Following the Crowd. There has been this concept that has gained attention recently that stems from a subreddit on Reddit. The subreddit, “Wall Street Bets”, is a platform where investors and such are able to comment and speak to each other about options trading, their portfolios, and the market as a whole. The concept I am referring to is “pumping” or some people may call it “trend following”. In the US Equity market, the two hottest stocks recently have been Tesla and Virgin Galactic. Tesla has gained 150% in the last 3-months and Virgin Galactic 296% in the same period. Pumping is when investors/traders all agree to buy stock or calls in the same company, pushing the stock higher. With Tesla’s cult and the profiteers who are looking to make an easy buck, they all jump on the bandwagon and this has proven to generate crazy returns. Some could say that this is illegal, and that the SEC could get involved soon, but so far this unethical style of investing has made people very wealthy.
How to Maximize Return During Market Panics. Bull markets are all different. In the 2000s, companies with exposure to emerging markets and commodities were the biggest winners. In the 2010s, the FANG stocks and other tech and software stocks drove the expansion. And in the future, renewable energy, cybersecurity, and tech can be the drivers of the next expansion, nobody knows. Crises are more predictive and are more alike. The smallest, cheapest, and the most conservative capital deployment of stocks perform much better during crises. Companies that are profitable and cash generative also tend to do well during recessions. Private equity or distressed debt funds perform horribly, and if you want to invest in debt, dedicated public debt is an optimal way.
Sales-to-Price Ratio. There has been a lot of chatter of how overvalued the market is and how its too expensive to enter in now. The ideology is, knowing that the market should contract soon, why should I invest into these higher prices? Valuation can never help us with market timing. An overpriced market can always become more overpriced. Based on the sales-to-price ratio, the nominal total annual return for US stocks over the next decade is about 4.5%.
Market Volatility. For the past few weeks, the market has been jumping to new highs despite global worries surrounding Coronavirus. Production factories have been shut down, with some companies stating that they are moving production out of China. Despite this, the market has hardly reacted as one would expect. In the past few days, the markets have been sliding as investors are moving to hold safer assets such as gold and cash, the former being at all-time highs. Just to add more confusion to the investing world, the 30-Year Treasury Bond is at an all-time low, further inverting the yield curve. Widely believed to be a signal of recession, this has been taken mostly in stride. Why? Some possible reasons lay in the governmental intervention. The Fed has shown that it will go against traditional indicators to stabilize the market. The Trump administration has repeatedly shown it will do whatever is necessary to ensure industries keep growing through the use of tax cuts and subsidiaries, the deficit be damned.
Factor Rotation. Heard of sector rotation? How about its new friend Factor Rotation. Over popularized at the turn of the century, sector rotation is an investment strategy that tries to predict the business cycle and overweight industries which expect to outperform in that scenario. In a general sense, when someone believes the market is overheating and due for a cool down, they would start moving their portfolio into Healthcare, Consumer Staples, and Utilities. When they believe we are on our way out of this cool down, they would start investing in Financials, Technology, Consumer Discretionary, and Materials. At the onset of the expansion, they would start moving towards industrials and energy. This strategy, which seems simple, usually underperforms the SPX, as its relatively hard to constantly predict the business cycle. Now another strategy, which has been around for a while, but is just now becoming mainstream is factor rotation. Factor rotation instead invests in companies that share common characteristics, for example, strong financials, constant dividend growth, and relatively low debt, which would make up a defensive strategy. Although this will allow investors to increase their general active specific factor, it keeps the factor tilt relatively the same as would be for sector rotation, which means it still requires a general reliance on detecting the business cycle.
The Millionaire in the Capitol. There are currently three billionaires running for president. Donald Trump with an estimated net worth of $2.48 billion, Tom Steyer with an estimated net worth of $1.6 billion, and Michael Bloomberg the 8th richest person in the world with an estimated net worth of $65.2 billion. The United States has a long history of wealthy presidents dating back to the very first. George Washington had an estimated net worth of $587 million (in 2016 dollars), and over half of all U.S presidents had a net worth over $2 million placing them within the wealthiest 10% of the population. Despite its long history of wealthy leaders, the U.S has never had three billionaire presidential candidates. While these candidates are running for various reasons, they are a reflection of current social sentiment. Voters across America feel that there is a correlation between the ability to lead and be successful and earning a large amount of money or the “smart businessman” argument, but many others also feel that large amounts of wealth lead to corruption, inequality, and the ability to buy the election. Traditionally, U.S presidential campaigns have been funded by donations from average Americans, political fundraisers for the wealthy, and more recently corporate donations to Super Pacs, but this year we have seen another option. Bloomberg has taken no donations and yet has spent $450 million of his own money to fund his campaign and join the democratic race. For some background, here are some of the wealthiest leaders in the world. Keep in mind that as we go down this list the estimates are less accurate and, in most cases, the large net worth is due to the corruption of world leaders and their ability to funnel public assets or national resources to their personal wealth. French President Emmanuel Macron $31.5 million, President of Chad Idriss Deby $50 million, Turkish President Recep Tayyip Erdoğan $50 million, Prime Minister of Singapore $51 million with an annual salary of $1.6 million, President of Rwanda Paul Kagame $500 million, President of Kenya Uhuru Kenyatta $500 million, President of Azerbaijan Ilham Aliyev $500 million, President of South Africa Cyril Ramaphosa $550 million, President Teodoro Obiang Nguema Mbasogo of Equatorial Guinea $600 million, President of Gabon Ali Bongo Ondimba $1 billion, Bashar al-Assad leader of Syria $1.2 billion, President of China Xi Jinping $1.5 billion, Sebastian Pinera President of Chile $2.8 billion, leader of the Czech Republic Andrej Babiš $3.7 billion, leader of North Korea Kim Jong-un $5 billion, and President of Malaysia Mahathir Mohamad $45 billion.
