Good morning,

With stocks showing some strain and negative undertows since the peak on March 1, the timing of potentially serious geopolitical events in Syria (by extension, Iran and Russia) and, now, in North Korea (China’s version of an American/Israeli alliance) couldn’t be a better cover for a Fed retreat from its hawkish tone on rates.

Let’s review the week in stocks, and then I’ll clarify the opening to this week’s newsletter in more detail.  

At the close of shortened week, all major stock averages declined, with bank stocks taking the brunt of the sell-off.  The performance this week is as follows:

DJIA -0.98%, S&P 500 -1.13%, NASDAQ -1.24%, Russell 2000 -1.42% and DJTA -2.53%.  

The BKX slid hard this week by -3.18%, with Deutsche Bank (DB) underperforming the BKX with a -3.65% drop this week.  Note, too, DB has again failed to close above its 52-week moving average (MA).  Watch this stock.

I also want to note that the major averages, DJIA, S&P 500 and NASDAQ broke below their respective 50-day MAs.  The Russell 2000 surprised me with its relatively modest drop this week of -1.42%.  

And the cold facts to this market include the DJTA, which closed down -2.53%, and which has traded below its 50-day MA for the 24th consecutive trading day.  The market cannot trade in this dichotomy for ever.  The other cold fact is, that the BKX has closed below its 50-day MA for the ninth consecutive trading day.  Because the BKX led stock on the way up following the US election, their leadership on the way down doesn’t warm me all over. 

But I did warn last week that the action in stocks of the previous week looked bad.  Every rally ended in a sell-off, if you remember.  And now that the DJIA, S&P 500 and NASDAQ have broken below their respective 50-day MAs, we’re on a mid-cycle sell signal this week.  

What does mid-cycle mean, you ask?  It means, although Dow Theory tells us the bull market is still intact, a correction signal has been triggered with both the DJIA and DJTA falling below their respective 50-day MAs.  But the rub is, with today’s aggressive intervention, the NY Fed might intervene to prop stocks up.

And the VIX, that’s being gamed, too.  As the VIX soared to 15.96 this week, the SKEW barely budged higher in comparison.  Isn’t that strange?  To me, not anymore.  We’re witnessing a managed market.

Okay, let me get back to clarifying my tantalizing opening to this week’s report.  I’m going to spend most of the first half of this report on some important stuff that relates directly to recent and startling geopolitical events of the past week, including the Fed, and the implications of the possibility of war breaking out for stocks and interest rates.  

I’ve been at this market business for long enough, and I’ve noticed too many timely and man-made catalysts since 2008 for herding traders into positions as means of maintaining credibility at the Fed.  This has been my observation, and a trend I’ve seen very clearly since the collapse of Lehman Brothers.

We all know the Fed lies, but the power it has by way of the printing press reinforces the illusion of control, and creates confusion among laypeople between cause and effect of monetary policy.  The Fed issues talking points to the investor masses in a way only Mandarins can appreciate.  And the crap being slung by the Fed for some years now has become ridiculous.  So, what does this have to do with today’s stock market?

As more macro economic data show the US economy may not support higher short-term interest rates, the Fed’s rosy outlook doesn’t jibe with deteriorating labor and consumer data.  In the past, the Fed has only once raised short-term interest rates when there was no meaningful labor cost rises running concurrently with miserable GDP growth rates.  The exception, arguably, was in 1937.  And that mistake had never been repeated.

In 1937, production drove US GDP.  Today, it’s consumer spending driving GDP.  If nearly 70% of the US GDP is supported by consumer spending, isn’t a peak in retail sales a warning sign that the consumer is tapped out?  And if that point is arguable, why is consumer credit outstripping spending?  This can only mean that aggregate household cash flow is negative.  

In other words, net credit increases have been used to sustain present day-to-day living standards.  I don’t remember the last time this has happened.  In the dog days of the 1970’s credit cards were not prevalent, and easy loans didn’t exist.   And to make matters worse, there is no help from stagnant wages.  The Fed reports stagnant wages.  

Wage growth fuels consumer spending, but there has not been any wage growth in the US economy.  And if the US economy is so good, why are loan defaults rising rapidly?  Again, this, too, has never happened during a rate-rising cycle at the Fed.

