Interview with Stan Druckenmiller

I typically don’t post anything from mainstream media, but this interview was too good to pass up. CNBC’s Kelly Evans speaks with Stan Druckenmiller about the stock market, tax reform, the Fed’s 2% inflation target, and his stock picks. This year has been a bear for many active managers, including Mr. Druckenmiller. As you’ll hear, if it wasn’t for a few select investments it may have been his first down year in 30 plus years. Check it out, it’s well worth the watch.

Stan Druckenmiller Interview

I’ll Pay You In Bitcoin. Is That Cool? – The Forecast Report December 2017

Over the past couple months, I have fielded a number of calls and emails related to Bitcoin’s meteoric rise in price. These calls and emails request my advice and insight into what I think about Bitcoin. So, I thought this newsletter would focus a little more of my attention on Bitcoin. My intent is to give my honest opinion as a trader and an investor. Both are not one in the same, although many take it as such. A trader typically tries to profit from short-term price volatility. The positions a trader holds could last anywhere from a couple of seconds to weeks. On the other hand, an investor is someone that takes a longer-term approach to the markets. Short-term volatility typically does not play into their strategy.

A Short History Lesson.

Back in the 1990’s the Federal Reserve provided easy monetary policies which helped create the gigantic technology stock bubble of 2000 that eventually erupted, and pushed the US into recession. In order to combat the recessionary pressures, the Federal Reserve decided to push interest rates to historically low levels of 1%. This eventually set the stage for the housing bubble and massive credit binge. As history shows, this led to the 2007 housing crisis, which then caused the Global Financial Crisis.

The Global Financial Crisis was the worst recession since 1929. It caused the Federal Reserve to once again, step in and cut rates to 0%. But, this didn’t work. So, the Federal Reserve decided to take an alternate course in monetary policy. They decided to print money.

This money printing scheme was called Quantitative Easing. This wasn’t the first of it’s kind. Money printing has been tried a number of times in history, but it has always failed. The difference this time is that the amount of money printed is unprecedented. Unlike the monetary policies of the 90’s and 2000’s which provided asset bubbles in very specific asset categories, such as technology stocks and real estate, the current monetary policy of the Fed has caused asset bubbles in almost every asset category throughout the world. Last month a Leonardo da Vinci portrait sold for $450 million or 2 1/2 times the record amount of any painting ever sold. I don’t know much about art, but $450 million seems like a lot of money for oil on canvas.

But, there’s one bubble that’s on everyone’s mind. It’s a bubble that makes the Dutch Tulip Mania or the South Sea stock bubble pale in comparison. It’s like nothing I’ve seen or read about before. It’s the insane world of cryptocurrencies.

To Infinity and Beyond!

At the beginning of 2017 Bitcoin stood at $950. It’s up over twelve-fold in just over 11 months. Since November 12, 2017, it has doubled in price. During the dotcom mania one of the fastest growing bubble stocks, CMGI, blasted off 904%. Guess what? Bitcoin destroyed it. Less than six months ago the total value of the cryptocurrency world was just over $100 billion. It’s now worth $327 billion. I think everyone understands why it’s the talk of the investment world.

As any trader will attest low volatility doesn’t make for a good day in the markets. As we have seen this year volatility has all but dried up. We are at historical lows for volatility. I won’t rehash the whole volatility trade, as you can read about it in November’s newsletter. My point is is that for a trader to make money there needs to be some short-term price volatility. Where have traders been able to find volatility, speculate, and make money? Correct, cryptocurrencies. It trades aggressive, it moves a ton, and the structure of the chart makes many technical analysts drool. There have been some amazing setups to make an amazing amount of money. Many have. Cryptocurrencies have been great speculative plays to take advantage of short swings in price.

A brilliant technical analyst by the name of Peter Brandt has been very involved in setting the stage for short-term opportunities in Bitcoin and Ethereum. Below is a great example of the type of trades he touts. He has been incredibly accurate due to very well known technical setups that stand the test of time. His most recent call is below. As I write this newsletter the price of Bitcoin stands at 12,741. Peter might be spot on once again.

