The following is from this year’s Note 29 of The Kelly Letter, which went out to subscribers last Sunday morning.
The simple allocation in our three tiers works well through various market environments because we own asset classes that do not correlate. This is the only distinction that matters. Diversification among different types of stocks, for example, is not useful when the market crashes because they all go down together. This is especially true in modern markets, which are so manipulated by central bank tinkering. Fed policies target major asset classes, not individual companies. Stocks are helped or hurt as a block by QE and rate changes. However, stocks and bonds behave differently. They are the most fundamentally different primary asset classes, and we own them in a target mix proven to work best through all environments.
I venture no guess as to where the market will go next, and I don’t need to do so. A further sell-off — which is, of course, the warning of the weekend across all commentator lips — would see our bond allocations grow as a percentage of our total portfolio, leaving them nicely poised to buy the cheaper stock prices. A recovery would see our positions appreciate again. This is all normal to and fro, not to be feared or ogled, but just to be monitored and used properly. …
If you’re moving a large amount of money into the automated plans, I suggest breaking your allocation to the growth fund into multiple buys to take some of the pressure off yourself to time it right. Eventually, your initial cost won’t matter much once you get several quarterly rebalancings under your belt, but everybody naturally tries to time their initial entry. While waiting, put all of your capital in the bond fund. Move the portion into the growth fund over two, three, or four orders. This way, you’ll feel fine no matter where the market goes in the short term, and in the long term it matters far more that you started the system at all than the initial cost basis at which you did so. This is counterintuitive, but true.
We can see evidence of this even in recent times. In last year’s Note 62 sent December 22, Tier 1 was worth $719,652 and its growth fund traded at $108.10. This weekend, Tier 1 is worth $717,314 and its growth fund is at $105.63. The overall tier is down only 0.3 pct even as the growth vehicle fell 2.3 pct. If the growth vehicle keeps falling in price, the 3 percent signal system will continue moving more of its capital from the safety of bonds into the bargain prices of stocks. When a recovery eventually kicks in, the tier will grow its outperformance margin even more. Through successive cycles, the system widens its lead over its growth index, which itself beats the majority of active market managers. In this way, the elegance of mathematics upstages the exertions of zero-validity managers and commentators.
Not that this will ever deter the z-vals from guessing publicly about the future direction and timing of price movements.
Former Fed Chairman Alan Greenspan said on Bloomberg Television’s “In The Loop” that “The stock market has recovered so sharply for so long, you have to assume somewhere along the line we will get a significant correction. Where that is, I do not know.” The problem with this type of open-ended warning is that it offers no practical value. Of course the market will experience a significant correction “somewhere along the line” — just as it will experience significant rises and long flat periods, as well. It fluctuates up and down on a long-term trajectory higher. There is no reliable way to time entries and exits ahead of the fluctuations, so musing on their inevitability is unhelpful.
Ron Paul, the former congressman from Texas who is an outspoken critic of the Fed’s monetary policies and the nation’s fiscal ones, warned that runaway inflation is on the way due to Fed stimulus. He said on CNBC, “I think there’s plenty of inflation, but my definition of inflation is a little different than the rest, because I think prices going up in the different areas is a consequence of inflation. There’s a lot of inflation in the stock market. I think there’s a bubble there.”
His chief concern is that stock price appreciation has outstripped economic performance. “The growth isn’t there. The only thing that grows is the debt, and just think about how much money they have to create value in the stock market. The unemployment is very, very bad, despite some of the optimism that is expressed with Wall Street, but that’s all deception. I think you still have to see a healthy economy and people aren’t complaining about structural employment, which is really insidious.”
These are valid points, but they’ve been valid for the past six years and have yet to come true. They still might, but we can see that they’re useless as market forecasting tools. Investing defensively against a comeuppance far in the future guarantees underperformance. The desire to profit from the stock market must include a willingness to experience its fluctuation. This is all we’re discussing here. Investing strategies predicated on avoiding downside while capturing upside will fail. Dismissing occasional good luck, the best an investor can do is mitigate downside and magnify upside, which is what our signal system does. …
As for stocks and bonds, we’ll keep automatically transferring capital back and forth between them in the fluctuations ahead. One advantage of relying on reactive arithmetic is that it disregards all guessing as to why prices went the way they did, and just signals times to buy and sell based on where they ended up after all the pressures were applied.
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The following is from this year’s Note 19 of The Kelly Letter, which went out to subscribers last Sunday morning.
