Rethink on Trump Speech

Based on what I am hearing, the expectations are pretty low for this Trump speech to Congress.  I am now leaning more towards this being a nonevent, just because I think Trump will just end up meeting those low expectations.  Plus, we have the first day of the month tomorrow, which is usually bullish, and it just isn't a great bet to short into the Trump speech tonight.  I was thinking the simple play, but the expectations are too low for my liking.

You cannot short in the hole in this market, you have to try to sell all time highs.  That is the only way you will get a decent risk reward play when you are still on the front side of the move.

Trump on Tuesday Night

The big event this week is Trump's address to Congress on Tuesday Night.  He is supposedly going to outline the budget and his tax plans, among other things.  This looks to be a buy the rumor, sell the fact scenario coming up.  Normally, the selling would not be much on something like this but the market has rallied so much that any bit of disappointment would be enough to get weak hands to sell.  I don't expect much selling, just enough to get us back down towards SPX 2340-2350.

It is hard to say exactly what kind of address it will be, but if Trump's previous announcements are a guide, it will be vague, lacking specifics, and probably disappointing.

On Friday, I thought we would finally get a volatile day and finish weak, instead the market made its lows in the premarket, and rallied straight from the open and closed near highs.  Europe is trying its hardest to bring the US down with it, but it just doesn't have the firepower.  Investors have learned to shrug off European weakness at the US open and treat these gap downs like a buying opportunity.

Bonds rallied huge on Friday despite the equities trading mostly flat.  I would not get sucked into believing that the bond market is going to continue to be strong, there are a lot of events over the next 2-3 weeks, so I doubt the bonds will rally higher into them.  In fact, I think bonds are probably a better sell than a buy here.  Equities should be a sell either today or tomorrow, still deciding on that.  

SPX and VIX Correlation

The VIX is flashing warning signs.  It did so last Wednesday, 2/15, and you had a pullback the following day.  Yesterday, on a slight up day in the SPX, the VIX futures were up firmly, especially April.  Today in the pre-market, you have VIX futures up again meaningfully.  As you can see below, the VXX, VIX short term ETN, has been trending higher along with the SPX.  In fact, volatility adjusted, the VXX has been up more than SPY during the uptrend over the past 2 weeks.  That is quite hard to do when you consider the steep contango embedded in the VIX futures curve, making VXX go down in a natural decay if VIX stays stable.

Past instances of VIX moving in the same direction as the SPX acted as a warning that the market is about to pullback.  With the French elections in April/May, Trump's tax plans seemingly taking longer than many thought, and continued hawkish rhetoric from Yellen, any one of those things could act as a convenient excuse for hedge funds to reduce their equity exposure.

The question is how far do we pullback.  Eventually, we should go back to the breakout area of SPX 2300, but it could take a few weeks to get there.  Before then, I don't think we can rally much from these levels.  We could chop around for a week or so and then drop in March.  Not a huge amount of conviction on the extent of the pullback, but the timing should be soon.  I would think that any Trump tax announcement in the coming weeks will be met with disappointment and a sell the news reaction.  There are still a lot of Republicans that oppose the border tax, and without it, you need a debt explosive tax plan, which seems like a possibility if the border tax doesn't get through.  Mid march would also coincide with a pre-French election risk off mood.  All signs point to a pullback.

I have yet to get a short position and I regret not shorting the intraday bounce near the close.  If we get another move towards yesterday's highs in the coming days, it is a good risk reward chance.  I am finally getting interested in shorts, but want to wait to short near all time highs to give myself a better chance to hang on through the chop.

Neutral on bonds here, it could go a bit higher into month end, but then you probably will get your typical selling early in the month ahead of nonfarm payrolls.

Bubble Time

It is a bubble now.  I still had some doubts that we would get a bubble because of the apathy towards stocks by the retail public, but you can't underestimate the pressure to chase performance among fund managers.  It's not their money anyway.  Their main goal is to keep their cushy jobs, not to outperform the markets.  The most conservative way to keep that cushy job is to hug the benchmarks, to be a closet indexer.

