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 TreasuryDirect.gov. 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 stockcharts.com) 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.

Sunday, February 6, 2022

“The real secret to investing is that there is no secret to investing.” --Seth A. Klarman

Up Your Asset Allocation

UP YOUR ASSET ALLOCATION (February 6, 2022): Surprisingly few people recognize how dramatically the financial landscape has changed during the past year. Exactly one year ago the vast majority of global assets were in bull markets. Today, more than 40% of all Nasdaq shares have dropped over 50% from their 52-week highs while most global stocks, high-yield corporate bonds, cryptocurrencies, NFTs, and perhaps even real estate have been in downtrends. Some oversized percentage pullbacks have created worthwhile bargains at various points in recent months.

I have shifted my equity short:long ratio dramatically toward the long side while remaining 2:1 short to long.

My current total as of the close on Friday, February 4, 2022 was long 20.636% and short 42.13%, or almost exactly 1:2, not counting TLT. If the bear market continues for large-cap U.S. growth shares as I expect then I will likely be more long than short before the end of 2022. I list the exact percentages at the bottom of this essay.

TLT has become very unpopular as investors don't trust a forty-year bull market.

One of my very first investments was purchasing long-dated U.S. Treasuries in 1981. At that time there was a nearly unanimous consensus that U.S. Treasury yields would keep climbing indefinitely due to permanently high inflation and soaring budget deficits. Each year, often more than twice per year even in the early 1980s, there was a proclamation that the bull market for the 30-year U.S. Treasury had ended, and we have continued to experience this gloom and doom each year since then including right now. On Friday, February 4, 2022, TLT dropped to 138.78 at 10:52:28 a.m. Eastern Time. I made my most frequent purchases of TLT on Friday since it had been even more depressed during the late winter and early spring of 2021. The longest-tenured writer at Barron's, Randall W. Forsyth, penned a bullish column about long-dated U.S. Treasuries which is the lead article in this week's print edition and can be found below:

The online version has the same essay but a different title: "Forget About Inflation. Contrarians Expect a Recession and a Drop in Bond Yields." It is probably not a coincidence that The Economist has the following cover story:

Many investors confuse the Fed's overnight lending rate with long-term yields.

If we are heading toward increasing recessionary expectations, as the flattening U.S. Treasury yield curve has been telling us, then this would mean higher short-term yields and probably lower long-term Treasury yields to create additional flattening. I plan to keep buying TLT into weakness because it could be one of the top performers as it has been in the past whenever investors have gone from almost zero expectation of a U.S. recession, like now, to a majority of investors expecting such an economic slowdown.

U.S. housing prices may have begun to drop following a more extreme bubble in 2021 than we had in 2005-2006.

The price of the median U.S. house dropped about 34% following the housing bubble we had sixteen years ago. Average valuations were even higher in 2021 by Case-Shiller and many other reliable measures, so the overall pullback is likely to be greater. The U.S. Fed's data for new home prices experienced its first pullback in a long time:

Numerous sectors had become especially compelling in recent weeks including GDXJ, KWEB, and XBI.

In addition to my very recent buying of TLT, I have been accumulating GDXJ, KWEB, and XBI into weakness. GDXJ is a fund of mid-cap gold mining shares; this sector had been one of the largest percentage winners following the collapse of previous U.S. growth-stock bubbles in 1929, 1972, and 2000. KWEB is a fund of Chinese internet companies which has one of the highest ratios of profit growth to price-earnings ratio for any U.S.-listed exchange traded fund. XBI is a fund of biotech shares which recently had more than a 1.5 to 1 ratio of profit growth to price-earnings, according to the sponsor's web site, and which had also featured significant insider buying of several of its components. XBI and GDXJ traded near two-year lows while KWEB had fallen to a five-year nadir. T (AT&T) is sharply out of favor partly over confusion about its upcoming spinoff and related uncertainties. I plan to continue to purchase all of the above into either lower lows or higher lows, especially whenever we are experiencing dramatic net outflows from these and related funds along with continued above-average insider buying relative to insider selling.

Too many investors are waiting for nonexistent triggers.

Extreme deviations from fair value in either direction are sufficient reason for dramatic price changes to occur. People often ask "what is going to trigger a huge drop for QQQ" or "what will cause Chinese internet shares to rebound?" I often answer these kinds of questions with this question: what caused U.S. internet companies to collapse after 1999-2000? What caused the crash of 1929? What caused stocks worldwide to surge in the late winter and early spring of 2009? The answer in all three cases is that, even with years or decades of hindsight, there were no obvious triggers to either of these major trends. Any irrationally huge deviation from fair value will always resolve itself sooner or later.

