Here’s How to Profit off the Real Brains of the Market

Stocks paused from their post-election rally last week as the Dow Jones Industrial Average gained a paltry 18.28 points or 0.1% to end the week at 19170.42. The S&P 500 fell -1% to 2191.96 while the Nasdaq Composite Index fell -2.65% to 52255.65. Further gains or losses may be less dependent on news from Trump Tower and more responsive to Italian voters’ rejection of constitutional reform on Sunday, December 4. The “no” vote in Italy bodes poorly for Italian banks, which are insolvent and in need of government support, and potentially a movement toward exiting the European Union. Despite a wider-than-expected margin of defeat (“no” votes were nearly 60% of the total), markets in Europe and the US by rallying. I have to confess that while I expected the “no” vote I did not expect markets to greet the result by rallying and am scratching my head at the response.

Italian voters are the latest to embrace populism and reject the elites governing their country. Following the Brexit vote and Donald Trump’s victory, Italians rejected much-needed constitutional reforms that could improve governance and chances for economic reform because they were focused on rejecting the heavy hand of the European Union and the straitjacket of the single currency that is suffocating their economy. This is what happened in the UK and points to the likelihood that the European Union is doomed in the long-term. For the moment, however, the immediate threat from this vote is to the insolvent Italian banking system that desperately needs to restructure. In the coming days, markets may come to see the vote with dark rather than rose-colored glasses as I do.

The US Dollar Index faded a bit last week but still closed at 100.66, near its 52-week high. On a broad basis, US stocks are now engaged in a battle between expectations of higher growth and earnings due to Trump’s pro-growth and lower tax agenda and the costs of higher interest rates and a more expensive dollar. The market is expensive with the S&P 500 Market Cap/GDP Ratio at 125%, near a historic high, and the Shiller Cyclically-Adjusted Price Earnings Ratio at 27.02 versus its historical mean of 16.71. While these valuation metrics aren’t deterring investors yet, they indicate that the market is very vulnerable to disappointments – and disappointments can come from many economic and geopolitical fronts.  With higher rates and European instability on the horizon, investors should proceed with caution. That may not happen until year-end performance chasing is over, but I would expect the rally to peter out in January.

Truth be told, stocks aren’t a reliable indicator of anything right now.

The real “brains” of the market (and the real profit opportunities) lie elsewhere.

Here’s what you should be watching instead.

In A Misleading Market Climate, One Indicator Tells The Truth

Markets are still driven by phony government statistics that paint a false picture of the economy. The November jobs report is a typical case in point. The government reported that the economy added 178,000 jobs in November and that the unemployment rate dropped to a 9-year low of 4.6%. But this is nonsense. The only reason the unemployment rate dropped so low was that over 400,000 people left the work force, distorting the calculation. In point of fact, if the labor participation rate (which remains at 40 year lows) was the same today as when Barack Obama began his disastrous presidency in January 2009, the unemployment rate would be over 10%. The only good thing about this phony number is that the members of the Federal Reserve’s Open Market Committee (FOMC) are dumb enough to believe it and use it to guide policy; in this case, it means that they will raise short-term interest rates by 25 basis points on December 15. In doing so, the intellectuals-yet-idiots who manage monetary policy will no doubt cite the phony low unemployment rate as one justification for their action when in fact low rates contribute to the low labor participation rate and sluggish wage growth, but at least they will move one tortoise-like step closer to normalizing interest rates. When they hiked rates for the first time in nearly a decade last December, the market threw a tantrum that sent the S&P 500 down 10% in January before it recovered. Whether markets will react any better this time remains to be seen though the psychological boost from the Trump victory will likely cushion any negative blow.

Some speculative stocks are skyrocketing as a result of expectations about the new administration that have no basis in reality. For example, Fannie Mae (FNMA) and Freddie Mac (FMCC) are up sharply since the election based on unfounded speculation that the Trump administration will allow the shareholders of these government-owned entities to share in their recovery since the financial crisis despite legislation that swept all of their profits into the government’s hands. Ignoring the fact that both companies’ profits are shrinking, that they have no capital base as a result of their past losses and government profit sweep, and that they may need more government help in the near future, investors are convincing themselves that a Trump administration will reward a bunch of hedge funds speculators who were nowhere to be found when the company needed capital in 2008. Naturally, the Obama administration handled the entire matter in an underhanded way that created an opening for sharp operators to sue the government to try to profit off the backs of American taxpayers, but the odds of shareholders prevailing here remain slim. Investors chase these gains at their own peril.

