Earnings Hype Dies Down

There was so much anticipation of blockbuster earnings this quarter, which is part of the reason there has been so much disappointment.  It is looking like peak earnings this year, and the market is not happy about it.  I heard so much talk about how great earnings would be this quarter, and how that would help stocks.  Well, stocks are selling off on the news.  It doesn't help that 10 year bond yields go up every day and have now pierced 3%. 

It is panic week in the bond market, and that is spilling over to the stock market.  There is so much leverage in the corporate world now, that even small moves higher in bond yields have a heavy weight on the market.  It is why you saw the liquidity absolutely dry up yesterday on a plunge once SPX 2660 support was taken out.  A 40 point plunge in a couple of hours.  Once the panic in the bond market fades away, stocks should find a stronger bid. 

Bonds are still in liquidation mode, but its definitely not going to stay in liquidation mode for long.  It is a nasty market out there, wholesale liquidations are happening and the Street is still too long stocks.  It will take months for the market to digest the monetary tightening and by the time that happens, the economy will probably be on the other side of the hill, looking down towards a sharp slowdown, similar to 2016.  Don't know if there will be a recession, as so much fiscal stimulus has been pumped in for the next several years, but I do expect an economic slowdown by the fall of this year, and stocks are not ready for that scenario. 

In the short term, stocks can bounce after the earnings season passes by, but obviously this market doesn't have the upside power like it did in past years.  We may get back towards last week's highs if nothing crazy happens, but I doubt we can get back to 2800. 

Media Talking 10 Year Yield

Usually the financial media doesn't care about bonds, except when you get a big selloff.  The selloff is now starting to get the media's attention, as all eyes are on the bond market to see if 3.00% 10 year yields will be broken.  I am sure there are some stops above 3.00% 10 year yields which could be triggered if the 10 year goes above 3%, but that would be a one time liquidation, akin to a stop hunt by market makers to take out stop orders and then quickly reverse. 

A lot of this bond weakness is due to higher oil prices, and some of it is due to the pure price action and reflexivity.  As prices go lower, more bond holders get nervous and hedge their long exposure by selling futures, and the trend followers pile on to the trade and sell more.  It becomes a non fundamental move, as panic sets in.  The bond market is starting to look a bit panicky as a relatively weak stock market doesn't help at all in keeping a bond bid. 

I am a longer term bond bull but in the short term, this bond market is in liquidation mode, so it can get a little worse before the bonds find a bottom.  I don't think bonds can selloff too much, just because the global economy is actually slowing down and higher LIBOR rates are having an effect on short term corporate funding costs.  If the Fed actually tried to follow their dot plots and take the Fed funds rate to 3.00%, the economy would crater and the yield would have already been inverted well before that happens.  Anything above 2% Fed funds is tight for this overleveraged economy, and trying to force feed interest rate increases on this vulnerable stock market would be a disaster.  I doubt Powell wants to be the one who pulls the trigger and blows the brains out of this debt laden global economy. 

Friday's selloff was exacerbated by continued bond weakness, and we have the relief rally gap up in progress.  I except choppy trade today, with a test of the overnight lows today, and then a rally later this week. 

Risk Parity Unwind Again

Yesterday was another risk parity derisking day.  Bonds started selling off and stocks couldn't hang on to the previous days gains and promptly sold off as well.  The higher commodities higher stocks correlation has been obliterated.  That was in effect during the crude oil panic in 2016 but now that Brent Oil is above $74/barrel, you are getting the other side of the picture.  It isn't low oil prices causing high yield stress, but higher oil prices causing bond weakness and fears of higher inflation and a tighter Fed.  Higher oil is now the enemy of the market, and from a seasonal perspective, oil should trade higher into early fall.  But speculative positioning is heavily long, so its a tough call.

We have a buyable dip after the bottom from early April.  These bottoms usually provide a grace period of about 4-6 weeks before being vulnerable to big selloffs.  That gives us a time window of early May to mid May for the market to grind higher before it tops out.  There is strong support in the SPX 2680 area, which was the high of the big 2560-2680 range that the market was stuck in for 3 weeks, as bad news after bad news poured into the market.  I would be a buyer of any dips today that bring the market towards yesterday's and the overnight lows of 2683. 

The bond market is trickier, because it is acting extremely weak even though equities can't surge higher.  Watch crude oil here, if it continues to go higher, that will pressure bonds. 

