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Boeing will take the Aid

The $2 trillion package has a special seventeen billion dollar provision designed specifically for Boeing. The bill almost names Boeing as the recipient stating

“Not more than $17,000,000,000 shall be available to make loans and loan guarantees for 18 businesses critical to maintaining national security.”

However, Boeing has made clear that they refuse to make use of this line of credit. It is almost certain that a precondition of these loans it that Boeing’s share will be used as collateral. While Boeing has $12 billion on hand, that will not be enough to make up for the prolonged troubles of their commercial business. With decreased demand and regulatory troubles, Boeing will be forced to drawdown these credit lines and dilute their common share. This dilution, while providing liquidity to the company, will almost certainly drive down their share price. With all of these compounding factors, it will be a long time before Boeing’s stock flies again.

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These Trying Times…

Ah these are trying times are they not. Jobless claims hit 3 million, the highest since the great recession, and the markets just shrugged. The market entered a bear market because it was uncertain about the future of the economy. The markets rebounded 20% from the bottom on the news of Congress actually passing a $2 trillion fiscal aid package.

The markets clearly believe that the pandemic is under control, that everything will be fine and the government will step up to pass important legislation. All of these hopes for the economy miss a key fact: the pandemic is not controlled. The markets will continue to go down. The economy will continue to be shuttered. Putting the economy on hold will not be solved by a mealsy $2 trillion package. No. This recession will last significantly longer.

The number of Coronavirus cases in the United States currently stands at over 100 thousand. This number only reflects the currently detected. Considering what we know about the proportion of asymptomatic cases the true number is probably closer to 1 million. The pandemic is not under control and will probably peak in 8 – 10 weeks. For assumption sake, let’s assume 70% of the American economy is offline right now. If that continues for the next 20 weeks that will cost America somewhere in the ballpark of $4 trillion. That is probably going to be the true cost of the virus considering America’s current trajectory with total infections.

Given my prognosis for the course of the virus, what do I believe the economy will do? In the short term, the economy will suffer. It will continue to push companies into the red and probably bankrupt many small corporations unless a second fiscal package is passed to plug this massive hole. But even with a huge fiscal bailout it won’t save many small business necessary to America’s long term viability.

Nonetheless, American will eventually recover. However, I firmly believe over the next few years we will have a prolonged period of slow and perhaps negative growth. So what does this mean for equities. I believe there will be a permanent pull back in Price-to-Earnings multiples. I also believe there will be a continued flight to safety, meaning lower bond yields and higher commodity prices. The American economy cannot be shut off and on without permanent damage. It would not surprise me to see another precipitous decline in stock prices in the range of 20-30 percent.

The one thing I am relatively certain of is a rebound in oil prices. Oil in Wyoming is literally negative. They are paying people to take away oil at $.19 dollars a barrel. This collapse of demand and oil price war is artificially depressing oil prices to a level that is unsustainable. Therefore, I believe oil represents a very good investment especially in these trying times.

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A new Bull Market and how to navigate it

The market officially entered a new Bull Market closing 20% above the most recent low. I’m sure that arbitrary metric is not very comforting to people’s minds after seeing their portfolio values during the market high set just one month ago. Considering the market is still down 20% from its peak the real question is: Is it time to buy?

This question is a fool’s errand. Timing the market is nearly impossible so we’ll start by focusing on the five-step plan, discussed in “What I learned Losing a Million Dollars”. The first step is to decide what type of market participant you are going to be. For our purposes as a retail investor, we must assume the position of an investor. What does this entail? Well, an investor is a market participant who has a very long time horizon.

The next step is to decide our type of analysis. Considering our position as an investor, a focus on fundamental analysis is probably best suited to our needs. This means focusing on the underlying fundamentals and the company’s ability to profit and grow their earning power over time. With this criteria analysis, how should we proceed? Well the first question to ask is “will the company in question be fundamentally changed by the Coronavirus pandemic?” If the answer is no (think Google), then ask “is their stock priced attractively?” If the answer is no, then continue to look for other opportunities, if yes, then we’ll continue to step 3.

Step 3 is developing rules. Our rules as an investor are simple: if the security is priced attractively with regards to their underlying business, we will hold the equity, if not we will terminate the position. This rule can easily become more idiosyncratic to the position with more information, however, the rules should largely follow the general one set above.