The first thing one notices on an Emirates flight is the lack of Emiratis among the cabin crew. Beneath the uniform’s exotic red hats and white veils are black, white, and yellow faces from around the world. A flight attendant from South Africa told me on my flight to Dubai from Tokyo that Emirates boasts the most diverse staff of any airline in the world. All of them speak English, and there’s somebody on staff who can handle any major language needed by passengers. The amenities on the flight are famously luxurious, featuring headliners like an in-flight shower spa and gourmet cuisine on Royal Doulton china, and the service is superb. Everywhere I turned, somebody smiled at me and pre-empted my requests with uncanny powers of prediction.
The airline is headquartered at Dubai International Airport, and serves as proxy for why Arab business influence is rising. The United Arab Emirates (UAE) has oil reserves that are the seventh-largest in the world. The country is redirecting this profit into impressive national development and global investment projects. Dubai is home to the world’s tallest man-made structure, the Burj Khalifa, which tops out at 2,722 feet at the tip. The top floor is 1,918 feet high. Around it are other modern structures along the Sheikh Zayed Road, which lights up beautifully at night.
Given the international leaning of the culture and its focus on quality and service, it makes sense that Dubai is a major global city and important business hub. Passenger traffic at Dubai International Airport is growing at a rate of 15 pct annually, with more than 70 million passengers per year. The only airport that handles more international passengers is London Heathrow. Narita in Tokyo sees half as many as Dubai; JFK in New York sees a third.
According to Babu Das Augustine, Deputy Business Editor of Dubai-based Gulf News, the UAE economy grew 4.7 pct last year, its fastest clip since growing 9.9 pct in 2006. Credit goes to higher oil production and a resurgence in domestic demand. The Institute of International Finance (IIF) expects the growth to continue throughout this year. The mixture of revenue is changing, too, underscoring the general sense that oil profit needs to be parlayed into non-oil lines of business, usually dubbed “non-hydrocarbon growth.” This year, for example, oil revenue is projected to decline while the non-oil sector grows 5.2 pct.
The director of IIF Africa/Middle East, Garbis Iradian, told Gulf News last week, “The completion of major infrastructure projects and the preparations to host the Expo 2020 should keep economic growth in Dubai above 5 pct in the coming years. In the context of moderating growth rates in emerging economies and relatively slow growth in the developed economies, the UAE growth rate ranks among the most robust around the world.” The government is being careful to shepherd growth in a way that avoids repeating the credit bubble trouble of 2007 by enforcing regulatory limits on loans and demanding healthy loan-to-value ratios on property debt. Current growth is not the vaporous variety emitted by excessive credit.
Indeed, major financial indicators including stock and real-estate prices, business confidence, and declining spreads on sovereign credit default swaps (CDS) indicating faith in government debt, all point to a healthy deployment of oil wealth into non-oil enterprises.
This hasn’t been lost on the world’s wealthy. NatWest International Personal Banking issued a report called “Quality of Life” in which it concluded that Dubai is attracting thousands of young British professionals for a variety of reasons, not least the zero income tax. Couple the absence of the tax man with plenty of high-paying jobs in the booming business sector, and Dubai becomes cat nip for the aspirational. It’s thrown open its arms to the wealthy and the wannabe wealthy, and they’re showing up by the limo load. Just after Australia and Canada, the UAE is the third most popular destination for British expats. A recent headline in the Daily Telegraph asked, “Is Dubai the new Spain for British expatriates?”
Beyond the financial appeal, what do the Brits find so appealing about Dubai? Its high rankings across a number of lifestyle indicators, according to the NatWest study, including availability of consumer goods, entertainment, food, law enforcement, public transportation, sanitation, housing, public services, the school system, and so on. In other words, it’s a darned comfortable place to live while amassing or enjoying a fortune.
In some ways, it’s more tolerant of diversity than its Western counterparts. I asked an African Christian living in Dubai if she experienced any difficulty coexisting with Islam. She said no. I asked how a Muslim in Dubai would react if I wished them a Merry Christmas. She said they would wish me one as well. This I found interesting, considering that I’m reprimanded for wishing people a Merry Christmas in America, and advised to stick with “Happy Holidays” instead. “Everybody knows holidays are just cultural differences,” she told me. “Nobody should feel proselytized when being wished a pleasant holiday from any background.” Right! Pass the word.