Less Uncertainty

This is what happens when you get some uncertainty cleared out.  Investors no longer are worried about Syria, and the trade war worries could only go on for so long before concrete proof of tariffs.  The trade warmongering has all been speculation and Trump's bluster.  They will bring the tariffs under review by multinationals and also the small fry who might be affected in May.  It will either be shelved or heavily watered down, as it is with anything that can hurt corporations.  But in a liquidation market, which was late March/early April, it was shoot first, ask questions later on tariffs.

The game plan is to just ride out the long a bit longer, up to SPX 2720 and/or 2760, depending on how this week goes.  I would give stocks the time to slowly rise this week, and see how high it can reach.  If you consider the bottom of the recent selloff as April 2, then this market should have about 4-6 weeks of runway to grind higher before the fast money is fully on board again.  That points to early to mid May as a possible topping out point.  That also agrees with the corporate buyback window reopening in late April as most earnings will be reported by then.

There could a couple of minor pullbacks (1-2%) this month along the way to 2720-2760, but they should be buyable as the grind higher window(early April to early May) is still well in effect.  Not expecting an explosive move higher to 2800+ just because of the length of the U bottom and the overall complacent retail investor atmosphere.

This isn't a great environment for putting on really long term equity positions.  It is too early to put on shorts, and although ok to put on longs for the short term, longer term, I expect lower prices to prevail.

Bonds are in a tale of two cities.  It is the short to intermediate end of the yield curve and then everything else (long end, global bonds).  The short to intermediate part of the Treasury curve continues to trade weak, as the Fed refuses to budge on their rate hike path despite the recent equity weakness.  The long end continues to outperform, as does non-US government bonds.  Australian 10 year yields are now below US 10 year yields, and the EU, Asia, and Canada 10 year yields continue to grind lower as the US yields stay near year to date highs.  In general, a flattening yield curve and strengthening global bonds are bullish for Treasuries.

Storm Has Passed?

The market looks like it wants to resolve the 2560-2680 range to the upside.  It sure has taken a long time and seems like there are those looking at earnings to save the day, so not a great long setup here, but we had the mini capitulations the last 2 weeks near 2560, so like past bottoming patterns, the market should grind higher for 4-6 weeks here.  That is based on historical patterns, ignoring the sentiment and fundamentals. 

The fundamentals look bad here, with extreme overvaluation and investors who have too much long term confidence in the economy and the stock market.  That is not the backdrop for a sustained rise higher. The mistake I made was in trying to trade this market as if it was still in a climb the wall of worry bull market.  It is a topping out phase, which requires more patience and precision with long entries.  The shorting is still dangerous, because it can rip higher for weeks at a time, but the payoff for shorting is much bigger in this phase of the market. 

Still think we eventually grind higher towards 2720-2760 area by May, but I don't see it doing what it did in the past, which is retrace all of the pullback and go to new highs. 

It is notable that Europe has been acting relatively strong compared to the US during this late March/early April pullback.  That is a short term positive but a long term negative.  It shows that the US market is saturated and investors are basically fully invested in US equities. 

Not Acting Like a Bull Market

The 200 day moving average is rising.  The trend is higher.  But this doesn't act like a bull market.  Maybe I am reading too much into the short term trading, but the market made a top on January 26 and its now April 10 and the SPX is still well over 200 points below that top.  A strong market usually doesn't act this way.  Usually a strong market V bottoms and lingers around the highs and grinds higher.  This is lingering around the lows.  A BIG change of character compared to the last 9 years. 

I still can't shake the pundits insistence that the economy is strong and earnings are great, so the market will go back up.  It seems like the crowd has bought into the hype about a strong economy and strong earnings.  If retail is all in, as mentioned in January, where is the marginal buyer going to come from?  It has to be more retail, because the institutions are heavily weighted in equities now. 

If the market made a bottom last week at ES 2560, why is it taking so long to break out of the 2560-2670 range that this market has been stuck in for almost 3 weeks?  Some people will blame the news flow, but that is a poor excuse for this kind of price action.  The market has known about these tariff proposals for several weeks, and Syria will blow over like all past Middle East conflicts.  Don't tell me its Trump and the FBI investigation.  The market would actually welcome Pence with open arms if he became President. 

