Whaley's ETF Picks: Long and Short

02/01/2016 10:00 am EST

Focus: ETFs

Landon Whaley

Editor, Focus Market Trader

Landon Whaley assesses the interplay between fundamentals, quantitative analysis, and human psychology in determining the outlook for various financial markets and sectors. Here, the editor of The Whaley Report discusses his proprietary strategy and his current outlook on stocks, bonds, gold, and China.

Steven Halpern:  Our guest today is new to the MoneyShow audience, Landon Whaley, editor of the Whaley Report.  How are you doing today, Landon?  

Landon Whaley:  I’m doing real well, Steven.  How are you doing?  

Steven Halpern:  Very good.  Thank you for joining us.  Now, you’ve taken a very interesting career path from your initial goals of becoming a doctor and ended up founding an asset management firm.  How did that happen?

Landon Whaley:  Well, when I graduated from undergrad I actually had eight months to kill before I would matriculate to med school and so I actually applied for and got an internship with a Wall Street firm.  

At the time I was thinking, “Well, I’m going to go off and be a cardio-thoracic surgeon so I better learn how to invest all that money I’m going to make.”  Well, one thing led to another. Management came to me a couple of months into the internship and asked if I’d like to start the training program.

I accepted, deferred med school for a year, and the rest, as they say, is history.  I spent the next ten years between two Wall Street firms before stepping out on my own and launching my own firm back in 2009.

Steven Halpern:  Now, you do know of the proprietary trading cost system, which has consistently outperformed its peers in the fund industry and the hedge fund universe. Could you share a brief overview of your strategy?  

Landon Whaley:  Absolutely. The entire process is driven by two core beliefs. The first one is that markets are a dynamic interplay between fundamentals, quantitative analysis, and human psychology. It’s critical that we understand how all three of those factors are impacting a particular market before we put a trade on.  

The second belief is that we have to be independent, unconventional, and open-minded because we can’t make extraordinary returns if we’re evaluating markets the same way everyone else is.  

Steven Halpern: Now, you’ve been cautious on the current stock market and have been very correct in that position and you’ve recently pointed to three factors that you want to see in order to justify considering a change to a long position. Could you expand on what those three factors are?  

Landon Whaley:  Absolutely. I think if I take a quick step back and give you an explanation as to why I went short to begin with, that’ll help readers understand how I put our philosophy into practice.  It’ll also set the stage to answer what I would need to see to get long again.  

I went short—for the first time in two years—back in August on the S&P 500 (SPX).  At the time, that was contrarian, but the reason I did that was because there was a divergence I saw within the fundamental, quantitative, and behavioral aspects of the market.  

Fundamentally, we were shifting. Our models said we are shifting into a period of time where US stocks are going to underperform other asset classes.  While we were seeing that bear sign quantitatively, and from a behavioral perspective, the market still looked bullish.  

More price action was constructive, volatility was declining, fund flows were within normal ranges, so everything from what the market was telling was that everything looked fine, but fundamentally we were shifting.

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Whenever I see that, when I see a shift in fundamentals that the market hasn’t picked up on yet, I know it’s only a matter of time before we get to put on a trade that goes against the crowd in a way that minimizes the losses if we turn out to be wrong.  

With that as a backdrop, what I’d need to see to get long now is bearish—further bearishness on price action—people shifting in the S&P future markets to a short positioning, which, right now, they’re long, and I’d need to see a change in the growth trajectory of the US economy and/or change in the set policy.  

That would be the fundamental underpinning that would say, okay, it’s time to be bullish and then I would wait for the price action and the behavioral aspects of the market to confirm that.  

Steven Halpern:  In addition to having a short position on the US stock market, you’ve also been particularly bearish on China and have held a short position in the iShares China 25 ETF (FXI). Do you still see downside risk here?  

Landon Whaley:  There’s definitely downside risk in China, but I’m proceeding cautiously. I’ve been short China since September of 2014, and so, that’s a long period of time.  What I’m seeing now—obviously fundamentally—China’s still a horror show.  None of the PBOC’s stimulus actions have helped.  

Even just last week, they reported, China reported the big three in data—retail sales, industrial production, and fixed asset investment—all three data points showed that the economy continues to slow despite all that the PBOC has tried to do.  

Quantitatively and behaviorally, you couldn’t get more bearish than FXI.  I mean, the market’s crashed, meaning declined 20% or more, in just the last month alone. Behaviorally, there’s not one person in the world that thinks China’s not going down the tubes. Everything is tilted extremely bearish.

