Stock market is a "fully-fledged epic bubble" and will burst

[ATM]

mwstewart said:

I'm not an expert by any means, but I am largely out of equities at the moment - I want to see how the effects of inflation play out over the coming months.

Some companies can do well during inflation if they can increase prices without losing customers. I think the example given by Warren Buffet is a toll bridge company. If the bridge is already built and they are just taking fees from people using their asset. However a general market downturn can just drag everything down. I'd guess these toll bridge companies - if we can find them - are already over valued.

[ATM]

DonkeyApple said:

my preferred means of targeting alpha is to hold a blend of trackers and in a clear downturn to simply short them

Are we getting close to or already in a clear downturn yet?

Do you short to be net flat or net short?

[DonkeyApple]

ATM said:

DonkeyApple said:

my preferred means of targeting alpha is to hold a blend of trackers and in a clear downturn to simply short them

Are we getting close to or already in a clear downturn yet?

Do you short to be net flat or net short?

I'm never looking for big returns. My personal opinion which has probably formed from not being a gambler combining with spending the last 20 years sitting inside firms which have millions of gamblers on their books is that the quickest way to fail is to look for abnormal returns. Almost everyone fails when they do this and the very tiny number that don't are just randomly lucky.

So for me, I'm only looking for quite big trends and aiming to act on them with quite small amounts. If I get it wrong then I don't want this element of my investing to be blowing any holes in my core portfolio. The other aspect of this being that I'm a bloke and I do enjoy 'testing' myself, as in, I have a view and I'd like to act on it for that reward of being right but not with sums that could have a material impact.

In my mind I don't want to go over weight or to hedge by more than 20% and typically it's around 10%. So, for each £1m sitting in solid, boring global blue chips I might at any one time want no more than £200k total firepower so £10-40k cash. £10k margin will get you £200k exposure but you then want a nice buffer of cash for variation margin, although if your broker knows you and knows that you are investing not trading then if you use a traditional firm you don't get troubled by variation margin.

That cash sits at my OTC broker mostly doing noting. There have been years when either I've been too busy to focus or the markets haven't done anything that I felt was actionable and the money has done pretty much nothing other than represent a 5% cash element to the overall portfolio. But each year I do start selling on Sept 1st. The industry always talks about selling in May and Going Away but in my experience Autumn is when the magic always seems to happen. Probably because that's when everyone is in the office, all the summer events are over, the ski season hasn't begun, kids are back at school so everyone is in work at the same time and and pretending to be really busy and hugely important ahead of the bonus decisions. As a result of this behaviour happening in all industries it all has a tendency to go bang. . With this activity I never bang it on in one go bit scale in. In theory, I'm acting on short term macro trends where the short term element is sort of 3-12 months so plenty of time and zero need to take any big positional risk.

With the FTSE for example the index is one tenth the value of a futures contract so each point the index moves represents a £10 contract movement. In spread betting terms, £10 per point. If the FTSE is at 7,000 then a £7,000 position is £1/point. You start selling on Sept 1st but you know the ultimate end point which is the end of Oct and £200k short/million. 8 weeks which means adding a £25k short position each week, £4/point. I randomly set a Wednesday for this just because I don't like doing anything on Mondays or Fridays and if my earlier positions are under water then I don't add any more. The idea here is that I average in to a small position on a timed basis but governed ultimately by whether the earlier positions are correct. If they're wrong then I don't compound that.

I'll often then go long for the common Christmas rally and be a buyer from 1st Nov. Maybe just £2/point/million so that Max overweight would only be 10% of the portfolio value.

Every few years oil will give you the same opportunity. I've spoken about this one many times over the last 15 years on PH. Crude is a rigged market. It's a market that always wants to be at about $75. When it gets pumped heavily over that it will always come back down and vice versa. But you have to wait until it's started to move not just for risk mitigation but the contracts are more expensive to hold due to being shorter term futures contracts etc.

