With John Thomas, AKA the Mad Hedge Fund Trader
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Guest John Thomas is a hedge fund manager and finance blogger who has dubbed himself the “Mad Hedge Fund Trader”, a title that may surprise you if you actually look at his resume and credentials, both of which are impressive: He founded and later sold the first international hedge fund and was a member of White House press corps in the 1980s, to name two highlights. Steve opens their wide-ranging conversation by asking whether it’s true that hedge fund managers—perhaps emulating a strategy used by some of the all-time great investors—often seek out assets that are mispriced. John agrees that, indeed, this principle is the “bread and butter” of fund managers and financial advisors. He adds that his fund tries to buy cheap assets and sell (short) expensive ones, a simple principle that unsurprisingly isn’t as easy as it sounds.
Stock Market 2017 Forecast and Trumponomics
Diving deeper into John’s recent writing and investment moves, he explains that he correctly foresaw that tech companies’ stock prices would get, as he puts it, “absolutely trashed” in the immediate aftermath of Trump’s election victory. The reasons he expected this short-term fall had to do with the well-publicized lack of love—politically speaking—between Silicon Valley and the President-Elect, and market anticipation that highly globalized tech companies could face strong headwinds from Trump’s anti-globalization, anti-immigration, pro-tariff stances. While tech stocks have rebounded, John pocketed some nice returns from his foresight and quick trades. In fact, he’s still bearish on the tech sector until Trump makes clear whether he intends, in John’s words, to “pursue his anti-globalization fantasies” of 35% – 45% import duties for Mexico and China. John is convinced that such reckless protectionism could lead to grave results for the US and world economies, setting up Trump to become a modern Herbert Hoover, the US president who led the country into the Great Depression. On the plus side, he doesn’t think that Trump will stick to these policies if it becomes apparent that they are sending markets into a tailspin. He goes further and remarks that if Trump’s economic plans begin to tank US markets, this would offer a golden opportunity to “buy the dip” on the assumption that Trump will rather quickly come to his senses. Convinced that most investors will take a pass on buying into a sharp move down in stock prices, John observes that volatility and mispricing becomes more pronounced in bear markets. Using the examples of Apple (low P/E ratio, underpriced) and Kimberly-Clark, the toilet paper manufacturer (higher P/E ratio, overpriced), John explains how investors flee to “safer” yet arguably overpriced companies—in this case, toilet paper instead of tech—and, in the process, create more opportunities for funds like his own to jump on mispriced equities.
In an interesting sort of sidebar to the main conversation, Steve and John discuss the curious situation of federal tax revenues and spending on the state level. Both the East and West Coasts pay into the tax system more than they get back from it in terms of federal spending, while states in the Midwest and Deep South—strongholds of Trump’s supporters—reap more than they put into Federal coffers. This is ironic given that many of these folks say they want to dramatically shrink the size of government, apparently not understanding the benefits they receive from military, infrastructure, and entitlement spending. Alaska may be the ultimate example of this irony, as their libertarian politicians vent about an overlarge federal government and brag about their fiscal independence while they receive $7 in federal spending per dollar of tax revenue.
US Politics and Markets Overlap: Lessons from History
Continuing with the theme of the overlap of politics and economics, John offers some observations about boom and bust cycles and their timing relative to Democratic and Republican administrations. He finds that the economy slowly grinds up during Democratic presidents, while, in contrast, it goes through boom and bust cycles under Republican presidents, including all the market crashes in the past century. This leads to some speculation about how markets and the economy will fair under President Trump, how much further the current 7-year economic expansion could go, and what might trigger a market crash. Though he concedes that the timing is basically unknowable, John expects that, based on historical patterns, we might enjoy 2-3 years of an almost “can’t lose” investing environment. During this phase, asset prices will climb, borrowing will be easy, and “you can drive things to insane multiples.” When the inevitable crash does come, however, his hunch is that it will be a major one on the order of 25%-50%.