Now, with all that said I’m not advocating that you go out, set up a coinbase account and get your speculation on. You better be damn good at speculative short-term trading and understand what you’re trading.  Ya, some people get lucky, but mother market has a knack for knocking the luck right out of you when you least expect it. My bottom line is that this market has been a breeding ground for professional short-term traders and some lucky traders to profit from. I have no problem with it, so if you know what you’re doing and you’re making money, keep killing it. From a trading standpoint, I don’t have any negatives to complain about, except that some novices need to be careful with trading this speculative market. So, let me tell you what Bitcoin isn’t.

But, Ghostface Killah Has One.

The prospect of infinite riches from Bitcoin has lured some of the entertainment elite. These include Paris Hilton, Mike Tyson, Dennis Rodman, and the rapper Ghostface Killah. Many of them backing various cryptocurrencies with suspect business prospects with names like Cream and PotCoin. Some notorious individuals such as James Altucher (tech bubble cheerleader) and John MacFee are calling for Bitcoin to be worth $1 million by 2025. But, is there any lasting benefit to Bitcoin besides the blockchain technology? I guess no one knows for sure, but I have my opinion and Fred Hickey says it beautifully.

Mr. Fred Hickey states…

“I know what Bitcoin isn’t. It is not a coin or gold as it is typically depicted in the media’s illustrations of it. It is not something that is “mined.” It is not growing in use as money to buy things – trade confirmations are too slow, the costs to process the transactions are too high (there are often additional fees charged on each transaction) and each transaction is considered an asset sale according to IRS rules and should be reported as a gain (or loss). For these reasons, none of the major retailers (Wal-mart, Target, Amazon, etc) accept Bitcoin as payment.”

“Bitcoin is not a ‘store of value.'” Stores of value (such as precious metals and great works of art) are tangible, (they’re real), they have intrinsic value and they’re limited in number. Cryptocurrencies, the most prominent being Bitcoin, are like fiat money – conjured up out of nowhere in unlimited quantities. today lists 1,326 different cryptocurrencies and the list grows longer nearly every day.”

Recently, there has been news of institutional buyers entering the market via Bitcoin futures. Over the coming weeks and months CME, CBOE, and the Nasdaq markets will be dipping their toes into the Bitcoin pool. For professional traders, this may be the best way to manipulate, er play the market. For the novice crowd, be careful what you wish for…

As a professional futures trader myself back in the early 2000’s I have seen some amazing games played in the futures markets. Let’s take Gold as an example. As Mr. Hickey states,

“As we know, these futures traders regularly (and brazenly) attempt to generate stampedes into and out of gold by manipulating the price (both higher and lower) by selling and buying massive amounts of futures contracts (billions of dollars in notional value, but with relatively little money down), often in a matter of seconds in order to manipulate the price in the direction they desire.”

So, what’s going to happen in a market much smaller than Gold, like Bitcoin? Manipulation by big ass future traders. My guess is that these futures traders are more likely to pop this massive bubble than propel it further. What’s to stop the ride down? It’s not like there’s a physical market for Bitcoin to buoy the price. As Mr. Hickey states,

“Gold owners know that there are always lots of physical gold buyers around the world (Particularly in the East) who will come in and buy gold on dips. The physical markets for gold are a limiting factor for the futures traders. That will not be the case for Bitcoin. There is no physical market for cryptocurrencies because cryptos don’t exist – except in electronic form. When futures traders start their stampedes there’s nothing to stop them. The collapse in cryptocurrencies is inevitable.”   

“…If I woke up tomorrow with my head sewn to the carpet, I wouldn’t be more surprised than I am now” – Clark Griswold

Speculation throughout history has ended in the same way each and every time. This bubble will end in a massive and uncontrolled sell-off that will catch 99.9% off guard. Everyone thinks they can get out in time. Think again. In the book “A Short History of Financial Euphoria” John Kenneth Galbraith states…

“They (the speculators) are in to ride the upward euphoria; their particular genius, they are convinced, will allow them to get out before the speculation runs its course. They will get the maximum reward from the increase as it continues; they will be out before the eventual fall. For built into this situation is the eventual and inevitable fall. Built-in also is the circumstance that it cannot come gently or gradually. When it comes it bears the grim face of disaster. That is because both of the groups of participants (the new era believers and the superficially more astute) in the speculative situation are programmed for sudden efforts of escape. Something, it matters little what – although it will always be much debated – triggers the ultimate reversal. Those who had been riding the upward wave decide now is the time to get out. Those who thought the increase would be forever find their illusion destroyed abruptly, and they, also, respond to the newly revealed reality by selling or trying to sell. Thus the collapse. And thus the rule, supported by the experience of centuries: the speculative episode always ends not with a whimper but with a bang. There will be occasion to see the operation of this rule frequently repeated.”

