A true contrarian look at investing and at life in general.
WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.
AUGUST WILL SUFFER A SEVERE STOCK-MARKET CORRECTION (August 3, 2009): Reliable leading indicators have been signaling that global equities are in the earliest stages of what will likely be a sharp, intense pullback over the next several weeks. The most profitable way to profit from this retreat is not to sell or to sell short, but to purchase the deeply undervalued volatility fund VXX.
Long-dated U.S. Treasuries and their funds, including TLT, have been forming a bullish pattern of higher lows since they completed high-volume 21-month nadirs on June 11, 2009. What's bullish for U.S. Treasuries is bearish for the stock market, since this indicates that the most knowledgeable investors have been shifting from a desire for increased risk to a quest for safety. Historically, any pattern of higher lows for the 30-year "long bond" has nearly always led to at least a short-term retreat for major global equity indices.
VIX, which measures the implied volatility of a basket of options on the S&P 500 index, has been forming a pattern of higher lows since July 24, 2009, when it completed a ten-month intraday bottom at 23.00. A rise in implied volatilities even when the stock market has been strong, especially when combined with a simultaneous rise for U.S. Treasuries, is signaling that the recent amateur surge into the stock market is about to lead to a convincing reversal.
I do not believe, as some bearish analysts do, that we have completed the so-called bear-market rebound. After perhaps one month of a double-digit retreat for the S&P 500 and similar indices, I expect that the powerful 2009 rally will resume in full force to achieve significantly higher highs. However, a shakeout of recent excited buyers is a must in order to resolve what has become a dangerously overcrowded trade on the long side.
VXX is a volatility fund which had lost more than half of its value from April through July. Too many investors have deluded themselves into believing that the relative calm in the financial markets which has persisted for the past three months will continue indefinitely. Instead, the recent lull is about to lead to a rapid correction of more than 10%, followed by an even stronger and truly dramatic rebound. You'll know that the late summer nadir has arrived when you hear frequent media debate about "whether the March lows will be revisited." When this occurs, VXX could easily regain 80, which would produce a return of more than 30% and perhaps even more than 40% by early September 2009. I therefore gradually purchased VXX over the past two weeks when it was close to 60 dollars per share.
INVESTORS ARE IGNORING NUMEROUS POSITIVE EQUITY DIVERGENCES (March 8, 2009): There are numerous positive divergences in the global equity markets which are pointing the way toward the strongest short-term stock-market rally since the Great Depression. Let's examine each of them to more fully understand their profound significance.
The first and most important divergence is the recent collapse in government bonds worldwide, including U.S. Treasuries. Long-dated U.S. Treasuries, such as the fund TLT, have been collapsing since they completed a historic peak on December 30, 2008. Very few individuals trade Treasuries; this sector is primarily the domain of major institutions and pension funds. The flight out of Treasuries represents a decisive shift away from safety toward risk and signifies a clear rejection of the "deflationary depression" hypothesis. If the global economy were really set for a major contraction, money would be flowing into government bonds instead of out of them. Therefore, the global economy is set for a major expansion.
Another important divergence is the U.S. dollar index recently forming a pattern of several lower daily highs after having reached a three-year zenith. During times of economic stagnation, the greenback is a nearly perfect inverse indicator: when the U.S. dollar is rising, this indicates that the global economy is contracting, and vice versa. The fact that the U.S. dollar index has been starting to move tentatively lower shows that the most knowledgeable global traders are beginning to position themselves in favor of economic expansion--thus confirming the message of global government bonds.
Yet another divergence can be seen in the strong performance of global commodity-producing shares since October/November 2008. Gold mining shares have more than doubled in value since October 24, 2008, as can be seen in a chart of GDX and similar gold mining funds. As the most reliable harbinger of upcoming inflation and growth, this doubling indicates that increased global growth and rising inflation will be the major themes of 2009. Other commodity-share funds have been forming bullish patterns of higher lows, including KOL (coal mining) and more recently RSX (Russian shares). Russia's economy is very heavily based upon commodity production, and therefore the recent relative strength in RSX is similarly signifying that both inflation and growth will be important global themes in 2009.
