Setting Up for a Sell in January

There are a few things going for the SPX bulls that will last till the end of the year: 

1. Stock buybacks, which are large in December, averaging 10% of the annual buyback volume.  January averages 3%, the smallest amount for any month.  So we go from a big stock buyback spree in December to almost no buybacks in January. 

2.  Reluctance to sell stocks with big gains in the final 2 weeks of the year to delay capital gains taxes for 1 year.  This effect will be gone by January 2. 

3.  Portfolio window dressing for year end, after a big up year, most fund managers are reluctant to reduce their longs and want to show that they have a lot of long exposure at year end to their investors. 

4.  Seasonally, the last week of December is very bullish.  A significant part of that is psychological, as investors are in a better mood and less likely to sell. 

So why do I think it is setting up for a sell in January?  Because when you push things higher in December due to deferred selling due for tax reasons, stock buybacks, and seasonality, that gives you a bloated market that is higher than it should be. 

I have to admit that I didn't expect this kind of strength in the SPX in November and December.  I expected much smaller gains, but I underestimated how many weak hand investors were just waiting to buy once the US/China phase 1 trade deal was finalized.  Those fast money/weak hand investors are the ones that have been buying over the past week.  That sets up the SPX to a window of vulnerability in early 2020 when the above mentioned bullish factors disappear and the Democratic primaries get closer. 

The best time to put on an SPX short is probably December 30-31.  Waiting patiently and seeing a lot of opportunity on the short side next year. 

US/China Trade Tunnel Vision

It seems like traders have a really bad case of focusing on one thing, and the thing isn't even that important from first order effects.  I would like to offer a controversial take on the US/China tariffs.  They are equity market positive because they are bond market positive. 

The total value of the tariffs imposed on China is $88 billion, but that doesn't take into account the farm aid given out since the tariffs went into effect, which adds up to $28 billion.  So its a net $60 billion tax, which can easily be removed by either Trump or a new President after 2020 election.  The US government is running over a trillion dollar budget deficit, reducing that deficit by less than 6% with some tariff taxes seems like a pretty minor effect, no? 

And what has the Fed done after the markets took a dip in May and August?  3 rate cuts and QE4 or, QE lite, whatever you prefer to call it.  Of course, the QE was not called QE but just some massive buying of T-bills masked as repo operations to keep short term funding rates closer to Fed funds.  The reason you are getting the higher short term funding rates is because of the trillion dollar deficit, not because of some "plumbing" problems as some pseudo experts like to call it.  There were no "plumbing" problems when the budget deficit was half of what it is now, all of a sudden, the regulatory capital requirements is too burdensome and banks don't want to lend at Fed funds rates anymore? 

No, the banks are stuffed to the gills with T-bill paper, and that is tying up their reserves, so less money to go around for short term funding. 

And since the Fed is always going to come to the rescue whenever the market has a temper tantrum, in effect, big budget deficits in the future that naturally result in higher short term funding rates due to huge amounts of extra T-bill supply will be monetized by the Fed.  That is why in the short term, big fiscal stimulus is dollar positive, in the long term, it is dollar negative because it eventually leads to money printing.  That is in the first page of the Banana Republic 101 textbook. 

Anyway, the Fed has overreacted again to short term equity market weakness and come to the rescue.  That is why we are having a risk parity party this year, why SPX is making new all time highs, while the bond market remains strong. 

The good news for traders in the long term is that stock market overvaluation sets up future volatility which should make things interesting for 2020 and 2021.  This bull market is unlike a lot of the past bull markets because it is being fueled by stock buybacks and not retail and institutional inflows.  So the only way to get a sustained bear market will be to weaken the cash flows at corporations enough so that stock buybacks are reduced.  That can either happen through a weakening economy and thus weaker revenues and earnings or through higher taxes.  If a Democrat wins in 2020, there will be a lot of pressure to fund spending by increasing the corporate tax rate and income tax rates on the rich. 

So if you think the Trump Twitter bombs and trade news headlines are nervewracking, wait till the market reaction to the release of Presidential poll numbers and Democratic primary results.  2020 and the election will make 2019 and the US/China trade war look like a walk in the park. 

Fundamentals: What Me Worry?

This may be the trickiest stock market of all time.  Usually when you have a stock market bubble, with extreme overvaluation, there is a lot of euphoria surrounding it.  There is nothing close to a feeling of euphoria.  Even when stock investors were at their most optimistic, both in regards to the stock market and the economy, January 2018, you didn't get a feeling of euphoria.  It was just widespread complacency as volatility selling was en vogue.  Now, everyone knows that the global economy is slowing, and will be slow in 2020, but that hasn't stopped the SPX from making all time highs almost every day over the past 5 weeks. 

We haven't had a deep correction this year.  The May, August, and October pullbacks all stopped after 6-7% moves.  What was more surprising during those downturns was the reaction to them, instead of treating them like a normal pullback with relatively little fear, there was definite sense of gloom during those brief periods. 

Some are saying that the recent breakout higher in the SPX is because Elizabeth Warren is falling in the polls.  I don't think traders and investors are thinking that far out.  It still seems like everyone is focused on US/China trade, and the global central banks, to a lesser extent.  But it is interesting to see that the person benefitting the most from Warren's slide in the polls in Peter Buttigieg, who's been compared to Alfred E. Neuman by Trump.  What Me Worry? 

The only true guiding light in this kind of market is sticking with the view that the stock market will not go down hard unless the bond market is showing overt weakness.  And at no point in 2019 has the bond market shown overt weakness.  Therefore, you could never be short with conviction.  That is why I rarely tried to short this year, sticking by the conservative principle that there must be real bond market weakness before you get real stock market weakness. 

Those who have ignored the bullish signs coming from the bond market have probably shorted stocks regularly this year, seeing the stock market go up despite a weakening economy, no earnings growth, and high valuations.  More and more, the economy is having less of an effect on the stock market while the bond market is having a bigger effect.  This makes sense when you realize that debt has grown enormously over the past 20 years while the financial markets have become more closely aligned with the economy.  With very low population growth and almost no productivity growth, you have a moribund economy that can only find growth through financial repression, i.e., forcing investors to take more risk and increase the velocity of investment capital by going from Treasuries to corporate bonds and then to stocks and private equity.  That push is fueled by the central banks buying the Treasuries and MBS, giving investors the cash to buy riskier assets. 

So naturally, lower bond yields will keep the Ponzi scheme going longer as corporations have lower interest payments, and can issue more bonds at less interest expense.  Those bonds being sold to investors helps fund the massive stock buybacks which are the backbone of the demand for stocks in the SPX.  But at some point, bond yields are so low that unless they go negative, (very unpopular and unlikely in the US as they hurt the banks), you aren't going to have a meaningful impact on investor behavior with incrementally lower yields.   We are not at that point yet, but I would guess that if 10 year yields get below 1%, further decreases in yield will have diminishing positive effects for stocks. 

At that point, earnings will be all that matters, and that will be dependent on economic growth and margin expansion, both which don't look to be future positive catalysts for stocks. 

If we step back from the news cycle and take a long term view, there is really no good place for a long term investment in either stocks or bonds.  Which means that you can't sit on a 60/40 stock bond portfolio and ride the risk parity gravy train like you have been able to for the last 35 years.  And when investors are not making money, they get more nervous, and volatility rises.  So that should make the next 10 years much more volatile than the previous 10 years.  2009 to 2019 has been a great 10 years for long term investors.  It hasn't been so great for most traders.  Even with all the quants and HFTs making the markets more efficient, it should be a more favorable environment for traders in the coming 10 years when investors are dealing with losses more frequently.   Nothing provides a catalyst for volatility like losses. 

Of course, the global central banks and governments could go on an MMT printing and spending frenzy over the next 10 years and make everything go higher in nominal terms.  While I see that as a distinct possibility in the US, I doubt that has the support from citizens in most other countries. 

First day of December, and we are seeing one of those rare days where the bonds are noticeably weaker while stocks are flat.  If we get further bond weakness while stocks trade either sideways or down, it will be the first sign that we are making a top. 

