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.