I have a vivid memory of seeing this type of scenario play out. It happened to me early in my career as a futures trader. As I mentioned, I started out trading the Dow Jones Futures contract in the Chicago Board of Trade pits in the early 2000’s. At that time the Dow was trading around 7,500. I started trading in the pits right after the tech bubble. This scenario was a little different in that the Dow wasn’t in any sort of bubble, but the concept is the same.

I remember the day like it was yesterday. I stepped into the pit around 7 am and stood by my normal position, the second step from the top.  On very rare occasions I would hold positions overnight if I had a good reason to. At this time, I had a good reason to. I was short 5 Dow Futures contracts. At that time the Dow Futures would move in 5 tick increments. Each tick was worth $10. That meant that every move made or cost me $250. I wasn’t a big trader, but the position was sizeable to me. The charts told me that the slide was going to keep going. We had an economic number that was coming out early in the day at 7:15 am. I remember hearing that this particular economic number would be in line with expectations, so I kept my short position.

7:15 am came and the economic number came through much better than expected. The Dow rocketed up. Shorts tried covering. We couldn’t. The market was moving too fast. I tried to find a seller. Nothing. My stomach dropped. I felt physically ill. The market kept moving skyward. After what felt like forever I was finally able to offload my position with the largest loss of my career.

I guess my point in telling this story is that this type of spiraling trade happens all the time. The difference is that bitcoin may be the biggest bubble of all time. When it does pop those that are still in the swimming pool will drown. Those that trade or invest in Bitcoin, be safe, smart, and keep those gains. The old tried and true, Gold, might be your best line of defense. 

I want to personally thank all of my readers for your support. Here’s to hoping everyone has a wonderful Holiday Season!

Other Stories of Interest:

Is The Swiss National Bank The World’s Largest Hedge Fund?

Over and over we have talked about the negative effects of global money printing. The focus has always been on the Federal Reserve, The European Central Bank, and The Bank of Japan for their money printing escapades that have dwarfed anything in the history books. Recently, The Bank of Japan has been front and center due to their aggressive money printing and investments. The Bank of Japan not only invests their newly printed money in forex, but they also invest in debt and equities of Japan. The BOJ buys ETF’s (Exchange Traded Funds) on a regular basis and has become one of Japan’s largest public shareholders. Both the Bank of Japan and the European Central Bank have grown their balance sheet more than the Federal Reserve. In fact, the Bank of Japan’s balance sheet is almost 5 times larger in proportion to GDP…and is still growing. Check out the chart below and look at the difference. And you thought the US overdid it…

Chart courtesy of Thoughts From the Frontline


But, there’s one central bank that’s has done something even more stunning…The Swiss National Bank. If you can believe it, the Swiss National Bank (SNB) has expanded their balance far more than the Federal Reserve, European Central Bank, or the Bank of Japan. The Federal Reserve’s balance sheet is $4.5 trillion which equates to about 25% of GDP. By comparison, the SNB’s balance sheet is $813 billion which is nearly 125% of the Swiss GDP! Of the $813 billion, $90 billion is invested in equities while the other $670 billion is invested in the Euro and US debt securities. The SNB has certainly had a good year being invested in US Equities especially when you look at where that $90 billion has been invested (shown in the chart below). But, what happens when they want to liquidate their portfolio? The SNB will have a huge hurdle to overcome. If anyone gets a hold of the news that the SNB is liquidating, all the buyers will disappear. It’s not like you can put 19 million shares of Apple on the open market and get filled!

Chart courtesy of Thoughts From the Frontline


Mr. John Mauldin writes about the SNB…

“The SNB owns about $80 billion in US Stocks today (June 2017) and a guesstimated $20 billion or so in European Stocks.”

“They have bought roughly $17 billion worth of US Stocks so far this year. And they have no formula; they are just trying to manage their currency.”

