Mechelany Advisors' MODEL PORTFOLIO Mechelany Advisors’ MODEL PORTFOLIO has been running in a fully transparent way since January 1st 2014. Its Purpose is to implement the conclusions of our research analytical process in a global portfolio managed using institutional liquidity, diversification, risk management and asset allocation processes. Our MODEL PORTFOLIO invests in cash, bonds, equities, commodities and crypto-currencies, it is not tied to any benchmark.
THE LAST INNING
With Apple Inc, reaching US$ 2 trillion market cap and TESLA rising 24 % in the week alone, after an 872 % rally in the past 12 months, signs of utter speculation abound and the vertical acceleration in this limited number of US tech mag-caps is telling us that the end of the rally is near.
Clearly, last week’s advances in these stocks have caused our Model Portfolio to live through one of the most volatile weeks in its history losing -6.04 % for a year-to-date performance of – 9.01 %.
By being short too early, we have given back 25 % performance since our peak at + 15 % in March 2020, but timing the top of a speculative bubble is a difficult exercise and we have still ample outperformance over the 6.5 years of management of our Model Portfolio to live through these exceptional times and exceptional volatility.
Being consistent with our strategy, we added to our short positions last week.
As we have highlighted many times in the past few months, the conditions are falling in place for a major correction in US tech stocks and even a global equity crash. Bubbles are bubbles and when they burst, the speed and magnitude of the coming fall will fully justify the curent volatility.
In the past five months, US equities have added $13 Trillion to their market capitalization totally ignoring the worst economic contraction since the great depression, the worst corporate earnings decline in the past 50 years, the highest unemployment rate since the 1950s, the highest rate of delinquencies in mortgage payments ever, the resurgence of COVID-19, the lack of additional stimulus packages, US-China tensions, and a messy US election.
Clearly, the massive monetary overkill engineered by the FED has given birth to a dangerous speculative bubble in a very limited number of shares and enticed a whole new category of investors to punt the markets relentlessly, buying shares of non-profitable companies and bidding-up shares to valuation levels never seen before.
The massive increase in liquidity, as measured by the increase in the M2 money supply aggregate from 6.7 to 23.3 trillion, failed to trigger investments, new jobs or even additional consumption but found its way in a limited number of companies shares, making their already ultra-wealthy owners even richer just as the time where deep America was sinking into unemployment, mortgage delinquencies and growing poverty.
Apple Inc. has become the US stock market by itself, accounting single-handedly for 87 % of the rise of the US Dow Jones Index and Tesla’ 25 % weekly rise made Elon Musk the fourth richest man on the planet.
What makes us think that a severe correction is around the corner ?
The S&P 500 added 0.7% over the last five days, notching its fourth straight weekly gain. It exceeded the Feb. 19 record high on Tuesday to cap the fastest bear-market recovery in history.
The Russell 2000 Index of smaller companies fell 1.6% while the Dow Jones Industrial Average was virtually flat.
The Nasdaq 100 performed better, climbing 3.5%, there again led by a very small number of stocks that we are short of and that are in a trend-ending vertical acceleration.
The main characteristic of this spectacular rebound since March is the fact that over the past 5 months, less than 38 % of the constituents of the SP500 have actually climbed back above their 200 days moving averages, denoting an extremely unhealthy market beneath the surface.
Moreover, the rise has been grinding with less and less volumes and less and less momentum.
With speculative extremes reached in the Apple, Microsoft, Tesla, and Amazons of this world, it is only a matter of time before these stocks start rolling over, succumbing to either profit-taking – Warren Buffett just sold 800 million Dollars of his largest holding Apple Inc. according to 13F filings – or mounting regulatory pressure on the tech giants as seen with the Apple developments last week.
When they turn, the entire US equity market will roll-over and fall into a savage liquidation tailspin.
Waning effects of liquidity
As can be seen from the charts below, the effects of the monetary stimulus are now coming to an end with the aggregate number of M2 plateauing and the Balance sheet of the FED as well. ( see Charts below )
With interest rates and bond rates almost at zero and the FED buying program plateauing as well, monetary stimulus has seen the best of its impact on the markets.
Economic Double dip
The economic rebound is definitely under way following the re-opening of the world economies and most surveys of economic sentiment are in expansion territory.
