Gotten shorter

Got a lot shorter yesterday.  I think the market falls this quarter.  This is the max short I'm willing to go.

I moved a pile of cash into my IB account, so I have some leeway in case the market moves against me (ie: my longs go down and my shorts go up).  Risk Management means "try not to die".

Edit: Jan 13th: Went another 2% short, couldn't resist.

Lessons Learned Trading Bear Markets

Trading bear markets is tough.  This post is about me finding a strategy to short bear markets, in a timeframe suitable for me.

My original plan was to simply short and hold into the depths of the bear market.

I had not counted on how sharp the bear market rallies would be:

Source: Wifey

I haven't covered my shorts, and I added to them last week.  But the last vicious bear market rally has given me some sleepless nights.  My shorts moved from a 70K profit to a 20K loss in 2 months!  I learned that prune juice helps constipation.

My timing wasn't great.  The chart below are my shorts (pink arrows) and coverings (blue arrows):

I can't trade day-to-day in the short term.  And its uncomfortable hodling shorts for the long term.  So I need to trade in the medium term - around the bear market rallies.  How can I do this when bear market rallies are unpredictable?

• Simply wait for the BMRs to occur, and as they do, add more.  Add a little at a 5% rally, more at 10%, more at 15% and some at 20%.
• If the BMR doesn't occur, don't short.  Take the attitude that I'll short if the market gives me the opportunity, but I don't have to.  I always have the choice to happily sit in my dividend stocks and cash, waiting for valuations to go low enough or for the macro outlook to change.  We get the worst results when we feel compelled to do something.
• Take some profits when it feels great.  When the market has dropped like a rock for several weeks, your profits are exploding night-by-night, and you are the king of the world...take some profit - maybe 1/3rd or half of my short positions.  I guess everyone learns this instinctively as they trade.
• Don't look at my percentage allocation (eg: shorts vs longs).  Successful short positions shrink, so at the bottom of a crash, they'll be small positions, just when I should be covering (making them even smaller).  Don't have a "target allocation".

We may be halfway through the bear market now.  As we get closer to its end, hodling shorts becomes a really bad idea.   I need to trade around the bear market rallies.  And start taking profits.  Wait for the next leg down...

With the last few days drop, my shorts are now profitable again.

Maybe this bear market rally ended last week:

Source: Keith McCollough

China reopening, oil, and doing nothing

I think China is reopening.  Rising cases occur when you reopen:

But official deaths have not gone up.  A quick google search shows a median of 18 days to die from covid, so we should know the death rate by now.  The latest numbers have 1 covid death yesterday:

Source: Worldometers.com

There's 2 risks to the reopening:

• China numbers are bullshit, so no one knows what the real hospitalisation/death rates are.  Low level officials will make up whatever numbers they think are desired.  And I'm sure no one reports bad news to Xi.
• Everything depends Xi.  He can reinstate zero-covid tomorrow.

We're getting a lot of confusing scenes out of China.  Protests, lockdowns and confusion.  It will be localised cycles of easing and tightening as they try to flatten the curve.  If they don't lock down soon, it will be too late, and they will have to let it spread.  So there's a small chance Xi imposes a harsh lockdown soon, and a bigger chance - growing larger by the day - that they just let it spread and try to slow it down.

My "China reopening play" is oil.  Zero-covid reduced demand by an estimated 0.5 to 1.5m bpd.  Long term I think oil goes up anyway, but China makes me buy it now.  Bought more CNQ and Equinor in the last 2 weeks, now its a 9% position (at buying price).  1% more to go.

Its a very oily portfolio: 10% in oil producers, plus another 35% in things correlated to oil (Gas pipelines, palm oil and LNG).

Also mechanically adding to my shorts as the S&P500 goes higher.  And the existing shorts are also growing bigger as the market gets higher; my shorts are now in the red:

Need to remind myself not to get too short, else the bear market rally will rip my face off.

Can't find anything to buy with the remaining 30% cash.  Despite a year-long bear market, stocks aren't cheap enough yet to catch falling knives.  I wait, either for things to get cheaper, or for the macro tide to turn so I can buy cyclicals like capex commodities.

Its hard, sitting in cash, foregoing dividend income, not going long or short.   I try to imagine myself as a multi-millionaire in the future, after the current bear market, recession and subsequent commodity bull.

Doing nothing is the hardest thing.

Added to My Shorts

Added a little to my shorts in the past 2 weeks:

My short position has also increased due to the bear market rally.  Will add a little more if it continues.  SPY is up 11% now, a 20% rally would be normal.  Wild swings in the market and the value of my short positions:

Still holding them.  At least till December.

Fundamentally, I'm not seeing anything to buy yet, except energy.  China/HK is out due to political risk.  Rising rates, a recession and an energy crisis fuck up lots of things.  Good quality companies are not yet cheap enough that I'd stick my hand out and catch a falling knife.

