1 May

Monday May 1, 2017


Good morning,

SC short report

With the exception of the Dow Jones Transportation Average (DJTA), the major stock averages moved markedly higher this week, fueled by short covering and relief buying following the French presidential elections of last weekend.  The DJIA rose to 20,940.51, up 1.91%; the S&P 500 moved higher to 2,384.20, up 1.51%; the Russell 2000 rallied to 1,400.43, up 1.49%.  But the DJTA noticeably bucked the trend, and dropped to 9,097.63, down 0.40% for the week.

The bank stocks participated in the broad-based rally with a 1.79% rise in the BKX, which closed at 91.24.  However, the BKX failed to rally through its 50-week moving average during Tuesday’s and Wednesday’s trade, and sold off during Thursday’s and Friday’s market-wide tepid trading days.

The standout stock this week was Deutsche Bank (DB), which soared 9.52% by Friday’s close, and now trades at its 50-day MA with an initial spike of 11.33% on Monday’s short-squeeze and relief buying that characterized the first day of trading this week.

After The VIX hit as high as 16.24 just prior to the French election, the index plunged to close this week at a very low 10.82.  

Conversely, the SKEW barely moved, which tells me the pros are increasingly hedging with options while the retail investor trades intermittently unhedged, then trades hedged, on a moment-to-moment basis.  I also believe the VIX may be game by the NY Fed, so I’ve added SKEW to my research.

Now that stocks are banging on the door of new highs, let’s talk about valuations once again, and the disparity between the sentiment of the professional trader and retail ‘punter’.  Did anyone catch this article, ‘A record number of market pros believes stocks are too expensive’ from CNBC?

The article states:

More than 4 out of 5 professional investors believe U.S. stocks are overvalued, and they’re fleeing to other parts of the world to compensate, according to a survey released Wednesday.

The monthly Bank of America Merrill Lynch fund manager report found 83 percent of respondents saying that domestic stocks are too expensive, a record number for data that reach back to 1999.

Consequently, they are shifting allocations.

Now, before you run to your online broker and sell everything you have, here’s another article from Investor’s Business Daily that paints a story of near-record influxes of retail traders entering the markets, citing retail brokerage house Charles Schwab’s report to investors in an article entitled, ‘Charles Schwab Tops Views As Account Openings Hit 17-Year High Amid Price War’.

The article states:

[Schwab] said in its Q1 earnings release that its advisor services unit brought in “near-record” inflows from independent advisor clients, notching a 57% increase. Net new assets grew 22% to $39 billion for Q1, with total client assets rising 14% to $2.92 trillion at the end of March, said the company.

A 14% rise in account assets during the first quarter?  Oh my.  

Apparently, the retail brokerage industry smells blood, and, as a result, there’s a pricing war going on between retail brokerages, Schwab, Fidelity Investments, E-Trade Financial and TD Ameritrade.  Commission are being cut during the rush of retail traders to participate in the US bull market.

Can anyone see where I’m going with this information?  If you think I’m going to surmise that the next phase in the US stock bull market may just be beginning to be characterized by spiking prices and even higher and more ridiculous valuations, you are correct. The ‘usual suspects’ who take stocks to bizarre heights at the end stage of a bull market are the retail investor.  And here they come!

Now let’s look at another issue I’ve been think about: the relationship between stocks, bonds and the US dollar.  Now that the threat of two populist candidates making it to the finale of the French presidential race has been thwarted (though I’m watching closely for a huge stumble by Macron or disqualifying dirt on him from, say, WikiLeaks) my thesis of where US stocks may go from here has precedence.


I think the market is forming a base before it begins a parabolic rise before a blow-off phase in the major averages.  These mom-and-pop traders like to see a stock market that appears as if one ‘cannot lose’, before jumping in with both feet.  

Today’s record highs after record highs in the face of deteriorating fundamentals of the US economy reminds me so much of the prelude to the 1999 buying frenzy before the huge bear market.

And as I read these two articles (above links), I hearkened back to a CNBC interview with Appaloosa Management’s, David Tepper, who said, back in late February, he is long stocks for the simple reason that the perception among retail traders is, that everything is swimmingly good.  Professional traders and retail mom-and-pops are “reacting to two different economies,” he said, intimating that professional traders are quite aware of the lofty valuations of US stocks, but mainstreet traders have no clue of the market’s historical context or underlying fundamentals that drive a stable and robust bull market.  The only thing these punters see is a rising stock market, and assume the propaganda spewed by mainstream financial news networks is all there is to know, because in their world, their home price and retirement account values have been going up, up and up.  Everything must be okay, then.  Right?

And to look at the insane stock valuations another way, why wouldn’t stocks today rival the NASDAQ bubble of 1999?   When the Fed has all but ensured cheap money—much cheaper money than rates offered in 1999—why wouldn’t retail investors do what they’ve always done in the past, which is to come back out of hiding and jump back into speculating in stocks, affecting that dramatic market move to an outrageously high market top?


