Personal Finance | Margin Rich

“It’s not what you don’t know that kills you, it’s what you know for sure that ain’t true.”

Posted on December 3, 2020 by Margin Rich

I return to this statement over and over as I play the markets. Mark Twain had unending wisdom. The speculating public, usually not so much. November’s stock market returns were a delightful 10% for the S&P 500 and an eye-watering 18% for the Russell 2000; thank you very much hard and fast sector rotation.

Despite this, ambiguity still reigns supreme currently. Context is critical. So does the ambiguity matter to long-term investors? No. But if you’re swing trading any asset classes in these markets then the ambiguity matters a whole lot.

Let’s use some simple, classic technical analysis to better illustrate how muddy the waters have become. We’ll start with the S&P 500. Depending on your trend-line bias, there’s a few different ways to perceive current action.

It looks like a very legitimate breakout. It’s been a hard chop since late July, but I thought we might see yet one more leg down to the high 3100s or low 3200s. The reason for this was the curious inter-market activity among various asset classes. Typical correlations weren’t holding up in November and the breakout just felt fake. But therein lies the problem of using “feel.” Obviously, I don’t just go with the gut when allocating capital but it has often paid to at least listen to it.

We know that one major, semi-new factor driving markets is option activity. Never before has one had to care so much about option Greeks to simply trade the underlying. Observe the enormous rise in single-equity options premiums as a result of the tidal wave of buying, most of that in Calls by retail and institutional.

Options activity has seen market makers make unparalleled purchases in the underlying stocks in order to hedge their Call sales books. As a result, volatility has chopped right along with the markets as moves have been fast and furious. So where is volatility possibly headed next? Again, the trend lines paint a couple of different pictures.

We have the current liquidity flood and more coming in 2021 to support fund flows into risk assets. There’s also the beginning of a sector rotational move into value. I don’t think that’s a done deal yet. I think growth i.e. tech still has legs left. I hypothesize that the bounce in energy and small caps is only the first strike of sector rotation, but the growth of SaaS and big tech will soon parry in 2021 which should stunt recent returns in energy and small caps…at least temporarily.

The one asset class that continues to dominate my thoughts is the US dollar. I’m reading tons of obituaries. They feel premature. A swift move up to the 95 area would not surprise me here; swift relative to its usual multi-month cadence. A “swift-ish” move in the USD would drop a hammer on commodities, which wouldn’t bode well for the recent rotation into energy.

The grains and sugar have been on an unfailing tear upwards. Typical COT activity would have already seen correlated reversals in these crops. I’ve seen insinuations that perhaps we’re in a regime change for those specific assets, but like the death of the dollar, that innuendo feels a bit premature.

For my own long-term portfolio of equities, I continue to evaluate the plays that many deem to have great forward looking prospects as not only technology evolves but society as well. They may seem obvious, but it’s hard to shake what a well chosen play can mean for the potential of a portfolio. This means gene-editing, cutting edge biotech, AI, data dissemination, and two of the oldest vices on the planet with tremendously long runways as a result of only barely being legitimized.

In the short-term, I think the commodity shorts present a most compelling current opportunity but so much rides on the USD’s anti-correlation.

If you really want to generate some returns with equities, consider after hours trading. This has been widely reported on for a few years now, but just look at a recent chart put out by Bespoke to truly illustrate the marked difference in strategies.

Of course, 2020 has flipped that on it’s head. See below, but after-hours is starting to reassert it’s dominance.

Stay sharp. Recent choppy action may not be over just yet. And with everyone predicting an amazing 2021, including myself, it might just take a little time to get the real momentum going next year.

Are You Prepared?

Posted on August 12, 2016 by Margin Rich

Fear sells. It’s one of those unfortunate, steadfast truths of life. Just look at the rise of politicians like Trump and the other fear mongers around the world. Look at the news. People love to be scared.

Fear is not what I’m selling. Rational thinking. Clear analysis. Proper asset allocation. But mostly, cognizance and comprehension. These are concepts being sold in today’s post.

I wanted to take some time to break down how I think this current economic-business-investment cycle, which started off of the 2009 lows, reaches its peak. This post may be a bit lengthy, so consider yourself duly warned. Read it in chunks if the need to go catch a virtual critter or watch some naked dating is simply eating at you like a heroine withdrawal.

In a world where blog readers want the meaning of the universe in under 800 words, this post will take some time to layout how arguably the most important component of the banking system works. Specifically, I want to visit swaps, repo, and the collateral needed to fund the whole party. I want to explain for the people that don’t know; the lay people. People that have no idea about finance, accounting, and economics. People that watched The Big Short and have an inkling but need a legitimate breakdown of what’s really going on in the financial system.

