HDGE: A Better Way To Short The Market?

Summary
• The extreme bullish market action of the last month has left an increasing number of investors feeling a disconnect between a worsening macro-economic picture and lofty equity prices.

• Using inverse or leveraged ETFs to short the market for more than very short periods of time presents a major potential risk in the form of compounding via daily resets.

• The AdvisorShares Ranger Equity Bear ETF holds an actual portfolio of actively managed short positions, meaning bears don’t need to worry about compounding losses over longer-term holding periods.

• Two of the funds managers, Brad Lamensdorf and David Tice, join Let’s Talk ETFs to discuss their outlook for markets and delve into their investing process, including specific names they’re particularly bearish on.

• This article includes a full transcript of the podcast that was posted last week.

Editors’ Note: This is the transcript of the podcast we posted last week. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast, embedded below, if you need any clarification. We hope you enjoy.

Podcast and Transcript:

Jonathan Liss:  For reference purposes, this podcast is being recorded on the morning of Wednesday, April 22 2020.
My guests today are Brad Lamensdorf and David Tice . Brad serves as the Portfolio Manager and owner of the Subadvisor for the AdvisorShares Ranger Equity Bear ETF (HDGE). He has served as a Portfolio Manager and Principal of Ranger Alternative Management since 2009, providing trading and marketing strategy for short only positions.
In January 2013 he commenced operations and serves as the Principal of the Lamensdorf Market Timing Report or LMTR.com , a newsletter which provides subscribers with technical analysis, and which will be familiar to many Seeking Alpha readers.
David Tice founded the Prudent Bear Fund (BEARX) and served as Portfolio Manager from 1996 to 2008. He began his investment career in 1988 by publishing Behind The Numbers an investment research service that focused on quality of earnings warnings and sell recommendations for more than 150 money managers. Gaining national recognition through several Barron’s articles he wrote and from hundreds of appearances on business television.

He recently joined Ranger Alternative Management and serves as the Chief Investment Officer of Hedge. He also currently serves as President of Tice Capital. Anyway, welcome to the show, gentlemen. It’s really great you to join.

Brad Lamensdorf: Thanks for having us.

David Tice: Glad to be with you, Jonathan.

JL: Yeah, absolutely. And I think the timing is really important in terms of US and global markets right now. I think it’s pretty clear that we’re sitting at an inflection point, the likes of which we haven’t seen in a very long time. So for example, one popular author on Seeking Alpha Michael Gayed his name is. He called the market action of the last month since the market bottomed on March 23 the greatest disconnect between markets and the economy in history.
How do you explain the action of the last month since markets bottomed on March 23 and have basically gone straight up since then roughly 25% or so?

DT: So I can start, Brad. One I’d say it’s not really surprising yet from a technical analysis standpoint, we certainly have retracement. And it’s not unusual after a big decline when markets get oversold for the markets to retrace, but eventually resumed the bear market. And so it could be at 38% retracement to 50% to 62% or so. And I think we’re probably at about a 55% retracement. However, there’s really been a disconnect in terms of this is unparalleled the decline in the economy.
And I believe we are in a recession people have talked about there being a 30% decline in GDP 25% unemployment. And Howard Marks was on CNBC the other day and he said, if you look at what’s wrong with this economy, it doesn’t seem like it’s down in the 20% economy.
And therefore, I think that we’re going to retest lows. I think we’re going to break through those lows, and therefore, it’s a very, very dangerous period. People want to believe. People want to be optimistic. Yes, we did get oversold.
You look at the ’08 decline was 55%. And I could argue that this decline is much more broad based and it’s not just affecting the financial sector and housing. This is significant with so many people out of work. And we have essentially burst five different bubbles. And therefore, a 36% decline so that we had off the high originally.

And then this rally — this is not going to be a V. We’re not going to be off to the races again. And unfortunately, I believe we have more pain to come into markets.

JL: Yeah, sure. And just to play devil’s advocate here a bit because I definitely share your bear thesis overall, at this point. What would you say about the fact that unlike in the great recession of 2008 and 2009, where there were really deep structural issues with the underlying US and then global economy.
But in this case, the underlying issues have really just been brought on one thing COVID-19. Something we know will eventually pass. This period will pass. And so if the underlying economic conditions were maybe late stage expansion, 2% GDP growth a year. There’s no reason to suspect that we can’t snap that back into place, once vaccine is invented for COVID or some kind of a silver bullet cure.
And so in other words, it really is a very specific event with a clear end in sight. And so even though the entire economy has been shut down, it shouldn’t necessarily be reflected in such heavy sell offs.