The key question then becomes, as Steve articulates it, how do you know when “the music has stopped” and it’s time to “sit down” and get out of markets? While John agrees that this is indeed a critical matter over the long haul, he suggests that average investors with 401Ks or mutual funds would do well to stay put during market downturns. The worst time to sell is at a market bottom when you’re feeling maximum pain. For investment professionals, it can certainly pay to be more nimble getting in and out of markets, but that necessarily entails more risk as well.
Thomas Bullish on Housing for Decade +
Finally, Steve and John shift gears to talk about residential real estate, an asset class John is strongly bullish on for the next decade plus. As he unpacks it, it’s all about demographics. The rise of the millennial generation—an 85 million strong group—and their role as the largest share of the housing market roughly 12 years from now will steadily drive home prices up. Because the generation that follows them will only number in the 60-65 million range, housing appreciation will lose steam after 2030, and John sees a long “secular” bear market following in the next decade. As John reminded his readers in a recent blog post on this topic, “Don’t forget to sell by 2030!”
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: John Thomas was the Tokyo correspondent for the Economist Magazine and the Financial Times. He was a member of the White House press corps where he covered the early years of the Reagan administration. He left all that to set up the first International Hedge Fund; then he sold it years later and reentered the hedge fund business in 2008 to take advantage of the trading opportunities created by the bursting of so many bubbles, as he puts it. He now writes the “Diary of A Mad Hedge Fund Trader”, which can be found at madhedgefundtrader.com. I found him on seekingalpha.com, and I’m really pleased to welcome John Thomas. Hey, John, welcome to the show.
John Thomas: Hey, good morning, Steve. Hello from the frozen wastelands of the west.
Steve Pomeranz: Yeah, so we’re recording this on the very last day of the year, so December 30th. We should talk a little bit about that, but before we do, one of the blogs that you wrote caught my attention and you entitled it “Technology or Toilet Paper.” One of the series that we run is the “Great Investor Series” and one strategy that springs up all the time is this ability to recognize investments that are mispriced. It seems to be the hallmark of a great investor, and you recently wrote about the mispricing between toilet paper makers Kimberly-Clark and Apple. Tell us about that.
John Thomas: Well, mispricing of assets is how hedge fund managers and financial advisors earn their bread and butter, and it’s constantly going in the stock market and among all asset classes. What we do is try and buy the cheap ones and sell short the expensive ones. I wrote that piece right after the November 8th presidential election where I expected technology to get absolutely trashed because of their clear anti-Trump sentiment in Silicon Valley and that the cash would go into the old economy stocks, and that’s exactly what happened. I wrote a piece called “Out With the New, In With The Old” that has really characterized all investments since the presidential election.
Steve Pomeranz: Kimberly-Clark, which has a profit margin of about five and a half percent and sells at 20 times earnings; Apple has a profit margin of 22% and sells at 13 times earnings. As you wrote, to suggest that making toilet paper is six times more profitable than selling iPhones and that just is, kind of, ridiculous. Why do you think this mispricing has occurred? Is it sometimes just steady wins the race, or do you think it was just a political move?
John Thomas: Well, there are many factors at work here. First of all, it’s political. There’s a concern that a Trump anti-globalization world is terrible for Apple, which it would be. I mean, Apple would fall apart without globalization being a reality. Also, you find that investors will pay premiums for safety during times of great uncertainty, and that’s certainly of what we have now. Everyone needs toilet paper; you don’t have to have an iPhone. We haven’t used Sears’ telephone books for a long time for those purposes, but—because Sears doesn’t make catalogs anymore—I think temporarily all of tech will be tarred by the globalization brush. If Trump really pursues his anti-globalization fantasies, 45% import duty for China, 35% for Mexico, that will trigger a great depression that will make the 1929 version look like a cake walk. Trump will go down in history as the next Herbert Hoover. He won’t want that, it may take him several months or a couple of years to figure that out, and he’ll have to backtrack from all of that. Imagine walking into a Walmart and all of a sudden everything is 45% more expensive. Who does that destroy? The Trump base in the Midwest. That won’t last very long.
Steve Pomeranz: These will not be gold-plated Hoovervilles, then? I suppose if it’s a Trumpville, I suppose that they’re not going to be furnished with the gold fixtures.