“Think about this for a moment: They have about $10,000 in US Stocks on their books for every man, woman, and child in Switzerland, not to mention who knows how much in other assorted assets, all in the effort to keep a lid on what is still one of the most expensive currencies in the world.”

“Switzerland is now the eighth-largest public holder of US stocks. And apparently, they are concentrating on the largest of the large-cap stocks. They own 19 million shares of Apple (as of March 31). That is roughly 3% of the current market.”

If this scheme ends in anything other than a complete catastrophe for the SNB, I would be very surprised, but hey on paper those 2017 gains are HUGE. So, they have that going for them which is nice.



Is Volatility a Ticking Time Bomb? – The Forecast Report Newsletter (November 2017)


It’s amazing how fast this year has flown by. It’s already (Mo)November! Unfortunately, the only way I can donate to the cause of the Movember Foundation is through monetary means, not through a beautiful Tom Selleck mustache. In fact, there probably isn’t a reason big enough for me to grow a mustache if I’m being considerate of all those that see me on a daily basis. Let’s just say facial hair growth isn’t my strong suit. But, I digress…

Some Stats.

The S&P 500 has risen for eight consecutive quarters and twelve consecutive months. Consumer Confidence has reached it’s highest point since December of 2000. Speculation, as measured by margin debt, hit another all-time high last month at $560 billion (NBD). There was even a new ETF that rang the closing bell at the NYSE, whose ticker symbol is SQZZ. What is SQZZ you ask? So, hang with me here…it’s an investment strategy that seeks capital appreciation by purchasing companies that it believes are subject to a short squeeze (a short squeeze is when a heavily shorted stock moves sharply higher, forcing more short sellers to close out their short positions which adds to the upward pressure in the stock). So, we have a short squeeze ETF that launched at all-time highs in US equity markets during a time when we have virtually no shorts left to squeeze. Sounds like Wall Street has their shit together…again 🙂

Zombie Companies

Alright, enough with the undertones of sarcasm. I want to talk about a recent report from the Bank of International Settlements (BIS – the bank overseeing all of the other central banks). During the 2000 tech bubble crash, many companies were effectively created out of thin air. Some with no sales to speak of. These companies would be considered “Zombie” companies where the interest expense on their debt far exceeded their earnings before interest and taxes. In a rising rate environment, these companies would effectively collapse as their debt payments would increase over and above their earnings. Currently, “Zombie” companies now account for more than 10 percent of the corporate universe across the developed world. That may not sound like much, but it’s huge. Many corporations are massively overleveraged. In fact, in 2018-2019 an estimated $134 billion of corporate high yield debt must be rolled over in, what should be, a higher rate environment. This 10 percent number could be much larger if inflation and rates rise. The rise doesn’t have to be large to have a significant impact on these companies. A well-known Austrian economist by the name of Ludwig Von Mises wrote about malinvestments in credit-driven booms: “The longer the boom of inflationary bank credit continues, the greater the scope of malinvestments in capital goods, and the greater the need for liquidation of these unsound investments. When the credit expansion stops, reverses, or even significantly slows down, the malinvestments are revealed.” This statement directly applies to the current state of the market where malinvestments are plentiful but aren’t shown due to the constant upward buying pressure without any thought as to what would happen to these companies if credit expansion started to slow. If credit expansion slows these Zombie companies will collapse and momentum investors will lose their shirts.

I had a few people ask me recently “if inflation is rising then why aren’t we seeing a larger increase in interest rates?” Let’s take a quiz. You have $100,000 that you MUST invest in a fixed income investment. Your options are a 1 month Treasury Bill that yields 1%, a 50 year Swiss Government bond that yields 0.5%, OR a 100 year Austrian Government Bond that yields 2.1%. These are all real bond offerings. In fact, if interest rates increase 1% or more the Austrian Bonds will lose over half their value. Ok, so now which one would you pick? I think you understand where I’m going with this. Global investors are still buying US debt because it’s safer and yields more than most of the global bond offerings. Thus, prices increase (or stay steady) and yields decrease (or stay steady). Of course, this won’t go on forever. It may only take a rapid and unexpected increase in rates, or geopolitical shock, for this cycle to violently unwind. If or when this does happen the central banks will be unable to respond to the future financial stress with more stimulus if inflation is rising. Don’t assume the central banks can keep a safety net around financial markets. The markets are bigger than the central banks.