But most years now we have these big, macro events that shift markets in an ebb and flow. Whether it's been buying the dip, when Trump opened his mouth or this month fears over China growth, stock deliveries, the impending winter Covid outcome. I simply don't bother with 'emerging markets' or 'smaller companies' for elevated risk. I know nothing about them, I don't want to and I can get my risk via dirt cheap debt on the actual market I'm invested in and following.

What you can note from above is that £million portfolios are using spreadbets in tiny size and where the leverage is used so as to keep cash in the main portfolio not to gear up excessively. A £20k spreadbet account that does very little all year and when it does is just scaling in over two months at £2 to £10/point is something not seen by many spreadbet brokers. When someone usually puts £20k on account they then go banging in £200-£400k positions betting on the market randomly moving in their favour before they get margined out. Investing via spreadbets isn't pitched by IFAs because they aren't regulated to sell the product but also, in my experience, you generally won't find an IFA who knows what a spreadbet is although most of their clients understand it. They also don't tend to have the mindset to learn either, unlike their more mentally flexible and open minded customers who tend to get it instantly.

Incidentally, if the markets keep heading south in the run up to Christmas then I wouldn't close the shorts but just keep adding on the same basis. And you can always apply stops to your individual positions so that if there is a big govt announcement that spikes the market you just get your profits banked and go flat without having to be awake.

For me the spreadbet is the most powerful investment tool we UK investors have yet almost everyone just wastes it on gambling and getting losses that aren't tax offsetable.

[bmwmike]

So timing the market, basically? Isn't that a little more toward the gambling end of the gambling:investing spectrum?

[dimots]

But surely using spread betting is an incredibly risky way to 'invest' because you are playing against the house who set the spread and you can't ride out any significant downtrends without going bust.

[DonkeyApple]

bmwmike said:

So timing the market, basically? Isn't that a little more toward the gambling end of the gambling:investing spectrum?

There is obviously a timing element but you're dialling out the 'gambling' element via waiting to see the trend, using cost price averaging and operating in very small size. As such, it's an investment mechanism. Gambling elements would start to appear if you were to attempt to guess the trend in advance which is what most retail traders tend to do, go all in at a single point or take size. What you're doing instead is taking the typical investment protocol and condensing the time frame to fit the shorter term macro trends that tend to occur through a typical year.

On a separate matter I'd even argue that in this low debt cost modern environment where volatility is also higher it would be lower risk to run a permanent 10-20% gearing on a high quality blue chip portfolio than to run the historic way of adopting risk for greater growth by picking emerging markets or smaller company funds.

In the context of PH, I'd be far happier taking IM's PH Equity fund and gearing that 10% to obtain risk growth premium than buying a smaller cap fund or an emerging market one.

[bmwmike]

DonkeyApple said:

bmwmike said:

So timing the market, basically? Isn't that a little more toward the gambling end of the gambling:investing spectrum?

There is obviously a timing element but you're dialling out the 'gambling' element via waiting to see the trend, using cost price averaging and operating in very small size. As such, it's an investment mechanism. Gambling elements would start to appear if you were to attempt to guess the trend in advance which is what most retail traders tend to do, go all in at a single point or take size. What you're doing instead is taking the typical investment protocol and condensing the time frame to fit the shorter term macro trends that tend to occur through a typical year.

On a separate matter I'd even argue that in this low debt cost modern environment where volatility is also higher it would be lower risk to run a permanent 10-20% gearing on a high quality blue chip portfolio than to run the historic way of adopting risk for greater growth by picking emerging markets or smaller company funds.

In the context of PH, I'd be far happier taking IM's PH Equity fund and gearing that 10% to obtain risk growth premium than buying a smaller cap fund or an emerging market one.

Gotcha, thanks for the explanation.

So my only dabbling with gearing was to use ~10k left over from mortgage cash to buy amazon shares back when they were (iirc) around $700 a share. Sadly, i sold the lot at 2k thinking i'd done rather well, little did i know they'd run a lot further, but then the potential losses got too much to stomach. Is that even gearing? I definitely wasn't gambling as it worked out haha.