What’s most annoying for me about the investment fear mongering today is that there’s no clear how or why we can expect a major market crash across all asset classes. Numerous potential causes are cited. Some say extended valuations. Others say central bank intervention has lost it’s efficacy. Still, others say a black swan will reveal itself to cause entire markets to be re-priced.

These are rational, true hypotheses and I agree that all three will hasten a great crash, but the fact of the matter is they all fall under the umbrella of debt. Debt was taken off of the private balance sheets(publicly traded entities) and shifted to the public balance sheets(sovereigns). All the owners of associated derivatives tied to that debt were either made whole or have continued to utilize the current system to keep the party going.

Worldwide debt levels are and will be the cause of the next crash. Debt sits like a boa constrictor with its coils wrapped around the world, slowly squeezing the economic life out of all markets. Think of the snake in The Jungle Book cartoon with its mesmerizing eyes. “Trust in meeeeeee.” Debt beckoned and the world heeded the call, only now there’s no escape and it’s getting harder and harder to breathe.

This is sort of a revelation for some who are just beginning to truly understand the error of the central banking cabal’s ways. The negative rates. The buying of investment grade assets and equities with taxpayer funds. The backstopping of public, systemically dangerous banks with taxpayer funds. The waterfall of money creation. The thought process that more debt on top of debt will somehow cure a situation caused by excess debt.

At this point of the post, any pros reading this are probably rolling their eyes and thinking “Go buy another gold bar you doomsday schmuck.”

No matter. I want my friends, family, and financially unsophisticated to gain some insight.

Where’d all this debt come from? It went from the private coffers to the public coffers. From the publicly-held, systemically important financial institutions (“SIFI”) to the central banks. And now that the developed sovereigns are sitting on all of it and then some from the 2008 system-save, the SIFIs have continued their unaccountable ways and the financial system is sauntering closer to the edge.

There’s nobody for the central banks to turn to. There isn’t an intergalactic central bank out on the edge of the solar system just waiting to be a lender of last resort to planets where the dominant sentient species decides to muck the whole financial system up.

Why did every single SIFI have to survive (except for Lehman, of course) after 2008? If the banking system blows up, there’s zero way to process sales transactions? People aren’t going to continue buying at Wal-Mart, Amazon, Kroger, and other retailers? Oil won’t be burned? Businesses will never hire and never expand again? Tightening the belt is not the same as eliminating altogether, but that’s not the picture painted by the players in control.

Just ask Charlie Munger or any other uber-wealthy and they’ll tell you how close the whole American system was to utter annihilation. It’s easy to take that stance when you have rainy day cash in the billions just waiting for an investment yielding 10% with a 100% government backstop.

The people that constantly state not to bet against American resiliency and determination, did just that by supporting SIFI bail-outs.

But those who lean towards the Austrian school of economic thinking, have long had a grasp on the consequences of current central banking Keynesian policies. And those consequences are now beginning to painfully avail themselves to a larger and larger percentage of the world’s population.

The good news is that the crash is not imminent. I know this because investor psychology dictates that we have a last-gasp, melt-up in the broader stock market. Not to mention, everybody is currently inclined to say that the game is over right now. Sell everything!

As I’ve said before, bull markets don’t end with everyone staring right at it while expressing their negative sentiments. We’ll need that final push upward in the S&P 500 to the range of 2,400ish. Who knows? Maybe even higher, but about 10% to 15% higher than 2,125 which proved to be such a strong area of resistance.

If you’re strong of gut, stay positioned to the top. If prudence guides your investment principals then it is way past time to have begun increasing cash levels.

When nobody’s looking, something’ll go down over a weekend; a major event or perhaps some sort of Western government proclamation. And on Monday, panic will likely ensue to get the real party started.

It’s been suggested that it will be the banking system, specifically a major bank such as Deustche Bank or an institution of similar magnitude that will stop the music. I disagree.

I think it’s going to be a country. Either via a currency policy error or an outright repudiation of debt or both or some other ill fated decision involving a SIFI, but I suspect a major developed country will be the entity that kills the dance music via a one in “ten-thousand year” tail-event.

The system-altering crash is not going to happen tomorrow. Crashes are like being pantsed. A pantser doesn’t pull down the trousers of the victim while the potential pantsee is looking them right in the eye. No. A pantser waits until the pantsee is not looking and in a position for considerable embarrassment before striking fast to yank down the pantsee’s trousers, inflicting maximum damage to the victim’s psyche.

That’s a market crash in a nutshell.

So investment portfolio’s are safe for now, but let me share some charts just to get readers’ old fear-juices flowing. Gotta break the monotony of my prattling.