Back to my original perspective, that’s got me concerned as a bear. Right? I’m looking for any sign fundamentally that things are shifting positively for China because I’ll be looking to get long as long as the quantitative and behavioral aspects remain bearish, there’s a shift in fundamentals that no one else sees yet.

I would be looking to get long back in that market, but at this point, yes, I’m still short and still a bear.

Steven Halpern:  Now, in the bond market you have an interesting mix of positions.  You’re short the iShares IBoxx $ Investment Grade Corporate Bond ETF (LQD) and you’re long the iShares Barclays 20+ Year Treasury ETF (TLT). Could you explain these different positions?  

Landon Whaley:  Absolutely, absolutely.  The short LQD trade is a play on the entire monetary conditions that the strong US dollar has provided.  What most people…it’s well talked about that the strength of the US dollar has caused tighter conditions throughout the world and that a number of markets have been impacted, including the high yield bond market here in the US.  

What most people aren’t discussing is the fact that other corporate bonds, not just high yield corporate bonds, but other corporate bonds are going to be impacted by the tighter conditions.  If the high yield market is the far right edge of the corporate bond spectrum, then LQD represents the left side, from a credit quality perspective.  

These bonds are not immune to what’s going on in the global economy, they simply react last, right?  The junk bonds react first and then you move up the credit quality scale to the LQD, which will react last.  We’re starting to see that now.  

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As long as said policy remains in a raising or a non-easing state, and the rest of the world is in an easing posture the way they are from a central banking perspective, then I’m going to say short LQD because the tightening conditions are going to prevail.  

From a TLT perspective, I like that from the long side for sort of different reasons.  Look, the number one thing is fundamentally we’ve seen a shift and US growth is slowing, global growth is slowing; those dynamics trust whatever the Feds are doing and most people haven’t figured that out yet.  

What I mean by that is, when growth slows, people run to Treasuries.  They ignore policy and they run to Treasuries.  Most people haven’t picked up on that.  If you look at the price action and you look at the behavioral aspect of the TLT market, both are still extremely bearish.  Smart money, meaning hedge funds, large asset managers, have never been more short long-dated US Treasuries than they are right now.  

Again, quantitatively price action up until last week, TLT was still stuck in a significant trading range and below a two-year downtrend line.  Both of those are starting to break out of both of those. The beauty of it is this trade is nowhere near getting started, more shoes need to drop.

First, when markets figure out that the Fed isn’t going to raise rates four times this year, that’s going to move TLT higher.  

The second shoe that’s going to move TLT higher is when the market realizes the Fed is going to actually have to start easing again, which I think will happen by the end of this year or the first quarter of 2017.  Both of those things are going to propel TLT much, much higher than where it is right now.  

Steven Halpern:  Now, we only have a minute left, but on the bullish side you’re also recommending the SPDR Gold Trust (GLD), as well as the PowerShares US Dollar Bullish ETF (UUP).  Could you give us a brief overview of your bullishness on these two sectors?  

Landon Whaley:  Absolutely. With GLD, I see the same thing as with TLT.  We’re moving fundamentally into a very pro-goal environment; the market hasn’t picked up on it yet. Since, behaviorally, everyone is positioned extremely bearishly on gold.  

Price action, you can look at a charge of GLD and see that’s it been in a trading range and just recently started to break out, but hasn’t accelerated higher yet.  Once the market figures out the Fed’s not going to raise rates and/or they’re going to go back to easing, GLD is going to move much, much higher.  

UUP, again I’m long UUP the same way I’m short XXI, cautiously.  UUP, I’ve been long UUP since July of 2014 so I’ve been long for a very long time. What has me concerned at this point is positioning is overly crowded on the bullish side and sentiment is very pro-US dollar.  

I’m going to look for two things to see whether or not I should stay long or maybe shift to a short buy in UUP and that’ll be how the US dollar trades around Fed-related events and how—or at all—how positioning starts to shift in the dollars futures markets because, again, right now it’s extremely long.  

If that starts to shift to the short side and/or the dollar’s reaction to certain Fed-related events causes concern, then I might look to shift to the short side, but I remain right now a dollar bull and a UUP bull.

Steven Halpern:  Again, our guest is Landon Whaley, editor of the Whaley Report. It’s been a fascinating conversation. Thank you so much for your time today.

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