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Category: Trending Topics

Are Rich Investors About to Get Crushed?

By John Del Vecchio

Dear JOHN,

No, I’m not talking about you, Rich Investor readers. I’m talking about individuals with huge stock positions.

These folks are neck-deep in the market. And while that might read as “confidence” to some, to me it reads “the other shoe is going to drop.”

We’re quickly closing in on the longest bull market in history, and it’s been a great ride.

Unfortunately, with investors and speculators leaning so heavily to one side, it could get nasty when the worm turns.

Merrill Lynch recent published a report indicating that its wealthiest clients’ cash positions as a percentage of their assets under management are at a low for this cycle.

Private clients (aka rich folks) hold their lowest cash position since just before the financial crisis.

You know, the one that turned a lot of 401(k)s into 201(k)s. Then, when the market bottomed, investors were flush with cash.

At exactly the wrong time.

Given their track record, I would consider private-client cash positions to be a contrary indicator.

That means it’s time to get cautious.

Since cash positions are at lows for the cycle, that means investors are, well, fully invested.

There’s little fresh capital waiting in the wings to buy stocks and boost prices. Everyone’s loaded to the gills.

But here’s where it gets even more disconcerting…

The beta, or the “juice” of their portfolios, has revisited the peak for this cycle and is at a much higher level than just before the 2008 crash.

A beta over 1.0 means that a portfolio is likely to make disproportionately large moves relative to the market.

Back in 2008, the beta of private clients’ top 20 stock holdings stood at about 0.85. Now it’s over 1.0.

That means you can expect losses to be magnified.

Additionally, everyone owns the same stocks because of substantial inflows into market index funds.

That means there will be nowhere to hide when the reckoning comes.

Market valuations are stretched. Volatility is low. Investors are fully loaded into aggressive stock positions. Now’s not the time to have your head in the sand, even if you like the view.

Good luck out there,

As appeared in the rich investor

LaCrock of Shit

By John Del Vecchio, Editor, Hidden Profits

Last week, National Beverage (Nasdaq: FIZZ) shocked the market by announcing it received a Securities and Exchange Commission (SEC) inquiry into a couple of “unique” financial metrics the company uses to measure sales performance.

National Beverage produces LaCroix seltzer water, the favored drink of Millennials and “influencers” the world over. The stock has been on fire as fizzy water gains share on traditional soda companies.

When the government asks for information, I find it wise to give it to them.

National Beverage refused, and the stock price sprung a leak.

This isn’t some random government meddling. The company’s actions raise serious concern.

On the surface, it’s a blazing hot market – which means any sign that growth may be slowing or unable to meet future expectations could send the stock into a tailspin.

Trust me, I know of which I speak.

I’ve spent the last 20 years focused on financial statement analysis and catching aggressive management teams with their hands in the cookie jar. The No. 1 red flag is when management messes around with revenue recognition.

Why?

Well, a modern company’s entire financial model flows from revenue on down. Revenue impacts profit margins, cash flow, and the strength of the balance sheet. When business is doing well and customers are eager for more product, there’s no incentive on the part of management to plays games with the top line.

Why mess with success?

That mostly happens when there’s a bump in the road and management isn’t open and honest about it.

That’s when they make stuff up.

And, to be clear, LaCroix’s metrics are made up. The company uses a figure called “velocity per outlet” and another one called “velocity per capita” to measure sales performance.

No one outside of the company knows what to do with those metrics.

That’s a problem, and it’s nothing new.

It probably won’t surprise you that companies do it all the time. The sweet spot for sour numbers is in the reporting of non-GAAP financial performance. GAAP is the acronym for “Generally Accepted Accounting Principles – you know, the legitimate stuff.

When it comes to non-GAAP figures, there’s a lot of leeway for management to create new metrics and, in doing so, report earnings in a sparkling light.

Warren Buffett calls these metrics “earnings before the bad stuff.”

FIZZ’s numbers might not be fraudulent. But management touted them enough to pique the curiosity of the SEC. When asked about what these velocity metrics measure, the company refused to answer and called them “secretive.”

Um, OK. We’re free to call them “bullshit.”

While “velocity per outlet” may look great on paper, using it in the first place is a solid red flag.

The stock has now recovered most of its losses. But that doesn’t mean the concerns have gone flat. In the end maybe, it’s nothing.