It’s critical when making comparisons to previous market-tops to only go back about 18 years, because that’s when true financialization took over the world with the passing of Graham-Leach-Bliley. That gave immeasurable power to the banking system and set us on the path we’re currently on. Everything before that was during an entirely different era. Sure, you could point to 1971’s USD unhitching and the creation of the credit destiny or 1986 and the MBS birth or Greenspan’s run, but the lead-up to the Dot.com crash is my preferred beginning comparison point.

The first chart I’d like to share is the divergence between earnings in the S&P 500 and the performance of the S&P 500 on a monthly chart with the Ultimate Oscillator (“ULT”). You’ve probably already seen this one in some iteration around the web. Am I the only one that thinks that divergence in earnings and the index’s price action looks a little off?

Yes, the index is sitting right at new highs while earnings continue downward, but look at the ULT. The depth and duration the indicator is hitting has only been seen two other times in the last 20 years…subsequent to the 2000 and 2008 market crashes. And yet here we are at highs across multiple financial assets classes and no recession in sight.

PHEW!!! We’re good then. End of post.

Actually, let’s look at another chart, courtesy of SentimenTrader. Want to know what those red arrows indicate? Then buy a subscription to Jason Goepfert’s site. It just may be the best research value available. SentimenTrader’s value is so good that I’d liken it to a stock with a $5 billion dollar market cap that trades for less than the cash on it’s balance sheet. It’s that undervalued.

Those arrows indicate each time in the last 25 years that the S&P 500 was within 1% of its all-time high and margin debt was more than 10% below its all-time high. Definitely ominous, but ultimately may mean nothing, however I’m willing to bet that this signal is far from meaningless.

Feel reassured about your current asset allocation yet? I’ll wager that you don’t have nearly enough exposure to the precious metals space.

Ready for another scary picture?

Back in May of this year, Michael Harris of the Price Action Lab shared a post about his Bear Market Probability indicator (“BMP”). You can see that over the last 20 years and for the last two major market meltdowns, the BMP was highly accurate.

In 2000 and 2007, the BMP would have gotten you out with plenty of time to spare to take profits and shift your portfolio allocations accordingly. Each time the indicator has cleared a probability of 0.90, a true bear market followed shortly there after. Our current market cleared 0.90 in late summer last year just before all the fireworks. I don’t think it’s a false signal in the least. The BMP’s efficacy is proven.

The bear-market delay is in all likelihood due to ridiculously low interest rates and accommodative monetary policy by the developed players of the world. But the bear will be staved off for only so long and not very long at that.

The Price Action Lab (“PAL”) software is another incredible value readily available for market research. I am not a subscriber however their software packages provide a window of access to the plebs of the world who want to see and know how the pro’s find trading opportunities. If you are statistically inclined and serious about trading your account or OPM, then PAL software can help you find an edge.

Additionally, the PAL blog is not only insightful but pretty funny. Harris consistently puts technical analysts, like myself, and over-exuberant quants in their place. Great site. Great content. I plug it and SentimenTrader often. Read’em.

Let’s look at a few more charts to really get you thinking that the end of this bull market just may be near. Afterwards, we’ll segue to the plumbing of liquidity within the financial system.

The following two charts are courtesy of the Leuthold Group. The top chart depicts the percent of publicly traded companies with rising YoY earnings per share. Not too healthy looking. And you can see what happened the last time we crossed under the 55 line in 2008.

The bottom chart is the HWOL via The Conference Board. As for the indicator’s composition,

“The Conference Board Help Wanted OnLine®Data Series (HWOL) measures the number of new, first-time online jobs and jobs reposted from the previous month for over 16,000 Internet job boards, corporate boards and smaller job sites that serve niche markets and smaller geographic areas.”

Just more compelling, supporting evidence of what’s in store for the world-wide financial system.

This next chart is a little dated from the end of last year but these common valuation ratios still stand in the same over-valued condition. Observe how close to the top these values in the PE, PS, and PB existed.

The common denominator is once again debt. Easy money policies and the continued backstopping of all markets via sovereign debt issuance is really the only thing holding confidence together. Once the confidence goes and liquidity dries up, you’re going to wish you’d heeded charts like the ones in this post.

The last chart selling market fear illustrates loan issuance drying up in the commercial and industrial space in the US. The Federal Reserve releases a survey of Senior Loan Officers every quarter and what we are currently seeing is 4 straight quarters of tightening loan standards in the commercial and industrial space. This is something only seen at the outset of recessions, literally.

Care to guess why these condition exist and yet we are “not” in a recession in the US? That’s right. Excess debt issuance. Cheap money backstops. And a cost of capital that has been perverted for far too long.

