Wuhan Coronavirus Paradox

They say that its not the news that's important for a stock, its the stock's reaction to the news.  Similarly, its not the news that's important to the stock market, its the global central banks' reaction to the news that's important.  And the market is making the high probability bet that this coronavirus scare will make the central banks more dovish even with stock indexes in the US near 52 week highs. 

Reduction in consumer spending due to the Wuhan coronavirus will be short term and temporary, eventually leading to a bounce back of stronger consumer spending in the future.  But any easing that central banks do in the short term will last way beyond any short term economic weakness, providing a lasting boost to the stock market.  When the Fed cuts rates due to a short term economic hit, they don't raise rates when the economy recovers.  They usually wait many many months and even a few years before they normalize rates back to where they were before the short term economic downturn. 

Just like the flu and SARS, the virus is at its peak when people's immune system is at its weakest, during the winter.  So when the weather gets warmer, beginning around April and May, the number of new cases will probably go back down.  And that's all it will take for people to believe that the worst is over, and then it will be back to business as usual. 

As bad economic news is good news for the stock market in recent years, this will also make yields go lower, which delays the big stock market crash, because as I've mentioned many times before, a big selloff in the bond market is usually what is needed before you get a big selloff in the stock market.  The coronavirus will delay the bond market selloff. 

So the top for this stock market will have to wait, and even though it seems like Bernie Sanders has a very strong shot at winning the Democratic nomination, the market is distracted by this latest topic so it probably won't focus on the 2020 election at least for another month when the primary season gets much busier. 

Short term, the market is still vulnerable because of the parabolic nature of the rally, but with the way the bond market is trading, going up relentlessly, I just don't see a sustained selloff here, perhaps it could get down to as low as 3200 if traders really panic, but that will be quickly bought up and the uptrend probably continues because the Fed has your back, without a doubt now, because of this coronavirus.  Which is in an odd way, providing protection for the stock market via a easily scared Fed. 

Too Early = Wrong

Getting short earlier this month was way too early, so I was wrong.  But I am not giving up on the short side as the overbought extremes get bigger and the action in the hot tech names (TSLA, AAPL, MSFT, etc.) keep the market going higher while the small caps continue to lag behind.  This is reminiscent of the 1999/2000 tech bubble when the big caps and high growth names vastly outperformed everything else.  The big difference this time is the Fed is in an easing cycle, while it was in a hiking cycle in 1999/2000.  That makes this bubble more resilient than the one in 1999/2000. 

1970-1973 was another period where you had a small group of large cap high growth stocks (Nifty Fifty) leading the indices higher.  That also ended badly with a brutal bear market in 1973/1974. 

Unlike 1973 and 2000, the Fed is on the same side as the stock investors and speculators, making it that much harder to top out and transition to a bearish market.  The bond proxy names like utilities are also on fire, along with the high beta tech names, as bonds have remained strong.  So its not just the high beta stocks, but also the safety stocks that are outperforming here.  That's like an extra shield of armor this stock market has protecting it from any selloffs. 

That is why I've been keeping such a close eye on the stock/bond relationship over the past several weeks.  While the SPX keeps making new all time highs almost every day, the bond market has refused to selloff, and since the start of 2020, has managed to rally along with stocks, reliving the 2019 playbook of risk parity heaven, as stocks and bonds both went up strongly. 

The first sign of bond weakness will be the warning sign that the top is close.  We've yet to see that during this relentless rally.  There seems to be a lot of complacency not just in the stock market, but also in the bond market, as we haven't had a simultaneous nasty selloff in both markets since 2018. 

The strength in bonds has given me less conviction that there is an immediate sharp selloff, but it doesn't take away from my longer term bearishness based on overvaluation, lack of earnings growth, and a potential huge negative catalyst in the Democratic primary and later on the November election. 

Lastly, I know the latest news headline is the China coronavirus and fears of a pandemic.  I am sure if it gets really bad, China will do its best to cover up the severity of the problem so you probably won't know about it for several weeks.  There is a very small probability that if it starts spreading everywhere, you will get a big fear based selloff, focused on Asia, but the US trades like its an island unto itself anyway so in that scenario, I don't think it has lasting effects, it will just be a big dip that gets bought up. 
Most likely, this coronavirus gets less prevalent and is forgotten in a few weeks.

Start of Year Inflows vs. Lack of Buybacks

From the trading in the first 3 days of the year, the heavy buying at the cash open and the cash close hints at massive fund inflows into equities, and the strong bid under Treasuries during the first 3 days points to overflowing liquidity at the banks after getting past the end of year as well as beginning of year bond inflows. 

It is clear that the phase 1 trade deal has pulled in a lot of money into equities, with the Dec. 13-19 2019 week being the largest weekly ETF inflow on record, with massive inflows into a couple of ETFs that I've never heard of, IVE and IVW. 

Also, the past week covering the first 2 trading days of the year also had big inflows (Dec. 30-Jan 3, 2020): 

After investors were reluctant to put money into equity funds for most of 2019, by December, it was a turning into a flood of money going into equity ETFs, breaking all time inflow records.  But the liquidity coming from the corporate buyer will be low for January, as this is a very slow buyback month, with the buyback blackout period in effect for most companies till late January. 

As everyone knows, the headline these days is on Iran, and possible retaliation after the US strikes.  I wouldn't get too excited about a US/Iran military conflict causing a big selloff.  I have yet to see a war cause a sustained selloff in the stock market.  And even if there was one, its such a lopsided match that it would be like the Gulf War all over again if things did escalate.  I don't see consumer or business spending being affected in that case, and the extra government spending to fund the war would be like a stimulus package for defense companies. 

All the Iran news did was take attention away from the Democratic primaries starting in February.  So if anything, it has probably delayed the selloff that I am looking for by a few days.  Still bearish, and the US/Iran news has no effect on my market views.  Still expecting a selloff in mid to late January, with a price target for the SPX roughly around 3100-3150. 

Bull Hunting

I have been eyeing the short side since the phase 1 trade deal was confirmed in mid December.  I didn't want to jump the gun because of the seasonally bullish late December period, so I decided that if the SPX was at all time highs on December 31, I would short.  It didn't happen, but the equity fund flows coming in at the first day of the year have boosted prices to levels where I feel comfortable shorting. 

I have started the short SPX campaign this morning, putting on about half my position.  I will wait either for tomorrow or early next week to put on the other half, preferably on a good ISM index number coming out.  The time frame on the short is 3-4 weeks, looking for lower prices as the Democratic primary in Iowa gets closer (February 3).  Market doesn't like uncertainty, and right now, its a neck and neck for the lead in Iowa, with Buttigieg, Sanders, Biden, and Warren all between 10-25% in the polls.  

As we get closer to February 3, stock prices should get lower as the focus is on potential bad outcomes with a Sanders or Warren win in Iowa.  

A longer term short (3 months +) will have to wait, as we'll probably see a reflexive rally after the first major pullback from the big surge from October to December, so this short is to play January weakness ahead of the Democratic primaries, with stock buyback flows very weak as corporations are in blackout period and traditionally don't buyback much stock during this month.