So how could i as a normal so and so take "IM's PH Equity fund and gearing that 10%" - presumably mortgage or personal loan not the best way, spread betting i'm a little familiar with, but not sure you can just spread bet on funds, or maybe you can..


Thanks!!

[DonkeyApple]

Yup, you could borrow separately but by using a spreadbet the borrowing is specific so you're only paying funding for the precise duration so would be cheaper. Plus the spreadbet being tax free means you have the same tax base as ones ISA or SIPP and the execution costs are very low. You can trade anything listed so ETFs and ITs are easy. PH Equity becomes a shade more complex as we'd need to replicate the fund using the underlying constituents but that's the traditional core of the OTC market so nothing complex.

Re single stock investments, they're more of a punt. You're risk, excluding leverage, is the action of going heavily over weight on a single entity.

Ironically, the joke in our industry is that the definition of an investment is a punt that's gone wrong. Ie our retail clients go heavily long hoping for a big gain very quickly but when that doesn't happen they'll just sit on it for months, even years just hoping to get their money back.

[NickCQ]

Given that the expected market return is > your funding cost plus you have the collateral to survive margin calls, have you ever run the numbers to see whether the return enhancement from this strategy is genuine 'alpha' or just 'leveraged beta'? To put it another way, wouldn't you make greater returns by running a higher leverage level through-the-cycle?

[DonkeyApple]

NickCQ said:

Given that the expected market return is > your funding cost plus you have the collateral to survive margin calls, have you ever run the numbers to see whether the return enhancement from this strategy is genuine 'alpha' or just 'leveraged beta'? To put it another way, wouldn't you make greater returns by running a higher leverage level through-the-cycle?

For me, beta is the return of an investment against a benchmark but as my core investment is those benchmarks, ie the global indices in the form of ETFs on them and I'm trading with or against those positions using the same instruments I wouldn't think of any excess return as being beta. Conversely, I think of alpha as being excess returns on a portfolio which is what I'm doing (aiming to do) by going over and under weight on the back of events through the year.

Margin variation risk is simply negated by the low position size, the fact that you're scaling in on the back of each successive position being in the money and your account being over funded. If a margin call is a genuine possibility then you've got an element wrong and are adopting too much risk/leverage.

As for simply running higher leverage on a portfolio on an ongoing basis, yup, frankly in the market we now operate in running an element of leverage ongoing is valid. The negative being that you'd need larger cash reserves to negate the lifting of stops and limits, so in reality you'd want a broker that charged a higher margin in the first instance but there's no incentive for them to do that which would take you away from spreadbets and to physical holdings where the funding tends to be dearer.

[NickCQ]

DonkeyApple said:

For me, beta is the return of an investment against a benchmark but as my core investment is those benchmarks, ie the global indices in the form of ETFs on them and I'm trading with or against those positions using the same instruments I wouldn't think of any excess return as being beta.

It gets a bit philosophical, but to me if leverage is the sole source of outperformance, there's no real outperformance on a risk-adjusted basis.

It's something LPs in our private equity funds ask us all the time - if you strip out the leverage and illiquidity premium, what value is the GP adding over public market strategies?

[NowWatchThisDrive]

I'm a long-term buy and hold investor with the occasional yearning for a quick play money punt on something markets/sports/politics-related. So although I have a couple of spreadbetting accounts for that, I can't say I'd want to use them for levered plays on anything particularly long-term or financially significant to me. Not comfortable with the counterparty risk against unhedged positions given some past high-profile failures, financing costs on the whole position not just the leverage, and their ability to just pull the leverage at the drop of a hat and leave you in a pickle (as IG did on a load of smallcap names earlier this year).

My mortgage is my favourite form of leverage. Cheap, tracks the base rate, offset so can dip in/out of it whenever, and there for the next 20 years with no hassle as long as I pay the interest every month. If only I could borrow more...