The charts all paint a clear picture. Ignore them at your own risk. Is a crash imminent? No, but you better be socking away some cash for value opportunities and you better be taking profits on positions that are starting to run out of steam anyways.

Let’s move on to the banking system. No, let’s take a break. My next post will be on the banking system and how it will exacerbate the shock to the financial system when whatever sovereign does what it’s going to do. Specifically, I’ll expound on liquidity. How it works and why every pro in the world already knows the danger it presents when it dries up.

Are you fearful? Based on average portfolio construction out there, the average investor is not nearly scared enough. Remember asset allocation only works over long durations. Diversification in the short term is just as susceptible as any other investment approach. Sure, the strategy is to offset so you lose less than the stock market as a whole. But if you’re near retirement, there’s not a lot of solace in thinking about how well asset allocation models hold up over several decades.

You know what also holds up over the decades? Intelligent trend following and value. Craftily insert risk assets that can carry your portfolio returns when times get rough. Don’t give in to the fear and don’t give up on the markets as new highs are being hit but now is the time to start questioning all your allocations in preparation.

Standby for part 2 on liquidity within the banking system.

A Travel Hacking Example for the Uninformed, Scared, or Lazy

Posted on December 5, 2015 by Margin Rich

Let me preface this post by stating that if you’re an experienced travel hacker then this example may be a touch old-hat. There are literally countless articles online from countless bloggers on the subject of travel hacking, so lord knows the world doesn’t need my two-cents on the subject. This post is more of a reference for those who know me so that they may glean a little more knowledge on the process. However, all readers are welcome to Marginrich.com even if it’s just to obtain yet another story about travel hacking a trip.

Unfortunately, this post does not contain any market or economic thoughts. And I know how much those are missed.

I deem traveling totally on one’s own dime to be a complete waste of money. The opportunity cost of compounded investment capital wasted on flights and hotels is a concept that really just sticks in my craw. Why blow thousands of dollars for travel when with a little planning and some credit card sign-ups, one could travel for free or at least at a significant discount and in luxury no less?

Travel hacking aka using travel reward points offers via credit cards and other promotions is a simple methodology to fund a larger-than-life travel experience primarily on some bank or corporation’s dime. If one is credit worthy and has a sufficient monthly spend, then literally, credit card companies are giving away free money to fund the trip of a person’s lifetime or several person’s lifetimes. Who doesn’t like free money, even if you are wealthy enough to freely spend on first class travel? Full disclosure, I ain’ts well-ta-do…or educated in proper grammar apparently.

Through general observation, I have ascertained three primary reasons as to why more people who are able to travel hack, don’t travel hack. One, people are lazy i.e. they don’t want to be bothered with keeping track of multiple credit cards. They don’t want to have to switch credit card usage between multiple carriers to use at various businesses depending on the current offer(s) or monitor their monthly spend. Also, signing up for multiple loyalty reward programs across various hotels and airlines is just too much work.

I got one word for that…spreadsheet.

Two, people get intimidated by the process and the initial time needed. Yes it takes some time to sign-up for the many different loyalty programs and submit credit card applications but that time is small compared to the value of a magnificent trip that could be earned. Plus, you can only take advantage of so many offers at a time. Widen the process. Credit card reward offerings generally need to be spread out a little to allow for adequate time to earn into a points bonus.

The fact of the matter is that you have what the credit card companies want and that’s usage for fee-driving. The user is in the catbird seat in this process so no need to be intimidated by any aspects.

Number three, the myth of the negative effect on credit scores for credit inquiries. I have noticed through conversations that people have a tendency to think that if they sign up for too many credit cards, which creates the credit inquiries, then that may have a negative impact on their credit score. It’s as if people think their 750+ score is going to go to 550. I swear people treat inquiries as if they were a bankruptcy or foreclosure and that is simply not the case.

I haven’t been travel hacking for long but I’ve never had a negative hit to my credit score when applying for 3 or 4 credit cards at once. Neither has my wife. Where there is the potential for a negative impact is if you need to take out some sort of loan in the very near-term.

Auto, home, business, whatever. Then the lender is going to prudently ascertain how responsible you are with credit usage and assess your credit profile for risk, but other than that, the negative effect on credit scores for application purposes is essentially null and void.

So let’s get to the example. In the fall of 2014, the Mrs. and I decided to take a close to three-week trip to northern Europe for some fast driving, great eats and coffee, beautiful old cities, and just straight-up relaxation. Our first stop would be Koln, Germany which means flying into Dusseldorf. Which by the way I always recommend over Frankfurt unless you’re specifically flying first class, because Dusseldorf is much less busy and so much easier to navigate through customs. It’s just a smooth process from baggage to car rental to hitting the autobahn.