The Month of October was an interesting one as it was the lowest recorded measure of volatility in history. During the month of October, I did a lot of research and talked to a very dear friend of mine who manages are very successful hedge fund in Chicago about volatility. The reason I dug into this theme is that volatility across asset classes is at mult-generational lows. I wanted to understand how an increase in volatility would affect the current market. As I was doing some research I came across a very insightful whitepaper written by Artemis Capital Management about volatility and risk. This whitepaper surmises that volatility could be the nitroglycerin that ignites the fire.

One of the most lucrative trades of the year has been shorting volatility. As an investor sees a spike in volatility they short it. They do this over and over again. Shorting volatility and deriving short incremental gains. It’s a bet or assumption that the markets will stay stable, but in exchange, the investor is also taking on the risk of substantial loss if events change and volatility increases.  Artemis states, “Lower volatility begets lower volatility, rewarding strategies that systematically bet on market stability so they can make even bigger bets on that stability.” So, why should we care about this trade? “The Global Short Volatility trade now represents an estimated $2 trillion in financial engineering strategies that simultaneously exert influence over, and are influenced by, stock market volatility.” Artemis goes on to say…“We broadly define the short volatility trade as any financial strategy that relies on the assumption of market stability to generate returns, while using volatility itself as an input for risk-taking…The danger is that the multi-trillion dollar short volatility trade, in all its forms, will contribute to a violent feedback loop of higher volatility resulting in a hyper-crash.” When you chart volatility you realize that it has nowhere to go but up. Currently, there’s no catalyst to produce that upward move due to easy credit conditions, low rates, and excess supply of capital to invest in assets around the world. But, don’t get too comfortable because central banks are massively reducing their money printing efforts.

Arguably the only undervalued asset class in the world is volatility. The short volatility trade is another way to provide yield to yield-starved investors outside of the fixed income world. It’s becoming an alternative to fixed income. Global money printing has created this very weird but interesting scenario, and there is a very specific occurrence that’s keeping this trade from collapsing in recent years. Since 2009, US companies have spent $3.9 trillion on share buybacks, which could be considered a massive levered short volatility position. According to the Artemis whitepaper, “In 2015 and 2016 companies spent more than their entire annual operating earnings on share buybacks and dividends.” Artemis goes on to say…“Absent this accounting trick (buybacks) the S&P 500 would already be in an earnings recession. Share buybacks have accounted for +40% of the total earning-per-share growth since 2009, and an astounding +72% of the earnings growth since 2012. Without share buybacks earnings-per-share would have grown just +7% since 2012, compared to +24%. Since 2009, an estimated +30% of the stock market gains are attributable to share buybacks.” These share buybacks are a huge contributor to our low volatility environment because large price-insensitive buyers (the companies themselves) are always ready to purchase on market weakness. Artemis goes on to say…“Share buybacks result in lower volatility, lower liquidity, which in turn incentivizes more share buybacks, further incentivizing passive and systematic strategies that are short volatility in all their forms.” This is all thanks to global money printing, which artificially depressed interest rates, which in turn allowed these companies to borrow money at historically low rates, which gave them the liquidity to buyback shares of their stock. It’s an optical illusion of growth.

Back in the day, the only investors that had access to this volatility trade were hedge funds or a wall street firm trading desks. Now your grandma and grandpa can trade volatility with the overabundance of newly issued ETF’s some being leveraged products. The majority is on one side of the volatility trade. What happens when the wind changes direction and volatility ramps up? Let’s just say there will be a very large liquidity gap for those trapped in short positions. These leveraged Volatility products will have unmeasurable losses and many will be completely wiped out. Artemis believes at current risk levels, as much as $600 billion in selling pressure would emerge if the market declined just 10% with higher volatility.

