Archives for February 2018

The Rick Gates Plea, an Apple Watch Mess, and More Security News This Week

Robert Mueller’s indictment of Russia’s Internet Research Agency—also known as the “troll factory”—feels like years ago at this point. It’s only been a week! And we took a deep dive into what it really says about Russia’s propaganda efforts during the 2016 presidential campaign and beyond. Trump campaign advisor Rick Gates has also copped a plea deal with Mueller’s team—which could have big implications for the investigation going forward.

We also got a rare look inside the toolkit of an up and coming North Korean hacking group, called APT37, which has recently started to branch out beyond targeting just its neighbors to the south. Meanwhile, cryptojacking struck once more, this time glomming onto Tesla’s public cloud to mine cryptocurrency. The silver lining? While sensitive data was apparently exposed, the hackers don’t appear to have pilfered any of it.

For whatever the inverse of a silver lining is, we look to US Customs and Border Protection, which has required RFID chips in passports for over a decade but never got around to installing the software that verifies the cryptographic signature, making forgeries and tampering potentially easier. And did you know that Facebook makes some users download antivirus software? It’s true! And weird! And not ideal!

And while it’s a rarity, there also was some good news this week. WhatsApp co-founder Brian Acton has infused $50 million into Signal, the gold standard for encrypted messaging, which should secure its viability for years to come.

And there’s more. As always, we’ve rounded up all the news we didn’t break or cover in depth this week. Click on the headlines to read the full stories. And stay safe out there.

Apple Repair Center Barrages Sacramento’s 911 Operators

Since October of last year, devices at an Apple repair center in Elk Grove, California have called 911 an average of 20 times a day, for a total of about 1600 dials, according to a local CBS affiliate. Apple acknowledged the issue in a statement, saying, “We take this seriously and we are working closely with local law enforcement to investigate the cause and ensure this doesn’t continue.” That investigation likely won’t take long; the Apple Watch automatically calls 911 if you hold the side button down for several seconds. Tapping the side button of your iPhone five times in succession does the same, if you’re on iOS 11. Those features are obviously helpful to people in legitimate danger. But unless Apple can wrangle its Elk Grove process to stop the influx of false alarms, it may end up blocking actual calls from getting through.

Money Laundering Hits Amazon’s Kindle Store

Here’s a novel way to launder money, as reported by Krebs on Security: Use a computer to generate about 60 pages’ worth of text. Slap a title and cover on it and toss it in the Kindle Store under someone else’s identity. Charge several hundred dollars for it. Buy it dozens of times with stolen credit cards, pocketing the 60 percent cut that Amazon shares with authors, and sticking the person whose name you stole with the tax bill. It sounds a little convoluted, but no more than your average John Barth short story. And in the case reported by Krebs, the scammers were able to successfully launder $24,000.

Stalkerware Finds Customers At the FBI and ICE

Consumer spyware is a bit of a scourge, as Motherboard has covered extensively. It becomes potentially even more alarming, though, when those consumers also happen to work for the FBI, DHS, or ICE. According to hacked data from spyware provider Mobistealth, people with email addresses from those and other law enforcement organizations have purchased the so-called stalkerware, as well as at least 40 members of the US Army.

The Black Market for Fake Certificates Lets Malware Thrive

Cryptographic certificates are an important part of internet security; they let your computer know that any given piece of software comes from the company it claims to. This week, researchers at Recorded Future released research that shows the market for counterfeit certificates jumped starting last year. The concern here is more over niche or targeted operations, given the expense of a fake, but the results can be vicious, tricking antivirus protections into thinking an intruder is legitimate.

Trump's Tax Plan: Bad News For Amazon, Tesla, And Netflix Shareholders

Trump Tax Plan’s Effect on Inflation and Interest Rates

As everyone now knows, President Trump got his corporate tax reduction bill passed in late December, lowering the tax rate on domestic business from 35% to 21%. Thus far, most investors and pundits have focused on how the lower corporate rate is a boon to big companies nationwide. Obviously, lower taxes should lead to higher profits, all else remaining equal. However, what has received a bit less attention is the effect that the tax plan will have on future interest rates and inflation. According to the Congressional Budget Office, the tax plan will add an additional $1.4 trillion (yes, that’s $14 followed by 11 zeros – or, if one prefers, 1,400 stacks of $1,000,000,000 each) to the federal debt over the next decade. Clearly, with the economy already strong and with debt levels already high, the tax bill should almost certainly result in higher levels of future inflation and, hence, higher future interest rates.

Indeed, it took only a month and a half after the tax plan’s passage for investors to feel the first jolts from higher inflation, as CNN reported on February 6th:

Be careful what you wish for.

Wall Street partied hard while President Trump pushed for huge business tax cuts that the economy didn’t really need. Tax cut euphoria carried the Dow a breathtaking 8,000 points to levels never seen before.

Now comes the hangover. Investors are remembering that giving lots of medicine to an already healthy economy can have side effects, namely inflation.

Those inflation fears are suddenly rocking Wall Street. They sent the Dow plummeting 1,800 points in just two trading days. The losses wiped out a quarter of the gains since Trump’s election.

