Trade Alert: Be More Cautious As The Bubble’s Probably Popping

I often talk about that the main reason I write about my trades and investments is so that I can keep a record of my analysis over time.

One of the best moves I ever made for my career as a hedge fund manager and pundit was when I turned from bull to bear in 2007 after five years of having been riding what I called an “Echo Techo Bubble” from 2002 when I launched my first hedge fund to 2007 when I closed it at the top. I’d launched my tech-centric hedge fund in October 2002, exactly ten days before the Nasdaq finished a 75% crash from the dot com bubble top in 2000. I closed the hedge fund in October 2007 and took a job as a TV anchor explaining to my viewers that part of my motivation for taking the job was that I wanted to trade the stock market for a TV gig as the real estate crash was about to hit. I wanted to see my analysis from 2007 when I’d turned from bull to bear and eventually sold everything but Apple and Google even in my personal account. Here’s what I found (I added the bold type today for emphasis on those points):

“Every time I mention the possibility that we’re entering my ‘Echo Techo Bubble,’ I get at least one question that invariably goes something like this from the comments section of my blog today:

‘Always a great article, and thank you, Cody! Now. Sorry, but would you again give readers your meaning of ‘echo techo’? Thanks.’ — gldengoose

When the Great Tech Bubble of the late 1990s popped, we slowly but surely saw most everyone get bearish on tech. By October 2002 when the Nasdaq had dropped 75% (and when I happened to have launched my hedge fund, by the way), there was very little reason to believe that tech would ever shine again. Most pundits, traders and hedgies became permabears and promised the market wouldn’t bottom until most companies traded at a fraction of their book value. Some permabears like Fred Hickey never stopped arguing that. (Good write up on that topic today by Jeff Matthews countering the silly props Barron’s gave him this weekend.) But sure enough, the stock market bottomed and tech stocks rallied hard.

The Nasdaq put on double-digit gains in 2003 and 2004, and all those permabears had to figure out how to explain how they could have been so wrong. They started pointing to history and the fact that the popping of most bubbles, from the 1920s stock market to the railroad bubble in the late 1800s, is usually followed by another big run which most people called an ‘echo bubble.’ It became vogue for traders and pundits, including many on our own pages, to explain their wrongness by saying that the rally in the Nasdaq off the October 2002 and March 2003 lows was just another bubble about to be popped and that the Nasdaq wouldn’t really bottom until it went much lower. I told them often in these pages that they were wrong about us being in an ‘echo bubble.’

So in 2005 and 2006, as the Nasdaq continued to climb, as housing started to look toppish, as the ongoing and steady economic boom started to show some cracks, I began to ponder the possibility that we might be setting ourselves up for an outright ‘echo bubble’ in tech. With tech continuing to grow, a Vista cycle, pent up spending from the enterprise on tech, new applications and technologies all hitting and the Fed still looking to juice and/or cut rates at some point, there’s a good foundation for the possibility of this market really going bubblicious. I created the term ‘Echo Techo Bubble’ because I do think we need to be prepared for its possibility. Even if it’ll make those permabears finally right about something.“

Cody back in real-time 2021: We’ve just recently lived through another Echo Techo Bubble and if you run through the charts of most any crappy small cap tech stock, you’ll see that it looks like that bubble popped back earlier this year. Could the Kurzweil rate-of-change mean that stocks, even those stocks, run back into another bubble right away? Perhaps, but probably unlikely given that amount of trillions of dollars that the government has already pumped through the system in the last year which probably can’t be replicated for many years to come. It’s that juice from pumping the economy with trillions of fiat dollars, along with endless corporate welfare and protections from the government, that are mostly responsible for these bubbles and crashes we live through.

“I keep going back to this theme that you don’t want to be a buyer when things are this good, and I was just reminded of that theme by my mentor, ‘Phil’ let’s call him, who just stopped by my offices here in NYC before flying back to his home in Lexington. When I was working as a real estate appraiser in Ruidoso NM back during college in the early 1990s, Phil was running the bank in town and was scaling out of some of the oil companies (yes, entire companies) he’d bought in the late 1980s when oil had crashed. Er, make that he was scaling out of some of the oil companies he’d bought back during that 1980s crash, because Phil has correctly ridden the oil cycle from bottom to top three times in his life time. My hometown’s economy is dependent upon Texan oil money (yeah, things are booming in Ruidoso right now, you can imagine…real estate included), and he’d also taken over the bank during that down turn.

I just can’t get comfortable with these markets. I recognize that we might be entering my echo techo bubble, but that’s not helping me get comfortable putting money to work on the long side in this wild environment. It all seems sooo easy — just buy and shut up. From a longer-term perspective, I’m happy to stick with my longs and many long-dated calls. But also from a longer term perspective, I remember how sick it felt to buy when things were horrible. And I now feel sick about selling and shorting when things are great.