Over the years there has been a massive shift from active management to passive management. It’s easy to see why as passive management provides lower fees while building a diversified portfolio. According to Bernstein Research, 50 percent of assets under management in the US will be passively managed. According to JP Morgan $2 trillion in assets have moved from active to passive strategies. Here’s the problem, this huge move from active to passive will amplify future volatility. Think of it this way…active managers provide somewhat of a buffer to volatility. They step in and buy undervalued stocks when the market is falling and sell overvalued stocks when the market is rising too much. Now, remove that buffer. What do we have? We have a very small amount of incremental sellers when stocks become overvalued and we have a very small amount of incremental buyers to stop a crash on the way down. This creates liquidity gaps because that active management buffer is no longer available. I’m certainly not saying that passive management is a bad thing, but we are seeing some unintended negative consequences of this massive shift in investor mentality, which could produce higher future volatility.

Volatility won’t be the thing that starts the fire, it could be the thing that pours fuel on the fire. Artemis states, “Volatility is the brother of credit and volatility regime shifts are driven by the credit cycle. When times are good and credit is easy, a company can rely on the extension of cheap debt to support its operations. Cheap credit makes the value of equity less volatilehence a tightening of credit conditions will lead to higher equity volatility. When credit is easily available and rates are low, volatility remains suppressed, but as credit contracts, volatility rises. 

I’ll leave you with a quote by Artemis…”Regardless of how it is measured, volatility reflects the difference between the world as we imagine it to be and the world that actually exists.”

I hope everyone had a wonderful Halloween! My one and a half-year-old took home the gold, as she brought in enough peanut M&M’s to last me a year!

If you’re interested in reading the entire Artemis Capital Management article you can do so by clicking this link.

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Volatility & The Alchemy of Risk

“The Global Short Volatility Trade now represents an estimated $2 trillion in financial engineering strategies and share buybacks that simultaneously exert influence over, and are influenced by, stock market volatility. Volatility is now an input for risk-taking and the source of excess returns in the absence of value. Like a snake blind to the fact it is devouring its own body, the same factors that appear stabilizing can reverse into chaos. The danger is that the multi-trillion-dollar short volatility trade, in all its forms, will contribute to a violent feedback loop of higher volatility result in a hyper crash.” – Artemis Capital Management

An outstanding white paper about volatility and how it can be the fuel that’s added to the fire.

Are We On The “Edge of The Cliff”

RealVision recently put together a compilation of answers from some of the best minds in finance regarding serious risks investors will face today and in years to come. There’s a lot of complacency and chest bumping from many investors who feel they are invincible to negative market swings. In this video there’s great insight from Kyle Bass, Jim Rogers, Jesse Felder, and many more. If you’re interested in their take on the bond markets, currency markets, equity markets and how they will be affected by central bank policies, this is a gem. Buying the dip and shorting volatility isn’t going to work forever. 2018 may be the start of something…interesting.

The Relentless Rise – October 2017 Newsletter (The Forecast Report)

When you’re dealing with stock market “bubbles” there isn’t much that matters…for a while. Bad news, good news, it doesn’t matter. It’s all bullish, or so it seems. Much of the news as of late has been horrific. Believe it or not, many well-known investors are frustrated by the current state of affairs, but the US markets are painting a different picture with its relentless rise. We have Harvey, Irma, and Maria that have caused massive human suffering, loss, and will cost hundreds of billions of dollars which have been siphoned away from productive infrastructure. We have nothing getting done in Washington as the most recent health care bill was shut down, foreign countries are hacking private servers for sensitive information, a transparent tax bill that, for the most part, is unworkable, the Tom Price shit show, and Trump’s failure in Alabama (Luther loses). The Geopolitical environment is less than stellar as North Korea is becoming more of a problem, Catalonia’s secession from Spain is causing riots and worse, and other European countries are still debating leaving the EU. In addition, Las Vegas was attacked in a mass shooting during a concert that took the lives of 58 innocent people and injured hundreds more. So, what effect did that have on the market? Zero, zilch, nothing, nada.

