“If it's obvious, it's obviously wrong.” --Joe Granville
EPHEMERAL EXTREME ELECTION EUPHORIA (November 8, 2020): As a result of eager investor anticipation of a new U.S. political configuration the shares of risk assets have generally climbed during the past several trading days. This has made the least-experienced investors especially excited about getting "back into the market" and once again buying unusually intense quantities of speculative out-of-the-money call options. Insiders have been doing the exact opposite, dramatically accelerating their selling to tabulate some of the highest-ever ratios of selling to buying ever recorded for many popular large tech companies. When the most-experienced investors are doing nearly the exact opposite of the least-knowledgeable participants then you can be pretty certain who is going to be correct once again. In March 2020 we had the exact opposite where we had two consecutive weeks of all-time record net withdrawals from equity funds while insider buying relative to selling touched its most elevated ratio since March 2009.
Following both March 2009 and March 2011 we experienced powerful two-month rallies. Following all periods of similarly intense insider selling relative to buying as we have recently experienced, the most popular shares generally declined dramatically over a few months and are likely to do so again.
Several investments are currently especially compelling either to buy or to sell. Here they are with the most compelling one listed first on down the line:
1) QQQ, XLK, and similar funds of the most popular U.S. mega-cap technology companies have only been more overvalued in their entire history at the beginning of September 2020 when most of them achieved all-time zeniths and during the second week of October 2020 when they completed marginally lower highs. We have likely registered or will soon finish making additional lower highs for these shares. Even in historic years for popular growth stocks including 1928-1929, 1972-1973, and 1999-2000 we never had valuations as stretched as they are currently. We are likely on the verge of the next important correction which will rival the February-March pullback earlier this year and will probably exceed its declines in percentage terms for the majority of the most popular tech stocks. I have been adding to my short for QQQ each time it touches 295. If current overnight trends continue then QQQ could reach 296 or more in early trading on Monday, November 9, 2020 which would represent an ideal opportunity to add more of it on the short side. The resolution of U.S. Presidential election uncertainty is providing a wonderful selling opportunity for large-cap tech shares since no political alignment can trump [pun intended] all-time record overvaluations.
Probably the primary difference between the February-March 2020 correction and the current one is that this one is developing much more slowly. I believe it will also be harsher for the most popular big tech stocks.
2) TLT likely completed its next important higher low at 155.10 at 19:20:17 on November 3, 2020 when the earliest U.S. elections results were beginning to be counted. Since then TLT has been choppily rebounding. I have been buying TLT consistently below 159 and it dipped again below that mark on Friday, November 6, 2020. TLT is a fund of U.S. Treasuries averaging 26 years to maturity. Many investors avoid TLT because it seems to be closer to its long-term top than its long-term bottom but this is overlooking a bull market which has existed for this sector since September 1981 as well as a recent huge surge of fresh commercial buying of U.S. 30-year Treasury futures. Below is a chart highlighting the intensity of the commercial buying--notice the maroon bars growing in size on the right:
With the kind of extremes that we have in the above chart it is worthwhile to purchase TLT and other funds of long-dated U.S. Treasuries whenever TLT is below 160 with the idea of selling in early 2021 above 170.
3) The U.S. dollar is widely hated but is completing additional higher lows not far above its lowest levels since April 2018.
On September 1, 2020 the U.S. dollar index slid to 91.746 which marked its most depressed point since April 2018. The U.S. dollar index seems to be forming higher lows while most speculators are betting on a weaker greenback. What is likely to occur is that the U.S. dollar will rally to its highest point since the stock-market plunge of March 2020. There is no ideal way to directly invest in a rising U.S. dollar but owning U.S. Treasuries, U.S. time deposits including bank accounts, and U.S. money-market funds is a worthwhile conservative approach. Preservation of capital is far more important over the next few months than trying to achieve unsustainable gains.
The Russell 2000 is nowhere near its August 31, 2018 top and has been forming lower highs throughout 2020.
Since the first U.S. stocks were traded in 1790 (in Philadelphia two years before the New York Stock Exchange) it has consistently been the case that small- and mid-cap shares complete their respective cycle tops in advance of their large-cap counterparts, and whenever this occurs the subsequent losses for both are huge. The Russell 2000 has not only failed to surpass its August 31, 2018 top of 1742.0889 but it has also made several lower highs throughout 2020. We have also experienced a massive surge of new investors who were mostly still in school when the last bear market occurred and have little or no understanding of market history. Regardless of the fundamentals of any trade, whenever any position becomes dangerously overcrowded the market almost always moves in the opposite direction of that crowd.
Investors are confusing the near-term market behavior with how it will behave between now and early 2022.
