Wednesday, May 3, 2023

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

2023 All-Time Danger

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Disclosure of current holdings:

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

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

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

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

I Bonds long: 9.35%;

TLT long: 9.04%;

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

QQQ short: 8.74%;

XLE short: 4.59%;

XLI short: 2.37%;

XLV short: 1.62%;

SMH short: 0.69%;

GDXJ long: 11.45%;

ASA long: 7.33%;

GDX long: 3.25%;

BGEIX long: 1.59%;

Gold/silver/platinum coins: 6.10%;

HBI long: 0.31%;

EWZ long: 0.20%;

EWZS long: 0.08%;

PAK long: 0.02%;

EGPT long: 0.01%.

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

Wednesday, March 22, 2023

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

Trapped Bogleheads

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

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

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

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

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

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

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

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

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

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

History always repeats itself with minor variations.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Here are some useful charts which illustrate the above points.

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

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

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

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

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

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

Disclosure of current holdings:

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

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

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

QQQ short: 7.70%;

XLE short: 4.29%;

XLI short: 2.28%;

XLV short: 1.51%;

SMH short: 0.67%;

GDXJ long: 10.74%;

ASA long: 6.64%;

GDX long: 2.95%;

BGEIX long: 1.45%;

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

TLT long: 9.33%;

I Bonds long: 9.31%;

Gold/silver/platinum coins: 5.86%;

HBI long: 0.27%;

EWZ long: 0.07%;

EWZS long: 0.04%;

PAK long: 0.01%;

EGPT long: 0.01%.

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

Tuesday, January 17, 2023

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

Caldron Bubble

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Bogleheads will be Bogleheads.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Here are some useful charts which illustrate the above points.

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

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

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

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

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

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

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

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

Disclosure of current holdings:

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

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

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

QQQ short: 6.23%;

XLE short: 4.61%;

XLI short: 2.24%;

XLV short: 1.53%;

SMH short: 0.06%;

GDXJ long: 10.84%;

ASA long: 6.77%;

GDX long: 2.88%;

BGEIX long: 1.48%;

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

I Bonds long: 9.19%;

TLT long: 8.65%;

Gold/silver/platinum coins: 5.55%;

HBI long: 0.30%;

WBD long: 0.25%;

EWZ long: 0.08%;

EWZS long: 0.04%;

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

Sunday, November 27, 2022

"Successful investing is about recognizing the widest gaps between fair value and present value." --Steven Jon Kaplan

Baby Done, Mama Next

BABY DONE, MAMA NEXT (November 27, 2022): All we really need to know we learned in kindergarten, including the story of Goldilocks and the Three Bears. 2021 was Goldilocks and 2022 was Baby Bear, so 2023 will be Mama Bear and 2024 will be Papa Bear. If you can remember this then you will invest far better than most grownups.

2022 was a classic first year of a bear market with familiar themes from similar past bear markets.

Bear markets are much more similar to each other than bull markets. We experienced a large-cap growth stock bubble one year ago which was very similar to the bubbles of September 1929, January 1973, and March 2020. Just as in those three previous periods from the past century, the large-cap growth shares which caused the bubble in the first place mostly dropped in 2022 about twice as much as the average U.S. stock during the past year just as they had done in 2000. We also had three sharp bounces along the way, including the current one which began around the beginning of the fourth quarter of 2022. It is therefore logical to assume that 2023 will be similar to a year like 2001, with generally steeper losses during each downtrend along with stronger bounces in between downtrends and probably with a moderately larger total loss for 2023 compared with 2022.

Throughout 2022 the U.S. dollar, emerging-market securities, and highly-speculative assets (think cryptocurrencies) also behaved as they generally do during the first year of major bear markets.

VIX and TLT varied from the usual script throughout 2022.

Two interesting differences from analogous past bear markets included 1) the failure of VIX to reach 40 throughout 2022; and 2) the dramatic weakness for U.S. Treasuries and their funds including TLT which dropped about twice as much as they usually would during the first downward phase of a bear market. Since we had more net inflows into the U.S. stock market in 2021 than during 2001 through 2020 combined (not a misprint), presumably these tardy buyers included many less-experienced investors who are not familiar with bear markets.

I expect U.S. Treasuries and VIX to surge sharply higher during the first half of 2023, partly to compensate for their overdone 2022 weaknesses.

In a bear market you can make money selling short on the way down while purchasing U.S. Treasuries and gold/silver mining shares along with other deeply-oversold securities near each intermediate-term bottom.

Selling short the most-overpriced U.S. large-cap equity funds will likely continue to be a winning approach which you can enhance by periodically selling covered puts against these whenever VIX is beginning another retreat. This can be enhanced by adding to the most undervalued long positions whenever there is the least insider selling and the greatest outflows by the least-experienced investors. U.S. Treasuries and gold/silver mining shares in particular tend to enjoy net gains even with sharp corrections during these kinds of bear markets; look at a chart of VUSTX (long-term Treasuries) or $HUI (gold/silver mining shares) from 2000 through 2003. I have therefore been adding to both of these sectors during their most depressed periods of 2022.