Step 4: Establish Controls. Setting parameters once rules have been set allows for the easy termination of a position if there is a change in the underlying fundamentals. By setting rules, the controls follow naturally for whether to keep the position or not. For example, if we decided before, that a drop in operating profits warrants the elimination of a position, then we will eliminate it once it drops below the predefined threshold.

Step 5: Celebrate. This is the final step. Relax and keep tabs on your position to ensure that it still fits the rules set beforehand. If it doesn’t then exit that position.

The markets have been wild. Setting a plan and adhering to it before entering into a position ensures predictability in an unpredictable situation. It may be impossible to know how the market will react, but you will know exactly how to act regardless of the market. Developing a plan is about the reallocation of power away from the market and into your own hands.

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Nuggets of Wisdom from “What I learned losing a million dollars”

In these turbulent times, people often look outwards for help. There are many information outlets that promise great riches in the market, but Jim Paul, author of “What I learned Losing A Million Dollars”, teaches us the opposite: how not to lose money. So in saving you, my dear reader, the mental hassle of reading the book, I read it for you.

My Quarantine Life

Nugget of Wisdom #1

Make a plan. If there is one lesson to take away from this book it is this: MAKE A PLAN. The five steps to a plan are as follow

  1. Decide what type of market participant you’re going to be
  2. Select a method of analysis
  3. Develop Rules
  4. Establish Controls
  5. Formulate a plan

“Depending on what your goals or objectives are on the continuum of conservative to aggressive, you will decide whether you are an investor or speculator, which in turn will help you decide what markets to participate in, what method of analysis you’ll use, what rules you’ll develop and what controls you’ll have.”

Reading these rules, and seeing how I broke all of them frequently, explains many of my market losses. Executing this plan does is not necessarily profitable but it does mitigate losses. This prevents you from continuing to stay in a bad position because you believe you are right. The method outlined above removes the emotional part of capital allocation and paramaritizes a continuous process into a discrete event. Adhering to this plan

The plan you develop “is a script of what you can expect to happen based on your particular method of analysis and provides a clear course of action if it doesn’t happen; you have prepared fo different scenarios and know how you will react to each of them.”

It matters less what the plan is then the fact that you have a plan. In this way the market is predictable because you will be prepared for whatever course the market takes.

Nugget of Wisdom #2

The market is indifferent to your ego. It does not pass judgment on whether you were correct or wrong. All it does is state the market value of your position, that is it. When trading, or investing remove any sense of ego and don’t consider an unprofitable decision as wrong, simply treat as what it is: an unprofitable position.

“When someone asks, “Why is the market up?” does he really want to know why? no. If he is long he wants to hear the reason so he can reinforce his view that he is right, feel even better about it, and pat himself on the back. If he isn’t long, he’s probably short and want to know why the market thinks the market is up.”

This problem is a symptom of not having a plan. By understanding the criteria that you would exit a position before you enter the position, mitigates the possibility of maintaining a poor position.

So what is the one piece of advice this book offers: MAKE A PLAN.

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Fiscal Package Savior … Probably Not

Today was absolutely electrifying. Seeing those equity prices rebound like that, man there is nothing sweeter. Don’t get too excited because the break in the storm is certainly temporary. The market was reacting to news that congress is closer to passing a massive fiscal bailout package. I suppose the old mantra “trade the rumor sell the news” is what’s at play here. Does the news of a shaky fiscal bailout really warrant this type of rebound?

The Dow Jones Industrial Average (DJIA) March 24 rebound

No. An unequivocal NO. A fiscal policy bailout is not nearly as important as the recent change in the Federal Reserve policy. The “Federal Open Market Committee (FOMC) will purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy. “ Let’s digest the words “in the amounts needed” for a minute. The federal reserve is essentially saying they will purchase an unlimited value of bonds. The Federal Open Markets Committee (FOMC) initially announced they “would purchase at least $500 billion of Treasury securities and at least $200 billion of mortgage-backed securities.” Considering their sudden reversal in policy the FOMC will purchase these securities in extreme excess of the initial $700 billion promised.

