Inflation at a 6 year high, economy doing great and UST bonds are up on the day (even before the tarrifs). COT reports a record number of shorts and sentimentrader.com also reports record bearishiness. I bought US 10y bond futures today. I'm expecting a rally as yields suprise everyone by doing down rather than up. Fed tightening should lead to some expectations Fed might induce a recession. That's good for bonds, not bad. Everyone and their mothers expect yields to rise, so that's probably wont happen. At least not now
A good side benefit of this trade is that I'm quite long in stocks, especially US stocks. I havent run the numbers but its around 70-75%. And the rest is in gold and cash. The cash portion I usually keep in long-term US bonds to create a 'hedge' effect during stock panics and recessions. But last year I sold those bonds and purchased 2y notes for safety reasons. I was in the camp that yields were going higher. Now its been a year later, stocks made all-time highs, GDP is printing 4%+, unemployment is bellow 4%, inflation is a multi-year highs, Fed is raising rates every 2 meetings and promising more without giving much care yet bonds STILL cant go down. They are throwing everything but the kitchen sink at it and bonds are shrugging it off. To me that is a sign of a market that will have an easier time going up rather than down. And there will be plenty of shorts to cover on the way up. By owning bond futures I 'protect' my stock positions in case of a stock crash, suprise recession, terrorist attack and other problems. My stop will be around $101 - $101.5 on IEF. Target is 2.5%ish yields on the 10 year
Consumer sentiment beat expectations today, inflation expectations in it are at 4 year highs. Yet bonds are up on the day. This is a classic market tone divergence. If the market cant fall on 'bad news', its going higher
I was reviewing my journals in ET from back in 2008 and 2009 to review some of my mistakes and learnings from those years. It was amazing what happened around Feb/Mar 2009. Here are some of my posts, here I was arguing FOR the idea of buying stocks in Feb 2009 "So I'm not enthusiastic about US equities but I recognize the R/R is getting worse and the PE is not that bad. I need to find counter arguments to my trade because overall bearishness has became the norm and the last time I was in this position I was long oil equities and ag commodities, if I had gotten carried away I would have lost something like 15% of my networth. " "It scares the crap out of me to see that the stock market performance is the worst ever for the amount of time it went for http://www.smartmoney.com/Investing/Economy/Even-Worse-Than-the-Great-Depression/# Meanwhile we had 0% rates, fiscal packages, no major protectionist move, bank recaps(which in the 30's it took till 33 I believe) and yet the market is worst than during the 30's where money was tighter, smoot-hawley had already passed (although its effects werent fully on yet) and the treasury secretary was an austrian 'let it collapse' type That could mean that animal spirits are even worse now and people are panicking or that leverage and global connections are bigger and that is having an impact Either way I'm getting more scared everyday" Mar 07 2009 "Yeah I can see some of these shorts still working. I also think it makes sense to increase exposure to assets with positve SP500 correlation. Its going to be annoying and it will make me work harder because I just wont sit and watch they tank. I'm going to have to find hedges(Like almost half of my networth in USD unhedged, my economic exposure is mostly the BRL so I have a 'long' that is negative correlated to SP500) and short some stocks for protection. Its just that I'm seeing lots of corporate bonds that are likely to be worth par even in stressed economic enviroments mar 12 2009 "I'm actually thinking the long Brazil short american garbage was a high confidence trade(I would not take profits soon) I could have put on back in mar, it would have worked as brazil put a 40% rally. The problem was I didnt believe in the rally, everything just kept going down and down and I found hard to buy anything, I allowed myself to get influenced by all the gloom and doom. I wont make that mistake again" Jun 2009 My idea back then was that I need to have my bearish bets (mostly short financials and leveraged companies) paired up with bullish positions so no matter what happened I was going to be fine. And I did that to a certain extent. I was short a bunch of companies and long Citigroup bonds, IFLC bonds (a healthy AIG subsidiary). But it was amazing how I was criticized in the journal when I brought up the idea that US equities could be cheap and that I needed to own more bullish bets to balance my bearish ones. Unfortunately I was too young, too new a trading (before 2007-2009, my trading experience was inexistent and all I did trading wise was to read and reread the Market Wizards, Drobny's work and other books, so I was all theory and little practice) for me to trust my instinct of building this 'double' book (I guess it was similar to how long short funds operate, expect my exposure was very much contained) So I never bought enough of bullish bets, when the march bottom happened and it just kept going, I kept getting squeezed on my shorts with not enough profits coming from my corporate bond positions. And then I fought the rally, even though I had acknowledged that the R/R was worse (to bet against US equities) and it started to make sense to be long stuff. All I had to do was to buy LQD, Blue Chip corporate bonds (to avoid withholding taxes) or something. But I was heavily influenced by the bearishness from almost everywhere. Its difficult, back then I was too heavily influenced by things like statistics, numbers and figures. It made sense to think there was going to be a depression so it didnt occur to bet to not fight the rally, there were so many articles with 'facts' showing how a depression was going to happen. Thankfully, by mid 2009 I started to cover shorts and buy Fed futures (which I viewed as a better expression of the bearish trade) and months later my financial puts expired worthless (so, having used them helped me). The fed futures was a home run trade and that ended up making my year as I kept adding and milking that cow. So I was a bit lucky to have had that trade avaliable but there were some big lessons: -During the 2008 early 2009 collapse, everytime there was a rally in the markets, I would cover some of my shorts. That turned out to be very costly. But when then was a huge panic in Oct 2008 and I decided that it was ok to fight the market. Why? Because I missed the drop. I was bearish all year but covered right before the collapse, as a result I found rationalizations that it was ok to fight markets and you got to wait for a gigantic drop to cover. Effectively the market 'taught' me that rallies were supposed to be sold, not bought. But of course, the exact opposite happened in 2009, there was the year where rallies where supposed to be bought not sold. I guess when I made the shift to total bearishness, a lot of other people did as well and that created the bottom (the market reached its maximum pessimism) So its a big lesson to me that its hard to be immune to herd behavior. I still got to policy myself in that regard. I have gotten much better at it, as I was able to buy the Brazil panic of 2015, however I did fail to buy BRKB in size at $125 even though I thought it was valuable there (then I was forced to chase it up at $146). I also did buy VRX on the way down, which ironically enough, I consider a GOOD thing. The only investors who dont get burned are the ones who hug cash and never invest. IMO one of the best things contrarians and bears could do is to find a stock that is a falling knife and buy on the way down (up to a 5-10% limit in their porfolios) and then learn to accept the loss, to be ok with it. If one with ok with the worse case scenario then everything is much easier. The problem with contrarians and bears (as I used to be) is the phobia of losing money with the crowd or with optimistic people. that phobia will distort their analysis, unbalance their inner thresholds (the thresholds to buy and sell certain investments) and overall lead to poor decision making.