Closed-end funds often provide outsized bargains during intermediate- and long-term bear market bottoming patterns.

Some investors aren't as familiar with closed-end funds as they are with open-end or exchange-traded funds. Especially during bear markets, closed-end funds are often sold by those who are disappointed or discouraged or who are otherwise emotionally unhappy about holding anything which has dropped for two years or longer. This causes many closed-end funds to sell at higher discounts to net asset value than they experience during bull markets.

In February 2009, near the end of the severe 2007-2009 bear market, I went to and ranked all closed-end funds from highest discount to lowest. By the middle of the ninth page the discount finally dropped below 20%. When I did the same test in January 2010, less than a year later but when fear of losing more money had been replaced by fear of missing out on additional gains, the discount dropped below 20% halfway down the very first page. This means that the number of closed-end funds with high discounts was 17 times as high in February 2009 as it was in January 2010.

It is especially likely that the next market bottom following a "Mama Bear" retreat, perhaps around the middle of 2023, could be accompanied by very high discounts for some worthwhile closed-end funds. Select those where the fund manager(s) have their own money in the fund, where they have been managing the fund for several years or longer, which have relatively low expense ratios, and which rely on value investing principles rather than using leverage or other financial tricks to enhance their performance.

Value investing is once again taking over from growth as these major groups take turns outperforming through the decades.

The following chart highlights the see-saw behavior of value vs. growth investing since 1975:

I expect value shares to lose much less than growth shares on the way down for a couple of years, just as value had lost much less overall in 2022, and to gain substantially more on the way up for five or six years during the next major bull market (2025 through 2030, approximately).

Differentiation is clearly underway.

In my last update I forecast that investors would begin to differentiate among sectors, so that not all shares would go up or down by similar percentages. This has been increasingly prevalent in recent months as gold mining and silver mining shares and some emerging markets have been far outgaining large-cap U.S. growth favorites from 2020-2021. Part of the critical shift from growth to value will be the increasing outperformance of small caps versus large caps, emerging markets versus U.S. securities, mining shares versus technology, and in general the big winners of 2000-2008 trouncing the big winners from 2009-2021.

It is okay to be a Boglehead with assets which may have completed their cycle bottoms including government bonds and gold/silver mining shares. It's not okay to be a Boglehead with SPY, QQQ, or any collection of previous large-cap U.S. growth favorites.

Why did U.S. large-cap growth stocks perform so well in 2021? It wasn't because their profits increased faster than the profits of other sectors. The primary reason by far is that we had the biggest-ever inflow of inexperienced investors in 2021 who in many cases had never invested in anything before. Being unfamiliar with the financial markets, they invested in names they knew from their everyday lives regardless of how overpriced they had become, and therefore created unsustainable bubbles. Just as a hangover must result from having far too much alcohol, 2022-2024 is the inevitable morning-after resolution of 2021. All of those big-name U.S. technology shares have to go back to fair value and probably well below, since bear markets usually end with an average 30% to 50% discount to fair value for these shares.

Dollar-cost averaging is not a worthwhile approach for any overpriced asset class. You might lose less on the way down but it will still represent a huge overall loss.

I am gradually adding to my short positions and reducing my long positions during the upcoming month to restore their balance from the middle of August 2022.

At the end of September and the beginning of October 2022 I sold covered puts and added significantly to all of my long positions in order to create a much heavier weighting of longs versus shorts compared with their mid-August interrelationship. Now that VIX has retreated almost all the way to 20, I plan to use the next few weeks, especially shortly after the opening bell into all upward spikes, to progressively reduce my long positions except for U.S. Treasuries and gold/silver mining shares and to add to my short positions in XLI, XLE, SMH, QQQ, and XLK. You can't make as big a percentage gain by selling short as you can by being long, but in a bear market the most consistent gains will almost always be on the short side.

XLI and XLE are new short positions, with SMH possibly joining them soon.

I began to sell short XLE when it had first reached 93 a couple of weeks ago, and I have been more recently selling short XLI at 101 and above. Both of these sectors are among those which have more than doubled from their respective March 2020 bottoms, have experienced intense selling of their components by top corporate executives, have enjoyed massive net inflows in recent weeks, and frequently climb shortly after the opening bell most days which is when the least-experienced investors do a large percentage of their total trading. SMH has experienced a sharp bounce in recent weeks so I may begin selling it short soon. If QQQ approaches 300 and especially if it surpasses that level, it is also worth adding to my already-existing position.

I'll take the over on the duration of this bear market.