John Thomas: It’s really hard to hide a stock market crash for people who are not in the stock market. The stocks were down 50% in 2009, everyone knew it, including voters, including the rust belt. I think Trump is going to avoid that at all costs. If he sees an anti-globalization strategy taking him in that direction, he’s going to dump it like a hot potato. This sell-off in tech, I think, is a golden opportunity to get in. You’ve been asking for a dip to buy; here’s your dip and then all of a sudden everybody’s scared to do it-
Steve Pomeranz: Well, that’s it. I mean, psychologically when things dip, it raises is the fear quotient, and then people step aside and wait.
John Thomas: Therefore technology trades at big discounts and toilet paper trades at big premiums.
Steve Pomeranz: There you go, there’s the reason. You think about what we’re going to be experiencing—there’s going to be a sea change for investors with all of the infrastructure spending and trillion-dollars worth of money flowing into the economy in certain areas. First of all, you mentioned this idea about taking the money from the coasts of the United States and funneling it to the center of the United States. Tell us about that.
John Thomas: Well, if you look at the US Government’s cash flows, it’s basically a gigantic recycling machine that collects tax revenues out of the East and West Coast and spends it in the Midwest and the Deep South. This has been going on, in a big way, since World War II, that’s not new. What the Trump regime will do is accelerate that process. Today, for example, Californians received 80 cents for every dollar of tax revenue they pay into the government. States like Wyoming get back $1.20 for every dollar of tax revenue their citizens pay in. Texas is like $1.10. Mississippi is about a buck 25. Alaska is $7.00, so it was always hilarious that you have libertarian governors in Alaska campaigning on their fiscal independence, when, in fact, they were getting $7.00 back for every dollar of tax revenue they paid in. Of course, the grand prize winner is Hawaii, which is $8.00 in government spending for every dollar of tax revenue— that’s because of a massive military presence and a massive amount of social welfare spending that goes on in Hawaii.
Steve Pomeranz: What about the states on the East Coast?
John Thomas: Well, again, New York, New Jersey, again they pay large amounts of taxes and only get back pennies on the dollar so long as they’re paying in. You don’t have any big military bases in New York or New Jersey. It turns out all the big Navy bases on the east coast are in Virginia—Hampton Roads—or in the South, Mobile, Alabama; Galveston, so on. Big Air Force bases, they’re in Texas, Kansas, North Dakota, out in the middle of nowhere. Also, infrastructure spending is a similar mismatch. If you’re building an interstate across Wyoming, the amount of spending per citizen there is enormous, compared to California where you’re splitting the cost among 39 million inhabitants.
Steve Pomeranz: My guest is John Thomas, a.k.a. The Mad Hedge Fund Trader and we’re talking about all things investing here. We’re trying to get a sense of what the new Trump administration’s going to mean for investors. It seems obvious that this spending pattern is going to occur, and the question is how does an investor take advantage of it?
John Thomas: Well, I’ve been trading in the market for about 50 years, so I’m just starting to get the hang of it. Basically, Democratic regimes are characterized by slow grinds up, sort of, a 5% of your thing, like we saw in 2016. Republican regimes are characterized by boom and busts. All of the crashes of the last century have taken place under Republican administrations. You had the ’29 crash under Hoover; you had the ’87 crash under Reagan. Bush actually had two crashes; you had the .com crash in 2000 and then the ’08/’09 crash, which we all remember. We’re now six weeks into the next boom/bust cycle, so what that means is the first two or three years you get a free pass.
I mean, anything you want to buy is going to go up; you can borrow like crazy, you can drive things to insane multiples. Anything you touch you’re going to look like a genius, but, I’m looking for a 25 to 50% crash at the end of this. Now, when Reagan took office, it was 16 years until we got a major recession, the .com crash. When Bush took office, it was only eight years until the ’08 crash. How long is it going to take for things to fall apart under Trump? With social media, with the internet, with everything on fast forward, it could be only four years or three, who knows. We are seven years into this bull market, seven years into this recovery. If you get a crash in ten, in three years, it’ll still be the longest economic recovery in history.
