Trading Alert

A lot has happened in the past few weeks, and I intend to be brief here to give an update. I just closed the last of my short futures contracts and bought a gold contract. In my view we are in the first inning of this thing, however I do expect a *short term* bottom in equities soon. The coronavirus is a catalyst that will bring about even bigger changes in our lives, and I am not just referring to the temporary lockdown measures in place now. Will try to post more to explain in detail what I expect. Godspeed everyone.

Note: This is not investment advice. I am just sharing what I am doing. Proceed at your own risk.

Ominous Waves

Coronavirus coming ashore

With so much information readily available at our fingerprints, it is not surprising that we often find ourselves in disputes with others over facts and data. I see a post headlined with the title “facts” about every other day on social media. The problem is that one person’s facts may be another person’s fiction. And if you can’t agree on the facts, you will never agree. With regards to data, one of the biggest ways to manipulate a narrative is to present a data set over a limited time frame, or by not disclosing particular control variables that could affect the results. Therefore when I look at something, I like to look at the biggest time frame possible, and then zoom in.

In the 1930s a man named Ralph Nelson Elliott postulated that the stock market was composed of natural recurring patterns that were driven by social sentiment and herd behavior. This became known as Elliott Wave Theory. Without getting into technical details of Elliott Wave, the thing that has always intrigued me the most is that tiny waves can be identified as fractal duplicates of very big waves. Meaning that the pattern holds, repeats itself, and can be seen repeatedly when zooming in and out of a timeframe. When I consider fractals, I automatically think of fractal patterns that occur and repeat in nature, like in ice crystals, trees, shells, etc. One then can’t help to consider, are human brains wired a certain way that reflects itself in the same recurring behavioral patterns, over and over again?

Below is a long term chart of the Dow Industrial Average, going back to 1900.

Long term Dow Chart dating back to 1900, log scale. courtesy of

From left to right you can see the run-up to the 1929 crash, i.e. the roarin’ 20’s, and then a rebound that started in 1932 that has essentially lasted until the present day with a consolidation period in the ’60s and ’70s. In Elliott Wave parlance this is a 5 wave impulse move. I have labeled the waves below.

Let’s zoom in and look at the 5th wave above in greater detail. This is the move from the dreaded 2009 low.

5 wave move from 2009 low

See any resemblance? How about the move from 1921 up to the 1929 crash?

Uh Oh. So, what I am suggesting is that we are just completing a 5 wave move from 1932 to 2020!! There are others who point to this timeframe as terminating a bigger degree wave all the way back to the 1700s!! Either way, this portends something very bad and very big coming our way. Is Covid-19 (coronavirus) the trigger? War? A change from capitalism to communism? The fall of western democracy? We can rationalize all day on what might be the catalyst, but the waves speak volumes. Something wicked this way comes.

Fake everything

When historians look back, they may identify this time period as something akin to the “Roarin’ 20’s”, with aspects of the 60’s mixed in. The underlying theme that doesn’t escape me is that nothing is real anymore. We have fake markets propped up the Fed, a fake impeachment that resembles a kangaroo court, and a fake trade deal with China that may or may not have been agreed upon. This is only in the past month. Is this what Orwell was describing? It sure seems like it.

Let’s start with “markets”. You recall that I called for hedging a little over a month ago. I stand by this as I rolled my contracts last night, and my moves are calculated in months and years, not in daily or weekly gyrations. Several weeks ago, the head analyst at Credit Suisse put out a research report describing the likelihood of an extreme liquidity crunch into the end of the year, or the “turn” as they call it. The Fed’s pre-emptive response was $500 billion in additional liquidity to be provided between Dec. 13th and Jan. 14th!! As a result, the repo crisis has subsided and markets are making new highs every day into year-end. Therefore if you are looking for an approximate trend turn date, one might look at mid-January when these “temporary” additional liquidity measures end.

Impeachment? This charade has been the epitome of a banana republic. Whether you like or dislike Trump, what is occurring now will have profound negative implications on our country for years to come. Why? Aside from that the phrase “abuse of power” is a bit vague, how do you justify an impeachment based on hearsay, opinions, and what you interpret is going on in someone’s head? It’s almost like pre-crime in the Minority Report. Even worse is they are impeaching this guy for asking to investigate corruption that occurred in the previous administration and involving the 2016 election. You can’t make this stuff up. Based on this precedent, you will see presidents continually get impeached if the opposing party gets the house, simply because they don’t like the person. The obstruction charge is even more laughable. How do you even remotely have separation of powers when an executive branch can not exert executive privilege? Therefore it is perfectly reasonable for the administration to ask the Supreme Court for relief. It is not the House that determines what is an obstruction between the executive and legislative branch. To put the cherry on top of all of this, Speaker Pelosi has delayed sending the articles to the senate until she is satisfied the senate trial will be a “fair” process. LOL. Banana Republic politics at its best.