I’ve not participated as much in this ongoing rally as I’d like, and certainly that’s part of what I’m feeling sick about. But guys, I really don’t like the short term set up here. People can and do call the permabears idiots (I’ve certainly implied that permabear thinking is idiotic over the years!), but that doesn’t mean markets go straight up. And not being a permabear doesn’t mean you have to be levered up long at every moment when the Chinese market’s up 40% in the last few weeks. Yes, everybody’s favorite growth economy’s stock market is up 40% just since it crashed 9% a few weeks ago.

Phil’s mostly playing with horse races in Lexington these days. That’s because things are great. Cycles matter. With things as wild on the upside as they are here and with a nod to the cycles that matter in both the long term and the short run, I just outright bought some index puts to really get hedged.”

Cody back in real-time 2021: Cycles matter. Things are great right now with the broader indices at all-time highs and the economy re-opening. But the cycle will change and I think assets in the crypto and stock and most other major markets are already pricing in that re-opening. Too many people need cryptos and stocks to go up right now. We were loading up on stocks and crypto years ago when nobody wanted them and nobody needed them to go up. Better to buy when nobody wants ’em. That is not the case right now.

“I come in this morning to another crash in the Chinese stock market, and my main thought is how I still have too much long exposure in this environment. I pore over my sheets looking for things to sell, and found a little bit, but there are few changes that I actually want to make when I dig in.

I’ve spent the last few months patiently positioning myself for two very different outcomes for this market. I’ve scaled into a lot of long-dated calls in my favorite tech and media names, including Google, Riverbed Technology, Adobe  and News Corp. I also still own some Apple and Microsoft and most of the other names I’ve noted in these pages.

Given the impressive bull market, most of those calls are now in the money, and I’m likely to start rolling up some of those calls by selling the more valuable, higher-priced in-the-money calls for less valuable, lower-priced out-of-the-money calls again, as I’ve explained was my strategy in Microsoft during its big run over the last year. But most of my current batch of calls aren’t up enough to make the rolling-up process worth the expense of slippage and commissions.

I have sold the last of my Cisco calls today and will look to add some long-dated out-of-the-money calls in that name, perhaps some January 08 30s or something. But in the meantime, like I said, I want a little more cash and little less long exposure.

Speaking of being less long, I also still have a whole bunch of puts in the names I think have the most potential downside in the event that this market deflates, rather than inflates, as the domestic economy cools and the world’s excessively liquid financial markets turn to something a little less excessive.

Novellus, my biggest and favorite put position, remains in a steady downtrend (TA alert!), and the company’s update last week did nothing to counter the idea that their storage customers are cutting spending and that Novellus is losing share. I also still own some tech index puts that help me reduce my net long positioning.

I debated two rather adamant bulls on Fox News last Friday: our own Tracy Byrnes, as well as Jill Schlesinger. As they explained how beautiful the current environment is for the bulls, I countered that you should be taking 20% off the table right now, as you always want to be a seller when the environment is beautiful for the bulls.

My bottom line, though, even if you’re out and out bullish at this juncture, is that I’d rather focus on individual names and trends. The alternative is to bet that the momentum in the world’s financial markets will last long enough and extend with enough magnitude to make staying completely long worth the risk when we’re hitting all-time highs and the environment is so beautiful for the bulls. I’ll stick with the former.

Even if you love every single position and name on your sheets, I think you have to be reducing some of your long exposure here. Trim, sell and buy some puts. That’s what I’m doing.”

Cody back in real-time 2021: Doesn’t this line ring true right now: “My bottom line, though, even if you’re out and out bullish at this juncture, is that I’d rather focus on individual names and trends. The alternative is to bet that the momentum in the world’s financial markets will last long enough and extend with enough magnitude to make staying completely long worth the risk when we’re hitting all-time highs and the environment is so beautiful for the bulls.” The more I read my old analysis from 2007 the more I see parallels, mostly bad ones, to today’s markets.

“Subprime is disastrous, and housing’s bad. The consumer’s finally been fading, especially on the low income side of the spectrum. Yet the markets keep running, as commodities and even tech lead the way higher. Perhaps the right question is which cycle, the consumer or the enterprise, will trump the other.

