Risk Storm

This what panic feels like.  This is worse than February 2018.  This is worse than August 2015.  This is almost as bad as August 2011.  I don't mention December 2018 because that was not a shock waterfall decline, this is.  When you go from low volatility to high volatility, that is what gets you.   It is the train that you don't see coming that runs you over.  When you expect a lot of trains to come by, then you are more careful and less likely to take big risks and get run over. 

I definitely didn't see this big of a move coming.  These waterfall declines are always low probability events.  And usually proceeded by a couple of months of volatile price action.  In 1987, the SPX topped out in late August, and crashed in middle of October.   In 2011, the SPX topped out in early May, and crashed in early August.  In 2015, the SPX topped out in middle of May, and crashed in late August.  All 3 of those waterfall declines were accompanied by tops that involved rising bond yields. 

Same with the waterfall decline in February 2018, which also topped the previous month with rising bond yields in January 2018. 

This time, we had steadily falling bond yields as the SPX made an all time high, and then crashed, which makes it unlike anything anything we've seen over the last 40 years. 

The only way to make sense of the price action is based on the complacent market environment and the massive overvaluation which left it vulnerable to investors panicking during a decline.  But even in similar overvalued markets like 2000, you didn't have this kind of a shocking drop in the SPX. 

Now it is about trading levels here, and as I write, the SPX is trading at 2928 overnight, leaving it in no man's land.  There should be some support around the SPX 2820 level, which is the low in August 2019, and if we somehow go beyond that, then we are talking about the June 2019 lows at 2730.  With this kind of volatility and the likely forced selling that it will precipitate if we go lower, you cannot rule out those kind of moves. 

So if you are looking to play for a bounce, know that you can face a big drawdown before this market bottoms.  But when it does bottom, it will be explosive. 

As it is a Friday, and with weekend coronavirus headlines lurking, the panic will be thick when the US market opens.  I will be looking to buy any panicky dips down towards the 2820-2840 level if they happen today, and if not, I will just wait.  And an  incomplete flush lower today would leave this panicky market vulnerable to a panicky Monday. 

I won't go into the coronavirus as you've got a million newly minted virus experts opining their opinions on pandemic possibilities and macroeconomic effects, but my opinion is that the market wouldn't be trading like this even with bad coronavirus news if traders weren't so bullish after the trade deal late last year and flowing into the new year. 

It is tempting to try to catch the bottom but when things get this volatile, a lot of forced sellling usually comes out so buying early can be painful.  For leveraged traders, its better to miss out on some upside or even miss the bottom completely waiting for great low risk entries rather than put your account at risk of a big blowup chasing the bottom here. 

Coronavirus and Fed/Bond Backstop

The market is now paying attention with a bunch of coronavirus infections coming out of nowhere in Italy.  The markets pay attention when things hit Europe.  Asia is still a minor player in global finance, just look at the ES and ZN overnight volume during a Globex session, with Asia being quiet and Europe being much more active. 

It is now abundantly clear that the number of coronavirus cases in China are being vastly underreported, probably by a factor of 10, so it wouldn't be shocking that 1 million Chinese are infected, as this virus seems quite contagious, even more than the flu.  In the worst case scenario, which is a global pandemic, you will have a monster central bank response which would contain the downside to 15-20% lower from here.  That is still a big move down, but not a deep bear market like 2000-2002 or 2007-2009 type of move lower. 

These quantum moves, stair step down are symptoms of an overly complacent market that has been ignoring earnings fundamentals and has just squeezed higher on momentum and a select few group of loved stocks, ironically, both high growth (tech), and highly defensive (utilities).  Historically over the last 30 years, you have not had a big move down in 10 year yields leading a big move down in stocks.  You have had a plenty of times when big moves up in 10 year yields led a big move down in stocks (1987, 1990, 2000, 2007, 2011, 2015, 2018). 

That doesn't mean you can't have a 5-7% pullback in stocks while bond yields are trending lower and lower, like May/August 2019, or October/December 2014, January 2015.  It just would be nearly unprecedented for the bond market to be so strong ahead of a waterfall decline of greater than 10%. 

It makes me less bearish here despite the complacency among US stock investors and the speculative fever in some of these growth names like TSLA and SPCE.  The Fed backstop is a huge factor in containing stock market downside, and the coronavirus is a convenient excuse for central banks to lower rates and expand QE programs.  With US rates still well above zero, there is still a fair amount of monetary ammunition that the Fed can deploy on a bigger panic due to the coronavirus.  The bond market is obviously sniffing this out and running ahead of the Fed in building up rate cut expectations, which the Fed almost always has to meet, and if they don't, another Dec 2018 like tantrum will happen.  And Powell doesn't want to deal with that again. 

