Asset Allocation | Margin Rich

Inflation & Recession: Strategic and Tactical Reads

Posted on May 8, 2023 by Margin Rich

It’s probably safe to say that most people who play in any capacity in the markets right now, regardless of discipline, are feeling unsure. That’s why cash levels are so high. Treasuries and money market accounts are a go-to.

While at the same time, equity markets are resilient. Bond volatility is moderating, while liquidity is getting soaked up. Precious metals may be in for a breather right in time for everyone to lose temporary faith in the dollar. Could be more downside in oil and copper.

But not much. Oil has been consolidating in a tight range for what feels like forever, but $65-$70 should serve as a new long-term base for some time with plenty of macro-factors as tailwinds. Copper danced along $4.20 and appears to be correcting in time around that number. Everyone sees and understands what’s going on in copper, but it sure doesn’t feel like real capital gets it yet. The banks and trading houses will force a change of perspective for everyone as supply/demand fundamentals begin to grind the price higher for the “greening” of the world.

We’ve got the rest of Spring and the Summer for economic activity to surprise to the upside in the US, just like Q1. I think the positive animal spirits of consumers are going to catch a lot of investors sideways. Between low unemployment, the wealth-effect on a continued equities rally (after a pause), and the amplification of credit card usage, the US consumer is just going to want to enjoy the Summer with a sense of normalcy. That normalcy will translate to surprising economic strength through the Summer and into the Fall, despite all the leading indicators showing recession is baked in but not sharing when.

I surmise the end of Q3 or Q4 is when the consumer retrenches. And if that ends up being the case, forget about Santa’s rally. It feels like the Fed has reached it’s last increase to the critical 5% rate. Now it will sit on that to let the lag continue to wend its way through the economy. My guess is that the recession rears its head in the Winter.

However, since we only identify recessions after the fact, I suspect the Fed will sit on its hands to stimulate the economy via its usual methods until sometime in Q2 of 2024. Banks’ asset quality reserve the right to interfere with timelines. If West Texas crude is north of $90/barrel and copper north of $4.5/lb. then the Fed will be pulled in both directions. The pending elections will ensure that monetary stimuli are chosen over inflation abatement, as behind closed doors, one has to believe that “they” know inflation will not be curtailed but instead wash over the world in rolling waves for the rest of the decade.

That cat’s out of the bag. Actually, it’s more like a boxer trying to wrangle a chicken in a pen. Central bankers and politicians may nab it at some point, but not before a whole lot more price pain in commodities which should co-lead US Dollar repudiation as a reserve asset. Geo-politics will take care of the rest.

So 2024 brings potential recession and definite US elections. While the banks bring their exposure to CRE and an incomprehensible lack of cognizance around rates sensitivity to their credit portfolios. Should make for some spicy times that long-term, large capital probably won’t have the tactical agility to operate effectively in. This will present a constant stream of opportunities for prepared traders.

I thought the environment we’ve been in since inflation took off was going to happen after 2008. Many did, hence gold’s run after the GFC. Even though I wasn’t even born when the 70’s inflation kicked off and was only a toddler when it was finally snuffed out, I’ve been preparing for this investment environment that the world currently finds itself in.

In order for long-term capital to outperform during the rest of this decade, I think strategic hedging via tactical trading and exposure to less traditional asset classes will be critical. Despite their tough year in 2023, CTAs should continue to be a top performer through the 2020s.

All capital has to independently quantify what that looks like for portfolio construction. Basically, if a portfolio manager is sitting on long equity positions where basis and dividends say to hold and if their long RE holdings or other real assets that must be held during inflation were purchased with low WACCs, then it will be critical to allocate capital to volatility strategies where the asymmetric returns offset paper losses of the long-term holdings.

This mindset will not take hold en masse by nearly enough asset managers, but those that do take this approach will probably see their AUM thrive while others are bleeding.

The volatility has to be embraced, not forsaken, as it is a critical component in understanding capital flows.

So what does that mean for portfolio construction? Hold equity in high-quality, cash-flowing businesses with resilient brands and position at opportune times. No shit, right? Save yourself some time using YCharts visualizations of valuation-ratios. Between the financials and the trend(s) of EV/EBITDA, P/S, P/B, P/FCF, etc., one can save a ton of time on due diligence. One could have picked up some CLX and CRM several months ago right before 40% and 60% runs, respectively.

Novo Nordisk and Eli Lilly look like no-brainer long-term holdings and the hard/soft cycle of P&C insurance continues to present good opportunities, especially with rates stabilizing.