The consumer’s clearly seen an inflection point in the cost of capital come and go, and the low income consumer has all but lost access to capital as the subprime meltdown has killed all the easy and often fraudulent means of tapping capital that the nationwide real estate frenzy/bubble had pushed on them as the writing on the wall become evident. Just as the car companies extended too much easy capital for too long to too many buyers in order to keep their boom going a few years ago, so too did housing, and to a much larger magnitude of dollars, of course. We saw the same cycle play out in recent years past, as the telecom equipment vendors started pushing easy and sometimes fraudulent financing terms to their customers when they started to see the writing on the wall of that bubble ending in 2000 and 2001.

It took several years for the telecom equipment world to stabilize after it collapsed upon itself. When these carriers finally started going bankrupt because the easy financing terms faded away, the telecom equipment guys who sold to those carriers started going bankrupt too. I used to write about ‘the race to zero revenues’ (Corvis won that race and decided to buy it’s biggest/only customer at that point), in that sector as the bubble was unwinding. The car companies, except for Toyota, are all still trying to figure out how to survive in the aftermath of their easy financing frenzy.

That easy credit creates artificial demand and that artificial demand creates virtuous cycles of higher prices and better business on the way up. But it comes back to bite hard as that artificial demand disappears, as is now happening in the real estate world.

Meanwhile of course, we’ve got tons of cash out there and private equity going nuts buying up assets and companies. We’ve got Microsoft paying tens of billions and 50x EBITDA for companies whose stocks were penny stocks and brand names the butt of jokes just five years ago. Enterprises are finally spending on technologies and the Vista upgrade cycle, slow motion as it is, is happening.

Just look around at these big cap tech stock that keep rallying to new all-time highs (even as the Nasdaq would have to double again to get back to its all time highs). We do have to ask ourselves again if we are headed into the echo techo bubble without pause? Everyday that Google or Apple or RIMM explode to new highs, everyday that the DJIA sets a new record, everyday that the markets enable companies to raise tens of billions of dollars of new capital, is another day we seem to setting up for some wild blow off tops down the road.

The upshot is that you want to stay long tech that sells into the hot areas of spending. That’s Internet video and related technologies with names like Adobe and Riverbed of course. And you want to stay away from the retailers. The paired trade themes remain very much intact.”

Cody back in real-time 2021: Those wild blow-off tops came and put a top into the markets that lasted for several years as it took a long time for stock prices to get back to their 2007 tops. Again, we probably have already seen a major bubble pop and top out in small cap tech stocks and it might take a little bit longer than most people expect for most of these small cap stocks to get back to those recent bubbled-up highs.

“It’s been an amazing week, an amazing year, an amazing five years and an amazing 25 years for the bulls, hasn’t it?  For all the handwringing and whining about:  inflation, the consumer being spent up, valuations being stretched, excesses from the bubble and whatever else the permabears tried to scare us with, the proof is in the pudding.   And that pudding’s full of bananas, ‘nilla wafers, market highs, record earnings and lots of other proof.

Now that said, wasn’t the best time to buy when unemployment in telecom was 30% (that was back in 2002; it’s back under 5% today), capital was scarce, the economic outlook was horrible, and war was pending (the market didn’t fully bottom until the day the US invaded Iraq, recall)?   I’m sticking with my echo-techo bubble calls, but I am already starting part of the rolling up process in names like Riverbed and Google where they rally’s been big. It’s been a helluva ride from those 2002 lows and I think caution remains key, especially since we’ve seen the credit cycle turn.

My ‘This won’t end well’ chart of the week:

Even better than the chart is this quote from the article, ‘Buyers and brokers across the city are confident that prices will only go up.’   Same is true of the stock market, right? Hoohah!

The handset market is all over the place.   Motorola remains horrible.   Stay far, far away from any major Motorola supplier like RFMD.   Still.  Samsung’s doing pretty darn great though, showing nearly 50% year over year growth.   Nokia’s new smart phones just don’t have any buzz, but the company’s products are innovative enough that its market share isn’t threatened.   Blackberry and Apple will have 5%, up from below 1% in 2007, combined marketshare one way or another within five years.   Smartphone marketshare will be nearly 20% within five years.

And with that, I’ll thank you for reading and head off to hit some tennis balls, take one more meeting, and then work most of the weekend.  I’ll be on Fox News this Sunday afternoon for a few hours if you’re near a TV.   See you Monday otherwise.”

Cody back in real-time 2021: It’s been an amazing year and an amazing 13 years and amazing 40 years for the bulls, hasn’t it? Since 1980, the markets have been on fire (in large part because of artificially low interest rates from the Fed along with corporate welfare and protections from the Republican Democrat Regime and endless borrowing and spending from that same Regime). Since 2010, the markets have been on fire. And since last March the markets have been on fire. Cycles happen though and a pullback, a real pullback in valuations is probably a good thing if we can get it as some sense of fear is necessary for capitalism to grow. Frankly, I’m worried that there’s a lot of fraud in the small cap stock market and probably some major cap fraud is going on out there too. And when that gets revealed, many companies won’t ever come back as their stocks head to $0.

