Buyback Blackout Periods

We are coming up on the stock buyback blackout period which usually lasts 4 weeks every 3 months in mid March, mid June, mid September, and mid December.  The SPX chart highlighting the time period for each of the last 4 years. 

Sep 2014- Sep 2015

Sep 2015-Sep 2016

Sep 2016-Sep 2017

Sep 2017-Sep 2018

As you can see during a period when the SPX has gone from 2000 to 2900 over 4 years, the stock blackout period during that time (64 weeks) is actually negative.  There was a spectacular failure early this year as massive stock inflows in January provided the buying power during a time when corporations are not buying back stock.  Other than that, it has been mostly a steadily negative time period. 

We got US-China positive trade deal news yesterday, and along with a benign CPI number, the bulls are pushing SPX at 2900.  Still remain bearish here. 

Toppy Internals

The market internals are flashing red as the SPX trades between 2870 and 2890.  The increase in 52 week highs AND lows as the market is still above its 50 day moving average has triggered Hindenberg Omens the last several trading days.  It is one of the few technical indicators that actually show a bearish bias.  Add on top that my risk parity indicator, which is showing short term bearishness as bonds are weak along with stocks since the start of September.  Lastly, I want to bring back the FANG+ index that I mentioned several weeks ago.  I am firm believer that the SPX can't sustainably go higher unless the QQQ is leading the way.  And right now, the FANG index is lagging.  

It looks like this market is setting up for a nasty fall sometime within the next 4 weeks, as we are getting closer to the stock buyback blackout period, which just happened to coincide with weakness in early February, late March, and late June.  So late September/early October seems like the perfect time for another pullback as the market internals bear their weight on this toppy market.  

Risk Parity Troubles

No one mentions risk parity anymore.  But the risk parity nightmare is slowly creeping back as both stocks and bonds are down this week. In particular, the long end of the yield curve has taken the biggest hit.  It reveals the underlying supply/demand problems that Fed QT and an ending of ECB QE and reduction in BOJ QQE are wreaking on the bond market.  If the ECB pulls the plug on QE, there are no willing buyers of European government debt that yield deeply negative interest rates.  Same goes for the BOJ, although they are stuck with quantitative easing due to the huge amounts of JGBs outstanding, and they are just trying to walk back from doing anymore damage to the liquidity in the JGB market, which is already a near zombie market.  

The central banks, who have driven the bull market in bonds, are not willing to push yields even lower here unless something bad happens in the economy.  The hurdle for central bank intervention has gotten quite a bit higher over the last year.  And it will continue to get higher as Draghi has just one year left in his term, and odds are high that he will be replaced with an anti QE governor, probably someone German.  So this is bad news not just for bonds but for stocks as well.  The magic carpet ride of higher stocks and higher bonds that we've witnessed from 2009 to 2016 is over.  Of course, if stocks take a big plunge, bonds will go a lot higher.  But you no longer have that free lunch of being able to just buy bonds to hedge your stock portfolio and expect it to make money under almost any circumstances.  That makes risk parity strategies riskier, and it is one of the reasons the market dropped so hard in February, as yields were going higher, something we rarely saw in the last 10 years.  

The nonfarm payrolls number didn't come in that hot, although the average hourly earnings number was better than expected.  Yet both stocks and bonds dropped on that number.  The big fear in the market is that the dollar will continue to rally based on strong US economic data and cause emerging market contagion.  I doubt that is a long term concern, because I don't think the dollar will keep rallying, but in the short term, with seasonal headwinds, there is a window of about a month where we could see some capitulation among weak longs.  The divergence between the US and Europe/emerging markets is too wide for it to continue much longer.  

With the weakness in bonds, it makes me a bit more comfortable to hold a short in stocks.  I was originally planning on covering at 2870, but will see if we can get one more leg lower in the coming days.  

Small Speculators in Treasuries

There was a lot of Twitter talk about bonds when Jeff Gundlach mentioned the big speculator short position in Treasuries on August 17, saying it could cause quite a squeeze.  The 10 year was at 2.87% that day.  It is now at 2.90%, and there has yet to be that big short squeeze.  Apparently, the lemmings decided to drink Gundlach's Kool-Aid and covered their Treasuries shorts over the next 2 weeks, as shown by the reduced short positions among small speculators in the COT futures data. 

The COT data for the 5 yr Note, 10 yr Note, and T bond futures shows a trend of short covering over the last few weeks, making small speculators the least short 5yr and 10 yr Treasuries since Sept 2017, least short Treasury bonds since January 2018.  September 2017 happened to be the top for Treasuries last year, and January 2018 was right before the big drop in Treasuries earlier this year. 

It is not the large speculators which are the contrarian indicator in the COT data, it is the small speculators.  And although they are a smaller percentage of open interest, they are the weakest hands in the futures market, with the worst track record, and therefore the best contrarian indicator in the futures space. 

The small speculators are a bit harder to track in the equity futures space, because of the emini and large S&P and Nasdaq futures contracts, but there is a small long in combined S&P futures positions and a small short in combined Nasdaq futures positions, so no extremes as of August 28. 

Market looks range bound here, consolidating the breakout from the double top at SPX 2870.  Despite what the bullish sentiment poll numbers say, the anecdotal evidence doesn't seem very bullish, and if anything, traders seem somewhat cautious here, perhaps because everyone knows that September is a seasonally weak month.  But the overseas markets trade heavy and that should eventually lead to a capitulation sometime this fall, which will take the S&P down with it.  Timing it will be a bit harder, but it probably happens when corporations can't buy back stock. 

Buyback Window Closing Soon

Stock buybacks are the main demand driver for equities this year.  Retail has been net sellers of equities as the fund flows are deeply negative, and most institutions are basically closet indexers now, so there is not much variability in flows there.  Hedge funds seem defensively positioned, from the articles that I have read over the past few weeks.  So really it is corporate stock buybacks that are the main buyers of equities this year, and probably what has been driving stocks higher since early August, when the buyback window reopened after Q2 earnings.  

So its not so much retail equity flows that one needs to watch, it is stock buyback flows.  And while they will still support this market over the next 3 weeks, by the last week of September, the majority of corporations will enter a buyback blackout period, lasting about 4-6 weeks, depending on when the company reports.  So the market could be supported at these levels for another 2-3 weeks, before it becomes vulnerable to selling pressure.  

Also, it happens to coincide with the most bearish part of the year, the September-October time period.  A lot of that is psychological, and it could be something  to do with changing moods as the days get shorter, and the temperature starts dropping.  In any case, the market is not far away from likely to face a move down to at least SPX 2800, and perhaps in a severe scenario, the July lows of 2700.  I don't see it being able to get back to the 2530-2580 area just because of the persistent strength it has shown in breaking to new all time highs, which must be respected.  In addition, the amount of the announced stock buybacks for 2018 and the amount actually bought is at a very large gap, so corporations will have to buyback more aggressively towards the end of the year if they want to fulfill their promises.  

It doesn't feel great to be short here, but will try to make lemonade out of a lemon.  

Expecting bonds to be under some selling pressure as there is usually a lot of corporate bond issuance after the summer lull starting in early September.  Longer term, I am bullish on bonds, but in the short term, leaning bearish due to supply factors and also the coming ECB and BOJ meetings which will likely be more hawkish than most expect.