Many investors believe that either the current U.S. equity bear market has ended or that it will terminate within a year or so. In my opinion that's not likely and I'll happily take the "over" on that bet. The earliest the current bear market could end, based upon the experience with all past lengthy bull markets (the bull market ending in January 2022 had begun in March 2009), would be in the summer of 2024 and that is probably too early by some unknown number of months.

I'm sure that by the time the current bear market has ended, I'll be losing plenty of money on the long side from having gotten invested far too soon and too high.

Old-fashioned savers can get their best deals from U.S. government bonds, especially U.S. Treasuries of 26 weeks, 52 weeks, 2 years, and 3 years until maturity.

Most investors are unaware that U.S. Treasuries have been sporting their highest yields since the summer of 2007. You can get over 4.7% on some securities and over 4% even on the shortest 4-week Treasuries. A good place to do this is which charges no fees and allows you to participate in the same auctions as multi-billion-dollar institutions.

The bottom line: 2023 will resemble 2022 but with larger percentage pullbacks, bigger rebounds, and outperformance by U.S. Treasuries and gold/silver mining shares.

As we transition from the first to the second year of a three-year U.S. equity bear market we are likely to have a similar transition as we had experienced in 2000 to 2001. Mama Bear will rip apart large-cap U.S. growth shares, but will be considerably gentler to safe-haven assets including U.S. Treasuries along with gold mining and silver mining shares; Baby Bear in his inexperience treated almost all assets the same (i.e., not with care). In addition to selling short, put lots of money into 26-week, 52-week, 2-year, and 3-year U.S. Treasuries which have enjoyed their highest yields since the summer of 2007.

Disclosure of current holdings:

Here is my current asset allocation as of the close on Wednesday, November 23, 2022:

TIAA(Traditional)/VMFXX/FZDXX/Savings/Checking long: 30.97%;

XLK short (all shorts currently unhedged): 18.84%;

QQQ short: 6.71%;

XLE short: 4.90%;

XLI short: 0.64% (November 25 close);

TSLA short: 0.35%;

GDXJ long: 10.40%;

ASA long: 5.93%;

GDX long: 2.74%;

BGEIX long: 1.34%;

I Bonds long: 8.95%;

TLT long: 8.78%;

2-Year/3-Year/52-Week/26-Week/13-Week/5-Year TIPS long: 7.76%;

Gold/silver/platinum coins: 5.54%;

INTC long: 2.34%;

TKC long: 2.33%;

GEO long: 1.87%;

TEI long: 1.42%;

KWEB long: 1.32%;

FXY long: 0.85%;

FXB long: 0.18%;

FXF long: 0.17%;

VZ long: 0.65%;

EPOL long: 0.34%;

T long: 0.22%;

WBD long: 0.20%;

HBI long: 0.11%;

LEMB long: 0.06%;

PCY long: 0.05%;

NGL.PR.B long: 0.02%;

CEE long: 0.02%.

The numbers add up to more than 100% because short positions only require about 30% to hold them with no margin required.

Sunday, October 16, 2022

"A value strategy is of little use to the impatient investor since it usually takes time to pay off." --Seth A. Klarman

Big Bottoms

BIG BOTTOMS (October 16, 2022): Most investors misunderstand bear markets. Bear markets create opportunities for much greater and much faster profits than bull markets. This is because 1) bear markets on average last about one-third the total time of bull markets; and 2) the annualized percentage fluctuations in bear markets are roughly triple those during bull markets.

A bear-market bottom is a lengthy process, not an event.

During bear markets some assets tend to complete their lowest points within one year of the original top. If we begin counting this bear market starting with the S&P 500 all-time zenith of 4818.62 on January 4, 2022 then the bear market is 9-1/2 months old. This is roughly the time when a wide variety of assets including U.S. Treasuries, gold mining and silver mining shares, and some currencies including the Swiss franc and Japanese yen often complete their bottoms prior to powerful uptrends.

Most investors don't respect fair value or differentiation.

Fair value refers to the price at which any asset precisely reflects its fundamentals. Currently the price at which the fund QQQ would exactly match its historic average valuations relative to the profit growth of its components would be about 114. This is very far from its all-time record overvaluation of 408.71 less than one year ago. While QQQ has slumped below 260 several times in recent days, this is still far above 114, so the overall long-term downward trend for QQQ must remain lower for another two or three years until it is trading at a typical discount of 30% to 50% below fair value.

Investors are as baffled about bear-market rebounds as they are about bear markets.

One of the least-understood characteristics of any true bear market is that these feature frequent intense rebounds. Already in 2022 we had two surges higher, from mid-March to late March and then from mid-June to mid-August. We are probably transitioning to the third powerful surge higher of 2022. This recovery has been clearly signaled with the highest put-call ratios ever recorded in the history of the stock market (see chart near the bottom of this update), all-time record net outflows from many U.S. equity funds, the highest ratio of insider buying to insider selling since March 2020, and other reliable rebound foreshadowing. The U.S. dollar index and VIX have formed lower highs since September 28, 2022 which, in an environment of generally falling stock prices, usually indicates that equity prices are set for a sharp bounce higher.

