Monday, October 16, 2017

Grind Can Last a While

It is not at all unusual for the market to grind higher like this for several weeks in row, or even several months in a row.  It happened for nearly 12 months straight, with one brief interruption (in late Feb 2007), from August 2006 to July 2007.  It was a regular feature of the powerful bull market in the mid 1990s.  It just hasn't really happened since 2008, even with an 8 year old bull market.  You had regular meaningful dips from 2009 to 2016, which would scare out those who had 2008 flashbacks, only to V bottom higher.  This year, you had a few shallow dips, almost as if the dip buyers were so thick that they stopped the dips from getting deep.

It is the triumph of the dip buyers.  They have won. They have been so successful that the dips are now so shallow and brief, that even a 3% correction looks like a monster buying opportunity. 

When does it end?  You want to see a VIX that is rising when the S&P is rising.  That is the first and biggest clue.  You want to see less inflows into bond funds and more inflows into stock funds.  And you want to see China's markets do worse, because they often foretell broader global stock market weakness. 

It is a grind these days, and there is not much new to add.  I don't want to repeat myself, but the top is months away, so either be long (if you can ride bubbles) or in cash.  Just don't be short. 

By the way, I will be writing fewer posts with the lack of action.  If things pick up, I will write more.

Wednesday, October 11, 2017

On their A-Game

They are on their A-game.  I am talking about fund managers.  It is easy to not make big mistakes when you are making money.  An equity market at all time highs and a bond market that is stable is about as ideal an investing environment for institutions.  They will not do anything rash under these conditions. 

While you can question their long term positioning, in the short term, they are not making the mistake of puking out positions on a short term dip, because they have learned their lesson.  They realize it is a loser's game to set tight stops and regularly get stopped out, only to see the market reverse right away and go higher. 

It is a lot like poker players, when they are making money, they play more optimally and make better bet, call, and fold decisions.  There is no feeling of desperation to make their money back, so they can play more calmly and without need.  Usually those that are losing money start to play more hands, try to win more pots, and go on tilt.

Right now, the players in the game are making money, and not making any short term mistakes.  To try to make short term money in this market is like trying to squeeze blood out of a rock.  I would rather just play high stakes poker.  At least that game is more interesting than trading this market.

Here is the thing about playing the money game.  You have to want it, but not need it.  Those that can trade without a need to make money can play the long game, looking out months and years ahead.  Getting caught up in the day to day market action can often prevent one from catching the longer term opportunities.  That is where the real money is. 

Friday, October 6, 2017

Finding Distractions

Dabbling a bit in stocks, anything to keep me occupied and away from making any big trades.  There isn't much of an edge trying to make a stand here against this type of momentum, with the VIX so low.  This type of calm upward, relentless momentum reminds me of late 2006, early 2007.  If you remember, the market didn't top till summer of 2007, so if this market follows that analog, then we've got about another 6 months of uptrend remaining. 

We are seeing a lot of speculation in small cap stocks, which is also similar to what you saw in 2006/2007, as well 2014/2015.  They proceeded tops by about 6 to 12 months. 

So there are couple of very early warning signs that the clock is ticking.  But lots of time left before we hit the apex.  If you can't ride the bubble higher, just stay away.

Wednesday, October 4, 2017

Hedge Funds and Risk Tolerance

With the low volatility, the day to day trading edges are very slim.  Sure, these days there are a few small cap speculative stocks where you have insane and irrational moves, but there are lots of trading frictions in those markets, the difficulty in finding borrows, exorbitant borrow fees, extreme tail risk, and lower liquidity.  The liquidity is the big thing.  You can't move large size easily in small cap stocks, which limits the scalability of a strategy.  So that pretty much leaves either large cap stocks or futures/options.  Since the large cap stocks provide little leverage, futures/options are a much more attractive area for speculative trading. 

I recently heard that hedge funds are making a comeback, with inflows over $80B this year.  I also noticed that their YTD returns are 5.1%.  The SPX is up 12% this year.  Bonds are also up.  Once again, a simple 60/40 stock/bond risk parity strategy which can be put on for near zero fees is beating the hedge funds again.  I recently saw that a hedge fund of funds manager, Mark Yusko, made a bet with Warren Buffett that he could beat a SPX index fund in 10 years, net of fees.  I think Yusko will lose that bet.  Just because of the fees.  Even with the SPX highly overvalued, hedge funds are basically a more costly, lower beta play on the stock market. Hedge funds don't really provide alpha anymore, just damped down beta covered in a thin veil of secrecy to protect their 2 and 20 business model. 

The reason I bring up hedge funds is because they are the main reason there are short term market dislocations.  If you take away hedge funds, that removes a lot of the speculation in the futures and options space.  Most of the money going into mutual funds and ETFs don't make big bets on FX, interest rates, and commodity prices.  The hedge funds are there to provide more fuel to the fire, making trends last longer, going to prices they probably shouldn't go to. 

Most hedge funds in the futures space are trend followers, so in general, they will blindly buy strength and sell weakness.  In the past, when trends lasted a long time, it was a good strategy.  Nowadays with so many following the same strategy, as well as low inflation and money printing central banks, you don't have as many long term trends in FX, interest rates, or commodities.  So they have been getting churned and burned since 2008. The returns of the Barclays Hedge CTA index (survivorship bias inflates these returns) is basically flat since 2008, while the S&P has gone up over 200% in the same time period. 

These CTAs built up a lot of their record when the futures markets tended to have long trends, and before their strategy got overpopulated, splitting what little edge they got from following the trend with other hedge funds.

Whether it is hedge funds liquidating positions that have gone bad all at the same time, or piling into a position with a herd mentality, there are opportunities created in their trading.  But the only real way to capture those opportunities is to extend your time frame beyond the hedge funds' time frame.  The hedge funds' time frame is constrained by their inability to accept big losses, since institutions don't want a lot of volatility in a fund's performance. 

This is their big handicap. Risk tolerance.  Hedge funds cannot withstand big drawdowns, which means they have to cut their losses before they get too big.  This creates opportunities during their liquidations, because often, they are liquidating not because they suddenly discovered a fundamental change in the market, but because they hit their loss limit on the position and they had to get rid of it.  That is where the opportunity lies.

On the other hand, the individual trader can trade more aggressively and trade more optimal size because they can weather big drawdowns and don't have to worry about redemptions.  They don't have to puke out their positions as much.  Yes, sometimes the individual gets a trade wrong and has to get rid of it, but it should be based on criteria of market behavior and price action, not a loss limit.  Remember, the fastest way to grow your account size is to follow the Kelly criterion.  This exposes your account to big drawdowns, because you are betting your edge, basically. A 10% edge on a 1 to 1 bet calls for a 10% bet. A 99% edge on a 1 to 1 bet calls for a 99% bet! 

Most hedge funds can't bet that way.  They are reluctant to lose more than 2% on any one trade.  That is a big disadvantage.  They follow a much, much less risky money management strategy, which while safer, offers much lower potential returns.  This is why I believe profitable traders are much better off accumulating their own capital and trading it aggressively, rather than try to gather assets and trade more capital, but in the process be pigeon-holed by their investors' lack of risk tolerance.  Plus, its a headache dealing with all the paperwork and regulations of managing a fund.

I expect the hedge funds to be the ones to push this equity market towards its ultimate top, taking prices too high.  I also expect them to be the ones who liquidate their positions en masse as the trend changes.  That is what you saw in 2015/2016, and I think you see that again in 2018. 

Monday, October 2, 2017

Long Way to Go

The S&P just won't quit.  It is going to surprise the mean reversion traders here, as this thing will grind them to dust, as they look for that 5% correction.  The problem is, the 5% correction will probably finally happen about 10% higher than here.  There is nothing worse than being an early short in a bull market.  And pretty much anything except for shorting within 2-3% of the top is too early.  Which leaves a LOT of time for being early as a short seller. 

I don't know why this thing is going up. I just know that with high probability, we are nowhere close to the top, in both time and price.  The driving force higher could be a few things:  animal spirits, bubble psychology, and momentum building on itself.  It certaintly isn't improving fundamentals, not with the Fed looking to continue to raise rates.  Those tax cuts aren't going to move the needle unless they get everything that they want, which is unlikely.  And even if they did pass those huge tax cuts, the pain in the bond market from higher deficits and more Treasury supply would temper any stock market gains off the euphoria. 

These are the type of markets that favor those who are expert bubble riders, riding it to the top, and getting out when they sense the volatility rising and signs of a top building.  It is not easy, and its something I definitely will not do, just from the inherent vulnerability of a market that is trading so high with no fundamental backing.  I don't think we crack, but it does feel like being long is the equivalent of selling cheap put options.  And I don't use a put selling strategy. 

The only real comfort I can take from this type of market is that it is building up potential energy for the market to get exciting again when the SPX does finally top out.  I think that happens in spring/summer of 2018.  In the meantime, I will focus more of my energy on other markets which have better opportunities, such as bonds, commodities, or individual stocks.

Thursday, September 28, 2017

Big Tax Cuts are Dollar Negative

FX traders tend to base every currency based on interest rate differentials, and the difference of the near term policy direction of the various central banks.  The generally accepted view is that big tax cuts which provide fiscal stimulus should strengthen the dollar, based on its effect on monetary policy.  It is assumed that you get tighter monetary policy with tax cuts.  But that overlooks recent history.  