They may not think of themselves as sheep, but they instinctively follow the herd, more so than retail.  Retail usually likes to sell all time highs, fund managers usually like to buy them.  This rally has been self reinforcing, as strength forces those underweight to chase for fear of being left behind.  One thing you can't do in the investment business is to lag everyone else.  If everyone else is fully invested, and the market is going up, then you need to catch up by getting fully invested or face possible redemptions.  

The structure of the business reinforces a herd mentality, and that is what you are seeing since the election, as we are going higher despite the Trump uncertainties about taxes and the upcoming French elections.  

This type of performance chasing can go on for some time, but not a long time.  Months, yes.  Years, no.  Eventually when the marginal buyer becomes fully invested, the buying power quickly dissipates.  Based on the strength in recent days, the buying power still seems to be there.  Usually a top is not defined by one point, but a series of points around a supply zone.  Like 2007, when the S&P flattened out at 1550 for a few trading sessions in July, and then again in October.  Or 2015, when the S&P flattened out around 2130 in May.  We still haven't flattened out yet.  That is what I would wait for before taking a shot on the short side.  

Yesterday the VIX went up with the market, which usually portends a pullback within a week.  The risk/reward for a short term short is getting more attractive as the VIX stays bid.  Only fly in the ointment to the bear case is that 10 year yields are refusing to go higher along with the S&P, which is equity positive, unlike what your paper napkin correlation traders say.  

Levels of Difficulty

Not all markets can be traded using the same strategies and tactics.  Some are much easier than others.  You can think of it like playing poker against rookies, casual players, and professionals.

First, you have the home poker game, filled with rookies and casual players who have very little understanding of the fundamentals of winning poker.  The Wall Street equivalent is the pink sheets/OTC/small caps.  Those trading in these markets are mostly rookies and casual players.  These traders will make many mistakes, chase momentum in pump and dumps, buy dips in permanent downtrends, and get caught up in the hype of meaningless press releases.  Basically, their ignorance provides the liquidity for insiders and promoters to profit from selling into the volume created.

The next level is the low to mid limit poker games in the casino.  You have mostly casual players with a small number of low level professionals sprinkled among them.  The Wall Street equivalent are large cap stocks.  Large cap stocks is usually traded by a mixture of casual investors, some professional traders, and a lot of fund managers.  These traders make fewer mistakes, usually have a good understanding of company fundamentals, but often get caught up in the hype, fall into value traps, and fall prey to more informed traders who have insider information.  

The highest level of poker is in the high limit poker games filled with professional poker players.  You have almost no newbies or rookies.   The Wall Street equivalent is the forex and futures markets.  Although you will find a lot of newbies and rookies in the forex and futures markets, their size is so small, that they have almost no impact on the market, and are mostly cannon fodder for the big boys.  Those are the high frequency trading firms, futures-focused hedge funds, and professional independent traders who have found an edge from years of experiencing studying and trading these markets.  These waters are filled with sharks, with lots of fish, but they being so small, that they aren't enough food for the sharks.  The sharks feed upon themselves, with the big sharks eating up the smaller sharks.

It also happens that the easiest markets to predict are the ones that are the least liquid.  In general, the more liquid the market, the more professionals there will be trading in that market, making it less predictable and harder to find an edge.  I always recommend traders who just start out to focus on finding an edge trading small cap stocks.  That is the easiest game in town, with enough liquidity for beginners.  In fact, I think those who have a lot of capital and are experienced should still trade these small caps if they don't want the stress of having to trade more unpredictable markets.

But there are a lot of traders out there who only want to trade the most liquid markets, who only focus on ES or big cap stocks, with every little edge, banging their head against the wall.  The easy money is in trading against the rookies and casual traders/investors.  That is only found in the penny stock/small cap world.

This market is amazing.  It is bubbly.  And we still haven't even gotten any details of the Trump tax plan.  There has got to be a top around the corner but once you get bubble like behavior, it becomes dangerous to fade the rally.  Still waiting for clearer signs of topping, and we just aren't getting it.

Feeling Toppy

The VIX is showing signs of life, although still well below that 14 level where things get much more interesting.  We almost hit 13 yesterday, but quickly went back down towards 12.  The market has gone parabolic over the past several sessions, and with VIX staying firm, usually a sign that we will get at least a small pullback.  At the very best I expect choppy sideways movement over the next couple of weeks.