Ok, so we decided to fly in and out of Dusseldorf, Germany. We intended to see a fair chunk of northern Germany’s biggest cities by doing a loop from Koln up and around to the east to Berlin and then back to Dusseldorf to fly out, with side trips to Holland and Denmark. The trip to Denmark ended up getting nixed due to logistics but it’s irrelevant for the sake of the example.

I had informed the wife that if we wait till the next year we could accumulate a ton of free miles utilizing credit cards and fly business class for 90% off the price and stay at most of our hotels for free. She was skeptical to say the least but she was supportive as I dived into and facilitated everything. She just wanted to fly coach for free and have all the hotels fully paid for with points and maybe the car rental, too. I wanted to fly business class but was willing to pay for a few rooms and maybe the car. I mean come on, if it’s no big deal to you to sit up straight for 8 to 10 hours and have little leg room to boot, then more power to you. I much prefer to lay flat whenever I feel like and drink unlimited booze, all while getting unceasing quality service from the crew.

Flying into Germany meant flying Lufthansa. That meant signing up for the Miles and More rewards program from Lufthansa. We then signed up for the Miles and More MasterCard when they were offering the 50,000 miles bonus. The minimum spend to qualify for the offer was $3,000 within 90 days, which is pretty standard. However, minimum spends vary by credit card and reward partners. Sometimes it’s as low $1,000 or $2,000 but the time-frame to obtain the bonus offer is almost always 90 days.

By the way when you click on links on travel hacking blogger sites, the blogger almost always gets a commission for you visiting and signing up for whatever offer the link leads to, but that is not the case here. I hyperlinked just for reference.

We then signed up for every travel hacker’s trusty go-to card, the Starwood Rewards Guest (SPG) American Express Card. Obviously, you’ll need to sign up for the SPG loyalty program as well. The SPG Amex came with a bonus offer of 25,000 points if you spent $3,000 within the first 3 months. Sometimes Amex will kick the bonus up to 35,000 so if you’re patient and can wait then take advantage of that. Another couple of reasons travelers love SPG is they have so many partners with which to transfer SPG points to and almost always at a one to one ratio plus if you transfer points in increments of 20,000 or higher then SPG kicks in another 5,000 points for free.

In other words, that 25,000 bonus points became 30,000 bonus points when I transferred it to Miles and More. And just like that we had 80,000 Miles and More points.

Now Lufthansa is not the best airline for redeeming rewards as their fees for “fuel and surcharges” are downright outrageous compared to their competitors. For economy seating, you end up paying approximately $650 out of pocket to use your points for one round-trip free flight and for business class it’s $950. However, they make up for it by offering crazy cheap travel specials every month.

Business class out of O’Hare to Dusseldorf is only 55,000 rewards points with their discount special. So it only takes 110,000 points for 2 seats and $1,900 out of pocket. You may think that’s expensive but consider that normal coach seats tend to retail for $799 plus fees and taxes on the cheap end. Business class tends to go for about $10,500 for a single round trip ticket to Dusseldorf out of Chicago, so $950 plus the requisite Miles and More points is essentially getting the ticket for a 90% discount. Plus as a B-class ticket holder you get access to the business class lounge where there is Wi-Fi, food & beverages, and well beer, wine, and alcohol for free.

I communicated with several businesses that assist travel hackers with obtaining the cheapest travel possible and not a single one could beat what I came up with using Miles and More to travel business class to Germany, based on the points balances we possessed. We rounded out our Miles and More rewards balance with our monthly spend and easily surpassed the 110,000 points needed for business class flights. We used the leftover points to book a room for a couple of nights in Amsterdam.

As for hotel accommodations, Marriott is our preferred provider and fortunately they partner up with Visa to offer a very nice rewards credit card. Normally, the Marriott Rewards Visa offers 50,000 Marriott Rewards points if you spend $2,000 within the first 3 months but we were fortunate. They were offering 80,000 points at the time we signed up. Factoring in our travel for personal and business reasons, we were able to accumulate enough points to cover 14 hotel nights. We did have to come out of pocket for 5 nights, but that was only because there was not enough Marriott’s with availability in every single city we visited but I’d say two-weeks’ worth of nights for free is still pretty dang stellar. Another reason for why we had to come of pocket for even 5 nights is because we picked an especially luxurious stay at the Hotel Am Steinplatz while in Berlin. And it was worth every excess point we spent for it.