One of the main reasons the Fed started QE in 2009 was because it wanted to lower the interest rate burden of the large budget deficits after the recession, because large Treasury supply was going to have to be taken down, and the only way that was going to happen was either by selling at higher yields or by having the Fed by a huge chunk of the supply.  If the market had to digest all that supply at higher yields, you would have had an absurdly steep yield curve, higher rates for corporations and small businesses to borrow at, and higher mortgage rates that would be a negative for the housing market.

With the rising trend in mandatory spending on Social Security and Medicare, the budget deficits are set to rise substantially anyway, without any tax cuts.  You add the proposed budget buster tax cuts to the mix, and you will see $2 trillion budget deficits within a few years.  That is why the market didn't skyrocket yesterday on the Trump tax cut plan.  Rising interest rates with low GDP growth don't mix.  And these tax cuts aren't going to do much for GDP growth, as it's mostly going to those who will pile it back into savings in the form of stocks and bonds, not consumption.  

So what will end up happening is the higher interest rates will more than offset any fiscal stimulus from lower taxes, and when you get the economy slowing down, the budget deficits will skyrocket and you will get huge amounts of Treasury supply coming down the pipe.  The Fed will react like they always do when the economy slows down in the face of rising interest rates due to excess debt:  they will lower them, and then do another QE.  

So these tax cuts will eventually lead to Fed rate cuts and then QE in a couple of years.  Which will lead to dollar weakness, not dollar strength.  Tax cuts are a long term negative for the dollar, due to the higher budget deficits and subsequent larger Treasury supply.  Just look at how the dollar performed in the years after Ronald Reagan's tax cuts in the 1980s and George W. Bush's tax cuts in 2001.  

So if you see any large tax cuts pass, keep this in mind when it comes to the dollar.

Dollar Index (43 year historical chart)

Wednesday, September 27, 2017

A Budget Buster

Based on Trump's tax plan, there is no way the Republicans can stay within their budget guidelines of $1.5 trillion more debt over 10 years.  Politically, most of those deductions have no shot of getting eliminated, with the power of Washington lobbyists behind them.

But the bond market thinks that there will be huge debt fueled tax cuts. For Treasuries, it seems like shoot first, ask questions later at the moment.  This is definitely a budget buster, and will increase Treasury supply enormously over the next 10 years. With the trend of higher mandatory spending for Medicare and Social Security as the baby boomers retire, you could see $2 trillion annual deficits.  Without a QE, that will roughly quadruple the size of the Treasury coupon auctions.  And there is no way that much supply is taken down at these yield levels without a recession.

That is based on the premise that Trump gets everything that he's asking for.  That's probably unlikely, even though the Republicans are desperate to pass anything to save their hides in 2018 elections.  Most likely, the tax cuts get watered down, with no deductions removed, and the corporate tax rate gets cut modestly and you get a little increase in the standard deduction.

But the bond market is hating the uncertainty of a possible whopper of a tax cut passing, and with ECB tapering coming up in late October, a suddenly hawkish Yellen, and VIX hovering around 10, it is fragile times for bond investors.  Once the dust settles, you should get to lower bond price levels which should hold up, but the question is how much lower.  Worst case scenario, if the SPX keeps making new highs till year end, we could revisit 2.60% 10 year yields.  More likely, I think we get up to 2.40-2.50% and find a top there.

In SPX land, the realized volatility is at 3 over the past 10 days, compared to a VIX around 10.  So even at a VIX of 10, vol is actually expensive here!  Just horrible for the ES day trader.

Monday, September 25, 2017

Stalling With VIX Under 10

They could not have ordered up a more boring year than this one for S&P traders.  I am glad that I branched out from being almost exclusively an S&P trader back in the early 10s.  I wouldn't know what to do if I had to trade S&P this year.  Probably just swing trade and wait for the once in 1-2 month dip, scale in and buy, and sell after it hits an all time high.  I don't think there is any other strategy that would have been very profitable this year.  Shorting such a low VIX market is so tough, especially when it grinds higher bit by bit and hardly dips.

The bad part about this market for the trader is that the crowd is very reluctant to go to emotional extremes, either on the downside or the upside.  It is almost as if the crowd has finally realized the stupidity of dumping in a panic on a correction, or chasing prices higher, that they are mostly sitting still, holding their stocks or their cash and just waiting.  Many are waiting for a correction to buy, but what is the point if you are going to let the market go up 10-15% while waiting, and then buying a 5% correction?  You end up paying 5-10% more that way.

The best approach is either:
1) You think the market is too expensive, and wait for a bear market to buy, or
2) You think the market will become more expensive, a bigger bubble, and buy now and hope it goes higher.

The worst approach is just waiting and waiting, until the market goes so high and the volatility starts picking up, and then buying the 5% dip during the topping phase, and panicking out once it becomes a bear market.  Sure, we could have a 5% dip and then keep rising and rising like we did several times in 2012, 2013, and 2014.  But VIX was higher then, and the market much more skittish than it is now.  This is such a complacent market that the tolerance for bad news headlines is very high, and it would take multiple stabs at this beast before the crowd sells in full force.

I am obviously in the 1) camp, thinking the market is too expensive and waiting for a bear market to buy.  That is why I am not buying here even though I see SPX likely to grind higher into the beginning of 2018.

There was a leak of the Republican tax cut plan released this past weekend.  It calls for a top individual tax rate going from 39.6% to 35%, corporate rate from 35% to 20%, and pass through (small business) rate from 39.6% to 25%.  This looks like a fantasy for the Republicans, but if they are all on board, then it will pass Congress because they only need a simple majority using reconciliation.  It would be a big weight on Treasury bulls if the full cuts go through, as the budget deficit will balloon to huge numbers, probably up to $1.5-2 trillion.  That would cause a definite steepening in the yield curve as the large supply would weigh heavily from 10 years to 30 years.  The short end would be anchored by the Fed funds rate, so less bearish for that end.  Anyway, it will probably take several weeks before the plan becomes a reality, so not an immediate negative for bonds, but a big potential negative catalyst for sure.

Thursday, September 21, 2017

Fed Dot Plots

Looking at the Fed dot plots for September, I find it interesting how the long run projection is still at 2.75%, albeit down from 3.00% in June.  What happened in 3 months that would cause a long run projection of interest rates to go down 25 bps?  Nothing happened, other than the Fed throwing the bond market a bone, to try to keep the bond vigilantes at bay, while they announced balance sheet tapering. 

Everyone with any money on the line knows that the Fed dot plots are a running joke.  They have consistently inflated future interest rate projections, only to bring them down in drip drip fashion.  Is that the Fed's way of increasing optimism about future economic growth?  I don't know if the Fed is being dishonest, or if they're just incompetent.  Probably the latter. 

If you look closely at that dot plot, there is one guy who keeps the projection at the current Fed funds rate level, at 1.00-1.25% till end of 2020, but somehow manages to put the longer run projection at 2.25% or higher.  I know this is Neel Kashkari, the super dove.  He's a bit controversial, and an attention seeker, but he's got the best forecast of them all, which isn't saying much.  Although his longer run projection seems way too high, unless he's thinking something like 2040 as longer run. 

The eurodollar market is pricing in 3 rate hikes over the next 3 years.  That would put the Fed funds rate at a 1.75-2.00% range by September 2020.  I feel like that is a bit ambitious considering that when pricing in future interest rates.  If you consider that there is a decent chance that the economy could enter a recession within the next 3 years and the Fed could cut rates, then there should be a lot less than 3 rate hikes priced in over 3 years.  Remember, you must come up with a probability weighted average of all possible interest rate scenarios, not just the mostly like one. 

The median Fed dot plot is between 2.75-3.00% by end of 2020.  Do they realize that when GDP growth went from 2.9% in 2015 to 1.5% in 2016, they stopped rate hikes dead in its tracks, and were scared stiff.  The economy doesn't even need to go to recession for them to stop rate hikes.  It just needs to slow down to under 2%.  Considering the heavy debt load, low productivity, and low population growth among the developed economies, it is more likely that growth will slow down from here over the next few years, not pick up. 

Add to that Trump's inclination to choose a dovish Fed chairman because he's a low interest rate guy.  Therefore, you have a bond market that is mispriced.  And a Fed dot plot that is even more wrong.  Now I could be wrong and the global economy could have a huge boom and the S&P could become a giant bubble, but that's not likely given the data.  There is always some uncertainty in predicting the economy and the financial markets, which is why there are mispricings in market.  This game is about probabilities, and it is the difference in how market participants weigh the likelihood of various scenarios which provide the long term opportunities. 

The S&P didn't disappoint yesterday.  Once again, it found a way to bounce back after the hawkish Fed statement.  And do it in a non-volatile manner.  It has proven its boring nature AGAIN.  Just untradeable.

Wednesday, September 20, 2017

Fantasy Land at the Fed

There is lot of projections that the Fed spews out, the most egregious and error-prone, being the dot plots for interest rates.  These Fed officials must have used a time warp, going back to the 1990s when the neutral Fed funds rate was at 6%.  They still fantasize about a neutral Fed funds rate above 3%.  Conveniently ignoring the 2% GDP growth rate and the heavy debt burden this global economy is running on.

It is funny that they can't even fathom the thought of consecutive 25 bp hikes at Fed meetings, especially since one of them would not have those "informative" press conferences, but they have the audacity to state that the Fed should reach a Fed Funds rate of 3.5% in a couple of years!

