Monday, January 30, 2017

Price vs Time Sensitivity

The motivation to buy or sell, to put on a position or to close a position depends on the trader putting in the order.  In general, traders are more urgent when closing out positions than when putting on positions.  That is why stocks often go down much faster than they go up.  You have those that are urgent and those that are patient.  The path of least resistance is usually directly proportional to the urgency of that side of the trade.  Every trade has to have a buyer and a seller.  If the buyers are more urgent, the price will likely rise.  If the sellers are more urgent, the price will likely fall.  This is common sense but it's often lost in the weeds of trying to find out why something is moving, what news came out, etc.

Opportunities arise when you have a lot of capital in the market that is time sensitive.  This is often times fast money, fund inflows/outflows, or those getting margin calls or having to sell to reduce risk.  That is when the market is the most inefficient.  You see this time sensitivity a lot in high volatility markets, because a lot of fund flows and hedge fund de-risking/re-risking is occurring.

It also occurs around key events that people worry about, like Brexit vote or the US presidential election.  Around those big events, you see a lot of time sensitive urgent trading going on, which is where the seasoned winning trader will step in and take advantage of the opportunity.  But in order to not get shaken out during the short term volatility, trade size has to be reasonable.  Too small and you don't make much.  Too big and you risk getting shaken out if the timing is a bit off.  Then, you become a time sensitive trader yourself, being forced to cut a position due to losses.  That is the worst of all worlds.  Knowing that your trade will go in your direction within a few days, but not being able to withstand the storm and having to reduce or close out the position for a loss, at probably the worst possible time.

Price sensitive traders are the fishermen.  They are patient, they go to the right spots, and just wait for the fish to bite.  The fish are usually the time sensitive traders.  The right spots, or markets, are the ones where the most stress/volatility is occurring.  As I have said before, traders under pressure and facing losses act with more urgency than those with comfortable gains.  That is why you get higher volatility (more opportunity) in down markets than up markets.

Interestingly, that is not the case for the commodities markets.  In commodities, bull markets usually have higher volatility than bear markets.  { That is because most commodities end users have a low price elasticity and will have to buy the same amount, whether the price is high or low.  The marginal buyer has to buy at a much higher price during a shortage, but doesn't have to buy at a much lower price during a surplus, because most commodities can be stored for years, and opportunistic buyers who are price sensitive will buy a commodity and put it into storage to sell later, creating a value floor.   Thus you get the asymmetric tail risk towards the upside, not the downside like in stocks. }

You DON'T want to the be the guy who has to trade today.  This hour.  This minute.  It usually leads to bad prices and entries.  The best prices to enter usually have a small time window.  Stocks don't often linger at the bottom waiting for traders to accumulate, and then burst higher.  They usually go down, find a V bottom, and quickly go back up.

There is a fine line between trading too much and trading too little.  You can set a threshold for a trade so that you take all 60/40 (60% winner/40% loser) trades or better, but a lot of those 60/40 trades prevent you from taking advantage of 80/20 trades.  For example, let's say I want to buy SPX on a dip to 2250 within the next 5 days.  If that is a 60/40 trade, waiting for a dip to 2230 within the next 5 days could be a 80/20 trade.  So if you take the 60/40 trade and buy at 2250, you prevent yourself from buying at 2230, unless you want to double down and add to the position.  But that has a notable downside.  It gives you a position sizing profile of having your largest positions be the ones that start out the worst.

But if you are too patient and only wait for 80/20 trades, then you are passing on a lot of good (51/49 to 79/21 trades), but not great opportunities.  Positive expected value (EV) trades that pass by without any money being made on them.  That can demoralize the psyche, especially if one is a full time trader.  But that may be the payoff a trader has to make in order to avoid overtrading and putting oneself in the line of fire day after day, with marginally positive EV trades.  Those are the type of trades that get traders in trouble, stuck with a loss, unable to cut the loss, and then having the loss get so big that it leads to forced selling at horrible prices.