Some investors believe that we will experience rising inflation, significantly higher interest rates especially on the long end, a resurgence for small- and mid-cap value shares, and generally rising commodities over the next 1 to 1-1/2 years. While this may be correct in the longer run it is almost certainly wrong in the short run since far too many investors have piled into these and related trades. The market will repeatedly punish stale long positions in the most popular shares. We will almost surely get significantly higher lows for VIX, TLT, and the U.S. dollar over the next few months combined with memorable losses of 30% or more for the most popular technology shares by the end of the 1st quarter of 2021 or sooner. Once most investors have given up on their positions we will then experience rising inflationary expectations and generally higher prices for commodity-related and other assets which prefer rising interest rates. The actual end of coronavirus, rather than its anticipation, will tend to accelerate this process.
The market's intraday behavior demonstrates repeated extremes outside of regular trading hours.
I have been trading much more frequently outside of regular hours in order to obtain the lowest prices for unpopular assets I am buying and to obtain the highest prices for the most overloved shares I am selling. I am much more frequently having orders filled with a combination of tiny partials instead of all at once. These two observations are related: the least-experienced traders who tend to buy near the top and to sell near the bottom only have enough money to trade a few shares at a time and are too busy at their 9-to-5 jobs to trade during regular hours.
Several undervalued sectors remain worthwhile for purchase but keep your total long positions smaller than your total short positions.
I am a big fan of those energy companies which have enjoyed the heaviest insider buying in recent months, along with other traditional value names sporting low price-earnings ratios, improving profit growth, increasing dividends, and repeated lows near the opening bell. MTDR, PSX, XOM, and GEO are examples of companies which fit into this category. Don't go overboard in accumulating these until VIX starts to form lower highs from a multi-month peak which will be a sign that the most-experienced options sellers are becoming less fearful of additional market losses. This will not likely occur until sometime this winter.
Boglehead investors in particular will keep underperforming due to not having sufficient cash to be a heavy buyer near each important intermediate-term bottom.
The growth of your entire portfolio in 2020 is primarily a function of how much money you had put into the market in March 2020--which is a function of how much cash you had raised in the weeks leading up to the February-March plunge. Those who were far too heavily invested in February 2020 didn't have nearly enough cash to do substantial buying the following month near multi-year lows and thus missed out on a prime opportunity to grow their total net worth. Similarly, those who haven't been opportunistically and aggressively selling near all important highs in recent months will not have nearly enough cash to be a major buyer whenever the next bottom is being formed perhaps in early 2021. This is one glaring deficiency of a Boglehead approach: it works okay in a smooth upward trend but fails miserably when it is essential to keep buying low and selling high on a frequent basis. Active asset reallocation in this kind of volatile market is far more important than exactly what you are buying, although you should favor securities which have rallied under similar past scenarios where small- and mid-cap value have begun to trounce previously-dominant large-cap growth including 1973-1976 and 2000-2003.
The bottom line: I am almost 2/3 in cash, 17-18% in long positions, and 30-31% in short positions [this actually adds up to 100% due to shorts being treated differently by the SEC].
I have increased my short positions in QQQ while gradually purchasing MTDR, PSX, XOM, and GEO each time those approach multi-month lows especially near the opening bell when the least-experienced investors tend to sell them in small quantities. I have been selling short QQQ at 295 and above as I have been doing since August 2020 and will continue to do.
Disclosure of current holdings:
From my largest to my smallest position I currently am long the TIAA-CREF Traditional Annuity Fund, bank CDs, money-market funds, Discover Bank Savings paying 0.55%, I-Bonds from 2001-2003, MTDR (some new), PSX (some new), GEO (some new), XOM (some new), XES, BCBP, BOH, KRNY, OPBK, CDEV, WTI, SONA. I have 9.4% of my total liquid net worth in the previously-mentioned energy securities, 5.9% in the regional banks I listed, 2.3% in GEO, 0.1% in EWZ purchased below 27, and am otherwise completely sold out of everything else on the long side.
I have 17.5% of my total liquid net worth short XLK, 5.2% short TSLA, 4.1% short QQQ (some new), 2.3% short ZM, 0.8% short AAPL, and 0.4% short SMH. I plan to keep adding especially to my QQQ short into strength whenever QQQ is near 295 or above. My cash and cash equivalents including bank CDs, savings/money-market accounts, I-Bonds, stable-value funds (fixed principal, variable interest) comprise 65.7% of my total liquid net worth. (It seems to exceed 100% but for short positions only part of the total cash value is required to hold them.)
I am currently sporting my heaviest net short percentage since August 2008, even more than at the beginning of September 2020.
Steven Jon Kaplan runs True Contrarian where this article appeared first.
Source truecontrarian-sjk