For months, investors basically ignored the threat that the tax cuts might backfire, causing bond yields to spike and raising the likelihood that the Federal Reserve will have to raise interest rates faster to fight inflation.

“We have an infinite capacity for self-delusion as investors,” said Bruce McCain, chief investment strategist at Key Private Bank. “When we feel good, we don’t want to be bothered by reality.”

How Inflation Swindles the Equity Investor

So, what does all this mean for shareholders? Back in May 1977, Warren Buffett wrote an article for Fortune magazine (full article linked here) entitled “How Inflation Swindles the Equity Investor”. Given that we now appear to be heading into an era of higher inflation, it pays to take a look back at Buffett’s thoughts on the subject from nearly 41 years ago. How does Buffett describe the relationship between inflation and equities in the Fortune article? First, he refutes the previously accepted view that equities act as an effective hedge against inflation:

There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner. You hardly need a Ph.D. in economics to figure that one out. It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might. And why didn’t it turn out that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds. I know that this belief will seem eccentric to many investors. They will immediately observe that the return on a bond (the coupon) is fixed, while the return on an equity investment (the company’s earnings) can vary substantially from one year to another. True enough. But anyone who examines the aggregate returns that have been earned by companies during the postwar years will discover something extraordinary: the returns on equity have in fact not varied much at all.

Basically, Buffett takes the view that equities are disguised bonds that pay around 12% on par value (i.e., book value, or shareholders’ equity). Thus, stocks are hurt just as much as bonds when inflation rises because the price-to-book ratio (and, consequently, price-to-earnings and price-to-sales ratios) for stocks must necessarily decrease just as a bond’s price decreases in inflationary times. Conversely, the lower the relative level of inflation, the higher bond prices rise and the more P/B, P/E, and P/S multiples for stock expand (all other things being equal).

Buffett goes on to identify a key additional characteristic of low inflationary environments: they favor companies that reinvest their earnings (versus paying them out via dividends). Why? Because when stocks are trading at 3.4X book value, as they are today, every $1 of cash from operations that gets reinvested in said book value should translate into an incremental $3.40 in market value for the shareholder (versus worth just $1 when paid out as a dividend, or even less after payment of taxes thereon). Buffett explains further:

This characteristic of stocks – the reinvestment of part of the coupon – can be good or bad news, depending on the relative attractiveness of that 12%. The news was very good indeed in the 1950s and early 1960s. With bonds yielding only 3 or 4%, the right to reinvest automatically a portion of the equity coupon at 12% was of enormous value. Note that investors could not just invest their own money and get that 12% return. Stock prices in this period ranged far above book value, and investors were prevented by the premium prices they had to pay from directly extracting out of the underlying corporate universe whatever rate that universe was earning. You can’t pay far above par for a 12% bond and earn 12% for yourself.

But on their retained earnings, investors could earn 12%. In effect, earnings retention allowed investors to buy at book value part of an enterprise that, in the economic environment then existing, was worth a great deal more than book value.

It was a situation that left very little to be said for cash dividends and a lot to be said for earnings retention. Indeed, the more money that investors thought likely to be reinvested at the 12% rate, the more valuable they considered their reinvestment privilege, and the more they were willing to pay for it. In the early 1960s, investors eagerly paid top-scale prices for electric utilities situated in growth areas, knowing that these companies had the ability to re-invest very large proportions of their earnings. Utilities whose operating environment dictated a larger cash payout rated lower prices.

We note here that the 30-year Treasury bond yield has jumped up recently, appreciating about 45 bps over the past six months to the ~3.20% level (source):

30 year

Granted, we are not even remotely close today to the ~15% level of the early 1980s, however, for equity investors, we currently appear to be moving in the “wrong” direction, at least if one buys into Buffett’s thesis. Indeed, looking at the very long view, it appears that the ~35-year bond bull market may finally be ending (source):

Now, we know why investors have been in love with so-called “growth” companies (especially big tech companies) during the recent moderate growth, low interest rate, and low inflation environment. These tend not to pay dividends but rather reinvest all their cash flows into existing or new operating businesses. Consider Amazon (AMZN) for a moment. All operating cash flow is plowed back by Jeff Bezos either into the existing retail business or in newer businesses such as Amazon Web Services. Unfortunately, the higher interest rates rise, the lower the relative benefit of the reinvested dollar for shareholders, and the less attractive “growth” stocks look compared to stodgy dividend payers like AT&T (T) or General Motors (GM) (again, other things being equal).

Buffett notes that a “reversal” phenomenon took hold in the mid-to-late 1960s just after major institutional investors had stampeded into growth stocks at nosebleed valuations:

This heaven-on-earth situation [regarding the superiority of growth stocks in low interest rate environments] finally was “discovered” in the mid-1960s by many major investing institutions. But just as these financial elephants began trampling on one another in their rush to equities, we entered an era of accelerating inflation and higher interest rates. Quite logically, the marking-up process began to reverse itself. Rising interest rates ruthlessly reduced the value of all existing fixed-coupon investments. And as long-term corporate bond rates began moving up (eventually reaching the 10% area), both the equity return of 12% and the reinvestment “privilege” began to look different.

