Shorting Palladium… Again

It’s not often that one gets an opportunity to execute the exact same trade based on the same investment thesis after closing out the initial trade profitably. But that is exactly what I am facing and decided to take advantage of by shorting Palladium last Friday at $802.

My first trade was initiated on March 27, 2015 at $742 per ounce and closed on November 25, 2015 for $540 per ounce. My rationale for that trade can be read here, so I won’t rehash anything that was stated in that post.

I will only add that we are closer to the mass production of electric vehicles, with the Chevy Bolt EV just released and the Tesla Model 3 coming out later this year. A drop-off in gasoline-powered car sales will reduce a major source of demand for palladium.

It’s interesting to note that the Palladium market is the only commodity that has remained resilient in the midst of a commodity bear market. The recent improvement in global growth has helped palladium to rally back close towards its mulit-year high price of just over $900/ounce.

But when (not if) China experiences another slow down, global growth will weaken and palladium prices will come under pressure, falling towards $500/ounce.

Selling Bank of America (NYSE: $BAC)

I have sold out of my Bank of America (NYSE; $BAC) position yesterday at the close for a 94% gain. It was one year ago that I purchased BAC after it sold off hard due to recessionary fears. I believed there would be no recession and a major, profitable, and under-leveraged bank selling for 80% of tangible book with an earnings yield of 11% was a slam dunk.

With close to a double in a year, the share price reflects a fair amount of optimism about BAC’s business. BAC is now selling for almost a 50% of premium to tangible book and 14x 2017 earnings which is expected to grow a strong 15% due to higher interest rates and less regulatory burden thanks to the Trump White House.

However, any kind of a hiccup from China’s economy, which I believe is a decent possibility in the next 12 months, and BAC could give up a lot of its recent gains. Therefore, I think holding BAC at current prices entails a fair amount of risk.

Why I Am Ambivalent About a Trump Presidency

Being just moments away from the release of results for the US Presidential election, I thought I would reflect on the importance of this election. Electing the president of the United States is always an important decision because the power that the winner is entrusted with can radically change the lives of billions of people across the world.

Therefore, although I am not an American, and cannot vote in this election, I have spent a lot of time examining both candidates to assess what impact each will have on geopolitics and the US economy, two areas that can impact my own life.

Ever since Hillary Clinton contested the New York Senate race in 2000, I always felt that she had an eye on the White House. After establishing herself as a First Lady who tackled public policy and had a central role during a presidency that oversaw an unprecedented economic boom and left the White House with the highest end-of-office approval rating of any US President since World War II, she seemed destined to be the first female president of the United States.

However, my view is that the Clinton presidency was not as successful as many believe and benefited greatly from demographics and the ultra loose monetary policies of the Greenspan Fed. Indeed, the US economy entered a recession in 2001 shortly after the Clintons left the White House.

I am also troubled by Hillary Clinton’s display of poor judgement in her role as US Senator when she voted for invasion of Iraq without evidence of weapons of mass destruction and again as Secretary of State when she used her private email server to communicate official business.

My view is that Hillary Clinton is a highly intelligent woman who is at times susceptible to making bad decisions. She is the stereotypical politician: makes false promises to get elected, and has many conflicts of interests with the business community. But she is also very experienced in public policy matters and has a track record of working with Republicans. The most likely result of a Clinton presidency is perhaps greater policy action than the Obama administration which failed to reach across the aisle.

Donald Trump, on the other hand, has seized on voter desire for significant policy change and a sentiment that the government establishment is not working for them. Trump is without a doubt a charismatic individual who knows how to brand himself. His straight-shooting  personality and radical ideas appeal to a significant number of voters who have become disenchanted by the false promises of politicians and have not benefited from US economic growth in recent decades.

His proposals of lower corporate taxes, greater infrastructure spending, and reduced regulations would lead to a pick-up in growth ( at the expense of higher government debt) and a rising stock market.

Unfortunately, the reasons for his popularity – the willingness to speak what’s on his mind and and his readiness to wear his emotions on his sleeve – are dangerous characteristics for a US President to exhibit. The President has to be willing to compromise and look past setbacks with an eye on the bigger picture. Donald Trump is known for not acting composed when confronted with personal and professional attacks that are par for the course during a US Presidency. In particular, I am worried about how he will handle geopolitical tensions.

