Short time
It is not lost upon me, the extent to which I was lucky with my timing on the market puts that successfully played out for me last year. Especially given the rapid return to the highs in a matter of three months this year, I figure I had a very small window to be right and I just happened to be at the right place at the right time.
Now with the end of the first quarter there is a new strategy that I have been playing with. Again, this is a short play to cover my longs but it comes from a scenario that played out in the last couple of downturns and I suspect will play out once again. The question I am still grappling with is if this is really a downturn that we are are staring down or is it really a goldilocks where the economy will chug along for a couple of years.
Early in the year there were ominous signs of a slow down from big industrials and transports such as Caterpillar, FedEx, Rails etc. Even today there was a downgrade of the global economy by the IMF and poor manufacturing numbers from Europe. So it is a little hard for me to believe that all is hunky dory and earnings will continue to move forward. With that scenario in mind....
One thing I have learnt from pervious downturns is that the first ones to get hit at the beginning of a downturn are the suppliers and more specifically the semiconductors. The semis always end up overbuilding to make sure its pipeline is full and cannot afford to not have sufficient inventory as demand ramps up in good times. The problem with that however is the lead time to build these things out and hence the amount of preordering that they have to do in anticipation of demand. This invariably means that when a downturn takes hold they are left holding the bag for the next 4-6 quarters trying to clean up inventory. We saw the first signs of this in November when the high flying semis were cut down to size but has hence rebounded and the SMH is now close to an all time high again. However, players like NVDA and AMD are yet to see there all time highs. If indeed there is a slow down that plays out in the next 2-3 quarters, I believe the semis will be taken down further to compensate for the inventory and lack of earnings visibility.
So the first short play is the semis. They include NVDA, AMD, MRVL, XLNX and MU. This time around I am experimenting with individual names because I feel like in uncertain times the index can hold up better due to automated buying and mass trading while individual names get caught up in the individual stories of inventory glut etc. I have put in a spread of PUTs starting from the end of second quarter to the end of year across these names. If indeed there is a downturn or even a significant slow down I suspect most of these will test their December lows again.
The second short play is the high flying software cloud plays that have come into the market relatively recently. These include TWLO, MDB and W. All these players have atrocious balance sheets and have valuations that price them significantly above market multiples given to even the best of breed growth stocks. Once again the time span is between third and fourth quarter. The reason to pick this class of companies is because they heavily rely on demonstrating exceptional growth at the cost of the equity holder, bleeding money while doing it. In case of a slow down most investors lose appetite for such companies as they shed heavy loss making enterprises with negative cash flow and very low amounts of cash on the balance sheet.
The reason I am also staying away from the overall market index instruments to short is because if the downturn is not a severe one, there will be a rush to large cap high quality stocks which will result in keeping the market index fairly stable due to market cap weighted indexing which will not play out well for way out of the money PUT strategy.
All this could very well blow up in my face and the market might very well be headed up from here which would make this a very bad choice on my part. But then again I figured I make the trade and learn a lesson from it one way or the other. After all what is the point in following the markets so closely if I cannot take calculated risks to protect my longs.
Now with the end of the first quarter there is a new strategy that I have been playing with. Again, this is a short play to cover my longs but it comes from a scenario that played out in the last couple of downturns and I suspect will play out once again. The question I am still grappling with is if this is really a downturn that we are are staring down or is it really a goldilocks where the economy will chug along for a couple of years.
Early in the year there were ominous signs of a slow down from big industrials and transports such as Caterpillar, FedEx, Rails etc. Even today there was a downgrade of the global economy by the IMF and poor manufacturing numbers from Europe. So it is a little hard for me to believe that all is hunky dory and earnings will continue to move forward. With that scenario in mind....
One thing I have learnt from pervious downturns is that the first ones to get hit at the beginning of a downturn are the suppliers and more specifically the semiconductors. The semis always end up overbuilding to make sure its pipeline is full and cannot afford to not have sufficient inventory as demand ramps up in good times. The problem with that however is the lead time to build these things out and hence the amount of preordering that they have to do in anticipation of demand. This invariably means that when a downturn takes hold they are left holding the bag for the next 4-6 quarters trying to clean up inventory. We saw the first signs of this in November when the high flying semis were cut down to size but has hence rebounded and the SMH is now close to an all time high again. However, players like NVDA and AMD are yet to see there all time highs. If indeed there is a slow down that plays out in the next 2-3 quarters, I believe the semis will be taken down further to compensate for the inventory and lack of earnings visibility.
So the first short play is the semis. They include NVDA, AMD, MRVL, XLNX and MU. This time around I am experimenting with individual names because I feel like in uncertain times the index can hold up better due to automated buying and mass trading while individual names get caught up in the individual stories of inventory glut etc. I have put in a spread of PUTs starting from the end of second quarter to the end of year across these names. If indeed there is a downturn or even a significant slow down I suspect most of these will test their December lows again.
The second short play is the high flying software cloud plays that have come into the market relatively recently. These include TWLO, MDB and W. All these players have atrocious balance sheets and have valuations that price them significantly above market multiples given to even the best of breed growth stocks. Once again the time span is between third and fourth quarter. The reason to pick this class of companies is because they heavily rely on demonstrating exceptional growth at the cost of the equity holder, bleeding money while doing it. In case of a slow down most investors lose appetite for such companies as they shed heavy loss making enterprises with negative cash flow and very low amounts of cash on the balance sheet.
The reason I am also staying away from the overall market index instruments to short is because if the downturn is not a severe one, there will be a rush to large cap high quality stocks which will result in keeping the market index fairly stable due to market cap weighted indexing which will not play out well for way out of the money PUT strategy.
All this could very well blow up in my face and the market might very well be headed up from here which would make this a very bad choice on my part. But then again I figured I make the trade and learn a lesson from it one way or the other. After all what is the point in following the markets so closely if I cannot take calculated risks to protect my longs.
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