Among Dubai’s non-oil endeavors is gold refining. Commodity trading is in the region’s DNA, evidently. In the desert just outside of the city, one of the world’s largest gold refineries is under construction. With demand for the metal moving toward Asia’s growing economies, other places are becoming more interested in catering to the buyers rather than buying the commodity itself. Call it the old pick-and-shovel strategy of winning a gold rush. Kaloti Precious Metals is spending $60M to help move Dubai beyond just trading the metal to refining and clearing it. The Dubai Gold and Commodities Exchange will introduce a spot gold contract next month.
Analysts are characterizing this transition as a brilliant use of Dubai’s portfolio of assets. It’s close to consumers in China and India, maintains a low-tax backdrop, and runs an efficient transportation system. Pair gold with these factors, and it’s easy to see why Dubai thinks it can carve out a niche for itself in an industry long dominated by Switzerland, which refines more than 3,000 tons of gold per year, about half of the global market. By comparison, the UAE refines 800 tons. Last year, almost 40 pct of the planet’s physical gold trade passed through Dubai, but the area has lagged in the refining business.
Kaloti and others are hoping to change this. The new refinery will deliver an annual capacity of 1,400 tons of gold and 600 tons of silver, more than trebling the output of any of the UAE’s current refineries.
The UAE is working hard to diversify its wealth beyond the oil industry that made it rich. It’s luring worldwide talent to its economy with generous compensation, low taxes, and a pleasant lifestyle. It’s spawning investor groups that troll the world for new businesses boasting high returns on investment. All throughout Europe, the influence of Emirati investment capital is being felt.
There’s an opportunity for some investment group in Dubai to get a leg up on the competition by sending envoys into target markets. If I were in charge of the operation, I would instruct the envoys to live in and love the destination, to learn the language, make friends, and send me letters explaining everything they’ve come to admire about their new home. Once those letters glowed warmly enough, I would fly to meet the envoy and discuss together what type of business the market needed and how our capital could best be used to make it happen. I would send gregarious people, not analytical ones. The analysis comes later.
From what I saw in Dubai, from what I experienced on Emirates, I have a feeling somebody in the UAE is going to catch on to this. Profit arises from a combination of heart and head.
The following is from this year’s Note 17 of The Kelly Letter, which went out to subscribers last Sunday morning.
Two weeks ago in this space, we got a kick out of Dennis Gartman of the Gartman Letter saying on “Fast Money” that he became scared ahead of what he saw being a “long-awaited and much-needed correction.” He even pinpointed the market’s flip from bullish to bearish to a 15-minute window on the morning of Friday, April 4. “I’m not sure what happened, but something happened between 11 and 11:15, that everything turned on a dime,” he said, and mentioned that he was hunkering down in cash and gold.
The irritating thing about 15-minute increments of game-changing magnitude is that they come up so darned often, Gartman has discovered. With his particular brand of prognostication, the world can change four times an hour, thus 96 times per day. At this frequency, the longevity of a Gartman forecast based on a previous 15-minute revelation is not ample. Along with mayfly lifespans, eclipses, and the rapt attention of voters, Gartman forecasts appear on the list of things to enjoy quickly before they’re gone. While it lasts, then, you’ll be pleased to know he’s bullish once more.
He advised in his newsletter that it’s time to be a buyer of equities “generally,” describing his portfolio as being “pleasantly long” stocks. What did it for him? Mainly the market’s refusal to go down as he warned it would. He didn’t describe it that way, of course. He said it was the market’s ability to bounce off strong support. He said that “after a good two weeks’ decline, after 50 big handles in the S&P, after barely going through but holding the 100-day moving average, you have to understand: it’s still a bull market. So it’s back to being pleasantly long again.” He advised that if his letter changes again soon — and why not? — it would be to “increase exposure to equities rather than to decrease it.” Another 15-minute epiphany could do the trick.
A convenient aspect of advice like Gartman’s is that you never have to worry about missing something he says. Just wait. Fairly quickly, he’ll come around to aligning his forecast with whatever posture your money’s in. Worried, and hiding in cash? No problem, Gartman will suggest it soon. Aggressive and buying hand over fist? He’ll get there before you know it. We could even automate Gartman’s appearances on CNBC with a simple algorithm. If the market goes down, the Gart-voice warns of going down more. If it goes up, the Gart-voice says it has further to run. Just plug in the Chatty Garty and fill the air time.