The stock market understandably prefers Hillary Clinton because of the greater certainty with how she will perform as President. Although Trump is more of an unknown, if he can keep his emotions from influencing his judgements, than I think Trump can be a great President. Unfortunately, that is a big question mark.

Selling Alibaba Group Holding via Yahoo (NYSE:YHOO)

On Friday, I closed my position in Yahoo (NYSE:YHOO) at $41.85. I purchased the stock at the beginning of the year during the stock market selloff as a cheaper way of buying Alibaba (NYSE:BABA). At the time I bought Yahoo, China’s economic growth was slowing and investors ignored Alibaba as a play on Chinese e-commerce that could withstand, and perhaps benefit from a China slowdown as the economy shifts its reliance away from investment towards consumption.

After buying the stock, my hope was to see the Chinese economy begin the de-leveraging process while Alibaba maintains strong profit growth leading the market to award Alibaba a higher multiple for this decoupling.

Instead, the Chinese government responded to the economic slowdown in the same way it has in the past: credit-fueled infrastructure spending. Thus, the economy avoided a sharp downturn in exchange for more debt, a resumption in the real estate bubble in tier 1 cities and a deeper slowdown in the future. Alibaba’s valuation has risen from 22x 2017 earnings at the time of my purchase to 32x currently. I believe that once this latest stimulus wears off and China experiences another slowdown, Alibaba could get hit again.

Another reason for my sale is that the Yahoo user data breach that has been recently disclosed adds uncertainty to the Verizon deal. As a result, I am content with my 25% gain in less than a year and will look to redeploy capital.

India: The Standout Emerging Market (Part 1)

I am a long-term bull on India, However, I do have some concerns that make me cautious in the near to intermediate term. As a result, I currently only have a tiny position allocated to Indian stocks, but am ready to increase my position substantially upon a significant selloff or once my confidence increases that the Indian economy is about to accelerate.

History of Subpar Growth

Politics in the first half-century after Indian independence in 1947 was dominated by the Congress Party which had a socialist bent and looked towards the Soviet Union as an economic model to emulate. In the 1950s, steel, mining, water, telecommunications and electricity generation were effectively nationalized.

The Industries Act of 1951, which required all businesses to get licenses from the government before they could launch, expand or change their products, stifled innovation. The “licence raj” reigned. The government imposed import tariffs in the name of encouraging domestic production, and domestic firms were prohibited from opening foreign offices. Foreign investment dried up under stringent restrictions and lack of competition meant that Indian firms could survive with inefficient operations.

As a result, manufacturing was unable to be a driving force and the economy grew at a subpar rate of 3-4% while many other Asian economies boomed. Between 1950 and 1973, the Indian economy annually grew 3.7 percent, or 1.6 percent per capita. Japan’s economy grew 10 times faster and South Korea’s five times faster. China grew at a sustained 8 percent annual rate. All that began to change dramatically in 1991 with the dissolution of the Soviet Union and the realization that the capitalistic model was superior.

Economic Liberalization

In addition, India faced a severe balance of payments deficit in 1991, and could no longer rely on the Soviet Union for support. With no other option, the Congress-led government sought funds from the IMF in exchange for implementing policies that would open up the economy. Additional rounds of market-oriented reforms by later governments, helped to boost economic growth in the 1990s and 2000s. India’s massive low wage, English speaking, and technologically savvy labor force was well-suited to make India a global leader in the IT and BPO outsourcing industries and attracted much needed foreign direct investment.

Modi liberalization

Despite significant progress made by the different Congress governments over the years in freeing up the economy and boosting growth, there was a sense of disappointment with the pace of reforms, the many corruption scandals, and development which eluded the poor. For the 2014 general election, the National Democratic Alliance (NDA) named Narendra Modi who was chief minister of the Indian state of Gujarat, as its prime ministerial candidate against the Congress-led UPA government.

Narendra Modi stood for everything that the Congress Party and its four generations of leadership by the Gandhi family lacked: a track record of responsible development which saw Gujarat improve upon several human-development indicators; a history of strong leadership by running a small government and putting his foot down when officials were out of line; a squeaky clean image; and a rise from humble beginnings as a tea seller.

As a result, Narendra Modi delivered the most resounding electoral victory in 30 years. Indian stocks surges as excited investors were filled with the hope that Modi’s successful governance would be replicated at the national level.

However, two years into the Modi government, there is a feeling among some investors that Modi has underperformed by failing to pass key bills such as GST and land acquisition. However, I believe that there was excessive optimism about what Modi could immediately achieve given the political environment he was handed.