Here is an example of the huge frequent bounces for QQQ during its 2000-2002 bear market when it had lost 83.6% of its value in 31 months:

Differentiation is likely to be among the top stories of the next two years.

What has happened so far in 2022? Investors have sold everything, especially in recent months: stocks, bonds, gold, currencies, real estate, art, etc. Almost nothing has been spared. This is common to the way that bear markets behave: in their early stages, investors are so confused that they sell everything and ask questions later.

Sooner or later, assets which classically bottom earliest tend to recover sharply. This usually includes U.S. Treasuries of all maturities, gold mining and silver mining shares, and safe-haven currencies like the Swiss franc and Japanese yen--and in this case also the British pound due to its widespread unpopularity. The more these assets diverge from QQQ and SPY, the more that investors will pay attention to them. Since very few assets are rallying in any bear market, the few which are climbing enjoy outsized attention and enthusiastic participation. Once funds like GDXJ have gained 50% or 100%, investors will be eagerly chasing after them because they desperately want to own something that is rising when almost everything else is falling.

Energy shares have been outperforming so far in 2022, thereby enjoying far too much attention relative to their fundamentals.

Why have energy shares been among the few winners so far in 2022? You will hear lots of explanations in the media, but the real reason is that they have been one of the few assets with positive gains in this calendar year. Investors are therefore crowding into them because they want to own something which is going up instead of going down. I believe this will end badly so I am staying away from energy until we have much lower valuations and much heavier insider buying in the energy sector. The lows in 2021 for funds including XLE and XES are warning of trouble ahead, representing a drop of almost half from their current levels whenever their 2021 lows are revisited eventually.

Gold mining shares and U.S. Treasuries will probably be among the biggest winners of the next two to three years.

Funds like GDXJ could triple or more from their recent lows including 25.80 for GDXJ, while "boring" U.S. Treasury funds like TLT will probably return 50% or more including reinvested dividends. This would not put either GDXJ or TLT anywhere near their respective historic highs. The more these ascend, the more that people will notice this behavior and will want to jump aboard the bandwagon. The secret to success with investing is to purchase these classic early-bottoming shares far ahead of everyone else, relying on their consistent bear-market outperformance to shine sooner or later. Investors become overly obsessed with only buying an asset which has already been rising, thereby causing such investors to miss out on half or more of their total percentage gains.

Selling puts on oversold but still-overvalued assets is a little-appreciated method which is even more profitable than selling covered calls.

Put prices tend to be their most overvalued when investors are panicking. If you are short something which is likely to eventually drop by 80% or more from its zenith--think QQQ--but which is temporarily being sold in a panic, then instead of covering your short position consider selling covered puts against it. This will allow you to capture temporarily-inflated time premium while retaining your short position. If there is an imminent collapse then you won't make as big a profit as you would have done otherwise, but you will usually get much more up front than you deserve in options premiums. Far more investors buy options instead of selling them, causing their prices to be inflated. Options buyers in general are buying hope via expensive lottery tickets, while options sellers tend to be more-experienced successful long-term options traders.

Long bull markets are followed by long bear markets.

The bull market which lasted from August 1921 through September 1929 was followed by a bear market which ended in July 1932, 34 months later. The bull market from October 1990 through March 2000 was followed by a bear market from March 10, 2000 to October 10, 2002, 31 months later. We just had the lengthiest bull market in history from March 2009 through January 2022, so expect the current bear market to last for at least 2-1/2 years and perhaps longer.

This gives us numerous opportunities to profit from--or to lose money by misreading--both the long and short sides.

Many assets will not bottom until 2024 or 2025.

The Nasdaq and the S&P 500 Index, along with related funds including QQQ and SPY, will probably not bottom until late 2024 or early 2025. Real estate, art, collectibles, and other non-financial assets will probably bottom several months later than U.S. equity indices just as they had mostly peaked several months later in 2022.

Here are five useful charts.

Investors are suddenly chasing after downside protection at a more frenetic pace than at any time in the 21st century:

The average investor has been panicking out of the market as aggressively as they were piling in near the end of 2021 and the start of 2022:

Commodity trading advisors are repeatedly buying near tops and selling near bottoms:

Gold's traders' commitments recently achieved a four-year bullish net extreme:

Commercials for the 2-year U.S. Treasury note reached an all-time extreme of net accumulation:

The bottom line: expect a powerful rebound but the U.S. equity bear market will not end for another two years or more.

Only buy something if it is historically likely to be in the process of completing a bottom which will be followed by dramatic percentage gains. Gold mining and silver mining shares often bottom within a year following a topping pattern for large-cap growth favorites, while U.S. Treasuries and safe-haven currencies also tend to bottom early. Most assets will not likely bottom for another two or three years.