Sold Petrobras and Getting Shorter

Sold by Petrobras 1% position at a 20% loss, too much political risk.  We've had Biden question why Exxon is making 'more money than God', the UK apply a North Sea tax, and Queensland apply a coal tax.  There's a risk of a diesel shortage in Brazil in the coming weeks/months, and energy companies are a good scapegoat.  Sell it while its worth something.

Now 96% invested.  Most of the new cash is from dividends and salary.

Increased my short position like a broken record, now 37% short.

I think the market bounces here into the start of July.  The same as its done every other month:

Chart from: The Market Dog.  Its actually Q's not SPY, but close enough.

A 'normal' bear market rally can be 20% - we haven't had one yet.  'SPY is almost up 5% from previous lows last night, I'll add 4% to my shorts next week if it reaches that (3817).  Then another 4% again if it goes up 5% more (3999).  And again (4181).  Then stop.  If it follows the past pattern, the market rallies into Independence Day, before selling off again. Its as good a guess as any.

Quick Updates on shorts

A violent bear market rally started 3 days ago, just after I built a comfortable short position.  The S&P 500 is now up 11% from its lows.  Although my shorts are getting hammered, my longs are doing OK, so I don't feel much pain.

I still think its a bear market.  It is going to take more than a quarter to work off the stimulus excesses of 2021.  The rally's job now is to convince as many people as possible that its a bull market.

Bear market rallies of 20% are historically common.  I'm currently 33% short.  Aim to go up to 37% if we get a 20% rally in the S&P 500 (to 4572), and 40% if we get a 40% rally (very unlikely).  I don't think the duration or height of the rally can be predicted, so just guess based on history.

Increased My Short Positions

Been shorting the bounces for the past week, now am 15.5% short with all positions nicely profitable.  Still bearish.  The fed is tightening into a slowdown.  Like a train heading off a cliff with the fed pressing the accelerator.  

The market probably bounces next week, I'll load up on more shorts.  15.5% short is small compared to 98% long.

Theres a small chance the market crashes next week, if that happens I'll hold my shorts, not trade around them.  They are a hedge.

Real money in the markets is made by being long.  These shorts are just a trade, maybe 2-6 months, to help me survive until its time to go long again.

Going short

I think the market keeps correcting in the next 2 months.  Maybe 6-8 months.  Economic growth is slowing, the Fed is tightening, and the market internals are crap.  Should be at least as bad as Dec 2018.  Right now its like the market has run off a cliff, but hasn't dropped.

I added some shorts on Friday's open, which are now nicely profitable.  This market cycle is my first attempt at shorting.  This piece describes how I'm trying to do it.  A value investor trying to turn into a short seller.

How do professionals short?  Risk managing shorts is tough.

John Hempton at Bronte Capital described how they do it as fundamental long-term investors.  They search for fraud.  Like companies with mysteriously high margins, or where the products/numbers don't make sense in the real world, or ones run by previously fraudsters.  These stocks can go up several times on the way to zero - sometimes ten times  - so they manage risk with a lot of small positions.  Around 50-200 positions for a short book thats 50% of their longs.  They avoid heavily shorted stocks.  And continuously monitor positions to avoid gamma squeezes.  Its not possible for an individual investor.

Short-term traders risk manage by watching the screen all day, recognising when the position starts acting against them, and cutting their losses quickly.  They might be successful with a 2-to-1 failure rate, with failures typically cut a few hours after being placed, while successful shorts run for days.  I don't know how to trade, and I'm asleep most US market hours, so I can't do this.

Why am I going short?

I don't wanna sell my stocks because:

• We are living off the dividends (my salary gets added to my portfolio every month).
• Inflation should drop from 8% to maybe 3-4% this quarter.  Holding cash with 3-4% inflation, is still losing.
• The commodity producers I'm holding (oil, copper & palm oil) have not yet fallen with the market.  Some have wobbled a bit.  These stocks probably get hammered in the next few months.  But they might not.  I'm still bullish on commodities/inflation long term, selling them now to buy back later is a risk.  For oil, for example, there are good reasons why it may go higher in the next few months (starts at 10:22), 

So I'm shorting to hedge my longs.  So I can stay long for longer.

How am I doing it? 

First, I'm using Hedgeye's risk range and following The Macro Show to determine what and when to short.  Basically, they look at what has historically gone down in the current economic conditions, confirm that is it going down now, then look for times it is overbought to short it.  They trade a lot, far more frequently than I can, so I have to adapt their process for my needs.

So I've got to be more of a trader when shorting.  When I buy something, there are hundreds of reasons: the company has a moat, its undervalued, or management is god-like.  When I short, its because the price is going down.

Second, I'm only shorting ETFs or funds: index, country or sector funds.  Hedgeye's individual stock shorts are often too quick for me, sometimes covering on the same day.  And individual stocks can move too fast: better than expected (or less worse) earnings results can make them gap up.  Or maybe Musk decides to buy them over.