Next time you trade, try to figure out if you are overtrading, trying to catch a lot of minor moves, and rushing your entry.  Or if you are being too patient and letting too many good trades pass you by.

We are a getting a gap down to start the week, after what I believe was a false breakout last week.  The market got overly excited last week with Trump's first week in office, where he looked busy, and promised massive tax cuts and infrastructure spending.  As this past weekend has shown, Trump talks a good game, but can he execute a good game?  So far, he's had to roll back a few of his haphazard executive orders.  The road to lower taxes and more infrastructure spending is not going to be as easy as people thought.  Trump really doesn't know how to operate in Washington.  There is a give and take to the process, not just take and take.  Missed the short last week, being too patient.  But it wasn't that great of a shorting opportunity so I don't mind.

Friday, January 27, 2017

Higher Rates Matter

Just because the market went up higher along with interest rates doesn't mean that it can keep doing so.  We are around 2.50% on 10 year yields, a level which starts to impede economic growth.  This is a financially repressed economy, which needs low interest rates to maintain reasonable growth rates.  Trump seems to still be acting like he's on the campaign trail.  There is only so much abuse that some of these nations will take before they retaliate and start a trade war.

Now I don't think a trade war is as negative as those in the liberal media and in business news channels make it out to be.  And yes, it is pretty clear that the media has taken a decisively anti-Trump stance.  Yes, it will reduce some exports for the US, but the US isn't that dependent on exports.  And the stuff that they do export, is not as price sensitive as the stuff that is imported.  So in a trade war, the US will win, and the opposing nations will take a much bigger hit.

So let's assume there is a trade war, that will reduce the US exports by 20%.  Well, the US imports would probably be reduced by at least 30%.  So the trade balance improves, and US manufacturers come in to take the remaining share of the pie left by the import reductions.  That will cause price of goods to rise, and increase inflation.  But let's get real, when was the last time the Fed raised rates because of high inflation?  1981?  The Fed is solely focused on the S&P 500.  If the S&P is rising, then they will be hawkish.  If the S&P is falling, they will be dovish.  No questions asked.

If you want to be negative on the S&P, it will be because we are overvalued, interest rates are higher, and the economy is just not that strong.  Not because of some tariffs and border taxes.

That little breakout seems to be fading here today.  I like the short side, but will wait till next week.

Wednesday, January 25, 2017

False Breakout

The market established a desirable level for the past month by trading in a tight band, mostly between SPX 2260 and 2275.  Yesterday we finally got a little breakout, and it is continuing in the premarket, looking like a breakout from a long base.  If this was 30 years ago, and there weren't so many traders looking at the charts and trying to play breakouts, the move could have a lot of meaning.  But these days, these breakouts tend to be better fades than trend trades.  These breakouts would have much more staying power if it was long term demand from retail and institutions, not short term demand from fast money.  Considering that much of this buying was pent up demand waiting to buy a post-inauguration dip that didn't arrive, you can be sure that it is fast money demand.  Odds favor that this breakout will fail, and we'll go right back into the comfortable tight little range that we've established.

Perhaps give the post-inauguration fast money a few more days to establish their positions, and then it could be time to get a short position on.  This is still Trump's honeymoon period, and the market still has a lot of hope for his fiscal stimulus.  Market is already fairly long, so I see limited upside from these levels.  Just like first quarter 2015.

Monday, January 23, 2017

Trump Uncertainties

When it comes to the stock market, fiscal policy is vastly overrated.  Monetary policy is the AK-47.  Fiscal policy is the butter knife.  Sure, Trump will try to maximize fiscal policy by blowing out the deficit to astronomical proportions, with his large tax cuts, but that comes at a price of higher interest rates, which feeds back to lower P/E multiples and tighter financial conditions.  Only if Trump can succeed in getting someone who will be dovish regardless of high inflation will he be able to boost the stock market to even loftier levels.  What he needs is a Fed chairman that likes him and is willing to play along in creating a high pressure economy.  Even then, he faces the headwind of unfavorable global developed market demographics, overcapacity, and lack of productivity growth.

