A Special Announcement and Market Update

Just wanted to share some exciting news and a quick market update. But first, I’d like to wish everybody a very Merry Christmas and a happy holidays! It means a lot to us here at MO that you’ve chosen to be apart of the MO tribe and for that, I want to extend to you our most sincere thanks and gratitude.

Now onto the exciting news…

Chris Dover is officially joining the MO team. If you’ve been in the Comm Center at all these last few months then you already know Chris. But for those of you who don’t, here’s a quick bio:

Chris is a Quant/Systems trader with over 19 years trading the markets and currently running his family office. A Former Marine, Government Contractor, a serial tech entrepreneur, Angel investor and lifetime student. Chris travels the world with his wife living out of a carry on bag, focusing on health and wellness, quality of life, running his trading systems and helping others achieve their goals of trading for a life.

Chris uses his focus on Quantitative Systems Trading to advise hedge funds, family offices and individual traders on building trading systems that achieve consistency and durability over time.

Chris brings a unique approach to markets, focusing on mindset, health and then finally, consistently profitable trading.

I couldn’t be more stoked to have Chris join the team. Not just because he’s a fellow Jarhead, but also because he’s an incredible trader who shares the Macro Ops passion for relentless learning, growth, and personal evolution.

We’ll be working out the details over the coming weeks on how Chris can best share his knowledge and experience with the group. But, things like a podcast and courses on theory/strategy in building trading systems are definitely in the works.

Our long-term goal at MO is to build a small team of 4-6 traders who are some of the best in their respective niches. This is kind of the old-school macro fund model where a team that includes a classical chartist, a fundamental value investor, a currency specialist, a systems/algo trader and so on…

There are a number of benefits to this approach from a portfolio management standpoint. One is that you get strategy diversification. Various strategies excel in different market regimes and you can tilt-weight your portfolio and focus on the strategies that best align with the current regime.

Another benefit and this is more specific to MO as a group, is that everybody is different and we all need to adopt trading strategies that fit our personality. This is key, because what works for me, likely won’t work exactly for you. That’s why the whole idea of your typical market newsletter which just gives you buy and sell signals is bunk.

Ultimately, everybody’s long-term success in markets comes down to their ability to consistently execute a trading strategy with a definable edge. And if one doesn’t fully understand their system, their edge, or if their approach isn’t aligned with their personality, then there’s zero chance of them executing consistently and they will inevitably fail.

This is why we spend just as much time discussing mental models and theory as we do covering markets and trade setups. We want to give everybody the tools with which you can mix and match and shape to make your own, in a system and framework that works for you.

We plan to do much much more of this. And bringing Chris on the team is going to significantly increase our bandwidth and allow for more of this sharing of ideas and theory.

In the end, we’re focused on rapid personal evolution. Not just in trading but in every area of our lives (health, fitness, meaningful relationships, and helping others), since success and growth in one area tends to overflow and permeate the next. And trading markets may be the best game in the world (I certainly think so) but it’s still just a game, albeit a serious one.

We’ll be looking to further grow our team over the next 12-months. A number of you have reached out in the past, looking to work with us. The timing wasn’t right then but if you’re interested, please shoot us an email and connect. We’re looking for right fits, experienced traders who are maniacally devoted to Learning, Sharing, and Evolving.

Now onto markets!

This is the best explanation I’ve heard as to what’s driving this slow drip selloff in markets. It mirrors what I’ve been hearing from the fund managers I talk with (h/t to @InsiderBuySS). The following is from Kuppy’s blog Adventures In Capitalism (emphasis by me).

Moving to small caps; I’ve been involved in this sector for nearly two decades. I can only think of two other times where I have seen so much pain and frustration amongst my small cap friends. That would be the 2008 to 2009 period and to a lesser extent during the first few months of 2016. I am stunned at how many high-quality businesses trade for mid-single digit cash flow multiples—despite strong balance sheets. I’m even more stunned at how many slightly leveraged businesses trade at low single digit cash flow multiples. It’s outright insane how many companies trade for massive discounts to NAV. Take a look at shipping for instance—you have dozens of companies where you can liquidate the fleet and double your money based on current vessel values. This is despite the fact that charter rates are up and values are increasing. Of course, this still doesn’t quite compare to anything exposed to the energy sector. These things are being given away as dozens of energy funds liquidate and sell everything they own. You could say that some of these businesses are challenged—they aren’t all challenged. Moreover, they shouldn’t all be declining by a few percent a day—with hardly an up day.

What is going on? You are witnessing a massive culling of the hedge fund industry as hundreds of funds are liquidated and thousands more get sizable redemptions. Many of these funds own the same companies—the outcasts from the indexed world, the cheap, the unloved; the same stocks that many other hedge fund managers own. With the hedge fund industry going in reverse, there is suddenly no natural buyer for what must be sold. As a result, you are seeing waves of forced sell orders and few buyers. It is creating rather insane bargains all around.

Like all trends, this one too will end. If your fund is facing a year-end redemption, you need cash in hand by December 31 and you probably finish selling a few days before then. Therefore, at most, there’s 9 ½ days left to make sales. It may get even uglier—it may not. No one knows how to time this. What I suspect, is that the pain will finally abate in two weeks. Or at least the forced selling pain will be done. If you look at Q4, despite only a small drop in the S&P, it has been one of the most painful that my friends or I can remember. There are lots of guys down 20% to 30% this quarter and suddenly forced to de-lever further, to get their risk ratios in order. This sort of pain and indiscriminate selling creates lots of opportunities.

Hedge funds have been getting slaughtered this year. The back and forth chop of the market has essentially taken a sickle to the bloated money management space. This is a good thing for us active traders and was kind of inevitable. There’s just too many money managers all crowding into the same damn trades.

Anyways, this hedge fund killing field, as Loeb put it, is driving end of year redemptions which means forced selling of positions. The Russell small-cap index is now down -27% on the year, with many good individual names I track down 40, 50, 60%+.

Anytime there is forced selling in the market, opportunities are created. This time is no different. I expect this grinding persistent selloff to abate sometime in the next week or two, as it looks like we’re seeing that total sentiment capitulation event that we’ve been waiting on.

Sentiment is nearing outright ridiculous levels…

The equity risk premium (difference in earnings yield versus treasury yields) via Sentiment Trader is now 4 standard deviations below average. This is extreme…

According to SentimentTrader when the ERP Z-score is below -2, the annualized return shot up to 40.1%.

According to the latest BofAML Fund Manager’s Survey, money managers continue to hold large amounts of cash. This is NOT something you see at the top.

And then here’s how every quarter performed following a 10%+ down quarter post-WWII via Bespoke Investments.

The market is setting up for a MAJOR buying opportunity. There’s likely a bit more pain ahead in the short-term but I think a bottom is near. Our puts in NVDA, BABA, TSLA, as well as our DAX short and long bond / long VIX position is hedging us well. We’ll look to take profits on a number of these trades in the week(s) ahead.

I’ll be putting out my stock shopping list this weekend. I haven’t been this excited for deals in a LONG TIME.

That’s all I’ve got for now. Shoot me an email or hit me up in the CC if you’ve got a question.

Enjoy the closed markets tomorrow and we’ll be back in the saddle on Wednesday!