DT: So I’m a big believer in the Austrian School of Economics, Ludwig von Mises and Murray Rothbard, Schumpeter. And we believe that there have been a great number of excesses created over this last 11 year expansion. I believe that we were set up for a big decline.
We had created a number of excesses. The banks were not in as much leverage position as they were in ’08. However, you look at the buildup in corporate debt, we ended up having $2.5 trillion of BBB debt, which is just one notch below investment grade.
And it grew at 14%, annualized over the last 10 years. Our total junk debt’s $1.2 trillion. We’ve had companies go out and take on massive amounts of debt to buy back stock. Most of the earnings per share growth over the last 10 years, the preponderance of it has come from companies buying back stock. We have many, many excesses in this economy.
The growth rate has been significantly below what it was prior to ’07 and ’08. We were an economy, a bubble waiting for a pin. And we had a virus simply provided the pin to prick that bubble. But this was a decline that was going to come anyway. We’d already inverted the yield curve. We had essentially artificially grown this economy through a lot of Fed Large S [ph] that it’s now paled compared to the Fed Large S that we have going on now.

JL: Yeah, sure. And I mean, one thing you can look at is that if you take away corporate buybacks, there actually were, everyone else combined in US markets has actually been a net seller over the last period.
So without those corporate buybacks, they’re really the only net buyer of stocks over the recent expansion period. So I think that is a case in point. So who’s actually debt buying right now then if corporations are not really able to use their free cash flow to buy back their own shares because of the current environment?

DT: Yeah, that’s going to be a problem. And we have essentially psychologically changed the way look at things. People talked about how the Great Depression changed attitudes. For people that grew up in the 30s there has been a lot of talk about what is going to be the attitude of consumers going forward.
I think it’s going to be a lot more savings, a lot more squirrel away savings, don’t necessarily pay to have somebody blow dry your hair, don’t necessarily have your nails done twice a week. There’s taking a more frugal vacation, deferring capital expenditure.

JL: If anybody even lets you on a plane to begin with, right?

DT: Exactly. And It’s going to take a while, even though there’s talk about opening up, there’s a lot of people that are not going to go into restaurants. And I think a lot of people don’t understand operating leverage where some of these companies — even if you let people into a restaurant, if they’re at 30% capacity or even 60% capacity that business model might not work anymore.
So a lot of companies are going to close down and those jobs are going to be permanently lost. And one thing we’ve had this massive, people call it a stimulus, but it’s not really a stimulus. It’s just a trying to sustain to try to keep the wheels on.
And frankly, I think it’s going to be too little, too slow, not long enough because I think there’s going to be a lot of people that are going to fall through the cracks. I think that it’s not going to last long enough.

And we’ve essentially resorted to modern monetary theory here MMT in order to try to keep the wheels on, in order to try to keep markets functioning. And this is truly a dangerous period. And we don’t know what’s going to happen with this virus. We don’t know if there won’t be resumption of significant more outbreaks once we do minimize social distancing.
The head of the CDC came out two days ago and talked about how in the fall and winter of 2020 is likely to outbreak even more significantly than what we’ve experienced so far. This virus can still — if you look at the Spanish flu, the second outbreak was far greater than the first outbreak.
So I just think there’s a lot of risk to financial markets. We’ve never seen a decline like this. But Americans want to be optimistic. We want to snap back. People have long time called me pessimist, but I say that it’s better to be realistic and you better be carrying money.

JL: Yeah, sure. Okay. So one more point here on or maybe counterpoint to that, which is that it seems like the Fed as you’ve said, they’ve resorted to MMT some of it with some precedent, some of it really unprecedented. They’re buying high yield corporate bond ETFs at this point to try to prop up some of that debt.
What do you think about people that say, simply don’t fight the Fed? Isn’t Fed at some point, for example, going to start buying equities also to prop up markets? And of course you can worry about things like runaway inflation a few years from now, but in the short term in terms of how investors should be allocating, what do you say to that argument?

DT: Well, fighting the Fed has been a losing proposition. I believe that there are consequences to learn monetary theory and you mentioned inflation picking up down the road. I think that is possible. There’s people smarter than me that are saying that inflation is going to come back. And I don’t have a direct call 12 months on that.
But this modern monetary theory is dangerous. And again, this unparalleled and it just doesn’t make sense. Why can’t we just give all Americans 320 million Americans million dollars and just everybody be happy? I mean this just doesn’t work.

