin to raise the overnight lending rates shortly after the U.S. Presidential election near the end of 2020. The real reason is probably that, not having experienced significant U.S. inflation since the early 1980s, most people on the Fed really couldn't imagine inflation surging the way it ultimately did. Similarly, with the last true U.S. equity downtrend ending in early March 2009, it seems psychologically to most investors that bear markets were something which happened a long time ago and are no longer a serious possibility.

The level of surprise is therefore going to be quite high whenever we undergo the largest percentage losses in over fifteen years for most U.S. stocks. Just about everyone has concluded that huge exchange-traded equity fund inflows will continue for many more years, that VIX will keep dropping below 13 for many more years, and similar "obvious" conclusions. George Santayana stated that those who don't remember the past are condemned to repeat it. My corollary is that those who do remember the past, but believe that "it's different this time," deserve to repeat it.

We have already been in bear markets for years, but hardly anyone pays attention to them because they don't involve the most popular shares.

The stock market in China began its downtrend during the second week of February 2021. Most small- and mid-cap U.S. shares also completed their tops in 2021, and even recently the Russell 2000 (IWM), after a strong rebound since October 2023, wasn't able to approach its high of February 2021, much less its brief spike higher in November 2021 when most U.S. stocks by count touched their highest points of their bull markets which had begun from the depths of March 2020. Since most investors don't track these or other emerging-market indices, or baskets of thousands of U.S. stocks, but only pay attention to the most well-known names, they are convinced that there is a solid uptrend for the entire U.S. stock market.

The most impressive percentage increases above fair value are inherently unsustainable, and are therefore consistently followed by the most impressive percentage declines.

You could argue that the rally for AI shares and related large-cap popular names since October 2023 has been impressive, and it has in the same way that the large-cap popular rally diverged from everything else and was impressive in September 1929, January 1973, and March 2000. However, all extremes come to an end sooner or later because the basic Boglehead premise is fatally flawed. There is a long-term uptrend to any asset, just as there may be a long-term uptrend in the temperature due to global warming, but that doesn't mean you throw away your snow shovels and winter tires in July and expect the weather to keep getting hotter. Mean regression has been proven by Benjamin Graham and Seth Klarman and many other value investors throughout history to be a much stronger force than the long-term uptrend, especially whenever the current distance from the mean in either direction is unusually extreme. That is why we had such powerful multi-year rallies which began in late 2002 and early 2003, and again in late 2008 and early 2009. It is the primary reason why we must experience an approximate repeat of the internet bubble over the next few years.

I am surprised how few analysts have pointed out the obvious parallels between the internet bubble of 1999-2003 and the current AI bubble 24 years later.

Usually nothing repeats exactly in the financial markets, although bubble collapses are so similar to each other that if I were to remove the X and Y axes on charts of the railroad bubble of the 1870s and the internet bubble from the early part of this century, and ask you to tell me which was which, I would challenge you to get it correct. In this case, however, we have almost an exact parallel in several ways, including the dramatic outperformance of the most popular large-cap shares in late 1999 and early 2000 which is almost exactly analogous to late 2023 and early 2024, almost to the exact day.

March 2000 is remarkably similar to March 2024. Nonetheless, most investors use the period from October 2023 through March 2024 as their guide to the next several months, rather than looking at what had occurred after March 2000 or January 1973 or September 1929.

In some cases the parallel is to the exact day, or as exact as it can be. The internet bubble for the Nasdaq and QQQ had topped out on March 10, 2000. This would have been impossible to occur on March 10, 2024, as it was a Sunday. However, on March 8, 2024, both XLK (a fund of popular tech shares) and SMH (a fund of semiconductors) may have completed their peaks for the cycle. QQQ could have done so later on March 21, 2024. In 2020, the S&P 500 Index (SPX) continued to receive inflows mainly from individuals in their retirement plans even after tech shares had topped out, causing SPX to reach its highest point so far on March 28, 2024. In 2000, the S&P 500 similarly experienced a delayed zenith on March 24, 2000. That's about as close as you're going to get in real life. This doesn't guarantee that QQQ will drop 83.6% as it had done from its top on March 10, 2000 until its bottom 31 months later on October 10, 2002, but it has to be a realistic possibility especially since by many measures this index was more overpriced in March 2024 than it had been in March 2000.

We have ended or are near the top of the sixth U.S. stock-market bubble in its history. It will collapse the same as the previous five.