Are we on the precipice of a new downward revaluation of stocks, given looming inflation? Today, stocks trade around 3.4X book value, compared to 2.0X book value in 2009 and just 1X book value in 1980. Let’s take an extreme scenario where interest rates are rising significantly and investors are only willing to pay book value for the S&P 500 again, as they did at the conclusion of the last bond bear market. Obviously, a growth company that trades today at 10X book value pays no dividends and earns 15% return on equity has much more potential downside than a dividend payer trading at 1.5X book value also earning 15% return on equity, since, even if the former were to trade at a consistent 3X the market multiple of book value (as it does now), it would still lose 70% of its value in the adverse scenario (i.e., its valuation would be reduced from 10X book to 3X book). In comparison, the dividend payer now trading at 1.5X book value might trade down to 1X book in the adverse scenario, meaning it would only have 33% downside, or less than half that of the growth stock.

Wither Tech Stocks Post-Trump Tax Reform?

So, how do some recent market darlings trade versus book value? Below are 5-year price-to-book charts for Amazon, Tesla (TSLA), and Netflix (NFLX):

PB 1

PB 2

PB 3

We find that Amazon trades at 26X, Tesla trades at 14X, and Netflix trades at 34X book, or an average for the three of about 25X book value. This represents a multiple of over 7X the overall market’s (already historically high) P/B ratio. Moreover, none of these companies pays a dividend, so they receive maximum credit from investors for the fact that all cash (including cash sourced from incremental debt) gets reinvested in the underlying business at book value. As interest rates have relentlessly fallen during the current 9-year bull market, investors have logically marked up the equity valuations of these three to higher and higher multiples of book value. If Buffett is correct, however, these will be the very companies whose valuations contract the most when inflation and interest rates rise, as should occur in an era of higher and higher government spending and deficits.

Moreover, the likes of Amazon, Tesla, and Netflix are also the type of companies helped the least by the Trump tax cuts. For one thing, they are either unprofitable or marginally profitable, so cutting their tax rate yields minimal to no gain for them in terms of immediate earnings and cash flow. Second, the value of any deferred tax assets on their balance sheets is lower, since going forward, the amount of taxes they will be able to offset with their DTAs will be lower under a 21% tax regime than a 35% tax regime (for example, Tesla had $2.4 billion in DTAs on its balance sheet as of the end of 2017). Finally, the current market valuation for all three companies is largely based on investors’ expectations of massive profits many years down the line (under typical sell-side analyst DCF analyses, near-term profits for these companies remains subdued to nonexistent and then explodes to the upside in the out years, similar to a hockey stick effect). Yet if the tax cuts lead to higher interest rates, the present value of these out-year profits will necessarily be less, as the discount factor applied to them will be higher. Thus, we find that the Trump tax cut has a triple negative effect on companies such as Amazon, Tesla, and Netflix.

Indeed, media outlets noted the initial negative tech investor reaction to the tax bill:

CNBC Tax

Of course, certain highly profitable large-cap tech players such as Apple (AAPL), Google (GOOG) (NASDAQ:GOOGL), and Microsoft (MSFT) should benefit from the Trump tax plan, as their cash taxes should decrease significantly going forward. In addition, they will be able to repatriate billions of overseas profits at favorable rates. Thus, not all tech companies should be put into the same boat.

Conclusion

The passage of the Trump tax plan looks to be a major negative for companies like Amazon, Tesla, and Netflix. Not only do they fail to benefit immediately from the lower corporate tax rate (since they generate minimal to no profits), the present value of their future profits is less if higher government deficits lead to higher long-term interest rates (a process which seems to be already well underway). Not only that, but if Warren Buffett’s analysis is to be believed, higher rates will necessarily cause price-to-book multiples to contract market-wide from the current (historically high) 3.4X level. As a group Amazon, Tesla, and Netflix trade at a massive 7X the overall market’s P/B ratio, indicating that the downside risk from such a contraction could be significant. To be sure, the valuation of any individual company depends on many variables, including the quality of management and products, revenue versus expense growth, market share dynamics, etc. However, the truly scary thing for Amazon, Tesla, and Netflix shareholders about the Trump tax bill is that the negative knock-on effects for these companies, as outlined in this article, are completely outside their and their company managements’ collective control.

Disclosure: I am/we are long GM, AAPL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are also short TSLA and NFLX.

Apple’s Long-Awaited AirPower Could Launch in March

It’s been awhile since we’ve heard much about Apple’s AirPower wireless charging device. But it might finally hit store shelves soon.

Apple is planning to release its AirPower wireless charging accessory on time in March, Apple-tracking block Macotakara is reporting, citing people who claim to have knowledge of the company’s plans. There’s still no word on exactly when the AirPower will launch in March, but it’ll be available both in Apple’s stores and at Best Buy, according to the report.

Apple unveiled its AirPower with the announcement of its iPhone 8, iPhone 8 Plus, and iPhone X last year. AirPower is a wireless charging mat that users can place their iPhones and Apple Watches on and power them wirelessly. The charging mat also works with the company’s AirPods to keep the wireless earbuds filled with power. Apple only discussed the AirPower briefly last year and said that it would share more details, including pricing and availability, sometime in early 2018.

