Beards
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A Brief @Twitter Timeline Of My 11-Month Correction Beard

Late last September I made a vow:

I had been making the case here and on Twitter that the bull market was long in the tooth and there were many signs that could be waning.

At the same time, stocks, which normally have a 10% correction once per year, hadn’t had one since 2011.

Within days my wife sent me this:

But, in just 3 weeks after my initial pledge the stock market fell about 9%…

…until the Fed came to the rescue:

Then the Santa Claus rally took over.

E*Trade called me out, on my birthday, no less.

Then the heat on the beard intensified.

As the stock market made new highs, the beard trolling got pretty loud.

And as the beard grew longer and longer, the media began to take note…

…as did the most creative of technicians.

Then this past Monday the market finally cracked.

To be clear…

…I was just trying to make a point…

…and have a bit of fun in the process.

Mission accomplished.

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Druck Backs Up The Truck And Loads Up On Gold

Back in April I wrote a post titled, “how to trade like Stan Druckenmiller, George Soros and Jim Rogers.” It centered on a quote from Druck that really gets at the key to his incredible success in the markets:

The first thing I heard when I got in the business, not from my mentor, was bulls make money, bears make money, and pigs get slaughtered. I’m here to tell you I was a pig. And I strongly believe the only way to make long-term returns in our business that are superior is by being a pig. I think diversification and all the stuff they’re teaching at business school today is probably the most misguided concept everywhere. And if you look at all the great investors that are as different as Warren Buffett, Carl Icahn, Ken Langone, they tend to be very, very concentrated bets. They see something, they bet it, and they bet the ranch on it. And that’s kind of the way my philosophy evolved, which was if you see – only maybe one or two times a year do you see something that really, really excites you… The mistake I’d say 98% of money managers and individuals make is they feel like they got to be playing in a bunch of stuff. And if you really see it, put all your eggs in one basket and then watch the basket very carefully. -Stan Druckenmiller

The way Druck generated 30% average annual returns over a period of decades was by being a pig, by putting all his eggs in one basket and watching it very carefully. Considering he may be the most successful money manager alive, you may be curious to learn what Druck is buying today.

Well, you’re in luck! Druck’s latest 13F filing shows that he is currently backing up the truck and loading up on gold. In the second quarter, he bought over $300 million worth making it his single largest position. He now has more than 20% of his portfolio allocated to the SPDR Gold Trust (GLD). This position is more than twice as large as his next largest holding.

Clearly, Druck feels (as I do) that it’s time to get greedy in the gold market.

UPDATE: I just noticed that Stan also bought a sizable position in Newmont Mining, as well. What a pig. 

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One Of The Single Largest Buyers Of Equities In The World Could Now Turn Seller As A Consequence Of The Oil Crash

For months now it’s been popular to consider the oil crash contained, that is to suggest that it has no repercussions outside the energy industry. However, equity investors should take note that one of the single largest buyers of equities in the world may now become a net seller simply due to the oil price crash.

Due to its massive North Sea oil reserves (the busiest drilling site on the planet), Norway has prospered greatly over the past few decades. This has allowed the nation, despite its relatively small population, to build one of the largest sovereign wealth funds in the world. So large, in fact, that the fund now owns 1% of all the equities around the world (including nearly 2% of European equities, making it the largest holder there).

The oil crash has not been kind to Norway. And in order to maintain its spending to prop up it flagging economy, some believe the country may be forced to dip into its sovereign wealth fund. In other words, the fund has gone from being one of the largest buyers of equities in the world to possibly a net seller. Bloomberg reports:

If the government has to withdraw money from its $875 billion sovereign wealth fund, it will be a historical step. It’s either that, or heavily rein in fiscal spending at a time when the country needs it most. The state’s spending could start to outstrip income from oil, which it pours into its wealth fund for future generations.

To his credit, Marc Faber outlined this possibility at the Barron’s Roundtable back in January:

…sovereign wealth funds rose to $6.8 trillion as of September 2014, from $3.2 trillion in 2007. Of that growth, 59% came from oil, gas, and related revenue. As oil prices fall, what will happen to the growth of sovereign wealth funds, which have been buying financial assets around the world? Their funding is going to evaporate, and they might be forced to sell.