The Europeans will be quite reluctant to chase equities higher here, especially with the French elections coming up in late April/early May.  The market usually starts worrying about these big events about two months ahead.  So you can expect the weakness to start in European equities in late February/early March.  Europe has already been lagging this parabolic rally in the US and China, and the main reason seems to be event risk.

The Americans could care less, but the Europeans are scared of Le Pen, fearing that she will want Frexit.  An EU break up is not going to be easy.  You will need to see much worse economic times in Europe before you get any hint of a break up.  Le Pen won't have the power to do a Frexit even if she wins, because a big majority in France want to stay in the EU.  But give it a few more years, and a return to recession in the EU.  That will be the biggest catalyst for change.  Not now.  Things are still too placid for any true EU members (UK is a pseudo member, which doesn't use the euro) to make rash decisions to leave.

The gap down in the futures today seems to be because of worries that Le Pen will win the elections.  We still have almost 3 months till the 2nd round in France.  You know European fund managers.  They are a bunch of scarecrows and will sell ahead of the event.  There worries are just getting started.

Still waiting for a good spot to short.  I would like to short all time highs if possible within two weeks.

SPX Delta Hedge Squeeze

There is speculation that a quant fund was short a massive amount of SPX Feb calls with a strike of 2300, leading to a big blowup and short squeeze the past couple of days.  It is rumored to be this guy who blew up.

It is one thing to collect fat premiums shorting puts after a dip, it is totally a different thing to short cheap calls when the VIX is at 11, expecting a range bound market.  I can't think of a worse strategy than shorting calls in a bull market.

I believe that the skeptics that remain are those that are either 1. die hard contrarians who think bullish sentiment is a sell signal, or 2. those who just hate Trump and get emotional about the market being irrational.  At least with the first group, you get your share of wins when the trend tops out, but the second group are just those making subjective bets on what they think should happen, not objective bets on what is likely to happen.

According to Mark Hulbert's sentiment analysis of newsletter writers, the level of bullishness is actually rather mild considering that we are making new highs.  The wall of worry is still there, which is a bit shocking to me, considering how strong this rally has been since the election.

I do believe this Trump rally is a bubble, and irrational, but I also know that it's not a high probability trade to just short the market when it is making all time highs every day.

One little nugget that I will give to the bears is that the VIX went up yesterday along with the market.  This is a warning sign that the rally is getting frothy and entering its terminal stage.  Also, the bond market is showing some weakness, but not enough weakness yet to really make stock investors nervous.  If we do get above 2.60% 10 year yields, look for stocks to actually go lower on further bond weakness.  That positive correlation between stocks and bonds hasn't really been there on the downside since middle of 2015.

I am still not active yet on the short side.  I am definitely not participating on the long side, as I just can't get myself to buy into a blowoff move.  Yesterday's VIX action does have me more interested now in looking for a spot to short.  If we get further strength in VIX with a flat to up market, then we should be close to a short term top here.  Watch the VIX.

Passive Investing Wave

The money is going into passive investments.  The index-based ETFs.  It only took 7 years of underperformance by active managers for people to finally dump their mediocre fund managers for something that at least keeps up with the averages.  It doesn't signal a top for the market, or a bottom for active managers.  But it does signal that we are getting late into the run higher for the equities.  Over the long run, passive funds will always outperform active funds.  The transaction costs by themselves make it nearly impossible for active funds as a whole to beat passive funds.  But most investors are illogical, how else can you explain so much money being invested in hedge funds, which are basically wealth accumulation vehicles for the hedge fund manager.

The popularity of these ETFs make it much easier to sell, and the selling power is much more focused.  We could see another day like August 24, 2015, when the bids just disappeared, some ETFs didn't even open, and you went locked limit down in the S&P futures.  The derisking is going to be violent, because instead of having to do the cumbersome fund selling, you can just go online and push sell to get rid of your ETFs.  The panic will be tremendous when we finally do top out and correct.  The flash crash and August 24, 2015 are symptoms of quicker trigger fingers when the crap hits the fan.  With so much overvaluation, there is very little value support below.  You will not attract many fundamental buyers unless you get closer to 1800 on the S&P.  