Risk Parity Shining Bright

The 10 year yield is at 1.81% today, the same level it was at on Monday, October 21.  The big difference between the two dates is that the SPX was at 3000 on October 21, and it is now at 3125.  So 125 SPX points higher in 1 month and the 10 year yield has gone nowhere despite Powell clearly stating that the Fed is pausing its rate cutting cycle for the time being. 

When risk parity is firing on all cylinders, like in 2019, the wind is at the back of the bulls.  It is a favorable environment for stocks to continue rallying.  Only when bonds noticeably weaken can you start to question the rally.  Right now, its a nightmare for short sellers, and frustrating for market timers who sold early and are looking to buy on a pullback.  That pullback is not likely to happen anytime soon with the way bonds are ignoring equity strength and staying strong. 

These are the type of markets that get counter trend traders in trouble.  They get used to the pattern of fading all time highs and expecting a sharp pullback like in May, August, and October, and the market isn't following that pattern.  November and December are the most active months for stock buybacks for the year.  Corporations who have made buyback announcements catch up to buyback stock before the year ends.  Buybacks are heavy, with benign price action and investors are starting to add risk after having low equity exposure for most of the year.  That is a recipe for an uptrend that confounds the bears and the market timing fund managers who thought all time highs always meant that stocks would pullback hard and consolidate its move. 

You can't be stubborn when you are a bear.  You take you profits on panicky drops and wait for the complacency to built up again and take another shot at shorting.  Only when the conditions are super bearish can you just hold on to the short and wait for a huge move down.  We are getting closer to those type of bearish conditions, but the seasonal upward forces are just too strong to fight right now. 

How can the markets keep going up when there is no earnings growth and valuations are probably in the 99 percentile in US stock market history?  Its because the institutional investors and corporations could care less about valuations when they buy and sell.  Institutions are just trying to keep up with the indexes, and the corporations have good enough cashflow to keep buying back stock and they don't need to spend money on investment and R&D because most of the big companies have quasi-monopolies and are just rent seeking.  That is the best business model to have, either acquire the competition or lobby your way to having regulations that keep competition at an absolute minimum. 

So despite the absurd valuations, the only way to get a sustained bear market is to have a big enough economic slowdown that corporations have a hard time both repaying debt and buying back stock.  A mild slowdown will not get the job done. 

But the perverse thing about the stock market in this modern age of financialization of  economies is that a bear market will probably be the event that starts the recession, not the other way around.  The stock market is driving the economy more that the business cycle is.  Its because when there is low growth and perpetual easy money policies around the world, the determining variable is asset prices, not consumption and investment. 

That is why the worst thing that could happen for most of the world economy is a big real estate downturn, and the worst thing that could happen for the US economy is a big SPX bear market.  And those are the 2 markets are that are currently the most vulnerable.  In most of the G20 countries, real estate has been the asset that has gone up the most in price since 2008.  In the US, it has been stocks.  So there is a huge vulnerability that has been building up over the years, as the increasing debt has been driving up both real estate and stocks. 

The key is the credit market, as the inability of debt expansion, both corporate and household, to continue at the same pace will cause a weakening in both real estate and stock markets.  It seems like China has reached debt saturation where only a suicidal money printing spree would be able to prevent a big downturn, and that money printing would only build up even more nonperforming loans and make the Ponzi scheme bigger than it already is, and it is enormous now. 

Yes, from a long term view, this is probably one of the worst times to invest in stocks or real estate, but since everyone has a short term focus, they are buying, because the corporations are, and because they have to in order to keep up with the S&P 500.  It will end in a bear market, like they all do.  Its just a matter of timing.  And the 2020 US Presidential election is probably the perfect excuse to start the selling. 

Keeping my powder dry, as the short selling opportunity for 2020 gets better and better with each new all time high. 

Monster in Waiting

The higher it goes, the harder it falls.  It has been a flabbergasting move higher on US China phase 1 trade deal headlines, repeated in various forms over and over again, yet still able to spike the futures higher whenever they hit the wires. 

This feels like the most extended relief rally on a nothingburger deal that will be meaningless after November 2020.  Learning from experience over the last 10 years, it is better safe than sorry in shorting the SPX.  One must be very careful picking spots to go short, because there is a big mental and financial cost for being too early to short, as one bleeds losses as the indices grind higher day after day, testing one's will and belief in the bigger time frames. 

I usually lean bearish, but I also realize that there are certain seasonal patterns that usually play out, such as November and December being bullish.  And the massive amount of equity fund outflows this year due to trade war and even recession fears also made it less likely that you would get a sustained selloff.  As you all probably know, the significance of the US/China trade war is blown way out of proportion and with the huge budget deficits that the US government is running, the odds of a recession are much lower than Wall St. thinks. 

But with the SPX at all time highs and at nosebleed valuations, you don't need a recession, or even much of an economic slowdown to make the market go down.   Just the uncertainty of the 2020 presidential elections would be enough to weaken the market next year.  As I mentioned before, the fear of a potential President Elizabeth Warren is real, and its not a baseless fear like most things on Wall Street.  This is a very real negative catalyst that could easily send the SPX into a bear market.  Especially if the Democrats could somehow be able to hold 50 seats in the Senate, which would allow them to use the nuclear option to pass tax hikes on the rich, corporations, and of course the much talked about wealth tax, which is making the billionaires howl in horror.  Paradoxically, the more the billionaires complain about a wealth tax, the more popular the idea will become with the general public, who realize how out of touch the rich are with the other 99%. 

We are setting up the perfect storm when you get investors excited about some measly tariffs getting canceled as the Democratic primary season will be all you hear about over the first half of 2020.  And that is a huge cloud hanging over this market, and it will be the only thing that investors think about starting in 2020.  I am already getting excited for what should be a monster short coming up. 

But I don't want to jump the gun, who knows you desperate the fund managers will get chasing performance into year end, and you have the biggest slug of corporate stock buybacks over the final 2 months of the year. 

The put call ratios have been extremely low this week, and is a sign that investors are throwing caution into the wind and getting greedy.  I see limited upside from current levels, but also due to the buyback support over the next several weeks, limited downside.  It should be a low volatility grind for the rest of the year, setting up a volatile 2020. 

Powell Pause

Chairman Powell is trying to pull off a mid cycle adjustment by cutting 3 times just like Greenspan in 1998.  Although he didn't outright say that the Fed is in wait and see mode, you could tell by the Fed statement and his subtle emphasis on reduced global risks in regards to trade and Brexit in the press conference. 

After 3 rate cuts and the S&P 500 being at all time highs, it seems clear that he doesn't want to waste his remaining rate cutting ammo when the financial markets are doing well.  But let's not pretend like the Fed is the one in control.  The STIRs and bond market are the ones that are making the decisions.  After last December's fiasco, Powell is now terrified of upsetting the markets, so he will be taking orders from the bond market, even if he doesn't admit it.  

The Fed is data dependent, and that data is coming straight from the short term interest rate market.  And the short term interest rate market is mostly dependent on the stock market, because the financial markets is the main driver of the economy now.  In the past, you had regular boom and bust economic cycles as the Fed wasn't overtly distorting financial markets.  That changed with Greenspan, and now we have a bubble based financial economy that needs a rising S&P 500 in order to sustain itself.  

There is a significant number of people in the US who need a rising S&P 500 to maintain a retirement fund while also funding their spending habits.  The worst thing that can happen for economic growth in this rising asset dependent economy is for financial assets, either stocks or bonds, to fall for a sustained period of time.  I am not talking about the 3 month bear market we had from October to December 2018.  I am talking about a bear market where prices go down, and stay down for over a year.  This happened multiple times in the 1970s and in the 2000s.  The overvaluation of the stock market with no earnings growth is setting up another decade of sustained lower prices. 

But unlike the 1970s and 2000s, the economy can't sustain itself with lower asset prices.  It is now a powder keg waiting to explode with how big a portion of financial assets, especially stocks, have become as a percentage of GDP. 

This doesn't include the private equity bubble that makes it attractive for overvalued companies to stay private and not get the scrutiny such as a WeWork has trying to IPO and sell itself for a ridiculous valuation expecting idiots to buy worthless equity for several billions.  

The main reason that the US is holding up so well compared to Europe and Asia is because of the quasi MMT policies of Trump boosting both government spending and cutting taxes.  A trillion dollar budget deficit goes a long way towards boosting GDP growth.  