High-yield corporate bonds have been forming a bullish pattern of higher lows since the first half of December 2008. While obtaining credit is still far from easy, lenders are much more willing and able to supply capital today than had been the case three months ago. Nearly all corporate-bond sectors have been choppily improving over this period of time, as have municipal bonds. As with government bonds, these are primarily traded by institutions and pension funds; the most knowledgeable investors are signaling that the most distressed period has already passed for obtaining borrowed money.
Implied volatility indices including VXO and VIX remain near 50, which is historically more than twice its average level, but which is far below the extreme readings of 80-90 that were seen in October 2008. Investors are becoming so accustomed to falling stock prices that an increasing number of surveys are showing more investors anticipating an additional 25% decline in the stock market than are expecting a 25% increase. This is among the most negative survey results ever recorded, and is in sharp contrast to the outlook in 1999-2000 when investors routinely anticipated annualized gains of 30% lasting for a decade or more. When so many average participants are gloomy, the only possible resolution is a powerful worldwide equity rally.
As a result of these and similar positive divergences, I am anticipating that the next half year will experience the most dramatic short-term global equity rally since the Great Depression.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, and then again on February 25, 2008 (page M14) and June 2, 2008 (page 41), as well as August 25, 2008 (page 32).
CURRENT ASSET ALLOCATION (fully marked to market on August 3, 2009): My own personal funds are currently allocated as follows: LONG POSITIONS: Gold mining funds GDX, ASA, BGEIX, INIVX, 38.1%; U.S. Treasury fund TLT, 8.4%; Japanese smallcap funds DFJ, SCJ, JSC, JOF, SPJSX, 7.6%; Coal mining fund KOL, 7.5%; Global equity fund VIDMX, 7.2%; Energy closed-end fund PEO, 5.6%; Volatility fund VXX, 4.1%; Russian fund RSX, 3.7%; General-equity closed-end funds ADX, CET, 3.4%; Natural-gas futures fund UNG, 2.2%; Natural-gas fund FCG, 1.8%; High-yield BB corporate bond fund VWEHX, 1.8%; Crude-oil futures fund USO, 0.8%; Municipal bond fund MYJ, 0.8%; VINIX, 0.2%; VIEIX, 0.2%; TRBCX, 0.2%; KRE, 0.2%; XRT, 0.2%; VZ, 0.2%; TRI, 1.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 3.6%; other collectibles, 0.4%; Vanguard Municipal Money Market Fund VMSXX, 0.2%; Putnam Stable Value Fund (retirement fund with stable principal paying variable interest), 0.1%; SHORT POSITIONS: None; covered ALL of them in October 2008 which had amounted to just over half of my entire net worth.
REMINISCENCE OF THE WEEK (May 25, 2009): In December 2008, my wife and I visited New Orleans. It was an unusual visit in many ways; on our first day there, they had their heaviest snowfall in eight years. Kids had a wonderful time building snowmen which they had previously only seen on television. We walked through a fascinating neighborhood called Bywater, which includes the street named Desire, and serendipitously found ourselves at the monthly Bywater Art Market. We purchased an unusual wooden sculpture of a cat made from a gourd--but the real highlight of the market was a fellow selling huge, rich chocolate truffles. We bought several, and then ran into him the next day at another outdoor fair in Washington Square Park where several remnants of snowmen could still be found, at which we purchased several more. He had some free time, so I spoke with him at length and discovered that the chocolate maker and I were born and raised in the same neighborhood in Baltimore. A month later, when our family was making plans for our parents' 50th wedding anniversary, I discovered that the chocolatier's grandfather was the rabbi who officiated at my parents' wedding.
(c) 1996-2009 Steven Jon Kaplan Your comments are always welcome.