2600+ Sell Zone

"Nature abhors a vacuum."

The market also hates a vacuum. From November 2016 to January 2018, the market took a straight line with almost no dips from 2200 to 2700. Since then, there has been very little volume traded between 2200 and 2600. Now is the time to fill the hole.

And it is happening in an environment of discomfort, as most of the holders of equities are in some level of pain. When investors and traders are in pain, they make more mistakes than when they are comfortable. That is why I've always considered bear markets VIP (Volatility Increases Predictability) markets. For most investors, it is starting to get stressful, but there are still many that are in denial of what is happening, expecting (hoping?) for a quick recovery in the second half, believing that the coronavirus is just a short term blip.

This virus is a monster.  A Chinese lab created monster.  No wonder it lasts so long in the human body, and passes to other without symptoms.  And is selectively deadly, wrecking the body's immune system, causing cytokine storms and ruining a lot of people's lungs permanently even when they survive it.  Those knuckleheads who think its just like the flu are probably the ones who are spreading it to others without even knowing it. 

All you need to look at is crude oil to see how much the economy has been wrecked by this pandemic.  And to those who say that its because governments have been too careful and gone to unnecessary lockdowns, the alternative is much worse.  Blatant neglect would lead to catastrophic numbers of cases and hospital visits, with hospitals filled beyond capacity, having to turn away coronavirus patients.  That case would force all but the hardest headed corporations to force their workers to stay at home, and work from there, if possible.

So no, lockdowns are not a cure that is worse than the disease.  Neglect and hoping it goes away is the worst strategy, and it is something that many governments tried before giving up when the number of cases started to skyrocket and hospitals became swamped with virus patients.

Let's not forget that just 5 short weeks ago, the SPX was trading at 3390, with rampant speculation in stocks like TSLA and SPCE.  It was a full blown bubble.  So you can't compare this to 2008 in that sense, because in 2008, stocks were already in a downtrend and valuations had come down to reasonable levels.  That is not the current situation.  Valuations do not support the current treacherous environment where many firms will be on life support unless the government gives direct cash injections.  And while that may happen, it is no guarantee.  And usually the conditions for receiving government cash are not favorable for the current shareholders.

We have rallied for 5 trading days since last Monday's bottom.  That is usually the extent of the oversold bounce before you get another sell wave come up.  With month end rebalance of pension funds ending today, the demand for stocks should drop starting in April.  I am a seller here. 

On the Fed QE

In an era where trillion dollars get thrown around like its no big deal, people are not focused enough on how enormous this Fed QE is.  The daily rate of $125B on Treasury/MBS purchases is almost twice as big as the monthly rate of QE during QE2 and QE3.  So on a daily basis, the Fed is currently buying 30 times more than past QE operations.   No wonder bonds refuse to go down this week as stocks rallied and pensions rebalanced out of bonds and into stocks.  The Fed is now the axe in Treasury market, dominating the money flows.
I vastly overestimated Powell.  Not to put it too bluntly, but Powell is a pussy.  He has no balls.  And no tact.  What he is doing now is 30 times worse than what Bernanke did.  Monetizing the debt is short term thinking and passing on the pain into the future.  Debasing the currency to try to drive long term interest rates from 1% to a few basis points doesn’t improve the economy.  It just breaks away bit by bit, the world’s confidence in the dollar as a reserve currency.  No one wants to hold dollars if its value is rapidly depreciating against real assets.

What Powell is doing not only a dereliction of duty, and a violation of the Fed charter, he’s speeding up the demise of the US dollar as the reserve currency.

The coronavirus, while a very deflationary force in the medium term, will not be an economic deterrant forever.  It will fade away, either through a vaccine or worst case scenario, global herd immunity.  Once its effects on the economy go away, what are you left with?  A bunch of junk on Fed’s balance sheet or hidden in SPVs at the Treasury.  And this is not like TARP.  Back then, the Fed actually had a lot of room to lower medium to long term rates through QE and ZIRP, thus providing plenty of monetary stimulus.  Now even the 30 year yield is barely above 1%.  Unless the Fed decides to go negative, which would only hasten the dollar’s demise, they are almost out of room to drive rates lower.