A few other notable cases are Sheikh Khalifa Bin Zayed Al Nahyan who is the leader of the United Arab Emirates and has an estimated personal net worth of around $18 billion. King Salman of Saudi Arabia with an estimated personal net worth of $17 billion, while the royal family has a net worth that may be as high as $2 trillion. Ali Khamenei, supreme leader of Iran had a claimed and estimated net worth as high as $95 billion. Lastly, Vladimir Putin with a very rough estimated net worth of $200 billion.
The Alchanati Campbell and Associates Team
From 2016 until now, investors have learned a valuable lesson: Don't bet against the house AKA Don't bet against Trump. With his administrations' tax reform, numerous trade deals, deregulation, tariffs on the EU, control over the Feds, etc.; his words and his actions have kept the market screaming higher. With his first term due to end soon and with his campaign for reelection, a market correction would be terrible for his chances. With this in mind, expect the stock market to continue to make new highs even if there is a terrible epidemic or other crises.
The Reason For No Recession. A yield inversion happens when a long-term interest rate crosses with a short-term interest rate. Example: 10-year Treasury with 90-day Treasury. The inversion of the short and long term yields have always been an indicator of a recession 6-9 months later. When the long-rate is dropping, businesses pull back on investments and reduce spending on CapEx. They stop borrowing and banks have less demand for lending, so they lower the interest rates to make the rates more attractive. Businesses indicate that the economy is slowing, and this may lead to a recession. BUT, in this global economy, foreign 10-year T-bonds are 0% or negative. All of these global investors want to be liquid, safe and returning positive returns. So they all buy US bonds, increasing the prices of bonds, and lowering the interest rates of these bonds. This is why the yield inversion may not indicate a recession.
Correlation Between Major Assets. Finding patterns in data has always been something that humans have tried to do to game the market. Usually, traders will throw up the two normalized data sets on a graph, and try to eye if they see correlation or not. This will usually end up with an erroneous outcome. Take Gold/Oil for example, although it seems these assets usually move in the same direction, and the graph shows a semi-consistent correlation, its R^2 (which is the % of the dependent variable explained by the independent variable) is 7.2%, with its R (correlation when using only 1 independent variable) is .268, which shows a weak correlation. When adding the USD into the equation, we see the r^2 and correlation jump up. This is explained by an error with multicollinearity, or the addition of the USD, which strongly influences both gold and oil, due to both assets being dollar-denominated. This means that when the dollar goes up, oil and gold will both follow inversely.
Checks and Balances. A set of organizations that split sovereign power among them in order to prevent dominance by a single individual or group of individuals. This can be as simple as having an independent board of review for a public company but generally refers to the distribution of power in a government. Checks and balances have existed as long as independent states have, but their widespread use only came with the advent of modern republican democracy, where the people, through their representatives, sought to prevent the reestablishment of autocracy within their lands. Generally, governments are split between an executive, legislative, and judicial body, each with separate priorities, and, importantly, largely independent. In the United States, this split is extremely formalized, with contradicting powers given to the different branches, including Congress’ power over the budget, the President’s power over actually spending government money, and the Supreme Court’s power of judicial review over the whole process.
Presidential interference in Stone Sentencing. Roger Stone, a long time confidant, and advisor of President Trump was found guilty of witness tampering and lying to congress in November 2019. His crimes had been discovered in the course of the Mueller investigation, as it had been found that he had cooperated with Julian Assange in the course of the WikiLeaks hacks of the Democratic National Party during the 2016 election. As a result of these crimes, an assistant US attorney followed the guidelines of the Department of Justice and recommended to the judge that he be sentenced to seven to nine years in federal jail. However, President Trump tweeted earlier this week that this sentence was inappropriately long, and, following this, the Department of Justice intervened in the case and recommended a far more lenient sentence. The four prosecutors involved in the case resigned, and the DoJ has received widespread condemnation for what has been termed “political interference in the judicial process.” Technically, what President Trump did is not technically illegal. However, it does greatly delegitimize the Department of Justice, as one could now view the department that is supposed to enforce and prosecute federal crimes as a political tool of the presidency, rendering investigations it pursues vulnerable to allegations of political bias.
