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’s 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!

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.

Time to Hedge

Time could be running out on the “everything” bubble

First I would like to explain my lack of posting recently as it is not for a lack of topics or opinions. My older son just had fall break, and we used the time off as an opportunity to travel to Florida for several days. The 80-degree weather was a nice respite from the cold in the midwest and the kids had a blast as usual. The resort we stayed at was great, and we gutted out one day at Epcot since we already did Magic and Animal Kingdom back in February. We also closed on a property that we had owned for almost 14 years (love the “mobile” closes). It was bittersweet due to the memories of living there, rehabbing the property, fixing things, and tenant issues (lol). Recently a tenant moved to Arizona, and I decided that I didn’t want to manage from afar or hire a management company. In addition, the market in Grand Rapids has been very hot which manifested itself in competing bids on our property (basically a bidding war over list price). A nice problem to have I suppose.

I would like to think that we are selling at the top and that my instincts are prescient. Maybe, but things usually happen due to a confluence of events and the timing becomes coincidental when looking through a rearview mirror. In other words, luck plays a big part. Luck aside, I do have a sense of foreboding regarding the current social, political, and economic situation which influenced my decision to sell. Whether it is quantitative indicators that I follow, civil unrest throughout the world, or simply conversations I have with people every day, “things” just don’t feel right. Of course, I could argue that it has been that way for a while. With this mindset, selling the property was just one step, and I have also started layering in “hedges” to protect my assets. Translation: I am building hedged positions (short) in the equity markets. A hedge is different in that it is not a primary investment, but rather a bet to protect those investments. Call it insurance. If you want to play at home, I shorted the Nasdaq and will layer in more shorts next week. Yes, I am fighting the Fed and realize it may be fruitless, but my take is that the Fed’s omnipotence will come to an end soon. When that happens, look out below. Aside from monetary policy reaching its limits, I believe we are at a bifurcation point politically which could have profound implications on fiscal policy, and life in general. In short, we are becoming a banana republic and anything can happen.

Disclaimer: This is NOT Investment advice. I am just sharing my thoughts and what I am doing.

Smoke and Mirrors

Chicago’s Budget

Previously I had written about the importance of mobility as bankrupt municipalities attempt to grab more and more of your hard-earned income to fill exploding budget deficits. A perfect example of this is the City of Chicago, which just unveiled its budget to address an $838 million shortfall for fiscal year 2020. To help close the city’s deficit, mayor Lori Lightfoot proposes to save $337 million through various efficiencies, including but not limited to the implementation of zero-based budgeting and department mergers.

Unsurprisingly, $350 million of the deficit is to be paid through new taxes. Her plan calls for higher taxes on ridesharing and restaurant food and drink. She’s also called for other revenues, including a progressive real estate transfer tax and a Chicago casino that need the authorization of the state legislature. If the mayor doesn’t get these items, she has threatened a property tax increase even though the city is still absorbing a record $543MM increase from 2015.

Where things get murky is the remaining $200 million which is expected to come from what I call accounting gimmickry, or “smoke and mirrors”. This amount will come from refinancing $1.3B in bonds and taking 20 years of interest savings in 2020. Yes, you read that right, the city is front-loading interest savings as a one-time event to show that it has a balanced budget. A few comments about these shenanigans. One, given that it is a one-time event, you will have a $200 million hole in 2021 and beyond. Second, this is an accounting entry and not on a cash flow basis, which means the city is not really saving $200MM in cash next year. Lastly, the method of refinancing will be through the use of “securitized” bonds. What is a securitized bond, you might ask? It mandates a sale of assets (i.e. transfer of ownership) in the event of default, in this case, future tax revenue!

In a nutshell, the budget is comprised of legitimate cost-cutting ideas, tax increases, and shady accounting while risking future services that could be obtained from tax revenue. There is nothing about structural pension reform needed to tackle Chicago’s growing underfunded retirement liabilities. Meanwhile, public teachers are striking after rejecting what Mayor Lightfoot called the most lucrative offer ever for the Teacher’s Union.

My decision to live outside of Chicago and Illinois altogether is looking prescient by the day. I suspect things will get much worse before they get better.


Brexit negotiations?

One of my favorite classes while studying as an undergraduate was physical chemistry. This was notable since most people hated physical chemistry, otherwise known as “Pchem”. The main reason for this is that quantum mechanics taught in Pchem is at odds with everything you had been taught in physics for your entire life, often called Newtonian or classical physics. For example, in quantum mechanics, the movement and location of electrons are defined by “probability clouds”, meaning they might be somewhere or might not. Given this uncertainty, it is interesting that “chaos theory” is derived from classical physics. In recent years however physicists are drawing parallels with chaos theory and quantum mechanics. Said another way, you can find order in chaos and chaos in order. I have often asked myself that if you can’t predict the exact location and movement of the basic constituents of what makes up human beings, how can you predict or even control human behavior? Therefore I have long been a proponent of “natural law”, meaning things will occur as they will in nature, and ultimately tend to chaos and decentralization.

If you look at current events, the existing social and economic order is unraveling at lightning speed. Brexit negotiations, China/US trade tensions, Ukraine, Yellow vests in France, Catalonia, Syria troop withdrawal, impeachment inquiry, Hong Kong protests, the list goes on and on. I could write multi-page posts on any of these topics individually, but that wouldn’t serve justice to the overall theme without losing sight of the forest through the trees. The “forest”, if you will, is that we live on a planet with a fixed amount of resources with an ever-expanding population. These disagreements, battles, controversies or whatever you call them, are often about how to control and distribute those resources.

In Syria, for example, the mainstream media and many in Washington maintain that we are severing alliances, abandoning the Kurds, and empowering ISIS by removing 1000 troops from a base near the Syria and Turkey border. Is that really the case? I would urge people to repeatedly ask “why?” to find the root cause, otherwise known as the “five whys”. Once you do that, you discover it is about resources, trade, and power over such. The land in question is very rich in energy and agricultural resources, and the real concern is that Syria and Russia will gain influence by brokering a deal in the region. In addition, the land occupied by Turkey is considered very strategic for China and its “silk road” project linking European and Asian trade. Therefore “ISIS” is just a perpetual boogeyman that will never cease to exist.

Ukraine is important for similar reasons. Do you think the recent “controversies” that surround Ukraine are coincidental? No, not in the slightest. Ukraine happens to be rich in agriculture and natural gas, and of course it is important to be able to feed your citizens and keep them warm. The origin of the ongoing issues in Ukraine is when Ukraine decided not to join the Euro and coincidentally (or not), the EU has to buy energy resources from Russia. Coincidentally (or not), the most recent wave of McCarthyism seems to have started at about the same time, when the Russians “invaded” Ukraine, a country with a lot of Russians. In other words, Ukraine not joining the Euro was an unacceptable result for those that want resources and trade further consolidated within the Euro. As it stands, the EU maintains it cannot afford to pay the price for natural gas that Russia is asking. Hmmm.

Ask yourself similar questions about Brexit, or even Trump. For the power elite, it is about outcomes that meet pre-determined criteria, narratives, and world view. Every time it doesn’t happen in the prescribed or orderly way, all hell breaks loose. If you don’t align with those views, you are labeled radical, stupid, ignorant, racist, or worse…a Russian asset.

Expect chaos and unpredictability to reign. Any attempts to further consolidate power and trade will only serve to enhance instability.