Then when it comes time to actually follow through on their projections, they chicken out with any excuse they could find, such as China in September 2015, the strong dollar and falling oil in March 2016.  Only after the S&P just keeps grinding higher, and the dollar grinds lower do they finally back up their fantasy land projections (at least for a few meetings), and put in rate hikes.

Ok, enough of the ranting, now time for how to play this upcoming Fed meeting.  I expect the S&P to be a snoozer, as it is about as boring as a market can be.  But for the bond market, it is a bit more interesting.  You have seen bond yields bounce back up strongly after bottoming a couple of weeks ago on hurricane and nuclear war fears.  Now that investors have regained their senses, they realized that they pushed rates too low, and we are getting the payback over the last several days.  At 2.23% 10 year yields, as I write, it is still in the middle of the 2.00% to 2.40% range that we seem to be stuck in at the moment.  With my expectations of the stock market to continue to be strong, I don't see how rates can break below 2.00%.  At the same time, there is just too much investor demand at higher rates for the 10 year to get much above 2.4% without seeing dip buyers charge in.

I do expect the Fed to talk tough, now that the S&P is at an all time high, and with rates well within their comfort zone.  Balance sheet runoff will be slow, and probably they won't be able to keep it going for as long as they say, because as soon as the market has a correction, they will stop dead in their tracks.  Guaranteed.  Think we could get more weakness in bonds over the coming weeks, and probably more of a grind higher in equities.

Monday, September 18, 2017

VIX is the Guide

In recent S&P 500 history, you have not had a market top out when the VIX was under 12.  In July 2007, the VIX was ~15 when the market topped out.  Also in May 2011, the VIX was ~15 when the market topped out.  2015 was a bit of an unusual case because the market topped out when the VIX was at 12, but you did have the market flatten out and chop for almost 6 months without any major breakouts, and it was quite a bit more volatile than it is now.

Right now, we have a VIX around 10, with realized VIX in the mid single digits.  Plus, we've made new highs since last week, and now easily above the 2500 SPX psychological barrier.  These are the types of markets which grind higher as investors watch in disbelief that there is hardly even a 5% correction.  Since we had the washout in late August, and nervousness till last week, this move higher has at least 2 more weeks to go, and probably well more than that.

It is a slow motion bubble, so it looks innocuous, with the low volatility, but it is building up a lot of potential imbalances when the top is reached.  When will that top happen?  That is one of the hardest things to predict, the top of an equity bull market.  It is clear that there are still not enough signs.  So while I will not participate in any upward moves from here, I definitely will not get in the way and short it until we start seeing more volatility.  The VIX has to sustain above 12 even after several days of rallying in order for me to be interested in the short side.

Saturday, September 16, 2017

Traders: What Not to Do

It is a fact that most traders end up losing over the long term.  In order to be part of the minority of traders who win long term, you must trade differently than the majority.  That is just simple logic.  Then the first step is to identify what the majority of traders do.  The second step is to avoid doing those things.  By reading books about traders (Market Wizards series is a good starting point), seeing what traders say on Twitter, Stock Twits, stock message boards, etc. you start to get a sense of what the majority do.

What most traders do:

1. Bet too big.  In equities, it is betting it all on one stock.  In futures and options, its using too much leverage by buying or selling as much as you can.  Even if you have good pattern recognition skills and accurate analysis of the long term macro situation, there is still a lot of uncertainty in this game.  Good traders still lose a fair number of times.  It is just part of the game, you can't be perfect in this business.  If you bet too big, you can have a string of winners and then that one big loser will eliminate all your gains plus more.  Or even blow you up and take you out of the game.

In my early career, I had a habit of trading only one or two stocks at a time, and using full 2 to 1 margin.  It led to some exciting times, lots of wins and losses, and I was lucky to have survived.  I had a very effective strategy and it worked about 90% of the time, but the 10% of the time that it didn't, I lost huge on the trade and it would eliminate all the progress I made building up my account.  This happened a number of times and I still didn't fully understand why I couldn't really breakthrough to the next level. 

It wasn't because I didn't have an understanding of the market or good pattern recognition skills.  I was just constantly betting too big. And although that led to rapid growth in account size during the good times, I would inevitability trade a stock that would act like an outlier and end up losing anywhere from 50% to 90%.  Remember, if you lose 90% of your money, you need to make 900% to get back to even.  900%!

Try this math exercise:  you bet 50% of your account on a 1 to 1 payout, with 60% chance of winning, 40% chance of losing.  See where that account value goes over the long term.  The effect is the opposite of compounding. 

2.  Try to make money everyday.  I am lucky that I didn't have to work for too long before I was able to just trade for a living.  I never developed that worker's mentality.  Although in the short amount of time I did work, I quickly developed a dislike for having to wake up early in the morning to do something that I didn't want to do, just for money and my "career".  So when I started trading for a living, I tried to make as much money as I could, so I could amass enough money to not have to find a job ever again.  Unfortunately, that led me to trade too big, and go all in too often, because of my greed and overzealous desire to build up my account as fast as possible. 

But I never really chased prices, and would often let halfway decent opportunities go by because I didn't feel like I needed to make money every day.  If a good opportunity was there, I would plunge in. And usually there was.  But if not, I didn't do any trades.  I watched TV, read a book, and tried not to stare at the trading monitors.  I didn't make money that day, but I didn't care.  I never treated trading like work, so I never expected to get paid based on the hours I put in.  I was willing to wait for the next good trade.

On the topic of daily trading, one of the dumbest things that a good trader can do is to quit for the day because he made his daily profit goal.  Unless that trader has some psychological problems dealing with winners, he should try to make as much as possible when the going is good because most of the time, they aren't.  Especially these days.  As Stanley Druckenmiller says, "it takes courage to be a pig". 

More importantly though, a trader shouldn't force trades and trade bigger to try to make a "comeback" for the day and turn a losing day into a winning one, to make yourself feel better.  I have made this mistake countless times and at the end of the day, when I stare at a huge loss on my trading screen, I think to myself, "What the hell am I doing?"  Its the same feeling a gambler would get at the casino when he keeps hitting the ATM to try to comeback and recover his losses, only to end up with a huge loser when the night is over.  Trading is a long term game, not a daily one. 

3. Think short term.  It is hard to come up with good trades, especially long term trades.  If you turn a good long term trade into a good short term trade, that is a big mistake.  Yes, it is a higher level mistake.  For those who have traded for a while, and made some money at it, it is a common mistake.  I have made it numerous times throughout my career.  If only I had just stuck with the trade for another few days, another few weeks, another few months.  Then I would have had a home run.  Those who have bought dips in the SPX know what I am talking about.  Same goes for those who bought dips in Treasuries this year. 

That is why it is so important to thoroughly analyze what the current long term opportunities are in the market and then when the market gives you a chance to get in at a good price, you need to ride it for as much as you can.  You can only do this if you have a lot of conviction on your trade, and your short term view aligns with your long term view of the market. 

How do you develop conviction that is usually accurate and helpful rather than irrational confidence?  Through studying, experience, and gut feel.  Some of it can be taught and developed, but the gut feel is usually more innate.  This conviction is something that I am constantly trying to improve, both in accuracy and breadth.  Some markets and time periods are just easier than others.  Right now, we are in a bit of a difficult time period, low volatility and very few good medium term opportunities.  However, that should pave the way for some monster long term opportunities.  There is a good long term opportunity developing, but it will only come to fruition once the price action and higher volatility confirms the topping phase of this US equity bull market.  So I am trying to preserve capital for what I view as interesting trading opportunities in 2018.

Wednesday, September 13, 2017

S&P Strength and Bond Weakness

The two big things that have happened over the past 2 days is the rise in the S&P 500, but more importantly, the disproportionately big drop in bonds relative to the SPX strength.  In a short term risk on move, you usually get about a 0.04% rise in 10 year yields for a 1% rise in the SPX.  We have gone up 0.12% on the 10 year since Friday, while SPX has gone up 1.2%.  In normal circumstances, the 10 year should have gone up only about 0.05%.

Obviously it does speak to the overshoot short squeeze higher that happened in the bond market last week while the stock market was only slightly down.  But it also re-emphasizes what I believe to be the new en vogue hedging strategy for the hedge fund manager.  They are now going long bonds as a hedge for their long stock positions.  In the past, they would have just used VIX or shorted SPX for a more direct hedge.  It probably means that you will not likely see much more upside in bonds this year until you start seeing stock weakness.  At these levels, I find it hard to believe that both stocks and bonds will just keep going higher without a break in that positive correlation.

I do expect the SPX to stall out here as we are right at that psychological 2500 level, which should provide short term resistance.  Also the weakness in bonds should be a bit of a headwind for stocks to go even higher.  Due to the near term SPX resistance, I don't think bonds will sell off much more, but I don't see much of a bounce either.  So while near term downside in bonds is limited, the near term upside is also limited.  It looks like last week took out most of the weak hands in both bonds and gold.

SPX should flat line around these levels right under 2500, and then expecting a dip next week. That should help bonds have a bounce, which probably won't last long, just as I don't expect any dips in stocks to last long.  Low conviction here, so I won't be putting on big positions.  October should provide better levels to make longer term trades. 

Monday, September 11, 2017

Irma and N. Korea Hype

You know how the media like to blow up headlines to draw eyeballs to their articles.  It is slightly, just slightly more refined form of click bait. 