In the 1830s investors insisted that since we never had canals before, we wouldn't experience a severe U.S. equity bear market regardless of how overpriced many of the canal shares had become by 1837. The same fairy tale was popular in the 1870s regarding railroad stocks, in the 1920s about industrialization, in the early 1970s regarding the popularization of computers, in the late 1990s with the internet, and now in modern times with AI. All of these involved huge societal changes, but they had zero net impact on the financial markets because the financial markets have always followed and will always follow the same basic principles. If a company has a certain level of profit, and that profit is increasing by a certain percentage, then regardless of whether you're living in 1824 or 1924 or 2024 you can compute how much that stock should be trading for. If investors are depressed or excited about investing, thereby distorting this number in either direction, it creates an opportunity for alert investors who recognize that all such distortions are temporary and will eventually fluctuate toward nearly equal and opposite extremes. During the late 1920s Benjamin Graham repeatedly insisted upon this key point even with loud Bogleheads like Irving Fisher insisting upon the Boglehead point of view even before it had that name. The worst bear market in world history proved that mean reversion will always triumph at any extreme, no matter how "permanent" famous analysts claim that it is.

We don't just have an AI or large-cap bubble, although that exists and is especially dangerous. We have simultaneous perilous overvaluations for cryptocurrencies, gold, residential real estate, and many other assets. The percentage loss of total worldwide net worth is probably going to experience one of its biggest-ever declines in history.

During previous historic bubbles including Tulipmania nearly four centuries ago in Amsterdam, it wasn't just tulips which collapsed in price. There had been simultaneous bubbles for residential real estate, the stock market, and numerous related assets which are not generally remembered by most people but which can be reviewed in detail for free online at "Extraordinary Popular Delusions and the Madness of Crowds" by Charles Mackay. Residential real estate is overpriced for the same fundamental reason as U.S. large-cap stocks: the ratio of housing prices to average household income in many countries including the United States is close to double its long-term average level. People's incomes in real terms are not going to suddenly double, which means that housing prices will have to fall by half in real terms. Gold has probably been in a long-term uptrend since August 1999, but the traders' commitments for both gold and silver, showing commercials net short about 2.7 to 1 for each, are a warning sign that the most-experienced investors who own actual gold and silver as miners, fabricators, jewelers, and so on, are betting on the price dropping. Gold will probably fall by a minimum of 400 dollars an ounce from wherever it is topping out in this cycle, and perhaps by more than 500 dollars, while silver will likely drop below 20 U.S. dollars per ounce at least briefly later in 2024. Once silver commercials go net long, as they almost did in March 2023 and had actually done in September 2022, it will be time to buy into this sector in the anticipation of a powerful rally.

As for cryptocurrencies, no one has any idea what they are worth. At least a stock with a price-earnings ratio of 50 will become a bargain when its P/E drops below 8, but any given cryptocurrency is only worth whatever someone else believes that it's worth. Peter Pan is one of my favorite children's stories by J.M. Barrie, but you can't use Peter Pan logic to justify any investment.

The following charts highlight rare multi-decade extremes from reliable media sources, some of which became their most exaggerated in a century.

The bottom line: the most popular shares as a group, as are epitomized by funds including QQQ and XLK, have been making many upward spikes since February 12, 2024 but haven't been able to remain above those key intraday highs. Hedge funds, which by far had been their most net long any asset in history when they had dangerously overcrowded into AI shares and related large-cap U.S. favorites, will likely curtail their buying or actually do some net selling, although as usual with more than 90% of hedge funds they won't become serious sellers until these and related funds have already dropped 15% or 20% from their respective March 2024 tops. We will continue to experience frequent sharp upward bounces for U.S. stocks for about three years, with some of those rebounds for QQQ approaching or exceeding 50%, but during that time all of the major indices will join the Russell 2000 in primary downtrends which almost certainly means a loss of more than 70% from its peak for the S&P 500 Index and more than 80% for funds of the most popular shares including QQQ. During the next twelve months, when hardly anyone is anticipating a significant drop for the U.S. stock market, QQQ will likely at least briefly spike sharply below 300 before recovering. Over the longer run, QQQ is likely to fall below 100 and perhaps much lower by 2027 or sooner. This will surprise most investors, but compared with its October 2002 or November 2008 bottoms it would be a very similar "Papa" bear-market bottom adjusting for inflation and earnings.

Disclosure of current holdings:

Below is my current asset allocation as of 4:00 p.m. on Tuesday, April 2, 2024. 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: 37.13%;

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%;

I Bonds long: 10.88%;

TLT long: 10.86%;

PMM long: 0.01%;

XLK short (all shorts once again unhedged): 30.58%;

QQQ short: 20.17%;

XLE short: 5.48%;

XLI short: 3.05%;

XLV short: 1.82%;

SMH short: 1.33%;

AAPL short: 0.03%;

SARK long: 0.88%;

PSQ long: 0.04%;

PALL long: 0.17%;

GDXJ long: 0.14% (fully hedged with covered calls at a strike price of 45);

Gold/silver/platinum coins: 7.01%;

FXY long: 0.24%.

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, 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 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.