The S&P 500 has now risen for eight consecutive quarters. It hasn’t seen a 3 percent decline in over 228 trading days (11 months for those counting). This year’s biggest drop in the S&P 500 is the smallest for any year in at least 104 years (that’s as far back as I could pull)! This has pushed investors to be complacent and has created a feeling of invincibility. According to Merrill Lynch, clients have the lowest allocation to cash in at least 13 years. Optimism has steadily increased. Look no further for excessive optimism and machismo than the millennials. According to a survey conducted by AMG Funds, they found that 81 percent of millennial investors (most are too young to have experienced the 2008 stock market bomb) consider themselves “extremely or very knowledgeable” when it comes to their finances, while just 19 percent of experienced investors felt the same way. 10 percent of millennial investors stated that they understand the benefits of diversification (compared to 50% of baby boomers). The majority of the Millennials polled are also piling into some of the most excessively priced ETF’s and cryptocurrencies. There’s no fear. Well, I guess many will learn the lessons of generations past the hard way.

Shaded blue region encapsulates the S&P 500’s relentless rise in 2017

There’s been a lot of financial pundits arguing about the S&P 500’s price to earnings ratio and whether it’s overvalued. Some state it is excessively overvalued and some state it’s high, but not excessively so. The problem with placing your faith in the price to earnings ratio is that it can be manipulated. Yes, the S&P 500 Price to Earnings ratio isn’t incredibly extreme, but there’s a reason for that. Much of the data is hidden due to all the financial engineering that has taken place to inflate earnings and hide the true excessive overvaluation of the market. The suggestion that I received when looking at overvaluation was to take into consideration the Price to Revenue metric, which has been very helpful. You can’t really financially engineer revenue, which makes sense. Grant Williams has a great chart (shown right below) that shows, according to the Price to Revenue metric, that our current market is the MOST expensive ever (by a lot). The chart includes the dot com and housing bubble.

The FED…

Last month the Fed unveiled its balance sheet reduction plan, or in other words Quantitative Tapering plan. To give a simple explanation the Fed is planning to let billions of dollars of maturing bonds roll off its balance sheet without reinvesting the proceeds. Our current quarter will see $10 billion of maturing bonds roll off the Fed’s balance sheet per month. As the quarters go on the amount of maturing bonds that roll off increase. For example, in Q1 of 2018, we will see $20 billion of bonds roll off each month ($60 billion total). In Q2 of 2018 it will increase to $40 billion per month and so on.  In effect, the Quantitative Tapering plan will take increasingly larger amounts of liquidity out of the monetary system as the quarters roll on.  It seems as though the plan could work, right? Oh, but wait. The ECB (European Central Bank) is also planning on reducing its Quantitative Easing program along with the BoJ (Bank of Japan). Even though the Fed stopped their QE program over two years ago, the market has still done well. Why? Because the ECB and BoJ have picked up the slack and then some. The liquidity they have produced is huge and much of that liquidity was invested in the US stock and bond markets because the US has been the best house on a shitty block. So, what happens when global liquidity starts drying up??? Well, if this liquidity has been fueling this relentless rise in the US stock market, which it has, without the liquidity stocks will fall, interest rates will rise, and it will rock the financial markets. So, this is the option the Fed is choosing in the hope that they can bring this market, O’ so gently, back to “normalcy.” But, once the central bankers start to extract this liquidity, no matter how gradual or gentle, you’re still letting air out of a massive bubble in stocks. If history, tells us anything about bubbles there’s no gradual way for it to end. No one knows where the breaking point is of the Fed’s Quantitative Tapering program, but that will be part of the catalyst that will end this bull market along with the ECB and BoJ Quantitative Easing reduction. The next logical question to ask is if the bubble does start to deflate, what will the Fed do??? Well, the last resort when the Fed realizes their Quantitative Tapering doesn’t work is, once again, to create Quantitative Easing Number 4…At that point, the Fed will realize that they are unable to exit from their QE program without inflicting pain on the market. The Fed will be out of “ammunition” and will have to succumb to defeat. This, in turn, will provide the public with the knowledge that the Fed is between a rock and a hard place, is unable to unwind QE, and as a result, the public’s reliance and faith in the Fed evaporates.