The algos didn't bite and refused to selloff the market on Friday ahead of the fear mongering.  As I said last Friday, the algos are getting much smarter.  There is definitely AI and machine learning going on, because they have gotten more sophisticated from even a few years ago.  If you had the same headlines and weekend risk 5 years ago, the S&P would have likely dipped at least 3% ahead of the event, led by emotional hedge fund managers, and then rebounded like a screaming banshee as those same hedge fund managers bought back what they sold ahead of the "scary" events. 

Nowadays, the hedge fund managers don't even do much manual trading, their performance reviews have shifted their funds to more quant based, AI and machine learning strategies.  This makes the market much less emotional and more price action based, which shows you the muted market reaction to the North Korean nuclear test last week, and less derisking ahead of the fears of a North Korean missile launch and Hurricane Irma this past weekend.  All in all, it makes the market tougher to trade, as there always has to be someone on the other side of your trade.  And AI computer based trading programs are much tougher opponents than trigger happy hedge fund managers.

We are getting a repeal of the risk off moves in Treasuries and gold this morning, along with a gap up in the S&P.  It is notable that the Treasuries and gold are selling off much more than expected for a 0.5% gap up.  It tells you that traders have resorted to hedging not by shorting S&P, but by buying Treasuries and gold.  They have finally caught up to the risk parity hedging strategy.  It could make for a nasty move if Treasuries can ever go down and stay down while stocks are flat.  But that's a story for another day.  Expecting a dull market this week in S&P land.  The bond market should be a bit more interesting, but it too is probably going to have a low volatility trade after today's selloff.

Friday, September 8, 2017

Short Squeeze in Bonds and Gold

Yesterday, you had heavy volume as bonds and gold both squeezed higher, after the ECB decided to postpone the taper.  This was what most expected, but you still had a significant minority that thought Draghi might provide more details of their future tapering plans.  He didn't give the bears an inch, and provided the usual dovish spiel, while throwing the euro bears a bone by saying that he is keeping an eye on the euro and its strength.  Draghi definitely likes to bring out the "whatever it takes" line on various topics, this time, it was on getting to 2% inflation.  He sure talks like a determined dove, but he can't solve the scarcity of German government bond supply problem when it comes to following the capital key guidelines for QE.

You basically had a perfect storm in the form of ECB can kicking, and of course North Korea and Hurricane Irma over the weekend.  That was just too much for bond and gold shorts to deal with and they finally capitulated and bought in a panic. We got remnants of that buying wave this morning, but with the current price action, it seems like most of the weak hands have been taken out. All this while the S&P trades in a sleepy range from 2350 to 2370 this week. 

I expect their to be a little relief buying in stocks on Monday, after the weekend event risk is behind us, but it should be a small pop because the market just hasn't gone down much ahead of these uncertainties.  It is clear that the US stock market has gotten smarter, as the market is very reluctant to provide a good buying opportunity even in the face of bad news.  If we had similar news flow 5 years ago, the market would have pullbacked a lot more, and then subsequently rebounded a lot more.  Now, its short and small pullbacks on bad news, and short and small rebounds after the V bottoms.  After seeing the volatility on Tuesday, I was expecting much more this week.  But it's been a dud for S&P traders. Just a dreadful S&P trading market.

Thursday, September 7, 2017

Debt Ceiling Deal and Dovish Draghi

We should be much higher considering we got the debt ceiling extension without any headaches and then a dovish Draghi at today's ECB meeting. So we had a good news wave that peaked out at SPX 2470 this morning.  That is the high optimism price point in this market.  Last week's low of SPX 2430 on North Korean missile launch is the low optimism price point.   Keep that in mind when trading this chop over the next couple of weeks. 

There is a lot of caution that I hear from financial TV, but the put/call ratios and the low VIX tell me that real money is not doing much here.  The low VIX is a tell that the pullback should be shallow, as the VIX is a very good predictor of near term potential losses in the market.  You would think with North Korea and a massive hurricane heading towards the US, the market would be a bit more nervous.  But this market has been so resilient for so long that the algos are all programmed to buy dips and support the market on down days.  That is why you got the V bottom on Tuesday, saving the market from an ugly close. 

Remember that last week, after North Korea fired a missile past Japan, there was a sense of optimism that the market was able to shrug off that event and head towards 2480.  The crowd got back to being bullish.  Now they feel like they are offsides. They don't turn on a dime.  I expect them to take a few days to sell off some positions to get to a more risk off stance.  One supporting factor, a big one, is the strength in bonds in the face of a flat stock market. The lower interest rates will help to keep the stock market from completely falling apart here. 

If we do selloff again towards 2430, I would expect there to be a lot of fear mongering on CNBC.  It should be a point where one should put on longs for the eventual ride higher.  This bull still has a while to go, and you need to keep that in mind when trading during these choppy times.

Tuesday, September 5, 2017

Nuclear War Threat

We got the North Korean nuclear bomb test and it was good for a 6 point gap down on the SPX.  Is anyone really surprised when the stock market shrugs off geopolitics?  This happens over and over again and investors still act like the market is acting irrational.  North Korean bomb tests are nothing new, and neither are their missile launches.  The only variable that's changed is Trump and general public mistrust of his judgement and temperament. 

The reaction in the non-Asian equity markets clearly shows that North Korea is a non factor.  The overnight trader overreacted again as we are now trading higher than the overnight range in the regular trading hours.  Oh and look at the bond market.  It is screaming higher, even when equities are basically flat.  All North Korea has done is provided corporations lower interest rates to sell bonds at.  So you have a net positive from a liquidity perspective. 

It's going to take something other than geopolitics to take this market down.  You will need to have a weaker bond market or a weaker economy to bring down this bubble.  Right now, economy is just strong enough to maintain low single digit earnings growth while keeping the Fed easy.  Real GDP growth at 2% is Goldilocks, post 2008 style.

If there is a dip down this month, anywhere close to 2420, I would buy that dip and ride it to SPX 2500+.  There is still some juice left in this bull market, as the Republicans will be desperate to get some kind of tax cut package through Congress to put some points up on the board.  After the debt ceiling, that catalyst becomes the main focus of the market, so expect a better tone to the market and higher prices once we get to late September.  In the meantime, hope for a little drop to get in long for the ride higher.

Thursday, August 31, 2017

ECB and the Euro

Draghi and the ECB crew are sending out smoke signals on the strengthening euro.  They don't like it.  These trial balloons, through their favored news outlet, Reuters, tries to keep the euro strength in check while they try to buy time for upcoming ECB meetings.  Remember, Draghi promised plans on QE tapering in the autumn.  Which means he has to say something on the topic either in the September or October ECB meeting.  The news on worries about a stronger euro means they are likely to punt tapering into the October meeting, backing themselves into a corner, making a decision over the next 12 months based on how the euro and financial markets trade during autumn.

It just reinforces my view that the central banks are turning into micro managers who react to short term market movements to make long term monetary policy decisions.  Of course, it is not a two sided coin.  If the economy is strong, then the central banks are slow to remove stimulus.  However, if the economy is weak, then the central banks are in a mad rush to provide immediate stimulus and jawbone the markets higher with phrases like "whatever it takes", etc.

This is why the bond market refused to selloff this year even as the S&P kept making new highs.  It sees an ECB reluctant to remove monetary stimulus, and a Fed that is increasingly worried about inflation being too low.  The Fed should be much tighter with the current loose financial conditions and rising stock market but it picks and chooses weak data to support their dovish bias.  This feedback loop keeps stocks rising and the bubble going, until fundamentals get so bad that the stock market can no longer ignore it and it comes down under its own weight, like 2015.

I see another 2015 scenario coming up in the next 6 months, and its going to be an uglier version this time, just because of the extra excesses and overvaluation.  But we've still got higher to go before that happens, so there is no rush to put on a long term short.  Shorter term, it looks like this market will retest the SPX 2470s narrow trading range that we established in August.  I expect the market to go back down to the solar eclipse lows of 2417 sometime in September ahead of the debt ceiling debate.  So there may be a short opportunity coming up soon, in the 2470s.

Tuesday, August 29, 2017

Too Much Liquidity

The S&P is barely down 0.5% in premarket and gold and bonds have already gone wild.  The sharp up moves that happen to bonds or gold when there is even a sniff of risk aversion shows how much liquidity there is in this market.  Even with the Fed tightening.  Remember, all that money that the ECB and BOJ are printing has to go somewhere.  And it definitely isn't just staying in their domestic markets.

It is the main reason why it is so hard to make money shorting the S&P 500, the final boss.  You need to have bonds react less bullishly to risk aversion situations in order for stocks to go down and stay down.  Otherwise, these down moves are fleeting, as the bond proxies in the equity market keep the equities afloat, and when the dust settles, you just have lower bond yields and stocks going back to their pre-selloff levels.

Looking out over the next couple of years, bonds are going to be the place to be when the equity rally flattens out and starts the topping process.  The bond market remains resilient due to the ample liquidity and steady retail inflows.  Europe and Japan are just too weak economically to get away from their NIRP and QE policies.  They will be there to be the marginal provider of liquidity to keep markets buoyant.  I would not be surprised if the ECB follows the SNB strategy and starts to buy equities for their QE program during the next downturn.