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Rumors have been swirling that Apple is planning to hold its first major press event of 2018 in March, where it could unveil new iPads and MacBooks. It’s possible that the company could use that event to reveal more details about the AirPower and its availability.

Apple, however, hasn’t announced any plans for a March event yet. The company has also remained silent on AirPower plans.

This Is How Much Snap CEO Evan Spiegel Got After IPO

Snap Inc.’s Chief Executive Officer Evan Spiegel is poised to become one of the highest-paid U.S. executives for 2017, thanks to a $636.6 million stock grant he got when his company went public.

The Venice, California-based maker of the Snapchat photo-sharing app awarded Spiegel shares equal to 3 percent of the outstanding capital stock when the initial public offering closed in March, according to the firm’s annual report filed Thursday. He’ll receive the shares in increments through 2020.

Snap has had a volatile first year as a publicly traded company. Executives overseeing product, engineering and sales have departed. Facebook Inc. has copied some of its most popular features for bigger audiences and Twitter Inc. is said to be working on a new Snapchat-style product.

Scores of users including Kylie Jenner have criticized the recent update of the app. The stock fell as much as 7.2 percent on Thursday after Jenner tweeted to her 24.5 million followers, “sooo does anyone else not open Snapchat anymore? Or is it just me…ugh this is so sad.” The stock also has lagged the S&P 500 Information Technology Index in the past 12 months.

Read More: Snap Royalty Kylie Jenner Erased a Billion Dollars in One Tweet

Spiegel, 27, also received about $1.08 million in company-paid perks including legal fees and $561,892 for personal security services. His salary was cut from $500,000 to $1 around the time of the IPO.

Chief Strategy Officer Imran Khan received $100.6 million in compensation last year. That includes a grant of stock worth $100.1 million that will be fully vested within about a decade regardless of the firm’s performance.

Both Spiegel’s and Khan’s grants were one-time awards, according to the filing. Companies often grant large blocks of equity to executives when they go public, saying such awards are necessary to keep them on the job.

Spiegel last week sold about $50 million of stock, his first disposal since the firm went public. The company’s executives and directors have sold about $160 million worth of shares since the IPO, according to data compiled by Bloomberg. Some of those transactions have been made solely to cover taxes on shares that vested.

Here Are the Next Cities to Get Amazon Go Cashier-Less Stores

Amazon’s attempts at creating a cashier-less convenient store that people actually want to go to are expanding to more cities.

The e-commerce giant will open up to six more Amazon Go cashier-free stores this year, Recode is reporting, citing people who claim to have knowledge of its plans. A few of those locations will be opened in Seattle, home to Amazon’s headquarters and the first Amazon Go stores. The company could also open in Los Angeles, among other cities.

The first Amazon Go store opened last month in Seattle. Unlike a traditional convenience store, there are no humans there to check you out when you buy products. Instead, customers simply walk into the store, pick up what they want, and they’re automatically charged for their purchases on their accounts. The stores use a variety of scanning technologies and algorithms to monitor patrons and verify purchases.

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For now, Amazon Go stores are tests to see if a cashier-less experience is feasible. The company’s decision to expand to more locations across Seattle and Los Angeles suggest that the early experiments are going well. But a true test centers on Amazon testing its Go locations in multiple places where customer behavior could be different. The effort to expand in six more locations this year appears to be a step in that direction.

The report didn’t specify as to when Amazon might open these Go stores and at least so far, the company hasn’t confirmed the news. Amazon also didn’t respond to a Fortune request for comment on the report.

Beware of Pranksters Crashing Apple iPhones Using Twitter

If you’re an Apple iPhone user who also enjoys Twitter, listen up.

Pranksters on the social media service have been sharing a character from the Indian Telugu language that causes iPhones to crash, according to Mashable. The offending users have been putting the character into their Twitter usernames and tweets and encouraging people to share them with their friends. If the character lands in a user’s Twitter feed, it will cause the social app to crash. The app will continue to crash after users try to boot it back up, ultimately stopping victims from accessing the service on their iPhones.

Last week, reports surfaced saying that a single Telugu character was enough to wreak havoc on iPhones. When the character is sent via any messaging or social networking app, the affected user’s app will crash. While it’s an obscure bug that only affects Apple’s iOS 11, it’s one that pranksters and those trying to cause harm are exploiting across the Internet. Worst of all, there’s no fix at the moment and unsuspecting victims needn’t do anything to be affected.

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Apple acknowledged the Telugu bug last week and has promised a fix. The company hasn’t yet delivered, though, and it’s impossible to say when it’ll be released.

According to Mashable, which tested the bug on Twitter, the only way for affected users to regain access to the app is to log in via Safari and block the person that shared the character. At that point, the character won’t show up in their feeds and Twitter will be accessible.

Here's Why You Shouldn't Pay $1.10 For A Dollar Of Investment Grade Bond Assets

I’ve received questions from prospective subscribers about the types of trade alerts that we issue to the members section of the Cambridge Income Laboratory. One type of trade is CEF arbitrage, or more specifically a pairs trade, where we simultaneously identify an overvalued CEF and an undervalued CEF in the same sector. The strategy then entails selling or selling short the overvalued fund while simultaneously buying the undervalued fund.