The bottom line: we have dangerous overvaluations for large-cap U.S. growth shares combined with compelling bargains for several other sectors. Now is a good time to combine long positions in unpopular assets and short positions in the trendiest shares.

Disclosure of current holdings (most recent purchases in red):

Here is my asset allocation with average opening prices adjusted for dividends/splits and newly-opened positions in boldface: 43.6% cash including I Bonds paying 7.12% guaranteed (available to anyone with a U.S. social security number), TIAA Traditional Annuity paying 2.758% to 3.519% (for legacy retirement accounts), and Discover Bank high-yield savings paying 0.50% (available for all U.S. residents with retirement and ordinary savings accounts); 18.0% short XLK (112.7737); 17.3% long TLT (147.86); 15.9% short QQQ (309.7504); 6.4% short TSLA (494.9721); 5.9% long GDXJ (39.68); 5.0% long GEO (7.52); 2.54% long GDX (28.98); 1.68% long KWEB (35.19); 1.32% long EWZ (27.33); 1.23% long TUR (17.17); 1.05% long ASA (19.49); 0.90% short AAPL (125.5481); 0.74% long XBI (86.14); 0.62% long ECH (22.98); 0.53% short IWF (223.0119); 0.40% short SMH (170.7813); 0.27% long T (23.33); 0.12% long UGP (2.565); 0.10% long ITUB (3.83); 0.052% long BBD (3.39); 0.014% long TIMB (9.99). It doesn't add up to 100% since short positions require less cash; there is no margin involved.

Monday, January 17, 2022

“The success of contrarian strategies requires you at times to go against gut reactions, the prevailing beliefs in the marketplace, and the experts you respect.” --David Dreman

Déjà Vu All Over Again

DÉJÀ VU ALL OVER AGAIN (January 17, 2022): Most investors are either treating 2022 as though it will be an approximate repeat of 2021 or else they believe that the investing world is totally different than it has ever been in the past. Both of these expectations are seriously flawed. The financial markets will consistently behave similarly to whatever they have done in the past under nearly-matching conditions. Early 2022 has numerous parallels to early 2000, early 1973, and the late summer of 1929. In addition, the past year which was 2021 was surprisingly analogous to 1999-2000, 1972, and 1928-1929. Therefore, what will occur over the next few years can best be determined by examining the market's behavior during 2000-2003, 1972-1975, and 1929-1932. This is especially true since so few investors are doing likewise, thereby making it probable that you will come out far ahead by studying and applying these valuable parallels.

We have experienced an exaggerated large-cap U.S. growth bubble which will behave like all previous large-cap U.S. growth bubbles, only more so since we had achieved all-time record extremes and divergences.

Imagine that you go to see the classic movie Casablanca with a friend. You observe how your buddy responds emotionally to the scenes which you have seen over and over again and which you conclude he must be watching for the first time. After the movie is over you plan to discuss this with him, and then one of the ushers you have seen there for years says to your pal, "You must be a huge fan of this film. You've already viewed it several times during the past couple of weeks." Surprised, you turn to your friend and ask him, "Is that true? The way you reacted to the most powerful parts of the film convinced me that you had never watched it before." "Oh, sure, I've seen it over and over," he responds, "but I keep hoping that it will turn out differently."

Expecting the financial markets to turn out differently than they had done in 2000, 1972, and 1929 is a serious mistake, because we have such a close repeat of those years. Several weeks ago we had 1099 new 52-week lows for the Nasdaq in a familiar pattern where investors crowd into fewer and fewer of the biggest names near the end of a large-cap growth bubble. Boglehead investing is incredibly popular just as it had been in each of those years. Huge numbers of people who had never invested before are participating for the first time: bucket shops appearing worldwide on ordinary city and town blocks in 1928-1929; discount brokers emerging for the first time in the early 1970s; online brokerages having their debut around 1999-2000; and Robinhood/Reddit and other trendy zero-commission mobile-phone apps appealing to middle- and working-class investors in 2020-2022. There are numerous other parallels including the kinds of options trading, the times of the day/week/month/year when investors are most eagerly participating, huge net inflows into passive index funds, and all-time record overvaluations for the most popular shares. Here is one chart highlighting one of these exaggerated extremes:

The next few years will likely be similar to 1929-1932, 1972-1975, and 2000-2003.

People frequently ask me why I consistently accumulate the most-underpriced shares into extended weakness when I expect the biggest large-cap U.S. growth shares to drop over 80%. The reason is because, following growth-stock tops, value shares often end up with absolute gains especially when they are notably undervalued. Below is a chart highlighting how value shares had performed while QQQ was busy collapsing 83.6% from its March 10, 2000 intraday zenith to its October 10, 2002 intraday nadir:

The above chart highlights the useful point that a bubble for large-cap growth shares, especially the internet bubble of 1999-2000 and the Nifty Fifty bubble of 1972-1973, were followed by extended periods of outperformance by low-price-earnings assets especially in certain sectors such as gold mining. As great as the Great Depression had been, many gold mining shares gained hundreds of percent starting near the end of 1929.