Some may think it is looking way ahead talking about flash crashes and lock limit down S&P futures, but it is something that is very much possible in the second half of the year.  The markets have gotten so overvalued that you are setting up one of these quick wipeout scenarios.  And much of that will be led by panicking investors dumping their ETFs.  

We closed at another all time high yesterday.  The spring is getting coiled and potential energy for a new bear market is building.  Give it time.  Watch the VIX, and when you start seeing it rise along with the market, then you know the end is near.

Blowoff

This is what it feels like when the market seems like it will never go down.  You have the contrarian indicators, Dennis Gartman and the CNBC Fast Money group bulled up.  You are making new highs on hopes of a "phenomenal" tax plan in a couple of weeks.  The only thing that would actually top this would be to have the tax plan get through Congress, which will happen in the middle of the year.

You get these surges of optimism based on fundamentally questionable catalysts.  Rarely do you have a news catalyst that is long term fundamentally important.  The ones that are usually relate to monetary policy.  Fiscal policy is vastly overrated, as fiscal expansion only shifts assets from bonds to stocks.  It doesn't increase nominal wealth like monetary expansion.  That fundamental fact has been lost in the Trump optimism.

In the long run, fundamentals rule out over paper napkin economic conjectures by market forecasters.  Finance is one of the largest sectors of the economy, yet it is one of the least scientifically studied.  The hard sciences and engineering are much more rigorous in their analysis, even when there is less money on the line, compared to finance.  It must be the lack of 100% absolutes in finance which prevents the academics from fully grasping what is important and what is likely to happen.

So we are finally getting that early 2017 surge higher which I expected would form a short term top.  My 2015 playbook is valid as ever, except there is one key ingredient which is different:  lack of volatility.  This is one of the reasons why I have been reluctant to short despite all the high optimism readings and inflows into equities.  I am sure we will be getting that volatility soon enough if this market goes even higher.  The higher they rise, the harder they fall.

2017 is setting up to form a massive top that should lead to the next bear market, and really good trading markets for several months to come.  As the markets grind higher, I can sense the trading drought ending.  It should happen by the summer at the latest.

Relax while you can, it is going to get busy for S&P futures traders in a few months time.

Grind Higher

These are the worst type of trading markets for the counter trend trader.  The steady grind higher in the S&P, with very shallow pullbacks, and small up moves.  In most cases, you will not get a meaningful top in the equity indexes until you see the VIX start to go up as the equities go higher.  I would like to see VIX at least trade above 14 while S&P is within 1% of all-time highs before I get interested in the short side.  I tried a small short earlier in the week and took a small loss.

The market is too calm these days and it can wear out one's patience.  The key to trading these type of markets is not to lose too much money, which often psychologically makes you force trades to make back your loss quickly.  And when there aren't many good opportunities, like this market, that often puts you in a bad spot.

Once you get to a certain level in trading, when you have a built up a trading strategy and approach, the differentiating factor is usually psychological.  Not everyone has the same psychology, but usually traders, including me, are at their worst when down a lot.  The best way to overcome that is to not take marginal trades that have a tendency to put you in a hole.

Yesterday, Trump stated out of the blue that he was going to announce a phenomenal tax plan in 2-3 weeks.  Didn't he already say something vague like this before?  Of course, he finally gave a timeline, but it's not as if the market doubted that he would introduce a tax plan.  It was a matter of when, and how it gets through Congress.  The big question is whether the Republicans will agree to another Bush Jr. debt-financed tax cut which blows out a huge budget deficit or if they decide on a smaller tax cut, partially financed by getting rid of some exemptions.  I have a strong feeling it will be the Bush Jr. variety with no thought about long term consequences.  Republicans talk a good game about fiscal discipline, but they have never shown it.

The bond market still seems like it wants to consolidate for the time being.  I don't see any imminent signs of major bond selling.  The speculators are still leaning short, albeit to a lesser degree than a few weeks ago.  Until you see much more certainty on tax cuts, there will be a reluctance to sell bonds when above 2.50% 10 yr.