Trump's press conferences, America first spiel, and "alternative facts" are just a sideshow.  What matters is economic policy.  Right now, it looks like Trump has decided that he will use up a lot of his political capital on abolishing Obamacare and revising trade deals.  Once he gets to the tax cuts, he may not be facing such a willing audience in Congress.  Especially if his popularity gets any lower.  And it is already pretty low for an incoming President.

At current valuations, the S&P 500 will not be satisfied with just token tax cuts.  Its expects taxes to be slashed and burned over the next 100 days.  With the direction that Trump is going, he may not be able to bully his way to getting all the tax cuts he wants.
Even if he does get all of his tax cuts through, they are a short term solution.  The effect of the tax cuts are temporary because the market soon discovers that deficit financed tax cuts effectively rob Peter to pay Paul.  You are robbing bond holders to pay stockholders, high income earners, and corporations.  Ironically, the elderly, those that were most likely to vote for Trump, will be the ones hurt the most by his economic policies.  Only when there is monetizing of the debt is there a nominally "free" lunch.  Of course in real terms, there is no free lunch.  You don't increase a nation's wealth by cutting taxes or monetizing the debt.

If corporations never had to issue debt, they would be riding a gravy train of fiscal expansion.  But a lot of them have to issue debt to function.  And if they have to pay higher interest rates to do it, that is a price that is not insignificant.  With the QEs, it was heaven for corporations as they could buy back stock through debt issuance at low interest rates.  Not so heavenly anymore, especially if interest rates keep going higher.

This is not a market to try to make big gains.  Frankly, it has been boring for S&P traders for the past few weeks.  There will be times like this when the market is near all time highs and investors are comfortable.  When investors are uncomfortable and under pressure, that is when the opportunities arise.  Right now, investors don't feel any pain and are sitting there happy to do nothing, close to all time highs.  Not forcing the issue here.  Waiting for movement.  And if it doesn't come, I will do nothing.

Friday, January 20, 2017

Retail vs Institutions

I am seeing counter opposing views on the market from retail and from the institutions.  It seems  that the overall retail market sentiment is reluctantly bullish with retail, while the institutional sentiment is more optimistic about Trump and bullish.  Since it is the institutions that are the ones that usually controls the market, I see very little upside in the market.

I know I stated that there could be a bubble, although a lower probability event.  The more time I've had to think about it, the probability of a bubble are much lower than I thought.  It just isn't a bubble inducing environment.  The economy is just not strong enough and Trump's tax cuts will not change that.  The economic growth slowdown is secular, and the Fed's ultra dovish policies have squeezed about as much as you can out of this lemon.  The global economy is a lemon.  US is the best out of a weak group.  It is still weak.

You don't have a supply-demand imbalance at these price levels.  There just isn't enough demand, and I doubt we see much more considering how high the current US household equity allocation is already.  Then you have valuations, which don't support a sustainable rise in the market without having a bubble.  And there just isn't the willingness among the public anymore to buy into equities in a bubble after getting burned so badly in 2000-2002 and 2007-2009.

This optimism about Trump's policies may be the last good opportunity to allocate out of stocks and into bonds at favorable prices.  February/March should be the time to do it.

Thursday, January 19, 2017

Trump Will Disappoint

I am reading articles about some of his intended budget cuts, and it is not going to be good news for the US economy.  I was expecting no budget cuts, massive tax cuts, some infrastructure spend, and a huge blowout of the budget deficit.  It looks like it could just be a big budget deficit, not a monstrous one.

As the days go by, I see Trump having less and less of an effect on the market, as his statements just don't have much teeth to them.  They seem to be a form of entertainment for him, not something that you can base his policy on.  The market will soon catch on to that fact and react less and less to what he says.