Gartman’s recent instability serves as proxy for something bigger at work, which is the desire of z-vals (zero-validity forecasters) everywhere to ring the bell at the top of the market. In fact, most major market tops are a process rather than an event. They generally take longer than, say, 15 minutes, to fully form. They take months and involve lots of to-and-fro, chartist chatter about confirmations and non-confirmations and divergences, and bouts of relief in the wake of quick scares.
Those on the lookout for a sea change in the market’s direction are paying close attention to how the Nasdaq and Russell 2000 broke their recent uptrend channels. They represent technology and small-caps, of course, and small-caps power our growth vehicle in Tier 1. Market watchers think small companies lead the market, so pay special attention to the Russell. When the broad market, defined as the S&P 500, never broke support after warnings from Gartman et al., analysts turned attention to the Nasdaq and Russell. They did break support, but then bounced back. The new area to watch is the overhead resistance on these two indexes.
Specifically, chartists advise that we’ll know the bull market is still kicking if the Nasdaq 100 can clear 3600 and the Russell 2000 overcomes 1190. They closed Friday at 3533 and 1123 respectively, meaning that a green light on further market gains lies another 2 pct gain away on the Nasdaq 100 and another 6 pct away on the Russell 2000. In a different manner, much more studious and believable, these wise oracles of the moving lines tell us the same thing Gartman tells us: we’ll know the market is moving higher if it moves higher, and should beware a move lower if it moves lower.
They do it with a straight face, though. Here’s Mark Arbeter of S&P Capital IQ, from his Friday note: “Selling pressure from these levels, resulting in a failure of the leading indices to sustain any new highs, would be a bearish signal and could create the type of divergence and non-confirmation that is often seen at market tops.” He clarified that the scenario is built on “a lot of ‘ifs’” so his firm intends to “remain prepared to identify and take action given a multitude of potential paths the markets could take. This scenario is one that we feel merits consideration, discussion, and ultimately preparation [in case] things begin to unfold in this manner.”
Let me remind you that the market can only go in three directions: up, sideways, or down. That’s it. Since the z-vals are just guessing, anyway, why would any of the three merit more consideration than the others? Why should any market forecast merit any consideration at all? We can’t know which of the three directions will unfold next, nor for how long, so all we can do is wait and react. Given this, the energy of consideration should be reserved for arenas in life where it matters, like choosing a place to work or planning a family vacation. These are worth researching. Future market direction? Not really.
Stock market analysts — known around here as z-vals due to the zero-validity of their 50 pct mistake rate — are busy forecasting what the turmoil in the Ukraine will mean to financial markets. Here we go again. There is no way to know, but that doesn’t stop them from posing as if there is. Let’s have a look at the absurdity of this effort.
First, a quick recap of what happened.
Freshly deposed former Ukrainian President Viktor Yanukovych was unpopular, and many believed he was unfairly elected. He has always been in the back pocket of former KGB thug and current Russian President Vladimir Putin, who wants to keep the Ukraine (now sometimes referred to as just Ukraine, without the definite article in front of it) politically and economically beholden to Russia rather than losing it to the European Union. Much of the Ukrainian population, however, wants to strengthen ties to the more progressive and sophisticated Europe and wash its hands of the backward and corrupt Russia. With Yanukovych at the top, however, Putin pulled the puppet strings.
A few months ago, citizens rose up and protested this subordination of the will of the people to foreign influence. In January, they became angrier when Yanukovych rejected a deal for closer integration with the European Union that he previously indicated he would support. There were other reasons for their anger, as well, and disposition varies by region of the country, with the Ukrainian-speaking areas in favor of European ties while the Russian-speaking areas prefer Russian ties.
Last week, the until-then mostly peaceful stand-off blew up. Riot police stormed Kiev’s Independence Square (also called Maidan in some reports, which Wikipedia can explain). The air filled with percussion grenades from the cops and Molotov cocktails from the protesters. Snipers picked off people in the crowd. Doctors operated on dining tables between incoming smoke grenades sent crashing through windows.
Politicians are nothing if not fickle fans of power, so when they sensed Yanukovych losing his they abandoned him in parliament. He also lost support of rich elites. Parliament passed a resolution ordering riot police to back off. With protection gone, Yanukovych fled his office and personal estate, leaving by helicopter as his belongings were trucked away. As protesters took over government offices and perused the fallen president’s palatial home, Yanukovych phoned in from an undisclosed location to mention that he hadn’t resigned. Parliament took care of that minor detail by dismissing him and his cabinet last Saturday. His own party called him a coward and a traitor for killing his countrymen and bankrupting his nation. Parliament bestowed interim presidential authority on speaker Oleksandr Turchynov, who said, “We have to return to the family of European countries. We are ready for a dialogue with Russia … on a new, fair, equal, and neighborly basis, acknowledging and taking into account Ukraine’s European choice.”
