Happy Easter and a Long-Winded Story

I’m going to tell a story to try to explain a few things that seem relevant in today’s markets and economy.  Driving home from the gym, I drove past my old work from my early 20’s.  It was an amazing job at a small futures and commodities brokerage that specialized on selling options on market indices.  The company grew from nothing to managing several hundred million dollars in just a few years, and the margins were massive.  The reason for the growth was that the strategy was that 9 out of 10 times, the strategy successful, and the trading platform was very intuitive.  It was a period of very low volatility, which was perfect for the strategy.  However, in periods where volatility suddenly picked up dramatically, the losses could be massive and outweigh several years of profits, if not more.  My friend and I worked on the night shift, facilitating trades for Australian clients who loved these strategies.  When I took the job, I didn’t know much about options, but the more I learned, the more I saw how powerful the positive attributes are, but also how dangerous they could be if used improperly.  

When we weren’t on the phone taking orders, I’d read my nerdy investing books from the likes of Benjamin Graham, Martin Whitman, and of course everything ever written by Warren Buffett.  During that period of studying market history, I had my Michael Burry (from the Big Short) moment.  I realized that it was inevitable that the strategy the firm was using was bound to blow up.  You see, we were selling what are called iron condors on indices such as the S&P 500.  This strategy of selling both calls and puts at points maybe 7% above and below the current price, expiring in 30-60 days.  At the same time, you would buy calls and puts outside of the sold options, which would cap the losses from being potentially unlimited.  The strategy was successful the vast majority of the time, but when markets would move aggressively in one way, the losses were very large and permanent.  It is a big difference to what we do at TTCM, which is if as a worst case, we are exercised on our options, we end up owning stocks we wanted to own anyways, just at a far better price and then we can hopefully ride them higher as they recover. 

I called a meeting with the owners, and I gave them a detailed PowerPoint presentation breaking down the data.  I had already come up with the business concept of what eventually T&T Capital Management would become, so I recommended that they transition their more aggressive strategy, into the value-driven strategy that we use to this day.  With the head start and client relationships they already had; I have no doubt the firm would have been managing billions to this day.  We are able to take advantage of the statistical benefits of selling options, but without the same risks of taking permanent losses of capital, which was the death knell of their iron condor strategy.  I was 24 years old at the time, so I’m not sure how serious they took me, but ultimately my ideas were rejected.  Within a few months, markets started showing extreme volatility as the Financial Crisis began in earnest.  Within about 6 months, the company experienced about 4 losing trades, which resulted in a loss of assets of roughly 60%.  This was a strategy that had worked repeatedly with maybe 2 or 3 losses over the previous 6 years, but in 6 months, everything was ruined.  The lesson here, is that just because a strategy has worked repeatedly, if it is unsound in nature, ultimately it will fail, and one can lose everything.  Think about this when you see stratospheric valuations that don’t make any logical sense, but “everyone is doing it.”  Passive investing is valuation agnostic.  It works until it doesn’t, just like the iron condor strategy.

There was a second lesson I learned, and it occurred on the day that about 80% of the workforce got laid off.  We all knew it was coming as we lived through the business imploding in real time.  After it happened, I was talking to my friend who still is one of my closest friends to this day, and I asked him what he was going to do?  His answer was he was going to Vegas.  I warned him not to blow his money as it probably was going to take time to get a good job being that we were going into a recession, but he literally blew it all within a month.  Fortunately, after a rough few years, he bounced back and I’m now happy to say he is doing better than ever as a family man, but it was a long hard road.

If you want to know how our economy is being propelled look no further than our government debt. The current debt to GDP in the United States, as seen from the image at the top of the email, is over 120%.  As recently as 2000, the number was 54.9%.  This debt is fantastic at creating jobs, such as all the construction you see in most cities across the country right now.  It is great for funding huge multi-billion-dollar manufacturing centers, which we see in various states such as Arizona, Texas, and South Carolina.  The debt, combined with a horrendous geopolitical environment where we have multiple major wars occurring, funds massive weapons manufacturing which boosts GDP.  My friend had cash in his wallet and access to credit cards when he went to Vegas.  It didn’t matter that his earnings power had declined dramatically, and he experienced a great sugar rush.  On a much bigger and longer-lasting scale, that is what we are seeing in the economy.  There is no effort by anyone on any side to balance the budget.  Cutting debt? Yeah right.  As rates have increased, the debt interest costs keep climbing that much higher, enlarging the problem.  At some point, the chickens must come home to roost, and you don’t want to be the one dancing once the music stops and all the chairs are occupied.  What is the catalyst?  Maybe war, maybe inflation, maybe the Cyber Attack the “elites” in NGOs such as the World Economic Forum keep shoving down our throats as a high probability.

The cost of living has never been higher.  Whether it is the grocery store bill, homeowner’s insurance, rent, or picking up a sandwich at Panera, times are very difficult for most Americans.  With that said, unemployment is still very low, and the reshoring of manufacturing is a very favorable and durable positive trend, which can have an enormous impact for our country.  Market analysts and people in general seem perplexed by the incongruency of the inflationary stress they are feeling, contrasted with euphoric markets and decent economic data.  When things don’t add up, they often turn out to be too good to be true, just as that job turned out to be for me.  I don’t believe that the underlying health of the economy is as good as key indicators such as employment are indicating.  Even on the jobs front, full-time jobs have been declining, outweighed by gains in parttime jobs.  The bottom line is, we need to stay disciplined and sensible, even when others are losing their minds.

If you made it through that, thank you and I wish you and your family the Happiest of Easter holidays!  The stock market is closed Good Friday as a reminder, so I hope you enjoy quality time with your family.

Here is a link to all of our most recent radio shows where we have been covering a wide variety of financial planning topics each week: Radio Shows

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