I don't see the crowd having high hopes for a rally after the inauguration, but I also see a lot of complacency building up as the volatility dies out.  That is usually a good sign that we'll get a little mini shake out, nothing serious, perhaps down to SPX 2240, about 1.5% down from here.  That would be enough to shake out some of the fast money.  I don't see the big dip from this level, as I don't see much exuberance on the long side.  It remains a 2015 type of market.  You will get choppiness at the top for the next few weeks, and then I expect an attempt at a breakout above 2300.

I see very little edge here either way, although if I had to choose sides, I would rather be short than long S&P.

Tuesday, January 17, 2017

Going After the Hedgies

The hedge funds are having a hard time of it so far this year.  As a group, they are short bonds, and long the dollar.  Both are moving massively in the other way, with bonds squeezing shorts hard since the last week of December, and the dollar getting wrecked since the first week of January.  There is a bit of an unwind of the Trump trade as they reflect on his lack of details on economic policy and his infighting with Congressional Republicans about corporate taxes.

These are your pre-inauguration jitters, and the uncertainty is being priced into crowded trades.  However, the S&P 500 has been resilient, hardly flinching as other macro bets go awry for the hedgies.  I do believe that the hedgies will be getting relief soon, when Trump starts going into specifics on his tax cuts.  That is the main piece of the Trump trade.  Blowing out the budget deficit with huge fiscal stimulus in the form of tax cuts and a little infrastructure spending, benefiting stocks and killing bonds.

The action so far in 2017 shows how tenuous these Trump trades are.  They are based on a belief that Trump will deliver everything that he talked about on the campaign, but now the uncertainty is starting to creep in and that requires adjustments in prices.  I still believe that we will get to a point in the first quarter when the hedge fund managers really push hard with the long dollar, long US stocks, and short bonds trade.  Right now, they are taking their foot off the gas a bit, waiting for Trump to reveal more concrete details of his economic policies.  Even though Trump is not the smoothest communicator out there, he does have a habit of wanting to get things done his way, which would mean really large tax cuts, and a total disregard for the deficit.  That is stock heaven in the short term.

The S&P 500 continues to bore us, and there is no need to force trades in these situations.  But I would rather buy dips than short rallies from here.

Thursday, January 12, 2017

Trump Disappoints

Trump was definitely not on his A game yesterday.  He threw flaming Molotov cocktails at the pharma industry and looked like he could care less about the stock market.  The Trump sell the news phenomena is at work today.  There was some short covering ahead of the Trump press conference yesterday, and then longs dumped as Trump was rambling about random things and just put on a poor showing.  That is not what the longs were looking to see.  They wanted more concrete details about tax cuts, deregulation, and infrastructure.  They got none of it, except a combative Trump chewing out the media.

We are chopping around at the top, just like 2015.  This time, the VIX is much lower, so don't expect the dips to be as big as the ones that we had in the first half of 2015.   Despite the big down move today, the VIX is at 12.5 as I write this.  That is a pathetically low level, a level where the VIX usually rises from, but often with the market rising as well.  That is when you have to start looking for a top to short.  Right now, use the chop to buy the weakness.  This selloff will not get serious unless you break SPX 2240 and stay below for a couple of days.  There is strong support at that 2240 area, around the closing levels of 2016.

It is a bit too early to buy the dip, although not a bad risk reward.  I will save my powder for the market to get closer to that 2240 support zone before I get aggressive with dip buys.  Sometimes you will miss 60% probability trades, waiting for that 75-80% probability trade.  But I expect there to be some selling ahead of the inauguration, as that is the motto that many fast money types are espousing:  Buy the election, sell the inauguration.  Instead, if we selloff into next week, I would want to buy the inauguration, sell the Trump economic policy announcements.

Treasuries are also lining up for a turn, as we get closer to 2.30% 10 yr yields, that could be a good spot to put on a swing short in bonds.  Although long term, yields should go lower, over the next few months, there are a lot of negative catalysts for bonds which should push yields back up towards those highs in December around 2.60%.

