Act Before the Panic

Posted On Feb 22, 2016 By Dave Gonigam

  • The return of “all you need is a pulse” mortgages
  • “Smart beta” ETFs and other buzzwords that will fuel the next market crisis
  • Six months after the Aug. 24 “flash crash”… will you be ready for the next one?
  • The investment angle everyone’s overlooking from a viral photo
  • The FBI vs. Apple: Did the feds screw up “accidentally on purpose”?
  • Crude rallies… How government never lets incompetence go to waste… “You can’t eat gold” taken to its logical conclusion… and more!

We can see the ads now — 3% down! No PMI!

No, this is not a flashback from 10 years ago: Bank of America is working with Fannie Mae and Freddie Mac to create a new mortgage “product” that would allow for down payments as low as 3%… and no private mortgage insurance, typically required for anything less than 20% down.

“That could make the new loans cheaper than those offered through the Federal Housing Administration, the government agency that has won big settlements from banks in recent years for what the lenders describe as minor errors,” says today’s Wall Street Journal. “Bank of America’s new mortgage cuts the FHA out of the process.”

Where there’s a will there’s a way! That’s the American entrepreneurial spirit!

The notion that it all might end in tears the way it did from 2007–09 wasn’t even broached in the Journal piece…

But EZ-credit mortgages are so 10 years ago: What about a more modern-day risk to the markets?

“These days,” CNBC obliges this morning, “there’s apparently an exchanged-traded fund for everyone.

“The proliferation of niche ETFs, which track a concentrated market segment, such as real estate or commodities, has given passive investors unprecedented power to make tactical plays with their portfolios.”

As you know, we’ve had ETFs on our mind in recent days, thanks to the warning siren David Stockman has been sounding. He believes ETFs will function as a “doomsday loop” during the next market panic: The market makers for ETFs will be forced to dump the underlying stocks, many of which are small and illiquid. That will drag down the indexes, forcing still more selling. And on it goes.

The CNBC story extols the virtues of ETFs that pursue certain strategies — “core and explore” or “active/passive,” for example.

But it’s “smart beta” ETFs that get all the buzz right now.

“Such strategies,” CNBC tells us, “seek to capture market inefficiencies by using metrics other than market capitalization — such as volatility, earnings, revenue, momentum or dividends — to weight the holdings within their fund.”

Right. Because studying, you know, individual companies for their earnings, revenue, free cash flow, return on capital and the like so you can “capture market inefficiencies” is so pathetically retro.

What the ETF industry sees as a plus is what David Stockman sees as an Achilles’ heel.

“Real long-term investors buy individual stocks after careful investigation and due diligence,” he said here last Thursday. In contrast, ETFs “are just a vehicle for momentum-based speculation. The punters and robo-machines that move in and out of them (often in lightning-fast trades) have no clue whatsoever as to the fundamentals of the underlying companies.”

The doomsday loop won’t be a one-day sort of event: “As the global economy and financial markets slide into the long, deflationary cycle ahead,” says David, “the hot money will flee sinking ETFs at an accelerating pace. At length, retail-level panic will ensue, causing a thundering implosion of the ETF sector.

“What lies ahead for retail investors is probably worse. That’s because ETFs inherently embody a liquidity mismatch. Almost invariably, the underlying stocks are not as liquid as the ETF shares that represent them.

“This means that retail investors may be faced with painful episodes in which ETF shares gap down violently to deep discounts relative to their net asset values. Accordingly, if shareholders have attempted to protect their portfolios with stop orders, they may be handed sharp losses. Or they may just panic and sell.”

As we mentioned last week, the “flash crash” experienced by many ETFs last Aug. 24 serves as a preview of coming attractions.

“In today’s markets,” David explains, “‘trading halts’ occur when a stock moves up or down too quickly relative to the trading range contained in market circuit breakers. Ordinarily, about 40 such trading halts occur each day, but during the Aug. 24 plunge, there were almost 1,300 such occurrences. And 78% involved ETFs, not individual stocks.

“This is crucial because ordinarily, only one-third of trading halts involve ETF shares. Stated in round numbers, there are ordinarily about 15 ETF trading halts per day, but on Aug. 24, that number soared to 1,000.”

And that’s how ETFs like the Vanguard Consumer Staples ETF (VDC) plunged 32% that morning… while its underlying index fell only 9%.

“After a few more such episodes during the unfolding bear market,” says David, “retail investors will become thoroughly disgusted with ETFs.”

We want you to be ready. That’s why David is hosting a live online workshop this Wednesday at 7:00 p.m. EST. It’ll be six months to the day since the ETF turmoil ripped through the market.

David will get you up to speed on the risks to your portfolio. And even more important, he’ll show you how to make a small fortune while everyone else’s hair is on fire.

We’re talking quadrupling your money by July. And that’s not an extreme claim: David’s unique trading strategy has already delivered average gains of 88%… in a holding time of a little over two months.

You can look in on this workshop at no cost, and with no obligation. All we ask is that you RSVP with your email address so we can make sure we have enough server capacity to meet demand. Here’s where to sign up.

To the markets… where, true to form this year, stocks and crude are kissin’ cousins.

A barrel of West Texas Intermediate is up nearly 6.5% as we write, trading at $31.55. The International Energy Agency is out this morning with a report projecting U.S. shale production will fall about 6.7% this year.

The stock market rally isn’t nearly as strong as crude’s… but the Dow has tacked on 200 points as we write, hovering near 16,600. The S&P 500 is up 1.3%, at 1,942.