To become law, bills must pass both the lower house of Parliament, or the Lok Sabha, and the upper house, or Rajya Sabha. Members of the Lok Sabha are elected by adult citizens and they hold their seats for five years or until the body is dissolved by the President. Most of the members of the Rajya Sabha are indirectly elected by state and territorial legislatures. Members sit for staggered six-year terms, with one third of the members retiring every two years.

While the BJP does enjoy a majority in the lower house of Parliament due to its resounding 2014 election victory, it only has 55 seats out of 200 in the upper house, which means that the support of rival parties are necessary to pass bills. The BJP’s main rival, the Congress Party, is resisting many of the major proposed bills despite being in favour of them when it was in power. The Congress Party’s goal seems to be to prevent the BJP from achieving anything of substance while in power so that voters would view the Modi government as ineffective by the time of the 2019 elections.

However, the BJP’s seat share in the upper house is about to increase as a result of elections being held for a portion of its seats each year and due to the BJP’s electoral success at the state level in recent years. In fact, the BJP is due to overtake the Congress in seats later this year. Though still short of a majority, the BJP need only to garner support from a few small regional parties to pass bills currently being held up.

Once these major bills pass in the next year, the Indian economy’s potential growth level will rise, though the GST is expected to hinder growth in its initial two years. Moreover, Modi still remains popular, and according to a recent survey, is projected to win again in 2019. Several more years of a market friendly government will help to ensure that India achieves its potential of high single digit growth.

In my next post, I will examine the demographic dividend that India enjoys, changing leadership at the Reserve Bank of India, and Indian equity valuations.

BoJ Soon to Take Its Deflation Fight to Another Level

I believe Japan’s aggressive monetary policies will continue to reward those who invest in its stock market. To review, the first arrow of Japanese PM Shinzo Abe’s “three arrows” of economic policy, aggressive monetary easing, was implemented by BOJ governor Haruhiko Kuroda to eradicate Japan’s long-standing deflationary pressures. In April 2013, soon after Kuroda became Governor, the BOJ introduced “Qualitative and Quantitative Easing” (QQE) which has since been expanded. Currently, the BoJ is buying annually 80 trillion yen of JGBs, 90 billion yen of  JREITS, and 3.3 trillion yen of ETFs. The money printing has caused the Nikkei to rally by 45% and the yen to depreciate by 28% against the US dollar up to January of this year.

Nikkei Performance During 1st Arrow


On January 29th, the BOJ tried to provide additional monetary stimulus by applying negative interest rates to banks’ excess reserves so that banks would be motivated to lend. However, the move backfired as the Nikkei has fallen 4% since then while the S&P 500 rallied 9% and the yen strengthened by 8%. A likely explanation for this market reaction:

BofA noted that the policy of applying negative rates to banks’ excess reserves didn’t take effect until mid-February and trust banks began passing the cost on to fund management companies in mid-April. That spurred the management companies to pass the cost on to investors, which worked against the BOJ’s efforts to encourage portfolios to rebalance toward riskier assets, BofA noted.

Although, I am not certain that negative interest rates is such a couter-productive policy, the fact that the financial media has widely panned it will prevent central banks from moving further in that direction. As almost all central bankers believe, a prerequisite for a monetary measure being successful is confidence from the public that it will work. Given the market’s current aversion towards negative interest rates, the BoJ is unlikely to rely on it going forward.

Kuroda’s recent statement that the BOJ can still ease policy substantially, indicates that the BoJ is likely to lean on QQE going forward. I doubt that it will cause the yen to depreciate as it did during the past couple of years because, despite the BoJ’s massive money printing, Japan’s money supply growth lags the 5%+ growth seen in the US.

Japan M2 Growth

Conversely, the yen is unlikely to experience a major appreciation since the large number of speculators which have shorted the yen over the past 3 years have unwounded their positions. In fact, speculators are now net long the yen.

Yen SpeculatorsSource:

QQE could nonetheless boost equity valuations. I believe the BoJ will expand QQE this summer via increasing the rate of ETF purchases. At the current rate, the BOJ is running out of JGBs to buy and will own 50% of all outstanding government bonds by 2018. Also, the amount of current ETF buying ($3.3 trillion a year) pales in comparison to the 80 trillion yen of government bonds it purchases.