With these new policies the Federal Reserve is effectively injecting several trillion dollars into capital markets. On top of this capital, injection is a several trillion dollar fiscal policy package being discussed in Congress. These policies will result in inflation but not necessarily asset inflation. A principal reason for the elevated Price-to-Earnings ratio seen in the markets over the past decade can largely be attributed to the fiscal policy bailouts of Congress in 2008. However the structure of the current bailout will not lead to the same asset inflation which helped equity prices over the last bull run. Both sides of Congress want to send checks to low-income Americans. This policy will probably stimulate the economy but not necessarily drive asset prices. Lower-income Americans tend to spend a larger portion of their income rather than saving it.

So why is all this printed money bad for my portfolio? Well several reasons. Firstly, this rapid influx of money coupled with increased consumer demand will lead to high levels of inflation, eroding your purchasing power. Secondly, all of this increased liquidity will not lead to a much-needed increase in security prices. The only thing that will help is a return in consumer confidence.

Image result for p-e ratio over the past decade
Elevated P/E ratios can be seen over the past decade from 2010 – 2020
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Don’t buy triple velocity products…

A levered product is not a buy and hold ETF, it is a short-term hedge for a sophisticated trader. Leveraged funds are associated with a well known phenomenon of leveraged-induced decay. To illustrate this phenomenon the US Natural Gas Fund was up 15% between April 2016 and April 2017, but it’s triple velocity product was down 12%. This principle applies to all triple velocity products. So unless you are a sophisticated day trader that requires these huge daily swings Triple Velocity products should be avoided like the plague.

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In the Time of Turbulence

The markets have been volatile ever since the Coronavirus outbreak. Everyone has made money one day to see it evaporate the next. And my oh my remembering our portfolio values at the market high, set only a month ago, to now, brings an extraordinary amount of pain. So, you ask, what’s the good news? Well, the only good news for your portfolio is that it’s condition of low value isn’t terminal. The market, over any 20 year period, has never been down. Given this axiom of the market, if you’re invested for the long run, don’t change your portfolio.

There is only one way of coping with these extraordinary events: stop internalizing. The market does not care what you think about it. It delivers it’s sentence of profitability with indifference. A profitable investment does not equate to brilliance likewise a loss is not stupidity. These losses (or gains) are strictly business not emotional decisions. While I’m sure it’s riveting to see your portfolio jump, it should only given be a nominal amount of emotional value. The same is true of the obverse, if the market goes down re-examine what lead to the position and if that same logic applies keep the position.

The bottom line is that markets will continue to free fall. If your logic still applies then do not change your position. Additionally, do not kick yourself for missing the huge drop in the market. Just remember the market will rebound and when it does you want to make sure you’re still in the market.

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What shape will the recovery be?

The economic impact of Coronavirus is going to be terrible. The world cannot take a break and not expect profits to plummet, but everyone already knows this. Therefore, there is only one real question: What shape will the recovery take. There are only two types of possible recoveries: V-shaped, U-shaped

V-Shaped Recovery:

Many people have been speculating that once this pandemic is controlled America and the globe will return to thriving economic activity. There is a major problem with this assumption. The pandemic will not be contained. The coronavirus will require increasingly stricter measures to contain its spread. It should not be assumed that this crisis will revert to business as usual quickly. Governor Cuomo of New York, said today that he expects the crisis to continue for months. The models of the virus project that infections in already hard-hit areas like New York City and California will peak in eight weeks. Additionally, the restrictions that China put in place lasted months after the peak. If China offers any lessons we can expect these lockdowns to last longer than a few weeks but should expect it to take months. Considering these facts it is highly unlikely a quick economic recovery will occur.

U-Shaped Recovery:

A U shaped Recovery refers to a slow anemic sub-par growth over a long period. This seems highly likely. The lost decade of economic growth that Japan experienced from 1991 to 2001 will be reflective of the next few years. Even with the large fiscal policy packages that congress is passing, it will not be enough for people to immediately go back to work. Credit crunches and a whole host of unforeseeable problems will prevent this quick turnaround in economic fortunes.

Japan’s Lost Decade

Given that the economic crisis at hand will take a protracted recovery time, what should you do? Well your portfolio is going to stay low during this time. Additionally the fiscal and monetary policies that are being pushed around the world will probably manifest in high inflation rates over the next few years. On top of that, with talk of giving the lowest wage earners money instead of corporations, there will probably be a permanent pull-back in Price-to-Earnings ratio. All of these things mean that the market is still not oversold. If anything the market is still priced at a premium. Industrial companies and consumer-facing enterprises will see a long earnings slowdown for a very long time. Expect your portfolio to continue downwards for the next few months.