With that, the gauntlet was thrown and all eyes to turned to Vlad the Impaler, who finds himself in a tough spot. If he invades to win back the western-leaning Ukraine, Putin will spark an expensive war against a nation chock full of Russia lovers. If he does nothing and simply cedes the Ukraine to Europe, he’ll lose his aura of authority and vision of a Eurasian Union. Just as the Ukrainians tossed out Yanukovych the moment he looked weak, so might Russia give Vlad the boot if he looks powerless in the face of a populist uprising against a wishy-washy leader ping-ponging between Europe and Russia for more grease in each palm.
The western parts of the Ukraine want to ally westward while the southern and eastern parts are gathering people in support of Yanukovych and Russia, and calling for the sort-of-deposed Yanukovych regime to crush the rebellion decisively.
That’s where it stands now, and this is where the coin-flipping stock market analysts arrive on the scene to toss their guesses into the forecasting ring. Raising questions meant to imply trouble ahead is a time-tested way to get the attention of investors. For example, the question, “Will the Ukraine be the next black swan for financial markets?” implies that you’d better watch out because it very well could be. In fact, it’s just a question, reaching no more of a conclusion than this one: “Will the Ukraine drop off the radar screen soon, just like Greece and Syria before it, with no impact on markets or relevance to your life?” We don’t know the answer to either one, as they’re just open-ended musings on possible outcomes.
The worry most presented is that the Ukraine will devolve into a civil war between its European-leaning factions and its Russian-leaning factions, that such a civil war could draw in support from the West and Russia, and that such an escalation could ultimately pit the United States against Russia in a hot war for the soul of the Ukraine. Because we’re discussing the view from stock market analysts, the further fear is that such a blow-up would cause worldwide stock prices to collapse.
Look at the layers of uncertainty involved here to the point of rendering forecasts silly. We don’t know:
Within this collection of shoulder shrugs, consider that past wars have been good for stock markets, not bad; that any outside support for factions fighting in the Ukraine would probably arrive in the usual manner of weapons, drones, intelligence, and so on rather than with Russian troops and American troops meeting directly on the battle field; that talk from the White House about consequences carries the weight of a helium balloon after the current president threatened them without follow-up in Syria; oh, and that the Ukraine matters about as much to financial markets as your napkin matters to the quality of your dinner. Sure, it’s part of the picture, but not exactly critical.
Just how minor is the Ukraine’s economy? It doesn’t even crack the top 50 by various world GDP rankings. Let me put it this way: Nigeria’s economy is bigger than the Ukraine’s. So is Thailand’s. Heck, even Glorious Nation Kazakhstan has cobbled together an economy bigger than the Ukraine’s.
Am I saying that the Ukraine’s strife will mean nothing to financial markets? No. Am I saying it will become a black swan? No. I’m not saying anything because I don’t know — and neither do the analysts, or the presidents, or the guys down at the bar, or you. Nobody knows, so why bother listening to forecasts?
As with all things related to the financial markets, intelligent reaction trumps folly-filled forecasting every time. Contrary to the image analysts love to put in popular media, it’s not necessary to know the future in order to do well in the stock market. This is good news, since nobody can know the future, not even the talking heads in fine suits. Keep your methodical investment plans on track through whatever scare angle they serve up next. Yes, someday something will send stock prices down again, but they don’t know when or what, so there’s no point tuning in to these coin-flipping exercises. Just react intelligently to what actually happens, not blindly in advance of what some z-val says might happen.
The Ukraine matters, of course, socially, politically, and in other ways. It might even matter to financial markets. There’s just no way of knowing in advance.
Back to it. Have a good day,
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Last Sunday’s Kelly Letter featured a special report on the growing concern about financial risk out of China, given warnings from Charlene Chu and Jim Chanos about the $15T in lending capital China created, which powered its infamous property bubble, which the analysts warn is ready to pop. Many subscribers asked me for permission to share the report with their friends and colleagues, which I granted.
I’m also offering the report to non-subscribers as an invitation to try the letter. It delivers far more useful content every Sunday morning than most once-per-month services deliver in four weeks. See how the letter is managing China the way it manages all scares of the moment as it steadily follows its methods to long-term profit with little stress.
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