There are numerous sectors today which will likely gain while large-cap growth shares keep making lower highs for two or three years.

Chinese internet shares have never been more undervalued relative to U.S. internet shares than they have in recent weeks by a large factor. Gold mining shares tend to perform especially well whenever large-cap growth shares begin powerful downtrends. Other currently-undervalued sectors include biotech, South American emerging markets, telecommunications, and recently Russian shares. Gradually purchasing these and other unpopular shares into extended weakness over the next few years is likely to be especially rewarding.

TLT and long-dated U.S. Treasuries have gone wildly out of favor in recent weeks.

Two essays were very recently posted by other analysts on Seeking Alpha which recommended selling TLT--after it has already been trading near a multi-month low. Commercials have been accumulating long positions in the 30- and especially the 10-year U.S. Treasury as you can see from maroon bars on the following charts:

We also had the greatest-ever two-week net outflow from TLT in its entire history. In a nearly exact inverse position from the spring of 2020, investors are minimally concerned about a recession and maximally worried about inflation. TLT will likely perform well until almost everyone is again far more concerned about a U.S. recession and continued losses for the Nasdaq 100, at which point it could become timely to sell TLT at a two-year high.

Think of your role as a jumbo-jet pilot, not an air-show sensationalist.

A jumbo-jet pilot's top responsibility is to ensure that the passengers remain calm throughout the flight, even if it means taking longer to reach the destination or even putting up with more turbulence than another approach. On a recent flight to San Francisco the pilot decided to break this rule and to make a sudden sharp dive to get us into calm air much more quickly. While he succeeded admirably in his objective and the remainder of the trip was surprisingly calm, quite a few people cried out or were otherwise upset by suddenly dropping thousands of feet. No doubt this would have been the correct maneuver as a military pilot with a squadron on board instead of ordinary passengers, but acting gradually has to take higher priority.

Even if I were to become absolutely convinced near a major bottoming pattern over the next few years that a particular drastic increase in portfolio risk is justified because VIX is at a multi-year peak, we have all-time record insider buying relative to selling, and we had the biggest weekly net outflow in decades, the next week could be even more extreme as we had experienced in March 2020. I have to discipline myself not to "pick up all those great bargains" too quickly.

Unfortunately I can't write a hundred-page essay for each posting, but you can subscribe to my twice-weekly email updates.

Several readers on Seeking Alpha usually say that I'm not giving enough detail to support my arguments. I would love to write a 100-page essay for each posting but unfortunately that's not practical. However, if you want to get additional precise details about what I am planning to buy and sell, at what prices, and in which quantities, you can subscribe to my newsletter at TrueContrarian.com. The subscription also includes two weekly Zoom meetings of 75 minutes apiece.

The bottom line: we have stealthily entered a meaningful rotation out of large-cap deflation-loving U.S. growth shares into small- and mid-cap inflation-loving global value shares. The ideal approach is to gradually purchase assets where their rate of profit growth exceed their price-earnings ratios by the widest ratios and where there is a history of outperformance by those shares under similar past circumstances. Too few investors are intelligently using 1929-1930, 1973, and 2000-2001 as a guide to 2022.

Disclosure of current holdings (most recent purchases in red):

Here is my asset allocation with average opening prices adjusted for dividends/splits and newly-opened positions in boldface: 44.1% cash including I Bonds paying 7.12% guaranteed, TIAA Traditional Annuity paying 3% to 5% (only available for legacy retirement accounts), and Discover Bank high-yield savings paying 0.40% (available for all U.S. residents with retirement and ordinary savings accounts); 18.7% short XLK (112.7737); 16.75% long TLT (148.259); 16.7% short QQQ (309.7504); 7.0% short TSLA (494.9721); 5.9% long GDXJ (39.96); 5.6% long GEO (7.65); 2.53% long GDX (28.97); 1.33% long TUR (17.17); 1.27% long KWEB (35.51); 1.22% long EWZ (27.33); 1.1% long ASA (19.43); 0.9% short AAPL (125.5481); 0.625% long ECH (22.98); 0.55% short IWF (223.0119); 0.45% short SMH (170.7813); 0.175% long T (23.17); 0.1% long UGP (2.565); 0.09% long ITUB (3.83); 0.044% long BBD (3.39); 0.013% long TIMB (9.99). It doesn't add up to 100% since short positions require less cash; there is no margin involved.