Right now, Wall Street strategists are busy tripping over themselves raising their 2017 targets for the S&P 500 based on Mr. Trump’s pro-growth agenda. But while stock prices rally, the real brains of the market – the bond market – is selling off awfully hard.

The yield on 10- and 30-year Treasuries are up to 2.38% and 3.06%, respectively after rising more than half-a-percentage point since the election.

30 Year Treasury Yield


The rise in yields already produced $1.7 trillion in losses, but these are only a small down payment on the catastrophic losses holders of investment grade corporate and sovereign debt are likely to experience over the next few years. If rates were to normalize by 200 basis points (which is a near certainty over the next 3-4 years), that would bring losses to over $7 trillion (though there would be some offset from interest income – at least where bonds are not showing negative yields). The bottom line is that bonds remain a toxic asset class that should be avoided by investors at all costs. In case that sentence wasn’t clear enough, that means that everyone reading this should sell every single long-dated (i.e. longer than 3 years) investment grade, municipal or government bond you own in order to avoid losing money on both a nominal and real (i.e. inflation-adjusted basis). Either stick the money in cash or use some of the money to buy gold (which is selling off for stupid reasons). Professional and sophisticated investors should consider shorting every piece of long-dated high quality debt on which they can get their hands.

One way to do that is to short the Vanguard Total Return International Bond ETF (NASDAQ:BNDX), which carries a very low yield that is heading higher and will lead to big losses. As always, I recommend puts as a safer (and cheaper) way to play the short side.

Of course, you should keep an eye out on our short equity plays too, because we’ve seen bad news for a couple of them very recently…

A Note on Two of Our Favorite Short Plays

Valeant Pharmaceuticals (VRX) received more bad news last week after a proposed deal to sell its Salix business for a multibillion loss fell through. It is becoming increasingly obvious to the market that VRX is insolvent and that its stock has no value, something I warned about a long time ago when the stock was trading at $170 per share (no, I didn’t catch the high tick at $262 but nobody’s perfect!). It ended the week at $15.45 per share. It is going to zero.

Tesla Motors, Inc. (TSLA) is going to be the next VRX, dragging down many hedge funds and other investors as the market comes to realize that the company is a personality cult and Wall Street fee engine rather than a sound investment. The SEC slapped the company on the hand last week for its bogus accounting while more astute investors are making the case that the company’s losses are unsustainable. Its merger with Solar City, which its stupid shareholders approved, hastened the demise of the company, whose stock ended the week at down at $181.47. Believe me, it is going much lower – most likely, all the way to zero. Tesla stock is like the SpaceX rocket that blew up on the launch pad a few months ago – all flash, no cash, a lot of hot air, and dangerous to bystanders. Short away my friends!


13 Responses to “Here’s How to Profit off the Real Brains of the Market”

  1. The people that oversee the markets and rush to support them in times of crisis or potential selloffs were on the job. The Fed trading desk, Exchange Stabilization Fund, the President’s Working Group … ie. Plunge Protection team … et al. had a lot of time to prepare for any fallout from the Italian vote. They propped stocks and the Euro and raided gold. All in a day’s work.

    That wasn’t a “market” reaction. It was just another example of rigging by the Powerz That Be.

    “There are no markets anymore, only interventions.” – Chris Powell

  2. Robert F. Pacione

    Hi Michael! Never change my friend from afar. You ignite a truth and honesty that is necessary for mankind. Or for those smart enough to absorb your knowledge. Would be wise to listen. Unfortunately we all have choice. Those dumb enough to ignore. Well! They will deserve the punishment coming to them. Also! Will continue to be ignorant to the truth as the robot mentality they have absorbed from there surroundings and the change they ignore within. Can only point there own finger at themselves. So! Fxxk them. I say. I know your right. I see it everyday the lies and manipulation laid out in a plan to destroy and mislead them into a bottomless pit of despair and empty accounts. For them and only them to find a justification that it was not there fault. A peerfect excuse to live with. Although you have warned them. I can tell you. I dont know many people. I walk alone mostly but I certainly can say. Whom I may talk with in my walk. I lead them to you and your team. Real Brains lie here at MoneyMap and I love it. Honesty is feared but we sleep at night. Just remember my friend. Fear nothing. It is there fears that create skepticism and they will learn the hard way. My only word of advice to you which you may not need is. Is the greatest fear in this world is facing yourself and the true change that comes with looking within. Is astronomical.