The China trade deal. Where do I start with this one? To recap, basically here is what happened after months of negotiations and rumors:

  • The United States will be maintaining 25 percent tariffs on approximately $250 billion of Chinese imports, along with 7.5 percent tariffs on approximately $120 billion of Chinese imports.”
  • no new tariffs will be imposed on Dec 15
  • China agrees to buy more Agri products
  • Structural reforms and other changes to China‚Äôs economic and trade regime in the areas of intellectual property, technology transfer, agriculture, financial services, and currency and foreign exchange”
  • Phase II Negotiations will begin immediately

All is well? Not really. First, according to US trade representative Lighthizer, China has agreed to purchase USD 40 billion in Agricultural goods in the first year (with “best efforts” to increase that to USD 50 billion the year after), that there will be additional negotiations and the deal is expected to be signed in early January (at a ministerial-level – not Xi and Trump). Lighthizer confirmed that China’s expectation is that there will be further phases and further reductions in tariffs, and he confirmed that the agreement will increase US Trade to China by USD 200bln over 2 years. The only problem is that China would have to quadruple its Ag imports from current levels and double the previous high of approximately $25 billion. To give further context, the entire US Soybean crop is about $36 Billion! So basically the math doesn’t add up. Rumors are that China may attempt to meet these obligations by counting Hong Kong trade and re-starting ethanol purchases. Accounting gimmickry? You be the judge.

What is even more troubling is that details of the deal, which include the structural changes to be made by China, will never be made public. Therefore how does one know what we are enforcing and against what metric?

The way I see this is that Trump basically folded in order to avert a trade war escalation that would likely crash equity “markets.” At best it is a de-escalation, or truce if you will, with the can kicked into the future based on illusory promises of tariff rollbacks on the US side and increased Ag purchases and structural reform on the China side.

With that, Merry Christmas everyone!

Smart Thermostats – worth it?

My new Ecobee 3 Lite Thermostat

Previously I had written about saving money on electricity costs using LED lights. The rationale was simply a low-cost investment in order to save several hundred dollars per year or more. This is versus trying to install a solar panel array, which has a much longer return on investment and are unreliable in outages if you can’t store the power with a battery bank.

Keeping with the theme of small, low hanging fruit investments to save money, today I will discuss smart thermostats. One of the key benefits of a smart WI-FI thermostat is that you can monitor or change the temperature setting from an app on your phone. Many people ask “why not just get a programmable thermostat”? The rationale behind that question is most savings are achieved from the programming in the thermostat rather than wifi capability. This is true if you program the thermostat properly, i.e. lower settings when you are not home or asleep. With a wifi thermostat, however, you can change the setting for 3-4 hour time periods when you are not home on the weekend or in the evening. This is aside from the ability to simply monitor your temperature when away for several days. This is a huge benefit as the thermostat serves as a potential warning trigger during a power outage. The Nest Thermostat actually has a learning function that claims to learn your patterns over time and adjusts accordingly. In the end, programmable thermostats can save up to about 15-20% of your heating and cooling costs if programmed properly, and you can add another 3-5% savings with a smart wifi thermostat.

Looking at what is available, the choice came down to an Ecobee versus a Nest and I reverted to the low-cost versions of these two, which are the Ecobee 3 lite and the Nest E. First, before explaining why I chose the Ecobee 3 Lite, let me provide my rationale for preferring the low-cost versions. I am of the mindset that most of the energy efficiency in your home is defined by insulation, windows, and ducting. For example, if you have poor insulation and old windows that aren’t sealed and caulked properly, it probably won’t make a difference if you have a smart thermostat or not. The ducting makes a difference because bends, elbows, and distance can cause a reduction in flow to some rooms. In that sense, it is better to have a 2 stage heating/cooling system especially if you have a bigger house with multiple levels. Therefore my conclusion is that a smart thermostat will help, however, I do not need the fanciest versions simply because they have a diminishing return for the additional dollars spent.