I like productive land or land with high optionality over buildings, but obviously buildings provide more consistent cash flows. The yield in multi-family will persist as supply/demand fundamentals in housing virtually guarantee it as long as the cost of capital was or is reasonable.

The recent action in precious metals has a hint of USD repudiation behind it. It just has that musk. Can’t explain it. Can’t quantify it. Just a feeling. But it looks and feels like precious metals time may have finally arrived. Riding shotgun will be crypto assets. Whether one believes it or not, the progress and development in Ethereum-based projects appear to be leading ETH to a potential seat at the table of reserves. Impossible to see how the protocol’s adoption rate develops, but between freedom of choice and potential ease of commerce, I can see how ETH’s price goes significantly higher from its relatively recent low of $1000/coin with the network effect already in place.

And of course…commodities. I think copper is the easy play here to have meaningful exposure. Between futures, trading houses, and large miners, there’s plenty of high-liquidity options that will allow one to capitalize on copper’s potential price rise.

The world is only at the early phases of inflation and electrification. It doesn’t feel like enough capital believes copper prices can move meaningfully higher. And that may be the case. Maybe copper just peaceably stays between $3 to $5/lb. for the next several years, but I don’t see it. The supply/demand fundamentals certainly don’t say it.

I like to rationalize copper’s potential against oil’s price action. In just the last 3 years alone, we’ve seen crude oil go from a negative price, where one was paid to take the most critical commodity on the planet off of the hands of others, to a high of $130/barrel. Everyone, everywhere uses oil and look at that volatility.

And yet somehow copper won’t be able to double? Or copper couldn’t move 50% higher from it’s high of $5/lb.? To me, these price moves seem very plausible. Very feasible. Exposure to this asset class appears poised to continue its outperformance in the coming years.

I contend that electrification and the build-out of infrastructure across the US will be how Main Street gets bailed out during the next crisis. Taxpayer dollars will be used to develop projects around these two key areas in order to provide critical jobs to large swaths of the population at a time when jobs may be hard to come by. Demand for copper should be even more inelastic and at higher prices. Then economics plus greed should take care of the rest in copper.

Elections. World war. Dollar repudiation. Inflation. Societal strife. Lagging and inconsistent monetary policy. Embrace volatility or potentially watch your return-profile lag this decade.

Credit Rumbles But Juice Left to Squeeze

Posted on March 22, 2022 by Margin Rich

Rising Rate environment. War in Europe. Inflation printing at levels seen 50 years ago.

Known knowns so they’re priced in, right? I suspect so.

Last week’s price action in equities is being widely viewed as a short-covering event. And there is a plenty of evidence to support that notion, which I agree with. But that doesn’t mean we haven’t seen a potential legitimate shift in animal spirits for risk assets, at least in the short term.

We’ve gone from 0.00% to 0.25% on the Fed Funds rate. Threats of an additional 50 basis points if and when needed at any of the next FOMC meetings and potential initiation of balance sheet runoff by the start of Summer

With 6 remaining meetings in 2022, you at least have a printed schedule of interest rate risk-events.

If the known knowns are essentially priced in, then how much volatility is left to sell and hedge? Which brings me to junk or rather high yield (HY). With the start of the year, the HY spread began to widen, but I suspect with current risks digested, people are still going to stretch for yield.

Over the past few years, each spread-widening event has been met with subsequent compression. Observe.

Why? Because interest rates are so low and capital requires yield. End of story.

Rates are still historically low and the Fed’s balance sheet liquidation process still awaits. This means liquidity. Recession risk is obviously rising as earnings will assuredly contract, but again, what’s priced-in in the short-term? I’d wager more than speculators suspect.

HYG is sporting a meaty 4.25% yield and a slight discount to NAV to boot at the time of article composition.

Sentiment in HY has reached an extreme, as observed in the HY McClellan Summation (courtesy of SentimenTrader). Observe an extreme not seen since the GFC.

Additionally, debt-volatility as measured by the MOVE (courtesy of TradingView) has begun to abate. Is the worst over? Not sure, but there’s enough signs to wager yes in the short-term at the very least.

Let’s take a look at HYG from a technical standpoint. A couple of things jump out. One, the buying thrust in volume last week (200M+ shares traded). Over the past few years, this level of green volume has typically led to solid, multi-week or month rallies as noted by the yellow circles. Couple failures (red circles) in 2020 as the world was being taught how to live with a pandemic. Different environment now.

