January Bear Raid

We got the oversold bounce last week, as a lack of bad news and with most of the big players gone, pension fund rebalancing was able to squeeze shorts into the close and get the market to a more neutral level. 

I am bearish for January as I expect economic data to start coming in weaker and more earnings bombs like Fedex coming down the pipe for later in the month.  While there may be a bit more of a bounce going into the first few days of January as asset allocators come back and add equities, the force of the fundamentals will eventually come to bear on this weak market.

I have seen a lot of articles and CNBC guests saying that the economy is still strong and will only slow down a little for 2019.  That is counter to what the stock and bond markets are saying.  I am hearing things like there will be no recession and that markets are panicking and being irrational.  This only tells me that many investors are still in denial and poorly positioned for 2019 equity weakness.  When the economic weakness is more obvious, most of the down move will already have been made, and it will be too late to short stocks. 

This game is about forecasting what will happen based on fundamental and market analysis, not looking at data in the recent past and extrapolating that into the near future.  I've seen a lot of statistical studies that say that in the past, under current oversold conditions, the market went higher 90% of the time.  They forget that the sample is curated from mostly a roaring bull market, or at the very tail end of a bear market. 

Don't forget the S&P was at an all time high less than 3 months ago.  Robots and quant strategies can adjust to current conditions much faster than humans, who still are framing stock price behavior from a bull market perspective.  Thus you get traders quickly embracing any rebound as a tradeable rally, like CNBC Fast Money on Friday, when in fact most of the rally is over with and quickly about to turn back to more selling. 

I have sold the remaining long SPX position today on the gap up off the Trump trade deal optimism and will look to short any rally in the coming days.  Anything around SPX 2525 on the short side should provide a good risk reward. 

Happy New Year and Good luck in 2019!

2018 Rhymes With 2000

Wow, I am still surprised that the GDP forecasts are still over 2.5% for 2019.  The economists are still looking at the rear view mirror in forecasting the future.  We just hit the peak of the economic cycle and apparently they've forgotten how the business cycle works.  GDP growth is not a steady ascent to higher highs, its a roller coaster that eventually goes higher due to underreported inflation numbers and productivity gains at the margin.  Mostly underreported inflation numbers in the last 20 years. 

The financial markets have spoken, and the Eurodollars market is pricing in no rate hikes for 2019 and rate cuts for 2020.  While the economists with no skin in the game and with huge rear view mirrors to stare at, are forecasting 1 or 2 rate hikes, just because the Fed dot plots said so.  You can't make this stuff up.  They have short memories.  They forget the Fed forecasting 4 rate hikes in 2016 at the end of 2015, and managing to hike just once at the end of the year, only after Trump got elected and promised a huge budget buster package of tax cuts and a surging SPX. 

Stocks don't lie.  The financials and other economically sensitive sectors are the worst performers this year.  The earnings guidance in October were screaming to investors that the earnings cycle has peaked out.  Yet too many are still believing the Wall St. and economist forecasts, and trusting the small data mined sample sizes where stocks rallied after huge selloffs. 

SPX April 1991-April 2001

SPX December 2008- December 2018

Here is what happened from April 2001 to April 2003

Is that a preview of December 2018 to December 2020? 

Economic cycle and Fed funds rate peaked in 2000, same as 2018.  We had a massive tech bubble in 2000, similar to what happened with FAANGs in 2018. 

It probably won't be as bad as 2000-2002, but looking at the big picture there is still a lot of downside ahead. 

I sold some SPX longs at the close yesterday, and will dump the rest on the next strong rally, probably next week.  I will buy back what I sold today at the close if SPX goes down to 2400 or lower. 

Scorched Earth

It has been so long since we've pricked a bubble.  2007 was not a bubble.  2015 was not a bubble.  2000 was.  2018 was. 

Post bubble markets seem much less rational because the bubble itself was irrational.  SPX over the last 3 years.  That is a big rally and a big correction.

Let's look at the SPX Price to Sales ratio for the last few decades. 

The price to sales ratio exceeded even the dotcom mania top in 2000.  Yes, corporate tax rates and profit margins are higher now, but profit margins fluctuate with the business and political cycles.  It would be difficult for these profit margins to sustain forever given populist uprisings globally. 

Yes, we've gone down quite a bit from the October top, and we are due for an oversold bounce, but valuations will not be supporting this market on the way down until you get closer to SPX 2100.  It is not as friendly of a monetary environment as the last time SPX was at 2100, in 2016.  There is tighter money and higher interest rates.  On the plus side, there are lower corporate tax rates.  If you say those two factors even themselves out, then a move back to 2100 would be reasonable.  But unlike 2016, we are currently on the down side of the business cycle, not the upside.  So that should also be considered a negative for the market. 

If we have a protracted, slow decline with many bear market rallies, then the bear market can last until 2020.  If the decline is sharp and steep with few bear market rallies, then the bear market will be over in 2019.  I am leaning towards a protracted bear market with the decline slowing down and flattening out in the first few months of 2019, as the economy will take its time slowing down.  This will give false hopes that the economy is not so bad and about to bottom, but the business cycle has turned, and that will last longer than a few months. 

I expect (hope?) a holiday week bounce after the vicious selling last week, and most of the fund liquidations for 2018 should be finished by now.  There will also be pensions looking to rebalance from bonds to stocks this month as the ratio has gotten quite skewed this month.  I am hearing $90B from bonds to stocks for pensions.  Anyway, Trump's desire to fire Powell and Mnuchin's panic reaction are putting downward pressure on the SPX futures here.  This downward pressure should dissipate as the day goes on. 

This is Not 2015-2016

I see some past data-centric players note the bearish sentiment, put/call ratios, drop in oil prices, renewed Chinese fiscal stimulus, and immediately assume that the current market is similar to late 2015/early 2016. 

But they forget the big difference:  the bond market.  This time 3 years ago, Yellen finally raised rates for the first time in seemingly forever and oil prices were plunging, with high yield credit spreads blowing out, but Fed funds were only at 0.25-0.50%, not 2.25-2.50%.  2% is a huge difference for such an overleveraged global economy.  And US rates affects a huge portion of the global economy via LIBOR. 

Another big difference is the current valuations.  Price to book and price to revenues are still higher than every period except the dotcom bubble era.  Price to earnings ratios are not so high, due to the tax cuts and the high profit margins, but corporate tax rates will be an easy target for the next Democratic president.  Investors assume that the corporate tax cuts are something that will last forever.  With the size of the budget deficits, and the projected increases in the future due to entitlements and an aging demographic, there will be pressure to find tax revenues, and with growing populism, corporations will be an easy target, even with the huge lobby base that they have installed in Washington. 

This time around, China is in an even worse financial position, having pumped out even more debt to keep the economy going the last 3 years, and they don't seem as keen to repeat the process this time around. 

From a cyclical perspective, this is even later cycle as we never got the recessionary flush and renewal in the past 10 years.  And the Fed chairman is Powell, not Yellen, so money will be tighter. 

I am seeing more of a 2000-2002 bear market scenario here, and will trade accordingly in 2019.  By the summer of 2019, it will become clear to everybody why the markets have been going down.  Of course, prices will be much lower at that point.  Now many are still confused as to why the market is dropping so hard even with strong wage growth and decent GDP numbers.  So there is still a lot of opportunity on the short side on bounces. 

Powell Pow

That was quite the uppercut from Powell to the jaw of the bulls.  The market was expecting a bit more optionality on stopping the balance sheet runoff but he blew that out the window dismissing the question with the word autopilot.  In a normal market, the reaction would have been subdued.  But this is a super nervous market in the middle of a waterfall decline.  Any slighht hint of hawkishness was going to cause massive selling.  Plus the expectations were too dovish, especially considering that the Fed is backwards looking and the data still hasn’t deteriorated in the US.

Unfortunately, I got back in too quickly after selling on the run up to the meeting, and am stuck with the long at bad levels.  But today’s price action, volume, and put activity is typical of a flush out bottom.  I am not sanguine about the markets like a lot of deluded bulls and underwater longs.  I know I will have to get out on any year end rally and will do so if Santa happens to show up next week.  I expect further selling in January, so I will not be overstaying my welcome on the lomg side.  Really best case scenario now is a move back up to 2600, but more realistically, a target between 2550-2580 is more likely.  Get out of this bad trade next week and move on to the next one.