Last time the Fed did QE, rampant inflation didn’t show up because the budget deficit declined steadily after 2010 until 2016.  Trump changed all that, and his tax cuts along with increased government spending blew a huge deficit during an economic expansion.  One thing politicians have realized is that voters don’t really care about the deficit, but they do care about taxes.  So taxes have been cut while spending has increased.   That's why it was so easy for Congress to pass a 2.2 trillion dollar fiscal stimulus bill.  People don’t care about the deficit because there have been no negative consequences so far from it.  Dollarization of world trade has assured of there being a constant source of demand for dollars.

But the US is taking its reserve currency status for granted.  It takes a lot for the world to move on from the dollar to another currency but actively debasing the currency is the first step in losing that trust.  There is a reason that the world went on a gold standard and stayed under it for so long.  Inflation was devastating many times throughout history, so the only way governments could gain trust in their currency was to back it with something that couldn’t be printed and had a finite and limited supply.

If the Fed doesn’t retract all its excess money printing and rapidly shrink its balance sheet after the coronavirus recession is over, they are opening the door to  government abuse of deficit spending having no consequences on interest rates, and thus high inflation.  This time is not like the Obama years.  Deficits really don’t  matter now.  The way inflation blossoms is not just through debt monetization, its through massive debt issuance + monetization.  We will have both ingredients in the future.  Plus reduced globalization which was a deflationary force in the developed world.  That is an inflation powder keg waiting to be lit.  Inflation will be coming in the next expansion, and with force.

SPX 2200 to 2600

Rough range estimate for the next month for SPX 2200-2650.  That means the middle of the range is 2425.  Right now, as I am writing, the SPX future are trading 2525.  It above the middle of the range.  As a rough rule, don't do anything in the middle, and sell 2550-2650, and buy 2200-2300 for the next 30 days.  It is not common to see a huge rally like we did yesterday, and then straight gap down 100 SPX points.  That is a new normal.  Buying rallies at the close are being punished the next morning like I nothing I have ever seen in my lifetime in trading. 

These are vicious bearish markets, and there is no positive catalyst now, with the fiscal pork stimulus behind us, and another one won't be arriving for at least another couple of months.  The only real positive I see is the dollar weaker this week, which is a sign that the rush for cash is mostly over.  Now its just a burnt down stock market with bottom pickers looking over the rubble for "bargains".  One month after a generational top in the stock market doesn't usually generate a "bargain". 

The huge bear market rallies will shake the convictions of the bears, and will excite the bulls, but its the crack cocaine of trading.  Sure the high is great, but it doesn't last.  This bear market rally didn't even last 3 days, before gapping down 100 SPX points!  That's almost 4%!  Before the cash market even opens.  Wild. 

This week has sucked in a lot of traders into the bullish side, calling bottom, and trying to play for a rally.  They are the ones that are puking it out early today, and its a warning for the next month:  don't chase strength, because it will come back down in a hurry.

The most bullish thing I see now is bonds rallying huge and not selling off even during the equity market rally the past 3 days.  But that bullish factor pales in comparison to the economic realities that most investors are still too complacent about.  A government stimulus program doesn't replace the economy.  The hopes are too high for all this stimulus, as if its a magic elixir that will paper over most of the economy's problems.  Don't buy it.  The damage is a lot deeper and long lasting than most believe.  It will play out all throughout the year, and that will present a lot of opportunities on the short side, and a few on the long side.  After the 3 day rally, its bear time coming up. 

Pork Barrel Rally

We are getting that big oversold bounce which many have been waiting for.  From an overnight low of 2174 on Monday to an overnight high of 2498 on Wednesday.  324 point range in 2 days, which is 15%.  These enormous moves are coming as the  economic realities collide with  monetary and fiscal stimulus to create confusion among investors.  Wow, did Congress put in a lot of pork in that bill, and $500B of an opaque slush fund for who knows what. 


With the $2 trillion pork barrel fiscal stimulus package out of the way, it is actually safer now to sell short, because one of the biggest positive catalysts is in the rear view mirror.  Sure, there will be more fiscal stimulus, but its going to take at least another few weeks before that happens.  That gives bears a lot of runway to run wild in this market.  The fundamentals have deteriorated much more than investors believe.  The consensus that I hear is that the coronavirus economic shock will last 2 quarters and then GDP growth will go up huge as the pent up demand drives the economy later this year. 