So from 2017 to 2019, the main reason the US economy isn't already in a recession is because the government went on a spending spree while cutting taxes which mainly helped corporations, thus boosting the stock market.  That is why the 2020 Presidential election is so important.  If you get an Elizabeth Warren in there, you are probably getting tax hikes and a likely recession.  This is one of the few times where the fear mongering over an event is actually the real deal.  Elizabeth Warren would be a nightmare for the stock market.  That is why the biggest negative catalyst is going to start when the Democratic primaries are in full force, in February and March next year.  

I would not be surprised if 2020 starts pricing in the possibility of a Warren presidency, which would mean much lower SPX levels.  How quickly traders and investors get bullish when the market hits all time highs, even when the last few times that happened this year, you had a sharp correction a few weeks later (May and August).  I expect that to repeat, as the earnings growth is just not there anymore to support this market ahead of an event heavy 2020.  

The Fed will likely be back in play for more rate cuts as I am sure business confidence will be weak heading into the uncertainty of the 2020 elections.  

November and December are stock buyback heavy months, so that will be a support for the stock market even at these nosebleed levels.  So I don't expect much downside for the rest of the year, but with all the negative catalysts coming up, I don't expect much upside either.  So probably a low volatility tight range market for the rest of the year.  The trade news is now just a side show as it loses relevance ahead of much bigger and important things in 2020.  

Investing Donkeys

LiveSquawk @LiveSquawk

57m

China Said To Want The US To Remove Tariffs So They Can Reach $50 Bln In Imports Of US Farm Goods

You thought China would roll over and play nice to Trump just so the tariffs wouldn't be raised again.  No, they want more to give in to Trump's demands for ag purchases.  The Chinese have time on their side.  They know the 2020 election is only a year away, and Trump wants to please the stock market with a trade deal even if its a nothingburger to have a "win" before the elections come up.  Xi has all the leverage in this negotiation.  And he knows it.  That is why after Trump hyped up the "phase 1" part of the deal, the Chinese wouldn't follow, and left room to ask for more before the deal is written and signed. 

And they will want more.  Because if both sides walk away, the stock market will go down, and Trump suffers more than Xi if that happens.  Xi could care less about the Chinese stock market, its viewed as a casino anyway in China, so if he torpedoes the US stock market and drags the Chinese stock market with it, at least he guarantees a Democrat win in 2020, then all the better.  Short term pain, long term gain. 

Xi will push Trump to the limit, to get the most out of a deal while giving up the least.  They know that the political tides are changing in America, and China is now viewed negatively by both the Republicans and Democrats.  So a free trade bonanza with no tariffs is probably no longer a realistic target for China.  They just want to minimize the tariffs as much as possible without giving in on IP theft, forced joint ventures, and other industrial policies that are completely one sided in their favor. 

One of the most overlooked factors about this US/China trade negotiation is that it won't lead to a deal that has any staying power.  And a temporary deal is about as bad as no deal.  Because on November 2020, there will have to be another US/China trade deal, which would basically make the previous deal meaningless, no matter who wins in 2020.  And no one who is actually sane in corporate America is going to make long term decisions based on any trade deals over the next 12 months anyway.  Because if Trump gets re-elected, he will likely break the deal and try to get a better one, and if a Democrat gets elected (probably Warren), then they will scrap whatever Trump did  to get the kind of trade deal that they want. 

The market right now is under the illusion that a US/China trade deal will be very small, and not change much.  Yet they think a substantial US/China trade deal would be a game changer.  The reality is that because of the 2020 election, any trade deal will be meaningless.  So there won't be any "positive" outcome from the trade negotiations.  Which is probably why the best possible scenario for the stock market would be for Trump to milk this US/China trade negotiation for several months, keeping the carrot in front of the donkey that is the stock market investor for as long as possible, without actually giving the carrot.  Because once the donkey eats the carrot, there is nothing else positive to look forward to, and ends up making the donkey feel worse afterwards.

That is why it is actually a positive for the stock market that Trump drags this negotiation out as long as possible, going with the phase 1, and hinting at phase 2 and phase 3.  He is playing the long con on the stock market investor, giving just enough hope for them to keep stock prices elevated, but not enough hope so that the Fed feels comfortable not cutting rates. 

But the uncertainty of the 2020 election and a >50% chance of a Warren win will be too much for fund managers to stay invested and they will sell fast and furious, especially if SPX breaks 2800. 

We got the relief rally on the verbal agreement to a small trade deal on Thursday and Friday, but its only gone up back to levels pre ISM.  There is a distinct lack of rocket fuel provided by the persistent down trend in interest rates that you saw from January to July.  Without that lower and lower rates rocket fuel, the stock market can't go up much.  The earnings growth is just not there, and there is just not enough dumb money in the whole world at this time to keep the SPX above 3000 for long.  The failed IPO of WeWork is a sign that at this stage of the business cycle, the dumb money is not going to play that hot potato game.  They've been burned enough by the debacle that was 2018. 

It looks like the volatility will continue to dissipate as earnings season rolls on, and we get closer to the return of stock buybacks.  With the trade deal event sort of out of the way for the next few weeks, the weak hands will slowly come back in to stocks, but they won't be aggressive, so don't expect any big surges higher.  At the same time, a lot of weak hands were taken out in August, and some more the last 2 weeks, so the market should be safe to trade in a tightening range, perhaps 2920 to 3020. 

From Trade War to 2020 Election

The never ending trade war, it feels like that is all the stock market cares about.  But it is October 2019, 13 months from the 2020 US election.  And less than 6 months from basically knowing who the 2020 Democratic candidate will be.  Whatever is done on trade will have diminishing effects on the market the closer we get to November 2020.  By next year, the focus will be on who wins in 2020 election, which determines much more important factors such as tax policy, corporate regulations, health care policy, and anti-trust actions. 

The most popular political betting market, Predictit, has Elizabeth Warren as a clear favorite to win the Democratic nomination, at 47%.  Even with the average of the polls showing her at about a statistical tie with Joe Biden, the betting markets don't think that will be the case next year, as Biden's popularity is falling while Warren's is rising. 

There was one fund manager on CNBC, who said that the stock market wouldn't open if Warren won in November.  That gives you a general feeling about what Wall Street thinks about her effect on the stock market.  I usually don't agree with these politically charged views on candidates and how they affect the stock market, but I do agree with the consensus this time.  Elizabeth Warren would be a nightmare for the SPX.  This is based on her plans to put a 2% wealth tax, as well as looking to do Medicare for All, a budget buster which would be funded with tax increases across the board, both income and corporate. 

The current US health care system is a huge source of profits for the health care sector in the S&P 500, cutting out the middle man and making the US government the health care insurance provider would be getting rid of a huge source of economic rents the health insurers and pharmaceuticals take from the general public. 

The increase in taxes is obvious, because anytime there are more taxes taken from the wealthy and from corporations, it reduces the amount of buying power available for stock buybacks and stock buying from the public.  The only reason the markets went up so much in 2017 was because of the anticipation of the huge corporate tax cuts and overseas fund repatriation amnesty which fueled the stock buyback frenzy in 2018.  Those aftereffects are what are keeping the SPX at such high valuations. 

Looking ahead, the current obsession over the trade war will be mostly forget and will be almost meaningless in the heat of the 2020 election season.  And a Warren presidency would be so much more bearish for the stock market than any escalation in the trade war that Trump goes with if he wins in 2020. 

We got a nasty little selloff yesterday based on dimming hopes of a trade deal.  The expectations are getting really low now, so any tiny bit of good news over the next few days will probably have an oversized positive effect on the stock market.  If we get bad news and no deal, we may get a knee jerk selloff day but I don't think it lasts for long, as the current consensus is that there won't be anything substantial done. 

SPX is the Best Leading Economic Indicator

All of a sudden, it turns to October, and the bad ISM and the ISM Services Indices have turned into huge market movers.  The crowd has been walking on egg shells, worried about recession (fear peaked in mid August), and those recession fears have spiked again with the back to back weak ISM numbers. 