Of course, we don’t want this to happen, but the public needs to open their eyes to the fact that this market is being fueled by nothing more than excess liquidity. It’s not increased earnings or profitability of companies. We are seeing market caps skyrocket with no underlying catalyst except new money pouring into the market from excess liquidity. The rise is relentless, but the result of the extraction of this liquidity is going to be really really difficult. You can’t have blind optimism that this bull market is going to keep going forever, but many in the public do. Unfortunately, these poor millennials are going to learn the hard way. It’s hard to blame them. They’re used to low volatility, buying the dips, placing their money in high flyers, and not diversifying. Why would they? It’s worked great so far. This will end and when it does investors need to protect themselves. This is a great time to protect yourself. Low volatility provides some great opportunity to protect your portfolios. This our two cents. Could we be wrong? Hell yes! We have been before, but we don’t plan on getting caught in something that has a high probability of occurring. We can’t know the future, but we can be proactive and plan for it. If you don’t have a plan, you’re going to be reactive. Reactive is never good when your an investor in the market, especially if chaos ensues (see 2008).  Don’t chase prices higher in the hope that a greater fool will buy your positions from you at higher prices. Could we see a slow creep up (or an aggressive push higher) through the end of the year? Absolutely and it wouldn’t surprise us. Will that last through 2018? I think you know where we stand.

We hope everyone stays safe out there and has a wonderful Halloween. I don’t know if any of you dads have the same Modus Operandi, but I can’t wait to raid my kids’ candy stash for a boatload of peanut M&M’s! I figured my one-year-old could do the heavy lifting on helping dear old dad out on his candy addiction 🙂

A quick note, you’ll notice that there are a few links at the bottom of this newsletter. These links lead to some articles that, we thought, were super interesting. Please let us know if you enjoyed them. We plan on keeping them coming along with some other awesome content!

As always, if we can help you or anyone that you know please feel free to give us a call or book a meeting. We always enjoy talking to new folks. Last, please forward this newsletter on to anyone that might find it of interest.


Afam Onyema – Jeopardy, Building Relationships, and The Organization Saving Nigeria

Afam was born on the south-side of Chicago. He graduated cum laude from Harvard University with a degree in psychology and played on the 1997 Ivy league championship-winning football team. Afam is also a Stanford Law graduate where he served as VP of the Black Law Students’ association, he was a two time public interest fellow, and a mentor in the school’s public interest mentor program.

In addition to his school accolades, He was named to the New Leader Council’s (NLC) “40 under 40” national list of emerging leaders in addition to being named to NBC News’ “100 People Making History Today”. Afam has been profiled or interviewed by NPR, US News & World Report, Forbes,com, Newsweek, Harvard Magazine, Stanford Magazine, and many others. He has given a TEDx talk and has presented at some of the most prestigious universities throughout the nation.

Afam forwent the prestigious, lucrative life of an attorney to run the GEANCO Foundation, a philanthropic health & education organization he co-founded with his father. GEANCO has been serving impoverished communities’ medical and educational needs in Nigeria since 2005. Donors include: Oprah Winfrey, Forest Whitaker, Ronnie Lott, Warren Moon, Silicon Valley Entrepreneurs, and Wall Street Investors.

GEANCO’s mission is to save and transform lives in Nigeria. Afam is one of the most intelligent, empathetic, incredibly gifted individuals I have had the honor of knowing for the past 25 years. This episode will make you realize just how much one person can make the world a better place. I hope everyone enjoys this conversation as much as I did.

Without further adieu, please enjoy Episode 2 with my good friend Afam Onyema.

Links from the episode:

Show Notes:

  • The experience of Jeopardy [3:40]
  • Personal background [12:45]
  • Growing up in Nigeria [16:15]
  • The dream of Geanco and modern day medicine [17:00]
  • Making an impact & the aids crisis [20:05]
  • Making the decision to lead Geanco [22:20]
  • The fork in the road [23:45]
  • Funding the first year of Geanco [26:40]
  • Geanco’s Mission [27:50]
  • Anemia Screening [31:15]
  • Terrorism in Nigeria and the girls affected [34:43]
  • Cases of serious medical conditions [36:40]
  • What Geanco is doing to help the children of Nigeria [42:10]
  • The ongoing violence in Nigeria [47:15]
  • How do you get in front of big name donors? [51:30]
  • Most memorable moment of one of first donors [1:01:05]
  • Are the bigger donors a lightning rod for other donors? [1:08:21]
  • Advice and roadblocks to someone looking to start a charity. [1:15:20]
  • What is Geanco capable of? [1:23:08]
  • Would you change anything? [1:25:35]
  • Quotes you live by? [1:26:03]