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Predictions for 2018

When reviewing our predictions for 2017, the biggest surprise was that we actually got a few right:

  1. Inflation begins to become a concern.
  2. U.S dollar peaks.
  3. Official U.S. deficit for fiscal year ended 6/30/17 exceeds $600 billion.

Yet the stock market ignored all of this bad news and rallied, with the S&P 500’s total return over 21%.  Large cap tech stocks did even better, reflected in the Nasdaq 100’s 38% rise.

Our picks for best performers on average outperformed the S&P 500 while the worst performers underperformed:


  • Wal-Mart (WMT): +46.56%
  • Dollar Tree (DLTR): +39.04%
  • Illumina (ILMN): +70.64%
  • Bristol Myers (BMY): +7.71%
  • Fertilizer stocks (POT, PHOR.ME)


  • Global banks (DB, CM, WBK): +16.06%
  • Investment banks (GS, JPM): +17.84%
  • Auto finance (AN, KMX): +6.41%
  • Municipal bond insurers (AGO, MBI): -21.88%
  • Office REITs (BXP, SLG, VNO): -6.41%
  • Retail REITs (GGP, O, PEI, SPG): -6.76%
  • Technology (XLK): +34.25%
  • Industrials (XLI): +23.99%
  • Chinese financials (CHIX): +53.60%

Our predictions for 2018:

1) The bubbles in blockchain, cryptocurrencies, and cannabis all burst.  Bitcoin ends the year under $5,000 (and possibly under $1,000).

2) Global bond markets continue the bear market that began July 2016.  The yield on the U.S. 10-year note, 2.40% to start the year, ends over 3.00%.  Government and corporate bonds sporting negative yields ($10 trillion currently) drop below $5 trillion.

3) Global stock prices peak in the first quarter.  The S&P 500, which hasn’t had a 5% draw down in a record 400 trading days, ends the year down at least 15%.

– best performers: genomic sequencing (Regeneron Pharmaceuticals), discount retailers (Target, Wal-Mart), retail roadkill (Bed Bath & Beyond), offshore drillers (Transocean, Ensco), natural gas E&P (Range Resources)

– worst performers: Tesla, global banks (Deutsche Bank, Westpak Banking, Canadian Imperial Bank), Chinese financials (CHIX), auto finance (CarMax, AutoNation), municipal bond insurers (Assured Guarantee, MBIA), office REITs (Boston Properties, Vornado), retail REITs (Simon Property Group, Realty Income), technology (XLK), industrials (XLI), infrastructure (Caterpillar, United Rentals)

4) The U.S. budget deficit goes from roughly $700 bil to over $850 by the end of 2018, despite an influx of repatriation taxes.  Higher debt service costs begin to become a concern.

5) Nascent global price inflation proves to be unshakable.  Gold and other precious metals benefit, helped also by less competition from digital currencies.  Gold mining stocks gain from the added tailwind of reduced costs relative to gold – especially fuel and equipment – and lower regulatory costs courtesy of the Trump administration.

6) Commodities will be a mixed bag with food commodities generally higher and economically-sensitive commodities lower:

– strong: coffee, wheat, natural gas

– weak: lumber, copper, crude oil

Canaries in the coal mine

  1. Several debt-fueled roll-ups have unraveled
  2. U.S. middle class consumer under stress
    1. Trump populism a symptom
  3. Creative destruction adding to woes of retailers
  4. State government finances under pressure
    1. Connecticut, Illinois, Kansas
  5. 35-year bond bull market ended a year ago


Traders buy the dip as Trumphoria begins to fade

There were two headlines about bearish sentiment on CNBC and Yahoo Finance this week that were classic.  CNBC claimed the fear gauge was “breaking out.”  Yet the VIX still shows plenty of bullishness (62nd percentile 10-year reading).  I pay little attention to the VIX: it’s mostly noise.  Far more important are the VIX futures 3 months and out.  The 3-month VIX closed the week at a 95th bullishness percentile.


Earlier in the week, this Yahoo Finance headline read: “By one measure, investors have almost never been this nervous about stocks.”  Reading the fine print, their methodology is flawed, even admitting that the cost of downside protection is cheap.  Delusional!


Buy-the-dip is so ingrained by 8 years of bull market behavior, hardly anyone sees any downside.  The crowd is rationalizing their behavior with talk of “fear” and “cash on the sidelines.”  All nonsense, of course.  This week assets in Rydex MMF dropped 13% to an all-time low $457 mil.


This all took place while the averages were breaking down with financials leading the way (XLF -2.63%).  On Fast Money at Thursday’s close, the fast monkeys were all foaming at the mouth to buy bank stocks!