Let's not forget, ISM index is a PMI, which is a survey of purchasing managers, so it is soft data, not real numbers.  The reason so many are freaking out is because they think the ISM is a leading economic indicator, but its more like a lagging stock market sentiment indicator.  Look at what happened to the ISM over the past 5 years: 

When you see the stock market react so strongly to economic data, it is usually during a time of weak market sentiment, or seasonal fears (bearish October, repeat of last fall), or most likely, lack of stock buyback support during this stock buyback blackout period (late Sep to late October).  Those are usually times when the market has already been going down and the bad economic data punctuates the final move lower, usually forming a bottom immediately or within 2 trading days.  (examples: June 4, 2012, October 2, 2015, October 3, 2019?).

I am sticking with my view that a recession will not start because of a trade war or because of weak Europe/China.  The most likely cause of a recession will be a bear market in the US stock market after the Fed has already reached the zero lower bound, unable to lower rates.  The stock market is the only real dynamic part of this low growth era, and it has reached such a huge size of GDP that it is the tail that wags the economic dog. 

So looking at economic data to try to forecast future stock prices is nonsense.   It should be the other way around.  The best leading economic indicators are not things like building permits, yield curves, or PMIs.  It is the SPX.

Yesterday, we made an intraday V bottom off a very oversold condition on the bad ISM services number.  And the bond market went up strongly, which is the risk parity trade working again.  On the in-line nonfarm payrolls number, bonds are not selling off even as stocks are going up.  Again, risk parity positive.  I will not be interested in long term shorts until we get sustained bond weakness when stocks rally.  Still nowhere close to that.

Recession Fears

The ISM number coming in at 47.8, below 50 for the 2nd straight month, was enough to fan the flames of recession fears and cause a 40 point drop in SPX yesterday.  The bond  market has a PhD in providing a leading forecast of future economic numbers.  The big drop in yields in August was a clear warning sign that the economic data for the next few months were going to come in weak.  That has happened as the August jobs number and ISM index were well below consensus, along with a bunch of other global PMIs.  That has continued with yesterday's weak ISM number.   Below are historical ISM charts.  We are back to late 2012 and late 2015 levels.

Another factor is the October effect.  The fear of October itself is enough to make investors sell at the slightest bit of bad news.  Especially after last October's brutal selloff, they aren't taking any chances and are playing it safe, selling first, and waiting it out.  It doesn't help that the US China trade talks are happening next week, and most are expecting a disappoint result.  

I am getting flashbacks to late August, when the trade war headlines were so negative, and it felt like a slam dunk to short any rallies, towards SPX 2930.  Once again, we have the negative trade war headlines, and now weak economic data on top of that.  It feels like another obvious time to short.  The trading gut tells me that now at SPX 2925, it is actually more dangerous to be short here than be long.  It doesn't make me want to be long, especially with the stock buyback blackout period lasting for the next few weeks, but it makes me cautious to play the short side.  

Not many are thinking about bullish catalysts, but here a few that I am thinking of:

1.  A truce and a can kick on further China tariffs after next week's US/China trade talks.  Trump seems more desperate to save the stock market, even lying back in late August about having talks with China to boost stocks after they took a dive on more tariffs.

2.  A more dovish Fed that starts QE4 lite to fix the repo market, and probably another 25 bps cut at the October 30th meeting, could ignite sidelined cash into stocks, especially with buyback blackout period ending at that time.  

3.  Germany announcing a fiscal stimulus package as it is becoming quite obvious with the latest Germany PMI that Germany is in a recession.  

Right now, I don't want to go long until I see extreme fear, and we aren't even close, and I don't think it will happen this October.  

Trade War Headlines

There has been a pattern to these trade war headlines that some observant traders will have noticed.  In general, when the market has been rising for a few days, near SPX technical resistance levels, a negative trade war headline usually pops up and brings the market down quickly (last two Fridays).  Then a positive trade war headline shows up during low liquidity hours or over the weekend (last two weekends).  On triple witching expiration day, Friday September 20, the China canceling the Montana farm visit dropped the SPX 25 points in a flash, then the White House denied that China canceled and said it was the US that canceled.   Same with the China investment ban headline.  Also denied over the weekend. 

The White House is treating the US stock market as their personal piggy bank manipulating the markets regularly and profiting through offshore corporate shells that are trading on their behalf.  I don't wear my tin foil hat much, and almost all conspiracy theories are bogus, but the amount of market manipulation based solely on US/China trade headlines is unprecedented.  It puts to shame any kind of trial ballooning that the Fed used to do to test the effect of certain policies. 

If the White House is putting out these trade headlines and profiting from them through trading them through offshore accounts in other people's names, then they have no incentive to make a decision on a trade deal.  The ideal situation for them would be to continue to keep the market on its toes, providing a sliver of hope, and then taking it away, escalating tariffs, and then delaying them.  Politically, making a trade deal with China only benefits Trump if the stock market continues to go higher after the deal.  There is no guarantee that will happen, especially if a trade deal is accompanied by a more hawkish Fed. 

Most people are skeptical of a long lasting US-China trade deal, and rightfully so.  So expectations have been lowered quite a bit.  That means a mere delay of some Chinese tariffs that were recently introduced should be enough to provide a relief rally.  At this point, the best strategy for both sides would be kick the can on tariffs and agree to future talks with nothing concrete happening. 

SPX is stuck in a 2950-3000 range for the past week.  The pullback from the trade war optimism of 2 weeks ago makes it less likely that you will get a sharp drop if the US and China don't agree to do anything.  The trade talks are scheduled from October 10-11, so there will be a lot of fast money traders that will look to get out of their positions before that date.  Since it seems like most of the fast money is short, we could see some short covering a few days before October 10, so it could start late this week/early next week.  If there is another dip down towards 2950 this week, I will consider a small trading long position.

Triple Witching Hangover

This week is turning out to be a classic post quarterly options expiration week.  The artificial buying pressure late last week after FOMC has been taken back plus more as the fund managers' puts expired out of the money.  It is going to take a few more days of nervous trading for the investors to get back to their normal level of put protection.

Also, it has been 1 month since the triple bottom around 2825 was hit on August 26, so the tailwind from fund managers getting back to their normal level of equity exposure is gone.  It doesn't mean the uptrend is over, but the probabilities are more even for up or down price movement.  We are in a chop zone and it favors the counter trend traders for the next 2-3 weeks.  After that, we'll probably go back to trending higher if the bond market cooperates and doesn't selloff too much.  Anything under 1.90% 10 year is enough to provide support for equities for the remainder of the year, as the fundamentals aren't bad enough to cause a sustained equities selloff with interest rates this low.   

The impeachment news is a distraction, as everyone realizes that Trump will not get impeached with a Republican majority in the Senate.  The House can call for impeachment, but the Senate will decide not to do it.  The impeachment has no impact on the US China trade deal, the Chinese were never going to give what the White House wanted, and some agriculture and pork/beef purchases won't be enough to get Trump to roll back the tariffs.  Its probably enough to keep tariffs where they are and avoid further escalation.  It seems both sides would rather just kick the can and keep things where they are, instead of giving in to the other side. 

Neither the long side or the short side excites me here.  If I had to put on a trade, I would reluctantly be a buyer of SPX around 2950-2960 support, and be a seller around 3010-3020 resistance.  The positive for the market is the low expectations for a US China trade deal, so there won't be much disappointment if nothing major happens.  The negative for the market is long term weakening earnings growth and overvaluation. 

Various Thoughts

1. When traders learn a pattern over an important event (FOMC meeting) and prepare for that event as if things will repeat, then the pattern is less likely to work.  The pattern was to sell ahead of the FOMC meeting and buy the dip a few days later after Powell disappoints and Trump ignites trade war angst.  

Ever since Powell has been FOMC chair, the performance of the S&P has been weak, much weaker than an average trading day.  But this time, Powell disappointed with a rate cut and no promise of future eases or repo facilities or whatever else the market dreamed of.  After the initial fakeout dip to draw in the Powell bears, we had a face ripper into the close.