Sunday, January 2, 2022

“An intelligent investor gets satisfaction from the thought that his operations are exactly opposite to those of the crowd.” --Benjamin Graham

Ring In Value, Wring Out Growth

RING IN VALUE, WRING OUT GROWTH (January 2, 2022): It is human nature to assume that the recent past will continue into the indefinite future. However, successful investing in 2022 requires identifying similar past historic parallels rather than assuming that 2022 will be like 2021.

Many investors not only don't realize how much large-cap growth shares decline following bubble peaks, but also how poorly they behave for several years after they collapse.

If you had been invested in QQQ at its intraday top on March 10, 2000 then by its intraday bottom on October 10, 2002 you would have lost 83.6% of your money assuming that all dividends were reinvested. What is perhaps just as bad, if not worse, was that the subsequent rebound for QQQ only returned it to 48.63% of its original peak by October 31, 2007, and then QQQ slid another 54.4% in just over one year to its November 21, 2008 nadir. Similar behavior had occurred in 1929-1932 and 1972-1974 and twice during the 19th century beginning in 1837 and 1873.

Perhaps you want to believe that for some reason it's different this time. Albert Einstein defined insanity as repeating a similar set of circumstances and expecting completely different results.

Here is a chart of QQQ, adjusted for dividends all being fully reinvested, highlighting its previous two 21st-century bear markets as we begin the third:

Insiders and billionaires have never sold more of their assets than they had done in 2021.

Both top corporate insiders and billionaires made all-time record sales and exhibited the highest-ever ratios of insider selling to insider buying in their entire history. It isn't likely that this is a coincidence. Some top insiders also sold real estate aggressively as they hadn't done since 2005-2006, with Elon Musk doing both on a grand scale with the heaviest-ever selling of any single company's stock in world history along with unloading all of his houses including his primary residence. You can believe that Musk only sold shares because Twitter fans made him do it, and that he only sold his houses because he's a simple guy who prefers fewer possessions. You might also want to believe in the tooth fairy.

Value shares overall have never been more underpriced relative to large-cap growth shares, nor have they ever experienced greater net outflows relative to the all-time record inflows for large-cap growth shares.

How popular were U.S. exchange-traded funds in 2021? They had more inflows for the entire calendar year than twenty combined years of inflows from 2001 through 2020. Meanwhile, value shares have never been more underpriced in both absolute and relative terms. By my definition this includes not only classic value sectors but also Chinese internet companies, telecommunications shares, and almost anything where prices have been far below fair value. At the same time, U.S. large-cap growth shares by most benchmarks have never been more overpriced than they were in recent months.

The following chart highlights how U.S. equity indices have behaved in recent decades following powerful outperformance by the ten largest companies by market capitalization:

Whenever large-cap deflation-loving U.S. growth favorites have such a wide disparity with small- and mid-cap inflation-loving emerging-market value shares, the same subsequent behavior has always occurred as in 1837, 1873, 1929, 1972, and 2000.

Since the second week of February 2021 we have experienced major downtrends for exchange-traded funds ranging from MJ (marijuana) to KWEB (Chinese internet shares) to EWZ, ECH, TUR, PAK, NGE (all emerging markets) to GDXJ, GDX (gold/silver mining shares). In the United States we have seen moderate downward behavior for IWC (small-cap U.S.) and mostly sideways movement for IWM (the Russell 2000). Investors have crowded into fewer and fewer large-cap growth shares in almost the exact same way they had previously done in years including 1929, 1972, and 1999-2000. The subsequent behavior is likely to be nearly identical to the above three examples from the past century, with losses of 80% or more for large-cap growth shares over the next few years.

The market's behavior over the past decade is a remarkable repeat of its action at the end of the 20th century:

Options activity has never been more extreme than it was in 2021.

We had all-time record speculative call buying relative to put buying, and for several months more people sold puts to "generate income" than bought puts as a hedge against a market decline. We also had record-low ratios of emerging-market valuations relative to U.S. valuations and VIX generating numerous higher lows throughout 2021 including the wildly-depressed reading of VIX at 16.62 which it had registered at 2:46 p.m. on December 30, 2021. Investors are excited about certain future gains for their favorite stocks, indifferent toward protecting the gains they already have, and complacent about the possibility of a serious downtrend. This is an especially dangerous combination.

Numerous sectors have never been cheaper than they were at their lowest points over the past two years, with some of those bargains still existing in a compelling fashion.

Gold mining, energy, and travel shares are three sectors which had never been more undervalued than they had been at their March 2020 lows. Chinese internet shares reached all-time record low valuations relative to their profit growth during the final week of December 2021. Except for parts of 1932, AT&T had never been as undervalued relative to its profitability in its entire existence dating back to 1877.