The advantage of a CEF pairs trade is that because both the sold and bought funds are from the same sector, we aren’t making a directional bet on the performance on the underlying assets. Instead, we’re simply relying on the powerful concept of reversion of CEF premium/discount values (see Reflections On Chemist’s CEF Report Pick Performance In 2017 for how this has worked well for us in the Chemist’s monthly CEF picks).

There are two main limitations of the CEF arbitrage strategy. The first is that the magnitude of the gains are unlikely to be very large, simply because it is by nature a hedged strategy. That’s the trade-off for the strategy being relatively low risk. The second limitation is that unless you already own the overvalued CEF identified in the pairs trade, you would have to locate shares of the overvalued CEF to sell short. With some of the smaller, less liquid CEFs, this can range from expensive to downright impossible. The most optimal set-up is therefore already owning the overvalued CEF, and then locking in profits by selling the fund and then replacing it with the undervalued CEF in the same sector.

With the introductory blurb out of the way, let’s see how this has played out for one of the more recent CEF pairs trade that we identified in the members section of the Cambridge Income Laboratory.

About 4.5 months ago (see Sell This Investment Grade Income CEF Now), we noticed the premium of Western Asset Income Fund (PAI), an investment grade bond CEF, suddenly spiking up to +10.16%. The 1-year z-score was +3.6, indicating that this fund was significantly more expensive than its recent history. My comments from the initial article are reproduced below:

I was looking through the CEF database today and noticed the Western Asset Income Fund (PAI) trading at an exceptionally high z-score of +3.6.

Its current premium of +10.16% is at a 5-year high.

(Source: CEFConnect)

A 1-year z-score of +3.6 tells us that the premium/discount is trading 3.6 standard deviations above its 1-year historical value. Statistically speaking, this would be a 0.02% probability of occurrence, assuming that the distribution of values is normally distributed (which it isn’t, but the point is that such a high z-score is a rare occurrence).

The 5-year chart above showed that the fund traded at quite substantial discounts over the past 5 years, sometimes exceeding even -10%. This makes the current premium of +10.16% even more unusual than the 1-year z-score of +3.6 would indicate.

At this juncture, I wanted to look at the entire history of the CEF since inception. Perhaps the past 5 years was just an anomaly, and that the CEF has commanded a consistent premium in the past? It turns out that was not so.

Going back to inception, only during a brief period in 2009 did the fund’s premium exceed 10%. An unusually high premium for an investment grade fund might be understood during the immediate recovery period after the financial crisis…but why now? I can’t think of a fundamental reason why someone would pay $1.10 for a dollar of investment grade debt.

(Source: CEFConnect)

I then check out the premium/discount values of the peer group. Maybe investment grade bond CEFs are for some reason on a tear thus accounting for PAI’s unusual premium? Nope, that’s not it.

The premium of PAI is 3rd-highest out of the 15 CEFs in the “investment grade” category of CEFConnect. But I don’t consider PIMCO Corporate & Income Strategy Fund (PCN) and PIMCO Corporate & Income Opportunity Fund (PTY) to be traditional investment grade income CEFs, so not counting those two funds PAI has the highest premium in the peer group.

(Source: Stanford Chemist, CEFConnect)

OK, so PAI is a pretty good sell or short candidate. What did I pair my short PAI position with?

What did I pair my short PAI position with? I chose the BlackRock Credit Allocation Income Trust (BTZ). I wanted to choose a fund with a negative z-score, but rather amazingly all 15 investment grade CEFs had z-scores 0 or greater. BTZ’s z-score of +0.8 wasn’t the lowest, but its discount of -9.04% was the widest in the peer group, as you can see from the chart above.

Next, I wanted to see compare the price and NAV returns of these two investment grade bond CEFs to check if there were signs of deteriorating portfolio values in the undervalued CEF, which might cause me to consider BTZ as the long partner in this pairs trade.

The opportunity for the pairs trade comes from the fact that PAI’s price return is significantly outpacing its NAV return, whereas that is not the case with BTZ. We can see from the chart below that PAI appears to be blowing BTZ out of the paper with a +19.29% YTD return compared to only +8.94% for BTZ.

Chart

However, their YTD NAV returns are nearly identical.

Chart

No warning signs there. That leads me to the conclusion that:

In summary, if you own PAI, now would be a great time to sell!

Let’s see how the thesis played out 4.5 months later. BTZ had a total return loss of -3.88% over this time frame. That’s bad, of course, but still relatively much better than PAI’s loss of -14.1% over the same period. In other words, BTZ outperformed PAI by 10.22 percentage points in only 4.5 months, or about 27% annualized.

Did PAI’s portfolio do much worse than BTZ’s? No, and in fact the reverse was true. PAI’s net asset value [NAV] fell by -2.10% over this time period, but BTZ’s was even worse at -3.24%.

If BTZ’s portfolio did worse than PAI’s, why was its total return (much) better? My regular readers will have already guessed at the answer: premium/discount mean reversion! Over the last 4.5 months, PAI’s premium of +10.16% has sank to a discount of -4.82%, while BTZ’s discount of -9.04% has widened slightly, to -11.9%. Therefore, the majority of the outperformance of the long BTZ/short PAI pairs trade was due to the contraction of PAI’s discount.