Third: I hope to hold these shorts for a few months, or until the market turns.  Won't be doing much trading in and out, since I'm not a good trader, even when I'm awake.

The main lesson I've learned is how fierce bear market rallies can be.  I shorted Q's in March.  QQQ had been dropping a while and was overbought, it was a good day to enter the short.  But it moved against me:

It was a 2% position, which was too big for a volatile instrument like QQQ.  Should have started with a 1/2 percent or 1% position, then added to it if it moved against me.  Need to keep my short positions smaller half the size of my longs, and remember that bear market rallies can rip your face off.

Right now my positions are:

• 98% invested in stocks (....the 2% cash is my last few month's salary).  Around 80% in low beta dividend payers, the remainder are commodity producers.
• 10% invested in Gold.  Yes, on margin.  Gold should go up when the market falls.  
• Offset by a total of -8.5% short positions.  Q's, Russel and Junk Bonds. Half these were added Friday.   May add more country shorts, eg: Korea, HK, Europe.

This piece is all I know about shorting.  If you've got this far, you'll realise I don't know much.  Its more a learning experience and probably too small to be a serious hedge.  Maybe it gives me some extra pocket money to buy more shares after the market has crashed.

Snap

Snapchat is an app that lets you send doodley pictures your friends.  Widely used by teens/millennials.  Its different from Facebook in that its private - you only send to your close friends, and pictures are removed after viewing.  Its a way to talk with around 20 or so of your friends, rather than to show off to the whole world.  70% of Snapchat users are female.

The Numbers

Snap has never been profitable:

• Revenue has been smaller than COGS for the last 2 years.  Let alone all the other costs.
• I've excluded stock compensation costs here.  Lets optimistically consider them "non-cash" or "one-off".

Snap is burning cash:

With 3.2bn cash on their balance sheet from their IPO, they can last another 4 years at their 2016 "burn rate".  The only good thing we can say is that cash burn remained steady in 1Q17.

The key for a company like this is to either:

• Increase its user base to gain critical mass by the network effect, so that they become attractive to advertisers.
• Or else, they may already have gained critical mass in the teen/millennial market, and look for a way to monetize it.

For the first way: their Daily Active Users (DAU) has risen spectacularly since 2014, but levelled out in 1Q17, sending the stock down 25%.

For the second, they have several ways of monetizing their experience (1) (2) (3) which look interesting:

• For their normal app: ads, lenses and geofilters.
• Stories: photos or short videos, with annotations, doodles and music.  Post them in your Stories section and they can be seen by all your friends for 24 hours.
• Spectacles: spectacles which can take 10s videos uploaded to snapchat.  They are pretty cool looking, not geeky like google glass.

We have not seen any meaningful increase in revenue in 1Q17 due to these.  Maybe we will later.

Competitors

Snap's competitor is Facebook, who tried to buy the company for 3bn in 2013 but was rejected.  Since then FB has directly competed with them by trying to make Snapchat clones (which failed) and outright copying their Stories functionality into Instagram.  This succeeded: Instagram Stories now has 200m users, more than Snapchat's 166m.

(Source: Business Insider)

FB wants to continue to dominate social media, and prevent (or buy out) any startup taking off.  SnapChat has an entrenched position in the highly desired teen market, which FB can't attack - no matter what new functionality FB comes up with, people will stick with an existing social network because their friends are on it.  But FB is preventing Snap from expanding.  So Snap either needs to monetize its existing user base before it bleeds to death, or find some way to completely re-invent the market - something completely different, like what the iPhone did to the mobile phone market.

My Short Bet

The story is put very simply here: 80% of Snap's free float has been locked up, but becomes tradable at the end of July till end August:

(Source: CNBC: heres why Snap shares bay be down in the dumps this summer)

I'm short: bought 22 SNAP Put options last night @ 2.18 each.  Strike $15, 19th Jan 2018 expiry.  Breakeven if Snap goes down to $12.82.  Total cost USD 4,815.75.  This trade has 100% downside (for me) and roughly 120% upside (if SNAP goes to $10).

Risks:

• The Q2 earnings release is due between the end July lockup expiry and end August one.  Snap may pull a rabbit out of their hat, e.g.: make more advertising deals, recount DAUs, or recognise some revenue.  Its possible that, since they know about the lockup time, they planned this and put all their bad news in the previous 1Q results (kitchen sink).
• This is a consensus trade - every man and his dog is short SNAP.  Any good news will cause a short squeeze.

This is a speculative trade, using 1% of my capital.  Might go to zero.

Overall, the best you could say about SNAP as a company is that its overvalued and theres a lot of growth built into the price.

References

Good look at Snap's strategy from Stratechery:

• https://stratechery.com/2015/old-fashioned-snapchat/
• https://stratechery.com/2016/the-audacity-of-copying-well/
• https://stratechery.com/2017/snaps-apple-strategy/