I disagree with that consensus.  I don't believe the pent up demand will be all that great, sure, there will be more savings built up this year as consumers aren't spending, and that is a source of potential growth, but a lot of that will be used to pay down debt.  And that savings is likely to be used much later than people think. 

If I had to choose an academic to trade, the last group I would pick would be the economists.  One of the first I would choose would be the psychologists.  Because a lot of what moves the stock market and the economy is psychology.  If you see how much of a panic a large portion of the population is in right now, you will understand that they will not be quick to spend their savings when they've just been laid off or had their businesses closed.  Sure, eventually they will get back to normal spending habits, but it will take a lot longer than 6 months, more like 18-24 months based on previous recessions, and this is much more severe than any we've had before, so it will likely take even longer. 

Another thing investors are overlooking amidst all the money printing and fiscal stimulus is the valuations of US stocks.  Stocks are not cheap.  We are in the midst of the worst economy in 90 years and the market is still priced as if things will get right back to normal.  

I am reading a lot of articles and comments on Twitter about how this is a generational buying opportunity.  I don't know if I am the one who is taking crazy pills, but the Price to Book and Price to Sales ratios are higher than they were from anywhere between 2008 and 2013.  So for a full 5 years, valuations were lower than they are now.  Recency bias with the massive overvaluation post Trump tax cuts skews peoples' perceptions of value.  And I don't buy that because Treasury yields are lower, valuations should be much higher.  If that was the case, Europe and Japan should be the most expensive markets in the world. 

I would urge caution buying after rallies, I don't see a sustained bounce until we see more capitulation.  Just not seeing it right now. 

Fed Banana Hammer

Here it comes again, another Fed money printing operation to try to save the stock market and suppress interest rates.  After failing to pump up the futures in the previous 2 announcements, the Fed has just stopped pretending that they are putting  limits to their money printing and have signaled unlimited QE. 

Anytime time you use the words unlimited when its comes to printing money to buy bonds, that will catch the attention of stock investors.  Fed will even buy asset backed bonds backed by worse than junk student loans.  The Fed's balance sheet has gone from taking US sovereign risk to taking on credit risk from students, small businesses, and corporations. 

The big banks will have a field day securitizing all kinds of junk student, and small, medium, and large business loans to sell to the Fed at a hefty premium, pocketing the difference, taking their piece out of what will be a steadily depreciating dollar. 

The Fed is getting closer and closer to the day where it will stop pretending like its not Japan and will start doing QQE, buying equity ETFs and perhaps even individual stocks if the US public is dumb enough to give them that kind of political power. 

Those who decry socialism are the ones in charge of getting the US closer to it, as the Fed is making a mockery of the situation, hell bent on printing their way out of a health crisis, paving the way for the US dollar to lose reserve currency status as it becomes more and more of a banana republic. 

There is no going back once you make these precedents.  These programs will be around for a long long time, and more likely than not, be permanent facilities.  Just like when you start a path towards financial repression, it is a trap that is impossible to escape, as the Fed tried for a couple of years raising rates and look what has happened.  Stairways higher when raising rates, elevator plunge lower when cutting rates and implementing QE. 

It is a perverse situation because of the coronavirus, over the next 12 months, demand for commodities will be way down, and that will keep commodity prices in check and it will make it seem as if all the money printing didn't have any adverse effects. 

Expanding money to a whole new group, including students, small businesses, and corporations of all sizes increases the number of potential borrowers by orders of magnitude, which is potentially massively inflationary if not taken back right away when things normalize.  And I have a feeling that once the Fed becomes everyone's sugar daddy, they won't be able to go back to normal and take back the money.

And unlike most economists and market forecasters, I don't believe there will be a strong second half rebound, because I don't think the coronavirus will completely go away and a vaccine, if an effective one is developed, won't be ready for mass production till the middle of next year.  So that is at least 12 months of economic uncertainty.  That will be negative for commodities and stocks.  But in 2021, if an effective vaccine is ready for mass production (likely, but not definite), the pent up demand will boost economic growth for a few quarters, and that's when the inflationary effects of these Fed actions will appear, with a vengeance. 

But that is a while away, something that most of you don't even have to think about because the deflationary effects of this coronavirus are so massive that they will mask the effects of any kind of crazy inflationary monetary and fiscal policies over the next 9-12 months. 