Disclosure of current holdings:

Here is my current asset allocation, with the funds in each group ordered from my largest to my smallest positions:

VMFXX/FZDXX/Savings/Checking long: 33.4%;

XLK/QQQ/TSLA short, hedged with covered puts: 27.9%;

TLT/I Bonds/2-Year/3-Year/52-Week/26-Week long: 23.5%;

GDXJ/ASA/GDX/BGEIX long: 19.2%;

Gold/silver/platinum coins: 5.3%;

INTC long: 2.21%;

TKC long: 1.67%;

GEO long: 1.50%;

TEI long: 1.29%;

KWEB long: 1.17%;

FXY/FXB/FXF long: 1.16%;

VZ long: 0.63%;

EPOL long: 0.29%;

T long: 0.20%;

WBD long: 0.20%;

LEMB long: 0.04%;

PCY long: 0.03%;

NGL.PR.B long: 0.03%;

CEE long: 0.02%.

The numbers add up to more than 100% because short positions only require about 30% to hold them with no margin required.

Tuesday, August 9, 2022

"Here's how to know if you have the makeup to be an investor. How would you handle the following situation? Let's say you own a Procter & Gamble in your portfolio and the stock price goes down by half. Do you like it better? If it falls in half, do you reinvest dividends? Do you take cash out of savings to buy more? If you have the confidence to do that, then you're an investor. If you don't, you're not an investor, you're a speculator, and you shouldn't be in the stock market in the first place." --Seth A. Klarman

Mama Bear

MAMA BEAR (August 9, 2022): Throughout 2021 some analysts compared the U.S. stock market with Goldilocks and her porridge: not too hot, not too cold, but just right. Unfortunately many of them played hooky in kindergarten so they never learned that Goldilocks is always followed by the three bears. This truancy has come home to haunt analysts and investors in 2022 which featured the appearance of Baby Bear throughout the first half of this year.

Far too many analysts have recently rushed to declare that "the bear market is over" but, alas, we haven't seen either Mama or Papa so far. Mama Bear is about to surprise many with her dramatic entrance. Unlike Baby Bear, Mama needs a lot to keep her well fed, so she's going to be around for a year or two. Once she's had her fill, Papa Bear will bring the proceedings to a thunderous grand finale.

The U.S. equity bear market has a long way to go, with QQQ facing additional losses of 75% or 80%.

On November 22, 2021 at 10:16:19 a.m., just after Jerome Powell was reappointed as Fed chair, QQQ completed its all-time record zenith at 408.71. After making lower highs through January 4, 2022, it didn't take long for QQQ to lose one-third of its value by June 15, 2022. Since then it has been generally rebounding for several weeks which has encouraged a surprising number of people, especially those who haven't studied market history, to conclude loudly that "the bear market is over." Often they'll mention something about inflation receding or a recession not being imminent or something equally irrelevant as justification for their outlook.

Quite a few of these folks declared in both late March and more recently that "the bear market is over," probably on the way to doing so several more times.

The bear market of 2021-2025 has almost nothing to do with inflation, recession, Ukraine, or energy. It has everything to do with all-time record overvaluations, insider selling, net inflows, and public participation in 2021.

The media have been completely clueless about why we're in a bear market and why it must continue for at least two more years. We had the highest overpricings in history last year combined with by far the most intense insider selling and greater total net inflows for 2021 than we had for 2001 through 2020 combined. The market has to reward insiders for bailing out and punish the average investor in a way which will be unforgettable, at least until the next bear market comes along and no one respects it either.

The two previous longest bull markets in history were followed by bear markets of 34 and 31 months respectively.

Some analysts would have you believe that the bull market from March 2009 through January 2022, almost 13 years altogether and by far the longest in U.S. history, ended with a 5-1/2-month mild bear market. If we look at the second- and third-longest bull markets then this is what we find: the powerful uptrend from August 1921 through September 1929 was followed by the most severe bear market ever recorded which terminated in July 1932, 34 months later. The bull market from October 1990 through March 2000 was followed by a bear market which ended in the U.S. in October 2002 after 31 months and in most of Europe in March 2003 which was three years (36 months) altogether.

If this pattern repeats itself then the current bear market won't end until either the second half of 2024 or sometime in 2025.

Bear markets aren't "healthy corrections." They destroy an average of one decade's worth of investors' total accumulation.

In any bear market a major index like the S&P 500 will return to its top from the bull market prior to the previous one. In this case that means going back to its October 11, 2007 top of 1576.09 which had been the previous all-time intraday record prior to the 2007-2009 collapse. Since the S&P 500 on January 4, 2022 had reached 4,818.62 this means a loss of more than two-thirds from top to bottom and it could be significantly higher than that.