Look at the telltale signs.  Defaults on student loans are rising fast along with auto loan default rates.  And the Fed thinks the economy is heating up?  Barron’s notes:

The delinquency rate for subprime auto loans is at the highest level in at least seven years.

• Banks are pulling back, and newer players with looser lending standards are stepping in.
• Used vehicle prices are dropping sharply, as the market is flooded with off-lease vehicles.
• The percentage of trade-ins with negative equity is at an all-time high.

The bottom line is: the Fed must find an excuse to renege on its promise to raise rates three (or four) more times this year.  It’s become clear the US economy cannot support higher interest rates.  

But you may ask: what about San Francisco Federal Reserve Bank President John Williams’ comments on Tuesday?  For those who missed this interesting bit of news, Williams said to the German publication Borsen Zeitung.

We need to further raise our benchmark interest rate and bring it back to a normal level over this year and next year, and we should also begin to normalize our balance sheet toward the end of this year.

Three to four interest rate hikes seem appropriate this year.  It certainly makes sense that we position ourselves so that we are able to either pause or further increase toward the end of the year.

My response to the latest edition of the Fed’s perception management technique is: Williams is setting the stage for the Fed to change the language of its statements from hawkish ones as a way of juicing market sentiment that an easing cycle may be in the offing, instead.  All the Fed has to do is back off its narrative of priming the market for further rate rises, and the tactic may be viewed by stock traders as ‘dovish’, without the Fed actually lowering rates.  In essence, with a change in narrative, the Fed hopes the stock market may actually trade as if the Fed is worried about triggering a sell-off and is ready to ease.  

And as far as unwinding the Fed’s balance sheet, as Williams’ suggests, forget about that.  The Fed will never be able to sell its balance sheet at the level of interest rates needed to prevent the US budget from exploding.   And to finally complete the circle back to my opening statement, the White House’s military attacks offer a narrative for why a stock market correction could happen despite the Fed’s rosy outlook, allowing the Fed to ‘save face’ when it becomes necessary to reverse monetary policy.  But, the Fed, in my opinion, will wait for lower stock prices before changing its tune.  How low will the major averages have to retreat before the Fed steps in?  I don’t know, but I’m preparing for this most probable scenario.

And do you remember Warren Buffett’s comment in his interview with CNBC on February 27?  Buffett said stocks were not in bubble territory (the headline), but he also said stocks could “go down 20% tomorrow,” which was buried in the text.  I think Buffett added his warning of a 20% drop in stocks for the purpose of protecting his ego and what reputation he may have left, as he knows very well a growing possibility of traders giving up on the positive momentum of this nearly eight-year bull market could happen in a flash.   

But if you think about the entire interview, as I have, Buffett predicated his assessment of stock price levels by comparing stock prices with interest rates.  “If you buy a 10-year bond now, you are paying over 40-times earnings for something whose earnings can’t grow,” he explained.  “You know, you compare that to buying equities, good business, I don’t think there is any comparison.”

Translation and analysis: if interest rates become competition for stocks, watch out.  Suddenly, there will be a “comparison.”  At 26.14-times Shiller earnings for the S&P 500, a guaranteed nominal return on a US Treasury 10-year note of 3%, or more (Jeff Gundlach’s Maginot Line rate for when stocks tumble), would look mighty attractive to an institutional fund manager at the top of a business cycle.  Stocks would suffer.

Of course, in the interview Buffett doesn’t talk about his viewpoint about the level of interest rates.  His response would spill the beans.  Wouldn’t it?  But, Buffett instead said, “Measured against interest rates, stocks are actually on the cheap side.”  And added, “If interest rates were seven or eight percent, these (stock) prices would look exceptionally high.”

What about 4%, Warren?  What about 3%?

In short, if you read between the lines of the CNBC interview of February, Buffett actually said absolutely nothing, but the impression he made upon viewers of CNBC’s propaganda network is, that stocks are not expensive when compared to bond market yields.  That was the ‘takeaway’ of the Buffett interview, and the headlines that followed.

I hearken back to Buffett’s CNBC’s interview for a very good reason.  The absence of a discussion with Buffett about the level of interest rates is telling.  Lying through omission is still a lie.  And Buffett is as slick as they come.