That’s not too far from the key level of 1,945 worth watching in the days ahead, says Jonas Elmerraji of our trading desk. “From here, stocks are likely to retrace a bit,” he says, “before making a run for 1,945. If that 1,945 price level gets taken out, expect to see it coincide with breakouts in a lot of the individual stocks that make up the index.”

Elsewhere, it’s dollar up, gold down. Gold retested the $1,200 level overnight… but survived. At last check, the bid is $1,210.

The dollar index is up nearly three quarters of a percent, at 97.4 — owing in large part to a tumble in the British pound. Relative to the dollar, the pound sits near a seven-year low.

Over the weekend, British Prime Minister David Cameron followed through on a campaign promise and set a date of June 23 for a referendum on Britain’s continued membership in the European Union. Cameron wants Britain to stay in… but London’s voluble, mop-headed Mayor Boris Johnson immediately came out in favor of withdrawal. Could get interesting…

Nearly everyone’s overlooked the investment angle from this viral photo of Facebook CEO Mark Zuckerberg at the Mobile World Congress in Barcelona…

NicholarDebock.png

Or as the techy website The Verge put it, “a billionaire superman with a rictus grin, striding straight past human drones, tethered to machines and blinded to reality by blinking plastic masks.”

The funny thing is that the event was sponsored by Samsung… and the people in the crowd are wearing Samsung Gear VR headsets… while Facebook is coming out with its own VR headset, the Oculus Rift, next month.

We bring it up today by way of updating one of our team’s 2016 predictions. On Jan. 12, Ray Blanco said this would be the year for virtual reality. And the way to play it isn’t Facebook or Samsung or anything like that.

“There will be lots of headsets available from different makers,” Ray tells us now. But one company has a virtual monopoly on “providing the processing muscle for creating hyper-realistic virtual experiences.”

The Oculus Rift, for instance, will require a sophisticated graphics card. “When the Rift ships,” says Ray, “I expect to see lots of gamers upgrading their graphics cards to Oculus’ recommended standards. I don’t expect someone who just dropped $600 on a Rift headset to balk too much about ponying up the cash for a new high-end card.”

Ray’s pick in this space — first recommended in Technology Profits Confidential — is up 50% and still a buy.

Did the FBI screw up accidentally — or, as the saying goes, “accidentally on purpose”?

That’s the question we’re pondering in light of the latest developments with the feds’ attempt to get Apple to unlock an iPhone belonging to Syed Farook, one of the San Bernardino shooters from December.

Turns out the phone became locked when Farook’s iCloud password was reset — only hours after law enforcement recovered the phone. Reset by whom, you wonder? Farook’s employer, San Bernardino County — the phone’s owner — said it reset the password at the FBI’s request.

As Business Insider sums up, “If the county didn’t reset the password, Apple would have likely been able to access the backup contents as it has done in past investigations without creating a backdoor to break the iPhone’s encryption.”

So was this rank incompetence on the FBI’s part? Or a deliberate act, knowing once the phone was locked the feds would have a high-profile test case in their efforts to break Apple’s encryption?

The stakes are enormous, writes Julian Sanchez at Time — “not whether the federal government can read one dead terrorism suspect’s phone, but whether technology companies can be conscripted to undermine global trust in our computing devices. That’s a staggeringly high price to pay for any investigation.”

“The FBI might want to check with Homeland Security before they hack Apple,” a reader writes.

“Homeland Security thought it would be too invasive to look at the Facebook page of Syed Farook’s wife and accomplice, loaded with terrorist blather, before they issued a visa.

“Might be more helpful to put Apple to work cracking the code to unscramble the brains of the people at these agencies.”

The 5: Yep. “U.S. Visa Process Missed San Bernardino Wife’s Online Zealotry,” said a New York Times headline shortly after the massacre. A few weeks later, FBI chief James Comey — the one who has a Javert-like obsession with Apple and encryption — said the Facebook postings were private messages, not visible to the public. Truth or butt-covering? We’ll never know; her Facebook account is long gone now.

But you’re looking at it the wrong way. Even if the postings were public, it’s not a failure on Homeland Security’s part. It’s an opportunity for government to get bigger — new gun laws, more surveillance and so on.

The Patriot Act sat on a shelf at the Justice Department for years, waiting for the right moment to be introduced. That moment came a few weeks after the feds failed to notice a bunch of suspicious characters asking for instruction on how to fly planes but not how to land them. The answer to federal failures is always new agencies, more personnel, bigger budgets and more control.

Regarding David Stockman’s prediction of ETFs fueling the next market meltdown, a reader writes: “Does this include all types of ETFs? 

“Specifically, one of the investments identified in Jim Rickards’ book The Big Drop as a ‘barbell strategy’ safe investment is the Schwab US Dividend Equity ETF (SCHD).

“Is SCHD considered vulnerable in David’s scenario — and why (or why not)?”

The 5: Are you current on your Strategic Intelligence subscription? Jim and analyst Dan Amoss recommended selling SCHD on Jan. 11 because deflationary forces are too strong.

“If I understand the rationale of the ‘You can’t eat gold’ argument,” a reader weighs in on an ongoing topic, one should invest only in carrots, potatoes, squash, etc.

“One should NOT invest in cartridges, batteries, gasoline, a generator, etc.

“One also cannot eat stock certificates or cash.”

The 5: Doggone it, we’re getting hungry here…

Best regards,

Dave Gonigam
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