There’s a primary rule you should follow when it comes to stocks you own. It’s especially true for high-growth companies, where expectations might be in nosebleed territory.

Here it is…

Every company is guilty until proven innocent.

That might sound cynical. But that’s two decades of looking at these kinds of numbers talking.

Management must show you – not just tell you – with its financial disclosures that everything is fine. It must demonstrate there’s no reason to be concerned, that it’s presented a true financial performance and it’s sustainable.

This requires looking beyond the press release and digging deep.

One of the best things you can do for yourself each quarter is to analyze your portfolio’s quality of revenue recognition and look for red flags.

It’s the sort of work I do each month with my Hidden Profits recommendations. We’ve closed seven positions so far, with six winners averaging 35.35%. Our top winner’s at 56.16%.

Good luck out there,

John

As originally appeared in The Rich Investor.

Not Your Grandfather’s Robot Overlord

Hey John,

Recently, I wrote about how automation is increasingly becoming a part of our lives. I’m ultimately bullish on automation in cars, not so much for my beer-drinking experience.

Computers and robots have pervaded our lives at an ever-increasing rate – not always for the good. Regardless, the concept of automating just about everything is gaining steam.

Many predict that in just a few short years, much of the work we humans do will be performed instead by “artificial intelligence.”

A 2017 report by McKinsey Global Institute forecast that half of today’s work activities could be automated by 2055.

Buzzwords always crop up around the new – “disruptive” technologies, for instance.

But a particular phrase attached to the automation trend really bothers me.

“Surplus humans”…

That’s both sad and scary. It feels like our robot overlords are just steps off scene.

As machines clock in on the factory floor, humans get pushed aside.

The problem is humans have mortgages, energy bills, health insurance, student loan debt, food to buy, and other humans to rear.

Robots don’t.

My grandfather worked for General Motors. He had three children and a stay-at-home wife. He owned a home and a car. There was food on the table. Life was not extravagant. But his family was comfortable.

He and my grandmother, both products of the Great Depression, saved their money, too. In their later years, it led to a comfortable existence. They were self-sufficient.

Those days are over for most people.

It’s possible there’s too much of good thing. You don’t have to be a card-carrying communist to think that as humans get displaced, the risk of civil unrest rises.

Automation might, in fact, make the world a much more dangerous place.

Enter Amazon.

The company recently announced an initiative to allow humans to run a service of up to 40 vehicles and deliver packages from 75 Amazon stations. A relatively small $10,000 investment is all that’s required.

I’m sure the devil is in the details.

However, if a company has “surplus vehicles,” it might make sense to work with Amazon to generate revenue when they otherwise would be sitting in the parking lot not making money.

Score one for the humans!

Back to autonomous driving…

I’m bullish on the sector, ultimately. While I wouldn’t have much confidence in the technology today, it is improving rapidly. Over the long haul, we may be much safer and more productive with self-driving vehicles.

In the upcoming issue of Hidden Profits, I highlight a hiding-in-plain-sight stock with a unique technology that’s gaining traction in the space.

In fact, I once shorted the stock and made a substantial return as it cratered. Despite that dive, it’s still very much unloved by Wall Street.

Now, I like its prospects – for very different reasons than the rationale for my bearish bet a few years ago.

It just goes to show there’s no room for emotion in investing. And, when the facts change, change your mind.

A company can be a disaster waiting to happen one day, only to emerge as a leader in a new industry the next.

(Let’s just hope “leader” doesn’t turn into “we welcome our robot overlords.”)

Good investing,

John

As Appeared In The Rich Investor

New Regulations Guarantee a Market Thrashing

Dear John,

Here we go again!

Earlier this week, when I noted the market’s bad breadth suggests lower returns ahead, I mentioned that this is occurring at the same time regulations are getting rolled back.

Human nature is a funny thing.

It’s almost as if our behavior never changes, and we forget (or ignore) all the bad stuff that happened just a few years ago.

That’s why 100-year storms in the market happen every 10 years. Once it looks like we’re in the clear, we allow the same problems to punch us right in the face all over again.

In the meantime, we insist “this time it will be different.”

“This time” is never different.

Most of the regulatory rollback has been in the gutting of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
This was a key campaign promise that Donald Trump ran on during the presidential election.