[DonkeyApple]

NowWatchThisDrive said:

I'm a long-term buy and hold investor with the occasional yearning for a quick play money punt on something markets/sports/politics-related. So although I have a couple of spreadbetting accounts for that, I can't say I'd want to use them for levered plays on anything particularly long-term or financially significant to me. Not comfortable with the counterparty risk against unhedged positions given some past high-profile failures, financing costs on the whole position not just the leverage, and their ability to just pull the leverage at the drop of a hat and leave you in a pickle (as IG did on a load of smallcap names earlier this year).

My mortgage is my favourite form of leverage. Cheap, tracks the base rate, offset so can dip in/out of it whenever, and there for the next 20 years with no hassle as long as I pay the interest every month. If only I could borrow more...

Luckily most of the shonky firms haven't been allowed spreadbet licenses, just CFD passports but you don't want to be using the pure online firms for proper attempts at making money.

Counter party risk is somewhat negated by FSCS coverage but also the fact that staid activity tends to get hedged. It's the forex, crypto, commode and small caps where the customers always lose where the bookmaker orientated firms operate and don't hedge.

We never liked small caps at IG and we swerved them as they are already high risk and far more trouble than they're worth. IG eventually gave up on offering them because the clearers pulled their lines and IG handled that it their typical fk you manner.

Financing is cheap and as the clearers charge on the whole nominal that gets passed on but of your holding indices then you're borrowing at 95% so paying on 100% is neither here nor there. It only mattered to high risk positions of higher margin such as those small caps but then those clients were high risk and very low revenue as they bought stuff that needed hedging because it was junk and then sat on their losses for months on end. Small caps were never good business but before GC and crypto it was where the punters got their fix. It's also pertinent to note that when using for investment the positions aren't naked but you've got them wholly covered by physical holdings 5-10 times larger, if not 20 times. Ie you've got a £1m pension or isa fund and your just running zero to £100k, maybe £200k tops outside of those wrappers. Most of the time you'd never be running more than aboit £50k per £1m at brief moments.

[Flooble]

"commode". Freudian slip?

[DonkeyApple]

Flooble said:

"commode". Freudian slip?

One of Apple's more accurate autocorrects at least.

[Derek Chevalier]

DonkeyApple said:

[ I simply don't bother with 'emerging markets' or 'smaller companies' for elevated risk.

It's surely more about diversification? If you pile all of your money into something that holds just large-cap developed market funds and this takes a tank (as it did post-dot com bubble), your drawdown is going to be worse.

[DonkeyApple]

Derek Chevalier said:

It's surely more about diversification? If you pile all of your money into something that holds just large-cap developed market funds and this takes a tank (as it did post-dot com bubble), your drawdown is going to be worse.

In terms of diversification, with the major global
Indices you pretty much have that covered by the immense range of businesses that are their constituents. And today, some of those constituents are far from developed anyway, many modern US constituents are still fledgling firms by some traditional metrics.

Emerging markets and smaller company stocks are horrible. For them to be a relevant factor in your balanced portfolio you need to go massively over weight into areas of the market most prone to evaporating. We can look at the dotcom sell off and see that major indices had become heavy in tech but you only need to go back a few years more to the bursting of the Asian Tiger where most local indices went negative to see which area you don't want excessive exposure to.

In simple terms, if you view the ftse100 v the FTSE 350 or all share you see quite quickly that the constituents outside the 100 are essentially irrelevant. In fact even within the 100 it's only about 10 stocks that are large enough to define any price movement. To get those smaller constituents to have any relevant impact on performance you need to increase their weighting massively.

If you weight them appropriately for their risk they have negligible relevance and there's probably a fair argument that if we get another dotcom style tech correction then emerging and small caps will get blown apart as all the VC funding is going to evaporate overnight.

