Archive for May, 2021

Orthodox Investor – The Angry Trade

The Angry Trade was inspired by a comment left by “Bob” at https://wolfstreet.com/2021/04/26/forget-2-inflation-with-margins-forcefully-squeezed-big-companies-are-raising-prices-and-point-at-massive-inflation-overshoot/#comments. The comment received many replies from other commenters. Bob wrote:

I’m angry. I’m completely despondent. I’ve missed this entire bubble market and have been sitting in cash. My entire life savings is being systematically destroyed and I have no idea what to do with my money. I’m ready to end my life if I end up being destroyed by this, but not before getting some justice against the criminals that have done this to me and other prudent people that “followed the rules”. There’s nothing to look forward to in this country. I can barely be bothered to work anymore. What for?

Part 1

I originally posted part 1 of The Angry Trade at https://wolfstreet.com/2021/04/29/its-a-perfect-time-to-sell-a-home-to-fomo-driven-buyers/:

It’s my personal belief that only those who are ridiculously overlevered will be allowed to fail, so the logical thing to do is to use maximum leverage while making sure you’re slightly less levered than the most reckless speculators. People who are sitting in cash have been taken to the cleaners by Jerome Powell’s monetary policy. It’s easy for those who are invested in risk assets to say “just do what I do and you’ll be fine”, but that ignores the fact risk assets are only good to hold if you had a good entry point. What do you do if you missed the speculative melt-up? What if assets prices never come down?

I’m going to present what I call “The Angry Trade” to appeal to those who have been sitting in too much cash and want to get back at Powell and those who cheer him on. Looking at the chart history, it’s too risky to bank on a decline in stocks or real estate. I have no confidence in my own ability to predict them. The trade I’m going to propose is to go long 30 year treasuries (10 or 20 year works too). In the unleveraged version, you are guaranteed to come out ahead compared to holding just cash, provided you wait long enough, and since treasuries tend to peak when risk assets bottom, it works for people who missed the rally and are waiting for asset prices to come down.

But the Angry Trade is to use leverage. The rationale is that we’ll win either way: Either the stock market keeps going up and yields remain low to sustain the bubble, or the stock market tanks and yields go lower in a flight to safety. In follow-up comments, I’ll go into more details.

Today, it’s looking like yields on the 10 year and 30 year are breaking out of a bull flag. The basic idea is to wait for for the 30 year to double top around 2.5% and use that as an entry point for a small initial position. The reason for starting with a small position is that the market may panic as inflation proves to be less transitory than Powell expected, causing a run toward 3%. The trade will involve futures contracts

Part 2

I originally published part 2 at https://wolfstreet.com/2021/04/30/wtf-charts-of-the-year-free-money-from-the-sky-stimmies-blow-out-consumer-income-and-spending-on-durable-goods/#comment-338558:

If we have reached peak stimulus, there is a possibility that treasury yields have already peaked. I don’t want to look like a fool suggesting a trade where I never pull the trigger to take an initial position. This brings me to:

The Angry Trade (Part 2)

Part 1 was posted in the comments section of the transcript for “It’s a Perfect Time to Sell a Home”. To recap, the Angry Trade is meant to put cash to work in an overvalued market where prudent investors are punished at the expense of leveraged speculators who are continually bailed out by the world’s central banks. The Angry Trade hopes for a crash in risk assets, but does not require it to be profitable.

In Part 1, I suggested waiting waiting for the 30 year yield to double-top at around 2.5%. That is the safer option, but I went ahead and went long treasuries at a yield of 2.3% as I will explain below.

An important aspect of The Angry Trade is getting paid to borrow money. This is accomplished by going long treasury futures contracts that trade in backwardation. The contracts expire 3 months apart, so they need to be rolled 4 times in a year to maintain the position. The backwardation effectively results in a positive carry. In other words, if interest rates remain constant, you are being paid to hold the position. This is largely thanks to other investors who want to short the treasuries and are willing to pay a counterparty to do so.

For those unfamiliar with futures trading, the thinkorswim application allows you to trade “paper money”. Your account is funded with fake money and you can trade like in a real account without risking anything, until you understand how it works.

There are four long-dated treasury contracts that are of interest. The Ultra Bond /UB contract can be thought of as having a 30 year duration. It has an $8000 margin requirement and for that money you speculate on treasuries with a notional value of around $185,000 at current prices, effectively giving you 23x leverage. The most actively traded contract is currently the June contract. The price difference between the June and the September contract is currently around $1650, which is similar to a 3.6% yield. However, the value of the contract decreases by more than a year’s worth of yield if the interest rate rises a mere 12 basis points in one year. It can easily rise that much in a single hour. Hypothetically, if the 30 year yield went back to where it was in 2018, you’d lose around $40,000.