The rental car came out of pocket too, but we paid less than $500 to Avis for a Ford Mondeo wagon for almost 3 whole weeks at a rate of less than $30 a day. The Mondeo is basically the European equivalent of the Fusion here in the states. And “if you haven’t driven a Ford lately”, it was a really nice ride. We were moderately surprised at the quality. Our last time in Germany for the Oktoberfest, we rented a 5-series Beemer wagon because we got a killer deal but after taxes and euro-area fees it definitely was not that good of a deal in USD terms. This time we rented ahead of time and did not upgrade. I found that the Mondeo, although obviously not as fast as the BMW, performed quite handily and had great pick-up speed when needed.

Let’s summarize:
1. $1,900 for 2 round-trip business-class tickets on Lufthansa to Germany with an actual retail price of $21,000
2. 14 free hotel nights (let’s apply a modest $125 average value)
3. 5 nights out of pocket hotel at same average rate of $125
4. Car rental for close to 3 weeks at a total of $425.

So getting to Europe, staying in Europe, and getting around Europe only cost us approximately $2,950 out of pocket. The value is actually less based on some of the Accor properties we stayed at but for the sake of the example I’ll just stick with the $125 average rate on the hotels. Compare that to the actual cost of around $24,000 and I’d say we travel hacked a pretty good trip at a damn good price. Of course, there is food and beverage to consider as well as kitschy crap as additional expenditures but we still came in way under any normal budget for that kind of a trip.

Don’t want to do Europe? Prefer fruity drinks and sandy beaches? No problem, British Airways is offering 100,000 Avios points for signing up for their branded Visa and the terms are very liberal. British Airways and American Airlines are tight partners so you can use those Avios points to fund AA flights to Hawaii and still have plenty leftover. Guess who’s going to Hawaii, soon?

One last thing to remember regarding credit card bonus offers. You have to wait 2 years from the time of card cancellation according to the banks in order to re-sign up for a specific credit card to get a travel rewards bonus again. That is how people keep taking these trips over and over as long as they continue to qualify. This is standard across the industry except for American Express where you only get to take advantage of the offer once and only once. Those bastards.

So the next time your travel bug is itching real hard, fight that impulse to go on Orbitz or Expedia or Priceline. Instead, take a breath and hop on the web to see what credit offerings are available and what would make sense to sign up for based on where you want to travel. Anybody with a decent credit score, decent income, and some organizational skills can travel hack the ultimate trip at the ultimate price. What you sacrifice in spontaneity, you can definitely make up for in quality.

Value of Increasing Portfolio Cash Levels

Posted on May 19, 2015 by Margin Rich

There are essentially two major views on cash in one’s portfolio. One view, which is predominantly held, is that cash yields nothing and thus must be allocated into an asset that does yield. The other view is that cash provides the ability to strike when value opportunities arise, and that ability is virtually priceless when the blood is running. What would you have given to have a warchest full of cash to deploy in March of 2003 or March of 2009?

The Spring 2015 edition of Columbia Business School’s (“CBS”) student-led value investing newsletter, Graham & Doddsville, profiled Matthew McLennan of First Eagle Investment Management, the house that Jean-Marie Eveillard built. By the way, Graham & Doddsville is published 3 times a year in the winter, spring, and fall. The newsletter contains interviews with investment pros, highlights of the CBS program, and investment theses by students. It can be a tad redundant of a read, much like Marginrich.com, but every now and then you can glean some quality insight from the interviewees.

McLennan shared some valuable insight on the value of cash, eloquently stating:

We can’t predict what the future will bear. At First Eagle, we view cash as a residual of a disciplined underwriting approach and as deferred purchasing power…We don’t feel the need to force cash to work just because it is a zero-cent yield today, because the return to cash has two components: it has the current yield, and it has the option of redeployment in distress. We feel, given the state of the financial architecture, there will be more windows of opportunity over the coming years to buy businesses that offer potential return hurdles in windows where the markets are less complacent.

It’s this option of redeployment why cash warrants a higher allocation right now. The spectrum of investors is vast with varying risk tolerances, varying asset levels, varying time tables, etc. Whether you’re a professional or an amateur, there is enough compelling evidence to espouse this view. Let’s start with valuations.

Sure, the major US stock market indices are hitting new all-time highs but the price action looks weak, and that’s on the back of some of the highest levels in history of current valuations. Traditional valuation methodologies such as the CAPE and Tobin Q are at levels only seen in 1929, 2000, and 2007. Does that not concern you?

Doug Short provides charts that depicts the CAPE, which he calls P/E 10, and Q plus the Crestmont P/E and S&P 500 regression from its price. One chart that particularly captures the moment in valuations, allowing for some perspective, is the Average of the Four Valuation Indicators with the standard deviations highlighted. Observe:

What immediately jumps out about the chart is that we are currently two standard deviations above the mean for the average of these four indicators, and we are also at a level higher than where we were at right before the Great Depression.