“I’ve been very cautious and even, at times, bearish for most of the last couple months. I can tell from some of the feedback I got that I want to be clear that I’m certainly not turning into my favorite teasing target — a permabear. But long time readers know that I want to respect the economic and market cycles . And I am not at all comfortable being out and out bullish right now. I just haven’t thought that the stability and steadiness of this five year bull market was sustainable when people like Sumner Redstone say there’s more capital than they know what to do with out there and when private equity groups are selling the stakes in their own companies to the public.

And frankly, even as I think you can trade this market for the next few weeks by buying extreme weakness and selling extreme rallies, I think there’s too much risk for sudden extreme weakness and downside dislocations in the market for me to be anything but extremely cautious myself.

See, I’m seeing it as though the permabears finally have some real catalysts to take down this still ongoing wondrously steady economic boom we’ve been living through for the last half decade. Would it surprise you at all if I told you that I think they’re missing the entire dynamic that’s going to cause their long-promised and long-wrong downturn?

The hundreds of billions of dollars in variable mortgages are going to be reset at (probably) higher rates in the next few years. I agree that rates are much more likely to to trend higher over the next few years, as the quarter century long decline in interest rates reverses to go higher again. I explained that in detail in the FT a few weeks ago here  and on Realmoney here .

See, I’m much more worried about the actual asset prices of those mortgages than about the interest on those mortgages. That’s because residential real estate is always valued on a relative basis using comparables of similar homes and properties. I worked as a registered residential real estate appraiser in college in New Mexico. And I know that when an appraiser puts together a valuation guess for a re-financing or a sell, he doesn’t go, ‘Oh, well these people are going to put 20% down (and/or not lever up too much on this loan) and they have great credit, so I won’t compare the value of this house to those houses that are being foreclosed because the gamblers who lived in them took out subprime, no check mortgages.’ All that excess demand inflated real estate prices. Now that excess demand is long gone and even normal demand is in serious decline.

No, see, we shouldn’t be worried about the mortgage resetting — we should be worried about the valuations of any lower priced real estate in the US. I mean, we already see prices collapsing in that sector. And see, all those properties priced ‘slightly’ above the lower priced/subprime/alt-A world are about to taking down in valuation big time too.

And we’re already seeing the ramifications of this mass-repricing of assets (and you thought it was a mass-repricing of ‘risk’! Ha, you gotta ‘flip it!’) Every investor wants to know her exposure to real estate and to make sure those assets are being priced right. As all the money managers of the world and their brokers updated the value of the subprime and Alt-A portfolios, marking those assets to market, investors are freezing their capital.

I expect there to be more waves of mass repricing of assets, causing more turmoil in the financial markets in the near term. And I expect the Fed to ‘bail’ out those financial markets and probably inflate my Echo Techo Bubble.

I’m not really a big fan of trying to game these types of macroeconomic forces. But I also recognize that the risk/reward for being long just isn’t very compelling for me right now. Stay cautious, stay vigilant, stay skeptical in the summer of 2007.”

Cody back in real-time 2021: The biggest threat to the economy right now is probably a massive repricing of assets like stocks and cryptos. Even with the recent pullbacks in cryptos and the small cap tech stocks, the charts for most of those assets are still parabolic from their levels one year, three years and five years ago. I am confident that we will get a better time to buy most stocks and most cryptos than May 2021 is presenting us with. Like I wrote in the summer of 2007, I think it’s going to be better to be cautious, vigilant and skeptical for the summer of 2021.

I watched a presentation for hedge funds who want to invest in bitcoin last week and the one thing that stood out more than anything else in the talk was that it was all the stuff I’d been saying eight years ago and five years ago and three years ago. They even said something about how they’d missed Apple, Google, Facebook, Tesla and Nvidia but that they weren’t going to miss bitcoin! Uhhhh. We still own all those stocks they missed and we also had bitcoin…at $100. Not at $50,000. Look, this is a hard business and I’m not dismissing anyone’s analysis. But I’m going to continue to try to get us into the Revolutions when nobody else is in them. Again, this is not that time.

Protecting our capital and our many gains is key for now. Long-time subscribers know that I have many times pounded the table when the opportunities to buy are there. This is not that time. I’m going to sell my Coinbase and take the small loss we have on it there. And I’m selling our DBA for a nice gain. I’m also selling all of my space stocks except for VACQ, SFTW and GNPK. I am excited to find us new opportunities at good prices with lots of 10x or more upside names in coming months in sectors like Artificial Intelligence, Virtual Reality and Space. So stay tuned.