The increased demand for Japanese stocks resulting from BoJ buying, coupled with a low valuation of only 13.6x earnings could lead to decent though not spectacular returns. I have been long Japanese stocks while hedging yen depreciation; I intend to maintain the position, but will sell if there is a significant rally.

I’m Not Betting on Emerging Markets… Yet!

After topping out between 2008 and 2010, emerging markets have woefully underperformed the US. I remember at the top the extreme amount of optimism that investors had towards China and other developing economies, while the US was shunned.

Emerging Markets vs. S&P 500 Performance

I first expressed my bearishness on emerging markets in a blog post in early 2007 titled “Beware of Emerging Markets”. It turned out to be a correct stance. The $EEM ETF got cut in half in the next year during the financial crisis, and, although it recovered all its losses, is still trading at the same levels from the time of my blog post nine years earlier.

Emerging Markets Equity Returns

My bearishness stemmed from the massive credit-fueled mal-investments that were made during the early part of the last decade in emerging economies. This was caused by a series of events: first, China entered the WTO in 2001 with a cheap currency and a large, low-wage workforce that it utilized to manufacture goods cheaply for the world; second, Greenspan kept interest rates artificially low to counteract  the fallout from the bursting of the technology investment bubble; third, borrowed money poured into China setting off a fixed asset investment boom there; fourth, the industrialization of China drove a huge demand for energy and metals, creating a commodity bubble; and finally, most emerging economies, which are commodity producers, also boomed due to an inflow of capital into mining and related industries.

Emerging markets are now dealing with a commodity downturn, large US dollar-denominated debts, and weak global growth. Complicating problems is that the US is experiencing solid growth and the Fed is embarking on a rate hiking cycle. Whenever, the US appears to be a more attractive investment destination than emerging economies, capital will gravitate towards the US and cause a loss of reserves for emerging economies, thereby tightening financial conditions.

I find it hard to pinpoint when this pressure will abate for emerging markets. In my view, the US economy will remain in decent shape and interest rates will go higher in the next couple of years – all of which suggest that the US is still the better place to invest. That said, I am compelled by emerging markets’ equity valuations which are at the low end of their historical range.

Emerging Stock Market Forward PE Ratio

The price to book ratio conveys a similar message.

Emerging Markets Price to Book Valuation
Source: J.P. Morgan Asset Management Guide to the Markets, March 31, 2016

Earnings expectations have experienced a substantial decline and are reflecting a further deterioration in economic conditions.

EM Earnings Expectations
Source: (Left) J.P. Morgan Economic Research, J.P. Morgan Asset Management. External debt includes public and private debt. (Top right) MSCI, US Federal Reserve, J.P. Morgan Asset Management. (Bottom right) FactSet, MSCI, J.P. Morgan Asset Management. REER is real effective exchange rate.
Guide to the Markets – Europe. Data as of 31 March 2016.

Unlike nine years ago, when I wrote my initial bearish post on emerging markets, sentiment has reversed and investors are favoring the US over emerging markets. Coupled with cheap valuations, emerging markets may be a great long term buying opportunity. In fact, I have bought a tiny position in Brazilian and Indian stocks to motivate me to keep a close eye on those markets.

However, I am hesitant to commit a bigger position to emerging markets. My experience has taught me that bearish sentiment and cheap valuations can remain for a very long time. Often the trigger for starting a new bull market is the assertion of favorable economic and business conditions. Unfortunately, I do not see any evidence of that just yet.

Assessing the Current Rally

Since the February 11th bottom at 1810, the S&P 500 has rallied 14%. The market is now within 3% of an all-time high. Although the market could pullback in the short-term, the technicals of the rally lead me to believe that the February 11th bottom could hold.

As I mentioned previously, I do not believe that the selloffs we have seen over the last year were fundamentally justified. Although there has been extensive media coverage about a possible US recession, the economy continues to grow at around 2%. The economy probably would be growing faster if it were not for the plunge in capex spending in the energy sector. This negative effect should lessen in the coming quarters. Moreover, there are signs that the US manufacturing sector, which was hurt by the strong dollar and weak global economy, has bottomed.


The decline in corporate earnings has also been citied to justify the stock market’s troubles. However, even with the cut in earnings estimates the S&P 500 trades at 17.5 times forward earnings – a historically cheap valuation given the low interest rate environment. And if the US dollar continues to weaken and the oil price continues to increase, then earnings could surprise to the upside.

Instead, I attribute the market sell off to a bull market that lasted several years without a meaningful correction and overwhelming bullish sentiment. The decline in earnings coupled with the first Federal funds rate increase in nine years provided the catalyst for market turmoil.