However, the absolute level of the recovery remains subdued and well under the levels of that would point to a V-shaped recovery. The US Conference Board now expects a 5 % economic contraction for the whole of 2020 and only a long term growth level of 2 to 3 % in 2021, meaning that it will take at least three years for the US economy to regain its level of 2019, and that is without the potential effects of the global resurgence of COBVID almost everywhere from the US to Germany top South Korea.
Much more worrying is the US unemployment number where last week another 1.1 million jobs were destroyed when the market expected 940’000.
Economists are touting the decrease in Continuing claims to point to health in the US labor market, but the truth of the matter is that this number is misleading as standard US unemployment benefits do end after six months on the dole, meaning that the decrease does not reflect massive job creations, but rather a sharp increase of people who will no longer benefit from any income or unemployment benefits in the coming months, with a lasting negative impact on consumption.
It is also becoming apparent that the US economy is suddenly plagued with a massive increase in total debt with a level of leveraged when compared to earnings that is now raising alarm bells at the banking regulators.
The ratio of debt to EBITDA has now reached an unprecedented level of 3.53 times in the high-grade space and almost 6 times in high yields.
The overhang is going to act as a major headwind for capital spending and hirings into the coming quarters, keeping a significant lid over the recovery
Dwindling prospects of new stimulus packages
The heightened political tensions in Washington have prevented the Democrats and the Republicans to agree on a new stimulus package before the August 9 recess deadline and although negotiations are taking place behind the scene, the prospects of an agreement are now down from US$ 3 trillion expected to less than 500 Billion.
On August 8th 2020, recognising the depth of the economic damage to the poorest and the ethnic minorities with growing and disproportionate unemployment within these groups, Donald Trump signed an Executive Order instructing the US Federal administrations to provide help and assistance to homeowners and renters impacted by the ending of the foreclosure and eviction 60-day moratorium for all single-family mortgages insured by the Federal Housing Administration voted by Congress two months ago.
Besides the fact that it is difficult to see how this executive order will actually be put into effect, it testifies of the desperate state of the Administration and the depth of the political stalemate in Washington in this crucial last mile of the Presidential campaign.
Exhaustion of the Bears
Virtually every constituency in the market has gotten more bullish as the S&P 500 surged 52% in five months and market bears are a dying breed in American equities, a sure sign that buying pressure is becoming exhausted.
When measured by the short positions of hedge funds, resistance to rising prices is the lowest in 16 years. Bears pulled out as buying surged among professional investors who were forced back into stocks despite a recession, stagnating profits, and the prospect of a messy presidential election.
Steamrolled by a rally whose velocity is the strongest in decades, bears have now covered their shorts and are giving up. In April, Goldman Sachs expected the SP500 to fall to 2’400, last week they revised their year-end target to 3’600.
At the start of August, the median S&P 500 stock had outstanding short interest equating to just 1.8% of market capitalization, the lowest level since at least 2004, data compiled by Goldman Sachs Group Inc. show. All major sectors except energy saw bearish bets sitting in the bottom decile over the last 15 years.
As a matter of example, Tesla Inc., the electric carmaker whose shares have surged almost 400% this year, saw its short interest falling to a record low, at 4.5% of total shares down from a high of 29% a year ago, according to IHS Markit data.
Mostfund managers over the past quarter went from being bearish and expecting a stock market crash to now becoming bullish. Sentiment has turned positive about equities in general but also for a return to growth.
Money managers have been forced to embrace the rally, ignoring this year’s profit contraction and banking on fiscal and monetary stimulus.
Rallying stocks are bad for bears — and that frequently pushes them out of the market at times that might be ripe for skepticism.
Consider the internet frenzy 20 years ago. Back then, large speculators, mostly hedge funds, were net short on S&P 500 futures in all but five weeks in 1998 and 1999. Those mostly losing bets were completely squeezed out in 2000.
That’s when the crash came.
We have just ended the proverbial climbing of the “Wall of Worry” and there are are no more shorts to cover, meaning that, at best the rally will stall, and at worst equities will collapse.