2. One of the most popular hedge fund trades is to bet on an extended rate cut cycle via long Eurodollar futures and call options.  The December 2020 Eurodollars futures contract settled yesterday at 98.45, which is pricing in a LIBOR rate of 1.55% at the end of next year.  LIBOR-OIS spread is usually between 10-40 bps, with occasional spikes higher above 40 bps.  So assuming about a 25 bps spread, that is pricing in a Fed funds rate of 1.30% by the end of 2020.  

With the current rate at 1.88%, that's pricing in about 2.3 rate cuts (58 bps) over the next 15 months.  While I don't disagree with the long Eurodollar futures trade, a better way to make that bet would be to just go long 2 year Treasury notes at 1.74%.  If the Fed cuts 58 bps, the Eurodollar trade breaks even.  However, the 2 year note yield would definitely trade much lower than the current 1.74%.  

3. A lot of traders and investors are reluctant to be long stocks and are long bonds because they fear a recession in 2020.  I don't agree about the recession call for 2020 because of the lack of overcapacity, lack of commodity inflation, and the huge budget deficits providing a lot of fiscal stimulus to the US economy in the background.  But I do agree that being long stocks is a bad risk reward now, not because of recession risk, but because of high valuations, no earnings growth, and political risk.  Political risk is not the trade war, but the risk of Elizabeth Warren becoming the Democrat nominee in 2020, with betting odds favoring her to beat Trump in the next election.  

Lower Bar for Powell

Wall Street has a short memory, but the memory tends to last longer when they are associated with big down days and the beginning of a sharp decline.  Almost every trader will remember that the August selloff was kicked off by a less than dovish Powell, and his mid-cycle adjustment comment, and the bear ball went further down the hill with the help of some Trump tariff announcements.  

That August selloff has all been taken back by the stock market.  But with the FOMC meeting closing in, with the accompanying dotplots and the Powell press conference, short term traders will probably be leaning bearish going into the meeting.  That means that expectations from Powell are much lower this time than back on July 31.  Powell has a lower bar to jump over to please the market this time, which makes it a bad risk reward proposition to be short going into the FOMC rate decision.  In fact, I see a higher likelihood of a short term pop rather than a short term drop after the Fed announcement.

There are also opex forces at work this week, with a bullish bias going into the quarterly options expiration.  The Saudi oil news and subsequent pullback probably provided enough fuel for a run higher into the Friday cash open SPX options expiration.  Market makers are usually short options, especially put options.  Although they hedge their exposure, they stand to gain more if markets go higher into the expiration, not lower.  

At current SPX levels of 3000, investors don't seem to be leaning bearish or bullish.  Other than the factors mentioned above, there isn't anything else that really presents an edge here.  The Saudi oil news is relevant for oil, and that's about it.  Oil doesn't really matter to the broader economy anymore because its only a small percentage of consumer spending.  And higher oil prices helps the oil producers just as much as they hurt oil consumers, so it mostly evens out in the stock market.  

Flashback of 2015

Just like 2014, 2019 has provided a huge rally in both the stock and bond market, feeding on the blood spilled by the bond bulls in the prior year (2013 and 2018 respectively).  That sets up a payback period in the following year, usually triggered by a big bond market correction.  In 2015, the correction happened from February to June.  In 2019, it is starting in September.  And it is likely to last a few months, so bond bulls, be prepared.  It will be choppy trading over the next 3 months. 

The top chart shows the SPX and 10 year yield overlapped from March 2014 to March 2015.  The bottom chart is the SPX and 10 year yield over the past 12 months. 

What isn't shown in the chart is what happened over the next 12 months.  And boy were they a rocky 12 months.  From May 2015 to August 2015, the SPX went from 2132 to 1867.  If 2019/2020 were to follow the same script after the bond market rally ended, it gives the market about 5 months before the bottom falls out of the market just like August 2015.   That approximates to February-March 2020. 

Nothing follows a script exactly, but the general concept is that bonds will no longer provide that great hedge against equity selloffs like it has over the past 9 months.  That eliminates a vital hedge which prevented investors from fully panicking out of the stock market during periods of weakness. 

So the stock market is now like a ticking time bomb ready to go off without notice, now that the low interest rate fuel has been used up. 

In fact, the August 2015 selloff was accompanied by a rather meek bond market rally, with the 10 year dropping only about 35 bps during the August 2015 waterfall decline. 

With the overvaluation being much greater now than in 2015, it is easy to imagine a waterfall decline in 2020 to be much steeper than the August 2015 decline.  There are a number of triggers that I can think of right now which will do it, the main one being the Democratic primary winner being either Elizabeth Warren or Bernie Sanders.  Odds of that are about 50% according to betting markets.  And the current polling shows Democrats ahead of Trump in the 2020 presidential election.  That would be a huge game changer as the main reason for the 2017 rally was a the corporate tax cuts, and a Warren or Sanders would likely raise taxes on corporations and the rich, which would be a huge negative catalyst for the stock market. 

We've had another big rally in SPX this week, thanks to positive trade talk.  Remember, the trade war is a distraction to what really matters.  The slowing economy, no earnings growth, and the potential of an anti-corporate welfare Democrat winning the White House in 2020.  There is resistance around the all time highs at 3025, but given the participation of small caps in this rally this week, there should be new all time highs coming up.  Still cautious on long term shorts, but I am getting much more constructive on putting on short term shorts because of the bond market weakness.   However, I will wait till after FOMC meeting and opex next week. 

Risk Parity Paradise

The SPX went from 2906 to 2978 in 3 days last week.  The main reasons traders cited was China yielding to Hong Kong protesters to China setting a date for US trade talks in October.  But its odd how the price action doesn't match how skeptical most investors are of a possible trade deal between US and China.  Sure, it was "good news", but most are assuming that the talks will end up achieving nothing. 

So how does the SPX go up 72 points in 3 days on nothing substantive happening?  Because the trade war isn't as important as most people think.  If the market was trading solely on how the trade war was going, the SPX would be down over 20%.  But there are other things that most investors don't think about that are much more important. 

The most important factor that has changed from now since July, the last time the market traded at these levels is interest rates.  Really, raising tariffs 5% on Chinese goods versus a 50 bps drop in 10 year yields is like comparing a bb gun (5% tariffs) vs a M16 machine gun(50 bps lower 10 year yields).  The attention is focused on the tariffs and US/China talks, but the big fundamental change since July is the much lower interest rates. 

At SPX 2980, the lower interest rates makes me more bullish about stocks than when 10 year yields was 50 bps higher, as it was in July.  It doesn't make me bullish, but it makes me less bearish. 

The above chart is beyond ridiculous and it is something that almost nobody would have forecast at the beginning of the year.  If someone told you on January 1st, that the 10 year yield would drop down to 1.42%, most would guess that the SPX would be lower than 2500, not higher, and even if it was higher, not near 3000! 

The bond market rally this year is reminiscent of 2014, when bonds rallied strongly after a bad 2013, despite an economy that was still growing, and nowhere near recession.  That year, the SPX went from 1850 to 2060, for a 12% gain, while the 10 year went from 3.02% to 2.17%.  So far this year, SPX is up from 2500 to 2980, almost 20%, yet the 10 year has gone down from 2.68% to 1.55%.  2014 and 2019 are turning out to the be 2 best risk parity years since 2008. 

If bonds sell off hard and the 10 year yield goes above 1.75%, then I will get more bearish and consider putting on shorts.  Right now, it is an uphill battle for short positions when the bond market is so strong without recessionary data.  It is almost a Goldilocks scenario for the US stock market to get such low interest rates without a really weak economy.  The US Treasury market is more reflective of global weakness than US weakness. 

Usually in markets good for risk parity strategies, like we are in now, stocks have a hard time sustaining big selloffs.  The hedging effects of a strong bond market take a lot of pressure off of money managers who don't have to panic sell stocks because bonds are providing a great hedge.  Good news for bears is that the year after strong risk parity years is usually much less bullish, mainly because most of the positive stimulus from lower rates is used up, i.e. 2015. 

It is a FOMO market now, the weak hands sold a ton in August (see the equity fund outflows data for August), making the market less heavy with supply and more likely to grind higher in the coming weeks.  There is a weak seasonal period starting from September 20 after options expiration, as stock buyback window closes until late October.  So if I want to consider a short postion, it will be after the FOMC meeting next week. 