Steve Pomeranz: Yeah, it’s easy to paint a picture like that. Being fully invested, leveraging up to the hilt, taking chances with your money may work for a while, but are you going to be … It’s like a game of musical chairs, someday the music is going to stop. Can a person actually get out in time?
John Thomas: Well, yeah, I tell all of my readers, “Don’t forget to sit down when the music stops playing.” Most people cannot do that. If you want to do that, you need to subscribe to a service like mine. It tells you when to sit down, when to go crazy, go pedal to the metal, and when to sit down when the music stops playing. We actually make more money in down markets as a hedge fund than we do in up markets because you get these massive explosions of volatility in huge shrinkage on the short side of the e-multiples. If you are a trader—and there are a lot of semi-professional traders who follow our service and who do extremely well—then, great, just don’t forget to sit down when the music stops playing.
Steve Pomeranz: That’s the key.
John Thomas: If you’re an average individual who has a 401 (k), the best thing to do is nothing. I can’t tell you how many people I begged not to sell all their stocks in ’09. Even when the media was practically forcing them to do so, I said, “This is the bottom, you’ll regret it.” Best thing to do over the long term with your pension fund is nothing, don’t touch it. Don’t ever sell. You don’t have to pay taxes, you don’t have to pay commissions if you never touch anything. Everything goes up.
Steve Pomeranz: I would agree with that. I often tell people that doing nothing is an activity. It’s a conscious effort to make a decision to do nothing.
John Thomas: Well, it also requires a lot more discipline, it’s a lot harder to do nothing than it is to do something-
Steve Pomeranz: A lot harder.
John Thomas: …… to do the marginal trade. That characterizes all beginning traders and investors. They’re always doing something.
Steve Pomeranz: I want to switch gears a little bit because you wrote a blog where you said your best performing asset just got better. You think that residential real estate is entering a golden age. Tell us why.
John Thomas: Well, it is entering a golden age, just look at the math, okay? Let’s just say you bought a house for $500,000; you put 100,000 down, 80%. The house goes up 5% in a year, okay? Well, the value of the house goes up from 500,000 to 525,000, your equity in that house rose by 25%. It goes from 20,000 to 25,000. That’s a lot of money, okay? What’s driving real estate is there is a massive demographic tsunami about to hit the housing market, as millennials start forming families, having kids, and buying homes, and there are 85 million of those. In the meantime, we baby boomers, who have been selling our houses for the last ten years, are dying off and they will slowly disappear. That will be the major driver of home prices for the next 20 years.
Steve Pomeranz: You’ve got other demographic shifts that are happening as well, population growth is one of them. Population growth is, what, 3% a year?
John Thomas: I would say it’s closer to two, but, remember, half of that is immigration. This is another thing that Trump is going to have to figure out going forward. At least 1%, maybe a one and a half percent, of our two to three percent a year economic growth is the result of immigration. Immigrants coming in, spending money, getting jobs, creating GDP. This has always been the difference between United States and Europe, which doesn’t allow immigration. That’s one major reason why our growth has outpaced theirs by about a 1% a year. We stop immigration, we cut our economic growth by a third. Again, if he’s looking for any kind of sustainability in his presidency, he’ll back off from that very quickly, too, once he finds the true cause.
Steve Pomeranz: There’s too many on this list to really mention, but one thing that does stand out to me is your statement, “Just don’t forget to sell by 2030.” Why do you say that?
John Thomas: Well, by 2030 that’s when your demographic forces start to wane. Your 85 million millennials will approach their 40s and 50s. They’ll be at their peak spending in their life and, after that, start to slow down. The generation behind them will only be about 60 or 65 million people. That is a 20-million gap in the number of buyers in the market, and that’s when the real estate prices start to enter a 10-to-20-year secular bear market like we had during the 2000s all the way up until 2011.
Steve Pomeranz: I guess we can safely say, to wrap this up, that timing is everything. My guest is John Thomas, a.k.a. The Mad Hedge Fund Trader. More of his stuff can be found at madhedgefundtrader.com. Hey, John, it was a real pleasure. Good stuff.
John Thomas: Hey, great.