HYG has also bumped down into it’s 150-week EMA. Nothing magical about that, but it did prove to be a stopping point at the end of 2018 when people were thinking the next GFC was upon us.

Huge risks are everywhere. None can be marginalized but they do have to be appropriately discounted and I think the markets are doing that now. If you’re looking for yield and maybe a bit of capital gain, HYG is worth a look at structuring a play.

Pride Goeth Before the Fall? – A Performance Review of 2021

Posted on March 1, 2022 by Margin Rich

It’s been awhile since completing a review of market calls made here at Marginrich.com. As my general knowledge of market inter-workings and crowd psychology has refined over the past several years increasing in nuance and depth, now’s as good a time as ever.

Let’s start with accuracy percentage and a list of the articles with basic details. Then I’ll provide a quick, detailed breakdown of each call afterwards down below. We’ll work backwards from the most current post, skipping 2 posts where I don’t make any directional calls or predictions.

Nine of the 11 asset forecasts between December 2020 and December 2021 were correct, for an accuracy rate of 82%. Stellar by any definition, especially for a free blog written in spare time. Each forecast was actionable via options, futures, the underlying asset, or simply raising cash.

Forecasts:

1. Trading Brazil – 12/12/2021: The Brazilian Real would strengthen against the US Dollar and Brazilian stocks were about to be re-rated higher. (CORRECT)

2. Options Markets Muting Signals – 11/20/2021: Trapdoor underneath stock markets and potential for a large selloff in the near future. (CORRECT)

3. Insiders, Metaverse, and Options – 11/16/2021: Options usage too extreme; quick & shallow selloff felt very close. (CORRECT)

4. I Can’t Fight This Feeling – 10/24/2021: Commodities sentiment extreme and due for a selloff led by oil with a rise in the US Dollar. (CORRECT)

5. If Everybody’s Thinking Alike, then… – 9/13/2021: Technically, I stated the cannabis sector looked as if it might be basing for a potential up-move. I didn’t actually make a directional call, but I’ll still own it. Same goes for EWZ, for which I actually did make a directional call 3 months later. (WRONG)

6. Volatility Interpretation – 9/1/2021: Volatility was about to show its face in stock markets. (CORRECT)

7. I Don’t Know Why I Talk About Crypto in a Public Setting – 8/30/2021: Ethereum on the verge of another run upwards. (CORRECT)

8. The Best Part of Waking Up – 7/22/2021: A correction in coffee was imminent. (CORRECT)

9. Bitcoin – A Quick Technical Read – 7/16/2021: I thought BTC had one more puke-dip into the $20k range, anywhere between $21k and $29k. Major whiff. My article actually bottom-ticked that particular correction before BTC went on to return over 100% within 4 months. (WRONG)

10. Oil Taking Its Breather…Finally – 7/7/2021: Oil correction had begun (not obvious yet) and XLE would sell off accordingly. (CORRECT)

11. Beware the Secular Trend’s Short-term Counter Move – 12/28/2020: The Euro/USD pair had reached an extreme point and a USD rally looked primed, which would coincide with potential fear-events in the equity markets. (CORRECT)

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So that’s the quick and dirty. Keep reading below for a bit more detail and to view the charts better illustrating each forecast. Each chart will have a yellow circle denoting the date the article was published.

Trading Brazil:

Calls on EWZ were the chosen expression for this trade. Pre-tax return was 100% in less than 2 months. While everyone has been focused on energy, I focused on an EM component that looked ripe to provide a kickstart to 2022 trading.

Real strengthening vs the USD. Any reader could’ve bet futures here on the currency pair for a tidy profit.

Options Markets Muting Signals:

This particular article actually top-ticked the NASDAQ Composite, but I didn’t go short here. Hindsight being what it is, I should have, but instead I simply raised cash levels for the opportunities that are currently availing themselves.

My focus was on the NASDAQ in this article however one has to include the S&P 500 if one is going to comment on general equity markets. No top-tick as there was a bit more demand for the S&P 500, but within a matter of weeks, the trapdoor opened for this index, too.

Insiders, Metaverse, and Options

You could almost smell the move coming, like a turkey basting for hours. Then, Black Friday delivered a little fear for the unprepared. No trade here as raising cash was the strategy, and the ensuing rallies assisted with that process. Going short up until the past few months was a dangerous endeavor and understanding option flows was and is critical.