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Capitalism in America is fundamentally broken

In 1996 the United States faced a well-heeled financial crisis. The Savings and Loan crisis caused the failure of more than 700 financial institutions and led to $400 billion being written off. This loss was more money than the banking industry had mad cumulatively over the past century. Of course the cost of this crisis was borne by the American taxpayer. This situation happened again in 2008. While the Federal Reserve did eventually turn a profit on the mortgage-backed securities it held, the U.S. government still spent $800 on a fiscal stimulus package that was never recovered. This system of huge irrecoverable losses covered by the U.S. government will inevitably fail. This same problem is happening again. 

The domestic Airline industry, and every other industry, are asking for a fiscal bailout. Does this fiscal stimulus make sense? The airline industry over the past year spent 96% of free cash flow on share buybacks. Why should the American government be responsible for bailing out an industry that failed to capitalize themselves? Management, not just of the Airline industry, must be prepared for large unforeseen exogenous threats to their business. While the probability any individual Black Swan occurs in low, there is a very high probability that some Black Swan event will happen. It may be impossible to know the exact nature of the event but the effects of the crisis are clear and possible to navigate.

The fiscal package that will inevitably be passed cannot allow for a resumption to business as normal. There must be change. The shape of this fiscal bailout must make clear that the government will not allow shareholders to realize returns while the government bears most of the risk. America needs to become comfortable with failure. Failure and competition, not government packages and bailouts, fostered innovation. Natural selection, over a long time horizon, favors a conservative approach towards success. The most successful companies have not needed government help and have been able to whether these “unprecedented” storms because they were prepared. For example, Berkshire Hathaway is a financial fortress. Warren Buffett has ensured that his company – and by extension, his shareholders – do not bear unnecessary risk, and are always prepared in times of crisis. Another (less savy) institution that has survived the test of time is Kroger. These companies survived because they were prepared. These companies do not and have not required government assistance. The rewards of the economic system are being unfairly parcelled out when the government throws the fiscal policy sink at these “unpredictable crisis .”

I strongly believe that the government should not be responsible for these companies’ short-sightedness. Regardless of their irresponsibility however, the government should push for better governance at these companies. Instead of tying management compensation to share price ( which over the short term they have very little control over), compensation should be determined by an independent board ( not these fishy you scratch my back I scratch your back, boards we have today). Also, management compensation needs to be smaller. Why should Oil executives, who have almost no control over the price of oil, be compensated when net income soars? This makes no sense. Management is being compensated for things they have no control over. This story of compensation which is tied to luck is a pervasive one. It will inevitably doom the continuation of American economic dominance unless we act.

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My positions right now.

One of the lessons I learned losing all my money was that I should write down why I’m holding my positions. Because of this fundamental lesson I am writing them down now.

Oil : 45% of portoflo

The largest position in my portfolio is oil. My exposure to oil is through two indexes. The first index is the “VelocityShares 3x Long Crude Oil ETNs linked to the S%P GSCI Crude Oil Index ER.” I wanted to leverage my exposure to the commodity so I went with a triple leveraged fund. The second index I’m in for oil is the “United States Oil Fund” which moves with the West Texas Intermediate futures price.

Cash: 25%

My second largest position is cash. I figured in these high volatility times keeping some cash makes sense.

Option Contracts:

J.P. Morgan $150 Call Expires 1/21/2022 ~ 13%: J.P. Morgan is one of the most profitable and well capitalized bank right now. I am not convinced they will be materially impacted because of the Coronavirus. Their return of equity is one of the highest among the large U.S. banks and Jamie Dimon is an extremely capable manager.

Snapchat $22 Call Expires 1/21/2022 ~ 10% : I do not think the Coronavirus will adversely affect Snapchat’s core business operations. Because of their recent 40% decline I figured a long term call would be a good bet. I also really enjoy their core product and believe it is popular with a very impressionable demographic which commands a premium to advertisers.

GE Call $12 Call Expires 1/21/2022 ~ 7%: GE is currently selling their Biotech division for $24 billion I believe. This capital will provide some breathing room and allow GE to weather the storm. Also, GE healthcare is one of GE’s largest business and is well positioned in the current pandemic. One of the reasons I believe this company is so sold off right now is because they are a major supplier to Boeing. I believe with the government assistance to Boeing, GE’s production of engines will resume close to capacity.