Investors have been exhibiting classic herd mentality in desiring to own shares in the biggest U.S. corporations with massive insider selling by its top executives than to purchase the best global bargains which have suffered massive price declines. People want to own what the least-knowledgeable investors widely own rather than following experienced insiders and billionaires. Guess whether the "little guy" or the wealthiest investors will get richer over the next few years.

Generally-rising inflation will be the most harmful to the most-overvalued assets.

The market's first response to the recent rise in inflation, especially in the U.S., has been for investors to crowd even more frenetically into the fewer and fewer assets which remain in uptrends. These are primarily the most-overpriced shares and other dangerously-overvalued assets of all kinds including real estate. This is almost surely the opposite of what will happen sooner or later, which will be that just as in all past episodes where inflation emerged from a lengthy period of dormancy, these assets were almost always the biggest percentage losers. Without exception, value shares have always trounced growth in an environment where inflation is a notable economic factor, although often growth wins out over an initial short time period.

One possible explanation for this behavior is that any significant unexpected change in the real economy, such as inflation suddenly moving higher, is greeted by confusion. People have no idea what to do so they look to see what others are doing and they blindly follow. Only later on do the well-established interrelationships and mathematical necessities become evident.

It's not just large-cap U.S. growth shares which have become dangerously overpriced.

Cryptocurrencies will likely plummet more than large-cap U.S. growth shares during the next few years, partly because the earliest one, Bitcoin, didn't even exist during the previous two bear markets. Owning cryptocurrencies is like owning an outdoor plant transported from a much warmer climate which has never experienced its first winter. Real-estate prices in most countries have reached all-time highs relative to average total household incomes in most neighborhoods. Many works of art, automobiles, and other collectibles have also reached unprecedented levels even if you adjust generously for inflation. Much of these occurred due to the unusual, temporary ease in obtaining borrowed money for just about any purpose.

The following chart highlights the most-popular trades among investors in both November and December 2021:

Anyone in the U.S. with a solid credit rating can purchase any property with zero net worth.

Here is a true story: I was scanning Zillow.com in one part of the United States where desirable houses tend to average about 600 to 700 thousand dollars. After ten to twelve minutes I started getting a sidebar questionnaire asking me about my job, my net worth, my credit score, and similar personal data. I responded (untruthfully) that my wife and I both worked for Amazon full time as package deliverers, that we had both been recently promoted to make twenty dollars per hour, that we had excellent credit ratings in the low 800s (the only honest piece of data and which could be easily verified), that we never owned property before, and that our net worth was literally zero. Within a half hour I received multiple email offers from lenders guaranteeing a mortgage of up to 750 thousand dollars for nearly any house we wanted to buy, and promised that all closing costs would be included in the mortgage financing. The next day I got several telephone calls about mortgage approval and none of them were the least bit discouraged about our complete lack of savings, nor our absence of history in paying a mortgage. Perhaps subprime mortgages or loans where the potential buyer lies about his or her income are no longer commonplace as they had been in the U.S. during 2005-2006, but the current situation seems even more perilously lenient.

Not surprisingly, mortgage debt has reached all-time record highs by huge ratios to their previous records in dozens of countries.

The bottom line: far too many investors have become converts to the Boglehead myth that if you keep buying U.S. large-cap growth equity funds then you have to come out ahead in the long run. While this might be true over thousands of years, humans alas don't live that long. Those who believed in the Boglehead method in August 1929, when John Bogle himself was a baby, were behind by 38% on average in real terms by August 1982 which was 53 years later (see chart from my November 24, 2021 update highlighting the exact data points). U.S. large-cap growth shares are significantly more overpriced now than they had been in August 1929 so expect similar losses for the masses of current investors who refuse to sell even a modest percentage of their holdings. History demonstrates that most of them will give up in disappointment following massive declines of 70%, 80%, or 90%, and will end up selling during the next major bottoming pattern just as Bogleheads (if by another name) had done in 1932, 1974, and 2002-2003 following similar growth-stock post-bubble collapses.

After each of these previous growth-stock bubbles we experienced huge declines for large-cap growth shares followed by subsequent extended underperformance. Large-cap U.S. growth shares may not regain anything close to their recent dominance until the 2030s when nearly everyone today will have give up on Boglehead methods.