So what! This time is different, right? We’ve got interest rates at basically zero and quantitative easing in Europe and Japan after having just finished in the US. With rates at the zero bound and QE occurring in the most major of markets, equities appear “fairly” valued. Which begs the question, then what is extremis? Is it 10% higher from current price levels on the S&P 500? 20% higher? 30%? Who’s to say? Certainly not the overwhelming majority of professionals. There will be some that nail the top; statistically it’s inevitable. However, the preponderance of evidence unequivocally shows that the professionals are as ignorant about the future of stock market price levels as the people who unfortunately rely on their opinions. They have no idea when the music will stop which is why they keep dancing and dancing and guiding the public to do the same.

Let me provide you with a perfect example. Here’s a December 2007 article from Bloomberg Business(pre-BusinessWeek acquisition, hence the references) titled Where to Put Your Cash in 2008. In it, seven stock market analysts were polled including some from the largest banks on Wall St. The list includes Chief Investment Officers or Chief Equity Strategists at banks such as Citigroup, BofA, and BNY Mellon. Here is where each member of the poll stated they thought the S&P 500 might be trading at by the end of 2008, 1. 1,520 2. 1,675 3. 1,680 4. 1,700 5. 1,675 6. 1,625 7. 1,700; for an average of 1,653.

Anybody recall right off the top of their head where the S&P 500 closed on December 30th, 2008? It was 890. 890!!! Even the most pessimistic of the 7 missed the mark by a whopping 42%. That is egregiously inaccurate for some of the most allegedly well-informed and experienced market forecasters. And what’s worse, these calls were made in December of 2007 well after the market had begun to turn down and create a lower-high. Now of course, hindsight is 20/20 and maybe BusinessWeek excluded any bearish pollings which may have been more accurate, but the fact is these chiefs help in the decision making of multi-billion dollar organizations with multi-billion dollar portfolios.

Many pros utilize statistical models that provide a false sense of security; not just the pros but the academics masquerading as professionals at the world’s central banks and asset management houses, too. They think everything in the world is simply a matter of accurately determining the mathematical expression of potential and probable outcomes. Because as long as you can assess portfolio risk via language like this,

then the world is your oyster. Recall 1998 and the wrench that LTCM threw into the equity markets thanks to its genius partners who could quantify anything and everything in the world so profits were guaranteed. More recently in 2007, every financial house and shop knew risk was mitigated because the statistical models quantitatively guaranteed it. Human behavior simply cannot be accurately quantified with any long-term consistency and the markets consistently forget that. If that were not the case then IBM would be the most successful hedge fund in the world with Watson precisely quantifying all human risk variables and factors to own the world of speculation.

The so-called smart men don’t have any better knowledge of the future than some guy off the street. The future cannot be statistically quantified within an if/then statement. The rationale of the central planners and economists is consistently, “If this then that”, but the world is not tied up and wrapped up so neatly with a bow on it. The same can be said for our economy and financial markets.

People think that the people at the top have all the answers and will provide fair warning for everyone, but that’s not the way it works and people’s incessant memory loss of all things financial prove that out. You don’t know when a component of your car’s engine is going to malfunction. It just happens. Same goes for the economy and the markets. Along will come an unforeseen event i.e. black swan i.e. fat-tail that will critically damage the component of the engine causing the machine to breakdown. Let me remind you, that the same people that stewarded the financial crisis of 2008 are still in power at all the major private, public, and government entities.

I don’t mean the same people in the literal sense, but the same kinds of individuals. All without extra sensory powers of foresight and omniscience. They continue to utilize the same models that have been so greatly leaned on since the 90’s. The kind of statistical models that say “Oh, this event could only occur once in every 10,000 years so we have nothing to worry about regarding the management of our risks.” When the next downturn comes along, and it will because cyclicality is but one of nature’s simple inevitabilities, all these smartest-people-in-the-room types will be poring over their models and wondering how such a deviation from the standard could have caught them unawares.

Don’t be caught in the same trap that ruined the financial portfolios for so many investors on the brink of retirement. Now is the time to prepare yourself, because your RIA or whoever else you entrust your financial future to will not be able to safely shepherd you through the next financial crisis. They can’t. It’s virtually impossible due to career risk, fund charters, and the greed of maximizing assets under management.