So, if the Fed cannot allow the 10-year to rise above 3%, according to the bond king, Jeff Gundlach, then raising short-term interest rates would further flatten the yield curve and break the banking system and the US economy, as had happened in 2008.  And today, bank stocks are tumbling for a good reason.  The spread between the US Treasury 10-year note and two-year bill is barely above 100 basis points.  Banks don’t make money on that narrow of a spread.

In conclusion, the Fed desperately needs a good reason to reverse course on rates.  The White House may be helping the Fed take some steam out of equities prices, handing an excuse for the Fed to steepen the yield curve again while managing the 10-year rate from rising above 3%.  

The March minutes of the FOMC meeting revealed concern among some Fed presidents about the lofty levels of stock valuations.  Another stock crash would seal the fate of the Fed’s credibility, especially after Fed Chair Janet Yellen has repeatedly said everything at the Fed is going according to plan.  And don’t be deluded into thinking the Fed didn’t intentionally add this discussion about the concern about the level of stock prices during the March FOMC meeting.  I think the Fed wants stocks to trade in a range for a long time, if I had to make a guess.

So, who will be blamed for a steep correction in the stock market, of it happens?  Will it be the Fed, due to yet another screw up of monetary policy, or President Trump?  That question is an easy one.  Trump will get the blame.  And an attack on China’s pet ally and regional pariah, North Korea, is a perfect place to shake US stocks and herd traders back into driving the 10-year back toward 2% (as is happening now), and at the same time allow the Fed to save face by offering an excuse to stop raising rates and driving bank stocks into the gutter.

And maybe, too, with all the threats of bombing and nuclear responses from North Korea to bomb back, President Trump may get his lower US dollar, after all.  The rising gold price (breaking through all resistance this week) and plunging interest rates and spreads are telling me investors are beginning to hunker down.  

See Reuters article here about Trump’s viewpoint of the US dollar.

The recent trend reversals in stocks, interest rates, US dollar, and the dollar-gold price depends upon whether President Trump goes forward with his promise to put a stop to Kim Jong Il’s nuclear ambitions.  Will China help?  We’ll see on both fronts soon.  In the meantime, trade cautiously.  And if you like volatility, you may be in for some fun in the coming weeks.

If you want to trade on the scenario I’ve laid out, try buying the utility ETF (XLU) and selling the bank ETF (XLF) as a spread trade.  The idea is, scared money may drive down interest rates and raise utility stocks, while banks come back to earth from their post-election moonshot.  Others may want to sell the the S&P 500 and go long gold until my target dollar-gold price of $1,325 is reached.

I’ve been pretty hot lately with my suggestion to go long bonds.  And my prediction that the spread between the gold price and copper price would widen has scored pretty big, too.  Those trading the cash market made 12%, while those spreading the two assets in the futures market made 81%.  Congratulation to those who’ve emailed me this weekend.

Okay, let’s move on.

My current portfolio: LQMT, CROX, LC, ANGI and GRPN

This Week’s JBP Stock Ideas

There were no trades this week, but who among my readers is long Liquidmetal Technologies (LQMT)?  Ha?  Many have emailed me, wondering when a big move would come.  Well, a Richter Scale reading of a modest ‘5.0’ hit this week.  LQMT rumbled to a 25.9% move higher.  The stock was up as much as 31.6% before profit-taking started come in.  

But, before I pop the cork off my recently-purchased Veuve Clicquot Cave Privee (1982), I want to point out that I think this stock is just beginning to run. 

There’s been a lot of buzz surrounding the stock.  Traders have been waiting for an announcement from Liquidmetal or Apple about whether upcoming iPhones will include liquidmetal technologies.  We know future iPhones may have liquidmetals incorporated into Apple’s icon mobile device, we want to know which model may be first.  That may be the day we see LQMT double and triple in price within 24 hours, maybe within only hours.  Then, this stock is ready for full NASDAQ visibility.  And who knows what happens then.

In the meantime, Liquidmetals issued a news release regarding the company’s new amorphous metal molding machines.  Notice the text:

This technology complements LQMT’s well established cold-crucible systems, which are capable of producing parts that meet requirements for the most demanding medical and automotive applications.

I’ve received emails that essentially say this, “Jason, there’s no mention of consumer electronics in the statement.”  And my reply to these subscribers is this:  Apple’s protocol of secrecy rivals protocols at the US Department of Defense, for cryin’ out loud.  

