This Week in Barrons – 12-11-2016:
Are we trying to pick a winner, or just going all in?
This week was the 20th anniversary of the phrase: ‘Irrational Exuberance’, and it couldn’t have come at a better time. The markets are pricing-in a perfect first 100 days of a Trump Presidency. This is drawing in more and more retail investors, and as the retail investor begins to become more involved – the professionals are taking profits and moving to the sidelines. The retail investors are cashing in their fixed-income chips, and doubling down on economically sensitive equities – failing to recognize that global financial markets are extremely complex, and virtually unpredictable.
CW (of Rockhaven Capital Management) pointed out a recent coin flipping experiment performed by Professors Victor Haghani and Richard Dewey. It seems that the professors built a coin that had a 60% chance of landing heads-up, and a 40% chance of landing tails-up. Each of the participants in the study had an advanced finance or economics background, or was a young financial industry professional. The participants (made to resemble the average educated retail investor) were given $25 and told: (a) to play for 30 minutes, (b) to bet as much as they want on each toss, and (c) to quit after they win $250. They knew the rules, and even knew that ‘heads’ had a 60% chance of winning. The results were stunning:
- 28% went bust,
- 5% ended with less than $25,
- 32% had between $25 and $100,
- 14% finished with between $100 and $250, and
- 21% maxed out at $250.
It seems that:
- 28% of the pool of young, educated, financial professionals actually lost everything in a simple game that was massively rigged in their favor.
- 30% of the participants actually bet their entire bankroll on a single flip giving themselves a 40% chance of being completely wiped out.
- And even though the probabilities were quite clear and the optimal strategy would be to NEVER bet on ‘tails’, 50% of the participants bet on tails at least 5 times (each) anyway.
The lesson to be learned is that when the retail investor enters the market – the market is closer to the end than the beginning. Keep some of your chips in reserve, and place your bets only where the probabilities are in your favor.
“Should I stay, or should I go?” … The Clash
Since the day Trump got elected, it's like the world swallowed a huge dose of ‘feel good’ medicine. Business confidence went from 38% to 65%, consumer confidence hit new highs, and the stock market is acting as if the up-coming year will be nothing short of amazing. We are experiencing the most powerful post-election run-up in history due to a convergence in:
- November through January being the strongest market period of the year,
- The normal post-election market run-up, and
- Our citizens believing that someone is actually working for them again.
But this rally is different from both the Internet bubble that ended in 2000, and the housing bubble that ended in 2008. This is a rally rooted in: credit, debt, hope, and outsiders. In 2000, the entire run-up was based on the idea that profits didn't matter because we had just given birth to a new technology called the Internet. The 2007 fiasco was a study in fiscal unsustainability – as $600k homes were being sold to minimum wage employees. Both market collapses were fairly predictable. But this time, we are soaring on the hopes that trillions of dollars in debt can be recouped by changing so much policy that companies come back to the U.S., hire workers, pay them more money, and we actually work our way out of this mess. After all, we are $20T in immediate debt, and over $100T in debt due to unfunded liabilities. The ‘gotcha’ here is that we are still a functioning nation. The $64M question becomes: Can we continue to thrive as a nation, halt the ‘Mad Max’ scenario, and slowly dig our way out over the next 15 years? I still think some form of global reset must come into play because mathematically debts that can't be repaid – won’t be repaid.
Market experts will tell you that markets look forward and price in elements 6 to 12 months in advance. But where were these same pundits warning of a market collapse in November of 2007 when the S&P and the DOW were putting in all-time highs? Because just 10 months later the DOW was down over 7,000 points from 14,000 to 6,600. The current market is way out over its ski's, and it wouldn't take much of a hiccup to yank it sharply lower. Both graphs below (the AAII Bullish Sentiment indicator and Professor Shiller’s CAPE market valuation ratio) are flashing cautionary pre-2008 and pre-2000 signals. But this market has minimal overhead resistance, so how far it runs is anyone's guess.
Under President Trump there are several, generic market trends:
- RATE Increase(s) – The FED meets on Wednesday, and it’s fairly clear that a rate hike is coming. I’m looking for only one more in 2017.
- DOLLAR Strength – This increases earnings of companies that sell ‘into’ the United States – like global mining and materials stocks (ETF = PICK).
