Are you too ‘smart’ to short the market? Then do this

Unlike most smart investors, financial pundits, TV commentators…

 

…and not least my eloquent friends at Wall Street Playboys,…

 

I do time the stock market, and I don’t shy away from making my recommendations or investments public.

 

Right now every fiber in my body screams to short the stock market:

  • Risk aversion is on the rise (seen in general market dispersion, chaotic and nervous intraday patterns, loss of trend uniformity, increasing High Yield spreads) and any little event could topple that first crucial domino that sets off the rest. The whole market is nothing but an unstable pile of fingers of instability.
  • The rally is extremely long in the tooth and some robot traders could just as well take that as a cue to try the downside (NB: 80% of the trading is automated robot trading)
  • Oh, did I mention the US stock market is the most expensive it has ever been (on some measures, and just 10-20% below the epic peak of year 2000 on others)? Swedes hoping for a safe haven in dear old Stockholm should note that the OMX index usually mirrors the US indices perfectly in downturns, no matter if OMX lagged a little before.

The stock market in a nutshell (pic from Hussman)

Why you should short stocks

Directly from Hussman, just as the picture above: The yellow shaded areas show points where credit spreads might be defined as “rising.” For simplicity, I’ve shaded all points where credit spreads had advanced 90 basis points from their 6-month low, and were greater than their 150-day moving average. Observe that the steepest losses we’ve observed in the S&P 500 in recent decades have been concentrated during those periods of objectively widening credit spreads. I’ll say this again: low and expanding risk premiums are the root of abrupt market losses.

The purple shading identifies only a subset of those points that also match the market return/risk profile that we currently observe (basically identifying recently overvalued, overbought, overbullish conditions that were then joined by deteriorating market internals or widening credit spreads).

 

But, I get it, you just don’t want to short the market. It seems immoral, dangerous, unnatural… You’d rather just wait for a good buying opportunity – and you don’t want your money to sit idly on a zero per cent bank account meanwhile.

You could copy my strategy, which is to slowly accumulate investments that have already become somewhat cheap (but, as always, risk becoming cheaper, much cheaper, further ahead) and trade others opportunistically (I like gold and currencies, since they don’t really have ‘intrinsic values’ like stocks. That makes it easier to disregard the dangers of picking unknown pennies in front of an unknown bulldozer)

 

So, what am I doing exactly? I mean, I have retired, I am officially a retarded hedge fund manager. I could live splendidly off of my capital for the rest of my life. However, as the retard I am, I want to prove that I am right. Just saying I said so afterward simply isn’t enough. I want to make some money too.

 

Except for my big short (which is waaaaay under water) on the Swedish stock market, this is what’s currently in my direct financial portfolio (except apartment, pension funds, private companies like the publishing company and the floating sauna company, russian art etc.)

 

  • Software as a service: A convertible loan and a sell option in a Human Resources software company – if things look okay, I’ll convert to shares and later use the sell option, if they look really good, I’ll convert and keep the shares for a while. If things turn really ugly, I’ll end up with a large mansion in the countryside
  • Cash at the bank (dry powder)
  • Loans to friends (not that dry gun powder, but perhaps I’ll get to call on these when the time comes – at least they stick to regular amortization schedules)
  • Gold (albeit “paper gold”) SPDR Gold shares ETF – gives me some USD exposure as well as some insurance against Yellen’s next move (+21% so far on this trade)
  • Gold mines (senior = actually producing gold) Market Vectors Gold Miners ETF – like above but with more juice (+24% on this trade so far)
  • USD 3x leverage – I halved my position in the USD yesterday (75% profit in a year) but still have a fair amount left. The Swedish Krona, SEK, usually falls in times of trouble. If China falters probably doubly so due to Sweden’s export dependency to Asia. The USD on the contrary, despite all its shortcomings, is the safe haven of first choice for most investors (incl. americans themselves selling foreign assets). The Fed might even consider raising rates this year which I can’t see any other central bank doing.

Smaller investments and speculative short-time bets (oil):

  • Creditsafe – small unlisted credit service company, provides credit quality information on companies and private individuals
  • Oil (Brent) 5x Leverage (entered today )
  • Peptonic medical – oxytocin pioneers (very small investment)
  • Opus – small investment (testing services and testing equipment mainly for the auto industry – hopefully a secular growth story, the share price has recently halved and that’s why I stepped in. However, the shares will likely fall a lot more before this is over)

 

My suggestion to you (except shorting stocks) is:

  • Invest in a business (your business perhaps?) or learning a skill
  • Keep cash ready for opportunistic buying in the case of a (flash) crash
  • Think outside your geographic region (stocks, currencies)
  • Slowly, slowly accumulate stocks that really excite you and have become forgotten by other investors that chase a shrinking pool of rising large caps
  • Consider buying things like gold or oil, but do your homework first, don’t just follow my lead

 

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16 Comments

  1. KM,

    Have you considered buying long calls into the stock of Brent Crude producers. I know that ETF daily resets can hurt your gains via high volatility.

    • Yes, I have, but thanks for asking.