JL: Yeah. I know that that is for sure. Unless you want to turn into the Weimar Republic or Zimbabwe or something along those lines. Yeah. So I’d love to move over to the AdvisorShares Ranger Equity Bear ETF ticker symbol HDGE full disclosure. I am currently long the fund myself. I have been for really just about a week and a half at this point, I think.
But to me, I think there’s two really great things about the fund and I’d love to hear both of you guys weigh in on it before we get into the actual process for selecting individual short positions when to open them, sizing, when to close them.
So the first thing I really like about this fund is that it offers investors like myself a retail investor, the ability to hedge the long part of my portfolio without worrying about needing to understand derivatives and swaps and without worrying about the losses from compounding, as you end up with leverage and inverse ETFs.
And it’s amazing to me how many people I speak to who buy funds that are inverse or double or triple leverage, hold them for months at a time and then scratch their head. They can’t figure out well, I don’t get it. It was a short S&P 500 fund triple leverage. The S&P was down 20% why am I not up 60% right now, why am I actually down also.

BL: Let us talk about that a second, if you don’t mind. So just to be a little more clear about this phenomenon that’s occurring. So the way that an inverse product works is they create an index, which is what’s called the S&P 500. And then they want to mimic the inverse.
So they set up a fund to do that. And then they go out and use swaps futures. They can even use options or just outright stocks to short the general S&P 500. Let’s use SH as example are one of the index oriented products that are out there.
What ends up happening on the reset is think of an index level at $100. And let’s say the market or the product fell 10%. So now you’re at 90. Then because the product doesn’t mark with an NAV like HDGE ETF, they basically compound on yesterday’s price action or performance.

So if the product was up 10% the next day after being down 10% the previous day, we only get back to 99. So try to do that 1000 or 2000 times and you can see the slippage that these inverse products end up having.
HDGE is an active ETF, we choose our positions, hand choose them. And with that we don’t have an index. So we don’t have an index to not track. So we don’t have a tracking issue. And we mark within an NAV like a mutual fund at the end of each day.
So there’s a very, very large difference between a short an active short only ETF, which is shorting in type three accounts, which is your margin account, which is where any individual would short a stock relative to these inverse products, which are really quite exotic when you really get into them.

JL: And so for example the example you gave a falling 10% to 90%, let’s say, then you need to gain 11% on the upside. This is particularly problematic in a market like this one, where every day, you seem to have a reversal of some sort or other.
So in a market that’s moving basically in a single direction, these kinds of products essentially can track an index properly. So they can track it two or three times as long as there is not that back and forth seesaw action. But the second that comes into play these products stop, they stop behaving in the way that people expect them to.
And just in defense of the issuers of these products firms like pro shares and direction, they advertise all of these products is daily, they don’t claim that they track these indexes at leverage or inverse over longer term periods of time.
But the bottom line is, there’s a lot of misunderstanding out there and a lot of misuse of them. Okay. So that really touches on the first thing I love about your fund HDGE, the fact that you’re actually physically shorting individual stocks, there’s no swaps derivatives. And so there’s no need for — there’s no compounding or lack of proper tracking going on there.

BL: And I’d also like to mention too that our positions are on our website the next day every day. So we’re very transparent too. People can see what we’re short the next day after a previous day.

JL: Yeah, sure. Well, we’ll get into that a bit in terms of whether you’re worried about things like front running at all. Well, let’s get into it now. So we just had a new active model, which has seen the light of day American Century launched two active ETFs.
I don’t know if you want to put that in scare crows or not the ETFs part of it. But essentially, they follow the Presidium model, they only need to disclose their position at the end of the quarter, which really is mutual fund like.
And so they have a NAV that gets published throughout the day, but it’s impossible for anybody buying the fund to actually know what’s in it in real time. Why are you not concerned about the sorts of concerns that most active managers have had that have kept them out of the ETF space and has kept them in the mutual fund space or the hedge fund space instead?

BL: Sure. Well, we definitely have been looking at these new non-transparents. One of the things we don’t want to happen is we don’t want our liquidity or our spreads to get affected. So we actually have been very interested in some of those. I do not think that we’re particularly front run as it is set up now.
And this is the reason why; one, the amount of money that we have under management a couple hundred million dollars for someone to come in and really push us around to make us have to cover something which really don’t have any rules where we were disciplined portfolio managers, but our prospectus doesn’t necessarily say, gee, if a position moves from 2% to 3%, you have to cover it.
So it’s not like we’re under any pressure. The majority of our companies are larger cap and liquid in general, and are probably much more difficult to push them around. If you’re a $20 billion fine and do have enough money to push those things around, why are you trying to press a $200 million ETF around.
In my opinion, there’s not enough juice in there to make it work. And we actually have run this scenario through with Virtu which is the largest institutional broker in the United States. And they agreed that it would be very unfruitful for someone to be trying to front run us in what we’re doing. And the positions that we’re putting on today, no one knows about until tomorrow. So it’s not like people see us in the market today doing what we’re doing today.