- INFRASTRUCTURE Fiscal Stimulus – Spending over $1T over 10 years on infrastructure will match China’s $2T infrastructure spend (ETF = IGF).
- TAX Cuts – By cutting the corporate tax rate from 35% to 15%, every effective 7% tax reduction – raises S&P earnings by 9% (ETF = SPY).
- REGULATION demise – Fewer regulations will lower costs and boost the profits of the energy industry across the board (ETF = XLE).
- TAX Repatriation – By enacting a 10% overseas tax rate, 79% of those new corporate profits will be used for stock buy-backs (ETF = XLK).
Before we drink too much ‘Kool-Aid’, SF sent me a Washington Post article showing that Senior Defense Department Officials suppressed a study documenting $125 billion worth of administrative waste at the Pentagon out of fears that Congress would use its findings to cut the defense budget. The report, which was issued on January 2015 by the advisory Defense Business Board (DBB), called for a series of reforms that would have saved the department $125 billion over the next five years.
Again, maybe this romp higher is just the stock market's reaction to Trump’s ‘No B.S.’ style of leadership. But be careful, because what the market is reacting to right now – may or may not come to pass – and that’s the big gamble.
Many of you have written asking me what websites I review on a constant basis – here are some of the financial ones:
- Forexfactory.com = I appreciate its trading calendar.
- Finviz.com = It has a great stock scanner and heat map for day trading.
- Miningfeeds.com = It has information on all of the metals.
- IFTTT.com = I use it to send myself free reminder texts on anything.
- TradingEconomics.com = I use it for global economic information.
- Stocktwits.com = I use it to measure bullish and bearish sentiment.
- Oanda.com = I like their heat map for longer term currency trades.
Barrons came out with a ‘Top 10 Favorite Stocks for 2017’ list and it includes: Alphabet / Google (GOOG), Apple (AAPL), CitiBank (C), Delta Airlines (DAL), Deutsche Telekom (DTEGY), Merck (MRK), Novartis (NVS), Toll Brothers (TOL), Unilever (UL) and Disney (DIS).
Not to be out done, an analyst community came out with their own top 10 list comprised of: Mallinckrodt Pharma (MNK), Endo Pharma (ENDP), Hanesbrands (HBI), Edwards Lifesciences (EW) Mylan Pharma (MYL), Allergan Pharma (AGN), Alexion Pharma (ALXN), Activision (ATVI), Salesforce.com (CRM), and NRG Energy (NRG).
Over this coming week I’m watching:
- SPX – if it breaks over 2261 it could run all the way to 2300,
- IWM – a move over 141 could signal another turn higher,
- SPX’s Put / Call ratio is under 0.7 signaling a fair amount of call buying. This is often a cautionary flag showing that there are no buyers left to buy – leaving only ‘sellers’ in the stock. And more sellers than buyers often predicts a ‘top’.
- WYNN and LVS – sell Put Credit Spreads because all of the panic sellers have vanished over the Macau news,
- CMG – bought a Call Credit Spread on a move downward to 370,
- PLAY – sold a Put Credit Spread and bought a Call Debit Spread – looking for a move up to 60,
- TSLA – bought a Call Debit Spread – looking for a move up to 195,
- FB – bought a Butterfly – looking for a move to 120,
- For this Wednesday’s FOMC meeting, I am buying straddles in: Gold (GLD), Bonds (TLT), the Euro (FXE) and Goldman Sachs (GS). I’m looking for the market to display a ‘Buy the Rumor, Sell the News’ behavior. I’m looking for a rate increase this week by the FED – which will spark an initial run higher in the financials and the dollar, and an initial drop in bonds and gold. This spike higher will allow me to sell the financial and dollar straddle calls, and sell the gold and bond puts. Then profit taking will allow me to sell the financial and dollar puts, and sell the corresponding calls in gold and bonds.
- This past week we had the VIX (the market volatility indicator) moving higher along with the markets. This simply signals increased nervousness surrounding the markets. It’s not impossible for this to happen – just rare.
To follow me on Twitter.com and on StockTwits.com to get my daily thoughts and trades – my handle is: taylorpamm.
Please be safe out there!
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