I am waiting patiently for the market to get closer to my buy levels, which are between S&P 2410 to 2420.  We nearly got there during European hours, but we've rallied quite a bit from those lows.  Trying to keep this S&P down is like trying to keep a beach ball underwater.  Its buoyancy still amazes.

You still need near perfect conditions to short this market, and with the level of caution out there despite being so close to all time highs, shorting is just not a high probability trade.  It is still a dip buyer's market, and I will continue to use that old, beat up playbook because it keeps working.  Sure, it is going to be a bit less effective than when the playbook was less well known, but it's like going from a 80% win rate to a 65% win rate.  Still high enough to make confident bets on the long side.

Friday, August 25, 2017

No Thrust

After the strong rally on Tuesday, when the S&P closed at 2452, a crowd of bulls came out of nowhere to declare the end of the pullback and a march towards new highs.  As I mentioned before, that is uncommon even during this long bull market.  The first big rally day after a pullback has usually been met with some skepticism or expectations that its a one day wonder.  Then we promptly managed to have 2 small down days before today's pre Jackson Hole gap up.

You can basically treat this Jackson Hole event like a non press conference Fed meeting, important, but not that important.  And usually the market gaps up on Fed days.  I don't expect any fireworks at this Fed meeting, I mean Jackson Hole conference, because Yellen will not want to be too dovish despite the weak CPI numbers, because of the weakening dollar, and Draghi doesn't want to be too hawkish because of the strengthening euro.  In that battle, I expect a stalemate, with the market left to go on its own path, which I believe to be a choppy pullback that stays between SPX 2455 and 2410.

The market is currently not too focused on Trump's words about a government shutdown if he doesn't get border wall funding.  But if there is one thing about Trump, he doesn't like to back down from confrontation.  Add to that the debt ceiling debate and there are negative catalysts waiting to be focused on at any sign of weakness.

Since we are near the upper end of that SPX range, I would favor either cash or a small short.  As for bonds, I would favor being long for the next few days as the SPX goes to the lower end of that range.

Wednesday, August 23, 2017

Flip Floppers

Well it didn't take long for equity investors to go from fearful to greedy.  The equity put/call ratios have fallen drastically from last week's levels, going from .78 and .82 on last Thursday and Friday to .57 and .55 on Monday and Tuesday of this week.  By the way, Monday was actually a flat day so investors were already starting to get bulled up before yesterday's big up move.

What is quite telling is the nontrivial gap down that we have in the SPX, right after we hit the June highs around SPX 2455.  Based on my social media read, traders seemed quite confident that yesterday was the start of another thrust higher off a panic low, which is quite a change of attitude from previous panic lows.  The crowd has finally started to catch on to the pattern that has repeated itself since the 2016 presidential election.  Buy any 1-2 day dips and be rewarded instantly, and for several days.  The market tends to repeat a pattern until it gets recognized by the majority of traders and then the pattern usually stops working.

Yesterday's rationalization for the strength was talks of tax reform.  It is quite surprising how fast the White House and Congress have regained their credibility after previous failures on health care.  Also surprised how fast everyone forgot about last week, when Trump's comments made everyone think tax reform was dead.

Congressmen have been bought and paid for by all the lobbyists and special interest groups, which is the main reason you haven't had any tax reform in 30 years.  No one wants to take the brunt of the pain when it comes to removing tax deductions and loopholes, and if there are no removals of tax deductions and loopholes, you can't have tax reform.  The Washington lobbyists will not stand for it, and that will be it for tax reform.  Tax reform is not the main desire of the equity market anyway.  The equity market wants unfunded tax cuts, that will blow out the budget deficit, which favors stocks over bonds.

Apparently Trump is now threatening a government shutdown over the border wall.  If he also threatens a breach of the debt ceiling he just might get it!

I sold my short term long yesterday, too early, but I just didn't feel like the rally would last beyond the day.  In hindsight, I should have just waited later in the day to sell, even if I felt like yesterday was just going to be a one day rally.  Something I will keep in mind next time.

Monday, August 21, 2017

VIX Underperforming

Compared to the one day drop we had on August 10, the current pullback is more severe but the VIX has actually been lower.  The VIX September futures closed at 15.25 on August 10, and 14.95 on August 18, despite the SPX being lower on August 18 than August 10.  Even with further weakness today, the VIX futures are actually negative on the day.

Although this pullback doesn't look like it will be a quick snapback higher to SPX 2470s, I also don't expect a big pullback that would crack 2400.  We could have a drive down to the 2410 area but I expect that to hold as there is already a lot of put activity in the equity options and the fear is already palpable on financial TV.  Fast Money on Friday was uniformly bearish, expecting more weakness.  When that happens, its usually a fade.

I have added to SPX longs today and will look to play for a short term bounce.

Friday, August 18, 2017

SPX 2410-2420 Support

The market is getting very close to SPX support levels of 2410-2420.  That is the level that has held all summer, after the Draghi tapering scare in late June.  With options expiration today, you are seeing a lot of delta hedging happening, pushing stocks lower, along with the usual fears that you get after the market gets whacked nearly 2% the day before.  The equity put/call ratios have stayed elevated since last week, and today they are sky high.

We are getting close to some decent short term buy zones here and I have gone in small buying the dip.  It is very possible that we see another push lower down to 2410, where I plan to add, but I want to have a bit of longs on hand just in case we pop right back up from these levels.

The financial media's infatuation with Trump and the political headlines is helping to push prices lower and bring out the fear, the right ingredients I am looking for when buying.  Funny how all of a sudden the market got scared that Gary Cohn was going to resign, as if he was the messiah for this stock market.  Tax reform will not get done, it will mostly likely be tax cuts with no reform if anything does get done.

This market has rewarded dip buyers over and over again, it is just a matter of how big of a dip to wait for before buying.  This dip should be a bit bigger than last week's, but not by much.

Thursday, August 17, 2017

Another Delayed Reaction

You would think with all the algo trading and computers pumping out orders all day, the reaction would be nearly instantaneous, but we've had delayed 1 day dumps, both on "bad" political news, last week North Korea, and this week Charlottesville.  Both are irrational excuses to sell, but frankly, the market is at irrational levels, so it was waiting for any type of psychological trigger to get the ball rolling downhill.

During this month, after my bearish tilt, the only real profits I made on S&P trading was on the long side, holding over the weekend.   It just goes to show you that trading from the long side has been the easier money, and continues to be so.  Of course, this kind of market will not last forever.  But the consensus among the investors that I hear from is that a 5-10% correction is due, and that it is a buying opportunity.  But the feeling I get is that we'll only get a 5-10% correction as the market gets volatile and is forming a top.  You saw that starting from the fall of 2014 going to summer of 2015, leading to the sharp drops in August 2015 and January 2016.

The way the crowd reacts to a pullback reveals a lot about the future direction.  I did not expect such a fuss over a 40 point pullback last week, and the market promptly rallied off that 2440 level.  Even as we bounced back earlier this week, investors weren't buying in and the rally earlier this week felt more like a short squeeze than anything else.  That can explain the strong price action ahead of the FOMC minutes yesterday, as shorts didn't want to hold a position ahead of possible dovish news.

So you have high equity put/call ratios on just a small dip in the market.  It usually means the downside is limited here and is a positive for the bulls.  On the other hand, the terrible breadth and potential negative catalysts (debt ceiling/ECB meeting) in September favor the bears.  I expect the kind of choppy trading like we had in March and April ahead of the French elections, this time ahead of the debt ceiling in September.  So probably a little bit lower, than chop back up a little bit higher, and repeat for a few weeks till the debt ceiling resolution gets closer.

It seems that the top will have to wait after the debt ceiling, and on more positive news flow.  I now expect new all time highs sometime in the fall.  There we probably have the final blowoff top, blasting well through SPX 2500.

See little edge here.  Missed the short as I was too careful on my entry.  You can't catch them all, and I've missed quite a few short term shorting opportunities being too careful, but no regrets as they weren't great opportunities.  May go in small again and buy the dip around SPX 2430-2440.

Wednesday, August 16, 2017

Draghi Wavering on QE Taper

The big news today is sources saying that Draghi will not send a new policy message at Jackson Hole next week.  Many were expecting Draghi to send hints of a QE taper like he did a couple of months ago but he's obviously not in the tightening mood these days.  With the stronger euro, Europe doesn't look so hot anymore.  It was the weak euro after all that boosted European stocks, not improving fundamentals.  In other words, Europe is the new Japan.

Europe is stuck now with permanent low rates.  They have fallen into the low rate vortex in which monetary policy has to rely on QE to have any effect on the economy.  It is something the US barely escaped and it is something Europe will not be able to escape this time around.  The baseline fundamentals are just too weak in Europe.  All the growth sectors (basically just technology) are based in the US, and the underlying demographics and labor inefficiency make European equities a poor long term investment at these valuations.  And of course European fixed income with the negative to super low yields.

The US stock market is benefiting from the weaker dollar this year, as the S&P outperforms the Russell 2000, but relying on a weakening currency for stock market gains is unsustainable.  Eventually other countries get sick of having to take the pain from a strengthening currency and they start loosening monetary policy to combat it.

Europe is stuck between a rock and a hard place.  They are going to have a tough time dealing with a strengthening euro, and you are seeing the first signs of Draghi feeling the heat.  This should be an ongoing story over the next year as Europe struggles to normalize as the euro strengthens.

We are right in the middle of the old range, now just waiting for it to hit the top of the range to put on some shorts.  With these unvolatile markets, 5 SPX points is a big deal.