Scarecrow Union

There is always something to worry about in Europe.  It is full of financial scarecrows.  You have US equities, which is immune to pretty much anything.  On the other end of the spectrum, you have Europe, which is scared of its own shadow.  It is not the EU. It is the SU.  Scarecrow Union.

Oh, it is the French elections now.  Frexit.  Europe is shuddering in fright over Marine Le Pen.  I am looking at the polls over there, and it is nothing like the US elections.  She is down by over double digits.  Trump always maintained a single digit margin behind Clinton, and was the candidate for a major party.  Le Pen is a candidate for the Far Right.  Big difference.  Just by being in one of the main two parties, you collect default votes from those who always vote their party.  That was what put Trump over the edge.  You could have the living corpse, Bernie from Weekend at Bernie's as the Republican candidate and it would still collect at least 35% of the national vote.  Le Pen doesn't have that advantage.

Even if Le Pen becomes French president, she will not be able to convince France to leave the EU.  The only way they leave is if they get kicked out.  And that's not happening.  The only country that would benefit from getting out of the EU is Germany.  Obviously they would be just fine without the EU, even with a stronger currency, they actually sell a lot of things other countries want.

Anyway, the Scarecrow Union will get frightened about something.  Even when it is from a member that doesn't even use the euro(Brexit)!  Italian referendum was a nothing burger.  So will these French elections.  This is such a slow and boring market that little bits of news that have no meaning suddenly grow in significance.

Treasuries and Bunds have been the main beneficiary of this worrying, and we are now heading towards the year's lows in 10 yr yields of 2.31%.  The S&P is hardly moving, and there is a busload of dip buyers waiting to buy any small decline.  Same as its always been.... The BTFD crowd has the strategy down pat.  And it keeps working, and it will keep working until we get that fiscal policy euphoria.  Nowhere close to that yet.

S&P Topping

The S&P is in a long, dragged out topping process.  Much like 2015, you won't have one moment in time to say that is the top.  You will have many moments during the topping process where selling is long term favorable.  The S&P around 2300 is very likely to be one of those points.  There is a growing divergence between the US and Europe, and of course Japan, so far this year.  The S&P is hanging tough, right at all time highs, while the other equity markets fade, one by one.  First it was the emerging markets, then came Japan, and now Europe.  These selling waves eventually gather enough momentum and take down the big boss, the S&P.

On Friday, I noticed quite a change in tone and attitude from the CNBC Fast Money crew.  I force myself to watch it because I need to get in touch with what the general investing public is thinking about, and what there mood is.  From being a bit pessimistic earlier in the week, due to Trump's immigration policies, to being optimistic again, for no real reason other than prices going higher.  Nothing much has changed.  The ISEE call index printed over 200, meaning you had over 2 times as many calls bought as puts.  That is usually an extreme level where the market often tops out at.  The equity put/call ratio was also low in the CBOE.  The crowd seems to have gotten a bit too optimistic here, and I am looking for shorts either today or Tuesday.

This market lacks the buying firepower that it had in November/December.  There isn't that much selling yet, but the buyers are definitely thinning out, as you can see from that sudden drop early last week.  There is a bit more volatility at the top now.  Nothing big, but enough to get me interested in shorting strength.  SPX 2300 should provide a tough level of resistance that I can short against, to target a 30-40 point pullback.  Nothing big, but considering the low risk, a short worth taking.

Bonds looks like they want to go higher, and they are staying firm despite all time highs on the S&P.  Look for the 5 year yields to retest that important 1.80% level soon if we get that pullback in the S&P that I expect.

Fed Won't Raise in March

The Fed has been very careful raising rates since it launched the first one in 2015.  Although they are being more aggressive with their rate hike talk, let's not forget their history of forecasting rate hikes and not delivering.  They forecasted 4 rate hikes in 2016 at their December 2015 meeting, and they delivered 1.  They forecasted 3 rate hikes in 2017, and the question is how many will they deliver?