      1. I can’t readily find such options on my platform
      2. I know the problems with ETFs, and the more leverage the worse it gets. But I’m speculating with TINY amounts here, just looking for a bounce, and wanted the simplest instrument possible.
      3. I’ve used ETFs for similar purposes before with good results. I just make sure to check the price history of that particular ETF to see how much it actually CAN move up and down over time. Efficiency has nothing to do with this.

      What I’m REALLY doing is waiting, but I actually am looking at more long term none leverage, none reset, pure brent as well.

      • Update: I sold half of the oil at a 40% profit today. I thought that was enough for 36 hours : )

        PS: Didn’t notice any disturbing reset costs or such ; )

        • Just for the record, I’m out of the oil trade now. Sold the 5x at 125% profit today.

          I actually think oil will be much higher by the end of the year but I don’t trust that instrument. I’m also worried Russia and OPEC will pump like crazy at any prices to keep their dictatorships afloat. Combined with an economic slowdown, oil prices should undershoot their warranted price heavily.

          I “hope” I can get in much cheaper sometime during the year. If not, who cares? Oil is not my core business, just a fun punt while waiting for the stock market to become cheap (not necessarily fall).

  2. Some confusing parts in the post in terms of what you’re recommending just trying to see what you mean here (based in the USA)

    – You’re saying to short the market and the USD will go up correct?
    – If the first part is true… then why do you recommend thinking outside the country in terms of currency? Wouldn’t it simply mean to just own USD.
    – In terms of oil, there is no reason for OPEC to decrease production at this point – market share issues, so why are you long oil?
    – What is opus? did a quick search is it Opus Group AB?

    Just trying to see how you think not trying to start a pissing battle.

    • Hi Kevin

      For me as a Swede it makes sense to think in terms of buying the USD (or US assets like bonds). That’s outside the box for ME. (however, I’ve have now started to divest my USD, since I think most of its rally vs the SEK is done. I’ve made almost 80% in a year being long a 3x product in USD). For you, based in the US, outside the box might be buying e.g. Vietnamese stocks, not as a bet on FX but as a way of buying cheap stocks compared to US domestic stocks. I will not give you specific tips on what to buy, I’m just saying to widen your financial investment perspective from “US stocks or not US stocks” to oil, gold, sugar, coffee, African stocks, agricultural land, forest land, starting a company, micro caps etc.

      I’m long oil since the cost of production is above the current price. In addition, the futures haven’t fallen anywhere close to as much as the spot price. Oil is a real asset, everything is based on energy. If everybody was willing to buy oil at 100 a while ago, it just doesn’t make sense to ignore oil at 50. Mainly it was a short-term bet on a bounce, but now I’m switching my potent 5x leverage products into delta 1.

      Opus is a small Swedish testing equipment company. This is its web page: http://www.opus.se/en/
      I’m not trying to get anybody to invest in Opus. It’s stock will most likely fall in the event of a market rout anyway (then I’ll just buy more), but its recent -50% share price development has made it cheap ENOUGH. I can never know if it will become even cheaper and there is no reason to try to hit the exact price trough. I’m trying to make you look for similar stocks in the US (and maybe relay that info to me), rather than going for the top 500 stocks that everybody else are hyping.

      I hope this helps.

      • Very helpful thanks. Basically you’re saying to buy up more commodities as you believe the S&P 500 index is over valued while crude oil is below production levels. By switching to delta one, assume this means you’re simply buying up crude with no leverage.

  3. Jag är riktigt osäker angsvenska marknaden atm och funderar, precis som du föreslagit att investera utomlands istället. Är det någon ide att sätta allt i länder som taiwan, vietnam och andra tillväxtländer eller borde jag sitta med pengar ifall en flash crash uppstår här på hemmaplan. Är för övrigt 19 år och kommer inte behöva pengarna inom 10år.

    • My answer disappeared. Short version:

      Personally, if I were 19, I would wait for a good opportunity to invest in a market I’m familiar with.

      That said, you could gradually make “Vietnam” familiar to you, and likewise gradually invest there too. Try contacting Marc Faber and ask him about Vietnam and similar markets.

      PS: Thank you Wall Street Playboys

  4. Thanks for an exceptional website!

    I want to speculate in a crash at the Swedish stock market, with about 1 % of my portfolio value on an annual basis from now on. How would you recommend doing that with as much leverage as possible, but without risking to lose more than the initial money set aside for the purpose (e.g. not short selling or selling naked calls)? But I’m fully willing to lose 1 % of the portfolio every year if the market stays irrational for longer than expected.

    To buy short certificates? How much leverage is reasonable? Or an ETF like XACT Bear?

    Or would it be a stronger bet to buy PUT:s deeply into the money? How deeply and at what expiration dates? There doesn’t seem to be so good liquidity…?

    What are your general ideas? How do you short the market directly and with the best leverage?

    • Out of the money index puts would suit your preferences best. Puts with a strike 10-20% below spot would give tremendous leverage if the market falls by twice that from here.

  5. “I’m also worried Russia and OPEC will pump like crazy at any prices to keep their dictatorships afloat. Combined with an economic slowdown, oil prices should undershoot their warranted price heavily.”

    -Sprezzaturian February 2015

    Oil Prices below $30 a year later.

    Good call Mikael. I now know to trust your judgements.

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