JL: Sure, right. Whereas let’s just take a really extreme example, if Will Danoff, Fidelity Contrafund (FCNTX) had to disclose his positions daily, a fund that size could take him weeks to actually get into a position or longer. So you could see what the concern would be there at that kind of scale.

BL: I also had something interesting to even mention outside of hedge. The US oil, which has been getting a lot of attention recently.

JL: Yes, just reverse split today. Actually.

BL: That’s actually — it’s not an ETF. It’s an ETN. And they’ve been having all sorts of problems with their futures with inside of that ETF and rolling and everything like that, which just kind of goes to show you that whatever you have in your underlying in an ETF is as important as the ETF.

JL: Yeah, absolutely. And you’ve seen several funds in that space actually close up shop in the last few days (OIL) [ph] being one prominent example. So definitely.
The other thing I really like about HDGE is the fact that it’s actively managed. And so, attempting to handpick names, let’s say that are most right for short thesis as opposed to just shorting the entire market, the hope is that there can be some sort of alpha there.
And unlike with, let’s say, long only funds where there’s maybe not a lot of history of being able to outguess the market, the short side of things has really very different dynamics. And so I like the fact that the fund is actively managed. So just out of curiosity, if we could start getting into what your process looks like for selecting candidates for inclusion in HDGE.

BL: Sure. So we run a — so we’re looking at the entire market with stocks above a billion dollars in market cap. And we start off with actually a fundamental screening process that is delivering us all in six or seven different screens. So we don’t get pigeonholed into just shorting value or just shorting growth. We don’t short momentum.
We tend to look for companies that are docking it, that aren’t necessarily — that are maybe under what we call distribution, where the uptown volume isn’t really terribly great. And a company can turn into a Fed stock, for instance, Zoom (ZM), people are talking about does it really need a $40 billion market cap. I just saw Verizon get into the business. I know that Microsoft’s in the business through Skype. But it’s a momentum stock right now. And what we would like to see is some characteristics of distribution before we start stepping in. So while we may not catch the top, we like to try to get the meat in the middle.

We always tell people that we’re probably not going to ever be sure to bankruptcy, but we probably won’t ever get caught up into a momentum stock as well because we have technical stocks on the majority of our positions. With that being said, we have about 70 or 80 positions.

JL: And that’s a large number, correct. I mean, it goes as low as 25 or 30 in different….

BL: It can’t get more concentrated, no doubt about it. In this environment where we’ve opened up the amount of names and we’re probably close to about 70. Our targeted percentage is about 1% to 2% right now. So we’re not taking necessarily big concentrated positions, but really spreading the spectrum.
But the characteristic of what we like to sure are companies that are playing shenanigans with their balance sheets, companies that are pulling forward revenues, companies with negative free cash flow, companies with negative organic growth that are issuing buybacks with debt that have levered up their balance sheet, companies that have basically put themselves in a box where, as David so eloquently said a modest pinprick creates a huge problem for them, they don’t have these bullet sheet balance sheets like Microsoft (MSFT) and Amazon (AMZN).
So when the market goes up, these tend to have a little higher beta. So if we’re 100% sure, a much higher beta portfolio and we walk away from the market. Market was up 30% last year, we were down about 34%. We’ll take it. We are an alpha generator. So we do like to try to beat the indexes.
However, a lot of the alpha degeneration that the fund tends to create is to the downside when you need it the most. So during this correction, the market at one point was down 35%, we were up as high as 50% at one point. So the excess alpha that we generate on the downturns is really what has made the fund popular just us interacting with our shareholders.

JL: Yeah, sure. And how much do things like cost to borrow, which can vary greatly by individual companies or risks of short squeeze, how much does that get factored in when selecting individual names?

BL: We really shy away from highly shorted stocks or stocks that are commanding a very high interest rate. And what Jonathan’s talking about to the viewers is sometimes a stock that you have to borrow from a bank to then short into the market. Sometimes they will say, well, this is a very sought after borrow, and we’re going to charge you 1% or 2% interest on that while you’re shorted.
Some crazy stocks like GoPro back in the day got up to a 100% a year borrow rate, which means you have to make 100% just to break even if you were short for a year. So we shy away from that kind of stuff. The cheapest form of shorting is called general collateral. And the majority of our positions you’ll find are in general collateral.

JL: Sure. And I mean, the expense ratio on the fund is not variable, right? It stays the same. So you kind of have to figure out a way too.