From its top of March 10, 2000 through its bottom of October 10, 2002, QQQ dropped 83.6%. Not many investors have prepared their portfolios for a repeat performance.

U.S. government bonds are irrationally underappreciated.

As I have discussed in previous essays, the best deal you can get is to put up to 65K each calendar year into I Bonds per couple or 35K if you are single. These are currently paying 9.62% free of state and local income taxes, and possibly free of federal income taxes if the money is eventually used for someone's college education. Once you have maxed out your I Bonds you can still get the highest guaranteed yields since October 2007 by purchasing U.S. Treasuries at each auction at The 52-week, 1-year, 2-year, and 3-year Treasuries are auctioned once per month, while the 26-week Treasuries are issued each week. I have recently been buying all of the above including the auctions on August 8 and August 9, 2022. Recent yields include 3.325% on today's 52-week auction and 3.202% for the 3-year U.S. Treasuries. Yesterday's 26-week auction yielded 3.130% which is much higher than you will get from any bank, plus the interest is free of state and local income taxes.

Bogleheads would do much better getting 3.2% guaranteed by the U.S. government than continuing to pile into U.S. equity index funds which are near double or triple fair value and which could still be behind after adjusting for inflation a half century from now.

Here is the official U.S. government link for the results of recent U.S. Treasury auctions:

Sell short in any bear market whenever VIX drops below 20.

Huge insider selling combined with massive net fund inflows are two clear signals that U.S. equities are headed much lower regardless of what they do in the short run. If you're uncertain about when to sell short, a useful guideline in a bear market is to track VIX. Whenever this measure of the average implied volatility of a basket of options on the S&P 500 Index goes below 20 it is safe to add to your short positions. The lower VIX goes below 20, the more aggressively you can add to your shorts, although always continue to do so gradually into extended equity strength.

Partially balance your short positions with long positions.

While funds including QQQ and XLK remain near triple fair value, other sectors tend to perform strongly during bear markets which follow growth-stock bubble tops. Gold mining shares consistently rally strongly following Nasdaq-style bubble peaks after an eight-month delay as we saw after September 1929, January 1973, and March 2000. For example, QQQ completed a key zenith on March 10, 2000; $HUI which is a long-running index of gold mining shares began a huge uptrend starting on November 15, 2000. In the current cycle QQQ peaked on November 22, 2021, so it is possible that the recent lows for gold mining shares eight months later may be following a similar pattern.

GDXJ is an ideal fund to hold during the current U.S. equity bear market. Other funds will likely become compelling over the next several months if they retreat irrationally during the next major downward phase for QQQ and SPY.

Not counting TLT and other funds of U.S. Treasuries, my equity short-to-long ratio is currently about 9:8. In other words, my combined short equity positions are modestly greater than my combined long equity positions, constantly adjusting both sides by buying into extended weakness and selling into extended strength.

Probably we will soon retest the upside a few more times for QQQ and SPY before we suffer their severe plunges.

It's somewhat unlikely that August will be the month where the U.S. equity bear market accelerates. Looking back at similar bear-market years including 1929, 1937, 1973, 2000, and 2008, it is probable that equity indices will periodically try to rally on "good news," especially near the opening bell, before we experience a more sustained decline after Labor Day to what will likely be the lowest points this autumn since April-May 2020.

A likely downside target for QQQ in the next phase of the bear market will be 215. We could bottom slightly higher and potentially much lower. Right now I expect this to occur before the end of 2022 although there exists a smaller chance of a slower descent into early 2023. If VIX suddenly spikes above 60 then expect this intermediate-term bottom to occur sooner rather than later.

Here are three useful charts.

Top corporate executives set new all-time records of insider selling to insider buying in 2021 and have recently been selling at their most intense pace since the beginning of 2022:

It's not just stocks which are overpriced; new homes under construction set a new all-time record as housing inventory is being transformed from a record shortage to a record surplus:

Among the few undervalued assets are precious metals, with silver's traders' commitments demonstrating the 99th percentile of its historic range. When commercials aren't hedging it's because they expect a substantial price increase in coming years:

The bottom line: the bear market is far from over as Mama Bear is about to make her appearance. An ideal way to ride out the current bear market is to keep a substantial percentage of your money in U.S. Treasury bills averaging 3.2% guaranteed which is free of state and local income taxes.

Disclosure of current holdings:

Here is my asset allocation in order from largest to smallest position: U.S. I Bonds along with 26-week, 52-week, 1-year, 2-year, and 3-year Treasuries, VMFXX, and similar cash reserves; short XLK; short QQQ; long TLT; long GDXJ (some bought in July); long GDX (some bought in July); short TSLA; long ASA (many bought in July); long GEO; long KWEB; long EWZ; long XBI; long TEI (many bought in July); long INTC (many bought recently including today); long TKC (many bought in July); long EPOL (some bought in July); long LEMB (many bought in July); long PCY (many bought in July); long TUR; short AAPL; long T; long ECH; short XLU; short XLE; long VZ (many bought in July); long FXF (some bought in July); long FXY (many bought in July); long FXB (many bought in July); short IWF; short SMH; long WBD; long VMBS; long EGPT (many bought in July); long PAK (many bought in July); long UGP; long ITUB; long BBD; long TIMB.