Tuesday, January 10, 2017

Reminds Me of 2015

The price action, charts, and investor attitudes remind me a lot of 2015.  That is, early 2015, before you had the big August plunge.  The sentiment is similar, we are near all time highs, yet it seems like investors are tepid about this rally, waiting for more proof, as in details of Trump's plans.  If you recall in the spring of 2015, you had bonds selling off while equities were chopping sideways.

As you can see below, the SPX had a thrust higher off a fear bottom in October 2014, and rallied strongly for 6 weeks, and then chop for the next 8 months before the bottom fell out in August.  The reason for the chop was plunging oil prices, and partially the stronger dollar.

This time, we don't have plunging oil prices but we have the return of the strong dollar.  Just like 2014, the market bottomed and ran up strongly for 6 weeks into the FOMC meeting in Nov-Dec 2016, where Yellen quashed some of the animal spirits, and we have chopped for the past 3 weeks.   The sentiment is similar in that you had lots of bullishness on the thrust higher, but then when you started chopping, the sentiment quickly became more neutral and tepid.  There was no enthusiasm at the top, just dull trading.

Hopefully this time we don't get the same scenario where the market turns dull and just flatlines.  One difference this time though is that the VIX has remained quite low during this chop, while the volatility was definitely higher in the early 2015 period.  The more chop that we get here, the less likely that we will have a blowoff top.  Usually blowoff tops require enthusiasm and I don't know if we will be getting that this year.  Perhaps we see some enthusiasm for Trump's policies once they get passed, but I think odds are that we don't.  There is a hard wired pessimism in this market among retail despite 8 year bull market.  It makes it more likely that we have an extended chop at the top rather than blowoff.

Looks like we are going to be hearing from Trump tomorrow, it seems like a sell the rumor situation considering the now widely held belief of buy the election, sell the inauguration.  It is a psychological game of chicken now.  Who will be the sucker left holding the bag when the crap hits the fan?  It seems like there is apprehension to hold the bag but the automatic roboadvisor inflows keep pouring into US equity ETFs.  With the lack of enthusiasm, it seems more and more like a chop till you drop 2015 scenario.
We'll have to see how the market reacts to Trump after inauguration.  My gut feel tells me we selloff before Jan. 20, and then rally after.

SPX October 2014 - October 2015

SPX September 2016 - January 2017

Friday, January 6, 2017

A Bubble Can Happen

It is hard to predict bubbles, because they occur when human nature goes from being scared to participate to fear missing out.  The huge inflows since Trump became elected clearly shows a transition taking place. From being scared of buying equities, which betrayed them in 2000-2002 and 2007-2008, to the fear of missing out, after 7 straight years of gains (with dividends included).

Although my base case is for the market to top out in the spring, near 2400, there is always a probability that the market overshoots and enters into a bubble, like you overshot in 2000 and 2007.  I would say there is a 30% chance that we top out between 2280-2350, about a 50% chance of topping out between 2350 and 2400, and a 20% chance of the market entering a full blown bubble and topping out above 2400.

The funny thing is that those who are looking for a correction and are bearish now, at 2275, will be eager to buy if we get to 2350 and then fall back down to 2275 later this year.  That is just human nature reluctant to buy all time highs.

It doesn't take a great imagination for investors to get all bulled up as Trump delivers on the big tax cuts and deregulation, and does almost nothing meaningful on trade.  That would be the most likely case.  The infrastructure is meaningless, because the implementation is so slow, and always done on too small of a scale.  All this stock market cares about is those huge tax cuts.  Once the tax cut bill starts taking shape and is announced, the enthusiasm will probably be much greater than what you see now, with a probable higher price tag on the S&P 500.

The animal spirits this year cannot be underestimated, especially considering the amount of bearishness you had for so long from August 2015 to June 2016 (Brexit).  It takes time for the public to fully embrace the stock market again after that long period of bearishness.  Usually at least a year from the scary period.   If we didn't get a purge like we did early last year, I would be much less confident about the market rising in early 2017.  The trick is to figure out the best way to play the rise and fall in 2017.  I am going to be conservative and wait for a good time to short, and not try to ride the final wave higher, although I am fairly sure that we still have higher to go.