Clearly, there are larger repercussions of the oil crash than many currently believe. One of these is that oil-dependent nations, some of the most powerful players in the markets, have already been forced to halt their buying of equities. Considering their buying has been one of the major factors behind the powerful bull market over the past few years this is nothing to sneeze at. What’s more, these massive funds may even be forced into becoming net sellers.

Considering the demographic headwinds facing our stock market right now along with the already extreme positioning of margin traders, it’s hard to imagine any other source of demand being able to make up for the loss of these massive buyers…  or even to just soak up the supply should they become net sellers.

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Everything You Need To Know About The Chinese Stock Market Bubble

This post first appeared on The Felder Report Premium on June 20, 2015.

I’ve mentioned the Chinese stock market mania here briefly in recent weeks. I’ve now compiled a fair amount of data along with some interesting anecdotes that show just how crazy it’s gotten so I thought I’d spend this week’s market comment laying it all out for you.

The first thing I like to focus on is valuations. If the dot-com bubble is the gold standard, then China is a bona fide financial bubble. According to Bloomberg:

Valuations in China are now higher than those in the U.S. at the height of the dot-com bubble just about any way you slice them. The average Chinese technology stock has a price-to-earnings ratio 41 percent above that of U.S. peers in 2000, while the median valuation is twice as expensive and the market capitalization-weighted average is 12 percent higher, according to data compiled by Bloomberg.

Another way to look at it is to compare current valuations around the world:

I’ve made the case that US stocks are more overvalued than they appear due to the fact that the median stock is now more highly valued than ever. There’s now a very similar but far more dramatic situation going on in China. Again, from Bloomberg:

The problem with the Shanghai Composite is that 94 percent of Chinese stocks trade at higher valuations than the index, a consequence of its heavy weighting toward low-priced banks. Use average or median multiples instead and a different picture emerges: Chinese shares are almost twice as expensive as they were when the Shanghai Composite peaked in October 2007 and more than three times pricier than any of the world’s top 10 markets.

So if US stocks are expensive on a median basis, Chinese stocks are incredibly so. What’s pushed valuations so far is euphoria like we may have never seen here at home. More than any developed stock market in the world, China’s is driven mainly by individual investors rather than institutions. This means that it’s probably more influenced by what Keynes termed “animal spirits” than most. And boy are there signs of those “animal spirits” in China today.

The number of new trading accounts being opened is simply stunning. I don’t know if I’ve ever seen a more dramaticly parabolic rise in anything.

And they’re not just buying stocks with cash. They’re using an incredible amount of debt, aka margin financing, to leverage their purchases right now.

What I find so stunning is that there are really no margin regulations on individual trading accounts. Yes, the brokerage firms all implement their own sort of margin limits mainly to cover their own asses but the regulators essentially allow for infinite leverage. In other words, it’s 1929 in China right now. The regulators are now considering implementing a 4-to-1 ceiling. To put this in perspective, the SEC allows for 2-to-1 leverage for US investors. Still it’s pretty plain to see what exactly is driving prices higher right now:

Though they make up the majority, it’s now gone far beyond individual investors. The Wall Street Journal reports that some manufacturing companies in China have completely shut down their main operations and put their cash to work in the stock market. Fully 97% of the growth in manufacturers profits now comes from this source of “income.” It’s hard to fathom just how insane this is: Manufacturers realizing they can make more money trading each others’ stocks than actually running their manufacturing businesses.

It’s also the growing popularity of index funds pushing prices to astronomical levels. A great example of this was the recent trading in Hanergy and Goldin Financial. Here were a pair of stocks that everyone knew were extremely overvalued. But they grew to a size that required index funds to add them to their portfolios. Now consider those valuation statistics above. 94% of Chinese stocks are valued more highly than the index. How many of these have also grown to a size that requires them to be purchased by index funds? I guess we probably won’t find out until the dust settles.

And if you think all these new traders and index funds, which are clearly at the mercy of some pretty hot money, are long-term investors, think again.

These guys make our dot-com era day traders look like Warren Buffett. The Chinese stock market just set a record for the shortest average holding period in history, just one week.

For some context here’s what happened to Taiwanese stocks after they witnessed the sort of frenetic turnover now driving the Chinese stock market. They fell about 80% over the course of just 8 months or so:

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“So how did we get here?” you may ask. I’ll let the FT explain:

There is one sense, though, in which euphoria in mainland Chinese equities is unusual. Far from being an unintended consequence of policy, the authorities are egging investors on with articles in the state-run press seeking to justify extreme valuations. The People’s Bank of China has been busy cutting interest rates.