BL: No it’s variable. So yes, so we were a liquid alternative a manager. So we chose 150 basis points for our management fee. And we charge about 15 basis points in expenses. And the other 150 basis points are ex dividends and ex interest that we have to pay to be able to be short.
And frankly, I really feel like those expenses should be hitting the fund because if I’m shorting a stock at 50, and it costs me 2% a year to short it, and the stock drops to 25, and I make 50% of my money. I have a profit in the fund. And then I have a 2% expense ratio to carry that position that goes on the expense ratio line.
Frankly, I feel like it should go over into the profit and loss call on for the trade. But the accounting rules of the United States would tend to differ with you.

JL: Okay, I guess you got to go with those then. But yes, which I do agree with you, it does make sense. In the same way they do make the expense ratio out of that net asset value. So yeah, it would make sense, agreed.
So just curious before we get into individual positions sizes here, I’m just looking at that sector breakdown here. And surprisingly, looks like at least currently the sector that you have the smallest allocation to is the energy sector, obviously, oil and forward month contracts going negative for the first time ever and crashing all down the futures curve have been in the news a ton lately.

And I’m just curious if that’s just a product of the fact that that sector has sold off so much already or if there’s other reasons that you’re not more allocated to energy shorts right now.

BL: Well, your first was correct. We were about 15% short coming into this mess. And I covered the majority of it on the lows during March.

JL: Okay, cool. So on a day like today where you are the last couple of days, let’s say where even though oil has really — the bottom has really fallen out of it in an unprecedented way. You’ve seen E&P companies actually being among the best gainers in the market.

BL: That’s right.

JL: This would be a sector I assume that if prices stayed really low for an extended amount of time would be right for shorting. Again, if you saw those stocks move up to levels you felt that they were right for the picking.

BL: Yeah, sure, if we could get some of the stocks back up to their 50 in 200 day moving averages we would be interested again to look at some of them again. But it’s kind of hard when stocks have dropped 80% 90% to stay short. And then when I first mentioned we probably will never be short of bankruptcy.
It’s just very, very difficult to short something all the way into zero. There’s a lot of volatility and the debt guys and the real distress guys come in and start lending them money and it just becomes a little less consistent of a game down at that level.

JL: Yeah, sure. I mean, the risk reward obviously starts turning more towards reward the closer to zero the thing gets.

BL: Yeah.

JL: Yeah, definitely. Okay, so I guess let’s just keep it on sectors for a second here. So you are fairly heavily short consumer discretionary, which I think is fairly obvious in this kind of an environment. But then you’re also very heavily short financials. And just curious what the underlying thesis is there.

BL: Well, it’s continued deterioration of the general economy which is going to put a lot of pressure on their loan books across the boards. We actually were even more short than you see right now. We were short the entire subprime area with (CIT), at a much bigger position and (CACC), we should short it synchronicity (SYF). So yes, CIT was another name that we had shorted and we covered all those in April 2, just because they had gotten so oversold.

But I will say that this subprime area is a complete meltdown waiting to happen, there has been so much debt raised in these lower credit tranches, no matter if you look at the covenant like loans, or you look at any of these different areas, it’s pretty weak. So we are just going to stick with the negative cash flow and stuff like that.

DT: And just to add in there. In terms of — we believe this decline is going to be so significant, and a lot of people have talked about how the banks are in better shape going into this recession, depression than they were in a way, but JP Morgan just raised their reserves by 450%. And I think that the magnitude of this decline being so unparalleled, even with all that save the payroll protection loans, et cetera.
There’s so many companies that are going to fall through the cracks and the banks are going to suffer a lot. And then you also look at the fact in a zero interest rate environment, financial institutions do not do very well.

JL: Yeah, flat yield curve, etcetera is very little they can do to make money particularly that the regional banks I would imagine are in.

BL: Also I’d like to tell you a story. So ABS which is really where some of the set, which is the car auto loans, where we were a bit focused on and I’d like to get some of that back on into this bounce somewhere. CACC is the most obvious position in that area, it’s vulnerable. But during the ’08 period, the reason that (ABS) which is the sector of the auto credit has been so strong over the last five or 10 years is because during ’08, it never broke.
ABS was a great bet. Everybody was driving to the work and blah, blah, blah, and using their car so they got paid. But the difference is the duration of that ABS paper during that period was three years, ABS paper now has exploded, doubled in duration to six or seven years. And if you start looking at the depreciation schedule, a used car when you start moving into that four and a half to sixth year, the depreciation in some instances can drop below the repo value of what the car is worth, creating a loss on the loan.