Chart
PAI Discount or Premium to NAV data by YCharts

Summary

This article hopefully conveys our thought process in recommending a pairs trade to our members. Anyone who owned PAI and swapped to BTZ to would have profited to the tune of ~10% in only 4.5 months (~27% annualized), which is equivalent to about 2.5 years worth of distributions from PAI!

Note that I did not need to do a deep dive analysis of either PAI or BTZ to initiate this pairs trade. This was based almost entirely on premium/discount mean reversion, or as my fellow SA author Arbitrage Trader likes to say, “simple statistics”.

Taking stock of the situation today, the long BTZ/short PAI trade has to be considered to be largely completed, as PAI is now trading with a discount of -4.82% and a 1-year z-score of -1.5, indicating that is now cheaper than its historical average. Although BTZ’s z-score of -2.5 is even lower, as is its discount (-11.9%), the gap in valuation is no longer there.

Are there any current opportunities? The following table shows the 12 CEFs in the database that currently have z-scores greater or equal to +2.5. If you own ones of these funds, if might be a good idea to seek out another fund in the same category that is trading with a more attractive valuation, particularly if the fund that you own is also trading at a premium. Don’t let mean reversion catch you out!

Name Ticker Yield Discount z-score
MS Income Securities (ICB) 2.71% -1.47% 3.9
BlackRock Science and Technolo (BST) 5.32% 3.05% 3.2
Tortoise MLP Fund (NTG) 8.61% 9.26% 3.2
ClearBridge Energy MLP (CEM) 8.85% 5.53% 3.1
Gabelli Utility Trust (GUT) 8.50% 44.95% 3.1
Templeton Emerging Mkts Income (TEI) 3.79% -8.17% 3.1
Sprott Focus Trust (FUND) 4.97% -8.86% 3.0
Nuveen S&P Dynamic Overwrite (SPXX) 5.58% 9.54% 2.9
RiverNorth Opportunities Fund (RIV) 12.09% 6.83% 2.7
Deutsche High Income Oppos (DHG) 5.42% -0.60% 2.6
First Trust New Opps MLP & En (FPL) 10.52% 6.67% 2.5

Western/Claymore Infl-Lnk Opps

(WIW) 3.79% -9.71% 2.5

(Source: CEFConnect, Stanford Chemist)

We’re currently offering a limited time only free trial for the Cambridge Income Laboratory. Prices are going up on March 1, 2018, so please join us and lock in a lower rate for life by clicking on the following link: Cambridge Income Laboratory.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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: I am long the portfolio securities.

Can Machines Save Us From the the Machines?

Is it just me or is the cyber landscape getting more scary? Even as companies and consumers get better at playing defense, a host of new cyber threats is at our doorsteps—and it’s unclear if anyone can keep them out.

My doom-and-gloom stems from the dire predictions of Aviv Ovadya, the technologist who predicted the fake news epidemic, and now fears an “information apocalypse” as the trolls turbo-charge their efforts with AI. He points to the impending arrival of “laser phishing” in which bots will perfectly impersonate people we know by scraping publicly available images and social media data. The result could be the complete demolition of an already-crumbling distinction between fact and fiction.

Meanwhile, the phenomenon of crypto-jacking—in which hackers hijack your computer to mine digital currency—has quickly morphed from a novelty to a big league threat. Last week, for instance, hackers used browser plug-ins to install malignant mining tools on a wide range of court and government websites, which in turn caused site visitors to become part of the mining effort.

The use of browser plug-ins to launch such attacks is part of a familiar strategy by hackers—treating third parties (in this case the plug-ins) as the weakest link in the security chain, and exploiting them. Recall, for instance, how hackers didn’t attack Target’s computer systems directly, but instead wormed their way in through a third party payment provider. The browser-based attacks feel more troubling, though, because they take place right on our home computers.

All of this raises the question of how we’re supposed to defend ourselves against this next generation of threats. One option is to cross our fingers that new technologies—perhaps Microsoft’s blockchain-based ID systems—will help defeat phishing and secure our browsers. But it’s also hard, in an age when our machines have run amok, to believe more machines are the answer.

For a different approach, I suggest putting down your screen for a day and picking up How to Fix the Future. It’s a new book by Andrew Keen, a deep thinker on Silicon Valley culture, that proposes reconstructing our whole approach to the Internet by putting humans back at the center of our technology. Featuring a lot of smart observations by Betaworks founder John Borthwick, the book could help us fight off Ovadya’s information apocalypse.

Have a great weekend.

Jeff John Roberts

@jeffjohnroberts

[email protected]

Welcome to the Cyber Saturday edition of Data Sheet, Fortune’s daily tech newsletter. You may reach Robert Hackett via Twitter, Cryptocat, Jabber (see OTR fingerprint on my about.me), PGP encrypted email (see public key on my Keybase.io), Wickr, Signal, or however you (securely) prefer. Feedback welcome.

The Google Chrome Ad Blocker Has Already Changed the Web

You might see fewer ads on the web from now on. But you probably won’t.

On Thursday, Google Chrome, the most popular browser by a wide margin, began rolling out a feature that will block ads on sites that engage in particularly annoying behavior, such as automatically playing sound, or displaying ads that can’t be dismissed until a certain amount of time has passed. Google is essentially blacklisting sites that violate specific guidelines, and then trying to filter all ads that appear on those sites, not just the particularly annoying ones.