The Alchanati Campbell and Associates Team
Helicopter Money. Helicopter money is an extreme, unconventional, and unorthodox practice of stimulating growth within the economy. It is comparable to Quantitative Easing, which involves increasing the money supply by purchasing debt from the market. Unlike, quantitative easing, helicopter money involves the central bank distributing printed money directly to the public. It is also referred to as a helicopter drop, as if the money were scattered from a helicopter. Consumers could do whatever they want with this money, but in theory, sustained helicopter "drops" would encourage spending and create demand, sparking growth. It is a permanent impact on society; once the money is out there, it cannot be taken back. Distributing money to the public comes with its own problems, such as inflation and currency weakening. Obviously, Jerome Powell is not going to charter a helicopter and toss money out of it (that seems like an Elon Musk type of thing). Rather, there are more tamed actions they can take to go about this. The Central Bank's spending on tax cuts and purchasing government bonds with the condition to distribute the interest directly to consumers rather than government spending are two possible ways of dropping money into the economy.
The Feds. This week the Federal Open Market Committee held the first meeting of 2020. The Fed’s position has not changed much since they met in January, stating that the “labor market remains strong and that economic activity has been rising at a moderate rate”. The Fed did note that household spending has been constantly rising and business fixed investment and gross exports remain weak. In response to current economic conditions, the Fed Funds Rate was held steady at 1.75 percent, which is within their target of 1.50-1.75 percent. The rate is down from a year ago when the rate was 2.25%. Since mid-October, the Fed has been buying $60 billion a month of T-bills, and reserve levels have risen by more than $270 billion since then to roughly $1.67 trillion. At the meeting, Chairman Powell expressed his intention to reduce the market's reliance on the Fed. He outlined loose plans to reduce cash injections into the market by the second quarter. Some analysts have liked these cash injections to a new round of QE, but the debate on that continues. Powell intends to lower the Fed’s reserves from $1.67 trillion to around $1.55 trillion which is the level the reserves were at when the market first ran into liquidity problems. With the trillions in annualized balance sheet expansions from Central Banks around the world, stocks will have a difficult time selling off much and any correction may be limited. In other Fed news, Trump has formally nominated Judy Shelton and Christopher Waller to fill the remaining seats on the Fed’s board of governors. Shelton is known for criticizing the Fed, advocating for a return to the gold standard, and questioning the independence of the Fed itself. No doubt if she is confirmed we will see future changes in the Fed’s policies.
Consumer Confidence. Consumer confidence measured through the Consumer Confidence Index (CCI) has recently reached a normalized high of 101.4 (meaning long term average is 100). This high hasn’t been seen since March of 2018. Although CCI has been reaching highs, business confidence (BCI) has been steadily decreasing, currently at 96.3 (normalized at long term average of 100). This rise in consumer confidence, not accounting for the Wuhan outbreak, is being brought on by an increasing job market, which is increasing optimism for consumers' futures wealth, fueling current consumption. This disconnect between CCI and BCI can be bridged by looking at the CEO confidence survey, which is at a level of 7 out of 10, which backs up the CCI report. This also brings into question what you believe powers GDP more, consumption or investment. With CCI backing up consumption, and BCI backing up investment. But what drives the market: consumers or businesses? Keynes’ Law says, “Demand creates Supply” and Say’s Law says, “Supply creates Demand”. I say businesses drive the economy; aggregate supply drives the economy while aggregate demand responds passively. Purchasing power grows out of production. The great producing countries are the great consuming countries. Consumer confidence is important, but the real factors to look at are business investment and business spending indicators. Once business slows down, consumer confidence and spending will slow.
VIX. Volatility is the statistical measure of the dispersion of returns for a given security. The higher the volatility, the riskier the security is. The price of the security can move more dramatically in a short period of time. BETA is how you measure volatility. A beta approximates the overall volatility of a security’s returns against the returns of a relevant benchmark like the S&P 500. The beta of 1.1 has historically moved 110% for every 100% move in the benchmark. A beta of 1 indicates that the security's price moves with the market. A beta of less than 1 means that the security is theoretically less volatile than the market. Low volatility means small fluctuations and high volatility means large fluctuations. Generally speaking, when investing the more risk you take with your money the higher the return can be, so investments that often see low volatility are lower in risk and therefore offer less of a return. The two most common ways to measure volatility are the VIX and Average True Range (ATR for short). VIX is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options. It uses the prices of options on the S&P 500 and then estimates how volatile those options will be between the current date and the option’s expiration date. The Volatility Index (VIX) is an index created by the Chicago Board Options Exchange. It shows the market’s expectation of 30-day volatility, constructed using the implied volatilities on S&P 500 index options; calculated from calls and puts. It uses the price of options on the S&P 500 and then estimates how volatile those options will be between the current date and the option’s expiration date. One of the biggest risks to an equity portfolio is a broad market decline. The VIX Index has had a historically strong inverse relationship with the S&P 500 Index. VIX below 12 is considered low, above 20 is considered high and in between, normal.
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The Alchanati Campbell and Associates Team
WHAT'S UP FRIDAY? is a weekly newsletter that will give you a summary of "What's up?" on Wall Street, in the US and around the World written by The Alchanati Campbell and Associates Team. What makes us unique is we focus on long-term knowledge; knowledge that will still be useful to you 10 years from now.