Of Mice and Men

Wow, the best laid plans... didn't quite go as planned.  We got the short term capitulation that I thought would wait till January, and the pressure from funds liquidating stocks was too much to overcome the seasonal tailwinds with the Fed meeting this Wednesday and opex Friday, with Christmas next week.  Getting down 70 SPX points, less than one trading day after entering is just horrible timing.  But at least we got the panic and cleared out a lot of weak hands.  I wasn't thinking about holding past Wednesday, but with the beating this market has taken, holding for a year end rally from here is getting to be a high probability scenario. 

The volume was heavy yesterday and the put activity was rocking, so there was definitely some panic out there.  That last drop towards SPX 2530 was scary, and I don't think I'm the only one who felt that way. 

The long that I am currently holding is just a trade, I am definitely hesistant to hold it past the end of next week.  If somehow there is a move towards 2620-2630 before the FOMC meeting, I will trim there, and look to buy back after the FOMC announcement, to hold for a few days into the Christmas week slowdown, which should be beneficial for the bulls. 

The expectations for Powell to rescue this market is still there, so if we rally into the announcement, I see room for a selloff right afterwards, but it should be brief, because of yesterday's capitulation clearing out a lot of the forced sellers. 

Being even one day early catching falling knives in this sick market can't get your hand shredded.  With the European close behind us, most of the pre-FOMC meeting sellers should be finished.  Still feel nervous holding an SPX long under the current environment, but it is the high probability play.  I am not expecting a big rally into year end, perhaps a move to SPX 2670-2690.  A lot of resistance at that level, so I would look to short there for a move lower in January. 

Complaints are Getting Louder

When the Fed was raising rates earlier this year and the market was still in an uptrend, there weren't too many complaints about Jerome Powell and his relatively hawkish stance.  Now that stocks are in a downtrend and there is more pain, the Fed critics are growing louder.  They want the Fed to back off, and by doing so, they think stocks will go up.  Even famous investors like Stan Druckenmiller are begging the Fed to stop rate hikes and balance sheet contraction.  Its interesting that his employee, Kevin Warsh, is also a co-author of the article, as if to give the opinion piece more "cred". 

It used to be common opinion that Kevin Warsh was a hawk, but apparently hawks are an endangered species at the Fed, as deep inside, they are all doves.  There are no benefits to being a hawkish Fed governor.  All the Presidents want a dovish Fed chairman, so the easiest way to get the top job at the Fed is to be a cooing dove.  That is Neel Kashkari's strategy to move up to the top, although he has looked foolish  begging for the Fed to not raise rates for years and then relenting this year as the data started coming in hot, only to backtrack now that its fashionable to be dovish again. 

The begging and complaints have done their job, as Powell has now clearly gone from hawkish to dovish as the SPX melted down in October, and convulsed into a high volatility mess in November.  Now everyone is expecting a dovish hike this Wednesday.  The crowd is right, that is what is going to happen, but they are wrong about what that means for the stock market.  Stocks will not go up just because Powell is talking like a cooing dove.  He will need to stop the balance sheet contraction and start cutting rates to actually catch the market's attention.  Stopping is not enough at this point.  Eurodollars pricing out the 2+ rate hikes from early November to now only pricing in less than 10 bps on hikes in 2019 hasn't been enough to get stocks to rally.  A move from 3.25% to 2.82% hasn't been enough. 

Over the next several weeks, this market will be feeling the pressure of a slowing economy but a Fed that is still in a transition from rate hikes to pausing.  The market wants it to go straight from rate hikes to rate cuts.  A Fed pause isn't good enough anymore.  It is mostly priced in anyway.  Unless Powell comes out and surprises the market with an announcement to stop balance sheet contraction and saying that the Fed is now at neutral, you will not see a sustained rally. 

I got long SPX on Friday near the close, but its only a short term trade.  I will not be sticking around beyond the FOMC meeting.  This a long term shorter's market, and that will be my approach after this trade is closed out. 

Small Window for a Rally

With less than a week till the much awaited FOMC meeting with the now expected dovish Powell, there is a small window for a rally to form as we are now on trading day #8 of the downtrend since the market topped on December 3rd on US/China trade truce euphoria.  That is enough time for investors to have reduced their equity positions, and there is evidence that mutual funds & ETFs have had huge outflows over the past week.  Emphasis on small.  It is a dangerous market to be long for more than a few days.  This is only for the nimble, not for traders with much longer time frames.  

This should set up a short term tactical opportunity to buy weakness today to sell into any rallies next week ahead of the FOMC meeting.  Traders are probably getting adjusted to the new pattern now:  Bottom a few days ahead of a big event (October 30, ahead of midterm elections a week later, November 23, ahead of G20 meeting a week later), and rally strongly into the anticipated event and then have one last euphoric rally for a day on the news and lifting of uncertainty, only to sell off like a screaming banshee afterwards.  

So I expect traders to add back to equity exposure next week, expecting Powell to give the market what it wants, and I am sure short sellers will also be actively covering to get flat ahead of Powell, wary of getting squeezed again on a big event.  Its all game theory and psychological warfare, the fundamentals are crap, the only way to make money on the long side is to play the hot potato game, and pass the potato before it burns your hand.  

Looking to buy SPX today, to hold into the FOMC meeting, and sell right before the meeting.  

Same Price as a Year Ago

The SPX has chopped its way towards the same price level as it was on December 12, 2017.  So here are the differences between a year ago and now:

1) Fed funds rate was at 1.00-1.25%.  Now it is 2.00-2.25%. 
2) 10 year yield was at 2.40%.  Now it is 2.89%. 
3) Investors were looking forward to Trump tax cuts and double digit earnings growth.  Now we are looking at peak earnings and poor earnings guidance from tech. 
4) Shanghai Composite was at 3300.  Now it is at 2600.  Eurostoxx 50 was at 3600.  Now it is at 3055. 
5) Investors were bullish. Now they are bearish.
6) Global growth was entering its peak.  Now it is clear that global growth is going down. 
7) There was still central bank balance sheet expansion (BOJ, ECB, Fed) in December 2017.  Now there is central bank balance sheet contraction. 

If you just look at the above changes from 1 year ago, would you expect the SPX to be at the same price?  No, you would expect the SPX to be lower.  There is a delay in investor reaction towards fundamental changes.  That is why there are long term trends.  Because investors take time to react to changed fundamentals. 

The most common argument I hear from the bulls is that economic growth is still strong and that there are no signs that we are going into recession.  Also, the next most common argument is that everyone is bearish and that usually means stocks go up in the intermediate term.  As I mentioned in my last blog post, that is looking in the rear view mirror.  This is not the same market as the one we've had for the last 40 years.  Valuations are clearly in the upper range of the last 40 years, and that in of itself makes the market more vulnerable to any signs of slowing earnings growth. 

We have another strong gap up today.  I expect the market to hold the gap up today, as usually 2 straight gap and crap days are not common, and it seems like the bulls are quite eager to try to catch the bottom and the Santa Claus rally.  I am waiting and watching for better opportunities.  I don't see anything great at the moment.   

Looking at the Rear View Mirror

The history of Wall Street is shorter than you think.  The S&P 500 was created in 1957, and the S&P futures were first traded in 1982.  It is difficult to get a statistically significant result from small sample sizes, and all the numbers are biased because you are making the basic assumption that the past 30-40 years of data are a good representation of the current market environment.  

It just happens that the US stock market has been in a huge uptrend since 1982, benefitting from 1) a dramatic decrease in the risk free rate as Fed funds rate went from 19% to the current 2.25% level.  2) a huge increase in profit margins as mergers and acquisitions fever hit Wall St., eliminating a lot of competition, and limiting wage growth.  3) a big increase in productivity thanks to technology.  That has stalled out over last several years.  4) a big increase in US stock market valuations.  5) A big decrease in both personal and corporate tax rates.  

I would argue that the future will be much less stock market friendly than the past 30 years because most of what I mentioned above will not be repeated.  The rise of populism is already happening under the current corporate welfare and income inequality regime, if that were to continue for much longer, there will likely be a revolt from the suffering masses.  

