Wednesday, February 22, 2017

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.  

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