Vertical Acceleration in Valuations
At 26 times forecast earnings, the S&P 500 is trading at the highest multiple since the dot-com era and valuations have risen at a pace never ever seen in the past with price-to-book ratios skyrocketing at a pace and to levels unheard of in history.
Market commentators have all been concerned with the sky-high valuations already reached in 2019 and the beginning of 2020, but the recent vertical acceleration in valuation metrics is now becoming unsustainable, regardless of the level of interest rates.
Once again, here, the metric to look at is not P/E ratios as the variation in earnings can make P/E ratios explode upwards in recessions or even stay at extremely high levels for growth companies that are still in high growth mode.
But Price to Book ratios are a far more solid indicator of long term value and the pace of the recent vertical acceleration cannot last for long if history is any guide…
Long term institutional investors are now openly questioning the validity of holding on to strategic positions in these stocks at current valuations, including Warren Buffet, and equity strategists are now clearly recommending to clients to avoid the FAMANGS for now.
Apple stock price is now decidedly above the average target price of the consensus of Analysts. Everytime this happened in the past, the stock went into a correction.
There is now an increasing number of HOLD and SELL recommendations and less and less BUY recommendations on the stock.
As a testimony of how serious analysts predictions are, Apple’s average target price in August 2019 was 220 and it has now risen to 429, a +95 % increase in 12 months !!!
In 2019, Apple’s total Sales declines=d by 2 % and its earnings per share grew 0.2%.
In 2020, Apple’s revenues are expected to grow 4.8 % and its earnings per share by +8.4 %.
So much so for the 95 % increase in target price in 12 months….
When all is said and done, almost each and everyone of our indicators is flashing bright red …
We have clearly been three months too early in our hedging and shorting bets as the Fed-induced speculative bubble was building-up
But, the delayed price action and the irrational rise of the past two months are just making the future that much more dangerous, hence the consistency of our positioning and our tolerance to volatility.
What to watch for next week
Global central bankers will be participating in the Jackson Hole symposium next week, with investors watching for any signs of future policy changes and looking to policymakers’ views regarding the world’s economic recovery.
Key data to watch for include the US second estimate of Q2 GDP, durable goods orders and personal income and outlays; Canada and Germany Q2 GDP updates; Eurozone business survey; and China industrial profits. Meanwhile, the Bank of Korea will be deciding on interest rates.
Almost every segment of our portfolio was a negative contributor last week with platinum falling by 9 %, European stocks being hammered, our US long portfolio losing steam, and some bright spots in our Chinese portfolio with the spectacular results of JD.COM for instance.
But the bulk of the damage came from our Short US portfolio with TESLA rising 24%, Apple rising 8 %, Amazon 4 % and our Short Nasdaq ETFs losing 10 %.
Once again, all these are in vertical accelerations that will not last.
Last week, we increased our exposure to Chinese equities through index ETFs and added to extremely cheap recovery stocks benefitting from the massive infrastructural projects decided by the Chinese Government to counter the deflationary effects of the Pandemic, China Communication Construction and GuangShen Railways.
We also increased our short position on the US equity indexes, Nasdaq and SP500 as we expect a significant correction to unfold anytime now.
We have refrained from re-instating our strategic long positions in Gold miners and Silver despite our positive long term view, as we expect more unwinding of the current long exposure of the market.
The inability of Gold to hold above 2’000 puts the precious metal in a crucial technical spot.
Either it is simply consolidation its first attempt at challenging the 2011 highs, before starting a new bull campaign, or Gold will not hold the key 1811 technical support level and can therefore fall towards 1600.
Gold is clearly working out its overbought status on a daily basis and it is a healthy consolidation for the next phase of its advance
However, the weekly indicators are still heavily overbought and need some more consolidation
The long term chart shows a temporary top after the significant breakout campaign above the 2011 highs and it probably needs some more consolidation before moving higher
Silver has had a spectacular run rising form our US$ 12 buying level to 29.85 at the beginning of August, a 148 % rise in five months. It is currently consolidating its advance but remains heavily overbought for now.
The Weekly chart shows a SELL signal on the MACDs with a declining RSI
The long term chart also shows a temporary top and probably the need for more consolidation before a resumption of the uptrend.
We remain structurally bullish on both Gold and Silver but are waiting for a better entry point to re-build our exposure.
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