I have been waiting for an ideal time to buy, hopefully into a mini panic, but they don't come around easily when the Fed is in there hammering away trying to prevent full blown panic.  I can only go by levels which I think are low risk entries, long and short, if they don't come, I will have to wait.  It is frustrating to miss your entry levels and then see the market go in the direction that you expected, but that's part of the game. 

I do expect a sell the news reaction to any kind of phase 3 stimulus bill that gets passed in Congress, so I definitely will not be buying ahead of that or right after that event. 

If there is no low risk long entry this week, the next best trade will have to wait a few days, which is to short a pension fund rebalance stock rally at month end. 

Economic Catastrophe

Things are very bad out there.  That is why these rallies are getting sold after just one day.  The stock market extrapolates the current situation and the longer it goes on, the further out it extrapolates.  It's 4 weeks of nonstop selling, and eventually investors adapt, and for one, they don't rally stocks on a Friday afternoon in anticipation of a central bank intervention.  They sell them off on a Friday because they got their heads handed to them the following Monday when they bought the strength on a Friday afternoon. 

I find it laughable when investment analysts think this will be like 2008 for economic growth, trying to factor in a strong rebound in Q3 and Q4 2020.  Unless they are fortune tellers and can tell how prevalent the coronavirus will be in the fall and winter, then they are just making wild guesses.  The number one thing that will stabilize this stock market is not a bigger bailout or bigger Fed QE, but a decision by the federal government to have a month long nationwide lockdown to try to eliminate the coronavirus.  2 weeks is too short.  A month may be too short.  The incubation period can be quite long for this monster of a virus. 

This brings me to a Wall St. psychology chart about where we are in the cycle:  We are definitely past the denial stage, and probably in the middle of the panic stage, but not yet at capitulation.  So getting there, but I would like to see few bottom pickers and more consecutive down days before I feel comfortable going long. 

Its easier to predict a bottom when there is continued selling without rally attempts.  But there continues to be a rally attempt every couple of days, so sustained selling is cut off, making it hard to pick a bottom off a capitulation point.  So we keep getting these one day rallies that give investors hope only to take it away the next day.  I want to see sharp sustained selling for 3 days to really get to a panic point and attractive price levels, but the dip buyers are stubborn and insistent on not missing the V bottom. 

Right now, as I write, the SPX futures are trading 2270, which is near the week's lows, on a Friday.  If we can get a sharp move lower next week, that will open up the door for a strong rally into the end of the month as pension fund rebalances from bonds to stocks will be massive at the end of this month.  From Morgan Stanley:

Now MS are joining GS with the >$150bn of equity buy flow that will happen into month-end. That is on par with what CTAs sold on the way down....Could we get a "crash" on the upside in a massive bear market rally squeeze?

“MS QDS estimates $160bn of global equity needs to be bought and even more fixed income sold for pensions and asset allocators to rebalance portfolios over March month-end. With this flow generally starting roughly 5-days before month end and peaking at the end of the month, it should build by mid next week"

And ideal buy area would be the 2015 highs of SPX 2130 before the August waterfall decline.  There was a lot of resistance in that area.  The market likes to fill a vacuum, and there wasn't much time spent between 2200 and 2600.  I think that will change this year.  

Sunday reopen will be interesting in S&P futures. 

Liquidation Continues

The bond market is revolting at the size of the proposed fiscal stimulus.  Giant moves in the Treasury market, especially the long end, are wreaking havoc with risk parity and relative value funds.  I am hearing rumors, from reliable sources, that a huge hedge fund (one of the biggest) is facing massive redemptions while its performance has been hammered this year.  Also hearing rumors of 2 other hedge funds that are big players in the levered fixed income space that are having to reduce risk levels
0 by huge amounts due to the Volcker rule regulation on VAR targeting.

If SPX futures are lock limit down, one would think that Treasuries would be rallying strongly, but bonds, especially the long end, have been quite weak and it trades like there are funds in bad shape and forced to liquidate their positions.  As I've mentioned before, this type of action happens in the panic phase of a downtrend, which we're clearly still in, considering the lack of sustained buying pressure after an up day.  Investors are using any rallies to get liquid, reduce equity exposure, and hunker down preparing for the worst.