Edited by DonkeyApple on Saturday 2nd October 17:15

[Derek Chevalier]

DonkeyApple said:

Derek Chevalier said:

It's surely more about diversification? If you pile all of your money into something that holds just large-cap developed market funds and this takes a tank (as it did post-dot com bubble), your drawdown is going to be worse.

In terms of diversification, with the major global
Indices you pretty much have that covered by the immense range of businesses that are their constituents. And today, some of those constituents are far from developed anyway, many modern US constituents are still fledgling firms by some traditional metrics.

Emerging markets and smaller company stocks are horrible. For them to be a relevant factor in your balanced portfolio you need to go massively over weight into areas of the market most prone to evaporating. We can look at the dotcom sell off and see that major indices had become heavy in tech but you only need to go back a few years more to the bursting of the Asian Tiger where most local indices went negative to see which area you don't want excessive exposure to.

In simple terms, if you view the ftse100 v the FTSE 350 or all share you see quite quickly that the constituents outside the 100 are essentially irrelevant. In fact even within the 100 it's only about 10 stocks that are large enough to define any price movement. To get those smaller constituents to have any relevant impact on performance you need to increase their weighting massively.

If you weight them appropriately for their risk they have negligible relevance and there's probably a fair argument that if we get another dotcom style tech correction then emerging and small caps will get blown apart as all the VC funding is going to evaporate overnight.

Edited by DonkeyApple on Saturday 2nd October 17:15

By global, I assume you mean Developed, and I take your point that it contains reasonable diversification, and you could also argue that with correlations increasing, especially during turbulent markets, that including EM is not necessary. However, historically, tilts towards EM (and also small companies) have generated a more sustainable income for a given pot, admittedly with the potential of more volatility, as not all sectors of the market tend to do badly for extended periods of time.

https://www.fa-mag.com/news/small-cap-withdrawal-m...

Going forwards, who knows, but if you look at the relative valuations of something like a developed market tracker (excluding small), it's around 2.5 times as expensive as an EM tracker on a P/E basis, with small-cap somewhere in between. Can the difference in relative valuations be justified......

[NowWatchThisDrive]

DonkeyApple said:

In terms of diversification, with the major global
Indices you pretty much have that covered by the immense range of businesses that are their constituents. And today, some of those constituents are far from developed anyway, many modern US constituents are still fledgling firms by some traditional metrics.

Emerging markets and smaller company stocks are horrible. For them to be a relevant factor in your balanced portfolio you need to go massively over weight into areas of the market most prone to evaporating. We can look at the dotcom sell off and see that major indices had become heavy in tech but you only need to go back a few years more to the bursting of the Asian Tiger where most local indices went negative to see which area you don't want excessive exposure to.

In simple terms, if you view the ftse100 v the FTSE 350 or all share you see quite quickly that the constituents outside the 100 are essentially irrelevant. In fact even within the 100 it's only about 10 stocks that are large enough to define any price movement. To get those smaller constituents to have any relevant impact on performance you need to increase their weighting massively.

If you weight them appropriately for their risk they have negligible relevance and there's probably a fair argument that if we get another dotcom style tech correction then emerging and small caps will get blown apart as all the VC funding is going to evaporate overnight.

Edited by DonkeyApple on Saturday 2nd October 17:15

Speaking as someone predominantly focused on small/midcaps I have to disagree with the blanket characterisation of them all as horrible! While there's an awful lot of dross especially on AIM that I wouldn't touch with a bargepole, there's a good number of quality, well-run businesses that generate solid cash and are worthy of serious consideration. Yes you have to put up with a bit more irrational volatility (I'm down 10% over the last 3wks while benchmark indices are more or less flat...) but if you're willing to really do the work, seek out great businesses to own in perpetuity and not fixate too much on macro + cycle noise then the outperformance is there to be had. The great thing about investing in smaller companies is you're fishing in a pond where you have a structural advantage over most institutional money, and it only takes a few big winners to truly change your life. Anyway, enough philosophical drum-banging from me...