Tuesday, June 21, 2022

“Macro worries are like sports talk radio. Everyone has a good opinion which probably means that none of them are good.” --Seth A. Klarman

Safe Havens Shunned

SAFE HAVENS SHUNNED (June 21, 2022): Since January 4, 2022 large-cap growth funds like SPY finally joined the bear market which began in February 2021 when stocks in the U.S. and worldwide began shifting from uptrends to downtrends. It took several months longer for assets like the Nasdaq and QQQ to reach their respective peaks on November 22, 2021 at all-time record overvaluations roughly 3.75 times fair value. Whenever a popular fund like QQQ with its current fair value near 116 is trading at 408.71, as it had been at its peak on November 22, 2021, then it's like drinking an entire fifth of Scotch at one go. It might be a special single malt which has been lovingly aged for decades but you're still going to first get drunk and then suffer a severe hangover. Right now we're 5-1/2 months into that hangover which will likely persist until 2024 or 2025. I expect QQQ to ultimately bottom somewhere around 70, of course with numerous strong bounces along the way including one which is probably happening right now.

I have continued to progressively shift my equity short:long ratio toward the long side and have now become 5:4 short to long versus 2:1 in my previous update.

Especially during the past week we have experienced historic bargains for many individual shares and sectors including GDXJ, GDX, ASA, XBI, INTC, TKC, TLT, and VMBS, thereby encouraging me to add to all of the aforementioned. There is also an above-average likelihood of a quarter-end bounce which could persist into July; 9 of the past 10 quarters have behaved in that manner regardless of whether or not we were in a bear market, plus we are finally seeing some short-term bullish signals. Most likely QQQ will climb to perhaps 310 before continuing its downtrend to its 2022 intermediate-term bottom somewhere around 210. Most investors expect neither a strong rebound nor a continued severe downtrend, thereby making both much more likely than usual.

For those who have not read my numerous previous postings, this does not mean that I have closed out my large short positions in QQQ and related shares. Instead I have added aggressively to the long side in my favorite undervalued holdings with low price-earnings ratios, heavy insider buying, and intense outflows. I have no intention of closing out my shorts just because I think the chance of a short-term bounce are higher than usual. When VIX doubles from its current level it might be time to consider closing short positions. I had previously closed out all of my short positions and related short funds in March 2020, December 2018, and January 2016.

If VIX surges higher, but I don't believe that we are approaching a major intermediate-term bottom for QQQ, then I will likely sell covered out-of-the money puts against some of my short positions.

Gold mining and silver mining shares are especially compelling, not only because they have been trading at their lowest levels in more than two years but because they have consistently and dramatically outperformed during three previous bear markets for large-cap U.S. growth shares.

We had important peaks or lower highs for large-cap U.S. growth shares on January 4, 2022. Previous similar tops include March 2000, January 1973, and September 1929. In all of the above cases, large-cap U.S. growth shares ended up losing more than 80% from their respective zeniths, while gold mining shares after an initial delay ended up gaining hundreds of percent.

Let's look back at 2000-2003 since it is easiest to find free chart data compared with the 1970s or 1930s. HUI ($HUI on bottomed at 35.31 on November 15 and 16, 2000 and climbed to 258.60 by December 2, 2003. This is a total percentage gain of (258.60 - 35.31) / 35.31 or 632.37%. Perhaps we won't repeat that exact percentage surge but, especially as we had similar impressive rallies for gold/silver mining shares during the 1930s and 1970s, an outsized gain is more likely than not over the next several years. I prefer GDXJ to other funds in this sector since its mid-cap focus tends to outperform large-cap shares like GDX especially when fund managers no longer fear repeated net outflows and are confident enough to diversify into holdings other than the biggest and most liquid names.

Here are two useful charts.

We are at the point in a typical bear market where a rebound has become much more likely than usual. If this rebound becomes sufficiently extended so that VIX moves back below 20 then this will be my signal to add to my short positions, as has been the case during the past several months especially in late March when VIX dropped below 19. In general this is a useful guideline during all true bear markets including 2000-2003 and 2007-2009:

At the beginning of 2021 almost everyone in the media and elsewhere had been bearish toward the U.S. dollar. This has been replaced by a nearly opposite consensus about a powerful greenback:

Recently I have been buying shares of FXY (Japanese yen), FXF (Swiss franc), and FXB (British pound). This leads to the next topic which is how safe havens are currently incredibly unpopular.