Yes, there are a lot of statistical studies out there that look at performance after oversold conditions, December seasonality, the year after a midterm election, etc.  Not only are the sample sizes biased, since they were mostly taken during a huge bull market, but number of cases is too small for it to be statistically significant.  You need hundreds and thousands of cases, and throughout all kinds of market environments, not just the past 30-40 years.  Even going back to 1900 isn't enough because that level of economic growth is not possible with the current level of population growth.  That is why you have to take most of these statistical studies with a grain of salt, they just aren't meaningful.  

We had a nasty selloff on Friday and sentiment is getting more bearish, but its been only 4 trading days since the top made last Monday.  Usually these selloffs last 5-6 days at the minimum, and since this is such a weak market, I would lean towards selling off more than expected, as that has been the tendency since the September top.  The market tone is vastly different (less time to sell the highs) than even February or April of this year when the market went lower.  Waiting for a capitulation under 2600 this week for a short term buy, or short next week if we rally above 2700 into FOMC on Dec. 19.  

Long Term Sentiment is Shifting

The bulls are now the traders.  It used to be the bears who were the traders, but now the bulls are the ones who are looking to get their points and get the hell out of the battlefield.  You saw what happened after the midterm elections when the bulls (including me, a temporary bull) were looking for a bigger, longer move higher, like what happened almost EVERY time after a V bottom from 2009 to 2018.  But look what happened on Monday, and what happened in the week after the midterm election rally.  It was a bull bloodbath.  

There are a lot of dead bodies above, and they haven't been able to unload the bodies on the bigger suckers on rallies, because the rallies have been so brief, and the market reluctant to trade for a long time near the top.  

And what used to be reliable reversal signals off of high put/call ratios and oversold readings have not produced the same type of rallies.  These rallies have petered out much more quickly, and the reversal off the tops have been much quicker.  There is a clear change of character that is much more deeply fundamental than trade war and Fed headlines.  Weaker earnings based on 1) slower GDP growth and 2) higher wage growth are starting to weaken the earnings outlook for 2019.  That was the fundamental backdrop for the beginning of the 2000-2002 bear market.  This is a similar situation.  

Earnings growth was the main driver for the bull market from 2009 to 2018, not QE.  Just look at Europe, who hasn't been able to get the same type of stock market gains despite doing a massive QE itself.  With lackluster earnings looking like a foregone conclusion for the next few quarters, the bulls no longer have the earnings growth tailwind at its back.  At current valuations, the bulls are now the ones fighting the uphill battle with fundamentals, not the bears.  Even at the current level of SPX 2690, you have a trailing P/E for the SPX of 21.7.  That is a lot to pay for low growth.  

What I am hearing from bulls to support their case are tactical, not fundamental.  Year end rally, bearish sentiment, oversold readings, etc.  It is quite a change from the more fundamentally derived arguments that bulls made earlier in past years.  With such weak earnings guidance from the tech companies, the bulls can no longer talk about company fundamentals as a positive catalyst anymore.  It is now just about investor positioning, sentiment, and technical analysis.  

We have a bit of a positive mood after the closing rally yesterday.  I don't think the selling is done, and would expect more weakness within the next couple of days, but I am not trading it yet.  Will wait for an easier trade as we get closer to the FOMC meeting.

What Happened with ES?

That is what inquiring minds want to know.  On the Wednesday reopen, you had the oddest non news related dump in ES futures that I've ever seen.  That includes the volatile times of the fall of 2008.  And the fact that the ES still can't trade much higher from those flash crash lows of 2649.75 tells you a lot.  The Asian and European markets were heavy.  You cannot blame algos for that, no matter how hard you try. 

I know there was some Huawei news that came out before the reopen, but are you really going to believe that's why someone dumped 20000 ES contracts?  Really?  No, someone really wanted to get out of his ES long position, and was willing to liquidate into an illiquid market to do so. 

One thing is becoming increasingly clear:  bull market is over.  Not everyone agrees with this, but that's where the opportunity lies.  If everyone agreed with what I thought, there would be no edge.  So if that is the foundation of every trade going forward for the next several months, then here are a few trading ideas:

1) Short SPX after good news is announced, especially after uncertainty is lifted.  This is what would have been great shorting opportunities on the day after the midterm elections and the day after the G20 deal.  The next opportunity is the FOMC meeting on December 19.  The only fly in the ointment for that event is that most traders will be viewing that as a positive catalyst, expecting a dovish Fed, and a repeat of the stock market reaction of last week when the SPX surged on Powell's dovish words.  It will be trickier this time because the expectations will be that much greater.  But I still expect a pop, but a drop will probably come quickly. 

2) Put on a 5-30s curve steepener.  The most bullish part of the yield curve is the belly, especially the 5 year portion.  The 5 year is sniffing out the end of the rate hiking cycle and is running with it, leaving the 2 year and 30 year behind.  Since the Fed reacts late to markets, there will still be some portion of a rate hike priced in 2019, but I expect that continuing equity market weakness will continue to lower those rate hike probabilities, which will benefit the 5 year the most.  But at the same time, Treasury supply continues to be massive, and there is still QT, so the 30 year should still continue to trade heavy.  So from a risk/reward basis, rather than putting on an outright long bet, a curve steepener is preferred. 

3) Don't BTFD.  That is not going to work when you have downtrends that last several weeks, not just a few days.  October was a preview of things to come.  With central banks now a net seller of bonds rather than a buyer, there just isn't the liquidity to lift stocks higher after a few days of selling. 

4) Focus on shorting during stock buyback blackout periods.  The next stock buyback blackout starts in late December, going until late January.  Ahead of what is probably going to be more gloomy earnings news, investors should be aggressive sellers in January. 

5) Don't be a contrarian.  This is related to BTFD.  When investors are nervous, they sell and keep selling.  The sentiment will be bearish.  Instinctively, many counter trend traders will view that as a sign that the trend will reverse soon.  Yes, in a bull market, that's true.  In a bear market, the selling keeps going beyond what most expect.  Stay with short trades longer than usual, and sell your long trades quicker than usual. 

Bear Market Action

Bear markets don't give you a lot of time to sell the highs, and that is what has happened when the SPX has gone above 2800 in each of the last 3 face ripper rallies since October.  In bear markets, if you hesitate, you miss the top.  

As I have mentioned before, fundamentals are the long term driver of stock prices.  Not investor positioning, not headlines, and definitely not technical analysis.  The October earnings reports gave you an in your face hint that earnings are slowing, and the FANGs got punished for it.  What do you think investors will do during stock buyback period starting in late December and lasting into end of January?  Wait for earnings to sell?  No, they will be selling ahead of earnings, which we know are going to be bad (at least those who don't have their heads buried in the sand).  

But this market is so weak, much weaker than the late 2015/early 2016 market, because at least those markets gave you a lot of time to sell the highs, and the rallies lasted several weeks, not several days.  Also, you had much more loose monetary policy back then along with lower valuations.  If I am a long, give me monetary stimulus over fiscal stimulus every time.  

So now that we're back to pre G20 levels, I am not so eager to look for a short, but I am definitely not looking to get long either.  It is hard to sell weakness because of the threat of a face ripper like we had last week, but if you hesitate in getting short (like I did), then you will often miss the golden shorting opportunity.  

I am hoping for a Fed rally sometime in the next 2 weeks when Powell speaks again or at the FOMC meeting.  That will be the time to get short and ride it down into late January.  I am not interested in the long side.  

As for bonds, I expect curve steepening, in particular, the 5-30 part of the curve.  Given the bearish stock market conditions, I don't expect the Fed to hike more than once so that should benefit the short end much more than the long end.  

Trade War Isn't the Problem

The market has gotten myopic about 2 things:  the Fed and US/China trade war.  As traders and investors are apt to do, they forget the big picture and focus on the latest headlines.

A couple of weeks ago, before Powell opened his backtracking mouth, the market was worried that the Fed was going to tighten until something breaks and that there would be no resolution to the trade war.  Fast forward to now.  Powell is now seen as being dovish, and wary of hiking more than 1-2 times, and the US/China trade war is looking to be resolved in a market positive way.

What Powell has done is not enough.  He has already broken something, and people don't realize it.  It just happened to be something outside of the US.  Global short term dollar funding is based on LIBOR, and the move higher that it made from November 2017 to April 2018 is what broke the camel's back.