Short term, I still give the bulls a slight edge here, but one has to question how long a rally will last if we do get above 2700.  It is pretty clear that the market has changed drastically, just looking at the day to day volatility and the reluctance to make V bottoms.  It is a nervous market so it does feel like the market should climb a wall of worry but the price action is so bearish that I am losing conviction on the long side the more it trades sideways in this range. 

Bonds look very bullish here as the curve is flattening, a good sign that 10 year yields will go lower in the future.  A bull flattening is a much more sustainable rally situation than a bull steepening. 

Bloody Game

These daily moves have been vicious.  There is no such thing as hanging out in the middle of the range.  Its either straight up or straight down.  The VIX is not correctly pricing in the amount of movement that this market is currently exhibiting.  Sure, the VIX is pricing 1 month forward vol, but usually implied vol trades at a premium to historical vol. 

This market is really testing the limits of how long a U bottom lasts.  Usually at the most, these U bottoms last 2 weeks.  It has been over 2 weeks since we first hit that panicky low under 2600 on March 23.  If this were to follow past bottoming patterns, it should have already been rallying.  Instead, the SPX is stuck in a 2560-2680 range for the past 2 weeks. Granted, that is a huge range, for just 2 weeks, but the moves have been huge on a day to day basis.  Usually that kind of volatility is a sign of a market bottom, and the elevated put/call ratios and bad news flow is usually what happens at a bottom, yet this thing refuses to go up and stay up. 

Perhaps it is the constant news flow that is making the bottoming process so lengthy.  I don't think its profitable to rationalize moves in the market with news.  Price is truth.  And clearly this cruise ship is crowded with retail customers bogging it down and making it hard for the trend to turnaround. 

I am still in the bullish camp, but losing a little bit of conviction with each passing day.  The longer this market tries to bottom in this 2560-2680 range, the more likely that it breaks this range to the downside rather than the upside. 

If there was no trade war fears and the market was trading like this with no headlines, I would be extremely worried being long.  As it is, the trade war hype reduces the meaning of Friday's weakness.  My first read and current read of the market is that we are in a choppy U bottom that will resolve to the upside, very soon, but if I had 75% confidence last week on that prediction, it is down to about 60% confidence now. 

Big picture, this is a topping process that will require a different approach than 2016 o r 2017.  It is trading like 2000, to be honest.  But that would be too scary to contemplate for longs if they remember how nasty that 2000-2002 bear market was.  I don't think it will be that bad, but it could very well be half as bad.  In that case, instead of 50% downside, you are looking at 25% downside, which would be still be  around 2150 from a 2870 top.  That is a big move down from here.  Keep that in mind when the market is trading more positively and it becomes reasonable to start playing the short side.  Gut feeling is that there will be some nasty down moves in the second half of this year as mid term election season nears. 

Trade War Fears

That is all the algo headline reading AI bots care about.  Forget about the credibility of the person doing the threatening.  It is one thing to be on the side of the big corporations doing big tax cuts.  It is a whole another thing fighting those big corporations with big tariffs.  One is doing what corporate lobbyists wants, and is easy to pass.  The other is fighting the corporate lobbyists and the bought and paid for Congress, which is a lot harder to do without committing political suicide. 

Perhaps its just the magnitude of the man's position, but there are too many people who take Trump literally at his word, which is like believing everything a pathological liar has to say.  I call your $50 billion, and raise you $100 billion!  Why not $200 billion? Or $500 billion? 

Let's not forget that raising tariffs is just applying a Chinese import tax, and with China reciprocating, having to sell goods at inflated prices in China with their tariffs.  It is essentially a tax on consumption of imported Chinese goods, which is a huge chunk of goods bought in the US.  And a lot of those Chinese goods are not manufactured and wouldn't be manufactured in the US because of expensive labor costs.  These proposed tariffs, if applied, (doubtful in its current form) would be cutting off your nose to spite your face. 

The pajama traders panicked on the news in overnight trading, taking the SPX down over 40 points, but a lot of that panic move on the $100 billion tariff headline has been taken back. 

This is similar to the overnight Cohn panic a few weeks back, when Gary Cohn resigning led to the SPX to drop 30 points overnight.  It made back all of those overnight losses during regular trading hours. 

It is always more bearish for the market to fall in overnight trading hours on no news than on scary news. The big gap down on Monday, March 19, was a gap and go move, and it was on no news.  That kind of move is always more vicious than a move that impulsively happens due to a scary headline.