Tuesday, August 15, 2017

Sell Top of Range

Remember that 2465 to 2480 range?  It was the same old trade day after day.  Now that we're back into the range, I don't think the bearishness from last week's dip has completely gone away.  Yes, it will go away, soon, but it may take a few days.  At which point I think this market will dip again.  Look at what happened to the bond market the last couple of days.  Usually the bonds keep their bid a bit longer even after a stock rebound due to after effects of the safe haven bid.  But bonds have given back all of their North Korea headline gains.

The notable weakness in the bond market so quickly after a rebound should keep stocks in check today.  I don't see a wild run to new highs like you would have seen in 2013 or 2014.  This is a heavier market and the breadth is worse.  So I will be a willing seller at the top of the range, near SPX 2480.  Just waiting for the buyers to get complacent again and we should get towards the top of range.

Monday, August 14, 2017

Back to Previous Range

We are now back to the lower end of that eternal range of SPX 2465 to 2480.  Once again, those that panicked off the splashy headlines are now in a tough spot of whether to buy back higher or be stuck on the sidelines.  However, this time, being stuck on the sidelines is not so bad considering the limited upside here.  With the ECB tapering cloud hanging over the market this fall, as well as the debt ceiling, you probably will not be able to break out higher in September.  The two weeks left this month look like we will be chopping from 2440 to 2480.  I did get long small on Friday but have already sold into the strength today, somewhat early.

In other news, bitcoin is turning into a full blown parabolic bubble going over $4300, another sign that speculation is hot and heavy in the financial markets.  I would fade this thing if I could get easy access to shorts.

Not much edge here, but thinking at least one more trip back down towards 2440 this month.

Friday, August 11, 2017

Delayed Reaction

We had one of those delayed reactions to North Korean headlines on Thursday.  On Wednesday, when the headlines were all over the news, the market gapped down and worked its way back to nearly flat on the day, giving bulls confidence that the worst was over.  Then we got the surge of selling in the indices and an unwind in short VIX trades.  Now we are near that 2440 support that I mentioned before.  It is sturdy support and it is probably good for a bounce here over the next few days.  I haven't gotten long yet but may put in a small long position either short VIX or long SPX going into the weekend.

I am sure people think that its crazy to be long over the weekend with all the possibility of nuclear war but I am playing technical levels and the fear after just one big down day was palpable.  CNBC Fast Money were uniformly bearish and looking for a deeper pullback.  It could happen if you see further volatility unwinds, but that is low probability.  Not going to go crazy buying the dip here, but will probably go in small and look to see what happens next week.  If we go down some more, I will probably buy more.  These are short term swing trades.  Don't want to do anything long term here.

Thursday, August 10, 2017

Soldiers are Faltering

The generals are marching on, but the soldiers are having a hard time following the leaders.  The Russell 2000 peaked out in late July above 1450 and made a 2 month low breaking 1400.  That would be the equivalent of the S&P dropping over 80 points in 2 weeks.  And you can't blame a weaker dollar for this divergence.  The USD index has basically been flat over the last 2 weeks.

I am sure if we get a selloff that the mainstream media and investors will blame Trump and North Korea for it, but the broader market has been selling off for 2 weeks already.  It only has gotten more extreme lately.  Typical of late stage bull market behavior is the lagging small caps and deteriorating breadth of the market.

As much as the market has changed with quants taking a bigger share of trading activity, the underlying tendencies remain.  Investors start crowding into the winners and high growth names as they have a harder time finding earnings growth in the rest of the market.  Volatility is really the only missing ingredient for a top at the moment.  And I am sure that will not last for long as a VIX at these levels makes no sense when the major indices are so far above their long term trend lines and moving averages.  Also, the prevalence of vol selling strategies to generate income probably contributes heavily to this kind of dead market.  You can not tell me an S&P 500 that closes between 2470 and 2480 for 3 straight weeks is normal and random.  It just sets up a spring coiled to go the other way when these vol selling trades unwind.

Human nature never changes.  They are magnets for catchy headlines like Nuclear War when boring headlines about central banks are much more important to asset markets.  It seems like yesterday's bullish reversal from a bad news gap down surprised traders but that playbook has been in play for several years now, just rarely in 2017.  How soon people forget.

We have another gap down today, perhaps it is delayed North Korean jitters (I am sure that will be the rationalization if we go down), but the truth lies underneath the Dow and S&P 500.  Still feel like there will be a pullback down to 2440 but just watching at this point, as I don't like selling short when traders are nervous about war, and definitely not buying this pig unless conditions are near perfect.

Wednesday, August 9, 2017

Volatility Comes In

We've finally shaken up this sleepy market, and who else but Trump to start it up.  You would figure the guy would have lost his credibility by now but the market still takes him at his word.  "Fire and fury" at North Korea was all it took for the market to suddenly get worried about nuclear war.  If it wasn't such a complacent market, this news would only cause a blip and be over with in a few hours but the markets are still feeling the after effects.  The VIX was so low and the range so tight.  The VIX is still low, not even a teenager.

It seems like I threw in the towel on the short a few days too soon, although yesterday's fakeout to the upside looked like it could last a couple of days.  And it probably would have without Trump's words.  These type of events aren't something that you can predict, coming out of the blue.  And long term, it has no effect on the market.  It is more psychological.  If North Korea was actually a real military power, then you might have something to worry about.  A North Korea vs US war would end quite quickly and the uncertainty of North Korea would be eliminated and the market would rally.  It would probably be similar to a Brexit type market reaction, down sharply for a day or two and then a face ripper once investors realized that its a nothing burger.

The news stations on a slow August day had a field day talking about North Korea.  Talking about Trump and nuclear war is irresistible to the mainstream news media, and blasting the news was enough to get traders nervous and selloff the futures.  We are at ES 2465, which is still part of the trading range over the last 3 weeks.  All that happened was the fakeout breakout above 2480 and then a return to the range on the North Korea headlines.

I see no edge at these levels inside that tight trading range of SPX 2460 to 2480.   Leaning towards a breakdown below 2460 to 2440 but not much conviction.  I don't think market participants want to be long heading into the weekend so probably trading heavy till Friday.

Monday, August 7, 2017

Placid at the Top

There is hardly a breeze even at this high altitude.  I have never seen a top so calm.  Which means that it's probably not the top.

Volatility usually happens when you get eager buyers and sellers clashing in a surge of volume.  We are definitely not getting that here, despite the potential bear catalysts in ECB tapering and Fed balance sheet reduction.   The equity market already faced a little heat back in late June when Draghi hinted at ECB tapering but both the bond and equity markets shrugged that off quickly.  Will that same catalyst be able to provide a bigger downdraft the next time?  It is questionable because the market has mostly priced in those events already, with the Bunds going from 0.25% to 0.60% over a few days last month.

There is the China put ahead of the National Congress meeting in the fall because the leaders want to make things look good and will pump plenty of money to do so ahead of the meeting.  So you don't have many worries out there, and I don't considering the debt ceiling a real worry.  That has been more of a political spectacle than anything else.  They always raise it after acting like the world will end if they don't.

The only long lasting downdraft that I can see is if we get that global growth slowdown that I see coming soon.  It doesn't have to be a big one, just enough to affect earnings negatively and inject volatility into the market.  Even a move in the VIX from the 9s to 15 would seem like a big earthquake.  This market has gotten so used to the calm conditions that a 1% down day these days feels like 2-3%.

The calm, overvalued conditions are not what precede a top.  It is unstable, overvalued conditions which do.  Right now, we are not even close to those conditions.  Which is a bit shocking considering how overvalued the equity market is.  Yes, the weak dollar is helping the US multinationals but that comes at the expense of Europe and Japan.  So globally, there are no net effects.

I was short last week and I covered for basically break even.  I gave it a shot on the short side, but it's taking too long for the move to develop and my conviction level has gone down to the point that I'd rather be flat than a little bit short.  Back on the fence and waiting for easier opportunities.

Monday, July 31, 2017

Tough to Time

This thing is taking its time at the top here.  I would have liked to see more volatility up here and some more weakness following last week's post FOMC intraday reversal.  But its reverting back to the same boring small range trade that it has been doing for months.  My conviction has been reduced a bit so I have accordingly reduced my short.  Still think we will go down to 2420 this month, but that probability is going down bit by bit with this kind of boring trade.

Crude oil is getting supported by Saudi Arabia, who seems to be cutting production to keep prices close to $50.  OPEC is basically Saudi Arabia, and they are trying to keep prices afloat ahead of the Saudi Aramco public offering.  Look for crude oil to go back down after the IPO since Saudis don't want to be the only one supporting oil here.

Will be taking a blog break for a few days, next post is likely going to be next week.

Friday, July 28, 2017

2015 Similarities

There are growing parallels to 2015.  First, you have the big inflows into Europe on optimism in the Eurozone.  That helps rally the euro off low levels and drags down the Bunds and Treasuries.  Then the risk parity cracks begin to emerge as stocks and bonds start selling off more frequently, and often on the same day.  Also, the momentum tech stocks outperform the broader market.

Not everything is the same, you don't have the Chinese stock market crash or yuan devaluation, or any worries about Greece.  But you also have much higher prices now compared to 2 years ago.  And volatility was definitely higher and markets choppier in 2015.  That is the one fly in the ointment.  The super low volatility is unlike any long lasting top I have ever seen.  I don't think you can just blame vol sellers for that phenomenon.  Realized vol is still significantly lower than implied vol.   So that takes away my conviction on a long term top, but I think we can definitely have an swing top with these low vol conditions.