Too Good to be True

It just seems too obvious to be short here.  Being given so much time to short at high levels, too much data to prove that the right side is the short side.  My trading gut would be giving me ulcers at this point, as the fundamentals collide with the gut feeling that there will be another WTF moment in the SPX, where the phoenix rises from the ashes AGAIN, and the bears and reluctant investors are left behind, pounding sand. 

Yes, the gut with ulcers tells me that the bears will snatch defeat from the jaws of victory.  This doesn't change the long term fundamentals of this market, which is driven by valuations, earnings growth, and interest rates.  Valuations are extremely negative for stocks now.  Earnings growth is a moderate negative.  Interest rates are a moderate positive.  That is the fundamental side. 

The technical side doesn't match the longer term fundamentals.  The stock market trades a lot stronger than it should.  And the only plausible explanation is the huge plunge in global interest rates in August, which has acted as a support system for the weakening fundamentals and news flow in the stock market.  But that support system only works because the Fed is cutting rates before the coincident economic data is getting bad.  They will not cut rates for too long if the data doesn't get noticeably worse.  So there is a limit to how much lower interest rates can go in a non-recessionary environment. 

To get a 10 year yield to 1% or below, will require recessionary economic data in the US.  And since the 10 year is already below 1.5%, the support system, pre-recession, is mostly used up. 

The reason the SPX can stay afloat at such high valuations is because pressure on the financial system from a weakening global economy has been relieved through much lower interest rates, but that release valve isn't an infinite source of support.  Once rates go down, that monetary "stimulus" is used up, and reflected in the equity market. 

We've seen 3 tests of SPX 2830-2840 support in August, with negative trade headlines recession fear mongering, and each time, support held and bounced quickly towards 2930-2940.  That is a sign of underlying strength in the SPX, and it cannot be ignored.  This technical strength is not to be used for a long term investing plan, but just a short term bullish sign that stocks are acting better than most people expect. 

Also, the Eurostoxx made higher lows on the last retest of SPX 2830-2840, signs of selling exhaustion in Europe. 

Technicals should only be used as a short term tool, not something to base long term investment decisions.  Right now, the technicals are bullish.  Fundamentals are somewhat bearish, and getting worse.  The plan is to wait for a intermediate term rally, and see what the market is like at that point, and then decide how much to short. 

Trump vs. Xi/Powell

Nonstop action in the overnight market these days.  Xi and Trump exchanging bombs every few hours, and the latest curveball, thrown by Trump, after he drops the tariff hammer down on Friday, and then tries to pump the equity futures higher with an out of the blue trade deal soundbite. 

It is either utter madness or masterful market manipulation by Trump and crew.  Occam's razor and Trump haters would support the first conclusion, and the conspiracy theorists and market cynics would believe the second conclusion. 

Who is the bigger enemy of the US:  Powell or Xi?  Trump comes from the old Nazi propaganda school (Joseph Goebels): "if you are going to tell a lie, tell a big one, and if you tell it often enough, people will begin to believe it".  His repeated attacks on Powell for not cutting rates or providing easier monetary policy is aimed straight at those without a strong opinion on Powell and the Fed.  Those who believe in the Fed and Powell will not be swayed.  Those who don't like the Fed and Powell already want to fire him.  And those in the middle are the ones that Trump is targeting to persuade that Powell is the fall guy if the US economy gets weak in the next 12 months. 

Look at the totality of Trump and Xi's actions over the past few months, it is clear that Trump is getting more desperate, and Xi is getting more comfortable.  There are a few different aspects of the trade war, and one of the most important is optics.  The optics of Trump and Xi couldn't be further apart.  Trump's random tariff approach has created more enemies along the way, from those in industry, to those on Wall Street, to farmers, by creating volatility out of the blue.  It makes Trump look worse and worse not just in US and China, but globally where unwelcome financial market volatility is blamed on Trump, not Xi. 

Xi has quietly wiggled his way out of promises and woven an exquisite path of lies, deception, and timely counterattacks (on a Friday morning, right before the US market open and Powell's Jackson Hole speech and ahead of the weekend) to induce Trump to overreact and hurt the US and himself, as well as China.  But the Chinese with the media under full CCP control, doesn't show the total picture, but a biased one which easily builds up nationalist support for Xi in China, as he battles Trump.  So even though the Chinese economy will feel pain from the tariff measures, the brunt of the pain is felt by US consumers, who end up having to pay the taxes on goods, creating tariff-related cost push inflation. 

Xi is also better delegating the news breaks to the public by going through his underlings and media outlets rather than putting out the news himself.  It gives the illusion that Xi's hands are clean when he delegates the dirty work of releasing counter measures to those below. 

So if the US economy turns sour, most people will not be blaming Xi or Powell, but Trump. 

It is quickly forgotten that the reason there was no trade deal this spring was because Xi backed out and reneged on his promises to make IP theft and forced technology transfer illegal under Chinese law.  That and pretty much everything else that Xi promised up to that point were revised and deleted in the final text of the Chinese offer.  So with the market at all time highs, Trump had plenty of confidence and fearlessness in putting on additional tariffs.  But as soon as the stock market started dropping almost every day (May), he got soft, and backed off Huawei and delayed some tariffs. 

That is why Trump pushed the tariff deadline from September 1 to December 15, not because it would hurt the consumer, as he said, but because he was seeing the stock market dropping and Wall St. panicking over his latest round of tariffs.  When the markets start dropping, Trump goes soft. 

That is what is happening in the overnight markets, as Trump saw the stock market reaction and felt a need to rescue the markets again after his emotional tariff outburst on Friday by giving the market some hope that a Chinese deal is right around the corner.  But Xi isn't going to play along.  It is clear the Chinese are looking for a nothingburger deal that allows the status quo of the last 20 years to continue, with minor concessions such as soybean, corn, and US beef/pork purchases. 

And I just don't see Trump desperate enough to swallow such a bad deal and try to sell it to the American public.  Maybe in another 6 months, if the US economy shows more signs of slowing, and the stock market is notably weaker.  But not now, when the stock market is still trading only 5% below all time highs, and the US economy still hasn't rolled over. 

So if you are going to be bullish on the stock market, it shouldn't be based on possibilities of a trade deal.  It would be because there is some fear out there, the ECB will come out with a big stimulus package, that the European economy is not getting worse, and the lower interest rates are providing a stimulus for housing and through refis.  Those are legitimate reasons, but also not strong enough to provide fuel for a long sustained rally.  So I am still leaning bearish, but would like to see less fear and more complacency before I go back on the short side. 

It is just crazy action since Trump lit a fire under the market with his additional tariffs tweets.  I was expecting the market to grind higher for the next 2-3 weeks, but it may chop around for a few more days before bouncing again.  With this big gap up in pre market, it takes away a lot of the potential juice from the long side so nothing compelling to do here.  Without a Trump pump overnight, we could have made a washout low today, but that has gone out the window.  So its probably lackluster trading from here, with no real edge either way.

US Banana Republic

The exorbitant privilege of having the world's reserve currency has kept the dollar stronger than its fair value.  Of course, it helps to have the next 2 biggest currencies yielding negative rates out to 30 years on the curve.

Recently, Argentina's stock market plunged by 40%, and the US dollar denominated Argentina 100 year bonds dropped 30%.  Here is a look at Argentina's government budget deficit as percent of GDP:

Nothing crazy, but it has gotten above 5% of GDP.  Here is the US budget deficit over the past few years and estimates out to 2021:

As the economy has remained steady since 2014, the US budget deficit has gotten bigger and bigger.  It is now around 5% of GDP.  That is while there is record unemployment and what has been a raging bull market in stocks.  In the past, even as recently as 2000, there was a budget surplus during the business up cycles, but in this current upcycle, the budget deficit hasn't shrunk, but has ballooned higher.

The US economy has basically achieved above trend growth through massive tax cuts and big increases in government spending ($300B for 2018/2019).  That is only sustainable if inflation stays low.  Argentina, Brazil, Venezuela, and other banana republics has shown throughout their history that if you have rampant government spending financed by money printing (QE), the end result is high inflation.

Having the world's reserve currency can buy you a lot of time before the currency starts losing relative value and foreigners start losing confidence in it.  We are not there yet, but the more the US government pushes the limits on how many dollars the free market can handle, the closer you get to the US becoming a banana republic.