And I think that that is going to be a huge issue. Used car prices have dropped year over year faster than any other period of time since ’08 at this point. So you’ve got a depreciating asset with a lot of loans outstanding against that stuff that most likely will, they’ll just turn in the keys to an asset that isn’t worth as much as the loan still has left on the lease.

JL: Sure. Yeah. I have to imagine those default rates are going to skyrocket soon. Also, I saw just across my news feed just a day or two ago that over 25% of auto loans are being deferred in the US at this point. And I have to imagine in a few months, some of those people just default, they stopped deferring.

BL: At that point CACC was still short a little. It’s definitely one of my favorite shorts for the auto credit.

JL: Nice. Okay, so you’re short a little you’re saying. So how are you determining position sizes here?

BL: So traditionally, we really magnate our position to 1.5%. And then traditionally price action will move us around a little. So if something’s getting a little overbought, we may move that position up. If something’s getting a little oversold, we may trim it down some and take some profit.
So our entry points and exit points actually are chosen a little more technically short term, we use a 14 day RSI. We use moving averages to help us. If a stock starts getting a little, for instance, if a 50 day moving average and a 200 day moving average. You had a stock trading in between those.
And then for instance, let’s use CIT, because it’s a good example. It falls out of bad and the current price is 17. And the 50 day moving average is 50. So that’s pretty far away from its mean. So we would like to see that that gap closed a bit before we came back to the position. And sometimes it may just need sideways time.

JL: Sure. And so I guess getting back into individual companies here, what are another couple of names that you’re particularly bearish on right now and why?

BL: Well, while we had done extremely well on, which was Wayfair (W).

JL: Mainly your top holding correct?

BL: Yeah, it’s probably toward the top just because the stock ran up. We covered half of it down at about 25 and then it’s gone from 20 to 95 this month. But here’s a company that doesn’t make money and they lose money. And they don’t lose just a little amount of money they lose a ton of money.
And they’ve gotten some short term business from this crisis. But the fact of the matter is you got Amazon and Target (TGT), Walmart (WMT) and everyone else setting up the same type of furniture websites as they do and coming in with a serious balance sheets that Wayfair just can’t, is not going to be able to compete again. So the fact that this thing so cash flow negative and doesn’t have in their business model an opportunity to make a profit for over five years at a minimum and the fact that it’s in such a competitive area with such razor thin margins, it’s a red flag for us and a reason for us to be short.

JL: Yeah, sure. Makes a lot of sense. And then was there another name that you wanted to throw out for listeners also. And of course listeners can go to the Advisorshares.com website and look for HDGE and see default holdings which are updated daily there.

BL: Right, another company that we’ve stayed short, with inside of that finance area is Santander Consumer (SC). They do mortgages and auto loans, and they’ve been real, real recklessly aggressive in the past. And I actually wouldn’t — it’s one of those stocks. It’s at 12. It’s down from 25. But I wouldn’t be surprised to see this go back to kindergarten, which basically means low single digits. I think a lot of the ABS type stuff that I was mentioning before these guys are right in the middle of it.

JL: Yeah, sure. And then one other thing, which I think I’ll be interesting to listeners. So you have to keep cash on hand, of course, to be able to cover positions. How do you determine? You have — I see here four different cash vehicles, although one them is really insignificant, Morgan Stanley one.

But you have two money market funds Fidelity and BlackRock. And then you also have an AdvisorShares fund (HOLD), which is roughly 34% of your cash position. And particularly just curious about whether holding money in these funds, particularly HOLD, which did actually get about 5% as the market was dropping.
But even the money market funds where we did see funds actually break the buck in 2008. If this adds some kind of unnecessary risk relative to that the yields that these funds can offer in this kind of an environment.

BL: Yeah. That was really a very unusual blow out that we had and all sorts of different items that shouldn’t have gotten blown out like that. However, the HOLD is an AdvisorShares fund, we do use it. They do produce a bit over what the normal Morgan Stanley or JP Morgan type money markets can produce.
What I will say is that we have spoken to Sage, and we are going to continue to use the fund and they are going to lower their duration. Their duration was about 180 days. And some of the other durations we have are a little less probably more like 60 to 90 days.
And after we spoke to them, and that occurred, they’re not going to freak out and just start blowing out positions. But about 30% to 40% of their positions will run off with inside of the next 60 days at 100 cents on the dollar.
And a lot of the stuff that they own is AAA stuff, Budweiser type, 60 day paper and things like that, that frankly shouldn’t have gone to that type of spread. But with that being said, it definitely is a concern because our cash covers our liabilities. And it really should not be taking any type of dip like that. And so we’ll probably see a lower percentage in HOLD, and we may even add some t bills into the mix to make sure that we have adequate amount of liquidity.