Unless Powell decides to cut rates and totally reverse what happened from January to May, he is coming up too little, too late.  He has already pushed down global growth just as the Chinese 2016 stimulus was wearing off.  And that growth won't be coming back for a while, unless China decides to throw the yuan under the bus and do another massive fiscal stimulus while the Fed is still reducing its balance sheet.  That probably won't happen unless things get really bad.  

On trade.  It was probably the most hyped up wall of worry this market faced since Brexit.  And as we all know, that is a nothing burger.  The amount of the tariffs is so small, and the threat of it actually going higher was so tiny, that I was a bit surprised that people were actually worried about a bad outcome at the G20.  Trump telegraphed what he was going to do in early November, and people ignored it.  He wanted to do a half-ass deal, calm down the rhetoric, and make the stock market happy.  He accomplished all those things.  Earnings aren't slowing down because of Chinese tariffs.  It is slowing down because we are late cycle and the central banks are not stimulating anymore.  It has nothing to do with the trade war, no matter how many times the so called experts on CNBC keep babbling about trade war as hurting earnings and "visibility".  BTW, anytime you hear the word visibility on a conference call, sell the stock.  Its only mentioned when revenues are going down and they don't want to say it, instead saying they have less visibility.  A euphemism for the crap is about to hit the fan.  

We have a monster gap up and I have sold longs and waiting for a spot to get short.  With Powell testimony probably coming up on Thursday (Wednesday is a holiday), the market should rally into it, as he is now considered a dove and a bull catalyst.  After he is done, it should be time to short as long as SPX is above 2800.  

Powell Throws In the Towel

He has ripped off his hawk mask.  Powell is a chest thumping pigeon.  He cracked under the pressure from Trump and the stock market.  The Fed chairman has shown his true colors and that is a stock market sycophant.  He tried his best to fool the market into thinking he was a tough, inflation fighting bubble buster.  It doesn't have a shred of truth anymore.  He is a pansy, and has lost all credibility.  Going from a long way from neutral, when the SPX was above 2900, to just under neutral when the SPX was below 2700.  The Powell put is in play, and it has a much higher strike price than people think. 

The Fed is one and done now.  Forget the useless dot plot.  They have been totally wrong 90% of the time anyway.  There is no way the Fed gets to 3.00% Fed funds.  They have given the green light to stock speculators to drive stocks higher and they will be hands off.  What a luxury for this toppy market to have a slowing economy and an angry Trump! 

The next big event is the G20, and the most likely scenario is a bunch of happy talk with an agreement to cancel an increase in tariffs from 10% to 25%.  The market will be satisfied with the outcome, and that should be good enough to drive the SPX back towards 2780. 

I do expect a little pullback today ahead of G20 event, perhaps down to 2720, but it should be short term, as the bottom is only 4 days old, so at least another 4-5 trading days of runway higher for the bulls.  The paper napkin chartists will be all over the double bottom on the SPX chart and that should be enough to get a continuation next week.  I will sell longs at that point and look to get short.  This is not like 2015/2016.  The monetary conditions are much tighter and China is in a worse financial and economic position as they can't do a full blown fiscal stimulus with the yuan so weak.

Fast Money was Bullish

Wow, the attitude on the market changes fast.  The CNBC Fast Money group, which have been bearish all throughout last week, have finally gotten bullish after a couple of up days, which is a warning sign.  Even though the Fast Money traders are usually a contrarian indicator, since they have been bearish for so long, you can't just suddenly say that the rally will fail.  It does probably tell you that there isn't that much upside, and if there is good news at the G20, that rally will probably be short lived. 

Sentiment is a short term trading tool, not a long term driver of stocks.  In the long term, the trend in earnings vs. expectations and valuations are what will determine stock prices. 

With central bank liquidity being taken out of the market, there is less money to go around to buy stocks.  Even though the stock buybacks are still coming through hot and heavy, it hasn't had the buoyant effect on stocks like it did in the past.  Remember, 2007 was a huge stock buyback year, yet, that is when the S&P topped out. 

We have a healthy gap up in the works, as Powell is set to talk later today.  It seems like traders are expecting a dovish message as they are bidding up stocks.  Aside from his last speech, Powell has tended to be optimistic about the US economy and sounded hawkish.  So we'll see if he has really changed his tune or if the last speech was taken too dovishly.  In any case, I think there is a likely pullback off this gap up and just a couple of days ahead of the G20.  I expect higher prices after the G20, mainly because of the likelihood of Trump trying to talk up whatever deal or agreement he makes with Xi.  I doubt he'll want to come out of the meeting with nothing tangible. 

Big Gap Ups Have Failed in 2018

We have a big gap up in the works today and if the pattern this year continues, which I think is the way to bet, then the gap up today on Holiday retail sales optimism and the pent up demand after a bad holiday trading week will probably be sold.  But that doesn't mean a gap up is not a good sign for the bulls.  A gap up this large after several days of selling is a sign of seller exhaustion, and an imminent turn higher in the coming days.  But that turn higher usually happens either the next day or a couple days later. 

The fear in the investor community to lower oil prices and poor guidance from tech companies is still thick.  And unlike previous fear related selloffs in the SPX over the past 10 years, there is a strong fundamental basis for that fear.  Fear based on a Chinese devaluation and lower oil prices in 2015/2016 were exaggerated and not built on a strong base of fundamentals.  But this time, not only are there Chinese devaluation and lower oil price threats, there is also the threat of a tech earnings peaking out with global growth as market valuations are higher now than they were back then.  Earnings growth built on tax cuts and fiscal spending is much less sustainable than organic growth based on a growing economy with a rising worker population and productivity. 

One positive that is different now than a few months ago is the change in tone from the Fed, which is now going from the raise until something breaks mode, into the raise only if the SPX is rising and economic data is beating expectations mode.  After the December hike, there will be a much higher bar for the Fed to raise rates.  In their minds, they are probably thinking rates are at neutral after the next hike, but will not be willing to be too transparent about their thoughts, because they want to leave a window open for further rate hikes if the stock market regains its strength. 

But much like 2000, the Fed pausing after an extended rate hike cycle doesn't necessarily mean that the stock market reacts positively.  When the stock market is as overvalued as it is now, the earnings path versus expectations overrides the longer term macro factors.  And the reaction to the Q3 tech earnings in October and November clearly show that stocks are not priced right for what is likely to happen in 2019.  Most of the leading indicators are pointing to lower growth in 2019, and the tech leaders have gotten so large that it is now hard for them to achieve above average earnings growth rates. 

Clearly the law of large numbers has caught up to AAPL, and is quickly catching up with AMZN, GOOG, and FB.  Expecting selling in the morning off this gap up.  There are residual sellers eagerly looking to get out on strength. 

Fear and Loathing in Tech Land

The last 2 days have been quite scary for the bulls.  Anytime you can drop 110+ SPX points in less than 36 hours brings out a lot of fear.  CNBC Fast Money were about as bearish as I've seen them, even more so than in late October when the market was plunging. One technical analyst who came on the show, who is almost always bullish, was bearish about everything. 

With Nasdaq getting trashed the last 2 days, it seems like the fund managers have thrown in the towel, as the AAPL bad news headlines was just too much for them to deal with, and they sold with reckless abandon yesterday.  Interestingly, the Nasdaq outperformed the S&P intraday, and many of the high flyer tech stocks like AMZN, FB, GOOG, finished well off the lows, even though the SPX finished weak. 

It felt like tech capitulation yesterday, and if the SPX can hold the lows from October this week, and start rallying, you will get double bottom and successful retest calls from your paper napkin chartists.  That will be the time to sell.  Right now, as painful as it is to stay long, you have to ride out the storm and wait for some optimism to come back before selling. 

But it doesn't take away from the longer term picture.  It is a horror show out there, and it will only get worse after we get the sentiment to at least neutral.  I think it is too much to ask for the market to rise enough for investors to get as bullish as they did earlier this year.  Not a lot of strong resistance until you get to the SPX 2720-2730 area.  Today and Friday are usually bullish days historically, as the holiday cheer makes traders more bullish.  With the strong selloff the past 2 days, it looks like we'll rebound at least for the next 2 trading days.  After that, it becomes harder, as the Monday after Thanksgiving is usually bearish.  But these are just seasonal guidelines, not something to have total belief in.