I Can’t Fight This Feeling

That little 11% jaunt downward in the underlying ETF over the next month resulted in a 135% pre-tax return on simple Put purchases. Of course, energy as a sector is a different beast entirely now, and along with inflation, the Russia/Ukraine conflict has put commodities front and center of the financial space again.

The US Dollar followed it’s typical anti-correlation to commodities by rising. Since that initial run upwards, it has chopped in this uncertain environment. I suspect the ultimate, long-term path is downwards for the USD, but that’s a philosophical discussion for another time.

If Everybody’s Thinking Alike, Then…

Ugh, what else needs to be said? This one is ugly. To reiterate, I did not actually make a directional call or bet here. I simply thought that the bear market in cannabis may be reaching a nadir. But investors and speculators had other ideas as the market pounded this ETF for an additional 50% loss subsequent to publishing the article.

Volatility Interpretation

The article literally bottom-ticked the VIX. Unfortunately, I didn’t directly trade Vol here. I used the ensuing volatility to pyramid some positions in the long portfolios.

I Don’t Know Why I Talk About Crypto in a Public Setting

Those percentages in the chart above were from the publishing date of the article (yellow circle). The actual moves were, 20% as annotated for the first ascent, then a quick 50% downdraft followed by a 75% spike. If you ignored ETH in 2021, or crypto period, then you missed some of the best trading opportunities of the year.

The Best Part of Waking Up

Coffee was the gift that kept on giving for about 4 weeks in late July through late August, before squeezing out of an old school pennant to what seems like non-stop upside. The initial trade was simple Puts on the JO ETF for a 40% pre-tax return in a week. Then I was able to scalp 20% in a week out of JO with some Calls before finally squeezing the last bit of Put juice for 10% in a week before THE breakout in coffee.

Subsequent to those trades, I did overestimate the extreme in buying-sentiment and underestimate the impact of the freeze in Brazilian crops. Consequently, I gave back a bit of the profit with additional Puts and failed to capitalize on the ensuing multi-month rally as a result of my bias. All additional lessons at a fair tuition price.

Bitcoin – A Quick Technical Read

I darn near bottom-ticked BTC with this particular forecast. So wrong! As BTC goes, so goes the crypto markets so it wasn’t long before I was pursuing the other opportunity as noted above. As has been said countless times by countless players, trading is all about managing risk (control losses & maximize gains).

Oil Taking Its Breather…Finally

Oil (West Texas Intermediate) was overdone. I top-ticked the high in July on the day of publishing and was fortunate to estimate an unsurprising 20% sell off in the commodity.

I favored Puts on the XLE as the expression for this trade and the market rewarded me with a 100% pre-tax return in under 8 weeks.

Beware the Secular Trend’s Potential Short-term Counter Move

I published this article in the midst of what felt like virtually everyone expecting the “obvious” demise of the USD. The dollar’s imminent demise down into the $80’s has since proven to be fallacious logic. Its haven status as the world’s reserve currency has kept it afloat and demand will probably keep it there for some time until internal and external geopolitical/economic events shift perceptions and capital flows.

Once again, the anti-correlated pairing could’ve provided currency traders with an exceptional opportunity. Admittedly, I failed to take advantage of this potential trade with a currency pair expression.

What I did do was expect more intense volatility. As such, I purchased hedges which ended up costing me insurance premiums as the S&P 500 simply chopped for a month before continuing onward and upward. Sure, I was correct about some volatility but wrong about the amplitude. Still though, I contend that the price paid for peace of mind was worth it.

It’s my sincerest hope that if you’ve read this full performance-review that my skills and experience are apparent. I’m not some wannabe, greenhorn daytrader posing as a professional. Although I mostly showcase my technical analysis skills here at the site, I’ve honed my fundamental analysis skills for all asset classes and sectors. Over the last 20 years, I’ve poured my heart and soul into building an amalgamated skill set around a professional-level understanding of investing, finance, banking, currencies, economics, accounting, business operations, sales, geopolitics, crowd psychology of markets, leading/managing/coaching, and asset management.

Now I’d like to test those skills in the appropriate arena. If you’re here just to have a read, I hope you’ve enjoyed. I’ll continue to intermittently share actionable thoughts. But if any readers from the professional, financial space are interested in how I can benefit their organization, please don’t hesitate to reach out. Email address is listed at the menu button in the upper-right of the screen. My LinkedIn profile can be accessed at the About page by clicking the hamburger in the upper-left of the screen.

Here’s to a fruitful 2022 for any and all readers of Marginrich.com.