Last year, market breadth provided a warning about an impending correction when it deteriorated as the S&P 500 remained near highs. The rebound at year-end was characterized by narrow breadth, which signaled a false rally and new lows were around the corner. Given how breadth has helped to forecast stock market moves, it is encouraging that the current rally has been broad-based.

NYSE Advance-Decline

NYSE New Highs

Although I am concerned that the financials have not performed better during this rally and the market is overbought, economic fundamentals and market breadth indicate that the lows have been seen for this correction and new highs could be forthcoming later this year.

Managing a Drawdown

I have been mostly on the right side in calling the stock market’s short term movements over my investing lifetime. Although accurately predicting the market’s short term gyrations is much more difficult than forecasting where the stock market will be in 5 years, I believe it is feasible with well-reasoned analysis which incorporates market sentiment, technical analysis, stock market history, macroeconomic fundamentals, valuation, and the simple view that markets are inherently cyclical.

After correctly predicting “a 5-15% multi-month correction to refresh the bull market” near the all-time high last year, I believed that the market’s ensuing selloff in the second half of 2015 was sufficient for washing out excessive optimism and reseting valuations. Thus, I did not see nor position my portfolio to withstand the market’s 10% drop year-to-date. In retrospect, I underestimated the impact that the Federal Reserve’s first rate hike in nine years would have on the market. It is now clear that the market needs more time to digest it and the relentless selling is to ensure that the pace of interest rate rises that the Fed is planning is slowed.

By being 90% invested in equities, with a heavy weighting in financials, my portfolio has suffered a meaningful 15% drawdown in 6 weeks. However, this is not my first experience dealing with losses. I have found that it is important to re-evaluate your original investment thesis, while giving close scrutiny to the arguments that are being put forth for justifying why your positions are going against you. If you determine that your initial analysis was faulty or did not incorporate important information, and you regret your current positioning, then it is necessary to cut losses and reposition your portfolio. On the other hand, if you believe your investment thesis is intact, then you need to be unemotional, hold your core positions and weather the storm.

I intend to follow the latter path. I see no evidence of a US economic recession – instead I think the current expansion accelerates – nor do I see any reason why a Chinese slowdown will impact the US in a meaningful way. Looking at my own stocks, rather than selling, I feel like buying more. For example, I take comfort in the fact that Citigroup ($C) is trading for 60% of liquidation value, while it is buying back stock and growing earnings.

I believe the stock market is closer to the bottom than the top. The 1998 Russian debt default and eurozone debt crisis of 2011 did not cause a US recession, but they did induce substantial stress in financial markets with 20% stock market corrections. It is possible that in a worst case scenario that the S&P 500 could also ultimately decline 20% from the highs, or fall to 1700. By having 10% of my portfolio in cash, using no margin and having invested capital which I have no immediate need for allows me to sleep well at night and ride out the correction, in case it deepens into a full-fledged bear market.


Buying Bank of America (NYSE: $BAC)

The relentless selloff in US bank stocks continued today as several of them hit new 52-week lows intraday before staging a strong rally into the close. I believe the selling is unjustified and decided to buy Bank of America ($BAC) at $12.66. The current market reminds me of the 2011 market when fears of a Eurozone breakup caused European bank stocks to plummet. US bank stocks also got hit hard due to fears of European debt holdings, a possible recession, and falling interest rates.

The fears turned out to be misguided as the Draghi-led ECB introduced LTRO and the US economy continued to expand, which led to a doubling of the KBW Bank Index ($BKX) within two years.

$BKX vs $TNX 2011-2016

Interestingly, interest rates continued to fall until 2012 before rising in 2013. However, the US 10-year yield now is at the the same level as in late 2011. The fact that the US banks have much higher share prices than 2011, shows that prices then were irrationally low and were pricing in more than low interest rates. Perhaps those low prices could be partly explained by forced technical selling. In any case, once it was clear that the US economy was not falling into a recession, it made little sense for bank stocks to be trading below tangible book value.

I believe the same realization will dawn on the market over the course of this year. Therefore, buying Bank of America at 80% of tangible book value represents compelling value, particularly if my expectation of the economy strengthening over the next couple of years plays out. Even if the Fed does not raise interest rates much, banks should benefit from higher credit growth and buying back stock at below tangible book value. I will track the performance of my Bank of America holding here.