The US has one of the lowest effective tax rates among the developed nations while also maintaining a gigantic military.

Taxation is a control on inflation, as it reduces the amount of currency in circulation.  Big budget deficits financed by the central bank (yes, that's the eventual path when the economy weakens, ZIRP and QE) is what will happen, and that is straight out of the banana republic playbook.  The big difference between Europe and the US is that the European Union's charter limits government budget deficits to less than 2% of GDP, and for the most part, its execution is successful.   That is a strong counterbalance on ECB money printing, keeping inflation under control.  The US has no such limits on budget deficits, and the trend is for bigger and bigger deficits, and most of the voting population doesn't care or understand the consequences.  The ones that do worry about the deficit worry that the US government can't pay back its debt, but that's ridiculous.  The government can just print money to pay back the debt.  The consequence of a growing national debt and big budget deficits in both up and down cycles is inflation, or currency debasement.

There has been a lot of talk in the media about a pending recession, many pointing to the inverted yield curve and surging bond prices.  I don't agree on the US recession calls for 2020.  There is just too much government spending, not enough excess capacity, and not enough inflation to cause a recession.  If oil was at $100/barrel, corn at $8/bushel, and natural gas at $7/mcf, then I would be more open to the recession idea.  But that's the opposite situation, with commodity prices low, wage growth the highest it has been since 2008, and with the stock market still close to all time highs.

The strength in the bond market is a relative game of negative yielding European debt causing a chase for "safe haven" yield in the US Treasury market.  The weak European and Asian economies are what's causing the huge plunge in US yields, not any imminent recession signs.  Yes, the leading indicators are slowing down but they mostly point to slow growth, not negative growth.  And with such a huge rally in bonds and yields this low, slow growth is enough to keep the SPX elevated for now.

Eventually, the SPX will fold under the pressure of no earnings growth even with low yields, but that's probably a 2020 story.  The biggest bomb that could go off on the stock market would be a liberal Democrat (non Biden) beating Trump in November 2020 and raising corporate tax rates and pursuing anti trust legislation against the corporate giants.  Anyway, the stock market is so short sighted, November 2020 may as well be November 2024.  But if Joe Biden fades from the top as I expect and a liberal Democrat (probably Elizabeth Warren) wins the Democratic primary, then all bets are off, and a real ticking time bomb will be placed right at the footsteps of Wall Street.

Its a resilient market, we got the classic V bottom off the mini fear low on last Thursday.  Everyone knows the drill, after 10 years of this action, and with FOMO, the things fly on a feather once it hits bottom.   Just watching and waiting, no good trades here.

Bond Bubble?

Every parabolic move has a kernel of truth.  Just because something is going up rapidly doesn't make it a bubble, or irrational.  There are strong reasons backing up the continuous rally in bonds.  I am sure there are a lot of traders shaking their head when they see recent strong inflation and retail sales numbers, and the bonds keep going higher anyway after just a quick dip. 

The bond market could care less about lagging or concurrent economic indicators.  All the leading indicators are pointing towards a weaker economy over the next 6 months, so the bond market is looking ahead. 

The inverted yield curve is a reflection of the large amount of front end supply being issued by the US Treasury, while there is a rush for long end duration as fixed income managers believe that Powell is being too hawkish and slow in cutting rates.  It has nothing to do with a recession signal.  The recession signal happens when the yield curve bull steepens, expecting a Fed easing cycle. 

The short end of the yield curve is much more economically sensitive than the long end, so the bull flattening is actually signaling an economy that isn't facing an imminent recession.  Usually the belly of the curve would be the best performer in risk off moves, but this time, it has been the long end.  This move has been more about a supply/demand imbalance in long duration bonds, rather than a weakening economy.

Stocks are getting pulled from both sides, the bullish side being the lower rates across the curve, the bearish side being the overvalued levels and lack of earnings growth.  It is a tug of war right now, so not much edge right here.  If stocks were to get flushed out in the next few days, that could be a short term bottom, but at SPX 2840 it seems too early here to go bottom fishing. 

Better Pickings Later

The SPX got up to 2940 and there was a mountain of supply waiting to meet the demand and it hardly traded at that level for more than an hour before promptly going back down to the middle of the range.  The new range in this post-shock market is roughly SPX 2830 to 2940.   I don't foresee a bigger move down during this pullback solely because of the immense strength of the bond market.   Bonds are providing a super hedge for stock/bond mix portfolios and have kept equity investors from becoming rabid sellers. 

The news looks horrible: intensifying US/China trade war, recessionary economic data coming out of Germany, continuous Hong Kong protests, and a Fed that is still not as dovish as the market wants.  Yet, we are at SPX 2875, less than 5% from all time highs. Eventually the fundamentals will come to bear on this stock market, but only after the bond market gets weaker.   And there are still no signs of that happening. 

I don't expect a US China trade deal unless Trump totally capitulates and gives everything that China wants.  And that is very unlikely.   China will definitely not budge from their position, their stance has become hardened and they will become more difficult to deal with as the days go by.  China is in no rush, and would prefer to wait out Trump.  As for Trump, he will only make a weak deal if he sees the US stock market act much weaker, a 5% pullback doesn't get his attention.   Its got to be another December 2018 type of correction for him to at least consider capitulating to China.

 Despite this negative trade war view, I would not be surprised to see the SPX make another move towards 3000 within the next few weeks.  I just don't view the trade war as being that big of a deal, its definitely much less important to the stock market than the bond market.  And the bond market is very supportive of stocks here. I am not bullish now, but am definitely not bearish.  There are better spots and probabilities to pick from on the short side, so I am waiting.  The time for a longer term bear raid is still ahead of us.

Bonds are Too Strong

Sometimes you have to know when to fold them. I wasn't expecting this kind of bond market strength on such a normal pullback. The SPX sold off 6% from last Wednesday's open to this Wednesday's open. Normally, that would cause year yields to drop about 15 bps. These are not normal times. The 10 year dropped 40 bps over those 4 days. That is why stocks shot up like it was released from a cannon yesterday. It is also why I eventually closed my short position, albeit a few hours too late, getting too caught up in my long term thinking, instead of focusing on the current picture.
The current picture is a market that is aggressively pricing in low yields for an extended period, even with Powell reluctant to signal a lot of rate cuts.
A strong bond market is the best defense for equity market weakness. It provides a buffer for investors who are making money on the fixed income side to make up for a lot of the losses on the equity side of the portfolio. That makes investors less nervous, and less nervous investors don't panic. No panic, no big selloff.
Here is a summary of some of the SPX pullbacks and bond market reaction since 2018: Feb 2018: SPX 10% selloff, 10 yr +19 bps. Oct 2018: SPX 9% selloff, 10 yr -13 bps. May 2019: SPX 7% selloff, 10 yr -40 bps. Aug 2019: SPX 6% selloff, 10 yr -40 bps.
As you can see, the 2019 market is seeing the bond market strengthen considerably when there is equity market weakness. If that continues, that will make a big selloff very unlikely. But there is good news for the stock market bears: Bunds are trading at -0.56%, 16 bps lower than the current deposit rate. There is very little upside left for Bunds, if you consider that the ECB with an overnight rate of -0.40%, can probably only cut another 40 bps and then will start facing the barrier of alternatives to cash storage in vaults rather than in a bank account if banks start passing on the costs to customers.
Without the Bunds rallying, the Treasuries are on their own, and that requires a weaker US economy with recessionary signs. And strong recessionary signs is a much stricter condition than equity market weakness. So without explicit signs of an impending recession, the days of don't ask, don't tell bond rallies are mostly behind us. That makes the stock market more vulnerable to a big selloff going forward.
Like the first several months of 2015, selloffs are likely to be more frequent but less severe, as the weak global economy keeps equity investors from becoming too optimistic, which keeps the upside limited, at the same time, making the market less likely to selloff a lot, because of the more defensive positioning.

Shock Market

These are not your old fashioned markets.  There is very little short term money controlled by human discretionary managers.  The short term money is now mostly quant strategies or simple CTA models.  Stock mutual funds are fading away into the sunset, as that is what the baby boomer generation grew up on, and now its either bond funds or equity ETFs. 