Does anyone think that a potential contractor of Apple’s would carelessly ‘spill the beans’ on what Apple has in store for its customers AND competitors?  If anyone was privy to contracts made between Apple and suppliers, the penalties for not following Apple’s protocols must be devastating.  I wouldn’t be surprised if Apple requires suppliers to gain Apple approval before issuing news releases.  If you look at what Wal-Mart imposes on its suppliers, what I’m suggesting is not outrageous.

The following is text of my latest thoughts of last week, then I’ll archive it.

April 10, 2017

LQMT: My large stake of 100,000 shares of LQMT was inspired by footprints made by this company and to where these footprints are likely to lead.  Hint: Liquidmetal new chairman and CEO, Professor Lugee Li (56), has embarked on a new venture and market that’s much bigger and profitable than the present commercial materials market his $661 million company, Dongguan Eontec Co., Ltd., now services.

The key to understanding the truly massive potential of LQMT must be gleaned by way of following the the company’s footprints.  The driving force behind Liquidmetals Technologies is Professor Lugee Li.  Essentially, Professor Li is the company, so allow me to tell you what I know about Li.

First, Professor Li spent his college years studying materials engineering, and achieved a Masters degree in the field.  He, then, began teaching at colleges and universities throughout China, more than seven, in all.

At the young age of 33-years old, Li founded Dongguan Eontec Co., Ltd., an advanced materials company listed on the Hong Kong stock market as a $661 million enterprise.  Since the founding of Dongguan Eontec Co., Ltd. in 1993, Li has sat on at least six boards of directors of companies involved in advanced materials for various commercial markets, primarily the medical devices industry.

Below, is a chart of the performance comparison between Dongguan Eontec and the S&P 500.  The orange line is the stock performance of Dongguan Eontec, and the blue line is the performance of the S&P 500.

From the stock performance of Dongguan Eontec, I surmise that Professor Li is not only an expert on advanced materials, he’s a good businessman, as well, the latter of which is of the most importance to investors of LQMT, of course.  At last look, Dongguan Eontec is expect to earn a triple-digit increase in profits this year.

In December of last year, Li gained control of Liquidmetals with a majority stake that cost him approximately $41 million.  He raised that cash from liquidating nearly 5% of his holdings of Dongguan Eontec in July 2016.  So, it appears that the modus operandi of Professor Li is to take complete control of each of his companies within his budding empire and grow them rapidly.  

The major players in the new field of ‘liquid metal’ alloys number only three:

1) Eontech (Liquidmetals): Liquidmetals is a spin-off in 2003 from California Institute of Technology (Caltech) and holder of numerous patents in the field of liquid metals.  Essentially, Liquidmetals holds much of the legal power of this technology.  

Since the company’s inception in the 1990s, Liquidmetals has sought to commercialize these leading-edge metal alloys, but has been unsuccessful in the past for the principal reason of the high entry price for entering the market.  Liquidmetals needed big capital, and Li has now provided it and taken control of the company as part of his Dongguan Eontech business in China.

2) ENGEL, a privately-held Austrian company, founded in 1945, makes specialized manufacturing equipment for the production of advanced materials.  At $1.6 billion of annual revenue, this company is the premier maker of industrial machines in the global advanced materials market.  But ENGEL is not a direct competitor of Li’s.

3) Materion (MTRN), a publicly-traded company base in Ohio, is in the business of producing specialized materials, a US competitor of Li’s.  At a market cap of $702 million, Materion is approximately the same size as Dongguan Eontech.

Since Professor Li took control of Liquidmetals in December, he hasn’t wasted time positioning the company to service awaiting makers of consumer products and medical equipment.  By March 2017, Li bought a manufacturing facility and machinery to begin production of liquid metals components.  But the mystery is: who is/will be his customers?

I’ll first begin with the possibility that Li is angling to service the medical device industry, either initially and/or as a longer-term strategy.  The number of applications in the medical devices industry for liquid metals is too numerous to address in this small space.  And needles to say, the market size is billions of dollars per year of revenue.  But I’m not convinced that Li’s fast-moving steps of taking control of Liquidmetals, buying a manufacturing facility and ushering in production machinery within a span of only three months points to a ready customer in the slow-moving medical devices industry.