Expecting SPX 3200 to be a support zone where it is probably worth a small BTFD play in SPX. 

SPX = 1996 Chicago Bulls

The parabolic rally continues.  The S&P 500 acts like the 1996 Chicago Bulls, crushing all opponents in its way.  The coronavirus just added more monetary fuel to the fire, and has probably extended the bubble by a few more months.  This time, the crowd has it right in regards to the coronavirus.  They aren't buying it as a sustained negative, unlike the fearmongers out there who will always find a boogey man under the bed (U.S./China trade and repo in 2019, coronavirus in 2020) to get negative.  The coronavirus is a net positive, because it is mostly contained to China, and has prevented global central banks from doing any kind of tightening and instead has increased the odds of more easing this year. 

That is why you are seeing 10 year yields near the lows of last year, as bonds rally with stocks and only the industrial commodities have been sacrificed at the altar of the market gods, a pittance compared to the stock and bond markets. 

Just as it has been since the Greenspan bubble days, the financial markets are under control of the Fed, who got scared stiff in 2019 and the coronavirus is another excuse for them to probably ease again this year.  Without a coming recession, Fed rate cuts are usually a market positive, because the market is getting both lower rates and while maintaining earnings.  That is the type of market environment, a dovish Fed with steady earnings that feeds the animal spirits and blows bubbles.  Yes, the valuations are getting to ridiculous levels but until the bond market starts showing weakness, there is nothing for the equity bulls to be afraid of. 

Eventually these kind of parabolic moves with excessive stock valuations end badly.  But leveraged traders can't take a lot of heat so the timing has to be right in order to profit.  With the Fed ignoring financial stability risks of a growing stock market bubble, things can continue to get even frothier before things fall apart. 

Based on backtests since the Fed started QE, the best predictive tool for the SPX is 10 year Treasury yields.  Treasury yields rising over a 3 month period have been a leading indicator of future SPX weakness.  We are nowhere close to that scenario now.  That is why I wait, even if the uptrend seems irrational and unsustainable. 

Exasperation

I am sure I am not the only one who is surprised by the rocket ship that the SPX has been this week.  I expected a bounce after Friday's massacre, but only to last week's highs, not to all time highs.  I am seeing some similarities between 2014-2015 and the current period starting from last summer.  I remember there was quite a bit of optimism in early December 2014 after the V bottom off the Ebola/growth scare in October, and plunging crude oil prices.   It ended up being near the top of the SPX (price wise, not time wise), and you had a lot of chop and flattish trading from December 2014 to August 2015 before the massive waterfall crash.  I could see a similar situation here, just like late 2014, with bond yields are stubbornly staying low and trending lower despite a relentlessly rising SPX. 

I see very little upside in the markets now with Presidential election uncertainty looming over the market and with an overvalued and overbought market.  I see plentiful opportunities on the short side this year as any new all time highs this year will be met with lots of selling due to the potential news bombs later in the year, with Bernie Sanders being the biggest one.  Right now, most are assuming that Trump will beat Sanders but most polls about a potential match up between the two have Bernie leading by about 5%.

It looks like Biden is slipping lower and lower, as his rallying cry about electability and having the best shot at beating Trump goes counter to the lack of enthusiasm most independents and Democrats have about the candidate himself. 

The best case scenario for the market was a Biden vs Trump election in November, because both candidates are Wall Street friendly and unlikely to try to raise taxes.  A Sanders vs Trump election is a heads/tails situation, Sanders you lose money, Trump you make money outcome.  A Bernie Sanders win by itself isn't so bad, as long as the Republicans maintain 51 seats in the Senate.  But Presidential election history shows that Congressional races usually have similar results to the Presidential race.  So a Sanders win would probably mean Democrats have gained seats in the Senate, giving them a possible 50+ seats which is enough with the VP tie breaker vote to pass the socialist legislation that Sanders wants. 

But right now, it is clear that the markets are not focused yet on the election, since it is so far away and because most believe that Trump would beat Sanders and would only really be challenged by Biden, who himself would be market friendly.  So complacency all round on Wall Street these days but that usually doesn't last for long with these kinds of overvaluation and parabolic charts. 

Lastly, on the stock of the year, TSLA, it is a great trading stock, with wild moves in both directions now that it hit a blowoff top this week.  It will probably consolidate its gains for the next few weeks but I expect another surge higher making it go past 1000 with ease.  I would rather be a buyer of dips on TSLA than shorting any rallies.  It is still in the parabolic up phase in my opinion.  There isn't enough supply of big market cap momentum growth stocks like TSLA to satiate the demand coming from both institutions and retail.  This isn't like previous bubbles like TLRY or BYND, TSLA has a better story and more of an institutional and cult following.  The bubble will probably last a few more months.