Bond funds don't move the market, and equity ETFs aren't really a factor either.  What moves the markets in the short term are hyperactive quant strategies and CTAs, which go from leveraged long to leveraged short within days.  What happened in the stock market post FOMC meeting and post Trump tariff announcement was mostly quants and CTAs going bananas, all going from big net long exposure to neutral and probably now to net short exposure.  It doesn't take them long, and they are not price sensitive.  They are trend sensitive, and don't want to be caught on the wrong side of the trend, even if its for only a few days. 

We are seeing a repeat of August 2015, February 2018, October 2018, and May 2019 (mini version).  It is no coincidence that these shock drops in the stock market are happening more frequently.  It is rooted in the trend of quant based strategies which encourage overshoots on the way up and on the way down.  On the way up, the market grinds higher, longer than most humans expect, and then without many clues, suddenly plunge as the fundamentals don't support prices and the process repeats. 

One of these days, the trend will stay down and keep going lower beyond comprehension.  It nearly happened in December 2018, except for Powell throwing in the towel and going super dovish.  Next time, that won't be enough.  The stock market will demand faster and bigger rate cuts, and eventually QE4.  It is not as far away as it seems, another repeat of December 2018, which is likely within the next 12 months, will be enough to force the Fed's hand, and the bond market will price in ZIRP and eventually expect QE4. 

The Fed is no longer an independent institution.  It is controlled not by the President, but by the financial markets, which have veto power over their actions.  If they don't get what they want, all hell will break loose.  December 2018 was a perfect example.  Powell is well on his way to being totally neutered by the markets.  He tried to resist at first, wanting to run wild, and sow his oats.  But the market won't let that happen.  The market is a stern teacher, not just towards traders, but towards Fed chairmen.  It wants easy money.  The market is the veterinarian and Powell is the dog.  The veterinarian will win all the time. 

It doesn't matter who the Fed chairman is anymore.  In this new age, the chairman of the Federal Reserve is the SPX and the Treasury market.  And that's not going to change anytime soon. 

Well, that escalated quickly.  From SPX 3020, to SPX 2960, to SPX 2920, to SPX 2780.  All in 4 trading days. 

Don't blame Trump.  The market was vulnerable to any little shock to the system and was ready to blow.  The global markets and the US stock market breadth gave you those warning signs.  And it is blowing up.  This is not because of a trade war.  This is because there is no earnings growth.  That is not due to a trade war, but because of late cycle dynamics of higher wages, slowing growth, and market saturation.  The easy excuse is to blame Trump and his tariffs.  That is meaningless in the grand scheme of things.  10% of $300B is $30B a year, that's literally pennies now in this money bloated financial world. 

No, its not the tariffs.  The problem is the underlying fundamentals of no earnings growth, grossly high valuations, and pitiful amounts of potential monetary stimulus available with these already low interest rates.  And 2020 will be a horror show if the economy weakens and nails the coffin in killing Trump's chances of winning reelection.  A Democrat president would be this market's worst nightmare, as the threat of tax increases and a breakup of the tech giants would be a monster 1-2 blow.  That isn't on anybody's radar now, but it will be all the market will be thinking about in 2020. 

The strategy is to add to shorts on bounces, and wait for a move down to 2720 to cover all. 

Hunger Games

These are the type of markets where you can't even go out for lunch, for fear of missing a huge move.  Literally having to stay hungry to trade the action.  And there is a lot of action now, you can always tell when the DOM thins out and the algos pull bids and offers at the hint of iceberg orders or size coming into the market.  That also goes for the ES overnight market as well. 

It was a classic overnight session, as Thursday night is the official Fright Night for SPX, as equity traders hate to go long over the weekend when markets are weak, and sell out early ahead of the weekend.  As much as the patterns are more random and less influenced by human traders, at the end of the day, the risk managers are all human, and the tendency is to avoid taking on risk exposure when volatility goes up and markets are weakening.  That means selling stocks. 

When the VIX jumps like it has over the past 2 days, usually the stock weakness lasts another 2-3 days at minimum, before the first significant rally attempt.  That means I don't expect much upside from current levels (2945) until next Wednesday.  The downside will probably somewhat limited for the next few days also, as I see support coming at 2920, near the tops from last October, and area of short term support in late June, and 2890, the top of the range during the volatile trade, post Trump tariff announcement in May. 

Powell is no Bernanke

Jerome Powell is a lot more easily influenced by Fed media coverage than either Bernanke or Yellen.  How often did you see Bazooka Ben and Yellen backtrack on their statements because they were too hawkish to please the markets?  They rarely had to.  Bernanke was just an over the top dove and a horrible Fed chairman, so he never had to take back his words.  After all, market participants only complain if the Fed causes the markets to go down by being too hawkish.  Being too dovish is ignored, just water passing under the bridge.  Yellen made one miscue about timing of Fed rate hikes at the beginning of her term, the media complained, and after that, she took the easy way out and became overly dovish, pleasing the markets by dragging out the beginning of the rate hiking cycle way too long. 

On the other hand, Jerome Powell actually seems to try to tamp down the animal spirits from time to time.  And market watchers hate it, because it causes the markets to go down.  Yesterday was one of those times he tried to pull back the punch bowl.  They call it miscommunication.  No, its not miscommunication.  Its idiots who still think that all Fed chairman are supposed to be like Bernanke and are surprised and disappointed when they don't get everything they want and more. 

Bernanke would ALWAYS promise lots of goodies and then overdeliver!  So it led to some inane monetary policy decisions, like QE2 and QE3, with the length and amounts of bond purchases for QE2 longer and bigger than the market expected.  Same with QE3.  He was a knucklehead who was scared of his own shadow, who saw a Great Depression around every corner. 

Bernanke's 8 year reign of free money distorted Wall Street expectations of what the Fed would do during its meetings.  That's why the Eurodollars were so grossly overpriced during Yellen's reign in 2016 and 2017, because the markets just didn't expect the Fed to come through with the rate hikes because it always kicked the can under Bernanke, and under Yellen, she delayed hikes at the slightest bit of market turbulence, (even a 5% correction in the SPX would stop them in their tracks! (March 2015). 

When Powell came on in 2018, he sent a strong message to Wall Street, and it was often ignored.  He would talk up the economy, calling it solid, pushing in rate hikes and continuing QT as promised even when the markets had a tantrum a few weeks prior (Tantrum: February 2018, hike: March 2018.   Tantrum: April 2018, hike: June 2018, Tantrum: October-November 2018, hike: December 2018).  He was the first Fed chairman since Volcker who actually followed through on his rate hiking plans and didn't water it down or slow it down, due to market weakness. 

So when he finally relented to the pressure and admitted that he got too hawkish and the market got too weak, the stock market celebrated by going up in straight line for 4 straight months! 

With backwards looking economic data showing strength in July, Powell was running out of good excuses to cut, so it showed in his press conference.  He was stammering to find the right words to match his actions, because he was basically cutting rates because the financial markets put a gun to his head and forced him to. 

Unlike the super doves that preceded him, he has a conscience, and is affected by the media criticism of the Fed bowing down to Trump, being servants to the stock market, not being data dependent anymore, etc.  And there was a lot of critics of his dovish words and his rate cut hints even though nonfarm payrolls came in strong and the SPX was at an all time high.  The media pressure got to him, and he didn't want to sound too dovish.  Now the media will criticize him for miscommunicating his policies, which is another way of saying you caused the stock market to go down. 

The financial media is a joke, and can't be taken too seriously.  It talks out of both sides of its mouth.  What we have found out though is that if the SPX keeps going down, eventually Powell will relent and signal more rate cuts.  The stock and bond market has an iron grip on his balls.  If he's too hawkish, they will squeeze hard, and only let go until he turns dovish again. 

The SPX is in a vulnerable place, what Powell said yesterday wasn't even newsworthy in my opinion, but with great expectations come disappointment.  And yesterday's price action is what happens when markets are disappointed.  I expect the disappointment to last a few days before the next rally attempt.  In any case, I am more interested in adding to my short position on the next rally attempt.  Yesterday was just a sneak preview of bigger things to come in September and October.