If I do play long, it would be for just swing trades, nothing long term.  But I have a feeling that this market will not be providing any easy long entries as we head towards the top.  Usually the final move higher in a bull market happens without a pullback along the way.  Picking a top right now is downright dangerous, so I will wait for more Trumponomics "certainty" before I short.

Thursday, January 5, 2017

Strong Treasuries Bounce

The strong bounce that you are seeing in the Treasuries over the past 2 weeks is a big boost to the bull case for the S&P.  The bond proxies will get a much needed reprieve, and this bond strength is happening despite the S&P near all time highs.  Also, I still see no enthusiasm for this S&P rally, despite all the contrarians harping about big inflows and excessive bullishness.  I just don't see it in the media.  Maybe there are a lot of shy bulls, like shy Trump supporters.  Bulls are definitely not that loud in public.

The biggest bear case for stocks was a big rise in yields causing interest expense pressure to corporations and slowing down housing and borrowing.  It seems like that is definitely not the case.  Yesterday's FOMC minutes showed a Fed that is still cautious, and leaning dovish, despite throwing out their worthless 3 rate hikes in 2017 dot plot projection.  They are always throwing out new uncertainties that prevent them from hiking, now it is fiscal uncertainty.  What will it be next?  The French elections?  Then the German elections?  They are a complete joke.

Those thinking the Fed can continue to hike rates and are bearish the stock market are holding incongruent views.  The Fed will only continue to hike if the stock market is going up.  They will either freeze or cut rates if the stock market drops.  That is how the post 1994 Fed operates.

Sad to say, but until we get more bullishness in the US stock market, I think we will continue to grind higher with only small pullbacks.  Any drop down to the 2016 close at SPX 2240 will be bought with both hands by fund managers.  As old and tired a strategy as can be, the buy the dip strategy still works great in the S&P.  It should continue until you start seeing some serious bond market weakness and excitement over Trump's tax cut plan.

Tuesday, January 3, 2017

Buying in the New Year

You can interpret a lot from the action on Friday, December 30.  First, you had a gap up, which tells you that European stocks were not being liquidated, and have very little fast money in them.  Second, you had the fear of January selling/terrorism/rebalance all rolled into one big sell fest.  The selling didn't feel organic.  It felt more like profit-taking ahead of January and hedging.

Obviously, it being December 30, the last trading day of the year, you had a lot of mechanical selling going on, to make the books look cleaner, buying Treasuries and selling stocks.  And since it is a less liquid time of year, there wasn't enough volume willing to take the other side unless done at a decent discount.

Third, you didn't close at the lows, like you did in the last trading day of 2014 or 2015.  That tells you a lot.  It tells you that the selling dried up and the buyers were more aggressive at the closing bell than the sellers.  Sure, you still closed near the lows, but that bounce in the last 5 minutes of the trading session told you that there wasn't much selling leftover to be done in the next trading session.

I may be trying to take too much meaning from one session, but it collaborates what I heard on CNBC and social media.  There is quite a bit of apprehension to embrace this rally.  I heard many more looking for a pullback than a continuation of the rally for January.  And when you hear that, it means the fast money has already sold down a lot of their equity holdings.  If the equity inflows into the US continue, like I expect, that will provide the firepower to take this market to new highs, as the fast money jumps along to ignite the flames.

Oil looks strong, despite the stronger dollar, which will help the energy space.  We all know the small caps are strong, with the Trump economic plan benefitting them the most.  It looks like bonds have found a floor, which will stem the selling in the dividend names.  I am no raging bull, and I am waiting for a spot to short at a later date, but it seems likely that we will be going higher as we climb the wall of worry.  By the time Trump gets his economic plan announced in Q1 or Q2, that wall will have been obliterated.

Looking for higher stock prices in the first few weeks of January.