This gap down is not as a high probability buy set up compared to the one on Wednesday, just because the SPX is 60 points higher than on Wednesday morning.  But still short term bullish on the market, but bearish in the medium to long term (more than 4 weeks out). 

As far as nonfarm payrolls, the worse the number, the better it will be for the market.  The last thing this market needs is interest rates going higher as investors are panicking about trade wars.

Tariff Tantrum

The news is hyping a potential trade war between the US and China.  There has been nothing passed, and corporations will have a chance to bring up complaints in May before a final determination on the tariffs.  In other words, these tariffs will have very little bite and will serve to just placate Trump's voter base without doing anything for increasing demand for US manufactured goods.  But in this kind of market, its shoot first, ask questions later. 

We've already had many selloffs on this trade war theme for the past several weeks.  After a while, it gets stale and unless something more concrete and meaningful comes down the pipe, the market will move on to the next worry.  What is more worrisome is how heavy tech stocks have traded.  That is what has kept the broader market in an uptrend.  But it seems like we've finally gotten to such high valuations for the big cap tech names that they just don't have much lift anymore.  They are no longer speedboats that can spurt higher.  They have become crowded cruise ships that move slowly and get easily bogged down. 

Today's price action after a big gap down seems to point to a market that is oversold and looking to have a counter trend bounce.  However, I don't see a long lasting uptrend off this low.  Perhaps a 2-4 week bounce.  I doubt a bounce can last for more than 6 weeks.  The market is too saturated with weak hands and retail longs to keep going higher for months on end like it did in the past.

A Different Market

In the past, when there weren't so many V bottoms, you had traders try to find a bottom by looking for signs of capitulation.  With the free money train changing trading patterns over the past 9 years, it changed to just BTFD and wait for eventual higher prices.  With the Fed no longer pumping money into the markets, and with ECB and BOJ liquidity injections shrinking, the market is morphing back to its original pre QE characteristics.  More panicky selloffs and less V bottoms.  More U bottoms, with choppy price action at the lows and less urgency to jam up stocks by market participants. 

The mood has definitely shifted towards more gloominess, but there is still a strong undercurrent of economic bullishness.  But unlike past economies, this economy is dependent on asset inflation to keep the economy going.  There is very little secular growth, so what growth that comes needs to come from either lower interest rates/QE, or lower taxes and government spending, or from a rising stock market.  If the stock market goes down, the economy becomes more vulnerable to a downturn. 

In the past, the stock market used to forecast economic weakness and recessions.  Now, the stock market movements can be the cause of a recession.  The doctor has become the patient. 

It is a tough market for those who have been using the same playbook as the past 9 years.  It is not an easy BTFD market anymore.  There will be fewer sustained uptrends, and more sustained downtrends.  This is how a long term top is formed.  Even though I am long, it is a trading long only.  It is not something I want to hold for more than a few weeks.  The bounce this time around will not last as long or be as strong as those in the recent past.  It is a different market now and we've got to adjust to the new conditions. 

Strong gap up today, which I think will likely be sold into during the regular trading hours, as we are 40 points off the lows from yesterday. 

2000 Similarities

I often think about past periods in stock market history which seem to resemble the current trading period.  It serves as a rough guide to see what we can expect in the current environment.  It is something to do more out of curiosity than anything else.  It doesn't replace a thorough overview of the current fundamental, technical, and statistical factors which determine my view and trading strategy. 

Right now, after a 9 year bull market, you have to look at past periods after extended uptrends.  That narrows the comparisons right away.  Next, you have to look at how the stock, bond, commodities and FX markets compare.  After making these comparisons, this period looks more like 2000 than any other that I can find in US stock market history. 

Here are the similarities to 2000: 

1.  The stock market had rallied strongly the past several years, punctuated by a more extreme and steep rally at the beginning of the year.  Sentiment was positive and investors were more fully invested than anytime in the past 10 years. 

2.  The Fed was in a rate hiking cycle as the 10 year yields hit multi-year highs.  Inflation had picked up from the previous year. 

3.  Oil bottomed after a deep bear market 2 years earlier (in 1998 for 2000, in 2016 for 2018). 

4.  The dollar was in a correction after rallying strongly the previous several years. 

5.  The Nasdaq was outperforming the S&P 500 very strongly for the past year, and a bubble was forming in select tech names. 

It is a bit eerie how similar the current market price action, with the increased volatility at the top, are to that of 2000.