Following some of these lessons, I have to consider that perhaps I'm suffering from the same problems i did back in 2009. Maybe I'm being influenced by articles, writers and certain statistics. Its possible that perhaps I'm too bullish when I should be neutral or cautious (with markets at all-time highs, I'm rulling out being bearish. only people out of touch with reality can do that). I did feel that I got influenced by the crypto optimism in late last year and even though I side stepped most of the BTC drop (I bought at $8-$9k on the way down) I did invest in a number of ICOs in January and February which are down a lot, that cost me 1-1.5% of equity. I could have perhaps avoided that. So what can I do to prevent problems? Probably implement some version of that 'double book' that I failed to do in 2009 as well as implement 'exposure limits'. For instance, limiting bullish exposures (like stocks) to a certain % of my networth, or to a certain multiple of bearish bets (say 4x maximum) Perhaps a 50% max stock exposure and a 4x multiple to bearish bets. So a 50% stock portfolio would need 12.5% in bearish bets to be balanced. The bets can be S&P500 puts, small short positions in high conviction shorts, UST bonds (altough they would have be weighted differently since their volatility is so low vs stocks), gold, cash (as with US bonds, they would have be to be weighted differently), longs in certain safe haven currencies and other bets. So that's a strategic move that I'm considering, trimming stock positions, raising some cash, find a short or two, buying some bonds (which I'm long now as a result of my futures trade), buying some S&P500 puts, etc. Just so I prevent any problems of not being able to see the top in real-time and having to endure a big drawdown. The thing about confirmation biases for a trader is that often, its hard to see its happening in real time. A double book and exposure limits should help to prevent the damage if I fail to bail out at the top
It just struck me that one way to avoid a lot of these problems is to buy puts in stocks instead of shorting the shares. The nice thing about puts is that they FORCE you to time the move (which leads the investor to HAVE to deal with the 2nd way bulls make money). One cant cop out and talk about the bad fundamentals and how it will end badly but you dont know when, that is trying to apply the Buffett method to shorting stocks, which is crazy. Puts enforce a good discipline and protects against a lot of issues. So maybe that's another good rule for shorts "When bearish in a stock, buy puts. If you dont want to buy puts in the stock you are bearish, YOU HAVE NO BUSINESS BEING BEARISH IN THE FIRST PLACE". Following that rule is very hard to get in trouble being bearish in a few names. Its when shorts think they are so smart but cant time the move (and hence, they short shares) that they get in trouble. If you think about, shorting shares theoritically make no sense. If you cant time the move, you have no edge (due those issues above), if you can time it, puts make more money with less risk. Shorting shares should be saved to very special situations where there aren't options avaliable but the stock is super likely to fail soon
https://files.brontecapital.com/amalthea/Amalthea_Letter_201712.pdf An interesting letter from Hempton. I'm not sure he can do what he claims to do (be able to put 40-60% of assets in shorts consistently, without hurting his risk adjusted returns) but I do like some of his thinking. He is trying to improve his sharpe and sortinos by having his short book hedge out his longs. What he would find that you can accomplish that with these shorts but also with other assets. Gold being one of them. In fact, in my asset allocation backtests (going back almost 100 years with US, UK and Brazil data), one of the easiest ways to improve risk adjusted returns (measured by Sharpe, Sortino, MAR ratios, etc, etc) is to add a 5-10% gold position. Another way to do it is to own assets in safe haven currencies. There might be other ways as well, there is a lot of room for creativity. If I were him I'd own a 5% position in gold even if it had to be done though futures. As a long-term policy it will help risk adjusted performance
I see that Hempton has closed his funds for new investment. I respect that move a lot. He only has $500M in assets and closed. He also openly admits that his shorting is not scalable. He is the opposite of Einhorn. Einhorn thought he could scale shorting to billions and billions. Furthermore he did shaddy stuff like a yearly reset in his high water market for his reinsurance company, GLRE. Einhorn went for a money grab, even at the risk of his career. Hempton didnt do that, and I respect that. Time will tell if he can come up with 10-15 short ideas every year consistently, he certaintly seem to be more aware of the dangers of shorting vs Einhorn so hes got a better chance than him
The thing about these long 100% short 50% type funds is that they tend to do great during market corrections but during good years, they tend to produce worse risk adjusted returns as the squeezes happen. Hempton said in one of his latters that in late stages of bull markets thats when his strategy performs the worst. Because he is long quality and short garbage. Quality tends to lag other stuff at late stages. If US equities go into a melt-up, this shorting hedging will likely harm his portfolio more than help. If instead he kept some cash, bonds, gold, haven currencies, plus his BEST short ideas (like 4-6 ideas), that perhaps could be superior than to short 15 companies per year