Dodd-Frank was passed in 2010. It was aimed at limiting the damage from banks deemed “too big to fail.” It was also meant to protect consumers from having to bail those banks out again. There haven’t been any Lehman Brothers or Bear Stearns disasters since, so now must surely be the time to loosen up the rules, right?

Congress just voted to soften up the rules a bit to help out small and mid-sized banks. We’re talking banks with less than $250 billion in assets. They get a reprieve from rules they thought were expensive and onerous. These rules include stress tests, increased cash requirements, and more reporting, to name a few.

While most of the story has centered on Dodd-Frank, the devil’s is in the details.

The rollback of this legislation is just the first step in a broader effort to weaken the administrative state. It’s the next round of deregulation that could pose huge threats to our financial system.

The Federal Reserve is getting ready to ease up on rules that allow banks to use other people’s money – your money – to make huge, risky bets. That’s the real story. Not Dodd-Frank.

This type of trading works until it doesn’t. Then, the bankers walk away with millions of dollars, and Joe Sixpack gets caught holding the bag.

This is where the deregulation is headed next. It could do a doozy on the economy.

Banks have no business taking on massive leverage to make risky trades. The great investor Warren Buffett aptly calls these trades “financial weapons of mass destruction.”

There are plenty of rewards for traders when things go well, such as million-dollar bonuses, but few, if any, traders go to jail when they flush the financial system right down the toilet with risky bets.

We’ll end up right back where we started.

Actually, we’ll end up worse off in the end.

A major bank failure is practically assured. The market will implode with it. Trillions of dollars in bailouts will be given to folks that took excessive risk. It wasn’t fun the first time around, and it won’t be fun this time around.

Due to the massive Federal Reserve liquidity bubble created by low interest rates, the next bear market will be one for the history books.

Good luck out there,

John Del Vecchio

*Originally published in the Rich Investor

How to Deal With Bad Breadth

The U.S. markets are nearly back to all-time highs. Does that mean it’s time to pop the corks and celebrate?

Well, if you’re keeping track of market breadth, you’re probably still chilling the Moët & Chandon right now.

What is “market breadth,” you ask?

Think of it as the number of individual stocks that advance alongside broader market indexes like the S&P 500.

When the market is at new highs, “good breadth” means lots of individual stocks are hitting new highs all at the same time. Thousands of stocks should be hitting new highs on days when the indexes are doing the same. That’s a healthy market.

We want to see stocks move in the same direction. It makes everyone happy. (…So long as that direction is “up.”)

It’s also a sign of “good breadth” when equity indexes tank without a lot of individual stocks hitting new lows.

It means many stocks may have already bottomed and are set to turn back up. If your portfolio is holding up well amid market turmoil, chances are that breadth is healthy.

Bad market breadth is the opposite.

It’s bearish when the market is riding high on the strength of just a few stocks. It means stocks are weak, despite the indexes suggesting a healthy market. Once the overall market turns, it’s already been a nasty ride for the average stock.

Unfortunately for investors, that’s the situation we find ourselves in today.

A 10-week average of new highs versus new lows suggests that market breadth is at levels consistent with poor market returns.

By this measure, market breadth is at its worst level in nearly three years.

According to Ned Davis Research, when market breadth is at today’s levels (or worse), the annualized returns are -5.90%. This happens about 20% of the time, so it’s not all too often that we have this many stocks lagging the market. Walking into a 6% loss is a clear warning sign to hold off on allocating fresh capital to stocks.

One of the dangers to the market is that weakening market breadth is occurring as complacency creeps back into the market.

For example, the government is rolling back Dodd-Frank rules. You know, the rules designed to help prevent “too big to fail” situations that practically vaporized the worldwide economy for years.

Banks are also making plans to gear up proprietary trading. That’s the kind of trading that led to trillions of dollars in losses in the mortgage crisis.

I bring this up because the sense of complacency stems from the misconception that we’re finally out of the woods. After all, the markets are near their highs! What could go wrong?

Well, a lot.

The breadth of the market suggests plenty of stocks are already showing weakness. Put another way, there’s a good deal of rust forming under the hood of this historic bull market.

It may already be showing up in your portfolio. The market may be near new highs. But are the stocks in your portfolio keeping pace?

If not, don’t put good money after bad. The odds suggest lower stock prices until breadth begins to improve!

Good trading,

John

 

This post was originally published on the Rich Investor.

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