Disclosure of current holdings (most recent purchases in red):

Here is my asset allocation with average opening prices adjusted for all dividends: 43.3% cash including I Bonds paying 7.12% guaranteed, TIAA Traditional Annuity paying 3% to 5% (only available for legacy retirement accounts), and Discover Bank high-yield savings paying 0.40% (available for all U.S. residents with retirement and ordinary savings accounts); 19.7% short XLK (112.7737); 18.0% short QQQ (309.7504); 17.4% long TLT (148.259); 7.0% short TSLA (494.9721); 5.8% long GDXJ (40.86); 5.55% long GEO (7.65); 2.4% long GDX (29.55); 1.25% long TUR (17.17); 1.05% long ASA (19.43); 0.95% long KWEB (35.94); 0.9% short AAPL (125.5481); 0.6% long ECH (22.98); 0.55% short IWF (223.0119); 0.45% short SMH (170.7813); 0.125% long T (23.17); 0.1% long UGP (2.565); 0.075% long ITUB (3.83); 0.0375% long BBD (3.39); 0.0125% long TIMB (9.99). It doesn't add up to 100% since short positions require less cash; there is no margin involved.

You may wish to check out the following article on BusinessInsider.com:

Wednesday, November 24, 2021

“With a good perspective on history, we can have a better understanding of the past and present, and thus a clear vision of the future.” --Carlos Slim Helu

Nasty Mean Reversion

NASTY MEAN REVERSION (November 24, 2021): There is a fascinating paradox in the financial markets. The most consistent pattern for asset behavior through the centuries is that assets which are dramatically below fair value will have a very high likelihood of rallying toward fair value and beyond to a nearly opposite extreme, while those assets which have become the most overpriced relative to fair value will have a powerful tendency to eventually plummet to fair value and beyond to a similarly-undervalued bottom. However, only a tiny minority of investors will structure their net worth to anticipate this process, since when assets are the most overvalued they appear to be the most superior and the most likely to continue climbing, while assets which are the most out of favor and the best bargains will appear to be hopeless and inferior and will emotionally induce selling rather than buying.

This is one of the primary reasons that we have experienced all-time record inflows into U.S. equity funds in 2021 which have surpassed the combined inflows from 2001 through 2020, while in years with the best opportunities there have been the heaviest net outflows. Investors keep psychologically projecting the past couple of years into the indefinite future.

People tend to be heavily influenced by the moods of their era, often subconsciously.

Andrew Tobias wrote a worthwhile book in 1980 entitled Getting By on 100,000 a Year (and Other Sad Tales). In the early 1980s hardly anyone wanted to invest in real estate, bonds, stocks, and most related assets, because the media were telling them every day why both interest rates and inflation would remain persistently high for decades or permanently. In that environment the most-popular investments were money-market funds which sometimes paid as much as 20% annualized. It was emotionally challenging to realize that if everyone else was shunning many kinds of asset classes then that made them ideal for purchase. Only a few assets in 1980 like precious metals were popular and wildly overpriced.

Today we have nearly the opposite situation in which recent participants are so confident that they are far more concerned about missing out on gains than they are about the risk of losing money. Meanwhile, precious metals which had been so overpriced in early 1980 have become undervalued along with some emerging-market stocks and bonds.

There are many ways to gauge under- and overvaluation including the ratio of total stock market capitalization to GDP for any country.

While emerging markets including Brazil, Turkey, and Chile are experiencing unusually low ratios of both household net worth and total market capitalization to gross domestic product, the U.S. has never been higher even at previous bubble peaks:

The Boglehead argument is most convincing when it should be most ignored and vice versa.

Almost no one wanted to gradually buy and hold in the early 1980s. Here's why: if you had invested in the equivalent of the S&P 500 Index in August 1929 then by August 1982--53 years later--you would have lost 38% of your money after adjusting for inflation as this chart demonstrates:

Ironically that would have made it extremely worthwhile to keep steadily buying stocks into all pullbacks in the early 1980s and at all subsequent higher bottoms. Today, when there is the greatest risk of a similar substantial loss over the next half century or so, being a Boglehead has never been more popular.

If everyone wants to "buy and hold" anything then you must do neither.

It is no coincidence that we simultaneously have very-overpriced assets at the same time as we have supply-chain problems, a shortage of workers, rising inflation, and other rare behavioral extremes.

People involved with real estate in Boise will tell you that Californians are piling in and causing permanently higher prices, while those in California will tell you that people from some other part of the world are causing housing prices to be unaffordable in their towns. Hardly anyone puts two and two together to conclude that nearly all of the peculiar distortions in the global economy are interconnected.

Imagine an inverted world in which we have a multi-decade record inventory of real estate and prices at multi-decade lows in inflation-adjusted terms. Also try to imagine dramatic losses for today's most-popular assets, multi-decade highs in unemployment in most parts of the world, and almost no one wanting to talk about cryptocurrencies because they have collapsed in value. While that might seem like an impossible scenario it is by far the most likely conclusion to the most-overpriced assets reverting to the mean and beyond to some kind of opposite extremes. This is not a far-future science-fiction scenario but something which could occur within three years and perhaps sooner.