Despite the advance hype, the number of sites Chrome will actually block ads on turns out to be quite small. Of the 100,000 most popular sites in North America and Europe, fewer than one percent violate the guidelines Google uses to decide whether to filter ads on a site, a Google spokesperson tells WIRED.

But even if Chrome never blocks ads on a page you visit, Google’s move has already affected the web. The company notified sites in advance that they would be subject to the filtering, and 42 percent made preemptive changes, the spokesperson says, including Forbes, Los Angeles Times, Chicago Tribune, and In Touch Weekly.

It may seem strange that Google, which still makes most of its revenue from advertising, blocks ads at all, especially since the company says it will even block those served by its own ad networks. But Google hopes ridding the web of its very worst ads might discourage Chrome users from installing more aggressive ad-blocking software that saps revenue universally.

A survey published by the industry group Interactive Advertising Bureau in 2016 found that about 26 percent of web users had installed ad-blockers on their computers, and about 15 percent had ad-blockers on their smartphones. Respondents gave a variety of reasons for blocking ads, including privacy concerns, page load times, and visual clutter.

The new Chrome ad-filtering feature doesn’t directly address privacy or page speed. Instead, it focuses only on blocking ads that violate guidelines published by the Coalition for Better Advertising, a group that includes advertising companies, publishers, and tech companies (WIRED’s publisher, Condé Nast, belongs to coalition member Digital Content Next). The group surveyed 25,000 users in North America and Europe to find out what ads they find most annoying, and used the results to craft a set of guidelines called the Better Ads Standards.

The guidelines identify four specific types of desktop ads and eight types of mobile ads that users find unacceptable, including ads that take up too much screen space, play audio automatically, and obscure the content users are trying to view.

Google has been reviewing the most popular sites in North America and the EU for violations of those standards. “We use a combination of manual and automated methods to review sites,” the Google spokesperson tells WIRED. “Every review is captured in video which is surfaced in the Ad Experience Report.”

The company notifies sites that are in violation of the guidelines before blocking them. Sites have 30 days to resolve the advertising issues Google highlights. If a site doesn’t resolve the issues, Chrome will attempt to filter all ads on those pages. Users will see a brief notification that ads have been blocked on a page. On desktop versions of Chrome, this will look a bit like pop-up blocking notifications, while on mobile it will look more like, well, a pop-up ad.

Chrome joins Apple’s Safari in offering limited ad-blocking features without the need to install third-party apps or plugins. Last year, Apple stepped up a feature of Safari that blocks third-parties from tracking what you do online, and added an option to Safari that allows users to view a stripped down, ad-free “reader view” of webpages by default.

Michael Priem, CEO of the Minneapolis-based advertising firm Modern Impact that works with companies like Samsung and Best Buy, says his clients worry about the impact these changes will have on their ability to reach consumers. But he says companies generally understand that bad advertising practices have a negative impact on their brands. “As long as you’re practicing respect for our audience, you’re OK,” he says.

The big question is how much Google’s moves will actually discourage people from using more aggressive ad-blockers. Yes, it’s already motivated a few sites to make some changes, and others will likely follow. Given that Chrome is used by about 56 percent of web users, according to StatCounter, being filtered could amount to a massive drop in ad revenue for sites that don’t preemptively clean house. But it’s unclear whether disappearing only the most annoying one percent of ads on the web will stop people from installing ad-blockers—let alone win back people who already use them—if other irritating practices continue, and users still worry about privacy and security.

Major web browsers have long blocked ads that open new browser windows. The end of those “pop-up” and “pop-under” ads was a blessing. But it didn’t stop new forms of aggravating ads from proliferating. Getting rid of talking ads and countdowns would be great. Truly cleaning up the advertising ecosystem will take time.

Ad It Up

'Black Panther' Review: All That a Superhero Movie Can Be, and More

What should a superhero movie be? What can it be? With Black Panther, we finally have an answer worthy of our time.

In the last decade alone—where the promise of progress in Hollywood read first as fantasy, then as farce—America’s cathedral of heroes offered little access to depictions that fell outside the mechanisms of the industry. Batman and Iron Man, billionaires. Thor, a Norse god. Spider-Man, a youthful prodigy. Captain America, a World War II recruit, became the literal manifestation of national courage and hope.

Black superheroes were never afforded the same deification. During the tail end of black cinema’s golden age, Wesley Snipes’ early-aughts Blade trilogy flirted with pop immortality, but even that character’s legend faded across the years. I sometimes wondered if black superheroes were ever meant to endure in the mainstream, the truth of America being what it is, or if the recurring image of black valor was too much of an irritant to the illusion Hollywood needed to project, to protect.

As you can imagine, what emerges in the opening tints of Black Panther sets the stage for no ordinary undertaking. Here, the past and present are linked by a shared future. Writer-director Ryan Coogler, raised as he was in Northern California, stays close to home, dropping us in the murk of 1992 Oakland. The occasion—death.