I do think as volatility increases, we will revisit that 2480 area again a few times.  But I remain a better seller of rallies and will be reluctant to buy dips.  Yesterday's sudden selloff even caught me off guard, as I expected a quiet day after the first hour was basically actionless.  But there is a lot of complacency out there and air pockets underneath.  Expect to see more of that type of price action in the coming month.

Wednesday, July 26, 2017

Blood of the Bears

The financial markets are built on blood.  After a long bull market, the blood of the beaten down bears is used to feed the next bear market.  And vice versa after a long bear market.

The early bears' pain is the timely bears' gain.  It is difficult to time the top of a market, much more difficult than timing the bottom.  One of the early signs is when the markets go from pricing in better fundamentals to just valuation/multiple expansion.  This phase of the cycle can last quite a while, which is why it is an early sign.  It is a basic ingredient for the next phase, which is the topping phase.
The tricky part about the topping phase is that sentiment actually gets a bit less bullish while prices chop around.  This can fool the contrarian into thinking that there is still a wall of worry to climb, when in fact the wall of worry is blocking higher prices.  There are nuances to this game which makes it so important to develop feel and intuition when trying to predict future price moves.

I hear cliches from traders about "trade what you see, not what you think".  Like many cliches, they have a kernel of truth, wrapped around a lot of myth.  Yes, it is true that if you hate Trump, then you would think the US stock market rally post election is irrational, so not trading what you think would be a good thing.

But if you aren't thinking about the future and only focused on the present price action, that is a recipe for chasing and getting chopped up.  A quote from someone before he became a bloated macro hedge fund asset gatherer, when he was a great trader who made spectacular returns trading macro in the 80s and 90s:

“I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.” - PTJ

It feels like a market turn is coming soon.  Since we haven't topped out yet and are still making new highs, it is speculative at this point.  But I am looking at the next few weeks where ECB tapering, Fed balance sheet reduction, and debt ceiling are on the horizon.  Those should be bear catalysts.

Monday, July 24, 2017

Europe Lagging

Feels like 2014 and 2015 again.  Europe and Japan have topped out as the US marches higher, led by tech stocks.  Even during a positive year in 2014, there were sizeable dips, one in January, one in August and one in October.  While January's dip was led by US, those in August and October were led by Europe, which topped out way before the US did.  Europe has signaled a saturation of global risk appetite for much of this 8 year bull market.

This time, Europe topped out in May, right after the good news pop from the French elections, and is down about 6% while the US is up about 4% during that time period.  That is Europe lagging the US by 10% over 2 months.

In much the same way that the yen has become a funding currency, so has the euro.  When you have negative interest rates, traders like to short that currency against one that offers a higher interest rate.  So the yen carry trade has morphed into a yen/euro carry trade.  Both are stronger lately.  While a dovish Yellen has masked the symptoms of this FX move, it still hasn't taken the pressure off these carry trades.

Remember back in August 24, 2015, the euro and yen both spiked higher on that infamous SPX limit down day.

By the way, I was watching CNBC Fast Money on Friday and they were universally bullish on tech stocks going into earnings this week.  It feels like a setup to pullback post tech earnings.

Friday, July 21, 2017

Finally Short

It finally feels like it is time.  I have gotten short SPX.  The final catalyst came out.  A dovish Draghi.  The good news is out there for the public to embrace.  Investors scared of tightening central banks have now gotten back into the pool.

The 2500 SPX psychological barrier is also another part of it.  Very few mention it, but most investors who set targets also put in sell orders around those big round numbers.  And the tendency is to put them just before that big round number.  So there should be plenty of this type of big round number-based resistance at these levels.

There are bearish catalysts out there on the horizon as well.  The budget battle/debt ceiling, potential ECB taper announcement in late August (Jackson Hole) or at the meeting in September, etc.  Also seasonally it is a weaker time of year for stocks, from mid July to September.

This is an intermediate term short, looking for a move down to 2420.  It should take a few months to chop around before the trend reverses, so no long term short yet.

Thursday, July 20, 2017

Playing the Downside

The market has "plunged" 10 SPX points from pre market Draghi highs, and is clawing back as I write.  Yes, he was dovish.  But the market knows that unless the ECB changes the capital key rules or goes into buying stocks, they will run out of Bunds to buy in 2018.  So they have to reduce QE or change the rules.  Of course Draghi will never admit that, but that's the main reason they want to taper, not because of a stronger European economy.  Europe is Japan 2.0.  It is unrecoverable.  The European economy will be right back to  near zero growth as the benefits of a lower euro dissipate, now that the euro is heading back up.  Based on the inflows into Europe and emerging markets this year, it seems like retail has fully embraced the "value" in European and emerging market stocks.  In 2015, that signaled a topping phase after a long uptrend.  I see a similar situation here, but with more dire consequences on the other side of the mountain.  Just because this time, the mountain and the air underneath is so much bigger.

There are a few options for playing the downside after the market makes a top.  And I really believe the top is coming soon.  These tops tend to come slightly below big round numbers for the S&P 500.  The 2007 top occurred right under 1600, at 1576.  The 2011 top happened at 1370.  The 2012 mini QE 3 top happened at 1475.  You get the idea.  It would not surprise me to see this market make a top right below the big 2500 psychological number.

You are getting a steady stream of low put/call ratios ever since the French elections removed a pall of uncertainty from the market.  While the super low VIX is not something I like to see when trying to pick a top, I believe that stems from investors selling volatility for income, artifically lowering volatility.  The tech stocks are acting bubbly, much like they did in 2015.  And we have gotten the good news from a dovish Yellen and today, from a dovish Draghi, which provide the final wave of FOMO buying which often forms a top.

I see three good ways to play the downside.  1.  Shorting equity indexes.  US, Europe, emerging markets, they will all work.  2.  Buying longer dated SPX puts, with SPX volatility so low, actually a good risk/reward.  3.  Buying 5-10 year Treasuries, with an equity market correction reducing the odds of future Fed rate hikes.

Wednesday, July 19, 2017

Bubble Times

It will end badly.  But timing the top gets harder when the Fed keeps its cautious rate hiking campaign.  The bond market has called the Fed's bluff.  They don't believe in 4 more rate hikes till end of 2018.  They are pricing in 1.5.  Janet Yellen blinked when the 10 year went from 2.10% to 2.39% and went back to being dovish.  That was the green light for investors to party on and make the bubble bigger.

But that is short term thinking.  Ironically, because of 2008, investors are now thinking short term and unwilling to tolerate big risks.  But that makes them get caught up in buying when things are optimistic, and dumping quickly when things start going down beyond a certain pain threshold.  And with the VIX so low, that pain threshold is pretty low, because investors have been lulled to sleep by such low volatility.  A 10% move down would seem like a shock to the system, when it's a fairly normal stock market volatility.

The end point will be the same.  It is just a matter of how much higher it can go before it gets back to more normal valuations.  And with normal valuations, we are talking a P/E of around 15 times GAAP earnings, not the pro forma nonsense that is used by the Street to tout stocks.  That would put the S&P around 1600 based on 2017 earnings estimates.  A 35% correction from these levels are needed to get to average valuations, which is where the market was in 2013.

After 8 years of a steady uptrend, with only a few corrections, it is hard for most traders to picture a scenario where the market goes down 35%.  All it would take would be for the economy to get bad enough that corporations wouldn't have the cash flow or the borrowing capacity to do stock buybacks.  You can guarantee that there will be equity fund outflows.  So without the buying power from corporations or retail, you will have to get to levels where value investors step in aggressively to counter retail outflows.  That level is probably around 1500-1600.

We have the ECB tomorrow and the Fed next Wednesday.  Those will likely be market positive, so I will probably wait till after Draghi does his usual dovish dance before going short.  We are at levels where the risk/reward is quite positive on the short side so am definitely eager to get started.

Monday, July 17, 2017

Economy and Markets

There is a reason the wealth effect from a rising stock market isn't improving the economy.  It's because most people own a negligible amount of stocks.  It's another one of the reasons why the Fed are clueless.  Bernanke believed in the wealth effect of rising stock prices, which is why he tried to goose the economy by doing 3 QE programs.  He only goosed the stock market.  He thought that people would spend more money if their stocks and funds went up.  The problem with his thinking was the people who didn't need more spending money were the ones who got all the benefits.  The people who did need it got none of them, and in fact got punished with higher rents and home prices.

The wealthy will just keep investing more if they have more money.  They already have almost everything they want.  The marginal utility of a third home is much less than a first home.  Same with cars, electronics, etc.  They don't need more stuff.  So when they got higher stock prices thanks to Bernanke's repeated QEs, they just put it right back into financial assets, not the real economy.  That's why you aren't getting the big inflation numbers despite all the central bank money printing.  All that money is just sitting there in brokerage accounts of the wealthy, or stuck in some luxury real estate.  

It is a little bit like the 1920s, except the average person isn't involved in the stock market.  The financial markets have become its own ecosystem, mostly detached from the real economy.  That is why the stock market would rather have a mediocre economy and low rates than a good economy and higher rates.  Higher rates mean much less wealth for the fixed income portion of the wealthy's portfolios.  A stronger economy isn't enough to offset that.  The market pundits think tax cuts will boost this market further but it would probably be a net negative as it would push up interest rates, which would curtail stock buybacks.   