While investors keep piling into mega-cap U.S. tech shares they have shunned Chinese internet companies, telecommunications shares, and several other sectors.

In the final weeks of 2020 and the early weeks of 2021 nearly all assets worldwide were moving higher in tandem. Since then we have been experiencing widening disparities between asset classes worldwide. The more that undervalued assets retreat in price, such as UGP, TUR, T, ITUB, and some other assets which I have been gradually accumulating recently, the more that investors are shunning these because most investors conclude that something in a lengthy downtrend will keep dropping. On the opposite overpriced end of the spectrum, analysts are focusing too much on profit growth by itself and too little on the connection between the profits of a company and its stock price.

The next few years will likely experience more frequent and more intense corrections than the average three-year period.

Periods of recent extraordinary overvaluation and extended outperformance tend to be followed by above-average pullbacks. You should therefore keep more in cash than usual in order to be able to take advantage of upcoming bargains. The more severe any overall decline tends to be, the more likely that some assets--often unknown in advance--will become especially oversold and undervalued and will thereafter rebound aggressively.

Be sure to take advantage of the U.S.-guaranteed interest rate of 7.12%.

Did you know that I Bonds, issued by the U.S. government, are currently guaranteed to pay 7.12% for six months with zero state and local income tax due on the interest (and sometimes no federal tax if the money is used for education)? Some people believe that you can only put 10 thousand dollars per calendar year into I Bonds, but that is per account, not per person. A married couple can contribute 65 thousand dollars per calendar year into I Bonds as follows: 1) 10K in your name; 2) 10K in your spouse's name; 3) 10K in the name of your revocable living trust which can be a single paragraph putting your shoelaces into it; 4) 10K into your spouse's revocable living trust; 5) 10K in your business name; 6) 10K in your spouse's business name; 7) 5K by intentionally overpaying your January 15, 2022 federal estimated tax by several thousand dollars and putting five thousand of your federal tax refund into I Bonds.

I may discuss I Bonds in more detail in my next post. Be sure to do your maximum total as soon as possible for 2021 since you have only about one month left. In early 2022 you can do your allocation for next year.

The bottom line: most investors are currently betting on some all-time record extremes becoming even more extreme. While this is always possible and may be more likely in the short run, eventually all assets regress to the mean and beyond to a roughly opposite extreme. It is therefore worth considering going against the herd. The most-overpriced assets today tend to be the most popular including large-cap U.S. tech, crypto, ESG, high-yield corporate bonds, and real estate, while many emerging-market and precious-metals shares are near multi-decade lows in either relative or absolute terms.

This mean regression could become nasty, probably involving much bigger percentage changes and greater volatility in both directions than most investors are anticipating.

Disclosure of current holdings (most recent purchases in red):

Here is my asset allocation with average opening prices adjusted for all dividends: 45.3% cash including I Bonds paying 7.12% guaranteed, TIAA Traditional Annuity paying 3% to 5% (only available for legacy retirement accounts), and Discover Bank high-yield savings paying 0.40% (available for all U.S. residents with retirement and ordinary savings accounts); 19.2% short XLK (112.7737); 17.8% short QQQ (309.7504); 17.2% long TLT (148.259); 8.25% short TSLA (494.9721); 6.3% long GEO (7.65); 4.55% long GDXJ (41.6112); 1.65% long GDX (30.1982); 0.85% short AAPL (125.5481); 0.7% long ASA (19.35); 0.7% long UGP (2.565); 0.55% short IWF (223.0119); 0.45% short SMH (170.7813); 0.2% long ECH (24.23); 0.2% long TUR (19.5525); 0.0375% long ITUB (3.94); 0.025% long BBD (3.44); 0.0125% long TIMB (9.99); 0.0125% long T (23.99). It doesn't add up to 100% since short positions require less cash; there is no margin involved.

I closed out my ZM short position on November 23, 2021 at 199.99 with an average short-sale price of 293.16.

You may wish to check out the following article on MarketWatch.com:

Monday, August 16, 2021

“It’s not always easy to do what’s not popular, but that’s where you make your money.” --John Neff

Bearish Rotation

BEARISH ROTATION (August 16, 2021): The media have featured numerous articles about how there has been a rotation among equity sectors. However, the assumption which underlies almost all of these analyses is that we are in a bull market and that the sequential pattern will lead to continued gains. Few analysts have noticed that the pattern of relative performance between assets in 2021 is most similar to years including 1928-1929, 1972-1973, 1999-2000, and other years which preceded major percentage losses for the U.S. stock market.

Numerous multi-decade extremes support a bearish conclusion for U.S. equities.