It seems like the financial pundits have finally caught on to the dovish pattern and most expect 2 rate hikes, some expecting 3.  I am expecting 1.  The reasoning is the following:  Unless the Fed is completely certain, they will delay their hike by 3 months.  They did that in September 2015 and 2016.  They delayed their taper in September 2013, pushing it out to December.  And guess what?  There is a debt ceiling in middle of March, right before the Fed is set to meet.  Then there is a good probability that we will have a pullback before their March meeting.  Also, there is the always lame political uncertainty excuse, which they pulled out before Brexit and before the presidential elections.  Don't be surprised if they pull that out before Trump sets his economic policy and before French elections.

Yesterday, they didn't hint strongly of a potential rate hike at the next meeting like they did before previous hikes.  That pretty much takes March off the table. They don't hike rates in their non press conference meetings.  They might change that this year, but it is going to take a really strong stock market to do so.   I doubt that happens, since I believe we are replaying 2015.  So that gives them 3 shots at raising rates in 2017.  But if you remember 2015, we took a plunge in August, on China devaluation fears.  And China is in much worse shape now.

So 2017 definitely has a good probability of a swoon between now and September meeting, which means if things don't correct before June, you can raise once in June, and then the market weakens and corrects, and you take September off due to the stock market going down.  At that point, you have one last shot for a double rate hike year, and that is December.  Who knows where the stock market will be at that point, but I believe it will be lower than here.  I don't see them pulling the trigger in December unless Yellen wants to decrease the likelihood of her reappointment in Feb. 2018 from 40% to 1%.  She desperately wants to outlast Trump, and she will probably have to agree to some favors (1 rate hike max in 2017) at a one on one meeting in order to have any chance of keeping her job.  And even if she delivers her promise, Trump may fire her anyway.  That is his style.

We are stuck in this low volatility chop.  Don't be fooled by intraday weakness.  We are trading right around the median of 2017 SPX levels.  We have gone nowhere, and I will not interpret that as bearish.  Or bullish.  As for bonds, it is notable that we got stronger economic data yesterday and the Treasuries dipped but rallied back to nearly unchanged after the FOMC meeting.  There is a lot of resistance around that 2.50-2.52% 10 year zone.  I believe it will eventually crack, but we probably see a bit more chopping around at lower yields before we breakout.

Why do I believe we breakout to higher yields?  Mainly because of two reasons.  The ECB will have to consider tapering because they are running out of Bunds to buy.  Unlikely that they mention that ahead of French elections, but I highly expect that to be in the news often after the French elections.  Also, Trump is going to start talking about his massive tax cuts soon, and that is going to make bond traders nervous.

Nervous Bulls

The bulls are a mile wide and an inch thick.  There has been a notable change in tone in investor attitudes from the honeymoon period, post-election, to what you have now, nervousness about what Trump will do next.  The worries pertain to his ability to execute on those massive tax cuts and infrastructure spending that he has been promising.  Sure, he will try, but will Congress oblige?  As Trump's popularity seems to be getting even lower, there are now doubts as to how willing Republicans will be to bow down to his every command.

You got a big spike up in the put-call ratio on Monday, and a fairly elevated ratio yesterday, speaking to the nervousness in the market about Trump's immigration policies, and his poor execution.  No, the market doesn't care about immigration.  They care about the public response, which has been mostly negative, and its effect on his economic policy, and his ability to get those massive tax cuts through Congress.  90% of the Trump rally is on those hopes.  The other 10% is infrastructure/deregulation.

If Trump gets much less than what he wants on tax cuts, then there will be the dickens to pay, as Livermore would say.  That is what is keeping this market on its toes.

We keep getting these intraday selloffs with a rally at the close.  The market keeps testing support, and it keeps holding.  Again, this is a bit like lower volatility version of 2015.  I don't see a big pullback till we get to the spring.  There is still too much of a potential bull catalyst when the tax bill hits the headlines.  I do believe Trump will jam it through.  Congress has never met a tax cut it didn't like.

What the past couple of days has taught us is that you absolutely cannot short in the hole.  If you are going to short, you better short after a rally, and wait for the market to fall.  Shorts who are chasing are getting punished in this low volatility market.  Will wait for extremes to short now, the gloves are off.  The rallies do not last long and it is getting safer to short strength.

The Fed meeting is today, and I expect no change in their language.  They are cowards.  Don't expect them to do anything to upset the applecart.