JL: Yeah, sure. Now, that makes sense. I mean, you saw that in a bunch of similar funds, funds like (MINT), which of course again, even if things are investment grade rated when you when you look at why they maybe would have sold off by roughly 5% or 6%. Also, then you start digging into the holdings.

And I don’t know about Budweiser (BUD), but you see things like General Electric (GE) there, and I could see why credit markets would be a little concerned about that even if it’s relatively short term because there are companies that are investment grade rated that are close to it that do seem fairly risky in this kind of market environment so.

BL: Sage is the manager who runs HOLD. And they’re probably one of the top fixed income managers in the United States. So the management is extremely solid. They do incredibly good fixed income work. Think they run about $20 billion in these types of strategies. And we definitely had a talk with them. And we definitely — they’re going to tighten things up for us.

DT: We are definitely very cognizant of that risk. And looking at that very carefully.

JL: Yeah, sure. No, makes sense. Okay, cool. So let’s move on from here. I think this has been really, really interesting so far. You guys obviously have a lot of thoughts on not only the overall outlook for markets and the economy, but how that actually drills down to specific companies.
So just love if we can make some kind of a bold call here. No one’s going to hold us to it. But where do you think the S&P 500 will be at the end of this year on December 31 2020, you got all kinds of investment banks who are basically paid to be bullish, saying things like it’ll be at 3000 or higher. Goldman famously made that call probably about a month ago. Where do you see the outlook and where do you think the market will be at the end of this year?

BL: David, you want to take a shot first?

DT: Yeah. I’m going to say 1500 on the S&P, which is down about 55% of its 33.80 high or so. And I’m not necessarily thinking that’s going to be the end. I believe that when you think about recent declines, and even going back to 1987.
So we saw that decline in ’08 and the decline in ’87 were just went and done [ph]. But then you also had the 1930s, and you had 2000 to 2002. I think this is more likely to be one of those protracted declines, that isn’t necessarily going to be went and done. I think it’s going to be grinding.

Bear markets typically don’t end until people are graveling. And that they never want to think about a stock again, instead of saying, okay, it’s over. Let’s jump back in, what are we going to buy? That’s typically not how horrible bear markets end. And unfortunately, I think this is a big one. We’ve had a lot of excesses. We’ve talked about the corporate debt. We’ve talked about this, altering people’s attitudes.
I don’t think there’s going to be as much pent up demand as people think because there are people that are just going to differ for some time. We not really know, how this virus is going to play out. So I think it’s not going to be pretty.

BL: I personally think that David’s — the 50%, from top to bottom make is correct. You got to think about where we came from coming into this. It’s not just the virus. Debt to GDP was higher than it was in the fall versus 2000. So that’s Warren Buffett’s favorite indicator. That’s why he had so much cash.
Price to sales were 20% higher on the S&P 500 than the peak from 2000 and ’07. So price to sales were very high. Now price to earnings didn’t look as high because everyone’s been issuing debt and buying back stock to lower their PEs.

JL: I was going to say yeah, it’s an accounting mirage.

BL: So we also have another indicator out there. And a lot of these I put on my lmtr.com website under chart of the week in the fourth quarter. But you also have something called Tobin’s Q, which is the replacement value of the market relative to its underlying assets, which also got to a 2000 level.
So while most people may say this is bad luck that we just came across a 100 year flu and dip the markets down. The markets were so overvalued. If the markets were realistically valued coming into all this, then the hit probably wouldn’t have been as bad as it is now.
But we came from such an overvalued position, that real valuation metrics that I at least look at would make the market cheap at about 1500 to 1800. And when you look at those metrics, of course, that’s usually when everything is looking the worst. And as David said, nobody wants to buy stock.

And people are saying to sell everything out of my cat. I don’t want to do have anything to do with the stock market anymore. Obviously, that’s the times to be a really big buyer. And I just don’t think, as David said, we’re in that type of attitude.
I will say that I do think that because of the liquidity that the Fed is injecting, we are going to have massive volatility. I mean, if you thought the boring low vol environment we had over the last three or four years was probably like, in that one of the lowest vol periods in the last hundred years.
I think in the next two years, this is going to be one of the highest vol periods you’ve seen in the last year or two. Because investor psychology is moving around so aggressively. Sometimes valuation has nothing to do with the psychological moves. When people start moving in herds.