2021 has featured an all-time record ratio of the total U.S. dollar amount of selling by top corporate executives relative to their buying. We had more money flowing into U.S. equity funds since November 2020, a period of 9-1/2 months, than during the previous twenty years combined:

Reliable historic valuation measures including Tobin's Q and the Rule of 20 demonstrate that 2021 reached considerably more extreme average U.S. equity valuations than previous historic peak periods going all the way back to the late 1700s:

Throughout 2021 we have had one equity sector after the other beginning a major downtrend in roughly the same sequence as it had done in the early months of previous major percentage declines.

In 2007 small- and mid-cap baskets of U.S. stocks including IWC had topped out on June 1 while QQQ and the Nasdaq reached their highest points on October 31 which was five months later. In 2021 we had IWC and IWM completing their highest intraday levels on March 15 which would suggest that we are right on schedule for the early stages of what could eventually become a full-fledged U.S. equity bear market. The past doesn't exactly repeat itself each time but the parallels are far closer than most investors appreciate until afterward.

Nearly all emerging-market bourses have begun downtrends between several weeks and several months ago. Energy shares and nearly all commodity producers have mostly also been in downtrends for weeks or months, in some cases already suffering notable percentage declines. The trendiest assets including TAN (solar energy) and TSLA mostly completed their highs early in 2021. We are frequently getting more new 52-week lows than 52-week highs for the Nasdaq even though the Nasdaq Composite Index remains very close to its all-time zenith, thus repeating a classic divergence which has marked U.S. equity topping patterns for decades.

In a bear market gold mining shares tend to be among the earliest sectors to complete their bottoming patterns.

Not many investors pay attention to precious metals and their producers, but funds including GDX and GDXJ had completed 7-1/2-year peaks on August 5, 2020 and entered downtrends which persisted for more than one year. During the 2000-2002 bear market gold mining shares (see HUI) were among the earliest assets to complete their lows on November 15-16, 2000, almost two years ahead of the Nasdaq's October 10, 2002 nadir. Gold mining shares (GDX) later completed an important bottom near the opening bell on October 24, 2008 while the S&P 500 didn't complete its final 666.79 low until March 6, 2009. Last year both GDX and GDXJ had bottomed on March 13-16, 2020 while most U.S. equities touched their lowest points on March 23, 2020. It is likely that the corrections for GDX and GDXJ, whether they are complete or not, will be followed over the next several months by key intermediate-term bottoms for nearly all equity sectors.

Bear markets tend to experience about half of their total losses during the first several months.

QQQ plummeted from a dividend-adjusted top of 104.99 on March 10, 2000 to 17.22 on October 10, 2002, a total loss of 83.6%. Very few remember the severity of this pullback which is likely to be repeated within the next few years, and even fewer investors recall that QQQ had lost 40% of its March 10, 2000 valuation by its intraday dividend-adjusted low of 62.95 on May 24, 2000. In similar fashion, the bear market which began from a similar top in 1929 had experienced roughly half of its total losses over a relatively short number of months.

Even investors who recognize stretched overvaluations and recognize the dangerous implications over the next few years are mostly complacent or bullish about the next several months when the downside risk may be especially elevated. Here is a chart of the 2000-2002 plunge for QQQ:

The previous pandemic featured a strong bull market followed by a severe bear market. A repeat is likely.

It is probably relevant that the bear market which began near the end of the previous pandemic on October 31, 1919 (the same calendar date as QQQ's top in 2007), and which continued for a total of 22 months, had completed about half of its total decline within less than four months by February 1920.

The bottom line: we have a sector rotation for U.S. equities which closely resembles the early months of several past severe bear markets. Good bargains will tend to occur earliest for those sectors which tend to bottom first, including gold mining and silver mining shares. Caution is warranted since the initial decline is often roughly half of the total bear-market loss and because U.S. stock-market valuations overall have never been higher. Near all 2021 peaks we have experienced both aggressive insider selling relative to insider buying along with all-time record equity fund net inflows, thereby confirming that the risk of being heavily invested today is highest when it is widely perceived to be lowest.

Disclosure of current holdings:

Here is my asset allocation with average opening prices adjusted for all dividends: 49.5% cash including TIAA Traditional Annuity paying 3% to 5% (only available for legacy retirement accounts) and Discover Bank high-yield savings paying 0.40% (available for all U.S. residents with retirement and ordinary savings accounts); 19.9% short XLK (112.7737); 17.8% long TLT (148.59); 16.8% short QQQ (301.724); 7.2% short TSLA (494.9721); 6.2% long GEO (7.65); 3.1% long GDXJ (43.826); 1.8% short ZM (293.16); 0.9% short AAPL (125.5481); 0.6% short IWF (223.0119); 0.5% short SMH (170.7813); 0.3% long UGP (2.94). It doesn't add up to 100% since short positions require less cash; there is no margin involved.