The 30 year bond /ZB contract behaves more like a 20 year bond. It has a $4000 margin requirement and has a notional value of around $157,000 at current prices. Here the price difference between the June and September contract is around $1500, similar to a 3.8% yield. A 19 bps rise in the interest rates effectively wipes out a year’s worth of yield. (Currently the spread between the 20 year and 30 year yield is 10bps. The last time interest rates peaked around 2018, the spread was around 10bps as well. In 2018, the /UB traded in contango and I didn’t touch it.)

The 10 year Ultra Bond /TN behaves like a 10 year bond. It has a $3100 margin requirement and has a notional value of around $145,000. The price difference between the June and September contract is around $1300, similar to a 3.6% yield.

The 10 year Bond /ZN behaves like an 8 year bond. It has a $1700 margin requirement and has a notional value of around $132,000. The price difference between the June and September contract is around $800, similar to a 2.4% yield.

The actual specifications and mathematics underlying treasury futures is complicated and discussed at length in a downloadable CME publication. What I’ve covered is a more intuitive explanation.

Currently, I believe there is a risk that the 10 year yield will rise faster than the 20 or 30 year yield, so the initial trade is to go long /ZB at a price of 155’22”. That’s the exact price at the time I’m posting this and it has been near this price all morning today. If interest rates go back to 2018 levels, I expect to take a $20,000 loss on this contract. In part 3, I will discuss the strategy for doubling down on the trade as interest rates rise further.

Part 3

https://wolfstreet.com/2021/04/30/wtf-charts-of-the-year-free-money-from-the-sky-stimmies-blow-out-consumer-income-and-spending-on-durable-goods/#comment-338558:

It takes a lot of time and research to figure out the prospects of individual corporations and their stocks. I could never gain any meaningful competitive advantage playing that game, and the key to investing is to learn what you’re good at. With that in mind, I’ll continue discussing a trade for those who are overly invested in cash-like investments, and have little or no leverage in their personal portfolios.

The Angry Trade (Part 3)

In part 1, I introduced The Angry Trade for investors who have been cautious with their portfolios and watched in dismay as irresponsible gamblers get bailed out time and again. In part 2 (see comments section of “Free-Money Stimmies Blow Out Consumer Income”, I described how The Angry Trade involves getting paid for using leverage. In fact, it is perfect for those who currently hold CDs and want to put that money to use without necessarily making an early withdrawal. You can continue earning money on the CD while using the asset as a backstop for long-dated treasury futures contracts such as /ZB. With a long position in /ZB, you’ll earn over 3.5% in yield on over $150,000, and the good part is that you only need to liquidate some of your CDs if interest rates move against you. In the best case, you effectively earn double interest. If you don’t want to risk losing money, you can always cover the futures position at some point in the future and buy actual treasury bonds and wait 20 years for maturity. The Angry Trade can be tailored to create the exact level of risk you’re looking for.

As mentioned in part 2, I bought a /ZB contract at a price of 155’20/32. I expect to lose $2000 for every 10bps rise in interest rates in a 20 year bond. The most useful guide to predicting the future path of 10-30 year yields is a multi-decade chart. The yield goes up and down almost like clockwork in a downward channel. Arguably, the 30 year bull run in lower yields is approaching its end and it may seem foolhardy to press long treasuries (especially using leverage) having missed most of the bull run that could have turned us into gazillionaires already.

During the 2018 peak in interest rates, you had Jeffrey Gundlach as a contrarian indicator when he predicted 6% yields on the 10 year. That was my cue to implement The Angry Trade at the time. This time, I find myself mostly agreeing with what Gundlach says, and that’s concerning. He now thinks the Fed can control the yield curve. So what if Gundlach gets it wrong again and yields blow out?

I think it’s extremely unlikely that yields will exceed the 2018 highs. I’m almost certain that we’ll see a lower high. It would be wise to have enough funds accessible to survive a brief spike to 4% in the 30 year yield (as in a flash crash), but I don’t see how the financial system survives a sustained rise in long-term yields. Financial assets would get decimated. Even real assets such as real estate and tangible assets of corporations would plummet in value as they rely on cheap debt. The only thing I see doing well is precious metals because there would be nothing else left to invest in, nothing else left to trust. This would be the scenario when the Wallstreetsilver crowd’s prediction of the silver moonshot would come true. Make 100 times your money. The problem with buying silver now is that premiums are over 15%. However, platinum works just as well. If The Angry Trade fails completely, I’m willing to bet that platinum will explode higher. In part 4, I will delve deeper into constructing an overall portfolio and the overall investment philosophy that The Angry Trade is based on.