We are first introduced to Prince N’Jobu (played pristinely by Sterling K. Brown), a Wakandan spy who is secretly selling vibranium—the meteoric ore native to Wakanda that is the life source to the nation’s technological prosperity—to Ulysses Klaue, a rogue black market dealer. When N’Jobu’s misdeeds are unearthed, King T’Chaka, his brother, is forced to confront him. Their meeting ends fatally, and the king must bear the weight of his secret: that it was he who murdered his brother to save the life of Zuri (Forest Whitaker), his trusted advisor. And though we don’t know it yet, this is the film’s heart, the moment every subsequent action will flow through.

The ensuing story splits along dueling ideologies. It picks up where Captain America: Civil War drew to a close, with T’Challa (Chadwick Boseman) assuming control of his country’s fate in the wake of his father’s death. For decades, Wakanda’s utopian spirit has thrived under the cloak of East Africa’s ethereal beauty, believing that if world powers discovered its technological and scientific ingenuity, the country would risk constant threat. Old-guard preservationists—among them, T’Challa’s mother Ramonda (Angela Bassett) and Okoye (Danai Gurira), head of the king’s women-only security unit, Dora Milaje—believe the country must continue as it has for centuries, solely nurturing its own people. Others, like W’Kabi (Daniel Kaluuya) and Nakia (Lupita Nyong’o), confidants to T’Challa, subscribe to a more pan-Africanist worldview, believing that Wakandans have a great duty to aid the less fortunate—be they refugees, poor kids in the US, or activists caught in the tempest of protest against unjust state influence. The time comes when Wakanda can remain immune no longer, realizing that it too must yield to the cry of a changing world.

A specter of change arrives in the form of Erik “Killmonger” Stevens (a villainous, power-drunk Michael B. Jordan); he’s a former Black Ops mercenary fueled by blood and vengeance for the death of this father, Prince N’Jobu. His price is T’Challa’s throne and sovereignty over the nation. Killmonger, who finds an ally in W’Kabi, believes Wakanda must position itself as a global wellspring by equipping marginalized factions with its cutting-edge weaponry—a move he’s sure will liberate the country from the shadows and into an international superpower. Coogler and Joe Robert Cole, who co-wrote the script, turn an age-old narrative on its head via Killmonger’s revisionist fury: The colonized as the colonizers.

Lines are drawn, and what transpires is a film of beauty, backbone, and startling discipline. Technically lush, Black Panther infuses itself with diasporic hybridity: Wakandan dress, architecture, and dialect pull from Mali, Nigeria, Kenya, Ethiopia, and Tanzania. Rachel Morrison, the Academy Award-nominated cinematographer attached to the film, delivers shots full of color and pure awe. When T’Challa travels to the ancestral plain to seek advice from his father, its gaping purple skies extend into the theater, as if we are on this dreamlike quest too. As Marvel films go, Black Panther is rife with franchise touchstones: thrilling action scenes—the most daring of which begins in an underground South Korean casino and rockets into a car chase through the frenzied streets of Busan—are undercut with moments of human spirit and levity (Letitia Wright’s Shuri and Winton Duke’s M’Baku offer up well-timed blushes of humor).

Coogler and T’Challa chart a parallel path here, seeking answers to the same question: who are you ultimately responsible to, your people or the people of the world? For his part, Coogler does due diligence by injecting the film with nods to black culture beyond the backdrop of Wakanda and the traditions of its people. I especially loved the moment when Jordan’s Killmonger, revealed to be of royal blood, calls Bassett’s Ramonda “auntie” with a razor-thin smirk. Or when Shuri jokes with T’Challa about the time-honored footwear he wore to impress tribal leaders, laying into him with, “What are thooose?!?!”

Even free of such context, Black Panther is an unmistakable triumph. Delivered through Coogler’s judicious eye, its existence alone generates a counter-history in film and mass media—first by scraping whiteness from its narrative core, then by making black people and black self-determination the default.

The 31-year-old writer-director has redefined the possibility of a superhero epic, a credit to his singular vision and belief that black stories matter, and that they imbue relevance on the big screen no matter what narrative shape they take. He proved that with Fruitvale Station, his breakout 2013 film about the killing of Oscar Grant, and again with Creed, the 2015 boxing flick that mined the importance of legacy and family.

Black Panther will manifest as a movement bigger than this moment. It’s more than historic pre-sale records, or box-office predictions. The collective hype that’s followed the film since inception has been absolutely volcanic, like nothing I’ve witnessed before.

It’s not that our need for black superheroes has shifted. Films like The Meteor Man and Steel may not have been commercially vibrant, but their stories and their images remain vital to black communities as what one friend described as “arbiters of hope and virtue in ways that transcend the limitations of our everyday, colonized lives.” Another friend who I spoke to this week shared a comparable sentiment: “we need black superheroes to remind ourselves that inventing yourself is not only possible, but necessary for survival.” I cite them because Black Panther, Coogler’s pièce de résistance, has been a reflection of shared hopes in creative industries where black identity is either undervalued or co-opted for empty laughs. These worlds, these august narratives, have always been viable to us.

So, what can a superhero movie be? It can be truth and fire and love. If we’re lucky, it is all of those things, perhaps more. It’s no mistake that Black Panther overflows with them.

All Hail King T’Challa