Which leads me to a much more likely customer: Apple Computer (AAPL).  There’s been a lot of speculation as to Liquidmetals’ connection with Apple Computer, and for good reason.  Apple is famous for bringing leading-edge consumer products to market first, including products known for their ease of function and beautiful design.

For a good synopsis of the facts that suggest Apple is primed to incorporate liquid metals technologies into its iPhone series, read this well-written and informative article of March 31 on PatentlyApple.com, entitled, Apple Patent Describes using Liquid Metal (Metallic Glass) for the Backside of an iPhone, wherein the author restates the ‘smoking gun’ section of Apple’s application at the US Patent & Trademark Office to register a new patented design of its iPhone, which includes liquid metals as the material of the backside of the device.

The relevant text contained within Apple’s application is as follows:

“In some embodiments, the metal substrate may be a metallic glass substrate.  In some embodiments, a metallic glass coating is deposited on a metallic glass substrate to form a coated metallic glass.  Pulsed radiation is applied to the coated metallic glass to form a metallic glass with altered chemical composition.”

Okay, Apple’s iPhone 8 (iPhone X) is anticipated by many analysts to be released no earlier than September of this year.  It’s been suggested that the iPhone 8 will feature wireless charging, have no physical buttons, and sport an all-new design.  For now, these suggestion are mere speculation, of course.  But consider the effectiveness of wireless charging technology is greatly enhanced by removing interference caused by the material used in the device being charged, the urgency to incorporate liquid metals into the iPhone becomes crystal clear to me.

After the information gleaned from Apple’s most recent patent application, the issue of the features slated for future models of the iPhone (after the iPhone 7) may now also include the composition of the backside of the iPhone.  Will the backside material of the iPhone 8 include liquid metals?  If not, the odds of the next iPhone (after the iPhone 8) featuring these new composite materials for the sake of being able to remotely charge the device soar.

Here’s my bottom line to my thinking behind LQMT.  Apple is on the cusp of incorporating liquid metals into its iPhones series.  Taking a stake in LQMT now may even be a better buy for traders than waiting to buy some shares after developments surface at Apple and/or Liquidmetals at a later time.  

If traders wait too long, LQMT may become merely a good play (or bad play), not a potential ‘jackpot’ play.  I’m holding now for the distinct possibility of a jackpot play of at least 10-times my investment, not just hoping for the possibility of a two-bagger play.  Just the speculation and hype surrounding the latest revelation that Apple plans to use liquid metals, alone, is worth the price of admission.

MY WATCH LIST

No news about FNMA this week.  The stock was down $0.05 to close at $2.41.  Volume was light.

Fannie Mae (FNMA)

After the Trump victory in November, shares of Fannie Mae (FNMA) soared to as high as $5.00, from $1.65, an amazing move for only 16 days of trading.  At that time, Trump was viewed as a pro-investor president, likely to nominate a treasury secretary who would take sides with investors.  

Optimism and profit-taking held FNMA within a large trading range of $3.50 and $4.50, until February 21, the date the U.S. Court of Appeals ruled that investors have no standing to sue the Federal Housing Financing Agency (FHFA).  On the news, the stock plunged to $2.71, from the opening price on February 21 of $4.18 per share.

So, what now?  

Well, according to Height Securities analyst Edwin Groshans, further appeals are the only course left for investors, unless FNMA investors would like to wait as much as an estimated 11 years, according to Groshans, to recoup Fannie Mae’s value through earnings.

However, if suitors take their case against the FHFA, a successful ruling for the plaintiffs would realize “instant value,” according Groshans.

“It is our view that despite the string of court losses, legal action is the path that has the best chance of monetizing GSE preferred shareholder investments,” Groshans told Benzinga.

I agree with Groshians’ assessment.  What else can investors do?  The court system is the only way to go, as I see it.  

I’ve add FNMA to my Watch List because of the risk/reward profile of the stock.  Famed investor, Bill Ackman, of Pershing Square Capital Management estimates FNMA to be worth as much as $47 per share, if the plaintiffs prevail in the courts.  

I have no problems with Ackman’s estimate.  All I know is: FNMA is a clear double-digit stock price, when/if the value is released to investors and not retained by the FHFA.

Until next time…

Trade Wise and Green!

Jason Bond