There will of course be the small cadre of asset managers that go to cash early by tactically liquidating the portfolio and placing intelligent counter bets to strategically capitalize on the next great dislocation; in the process becoming hailed as new gurus. However, the financialization of our economy has driven so much talent into the markets that it’s statistically impossible for most money managers to not lose big. Inherently, the players in the field know and understand this but the people placing their hard-earned money with these players generally do not share the same level of comprehension.

I’ve been sharing my thoughts for some time now on the potential benefits of raising cash levels. I don’t think it’s alarmist. I continue to think it’s prudence. I’m not saying exit the markets. Just start to build cash levels. Examine the chart below with the obvious benefit of hindsight.

Let us assume the next great dislocation takes the S&P 500 down by 50%. This assumption is based on the approximate haircuts of 47% and 56% in 2000 and 2007, respectively. For the sake of the illustration, let me also generously give the S&P 500 another 30% of upside from current levels. That would put the S&P 500 at about 2,770. Halve it and you have 1,385 which is still 35% lower from current levels, a bear market by any standard but the 50% markdown would be avoided for a portion of holdings. Then with valuations in the trough, one can begin to selectively capitalize. All the variables are unknowable. It’s a simple exercise for the sake of illustrating the value of having cash available at the appropriate moment in time.

As previously stated, if you think leaving your hard-earned money in the hands of a professional will protect you, you are mistaken. Chuck Jaffe, MarketWatch columnist, penned a recent article which imparts this very notion. The piece’s opening headline states, “Only four funds have beaten the S&P 500 for the last eight years.” That’s four as in you can count the number of actively managed funds on one hand that can beat a simple index of the S&P 500 over the last eight years. Those four funds are all in healthcare, which means it has taken the tailwinds of what is arguably the strongest demographic opportunity for the next 10 to 15 years to beat a simple index.

The markets are cyclical and what was old is new and what is new is old. The sun may wane on indexing for a time and active stock picking may get revitalized. If you intend to be one of those stock pickers then it is imperative to have the cash available for opportune investment. I’ll share what I feel is a poignant quote from Charlie Bilello, of Pension Partners, that summarizes the value on boosting cash levels in one’s current portfolio. In the article, Bilello is referring to the ATAC rotation strategies that Pension Partners advise on and utilize, however the sentiment is equally applicable to what has been articulated in this post. To wit(emphasis mine),

Similar to the mid to late 1990’s the last few years have featured runaway gains in U.S. equities. Any strategy that was built to minimize downside over this time has dramatically underperformed as there has simply been no downside to capture. While some would view this as flaw in these strategies it is the only way they can work over time. In order to minimize downside you have to be willing to give up upside in return, and by extension this means underperforming during runaway phases in bull markets. There is no other way if your primary goal is to protect capital. The tide always turns and while out of favor today, preserving capital and managing risk will be back in vogue once more, but only after the declines occur.

Brush up on your valuation skills. The sacrifice of modest current returns versus potential outsized losses while waiting for the inevitable fire sale makes cash a superior asset. Set aside the ingrained notion of maintaining a current unproductive asset bearing debasement losses for the simple notion of sometime in the near future you could be buying the most productive businesses or assets on the planet for 40 to 60 cents on the dollar. Will we get another crack at the beginning of a true secular bull market beginning with a CAPE in the single digits? Possibly, but I’ll take a CAPE in the teens just as well and I’ll want to have the ammo available when such fortuitous circumstances(for some) arise.

Update: 5/22/2015
I readily and regularly admit to not exactly being an intellectual heavyweight, so here’s an interview with Nassim Taleb from the Swiss website Finanz und Wirtschaft. They consistently feature quality international pieces from international guests. In the article, Taleb(a legitimate intellectual heavyweight) shares many of the same sentiments expressed in this post; just to add a touch of support to the claims.

The Top in Douchebaggery?

Posted on July 8, 2014 by Margin Rich

I promise to get back to trading and investing tomorrow, but I just wanted to link to a story from the New York Post. I have to admit, I thought it was a joke at first. Alas, this thing is real and you too can obtain NYC DB status for the low annual fee of only $250.

Here’s the link to the story: The College Dropout Behind NYC’s Most Exclusive Credit Card.

Before you comment, send in hate e-mails, or forever unfavorite my site, please know I understand I’m being a hater here. Save the, “Who are you to judge this entrepreneur for supplying what’s demanded? What makes you so f’in cool? You’re just mad because you’re not a VIP anywhere in the world.”

I get all that. Props to this young man for having a successful vision and creating a niche product that just may turn out to make him very wealthy. It’s just the story reads like a satire and it’s difficult to believe that users can get so excited for The Hard Rock Pool of credit cards.

Is Magnises the top in douchebaggery? Can’t know; my crystal ball obviously only works in the markets.