"I'm forever blowing bubbles."
That, according to John Mauldin, should be the Fed's theme song this year. Not too many people disagree that we're in a bubbly economy and no one disagrees that the Fed and other Central Banksters' easy money policies are the cause. What does seem to be subject to debate is whether or not this is a bad thing.
That's why that first link is very important – it reminds us how the "best and brightest" minds of a generation can be so completely wrong about something so "obvious" in hind-sight. The reason us macro guys don't like bubbles is PHYSICS – they burst. And, when economic bubbles burst, they cause a lot of damage – the hangover simply isn't worth the party.
As Mauldin notes, Since 1990, the P/E multiple of the S&P 500 has appreciated by about 2% a year; in 2013, the S&P's P/E has increased by 18%. We already know that margin debt is, once again, through the roof, back to pre-crash levels of 1999 and 2007 but trying to warn you off this market is like standing in front of the new keg that just came into the frat party and saying "Don't you think we've had enough already?"
People simply aren't wired that way. You KNOW there is no such thing as a free lunch yet when do you ever turn down a free lunch? We tell our children not to take candy from strangers but then make up an entire holiday where the whole point is to take as much candy from strangers as you possibly can. My daughter came back home with a pillowcase full of candy – more candy than she's allowed to have all year, not counting last November, when she consumed her last pillowcase full of candy.
We are stupid animals. If alien scientists are studying us as investors, they would be incredulous that we are making all the same mistakes we made 5 years ago, which were essentially the same mistakes we had made 8 years before that. What we generally like to call "economic cycles" is generally just our tendency to repeat really stupid behavior – over and over again.
Here's Alan Greenspan, "wisely" using his hindsight goggles to explain why the market was collapsing on March 11, 2009, which, interestingly, was a day when I was banging the table telling our Members to buy anything that was not nailed down:
There are at least two broad and competing explanations of the origins of this crisis. The first is that the "easy money" policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess.
The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria.
It's not complicated to make money in an up market, on September 10th, when the S&P broke over our 1,660 line on, I wrote up "5 More Trade Ideas that Make 500% in and Up Market" and, of course, they are all up huge, as are most of the 100 other mostly bullish trade ideas we had during the month of September (see September Trade Review, Part 1 and Part 2). The "5 More" refers to the fact that these trades were a follow-up from our bullish April set of "5 Trade Ideas that can Make 500% in an Up Market" which we wrote up at 1,550. Now the S&P is at 1,760 and I think it may be time to take some of those profits, at least 30% going forward from here – and begin putting them into trades that can pay us 3-500% to the downside.
Taking a few downside hedges on the way up doesn't make you bearish – just intelligent! Let's say we put 10% of our Portfolio into our April 500% plays. Those hit goal in Sept so now 50% of our original portfolio. Then we put another 10% into the Septemeber set but it's 10% of 150% so 15% and now those are up about 300% so 45% + 135% = 180% and all I'm saying now is we begin to put just 10% (18% of original amount) plus 30% of gains going forward, into downside positions.
That way, we still have about 160% playing to the upside but now about 20% invested in a drop so, if the market suddenly drops 10%, we'll lose maybe 32% on our upside positions (assuming normal leverage) but our highly-levered downside positions will make 40-60% and keep us cash-neutral or better. Since a 10% rise in the markets will make 32% (same leverage) and lose us maybe half of the 26% we spend on hedges, then we're still capuring most of the additional upside without risking our already generous gains. Doesn't that make sense?
Hedging and portfolio management will both be topics of discussion this weekend at our Las Vegas Conference – I look forward to seeing you there!
Meanwhile, for the cheap readers (we'll discuss more hedges in Member Chat today and tomorrow), one nice hedge I always like is TZA, the ultra-short Russell index. It's down to $21.04 and the April $17/22 bull call spread is $2.10, which gives it a nice 138% upside if the Russell even flinches down.
There are a couple of ways to increase the leverage on that spread and one is to sell the $18 puts for $1.60, which drops the net down to .50 with a 900% cash payout at $22. The logic of doing this is you don't get the stock put to you unless the RUT is 5% higher and, if the RUT is 5% higher – won't you want a short hedge anyway?
The other way to hedge the hedge is simply to pick a stock that you think will not be lower if the Russell goes up another 2.5% and forces TZA below your break-even. That could be any stock you REALLY want to own if it gets cheaper, like selling FB March $40 puts for $1.75 or FCX Feb $35 puts at $1.55. Just find something you think is too cheap and sell the puts at a strike you're willing to enter.
Much more on this topic in Member Chat and the rest of the week!