On EMs esp Asia I broadly agree; I tend to steer clear as completely different business and regulatory frameworks, with abundant cultural/political factors that are well outside my circle of competence to understand. Also agreed on the FTSE100 being a rubbish index but that probably merits a thread on its own.

[DonkeyApple]

NowWatchThisDrive said:

Speaking as someone predominantly focused on small/midcaps I have to disagree with the blanket characterisation of them all as horrible! While there's an awful lot of dross especially on AIM that I wouldn't touch with a bargepole, there's a good number of quality, well-run businesses that generate solid cash and are worthy of serious consideration. Yes you have to put up with a bit more irrational volatility (I'm down 10% over the last 3wks while benchmark indices are more or less flat...) but if you're willing to really do the work, seek out great businesses to own in perpetuity and not fixate too much on macro + cycle noise then the outperformance is there to be had. The great thing about investing in smaller companies is you're fishing in a pond where you have a structural advantage over most institutional money, and it only takes a few big winners to truly change your life. Anyway, enough philosophical drum-banging from me...

On EMs esp Asia I broadly agree; I tend to steer clear as completely different business and regulatory frameworks, with abundant cultural/political factors that are well outside my circle of competence to understand. Also agreed on the FTSE100 being a rubbish index but that probably merits a thread on its own.

It's the amount of research and co tools required to even begin to dial out some of the risk on small caps. Most investors are taking positions in the hopes of a liquidity squeeze as opposed to an actual increase in the fundamentals, whether they realise they're doing this or not. You see this overwhelming addiction to RNS as opposed to audited accounts.

On top of that, the professionals involved tend to be the worst in the industry, or rather not remotely professional. The number of genuine small cap analysts in proper institutions is now tiny. It's simply not an area of the equity market that has any credible oversight today

My industry at the bottom end has massive crossover with the small cap industry because they are both built upon bullst and the end punter's addiction to gambling whether they realise it or not. Over my nearly 30 years of being in broking I've seen first hand the practices of this he small cap industry here and abroad. I remember when AIM first launched and the company I worked for back then launched some of the first listings all of which were frauds, just as most had been on OFRX one way or another and most are in some shape or form on crowed funding platforms. The people involved in pedalling small caps are horrendous. You get things like Beaufort Securities at one end and frankly, at the other Woodford. To me, Woodford is a great example of the toxicity of small caps when it starts to unravel because even if the underlying company is quality you find that there are no buyers so the stock has no value.

Woodford was and is a great stock picker who looked into every aspect and dirty corner of a small cap and invested in quality but what his downfall showed was something that has always existed but that many people, even professionals, never fully appreciated about small caps which was that none of that ever matters in a big event. To get returns you have to go smaller and smaller and take on more and more risk and ultimately, the fundamentals of the business play absolutely no role in the pricing during an event. I hey either get ramped up by a liquidity squeeze or the buyers simply evaporate and the equity is worth nothing despite absolutely nothing at all changing with the business itself.

so I simply don't see how a quality fund could be constructed out of listings which are illiquid so toxic with size risk, no credible third party oversight and where the market 'professionals' who do operate in this space have a remarkable tendency to be properly dodgy and mostly just door to door salesmen clothes in stripy nylon. And then to make that investment give any relevant returns as a share of your overall portfolio you need to go quite heavily overweight in then.

Small caps as far as I am concerned are fine if someone is spending enough time monitoring them and looking at the right things. For me, that would be looking for the listings being pumped by the most successful crooks But I wouldn't rush to think that the typical small cap fund manager is any kind of rocket scientist and nor would I want to be holding much in the way of funds where the price can deviate so significantly from the fundamentals.

Re the FTSE100, I quite like it. I think it's absence of tech has made it quite relevant and along with its yield at 3%+ and an underlying desire of the State to pump money into its constituents its possibly the closest thing to resembling a bond that exists anymore. . Bit I think the index is a good foil to things like the US indices.

Edited by DonkeyApple on Sunday 3rd October 09:13