Look at the chart, below, of the historical rates of the US 10-year Treasury.  What was the approximate rate of the US 10-year Treasury in 1999?  About 6%. Thirty-year mortgage rates nearly touched 8% in December 1999.



Today, the US 10-year Treasury yield is 2.29%, and maybe falling back to 2%.  And the 30-year mortgage rate today is: 4.00%.

The median sales price of an existing home in the US was $143,000 in December 1999 (St. Louis Fed data).  Today, the median sales price is $236,000 (St. Louis Fed data).  These statistics vary from other statistics.  I know.  I’m applying an apples-to-apples comparison to make my point.  

Applying these two statistics, a household is able to carry $102,000 more of a mortgage balance in 2017 because of a lower interest rate.  That $143,000 house in 1999 carries the same as a $245,000 house ($143,000 + $102,000) today.  Add in another 34.5% on top of a $245,000 mortgage, due to a rise in household income since 1999, and an existing home price of $329,500 is the equivalent price in today’s dollars to match the same housing price bubble of 1999.  So, housing prices must increase by another 39.6% from today’s $236,000 existing home price to match the 1999 housing bubble.



The chart, above, corroborates my analysis.  According to this chart, an equivalent ‘affordability’ limit to match the 1999 housing bubble must include needs a rise of 24% in the price of a median existing home before the 1999 housing market is rivaled.  That’s close enough to my 39% estimate.  The point is, home prices may soon rise further before this train wrecks, but the wealth effect would certainly loosen purse strings to buy stocks as had happened in between 2003 and 2007.

The chart, below, shows the correlation between housing prices and stocks prices.  Creating another housing bubble in the US can only help to keep stocks elevated, and that’s what the Fed wants: elevated stock prices.  Pay no attention of the gratuitous mention of some members concerned about the level of stock prices as reported in the FOMC minutes of March 2017.  Since when do Fed governors talk about stock prices during an FOMC meeting, and then report of these conversations in the FOMC minutes for all to see?     




Now allow me to apply a similar back-of-a-napkin analysis to stock valuations.  

The Shiller p/e for the S&P 500 in 1999 reached approximately 34-times.  Today, the Shiller p/e for the S&P 500 is 25.22-times.  In 1999, bonds yielded 6%, while stocks were capitalized at a rate of 2.94% (1/34).  

Today, the US stock market is capitalized at a higher rate, of nearly 4% (1/25.22), while the yield of the US 10-year Treasury has just reached 2.29%.  Interesting.  Using this crude and narrow metric, the S&P 500 would have to reach 9,300 to match the magnitude of the stock bubble of 1999, at present interest rates.  Bizarre.

Sure, professionals will be looking for ‘value’ plays in Europe and SE Asia, but mom-and-pop trader in the US may be ready to go all-into US stocks.  The spike in new accounts at the nation’s top retail brokerage firms tells us that a repeat of 1999 is a distinct possibility.  

And I think the Fed welcomes this development.  What else can the Fed do to bring back spending in a US economy, an economy that derives 70% of GDP from consumer spending?  The remainder of GDP comes from net exports, which has been a negative number since 1971.  And capital investment?  That isn’t happening.  Real capital spending is still at below 2008 levels.  And the rest of US GDP is derived from government spending (and deficits), translating to more debt and greater supply of US Treasuries.  So, it’s been a strategy of goosing the consumer that’s been the sole hope of supporting US debt and stock prices.

Despite the recent rhetoric at the March FOMC meeting, the Fed wants to create asset-price inflation in the hopes consumers will feel wealthy and spend their ‘unearned’ money on cars, homes and durable goods.  And as we can see, the strategy of inflating home prices and stocks is working for many of those retail stock traders who make up the top 20% of the US consumer wealth hierarchy.

Now, let’s go back to two interviews in February, one with David Tepper, and the other, with Warren Buffett.

And of course, we all remember what Warren Buffett told CNBC about stock valuations at about the same time as the Tepper interview.  

In the article that accompanied the Tepper interview, CNBC writes of the comparison between the Tepper’s thoughts on stock valuations and the thoughts of Warren Buffett during his interview:

U.S. stock prices are “on the cheap sidewith interest rates at current levels, Buffett told CNBC’s “Squawk Box” on Monday morning [February 27].

In his own slimy way (leaving out some big caveats), Buffett is technically correct, as my brief analysis demonstrates.  Tepper, too, sees what Buffett sees.  Now you see what these two men see.  Stock prices are rich, according to 83% of fund managers, and myself, but valuations can also get much richer.

The rub, of course, is the level of interest rates, which Buffett conveniently neglected to talk about.  If DoubleLine’s Jeffrey Gundlach is correct in his assessment that interest rates have bottomed, we’re doomed.  But, if the alternative to the US dollar is worse than the quagmire facing the Fed, the 10-year yield may indeed reach 2%, or lower.  A troubled world brings money to the Treasury market.  