And they have not yet cracked down on the incredible leverage being used by individual investors. The powers that be in China have carefully cultivated this incredible bubble. The reason they have done so is that, after the huge boom they have created over the past 20 years or so, they are now facing a potentially huge bust, especially in real estate (sound familiar?).

John Hempton recently wrote a blog post about his personal experiences with the incredible over-investment in China that is now coming home to roost. It sounds like Potemkin Villages on steroids over there.

And companies have been continuing to lever up even in the face of a deteriorating economy.

…until very recently.

So the equity bubble is a desperate attempt to avoid or at least ameliorate the damage of the economic bust the country now faces. The FT reports:

Why, you might ask, would those charming officials in Beijing wish to encourage a bubble? A consequence of the investment boom is that many state-owned enterprises are lossmaking, while state-owned banks have lent excessively to these companies and to local governments. The authorities are urging them to lend more despite the fact that they will never be repaid in full. The obvious way to de-risk this dangerous game of extend and pretend is to recapitalise the state-owned corporate sector. Bubble valuations will make this easier and cheaper.

Will it work? That is the $64,000 question. Still, I think it’s fairly easy to answer. Every other bubble in history has ended the same way. It’s popped. For the Chinese authorities to think they can avoid these consequences is probably fairly naive. Still, their grip on power over the country may depend on it so I don’t expect they stop short of doing whatever it takes to keep the game going. Having said that, once sentiment turns against the markets, it’s probably impossible for anyone to stop it.

Hanergy may actually provide a decent example for what that looks like. Once the game was up, it ended in a flash – literally less than a second.

Amazingly, the person who may have take greatest advantage of the situation was the company’s Chairman, Li Hejun, who shorted a boatload of his own company’s stock just prior to plunge.

Li is not alone. Reuters reports that Chinese corporate insiders are selling at a record pace.

In May company insiders – senior executives or their relatives – sold a combined 1.68 billion shares, a tripling from April, and much more than in each of the previous months of this year, according to data compiled by Reuters… A similar trend was captured by an index compiled by Shenwan Hongyuan Securities that tracks major shareholders’ trading activities. The index surged over the past month, to a record high, meaning major shareholders are reducing holdings at unprecedented levels.

It looks like all those individual investors, manufacturers-turned-day-traders, and index funds are going to left holding the bag. Last week the market lost 12.5%. A few weeks ago I suggested the ETF below had potentially seen blowoff-type volume. Now I’m even more convinced. And I wouldn’t be surprised to see a Taiwanese-style bust over the next 6 months or so. sc-6On a broader level, if this is the end of the Chinese equity bubble it has major ramifications for every other market and economy around the globe. For this reason, I expect more market participants to start paying very close attention.

We’ll just have to stay tuned and see how it all unfolds.

Disclosure: I own put options on ASHR.

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Calling All Bulls

It’s no secret I’ve been bearish but in the spirit of seeing the other side of the trade, I’ve been looking for a compelling bull case for equities for some time now. So this is a call to all the equity bulls out there. I’m looking for someone to make a compelling case for owning the broad US stock market over the next 3, 7 and/or 10 years.

I’m using these timeframes because I’ve shown here that margin debt suggests 3-year returns could be very poor. Jeremy Grantham’s shop, GMO, believes 7-year real returns will be negative. And there are plenty of measures that suggest 10-year returns should be close to zero. In fact, if the Fed is right, and demographics do matter to asset prices, returns over the coming decade could be significantly worse than zero.

Here are the ground rules. Any bullish case for equities under consideration here should:

  1. Be more than just a trend-following argument. I know the uptrend is in tact but that, in itself, doesn’t mean investors are likely to generate positive returns in coming years.
  2. Do more than simply criticize the CAPE (which is not even mentioned above) or any other measure, for that matter. Debunking any of my previous studies is welcomed but that’s not going far enough. It should make the positive case for owning equities going forward.
  3. Demonstrate, using some sort of historically valuable (meaning more than merely one prior occurrence) measures, that equities will likely outperform the risk free rate over any of the aforementioned time periods.

Send your responses here. I’m eager to see what you come up with. I’ll select a few that meet this criteria for publication here.

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