The recent peak in treasury yields resulted in a record oversold condition, so any meaningful spikes higher from here will likely meet resistance. With that in mind, the strategy for doubling down is straightforward: Buy 1 /ZB at 2.3% yield (30 year yield or TYX), buy 1 more at 2.5%, buy 2 more at 2.7%, buy 4 more at 2.9%, buy 2 more at 3.0% to go ALL IN for a total of 10 contracts. I set up GTC orders, since the market trades 23 hours a day, so I will most likely not be watching when the levels are hit. The faster and more unexpected the rise in yields is from here, the more aggressively I will go long (I can always reduce exposure on pullbacks). The slower and steadier the rise in yields, the more patient I will be.

Part 4

https://wolfstreet.com/2021/05/11/job-openings-explode-in-manufacturing-other-sectors-spike-to-record-overall-as-companies-struggle-to-hire-while-16-2-million-people-still-claim-unemployment-benefits/#comment-341450:

In parts 1, 2, and 3, I presented The Angry Trade as a way to profit the most from a major selloff in risk assets, but that is likely to be profitable even if risk assets never see a significant downturn. Part 3 is in the comment section of “Intel & TSMC on Chip Shortage…”. In part 4, I comment on overall portfolio construction.

Based on historical market patterns, a 5-15% drop in the S&P500 from current levels sometime this year is a probable event. The trough will likely coincide with a short-term trough in long yields, so we want to try to time the trough and sell a portion of treasuries at that point.

While the 30 year yield looks like it just had a clear break out of a bull flag, the bull flag on the 10 year yield still seems to be in the process of forming while the 10 year yield remain below 1.65%.

The overall trade is likely to take 1-2 years based on how long it has taken historically to go from peak to trough in long-term yields. The next action to take will be to triple down on the long position by buying more of the September ZB contract if it drops to 151’22/32. This roughly corresponds to a 30 year yield of 2.5% (20 year 2.4%). The initial purchase of one ZB contract occurred at a price of 153’22/32 (0.2% lower yield).

The orthodox view of investing is that what matters is relative performance. Investing is a competition. You need to be more worried about how much the rich have and how you can catch up with them. The reason is that the rich could theoretically buy up all tangible things in the world. Then they’d own everything, and you’d own nothing. As the rich are now getting richer at a faster and faster pace, the only chance to narrow the wealth gap with them is to buy things that they don’t already own. In this limited sense, the cryptocurrency boom is highly rational. You’re not gonna make progress buying unlevered real estate, a diversified stock portfolio, or unlevered fixed income products. The market cap of these investment classes is already large, so if you double your money, so do the wealthy people who are the owners of these assets today. The only real forward progress you can expect to make is to look for overlooked assets or go for broke using leverage.

Given the brainpower that is being deployed to outsmart everyone else and come out ahead in the game of investing, the most important competitive edge that a little guy can have (unless you have a special talent or special knowledge) is the ability to do nothing. Big money managers are forced to chase performance, or they will lose clients. The little guy can afford to be patient, sitting in cash until an opportunity presents itself.

The key lesson from financial market history is that various assets become absurdly cheap on a regular basis. There is wisdom in investing in many different things, but as an individual investor, you can afford to wait for good entry points. In late 2020, Jeffrey Gundlach did many interviews in which he suggested a simple portfolio model: invest 25% in cash, 25% in long-dated bonds, 25% in stocks and 25% in gold. Steven Van Metre, who quickly gained popularity on Youtube kept telling his followers that the long bond yield would go down when the 30 year yield was below 1.5%. It’s as if they are trying to lead the lambs to the slaughter. The 30 year yield had just dropped from a cyclical high of 3.5% to 1.5% when Gundlach and Van Metre started recommending 30 year bonds. That’s selling low and buying high.

The ideal portfolio is close to 0% invested in cash because we were able to buy things cheap and even a sharp selloff wouldn’t affect the profitability of our portfolio positions. Orthodox asset allocation depends entirely on what goes on sale. The market will tell us what to buy.

The goal of The Angry Trade is to achieve a 100% gain on idle cash in a 2-3 year time period and use the proceeds to buy whatever is cheap at the moment. However, if yields don’t rise enough to warrant a leveraged long position in treasuries, I will make no attempt to force these gains. I’ll take a 5% or 10% gain, if that’s all the market has to offer.

Part 5

(in progress)