Investors have been making net ouflows from safe havens of all kinds including U.S. Treasuries like TLT, the above-mentioned currencies, emerging-market government bond funds including TEI, LEMB, PCY, and ELD, as well as other government-guaranteed funds like VMBS.

Investors have become so accustomed to the failed Boglehead approach that they've actually been net sellers of gold/silver mining shares, government bonds of all countries including the United States, safe-haven currencies, and related assets like U.S. government-guaranteed mortgage-backed securities (VMBS). Most of this money has gone into buying still-very-overvalued large-cap growth shares and funds. This has created compelling opportunities for safe-haven sectors which in many cases have been trading near multi-year lows. Long-dated U.S. Treasuries haven't sported such high yields in more than eight years, including TLT which traded at 107.78 at 7:47 a.m. in the pre-market session on June 16, 2022. This marked the lowest point for TLT since April 3, 2014.

TEI is a compelling fund of emerging-market government bonds with a discount that is 50% above its long-term average.

TEI recently traded with a discount of more than 13% versus its long-term average near 8%. Emerging-market government bonds aren't well known to most investors and are usually ignored regardless of their valuations. This fund has been actively managed by the same lead advisor since 2006 and is well-diversified internationally.

Some aggressive underpriced assets have become worthwhile for purchase.

Companies including INTC, TKC, and GEO have recently been trading at unusually low price-earnings ratios relative to their profit growth. Some entire exchange-traded funds including XBI have also been periodically underpriced, with XBI also experiencing very heavy insider buying of many of its components including notable CEO purchases. KWEB had experienced a deep undervaluation earlier in 2022 but has now rebounded sufficiently so that I will continue to hold it but I will not add to my position unless it retreats to an important higher low later in the year.

Considering that we are in a severe bear market, VIX has been peculiarly low so far in 2022.

VIX has remained irrationally depressed throughout 2022, indicating that much greater losses lie ahead even if--or especially if--we have powerful upward bounces along the way which cause VIX to drop below 20. I am baffled by the failure of VIX so far in 2022 to reach 40, not to mention a much higher level like 60 or 70.

If you and I both had perfect advance knowledge at the beginning of 2022 regarding what QQQ and SPY would do during the first half of 2022 then I would have bet you a lot of money that I could forecast the behavior of VIX. And I would have been dead wrong. I have been puzzled that 1) VIX hasn't touched 40 so far in 2022; and 2) VIX has retreated below 20 several times in recent months. Both of these phenomena indicate that even professional investors are mostly unafraid or oblivious to the possibility of a significantly extended downtrend in 2022. It's not going to be different from every other bear market in history: eventually VIX will rally to double or more its current level and when that occurs it may become timely to finally close out some or all of our short positions.

Too many investors are comparing current valuations with their all-time peaks of 2021-2022 and drawing faulty conclusions.

I have met dozens of people who tell me something like this, "Look how much QQQ has dropped from its top. If it's down 30% then it has to be a great bargain." This is like announcing while you're descending from the peak of Mount Everest: "I've come down seven thousand feet so far, so I have to be very close to the bottom." If we look back at the highest-ever peaks for U.S. equities in their entire history then the beginning of 2022 is by far the all-time record, followed by March 2000, September 1929, and January 1973. (You could also count the railroad bubble of 1873 and the canal bubble of 1837 but let's skip those for now.) As of today's closing prices, large-cap growth shares overall were almost exactly matching their January 1973 tops and weren't far below their September 1929 zeniths which many people in the Great Depression believed would never be exceeded. In other words, what looks at first glance like a great discount compared with the top is still enormously above fair value and historic averages. If QQQ were to drop 75% more then it would be at the average level of a bear-market bottom at roughly 40% below fair value.

The bottom line: as the current bear market progresses in typical fashion with periodic sharp surges higher, there are opportunities to make money on both the long and the short side. Be persistent, gradual, and disciplined at all times and continually rebalance your portfolio to adjust to these fluctuations.

Disclosure of current holdings:

Here is my asset allocation in order from largest to smallest position: cash including I Bonds paying 9.62% guaranteed (available to anyone with a U.S. social security number); TIAA Traditional Annuity paying an average of about 3% (for legacy retirement accounts); long TLT (some new); short XLK; short QQQ; long GDXJ (many new); long GEO (some new); short TSLA; long GDX (many new); long KWEB; long EWZ; long ASA (many new); long INTC (many new); long TKC (many new); long XBI (some new); long TEI (all new); long EPOL (some new); long LEMB (all new); long TUR; short AAPL; long T; long ECH; short XLU; short XLE; long PCY (all new); long VZ; short IWF; short SMH; long WBD; long VMBS (all new); long FXF (all new); long FXY (all new); long FXB (all new); long UGP; long ITUB; long BBD; long TIMB.