JL: Sure. So the bottom line I’m getting from both of you here is that COVID-19 is really just the catalyst. But this was already in the making for several years probably looked like it was going to happen in the fourth quarter of 2018 and things turned around.
But this was inevitable anyway. And once you have the catalyst, it almost doesn’t matter how the virus plays out exactly. So there’s going to be some, even if economies are opened up, there’s going to be many people that choose to social distance, many, many industries are going to be badly hurt and the domino effects that had been set into motion where one industry turns over and then that — oil and energy turns over and then that hits the banks and then that hits real estate and manufacturing and every other sector. Those pieces are always already in place,

BL: And also to everyone’s thinking, oh, when they get the economy open, things will be better. I was listening to lots of different interviews and one interview I was listening to was from a guy who runs a tractor supply store in Denver. And he says, I don’t care about the business, I’m losing this month or next month, what I care about, is the fact that I could lose 20% of my business over the next year. And he goes, that is my profit. That’s the problem here.

DT: And that’s a great point, as I mentioned before the operating leverage. And then a company cannot afford to lose 20%, 30% off the top. That doesn’t mean his profits go down 20%. I mean, it means the profits go away. And the whole economy is this kind of just in time. We need to be operating exactly where we are.
And if you lose 5% or 10%, off the top it is severe, you lose 30% or 40% off the top, the impact on your profitability is extreme. And then you couple that with the fact that on the solvency side these companies and individuals also don’t have much margin of safety. And they can’t get through six months of a down period. A lot of times you can’t get through a one month of a down period.

JL: Sure. All right. Well, anyway, hope you guys are wrong to some extent, just not even in terms of markets, just in terms of the massive amount of pain and suffering that it means for US businesses, individuals and people across the world who are experiencing similar things.
But I guess what goes up must come down to some extent. And when you’re leveraged to the extent that economies like the US have been, there has to be some kind of a deleveraging process at some point.

DT: I’m glad you said that, Jonathan, because Brad, John and I are real people, we hate that people are going through pain and suffering and unemployment is high. And people have lost loved ones in this. And we are not ogres trying to protect people’s portfolio by providing a short side component to the portfolio.
We truly hope every day we’re wrong and that we get through this positively. But our job is to objectively assess this and try to do the best that we can for our clients.

JL: Sure. It is well put. So anyway before we wind things down here I want to thank you guys for being so generous with your time here today. What’s the best place for listeners that want to further research either HDGE or other things you’re working on, LMTR et cetera? Where’s the best place online for listeners to go and continue the research process?

BL: So lmtr.com is our research portal, and it’s free. You can sign up for a newsletter. And we send out stuff a couple of times a week at least I do. Chart of the week and sentiment update. Chart of the week is usually something that I see that is interesting relative to the time to the current time.
I was there putting out lots of bearish charts of the week in the fourth quarter at the lows. I actually was putting out some pretty bullish type charts of the week. So those charts of the week are actually pretty important to look at that.
Then we also do a sentiment update where we’re reviewing the optimistic or pessimistic nature of the participants with inside of the market through different gauges and polls, and we put that out usually on Thursday or Friday. And then David is recently just come on the site to start blogging, and he’s going to start putting out a couple of pieces a month. And then anything on the HDGE ETF, you can go to advisorshares.com and our fact sheet and data holdings and things like that are on the site there.

JL: Nice. And we’ll link to all that from the accompanying article in the description of the podcast and all the major platforms, Apple, Google, etc. And then what about social media? Are you guys doing anything on there? Anywhere for listeners to follow you Twitter, LinkedIn, Facebook?

BL: We are on LinkedIn. David’s on LinkedIn, too.

DT: Yeah, I tweet. I tweet every now and then as well. But I’m going to start writing a little more for LMTR.

JL: Nice. That’s great. Anyway, I want to wish both of you best of luck, health obviously first and foremost. But also best in luck in everything you’re doing right now. Definitely providing a very important service, allowing investors that really don’t want to be long only have the ability really in a relatively easy and simple way to access the short side of the market without needing to be financial wizards and understanding all kinds of exotic products. So thank you for that. And I hope we can do this again soon.

DT: Thank you so much, Jonathan. You’re providing a great service to your listeners and readers.

BL: Thank you very much. We’re big Seeking Alpha users.

JL: All right, great. Thanks, guys.

For disclosures HDGE is currently short most of the stocks we mentioned in today’s show. For a full list of holdings updated daily, go to advisorshares.com/etfs/hdge. I Jonathan Liss am long hedge in my personal investing account.

Disclosure: I am/we are long HDGE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: HDGE is currently short many of the stocks we mentioned in today’s show. For a full list of holdings, updated daily, go to advisorshares.com/…

Jonathan Liss currently has a small long position in HDGE.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.