With that in mind, I chose the Ecobee 3 lite for three main reasons that were specific to my situation and preferences:

  • The lack of a “c wire” in my house
  • Detailed Energy reports and analysis
  • more versatile remote sensors

The big disadvantage of the Ecobee versus nest is the Nest learning function. I can mitigate that however by simply using the app to turn settings down while I am away. The “c wire” issue was a big deal for me since I have an older home without a c wire. Both units can operate without a c wire but it is how they do it that matters. Nest uses a trick called power stealing that can cause problems with your HVAC unit. Ecobee, on the other hand, comes with a power extender kit (PEK) that includes the extra wire needed and is easily installed out of sight near the furnace control board. The PEK Kit creates no interference with your HVAC controls.

Ecobee PEK kit – 4 wires in, 5 wires out

The remote sensors are a funny subject because I debate if they are really necessary. I could, theoretically, put one in my son’s room where I know it is colder in the winter and hotter in the summer. However, if the airflow to that room is poor, it will simply try to overcompensate by running the system longer and making the rest of the house too hot or cold. I could then add another sensor somewhere else and the thermostat will average the three. That could work, however, the remote sensors would have to be strategically placed so as to get an appropriate average temperature within the house, and in the most used locations. This leads to the advantage of the Ecobee sensors versus Nest sensors. The Nest sensors detect only temperature, while the Ecobee sensors detect both temperature and motion (occupancy). This is a very notable exception when considering the use of remote sensors.

The home report and data analysis function of Ecobee is a no brainer. It keeps 18 months of detailed charts for temperature, motion, and weather. For energy reports and analysis, it has a “Home IQ” function that is accessible online. As an engineer by trade, I love this. The Nest has improved its data analytics somewhat, however, it is nowhere near the level of Ecobee.

So I chose the Ecobee over Nest primarily due to preferences and my situation, but the Nest is still a great smart thermostat. In most cases, either one will suffice and provide you with additional energy savings while allowing you to control your system remotely.

Managing Risk in an upside-down world

Another week of craziness in the world, politics, and financial markets. A president steps down in Bolivia, soldiers on the street in Hong Kong, and of course, new all-time highs in some US equity markets. I try not to watch too much TV, but I couldn’t help but check in on a notable financial channel on Friday. I like to do this occasionally just to check in on sentiment and the prevailing narrative. The narrative was exactly as I expected. Basically that stocks will never go down and that NOW is the time to get in. Some things never change. What was particularly hilarious was a money manager saying that one needs to focus on the data rather than politics. It is funny when people opportunistically use extreme price action to rationalize a thesis, or as I like to say, simply “talk their book.” The other irony of the “data” narrative is the only data that really matters is the size of the Fed’s balance sheet and more importantly, how much that balance sheet is increasing due to QE operations.

To me, it feels like we are living in a version of Orwell’s 1984.

War is peace. Freedom is slavery. Ignorance is strength.

In other words, up is down, right is wrong, yes means no. I may sound overly pessimistic in this sense, so to be clear I am actually optimistic about the long term health of the economy. My concern rather is in the short to medium term (6 months to 2 years). Economic policy risk is near all-time highs. Investor complacency is at the most extreme level, ever. Some banks are so starved for liquidity that the Fed actually just increased its newest QE operation, again. I am not here to give you the full “gloom and doom” narrative, however. My preference is to be pragmatic and constructive in the face of uncertainty. Therefore how do we manage these risks? It is not to “sell everything” like many did in 2008/2009. To that point, and to the point of my previous post, it is prudent to “hedge” against a significant downturn. A tool that I recently discovered which is suitable for my needs is the Micro futures contract. This is after using multiple other methods to hedge over the years, all of which have various deficiencies. Options? You deal with time decay unless you are heavily in the money. Sell something short? You run the risk that the shares are called back by the exchange due to scarcity, forcing you to cover at a loss. Leveraged Inverse ETF’s? You lose money every day due to daily rebalancing that has the effect of a permanent time decay. How about regular futures contracts, or minis? Well, the leverage is enormous. One e-mini contract on the S&P 500, for example, has 50x leverage! This means that every point is worth $50 per contract purchased. Wow.

The broader point is that managing risk is not just hedging or identifying the correct thesis, it is also the size of the hedge as a percentage of your liquid assets. Therefore the micro futures contract offers the huge benefit of trading only a slice (1/10th) of the most liquid equity index futures. For example, one point in the S&P 500 equals $5 per contract rather than $50. Below is a snapshot of the most current contracts (December):

I hope this helps alleviate some of the fears and “exoticness” of using futures as an investment tool. It does for me, and I can still sleep well at night!

Disclaimer: This is NOT investment advice, but rather an idea that works for me and my own risk tolerance.