Market timers remain all-in.  The NAAIM Exposure Index jumped 19% to 86.7%.  Among assets in Rydex bull and bear funds, just 7.6% are positioned for the downside, weighted for leverage.


I realize we shouldn’t get overly infatuated with market timing, but this “what, me worry?” behavior struck me as noteworthy.  So far, at least, this is very different from the breaks in August 2015 and January 2016 in which Rydex MMF balances and 3-month VIX futures spiked.

Predictions for 2016

“It’s OK to forecast the end of the world, but don’t ever give a date.” ~ Burton S. Blumert, 1929-2009


With that sage advice as a caveat, our thoughts on how 2016 might play out:

1) Global economy will be in full blown recession by the end of the year.  China leads the way, but the Euro Zone and U.S. not far behind.

2) Global equity bubble bursts, with the S&P 500 down over 25%.

– Worst performers: financials (global banks, auto finance, asset managers like BlackRock), technology (including highflying “FANGs”), REITs (especially those with exposure to shopping malls and NYC real estate), health care (heavily leveraged serial acquirers like Valeant, pharma companies with dubious patent protection, health insurers gaming Medicare), Chinese financials and real estate-related

– Best performers: Wal-Mart, food-related, fertilizer, defensive/consumer staples stocks in beaten down markets like Brazil

3) Euro zone bonds decline (yields rise), reflecting too much debt and too weak economies to service that debt.  German, Italian, French, Spanish bonds all decline.

4) U.S. dollar peaks

– Japanese yen surprise winner as speculative carry trades unwind; Swiss franc reemerges as safe haven – Gold holds up well and gold mining stocks outperform as costs decline (but sticking to high quality companies and royalty companies that control their owns destinies and don’t depend on rising gold prices); platinum and silver also do relatively well

5) A Republican wins the 2016 election as Dem experiment of last 8 years is discredited (50-50 chance it’s Trump).

6) Optimism and dip buying remain intact; Jim Cramer still working for CNBC; no more than 1 or 2 short selling hedge funds are launched.  Denial is still the order of the day.

7) Fed raises rates no more than 2 more times, then does an about-face.  The world’s central bankers begin to lose credibility and swagger (though still early in the process – no “Wizard of Oz moment” yet).  (Yellen & Co. may not even raise at all.)

8) Biggest winners in 2016: short sellers (though they are still treated by the mainstream financial press like pariahs).

Happy New Year, everyone!

Is market timing overrated?

Markets are hopelessly complex, yet many try to make them black and white.  “The stock market is a house of cards.”  “You can’t time the market.”  These become excuses to either put all your eggs in the macro basket or none at all.

What is more important, market timing, a sound economic framework, or getting the business right?  The success of Warren Buffett shows the value of the last.  Here is an example: Sanderson Farms, a poultry producer from Mississippi.  What does the chicken business have to do with business, credit, and market cycles?  Some, but not as much as, say, Goldman Sachs.  People eat chicken in good times and bad.  There are plenty of other factors that influence their business such as grain prices, bird flu epidemics, and export markets (the industry tends to take the brunt of trade tensions).  Since 12/31/97 SAFM has plodded along, growing revenue from $500 million to $2.9 billion today (10.4% CAGR).  Over that time, total return to investors was 13.8%/year.  Had an investor timed the market perfectly, selling at the top of the tech bubble in 2000, buying at the low in 2002, selling at the credit bubble high in 2007, and buying again at the low in 2009, his total return would have been reduced to 10.5%/year.

Timing is not everything… market timing, that is.

That said, the macro environment is as dangerous as any we’ve experienced.  But some companies will be fragile (banks, for example) while others will be robust, such as the poultry business.

Peak profits, stock prices?

Recently a respected colleague said our strategy was rational but markets, and the world for that matter, were highly irrational.  After participating in financial markets for the last 25 years I thought my experiences allowed me to see it all-wrong!  So after reflecting on our irrational state of affairs the logical side compiled some of the glaring data sets signifying a massive market top. 

First, a chart created by John Hussman ( indicates how much excess we’ve witnessed in corporate profitability vs GDP lately.  Keep in mind his data includes financials which to this day remain a subsidized black box.  (Click on image to enlarge).New Picture (1)

Of course this hasn’t stopped wall street from expecting further net margin expansion:


Profit margin growth

Before Wall Street follows Congress out the door for the holidays maybe they should scrutinize this:

profits vs labor

To derive this unprecedented profit picture both consumers and government went on a spending binge.  US national debt, through 5 years of record deficits, added almost $7.7 trillion to our balance sheet-can you say malinvestment?personal savings govt deficits profits


Now, if we remove the creators of financial alchemy we notice the real economy topped many quarters ago. 