I Don’t Know Why I Talk About Crypto in a Public Setting

Posted on August 30, 2021 by Margin Rich

0 for 2. That’s my hit rate in publicly forecasting bitcoin price action. Crash & burn.

Can’t get everything right. That’s trading. You just have to manage risk within your directional bias regardless of the asset class.

If you read my piece from mid-July on BTC, then hard and major props to Katie Stockton and her team at Fairlead Strategies. They literally bottom-ticked the bitcoin price.

Although from a short-term standpoint I’ve made a couple of idiotic calls on BTC, I firmly believe in the long-term potential of blockchain technologies’ disruption.

“Metaverse” is being bandied about lately as if the Oasis will be online by Christmas, but that is a major, major area where blockchain tech has the potential to install itself at the heart of a new-ish digital economy.

And if so, then early on it appears Ethereum may be the killer app. Too early in the game to tell, but ETH looks like the stallion to bet on based on wide usage as the foundation for so many trustless applications. It’s not about investing in a “currency” to replace the USD. It’s about investing in the future of commerce.

Or at least that appears to be the path. Why else would the largest of largest Silicon Valley angel veterans be investing in the space? They don’t appear to be worried about contributions to the “enabling” of cybercrime empires.

To crypto nubes, maybe this is enlightening. To crypto vets, this is all old news.

Now let me take another shot at a crypto price projection and see if I can’t get my batting average up to .333. Worse case, my commentary can be readily identified as anti-correlated to BTC & ETH price action and I go 0 for 3.

TradeSmith has a timing service for assisting with forecasting various asset classes. The premise of the service is that everything follows a cycle. Everything. And once a cycle is recognized then TradeSmith’s software can make a best guess on future price action.

Below is a chart of the Grayscale Ethereum ETN (ETHE) using that forecasting tool. It’s not about amplitude; just general direction. The composite forecast line (purple) shows an interesting set-up for the ETN. Observe the green lines denoting the upward advance within the last 2 cycles.

Are we on the verge of another possible run upwards in Ethereum? Current action and sentiment sure seem to be lending themselves to the notion.

After recently commenting on Mark Zuckerberg and Jack Dorsey to Bloomberg, Vitalik Buterin’s shared a vision for ETH:

And he continues to have big plans for the Ethereum network. When asked where he sees it in five to 10 years, Buterin replied, “hopefully running the metaverse.”

Beware the Secular Trend’s Potential Short-term Counter Move

Posted on December 28, 2020 by Margin Rich

Right now the markets are at extremes. Essentially all of them. Current price action across a broad swath of sectors and assets classes strongly reminds me of the end of 2019 and beginning of 2020.

My gut tells me that a fear-event is near. And my gut is being primarily led by current action in the US dollar. Short positioning in the buck is extraordinary.

Yeah, yeah, macro-top-down, commodity bull, central bank largesse, and all that in regards to the USD but this is egregiously exaggerated. Not that it can’t get more extreme, but consider the following charts.

Seasonality, courtesy of SentimenTrader, tends to be pretty strong in January for the buck.

With currencies, large fast moves in a short period are atypical but we live in a time of atypical. Pairs always have to be acknowledged and the anti-correlation to the euro is at a bit of an extreme. In the last decade, every time the Euro to USD line (white-monthly) has approached 2 standard deviations above the 25-month MA, then it’s been go-time for a USD rally (green).

Does this mean a reversal is imminent? Nope. Does it mean additional portfolio hedging here is warranted? I’d say it’s a prudent use of capital.

The long-term case for the dollar’s demise is well documented. Goldbugs have been the longstanding voice of fiat destruction, but more recently, Ray Dalio has picked up the baton. Sam Zell has now officially thrown his name in the dollar-destruction ring with this recent quip.

The single greatest risk that we are dealing with today is the loss of the U.S. dollar as the reserve currency. If we keep doing what we are doing right now, I think it is 10 or 15 years away.

These investment legends are right. The USD will in all probability lose 30% to 40% of its reserve status this decade. And world markets as well as geopolitics will be volatile as a result.

Why do you think Bitcoin has jumped so hard? That’s institutional fear of central banking monetary policy, not retail FOMO driving Bitcoin. It’s palpable, but it’s ahead of itself in the USD and Bitcoin.

Nothing moves in a straight line and short-term counter spikes in any trend are as sure as sunrise. I’m not implying that a fear-event has to rival Covid’s March spikes or we’re at a long-term top in equities. Just saying that a short-term move to remove some excess is worth hedging at this point.