Forget Trump's Peons

You had Mike Pence act like a tough guy at the APEC 2018 meeting, talking hardball with China on trade, while Xi tried to squirm away from criticism that he is using One Belt One Road as a scheme to trap EM countries as Chinese debt slaves.  Don't forget that Trump is erratic and is not some master commander pulling all the strings.  If what Bob Woodward states in his book on Trump is true, which I believe it is, you have a lot of Trump underlings who don't have any respect for the President and choose to call their own shots. 

Trump is going to make the final call on a deal with China, and it is apparent that he is getting more eager to make a deal as the pressure from Wall Street increases, and the stock market trades weaker, and with the midterm elections over.  What Pence, Navarro, Kudlow, Ross, and the others say are meaningless.  They are probably daytrading secret anonymous corporate brokerage accounts to profit on headlines that they make. 

What a difference a few weeks of market turmoil can make on the Fed.  Suddenly, you have Powell softening his rate hike talk, and all the other Fed members are following the dovish tone like sheep.  As much as the Fed says that they are data dependent, they forget to mention that their most important data point is the SPX.  Not employment or inflation, like their mandate says.  The Fed has veered so far away from what their legal charter states as to make a mockery of the government and its rules and regulations.  Everything is bought and paid for in Washington now.  The corporations have a firm headlock on the political process and will not let go.  In fact, they are emboldened as all of their mergers and acquisitions and collusion are ignored and given a rubber stamp of approval, as they are the ones financing the campaigns of the politicians passing the bills and enforcing the laws. 

We have bounced from the short term oversold conditions last week, hitting bottom at the year end 2017 SPX level of 2673.  I see potential for a bounce up to 2760 as Thankgiving week is usually bullish and the bond market is no longer hampering the rally as risk parity strategies are performing well again. I will use any holiday strength to lighten up on my longs, as I have little medium term conviction on longs. 

Tech Wreck: 2000 Redux

Another of the tech darlings got pummeled after their earnings release.  NVDA bombed out with weak earnings and is down 17% in premarket.  It is a new 52 week low and the hyperbolic chart with a steep decline reminds me of MSTR.  For those who traded during the tech bubble days in 1999 and 2000, they will remember that MSTR (Microstrategy) was an internet darling until they reported horrible earnings in April 2000, promptly destroying the stock, it must have been a 40 or 50% down day, and I distinctly remember suicide posts in the MSTR Yahoo message boards.  This period coincides with the immediate aftermath of the March 2000 peak in Nasdaq.   

One by one, the tech favorites are getting heavily sold on lackluster earnings reports.  First it was FB in July.  then came AMZN in October, and then AAPL in November.  You can add NVDA to the list.  This is classic post bubble price action.  The law of large numbers and a slowing economy has finally caught up with the large cap tech momo names.  Without tech leadership, this market will have to find another sector to push up the markets, and I don't think health care, consumer staples, and utilities will get the job done.  Those sectors combined are too defensive and low beta, not enough juice to spur the averages higher when everything else is lagging. 

Forget about emerging markets or crude oil, the heart of this US bull market was the large cap technology companies: AAPL, AMZN, GOOG, FB, MSFT, NFLX, NVDA, BABA, etc.  All those stocks except MSFT have underperformed the S&P 500 over the past 3 months.  The bears have caught the bull and is chomping at its heart.  When you rip the heart out of a bull, it dies.

We finally got an oversold bounce yesterday, much to my relief, but promptly we gave up a large chunk of the gains overnight.  Thanksgiving week is usually a very bullish period of the year, so I am hoping for some holiday cheer to pump up stocks so I can dump my long holdings.  Although I expect the beginnings of a trade deal to be laid out at the G20, so much of that has been leaked that I don't see as big a pop on the news as previously thought.  If the SPX can get back to 2750-2760, I will sell my longs and just wait for a good time to short, hoping it can get to 2800-2820 for a shorting opportunity.  I don't have enough confidence in the buyers for me to try to eek out more of a move on the long side. 

Fundamentals are on the Bear's Side

In the short term, news, sentiment, investor positioning, buybacks, and performance chasing will play a large part in affecting price.  A couple of things surprised me in the past few days.  1) How quickly the post midterm election equity gains were taken away plus more.  2) Dollar continuing to rally and crude oil plunging.  This is not a healthy bull market.  It is an aging bull with a growing list of health problems. 

The biggest thing is the leadership that has led the bull market for the last several years is cracking bigtime.  The growth tech names are rolling over, and the latest one is AAPL.  That is in the face of what are sure to be daily heavy buyback activity coming from AAPL headquarters.  The market should have been able to maintain a more solid bid with all the buybacks roaring back after the October blackout period but it hasn't been able to support this market.  A bad sign. 

It seems like all the bulls are hoping that year end seasonality, currently bearish sentiment, and stock buybacks will bail them out.  But those are not long term drivers of stocks.  They are just tactical plays looking to sell to the bigger sucker at higher prices.  The poor earnings guidance, slowing global growth, and a stubbornly hawkish Powell are the fundamentals that make this overvalued stock market a toxic long term hold.  It doesn't mean that stocks will roll over and immediately enter a bear market.  But it means that the probability of this becoming a bear market are much higher than they were a few months ago. 

By the way, the trade war is the most overhyped reason for this market's weakness.  It is great news fodder, and I expect a trade deal to eventually get done over the next couple of months, because China wants one, needing the dollars to keep the yuan from imploding, and Trump wants one.  Why else would they keep pumping out trade deal rumors every other day when the stock market is going down.  They are trying to keep Wall Street happy, and the Trump administration believes a trade deal will make stocks go much higher, and they admitted that their scorecard is the stock market.  When stocks were going higher in the middle of the year, there was no sense of urgency.  Now that stocks are going down, and there is a G20 meeting coming up, there is a renewed sense of urgency to get a deal done.  The Chinese will pretend to go along with the trade deal and later not honor the more important aspects (IP theft, forced technology transfer, etc.).

We've gotten another gap up after a weak close, of course.  It is natural these days for the market to go down during US cash market hours and then grind higher in the overnight market, getting help from the "invisible hand" and giving bulls hope.  It is a staple of the ES market, and don't expect it to go away, even in a bear market.  I am a temporary bull hoping for trade deal optimism in the coming weeks to sell my longs and enter long term shorts. 

Curve Steepening

Something unusual is happening in Treasuries during the middle of a tightening cycle.  The 5-30s spread is increasing, not decreasing.  This usually only happens at the tail end of a tightening cycle when the market can see the end of rate hikes and is anticipating lower Fed funds rate in the future.  If that was the case, the Eurodollar and Fed funds futures markets wouldn't be pricing in 3 more 25 bp rate hikes through the end of 2019. 

6/13/2018 (Fed raises from 1.5-1.75 to 1.75-2.0%):   5 yr 2.85, 30 yr 3.10 (25 bps)
9/26/2018 (Fed raises from 1.75-2.0% to 2.0-2.25%): 5 yr 2.96, 30 yr 3.19 (23 bps)
11/09/2018: 5 yr 3.05, 30 yr 3.40 (35 bps)

Equities have not traded drastically lower, at least not enough for the market to reduce rate hike forecasts for the next 12 months.  So what is going on? 

1) Long end supply.  The Treasury is issuing more long term debt, and there is less willingness for dealers and fund managers to take down duration during a continuing bear market.  The size of 10 year auctions has gone from $20B in January to $27B in November, and the size of 30 year auctions has gone from $12B to $20B in the same time. 

2) There have been bond fund outflows over the past few weeks and that usually hurts the long end more than the short end. 

3) The curve flattener trade was very crowded and the equity market weakness in October caused liquidations of a favorite hedge fund trade. 

4) Bond fund managers feeling the heat from a negative year don't want to take duration risk and are content to just clipping coupons in short term Treasuries. 

5) The long end was overpriced relative to the short end.  With trillion dollar deficits as far as the eye can see, investors are now demanding higher rates for long term bonds with so much supply coming down the pipeline.