    Now! My only skepticism on gold is that you have The Arora Report stating gold is dropping to 800 bucks and then having an individual who is smart as a whip selling gold at 10000 to soon. A little premature. My opinion only. Cause why would a guy who works for the same government who is hiding a truth misleading them into a possible pit before the rise in years from now after the crash in February. My prediction when it will happen. Janet Yellen is beneath my feet. Coming from this guy. And I’m Canadian. lol Wish she would step down but hey! Let her ruin herself. Its in the numbers anyways. Let her be the fall guy like Hilary was for her controllers. Failure is necessary before it can be repaired and I hope you apply for her position if you can. Why! Cause you carry the knowledge necessary to lead the way. Yet! I fully understand why its fun watching from the sidelines. Just hate when we are all affected.

    Take Care
    Keep up the great work.

  3. Notice you mention this,
    “catastrophic losses holders of investment grade corporate and sovereign debt are likely to experience over the next few years”
    “sell every single long-dated (i.e. longer than 3 years) investment grade, municipal or government bond you own ” – no mention of “corporate”
    then this refers to “short the BNDX” which is a “Fund” not the same

  4. Good article, and good commentary.
    I respect the magnitude of wealth it takes to manage the markets in currencies , commodities, debt and equity markets, here and abroad along with the costs that enable them to pursue their agenda, what ever that is. I always find myself anticipating the inevitable is eminent, which is toxic to your health and relationships. Now events are in fact occurring more frequently, and a variety of symptoms and probabilistic interpretations suggest coming events will lead to dire consequences. There is one in particular: the IMF’s SAR currency, that included the Yuan in this new world money this past Sept. The IMF has fully prepared for international access and transactions I’ve read, and I think this world money is the escape hatch for the rest of the world to sell dollars and buy SARs. This could already be why bond yields are moving?
    Time to spend your strong dollars wisely, and soon. Michael’s put options are a good example for staying ahead of inflation, as are commodities,PM’s and select emerging markets IMHO, but more important to cover your safety and other needs too.
    So reasons to draw this conclusion:
    Commodities excluding energy are moving up; precious metals have succumbed to the big shorts in the futures; $2M all premium call option on the Russian currency, 6 quarters of declining earnings, buybacks and the cool aide, we have a rally in equities and the strongest dollar in a dozen years. Yet the Aussie dollar strengthens.
    India’s experiment in banning large denomination currency seems like a desperate, poorly planned action. Its a major disaster for the people, a colossal failure. Why? Inept, stupid? I don’t think so.
    The Fed stated objective has always been inflation, and I can imagine the inflation they need to dissolve the debts is much greater than 2%. Beware.

    As mentioned by Michael, a huge promotion is underway that is all about an equity rally.
    If nothing else, consider what just happened. The establishment rallied Hollywood, the media, silicon valley , wall street, and washington in an effort to derail Trump. They openly hate his guts says Robert DeNiro. Recall the whole year of this, non stop,,,,, now that he won, the establishment flips 180 degrees promoting his proposals as a sure thing to invest in. The financial media is doing its job, and the buybacks continue, along with a good supply of foreign investment. “Times are good” tis the season, (strongest month for stocks). This smells funny.
    I for one am very suspicious of what the new year brings. But please note I’ve been suspicious for a long time
    Best to all of you

  5. Kevin from Reno

    Based upon your recommendations I have purchased Puts on both VRX and DB. So far I have lost money on the DEC DB Puts I had purchased several months ago. The other DB and VRX Puts which I am holding are not even close to their being profitable. Even if it is inevitable that a stock’s price trend will become largely negative, the timing of the demise of equities is tricky business. My fervent hope is that your predictions that DB and VRX’s respective stock prices are going to tank in next year comes to fruition. If not my listening to your advice will have become an expensive lesson.

  6. It would be more productive if realistic average investor ways to protect oneself from a market downturn were offered like a ETF or stocks to counter what you speak to here. Shorting stocks or bonds or their funds is unrealistic for the average lay investor, especially those with smaller portfolios.

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