Labor is cheap now.  There is too much supply of global labor.  That keeps wages low, profit margins high, and fuels the growing inequality and mediocre economy.

The only way the economy gets better is helicopter money.  Universal basic income.  If you gave everyone $1,000,000, consumer spending would rise so fast your head would spin.  Economic growth would skyrocket.  But the power players in Washington don't want it, because that would crush their fixed income portfolios, and they are just fine with the status quo of low rates and high equity prices and will lobby aggressively to maintain it. 

Market is a bit stronger than I expected.  It really does seem like investors were worried about a Fed that was too tight.  Now that monkey is off the back, we are getting a wave of buying.  Not ready to fight it yet, but the higher it goes, the more interesting the short side looks.  

Friday, July 14, 2017

Bad Data is Good for Stocks

We are back to the bad economic data is good for stocks price action.  Retail sales came in less than expectations, as well as inflation, and with yields going lower, stocks are pressing back up towards 2450 again.  It didn't take long for the market to forget last week's worries about higher interest rates.  We are getting to interesting levels on the short side this morning, but I don't want to pull the trigger because of the strength in bonds.  I would much rather just short the market when only stocks are going up.

I anticipate bonds being strong all summer, so it's not going to be easy pickings to short stocks unless data gets really bad.  And right now, data is just mediocre, enough to keep yields from going up, but not so bad that it affects earnings.  The only way I see yields going up for more than a few days is if tax cuts go through.  Oddly, the tax cuts that equity investors so badly want would probably be the nail in the coffin for this bull market.   While tax cuts would be a short term positive for stocks, it would be a long term negative because it leads to higher yields from greater bond issuance.  The small economic gain from tax cuts would be taken away by the negative effect of higher yields.

In 2015, you had an attack on risk parity (bond yields were reluctant to go down as stocks went sideways) which was the precursor to the 2016 down move.  Right now, you don't have that.  You did for a few days at the end of last month, but Yellen went right back to looking away from asset bubbles.

She gave her seal of approval to this bull trend in stocks, which is not surprising because the Fed talks a tough game but usually doesn't follow through.  At least Yellen was honest that the Fed boilerplate message of transient inflation and strong labor markets was just a pretext to put through a  few rate hikes.  Now that the Fed fund rate is back above 1%, she doesn't feel the urgency to keep hiking.  Unless the stock market keeps making new all time highs and busts out over 2500, what Yellen said on Wednesday should be the new boilerplate message.

This year, unlike 2015, bonds are looking bullish and that should make it harder for stocks to go down without some kind of shock to the system, which is lower probability.  I am still leaning bearish, due to valuations, but current financial conditions are still loose enough that stocks could grind a bit higher than expected before getting hit with a correction.

Wednesday, July 12, 2017

Yellen to the Rescue

Here they come again.  The Fed is back with a giant fire hose to blow out a little brush fire.  I guess Yellen had seen enough of the rise in bond yields from 2.10% to 2.39%.  29 bps was all it took to go from hawkish(supposedly) to dovish.  Talking out of both sides of her mouth.  Saying the Fed will keep raising rates and that neutral rate is 3% and saying that not many rate hikes left till they get to neutral.

The market did overinterpret the last FOMC meeting when she kept to the script of balance sheet rundown and another rate hike this year.  That was just her staying on script, not really revealing what she had in the back of her mind.  We got the truth today.  She is worried about low inflation and worries about high asset prices is way down on the priority list.  The tightening theme of global central banks taking back liquidity was dealt a blow today.  It had become popular on TV to say that central banks tightening policy would keep stocks from going higher.  The market was offsides for a dovish turn by Yellen.

How quickly those emails from Trump Jr are forgotten.  Now the bulls will think its clear sailing.   Overall, the conditions are still the same.  I never was banking on a hawkish Fed to take down the stock market.  That's not going to happen this time around.  They are chicken littles who will coddle the stock market if it has a tantrum.  My bearish view was more fundamental to overvaluation, low economic growth, and investor positioning.   Those things are still there.  I would like to see a slight break above SPX 2450 to all time highs to put on my shorts.

Monday, July 10, 2017

Fed is Late Again

They did it again.  Same mistakes, different time.  The Fed has set a pattern for their monetary policy which is:  they react to economic weakness quickly and react to economic strength slowly.  They will cut rates in 50 bps chunks at every meeting, and even between meetings, because they can't wait a few weeks.  You ever see the Fed raise rates between meetings?  For interest rates, it is  the staircase up, elevator down.

Starting with the Greenspan years, you had the 2004-2006 rate hiking cycle, in 25 bps increments, as the housing bubble was getting bigger and bigger.  They started too late and went too slowly.  Now the Bernanke/Yellen years.  Stretching out tapering over a year.  And that was with a 3 month delay because they hinted at it during May/June 2013 and should have done it in September but didn't do it till December.  Did they ever start QE gradually and build it up to full size in one year?  No, it was huge from the start.

And you wonder why the bond market doesn't believe the Fed when they predict 1 more rate hike this year and 3 more rate hikes in 2018.  Because the Fed overreacts to market weakness, and will either stall their rate hiking campaign or go to cutting again if we get a correction.  And odds are high that we will get a correction.  Don't believe the Fed when they say they are worried about high equity prices.  They will change their tune as soon as the S&P drops 10% and start worrying about stock prices getting too low.  They are Tony Larussa (retired micromanaging baseball manager) on steroids.
It has been a painfully slow rate hike cycle, and the Fed has lost their credibility when it comes to controlling asset bubbles.  They have babied the markets for so long, there is a expectation built in for  them to come to the rescue on any big dips.  And they will again.  Just like they did by delaying rate hikes in 2015 and 2016.  Now they have suddenly gotten brave with their 25 bps hikes every 3 months as the S&P has only gone up.

The financial pundits really do have a short memory.  They suddenly fear the Fed and their tightening cycle hurting stocks when they should be more afraid that the market is just a big fat bubble whether rates are at 0 or 3%.  

It looks like another boring summer day.  "Goldilocks" nonfarm payrolls number got traders positive again on stocks.  That shouldn't last for long.  Expect a move down this week to take back those Friday gains.  Chop continues.

Thursday, July 6, 2017

Relentless Bond Selling

They are crushing them again today in the bond space.  Led by the Bund, which is leading this selloff as the Europeans are starting to freak out about ECB tapering.  Draghi opened up a little crack in the door for tightening and traders have busted it wide open.  The equities keep reacting negatively to the higher rates, a bad sign considering where we are in the cycle.

This is reminiscent of what happened in May and June of 2015 as a German Bund bull market came screeching to a halt, at 7 bps, and rallied into the 90 bp range.   It was a preview of the risk parity fiasco of August 2015.  By the way, the SPX topped out in May of 2015 at 2134.  After that, stocks really couldn't go anywhere, and chopped around for another 3 months.  This is something that has been on my mind all year, the similarities to a 2015 type market, as the market tops out and chops for months on end, and then drops suddenly.

I don't know why those financial experts on CNBC think that low Treasury yields are something to worry about.  We had Treasury yields going lower for most of this year till last week, and the indices were doing great.  Now that you get this bond selloff since Draghi opened his mouth last week, you have a more volatile stock market that can't find any upside.  No, it is higher rates that stocks have to worry about.  And also a bunch of other things, which are a bit less urgent.

The recent price action is a signal that there are way too many assets in risk parity strategies.  Stocks are very fragile at these price levels, considering its sensitivity to what is happening to bonds.  I was listening to a podcast the other day and I heard a pension fund asset allocator talk about risk parity as a risk mitigating strategy that they use as a hedge for equities.  How about just having less equities and more cash in the portfolio?  Oh yeah, they need to meet their target annual return of 8%.  Good luck with that at these asset price levels.

There are way too many funds using long bonds as a hedge for their equity holdings.  It leads to these short term dislocations when bonds don't go up when stocks go down.  As volatility has died out, VIX as an equity hedge is now frowned upon, especially with its heavy negative carry.  The fund managers have smartened up, and gone to bonds as a hedge.  But this sets up vulnerabilities that you have seen recently.

The biggest pain trade right now is an explosion higher in VIX, which would lead to a cascade of selling in stocks, and muted upside in bonds.  The VIX sellers would be panicking as volatility exploded only exacerbating the situation.  That is what happened in August 24, 2015, but this time, the move could actually be much bigger with so many more assets in risk parity and so many more bearish on VIX.

In the long term, the stock market weakness on weaker bonds will keep the Fed from tightening much more, because they will be much less hawkish when stocks are going down.  So while I view this stock market price action as bearish for stocks, I think it is long term bullish for bonds.  These bond selloffs tend to last about 2 weeks, and then peter out.  So we could be getting closer to a bond bottom by early next week, depending on what happens with nonfarm payrolls.  A strong nonfarm payrolls number will probably make the bottom come quicker, perhaps even by tomorrow.

By the way, Nasdaq is going down much more than the S&P 500 on down days recently.  Also, biotech has been popular.  Chasing high beta sectors is late cycle behavior.  The fund managers chased tech stocks higher to catch up to the averages.  Now they are loaded up to the gills and have to sell when they start feeling the pain.  I expect volatility to increase this summer as the topping process continues, setting up a nasty correction in late summer/early fall.