Nonfinl corp profits

So if you care to break away from CNBS and look at the graphs above rational behavior would suggest profit taking and or short exposure.  In fact, it was just 7 years ago that many of these same signals were sent to the market yet we were labeled as the boys crying wolf.  If your timing is perfect the crowd labels you a genius but too early, a chump. 



Glencore, LinkedIn successfully complete IPOs today

And they were doozies!

Glencore began informal trading today at 530 pence per share, which quickly rose to 547 pence a share, valuing Glencore at GBP$36.7 billion, or $59.3B in USD, making this the largest-ever IPO on the London Stock Exchange. When we wrote about the impending IPO a few months ago, there was talk of the company issuing $7B USD at the time. Media reports now state that the share sale will raise $10B, with another $1B if an overallotment option is exercised.

Meanwhile, in the US, LinkedIn began trading on the NYSE today and shares quickly rose from the initital $45 per share offering price to (currently) trade at over $104 per share. According to news reports, this is the biggest US internet IPO since Google.

With under $300M in annual sales an a 2010 profit of $15.4M, LinkedIn’s market cap post-IPO is in the $9.5-10B range.

Glencore International, world’s largest commodity trader, considering $7B IPO

IPOs like this occur frequently, but not always, near the top of an industry’s underlying price ranges. From CNBC:

Glencore International, the world’s largest commodities trader, is signaling to bankers that it expects to issue at least $7 billion in stock as part of an initial public offering to launch as early as April, says someone familiar with the matter.

The Swiss trading firm, which is also heavily engaged in the physical production and marketing of oil, gas, wheat, corn, aluminum, nickel, and other raw materials, met with bank analysts in London as part of a two-day presentation earlier this week, according to several people who were briefed on the meetings.


The company carries a heavy net debt load of $14.8 billion, up from $10.2 billion last year.

Indebtedness and the strong need for cash in its capital-intensive trading business may be spurring Glencore’s desire for an IPO, say bankers and traders knowledgeable about the company. Glencore debt trades at junk levels, and its bonds were battered during the financial crisis, amid doubts about the company’s future creditworthiness.

Minyanville: Long term view of housing says sell

Lee Adler has put together a piece on the housing “recovery” over at Minyanville that highlights several disconcerting statistical trends related to the housing and labor markets. Below is a brief synopsis of that piece as well as some of the most telling charts:

  • As of 4Q 2010, 6.1 million vacant housing units available for rent or sale in the US
  • Another 3.6 million were held off the market (likely as bank REOs)
  • This shadow inventory could be released onto the market at any time
  • Together, 9.7 million vacant units
  • NY Fed estimates 4.5% of all 100 million US mortgages are “seriously delinquent”
  • This is an additional 4.5 million units that could be shadow inventory, bringing total available housing inventory to 14.2 million
  • Absorption rate of rental units has averaged 600,000 since 2006 and is tied to employment; even generous employment growth assumptions and a 1 million unit annual absorption rate means there is a 9.7 year supply of housing units on the market, not including the 4.5 million seriously delinquent mortgages

Some telling charts to accompany this data:

For the full story, please consult the rest of the article by Lee Adler, linked to above.

Zynga: Social Media Providing Rich Valuations, Or A New Hope?

(click to enlarge)

This chart compares the combined enterprise value (EV = Market Cap + Debt – Cash/Cash Equivalents) of the 4 biggest publicly listed video game publishers in the US, Activision Blizzard, Electronic Arts, Take Two Interactive and THQ, versus the current implied market capitalization of online, social game start-up Zynga. Because Zynga is not yet a publicly listed company, its debt and cash levels could not be found to create an EV. Additionally, the market cap is implied based off of a recent round of private fund-raising, whereby observers of the transaction can see the amount of money raised for a given percentage of the firm and then calculate what the total value of the firm would be by multiplying that value across the remaining fraction of the equity. For additional illustration, I have provided last year’s annual revenue figures for the two entities.

While Zynga has massive growth and is already a profitable company generating sizeable revenues (and mostly financing its expansion through its own cash flows), the huge multiple on market cap versus revenues versus the EV of the 4 majors is concerning. Such discrepancies seem to imply either that the 4 majors have a real, innovative challenger on their hands and the market is putting a premium on the start-up (or is that, up-start?) and its ability to grow and become the next big thing which simultaneously implies a discount for the value of the 4 majors, or it might reflect a level of exuberance and overall hopefulness of the social game provider that doesn’t accurately reflect material fundamentals.

We’ll keep our eye on Zynga and look forward to seeing what the future holds for this confident young gun, but in the meantime it’s our guess that the valuation chasm here is more reflective of Ben Bernanke’s monetary policies and the seemingly never-ending triumph of hope over bitter, painful experience.

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