I expect the curve steepening to continue as I don't expect equities to be strong enough in the coming months, making it tough for the Fed to be more hawkish than expected.  Also, the sheer supply of Treasuries that will need to be taken down by investors is going to weigh on the long end more than any other part of the curve.  Int this part of the business cycle (late), without the Fed gobbling up long end supply, it makes it harder for the 30 yr part of the curve to outperform the short end. 

We got a bigger pullback than I expected on Friday, and it seems like the post mid term elections move higher was just a massive short squeeze/FOMO event.  We are back to reality now and it is not pretty.  I am long and missed the exit window, but I can objectively say that this is not a good situation for longs.  The upside will be limited, and although the market should grind higher in November, with each passing day, it gets more dangerous holding longs, as a retest of October 29 lows within a few weeks is not out of the question.  Still short term bullish for the next 2 weeks, but lower my price targets. 

Certainty = Higher Prices

There is a price to be paid for being certain about an event.  Now that we see the reaction after the midterm elections, a sizable number of investors were waiting to buy until after the election results came out.  This is what happens after events like Brexit and the 2016 US presidential election (big move lower overnight after Trump elected) where you had knee jerk selling and then a big rebound.  The midterm elections ended up as expected, which is enough to ramp the SPX futures up almost 1%. 

It is not just equities that investors were waiting to buy.  Bond futures are also considerably higher despite the big move up in SPX futures.  I still get a sense that the Fast Money crowd is leaning bearish, although after today's market reaction to the elections, they will be quickly moving back to the bull crowd.  The bulls have the advantage for the next few trading days, as the migration from those on the sidelines come in to provide buying power for stocks.  I am still long, but I will be looking to sell in the coming days after the rally matures a bit more.  There are still quite a few equity underweight fund managers that need to jump back in to keep up with the indices. 

I am not ruling out a move back up to the January highs of SPX 2870, but I will sell before then.  I don't have enough confidence in the long term picture for stocks to try to catch the last bit of the up move.  A rally to 2820 and I will eagerly sell my holdings and wait to put on shorts.  I am especially going to be intrigued if there is a trade deal with China, which would be the good news knee jerk rally that would be a great time to short. 

Big picture, this is shaping up to be part of the topping process, as the leaders start to fade and defensive sectors start to outperform. The recent weakness in energy stocks is notable because they are one of 3 sectors, along with financials and utilities, that historically perform the worst in the last 3 months of  a bull market.  Financials have been lagging all year and utilities, which usually are bond substitutes, have been surprisingly resilient despite higher rates. 

The biggest thing that stuck out to me over the past few months of action is the underperforming tech leaders in the FANG group.  I am keeping track of the FANG+ index, which includes the hottest and most popular tech names, and the chart clearly shows those stocks topping out. 

Over the last 3 months, SPX is + 3.1% and the FANG+ index is - 3.47%.   The FANG underperformance has gotten worse in the past 2 months.  This definitely rhymes with 2000 price action, when the Nasdaq topped out before the SPX.  Without the leadership from the growth names, I have a hard time picturing a sustained rise in the SPX. 

Short term, there is nothing to do if you are already long.  I would wait a few days to let this rally mature a bit more and wait for higher prices to sell.  For those in cash or looking to short, patience is needed.  The fund managers are still migrating back to equities and it will take a couple of weeks for them to get all back on board.  Plus the wave of stock buybacks will be huge this month, so the market should grind higher for now.

Trade Tizzy

The overreaction to trade deal news is typical stock market behavior.  A lot of bad things that are happening to the stock market are conveniently being blamed on either the Fed or the trade war.  The Fed has repeated the same message at the start of the year as it has now and somehow the market is going down because of the Fed.  Same thing with the trade war.  It has been the same rhetoric and overreaction to trade headlines for months on end and now somehow the end of the trade war will make everything normal and perfect again.  

Stock market weakness is not about the trade war.  It is about slowing global growth and earnings.  The FANG stocks all issued poor revenue numbers and guidance.  That is the crux of the US stock market problem.  It is not about trade wars or the Fed.  China is not slowing down because of some tariffs.  It has much bigger problems and have made a mockery of their financial system.  The yuan is a joke.  That is their biggest.  Not tariffs.  

We're now working on day 4 of the rally off the bottom, and we are reaching some minor resistance areas around 2760-2770.  Based on the strength of the market in recent days, and the upcoming stock buybacks, there is clearly a change in market character.  Longs are looking a lot better here, and 2800-2820 look like a reasonable price target.   Still long, although I reduced some of my position yesterday.  I might buy back today on a morning dip.  It looks like a rally at least for another week, and will reevaluate at the end of next week.  

Earnings Bombs

AMZN and GOOG brought out the cherry bombs to the bull parade in after hours.  And Europe, as it has a tendency to do, exacerbated the selling and turned it into a panic.  The volatility has been through the roof this week.  Usually that is a sign of capitulation, and while yesterday's price action before the earnings announcement looked constructive, the investors are nervous and are selling first and asking questions later.  In the overnight session, the selling got emotional, and we are retesting those lows made near the Wednesday close. 

Based on past experience, usually these emotional gap downs get bought as soon as the US cash market opens.  Especially when it has come after several days of selling.  I expect there to be buying when the US regular cash session opens.  Long term, these negative earnings reactions to relatively benign earnings from AMZN and GOOG do tell you that the leadership is no longer outperforming, and that means the bull market is basically over.  But even if its a bear market now, I expect there to be an oversold bounce that lasts at least 2 weeks going into a positive seasonal period. 

Shades of 2000 and 2007

This is the beginning of the end of the 10 year bull market.  I made a tactical error treating this like just an ordinary correction in a bull market, expecting buyers to be there when the market got panicky, but clearly without the stock buybacks (blackout will be lifted for most companies starting next week), there is no support for this market.  All the leading indicators showing a slowing economy in 2019, with the Fed still unwilling to stop their hiking path without bigger weakness in the stock market, means the Fed put will not be the support that it used to be.  The Fed put strike price is much lower than current SPX levels. 

I believe we are topping out here much like in 2000 and 2007.  The initial sharp selloff in 2000 occurred in April, and then it was lights out in October.  In 2007, the initial sharp drop was in late February, followed by a big, scary dip in August 2007, and then it went down in earnest starting in November.  2018 had the big scary dip in February with retest in April, and now another big drop in October.  This feels more like August 2007 than October 2000, so there should be a sharp rally in November.  If not, the rally should only last 2-3 weeks and then go back down again.  Considering the seasonal tailwinds, I expect a 4-6 week rally towards at least 2870.

SPX 2000

SPX 2007

SPX 2018

Now that I am stuck in a pickle, buying the dip, I will try to wriggle my way out of this mess.  There is no way this gap up will be sustainable going into the middle of the US cash session, so I expect sellers to immediately bring down this gap up at 2684,as I am writing, when the US cash market opens.  There should be initial support at SPX 2660, and yesterday's lows at 2652.  I would wait till after Europe closes, during the US lunch hour to think about buying a dip.  If the SPX is below 2660 at that point, it could be a good dip buy looking for an oversold intraday reversal.  I hate to do it, but I will need to do some microtrading intraday to try to pick up some points from the bad long entries last week and earlier this week. 

There should be a decent intraday bounce coming up after this week is finished, as the stock buybacks will be back with a vengeance starting next week.

Panic Opening

Well, that elevated quickly.  We finally have the big gap down opening, after countless selling of the gap up opens over the past 2 weeks.  It looks panicky out there, and I put in some small buys in the premarket into the carnage.  Holding my nose and buying.  It is not for the faint of heart, or for the scared, and it looks risky, but we are close to 2700 support, so I like the risk-reward at these levels. 

It is notable that in the premarket, the VIX is trading at 24.18, as I write, which is lower than the levels on October 11 and October 12, when the SPX traded higher than current levels.  So at least the VIX isn't getting totally out of control. 

We have earnings bombs from CAT and MMM, which was foreshadowed by their weak charts.  It looks like de-risking ahead of the heart of earnings season, which definitely lowers the bar for upcoming earnings for the big names like MSFT, AMZN, GOOG, INTC later this week. 

I am expecting buyers to step in here at the US cash open and should see some reflexive buying off the big gap down open after the weak close yesterday. 

