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A little more long

Last week I wrote about how my portfolio was positioned “nominally net long” but “in terms of my portfolio’s response to market moves, a little net short”. I also wrote that I thought “that a change was coming” where the bear market would end soon.

Since that time the market has gone down (it was about 3,800 then, is a little over 3,600 now) and my portfolio has not done much of anything. But my thinking has changed a little. I’m not so sure about the change, ie. not so sure that this bear market is going to end soon. But I’m not sure we have to go straight down just yet. And in the mean time, I think some stocks could go up while others go down.

This week, with a few fits and starts (I never seem to know what it is I want to do until I do a few things and realize that those are not it) I cautiously moved my positioning to being a little more net long, which I think should mean that I am actually net-net long in terms of my portfolios response to market moves. I did this even as I feel like the medium term picture is probably more bearish for the economy.

The moves I made were to take off about 20% of my index short on the S&P (the HIU), close my short on the Nasdaq, add to my position in Google, add back my position in Bank of America, add a new position in Constellation Software, add a new but so far small position in TLT, and go back to a gold names with Newmont and Barrick Gold. I also added a position in VIXY.

None of this is going to cause wild gyrations in my portfolio. If the market goes up 5%, I expect my portfolio will go up 1-2%. And (hopefully at worst) vice-versa. But I think I am more likely to participate in upside now, whereas a few weeks ago I dreaded the big up days as much (or more) than the big down days.

Ok, so why did I do what I do?

Well, I have read and listened to a lot of bearish stuff the last couple days. There are a lot of bears out there and they make a lot of good points. There is a lot to be bearish about.

If you want to hear a really bearish take, listen to this spaces, with Michael Taylor. I like listening to Michael Taylor. He is a very smart guy and well connected to the hedge fund business. As he says himself, Taylor talks primarily with 50 major hedge fund managers.

Taylor is extremely bearish, especially on the British Pound (which he says is going to blow up) but also on the stock market. Stocks aren’t seeing what bonds are seeing, he says, and if they were they would go down. I imagine most of the fund managers he talks to think the same thing.

Taylor thinks that we are going to see big redemptions from hedge funds (other hedge funds), especially around year end. He thinks the economy is going to crash (he says there is a 100% chance of this) and it is going to happen now. He thinks high yields are going to blow out, while US Treasuries are going to reverse and fly higher. It is quite dire.

Most importantly, he outlined how the carry trade is blowing up many funds. And how that has become a big headwind for the market.

As Taylor explains, it is the unwind of carry that led to the collapse of the British Pound and the eventual rescue of the UK bond market by their central bank. Taylor linked this FT article that describes the bets that went sideways for pension funds and appear to have nearly led to a collapse of these funds. This FT article, written in July, describes how pension funds have been forced to put on large carry trade bets to match their liabilities, which get larger as rates fall.

I’ve written about the carry-trade a couple of times before but not for a couple of years because when things are going well it doesn’t really matter. Knowing that it is being unwound makes me pause. Because something could blow up and this week it sounds like it almost did.

For this reason alone (and its not the only reason) I would not want to get too long of stocks right now. Taylor believes that some sort of big whooshy crash is inevitable. I’m not nearly so sure. But if there is a small probability of a whooshy crash, I want to be prepared.

For me, that is where the VIXY comes in. If something systemic is truly about to happen, the VIXY should go up a lot. Consider that it usually comes close to a double when something fairly bad happens. When something really bad happens (like COVID), it can go much higher. The trick is to buy it close to when you think a risk is there for something very bad but not so close that the bad is already priced in. When I bought it (on Monday), it wasn’t really pricing in very much risk being just a couple of points off the lows. It still isn’t.

I know any VIX ETF is a terrible instrument to hold for any length of time (see the awful chart below). But that is because it is the inverse of a carry trade, its purpose is to have sudden bursts of out-performance during times of volatility while carry-trades implode. Carry trades are essentially “short vol” trades. If they are being unwound, then the VIXY seems worth it to me as a part of my hedging routine right now. It won’t collapse overnight but it may spike overnight and if it does my hope is, in addition to my other hedges, it will put me well positioned to deal with ensuing chaos.