And how is the US dollar’s primary fiat competition, the euro, working out?  Would investors rather hold a 10-year US Treasury at 2.29% or a German Bund at 30 basis points?  Germany cannot print marks, but the Fed can print dollars.  Besides, the ECB already owns approximately 40% of European debt.  How much further can the ECB take these purchases without smashing the euro more?   See my point?  But, it’s a good idea to continue your hedges.  Stuff happens.

And those new retail brokerage accounts being opened by the ‘paper wealthy’ homeowners among us may just take US stocks still much higher— a la 1999.  I think another 1999 may happen again.  File this report.  The inflation everyone is expecting will be in stocks, bonds and real estate prices, not in the price of copper.  

And if there’s a question as to where US retail traders put their speculative cash, when was the last time you talked to a punter, and he said, “Well, I think Spanish and Malaysian stocks are undervalued at the moment.  I’m long the KLSE and IBEX.”  Americans can’t even find Spain and Malaysia on a map.

Okay, let’s move onto my new addition to my holdings (a short), Santander Consumer US Holdings (SC).

My current portfolio: LQMT, CROX, LC, ANGI, SIEN, GRPN and SC

This Week’s JBP Stock Ideas

There was one trade this week.  I have 2,000 shares of Santander (SC) held short left from my original 7,000-share short.  Read my confidential report about this trade on my site.  I’m ‘in the green’ by 2.08%, and the stock has broken down below its 200-day MA.  That’s encouraging, as I think SC is grossly overvalued.

It was another good week for my portfolio.  Aside from no change in the share price of LQMT and ANGI, all my other tickers closed higher this week, with CROX leading the moves higher with a 2.3% gain.


Fannie Mae (FNMA)

I wrote in the April 24 edition of these reports about an interesting article about comments made about FNMA by famed bank analyst, Dick Bove.   Here’s what I wrote last week:

No news about FNMA this week, but I found an interesting article about comments made by famed banking analyst Dick Bove, entitled, Rafferty Capital’s Bove Notes ‘Potential Game Changer’ for Fannie Mae (FNMA).  It’s definitely worth the read if you want to jump aboard the FNMA drama.

Well, FNMA soared $0.46 to close the week at $2.97 per share, an 18.53% surge.  Anticipation of the passage of H.R. 1694 out of the House Oversight and Government Reform Committee lifted the price of FNMA throughout the week.  

H.R. 1694 was passed through committee just prior to the market close on Thursday.

Under current law, plaintiffs in the lawsuit against Federal Housing Finance Agency (FHFA) ran into trouble to Fannie Mae’s exemption from the Freedom of Information Act (FOIA), apparently because, technically, Fannie Mae is not a federal agency.  

How then are the plaintiffs able to prove intent in their lawsuit?  H.R. 1694 provides for the inclusion of Fannie Mae and Freddie Mac under FOIA.

Well, the idea behind taking a long position into the passage of of H.R. 1694 is, now plaintiffs may uncover proof of a conspiracy by FHFA to withhold income derived from Fannie Mae to stockholders, knowing that lots of income would be expected following the conservatorship of Fannie Mae and Freddie Mac back in 2008.  

My subscribers who acted on my Watch List narrative on FNMA ate dong quite well.

Here’s a bit of background on FNMA:

After the Trump victory in November, shares of Fannie Mae (FNMA) soared to as high as $5.00, from $1.65, an amazing move for only 16 days of trading.  At that time, Trump was viewed as a pro-investor president, likely to nominate a treasury secretary who would take sides with investors.  

Optimism and profit-taking held FNMA within a large trading range of $3.50 and $4.50, until February 21, the date the U.S. Court of Appeals ruled that investors have no standing to sue the Federal Housing Financing Agency (FHFA).  On the news, the stock plunged to $2.71, from the opening price on February 21 of $4.18 per share.

So, what now?  

Well, according to Height Securities analyst Edwin Groshans, further appeals are the only course left for investors, unless FNMA investors would like to wait as much as an estimated 11 years, according to Groshans, to recoup Fannie Mae’s value through earnings.

However, if suitors take their case against the FHFA, a successful ruling for the plaintiffs would realize “instant value,” according Groshans.

“It is our view that despite the string of court losses, legal action is the path that has the best chance of monetizing GSE preferred shareholder investments,” Groshans told Benzinga.

I agree with Groshians’ assessment.  What else can investors do?  The court system is the only way to go, as I see it.  

I’ve add FNMA to my Watch List because of the risk/reward profile of the stock.  Famed investor, Bill Ackman, of Pershing Square Capital Management estimates FNMA to be worth as much as $47 per share, if the plaintiffs prevail in the courts.  

I have no problems with Ackman’s estimate.  All I know is: FNMA is a clear double-digit stock price, when/if the value is released to investors and not retained by the FHFA.

Until next time…

Trade Wise and Green!

Jason Bond


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