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.