China Bottoming and Day 13 of Selloff

China came out with some fiscal stimulus in the form of tax cuts to support the economy, and from reports, I am hearing that they are trying to push loans out as fast as possible to reverse the slowdown.  I don't think it works in the long run, but it does help sentiment in the short run.  Also, Shanghai Composite has gone up 8% over the past 2 trading sessions, so it does look like it has found a short term bottom.  I don't think it will go up much from here, as its already rallied a lot, but if it can just stabilize, that will take away one brick from the wall of worry for this market. 

Also, Italian 10 year bond (BTP) yields have stabilized after surging higher last week on Italian budget worries.  With the ECB unlikely to raise rates for another year, and the huge amount of carry in the Italian BTPs, once the budget concerns die down, there is a lot of room for BTPs to rally.  It is not going to be easy to kick Italy out of the EU, and even if they did leave, the Italian central bank would set their yields close to the ECB rate, just because of the state of their economy. 

Friday was a tricky session, the fakeout rally in the morning sucked in eager bulls and then chewed them and spit them out into the afternoon and close.  It was a classic Friday risk off session, as the sentiment gets worse.  From a purely time perspective, this selloff has run its course, and most selloffs in bull markets end by day 13, and I am still considering this a bull market based on the rising 200 day moving average.  With the gap up this morning, it probably will get tested by sellers after the US cash market opens, but I expect buyers to show up around the SPX 2760-2770 area, like it has on Thursday and Friday. 

This is the heaviest earnings announcement week, so once this week is behind us, there will be a deluge of potential stock buybacks coming.  Odds favor the bulls here, so I got long on Friday, and will look to add on any intraday weakness today, to hold for several days. 

BTFD Fridays

With the market acting skittish, but unable to make substantial down moves, I will be looking to buy weakness off this gap up towards SPX 2770.  There seems to be a lot of support in the 2760-2770 area, and the selling has dried up whenever it reaches that price level.  If the market manages to pullback towards the closing price zone of 2765-2770, I will be an eager buyer today. 

Usually you don't get gap and go moves higher on Friday, especially on options expiration day, so I expect some kind of pullback at the open.  I doubt we get continuation selling, just based on closing price action yesterday and the ease with which the SPX is adding on points in the premarket.  A continuation of the selling from yesterday is usually signified by a close near the lows of the day, or at least a gap down from the middle of the afternoon trading range (2758-2786). 

Traders seem well hedged as the options volume has been elevated for the last several days.  That should allow for more aggressive buying from fund managers for the next few weeks.  That also coincides with the return of stock buybacks.  Leaning bullish for the intermediate term. 

Too Late To Short

Sometimes patience is a good thing, but this time waiting to short was a mistake, and we are down over 50 SPX points from the close and increasing.  Its been a week of missed opportunities, but if the selling gets extreme enough to take the SPX down to 2750, I will be interested in buying that dip.  We'll see how the afternoon trade goes, but since I missed the short, I will look to get long on further selling.  Unless this sell cycle turns into a month long affair, this second sell wave should be finished by Friday, as that will be trading day 12 of the selloff.  That is a common length (12-13 trading days) for a selloff in the past.  After this week, the market will likely grind higher as the stock buybacks slowly come back. 

I am not ready to get super bearish on this market yet, the seasonal effects will be a marginal positive for the stock market, so I will wait for later this year/early next year to put on long term shorts for a big down move. 

Timing Off By a Day

There is still that fear of missing out on the next uptrend, even during a topping process.  It will provide the bounces that are profitable to short for the next few months.  There is an upside and a downside to the tendency to panic quickly, both on the way down and on the way up.  The upside is that it provides more short term trading opportunities.  The downside is that the jumpy, quantum leaps up and down make it riskier to fade the short term trend with leveraged positions.  Essentially, due to the low bucket shop margin requirements, futures trading is hyper leveraged trading disguised as a hedging tool. 

What happened on Tuesday was what I was expecting for Monday, so when Monday was actually a down day, I rewrote the trading plan and it cost me.  Just because my timing was off.  There were a lot of points to be made on Tuesday that I missed because I doubted my previous forecast because of one small down day.  I did not expect the market to delay the oversold rally by a day, skipping Monday and instead deciding that Tuesday was a better day to buy. 

Sometimes these things happen, when I forecast the market to go a certain direction, and when it doesn't happen in the expected time frame, I change the forecast.  Often times, the forecast is correct, just the timing is off by a few days, as the market takes its time when making a move.  That doesn't match my general observation that the markets in recent years move faster towards their price targets and don't give traders much time to jump on board the trend. 

There is a lesson to be learned from this.  It is to to put on a position a little early, even just 1/3 to 1/2 size, just in case my forecast for the timing of a move is off by a day or two. 

Now that SPX is above 2800, we are right in the post panic sell area. If the SPX stays under 2840 this week, that rules out a V bottom, and we should look to short on Friday for a move back down to 2740-2750 for next week.   Just to stay out out potential trouble in a V bottom scenario, I will not be shorting today or tomorrow.  I don't want to go long unless there is another flush out of yesterday's buyers.  So nothing much to do in SPX for the next 2 days.

Weak Bounce

Heading into this week, I was looking for a bounce to take up to at least SPX 2800, as the market seemed to have flushed out the weak hands in the short term.  But the lack of follow through buying and the weakness overnight was an omen.  Clearly, investors don't have FOMO here and are not ready to take any risks chasing strength here. 

Monday should have been an up day, with short term traders looking to buy the dip to start the week, after the panic last week finally subsided, with a V bottom on Friday.  But the intraday bounces were sold and the put/call ratios went back to normal levels, not a great sign. 

You can forget about the V bottoms that you saw with regularity from 2009 to 2014.  We are in the messy bottom phase of the stock market cycle, similar to 2015, and earlier this year.  This market can't hang on to strength without stock buybacks to fuel the buying power.  There are many that are skeptical about the seasonal effects of the buyback blackout period on stock market performance, but the data is right there if you look for it.  When retail is still a net seller of equities and fund managers don't have the inflows, they don't have the buying power to support the market.  Pensions are becoming a smaller part of the buying pool and have a much smaller effect on the market these days.  The main buyer of stocks are the companies themselves.  This makes any earnings downturn deadly for stocks, because these companies won't be able to borrow money at decent rates to buy back their stock, and will have less cashflow to direct towards supporting their share price. 

A note on the bond market.  There was a below consensus CPI number on Thursday and weak retail sales number on Monday, and the SPX has gone down 180 points from the highs.  And the 10 year yield is still lingering near the highs, at 3.17%.  The lack of a flight to safety bid for Treasuries is the most important thing that no one is mentioning over the past week.  Remember, this whole pullback started because the 10 year started breaking out to new highs, and that monkey is still on the stock market's back.  Once the buybacks comeback starting in late October and the stock market bounces, look out for a potential ugly selloff in Treasuries. 

The game plan for trading the SPX is either to put on a small short on a bounce towards 2780-2790 either today or Wednesday, or wait for the next sell wave to complete and buy around 2680-2700 later this week.  Not expecting much to happen today, probably just chop around the range traded on Monday. 

Panicking More Quickly

The US stock market behavior has changed since 2008.  The jumpiness of the VIX has increased dramatically.  A look at the numbers since 2007 show that during the first big correction in 2007, on August 16, the VVIX closed at 142.99.  In the height of the financial panic in 2008, the highest VVIX close was 134.87 on October 27.  In 2009, it never closed above 105.  In 2010, a couple of weeks after the flash crash on May 20, it closed at 145.12.  In 2011, during the middle of the European sovereign bond crisis, it closed at 134.63 on August 8.  In 2015, the VVIX hit a record close of 168.75 on August 24.  In 2018, the record was broken on February 5 when VVIX closed at 177.34, after hitting an intraday high of 203.73.

It is quite telling, that even during the biggest bear market of our lifetime from 2007 to 2009, the highest VVIX close was 142.99, while milder corrections in 2015 and 2018 resulted in much higher VVIX readings.

It struck again when the VVIX jumped up to 147 intraday last Thursday as the SPX hit 2712, down just 7% off all time high. 