So that is the VIXY. What about the longs? Well Taylor’s very bearish conclusion is that the market (I’m can’t be sure if he means the GBP, the stock market or both but I think he means both) is going to go down hard. Though he had covered his entire short position after the BOE pivot, after listening to his own talk, Taylor went max short again and made big money again today (though fortunately not the GBP, which was up big today).

I am not so nimble, so I will not being going max short or long of anything at any point. Instead I will just try to eek out a few gains in both up and down markets.

This is clearly been a down market. Yet (apart from my VIXY crash protection) I’m moving my position to being more bullish. Why?

Funnily enough, it is because of what Taylor says.

Taylor is very long US Treasuries. He says on a few occasions he is long $100 million of 10-year treasuries! I am not long $100 million of 10 year treasuries. But I took a small position in TLT.

I have been scratching my head the last couple weeks about why the bond market keeps falling, ie. rates keep going up. How can this be happening when just about anyone can see that things are slowing, maybe dramatically.

Taylor explained this conundrum. Its the carry-trade! The unwind of the carry-trades in the UK has been causing funds to liquidate UK bonds. I can only presume that the same thing is happening in North America and elsewhere. Bonds that were either on the other side of the trade or being used as collateral for the other side are being sold, and it has nothing to do with rate expectations.

If this is why bonds are falling, it will end. So I followed Taylor, who has been long treasuries for at least a little while, and took my own position in the TLT, which has done very badly this year.

Taylor thinks that the market is going to tank and that government bonds are going to become the “only-one-to-own risk-free asset” again. On this point, I am kind of in agreement, but only up to a point with that point being treasuries and not tank. The market has gone down quite far, quite fast over the last month, sentiment is very bad, and it doesn’t seem to me or the transcripts I read that the US economy is doing all that badly just yet. So I’m not sure I’m onboard with the whole tank side, at least for now.

Absent a systemic catalyst that is. Which could happen. And I can’t predict it. So I’ll keep tight with the hedges and VIXY for the moment.

In my post last week I basically said I was out of the small-cap stuff and in with boring larger cap names like Verizon, Vertex, Google and Pfizer. But I wasn’t entirely sure why.

I think I know now. I think that if Taylor is right and longer term interest rates are going to peak and begin to fall, big cap names are going to outperform.

Rates will be falling because the economy is weakening. But there won’t be an expectation that the Fed will come to the rescue and save everyone. All those crappy, money losing stocks that, as Taylor says, “need the HYG” (the one’s I tend to be short) are going to have trouble. But falling rates are going will provide some positives for more established stocks, both because they mean we aren’t going into an inflationary spiral, that there will be a chance of a soft(er) landing, that bonds aren’t in competition to dividends (ala Verizon or Pfizer) and that lower discount rates translate into higher multiples.

Meanwhile a stock like Bank of America has a PE of 9.5x. Pfizer has a PE of 6.8x. Google has a PE of 17x. Constellation is more expensive, at 23x next years earnings, but it has a 5% FCF yield and grows at ~20%.

I understand that if things deteriorate enough, all of these P’s and E’s can go down more. But if rates are coming down, it will be a signal that an end of tightening is in sight (it worked!), and so just how far should the PEs of the best companies be compressed?

That same argument is why I decided to take down my S&P index short (which is weighted towards the big cap names) and not my Russell or single name shorts. Again, “short the companies that need the HYG”.

I want to keep my exposure to being short crappy stuff but get a little long the not-so-crappy stuff.

Meanwhile, there is SO MUCH negativity out there. While I am not the sort to take sentiment indicators all that seriously, sentiment certainly seems overtly bad right now. It makes me more nervous about my shorts being too large than my longs. I can imagine a scenario where something, anything, good happens, the Canadian dollar rips off of extremely oversold lows, the market rips off of its extremely oversold low, and I am left getting smacked by a big up day.

My feeling is that a big up day is the bigger risk right now than a big down day. And with a big down day I always have that VIXY backstop. Besides we’ve had a month of big down days. The Nasdaq is down ~20% from where it was mid-August. Bonds have been in a straight line down. Non-USD currencies have been in a straight-line down. After such extreme moves it is usually not prudent to press while it is usually prudent to rebalance. So that’s what I am doing.

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