These high VVIX readings this year is an indication of how offsides the investment community was in regards to SPX downside risk.  The fund managers have been lulled to sleep over the low VIX readings since May.  It takes time for them to adjust to the new volatility regime, more than the 7 days since the beginning of the selloff from 2925 on Thursday, October 4.  It has been 7 trading days since.  Usually for big drops like this, it usually takes at least 12-13 trading days for fund managers to hedge themselves and lower risk to adjust for the higher volatility, and for weak hands to get stopped out.  So this should be another week where bounces will be brief and sold quickly. 

As I writing in premarket, the SPX is already over 20 points off the close on Friday, on no news, and negating the intraday reversal pattern.  It was a fakeout reversal on Friday, a combination of short covering at the close and eager bulls piling in hoping to catch the bottom.  I am still looking for 2680-2700 area as a buyable zone, but with the recent jumpiness in this market, and the herdlike behavior of the systems traders, I won't rule out a monster flush out towards 2600.  This is no longer the kiddie zone of the pool.  We are in the deep end, sharks are lurking waiting to feed on the weak handed fish.  Right now, the longs are the fish.  Next week, it probably will be the shorts.

With the big gap down on a Monday, I do expect intraday day buying off these levels from short term traders which likely pushes the market towards the Friday close of SPX 2767.  If SPX is below 2767 by 3:00 PM ET, then we'll probably see a weaker close as traders will want to lower long exposure ahead of overnight risk, and the sell bots will swarm this market back down towards the 2740s. 

SPX will have trouble going above the Thursday highs of 2794 this week.  It is still safer to sell the bounces than try to buy the dips here.  The selloff has not fully matured yet, give it another 5 trading days and we'll reevaluate where we've hit bottom then. 

First Wave of Selling Done

They don't make this game easy.  I was waiting for a puke out in the final hour of SPX trading to buy, instead there was a fakeout rip higher to 2760 and then a fade of that rip back down to 2730.  And then a bounce off the 2730 area right back to 2750 in just 15 minutes into the futures close at 4:15 pm ET.  And its been off to the races since then.  So this is not a repeat of February.  This is the junior version of that selloff.  More traders were more cautious this time around then back in January/February, so the selloff should be less severe.  Plus the seasonals favor the bulls starting next week.

The most important time of the day isn't the final 15 minutes of cash trading, its the 15 minutes from cash close to futures close, from 4:00 pm to 4:15 pm ET.  That aggressive buying out of nowhere was likely sell bots that had sold the last 15 minutes of the cash close, expecting further weakness into the futures close at 4:15, and instead sold a bounce and got stopped out and exited all at once.  

The trade from 4:00 to 4:15 has been a foreshadow of what is to happen in the overnight session.  On Wednesday, the weakness in the last 15 minutes of futures trading spilled over into the overnight session.  On Thursday, the strength in the last minutes has continued overnight.  The bounce off the lows emboldens the BTFDer who now believes that we've hit bottom, and they are piling into the futures overnight.  

It appears like the first wave of selling is finished and we can look foward to a bounce in the coming days.  Looking at a 50% retrace of the down move from 2940 to 2710, is 2825.  So roughly 2825 is the target for any bounce early next week.  After that bounce, expecting the second wave of selling and a more lasting bottom to be hit, somewhere around 2680-2700.  With the velocity of moves in the bot era, 2825 to 2700 could happen over just 2 trading days.  

Friday's US cash session should provide one good selloff to buy, not sure whether that will be in the morning or in the afternoon.  I would be surprised to see a gap and go trade, as traders usually don't want to get aggressively long over the weekend after such a bad week. 

Algos Looking for Blood

2018 has been an all or nothing year.  Either up continuously or down continuously.  Unlike past corrections in prior years, the market has tended to do nothing for months, trade with low volatility, and then suddenly, one day, the volatility explodes.  There were no 1% moves for over 3 months and then suddenly you have an over 3% whopper and now another 1% lower in premarket just to kick the BTFDer while he's down.  

The CTAs and the hedge funds are all in the same trades, enter gradually into their positions, but puke them out all at once.  It happened in February, and it is happening again.  Both times due to higher interest rates.  

The HFT algos are like sharks sensing blood in the water.  They are predatory and very profitable.  Especially on big down days.  The institutions who are panicking and dumping stock are being ruthlessly front run and are either forced to puke out at rock bottom prices or can't get out.  It is a roach motel market now.  

I am out of the short, and will wait for lower prices before putting on longs.  Clearly the velocity of the selling into yesterday's close made 2800 look like it was nothing.  Now it is on to 2700, and then 2675, the closing level of 2017.  Beware of trying to buy the dip on Thursday.  The market has changed character and traders like to liquidate and panic on Thursday afternoons and Friday mornings, getting ahead of the "afraid of being long over the weekend" crowd.  It doesn't wait for Friday afternoon anymore to panic sell weakness.  

It is going to be wild trading over the next few days.  With bonds not providing a good diversifying hedge for equities, it puts more pressure on portfolio managers, many of them running 60/40 stock/bond allocations, who don't know how to deal with big down days as bonds aren't providing a safety valve for their stock holds.  Risk parity pressures are going to be a weight on this market so don't expect a run right back towards 2900 like nothing happened.  The damage is real this time.  While we will likely get a year end rally, there is no need to rush into any longs at this point.  Let the algos do their job.  

If SPX opens at current overnight levels, around 2750, you should get a reflexive buy program in the first hour, taking it up to yesterday's close at 2785, and consolidate that move for a couple of hours and then selloff again in the afternoon, as longs get scared of holding overnight and also over the weekend and beating the Friday panic selling crowd.  A weak close today and a gap down on Friday will likely set a temporary bottom on Friday. 

The Fed: Always Late to the Party

In the past few weeks, you have had a wave of Fed speakers give hawkish speeches, chiefly the boss, Jerome Powell.  You would figure that with all this hawkish talk, the Fed would actually consider raising more than 25 bps every 3 months, but central banks have been mostly talk, little action.  

It has been an excruciating rate hiking cycle, starting in 2014 with a Please Hammer, Don't Hurt 'em MC Hammer style slow QE taper, when the US economy was at its post 2008 peak.  The taper should have never happened.  It just delayed the start of rate hikes by over a year, and when the US economy finally started slowing down in late 2015, the Fed reluctantly raised once and froze in the face of a slowdown, with Fed funds stuck at 0.25-0.50%.  

The delay of Fed tightening just allowed more corporate debt to build up and the stock market to reach levels of overvaluation rivaling 2000.  The short term thinking at the Fed, overstaying easy monetary policy and slow to tighten when the economy improves, has resulted in longer, more tepid booms, but also bigger busts.  When stock prices get this overvalued, they eventually lead to a bear market, and that will be the trigger for a recession.  Ever since 2000, the US economy has basically been the stock market.  The stock market is the tail wagging the US economy dog.  There is no real wage growth, so a strong economy won't boost consumption.  It will just make the rich richer, and lead to higher inflation.  That is why there always seem to be a bit of skepticism in regards to the US equity bull market, because it just doesn't match the low growth economy.  

That being said, the current US GDP growth rate is not long term sustainable.  It took a strong US bull market, big tax cuts, with a huge increase in government spending to get to 4% GDP growth.  That isn't happening again next year.  Economy is cyclical, and high PMIs and consumer confidence numbers mean that people and companies are spending now, which makes them likely to spend less in the future.  

Back to the Fed.  They are finally catching up to what the economy has been for the last 18 months.  All this hawkish rhetoric should have been said in the beginning of 2017, not now.  The Fed is already behind the curve.  The Fed funds rate should have been at 3.00% for the last 12 months.  Now they probably can't make it to 3.00% before the SPX has a big correction, which would immediately freeze the rate hikes.  And once they freeze the rate hikes, since the Fed funds is now near neutral, they won't be able to hike anymore.  

That is why you have been seeing the yield curve bear steepening, because the bond market is sniffing out future equity market weakness.  While that can be right in the very short term, beyond the next couple of weeks, I see a flattening.  I don't think the stock market can fall too much because the majority of stock buybacks, nearly 25%, happen in the last 2 months of the year.  That gives the bears about 2 weeks to make their move, and then it will be the bulls taking control with buybacks fueling it.  That should cause the curve to flatten back out in November and December.  Right now is probably the ideal time to put on a 5-30s flattener, at 32 bps, with expectation that it will go back to the level seen in August, around 21 bps.