It looks like SPX 2370 wasn't the bottom, because this market trades like it wants to test much lower levels before stabilizing.  With 3 horrible gap down Mondays in a row, investors will be extremely nervous heading into the weekend with all the bad news out there and panic widespread, so I expect more selling for the rest of the week. 

The amount of selling is off the charts, the intensity of this down move is something I've never seen before.  This is more intense selling than October 2008.  I will venture to make a guess which might surprise people but is going to be pretty obvious when you think about all those laid off or not working:  the economy will be weaker than 2008/2009.  Whole sectors of the economy are being annihilated.  That never happened in 2008.  That is not priced in at current SPX levels.  The US market is still richly valued. 

The more I read about the coronavirus, the harder it seems it will be to contain.  About half of those who catch it show no symptoms, but can still pass on the virus to others.  And it is very contagious, and very deadly for the elderly and those with existing medical conditions.  The US is taking too much time to enact a strict virus containment policy.  The US should be following the steps of Italy and Spain and put the whole country under lockdown, only allowed to go outside for groceries, and absolute necessities, health care, or required work.  That is the only way to contain this.  And I doubt that is what the federal government will do until the number of cases has gotten huge and harder to control. 

The bear market rally off the bottom will be explosive, its just seems more likely to happen from lower levels than here, perhaps SPX 2150-2200.  If I miss the bottom, its ok, shorting the bounces is the safer play anyway. 

Rush to Cash

What you saw from Wednesday to Friday was a classic liquidation panic a la October 2008.  There was nowhere to hide being long.  Treasuries, which would usually thrive under a panic risk off scenario, were getting liquidated as a source of funds to raise cash.  That is a sign of extreme stress in the financial markets, when the most liquid safe haven asset gets sold to raise cash.  And not just any cash, but the dollar, as in a normal risk off scenario, the positive carrying currency gets sold (dollar), and the opposite side gets bought (euro).  But in times of extreme stress, where US dollars were needed, the dollar rallied huge off the initial carry currency selling to reverse most of its previous losses.  Crazy times. 

 In fact, as the SPX was melting down from 2880 to 2480 in 2 trading days, 10 year Treasury yields went up from 0.39% to 0.84%.  It was an even bigger bloodbath in 30 year bonds.  Risk parity funds were getting crushed this past week, which is something that has only happened to this degree in October 2008 and February 2018.  And February 2018 was not because of fears of a global recession, but an inflation scare.  So this situation has more similarities to October 2008, when Treasury yields were actually going up during the steepest part of the decline from October 6 to October 10. 

March 2020

October 2008

As you can see from October 6 to October 10, 2008, as the SPX plunged from 1100 to 840, the 30 year Treasury yield actually went up from 3.94% to 4.14%.  Long term Treasuries lost safe haven status in favor of cash. 

For those who are still stuck in BTFD mode and complacent from past shocks like February and December 2018, August 2015, August 2011, they will be in for a big surprise.  Those past shocks were short term financial corrections that had no effect on the US economy.  This will have a huge effect on the US economy.  This is not a market correction.  This is an economic correction that will lead to many credit downgrades, equity dilution among the energy, airline, and travel/leisure segment of the market, and much lower overall SPX earnings due to consumer retrenchment.  QE4, Fed commercial paper funding facilities, or repo injections will not change that.    Neither does the fiscal stimulus that will be coming, barring a giant helicopter drop of money out of Congress, which is doubtful considering the Democrats' reluctance to paper over the problems during an election year in an epidemiological crisis. 

This is not like anything we've seen since 2008, and before that, 2000.  This market is an odd mixture of October 1987, April 2000, and October 2008.  I am still trying to get my head around how the markets will trade for the next several months, and my base case would be something like this: 

After a liquidation Monday, there should be a bounce afterwards, but Monday could get quite ugly so hard to predict levels beforehand.  If it bottoms at 2350-2400, which probably give us an idea of the bottom of the new range, we should chop violently sideways till late March, and then make a push to retest the lows and break them marginally, probably down to 2300 area.  And from there, I expect a strong rally into the summer as the market hopes that the worst is over as coronavirus fatigue sets in.  Then as the market realizes that the economy is not doing as well as it expected, there should be renewed vigorous selling into the fall, and probably new lows for the year in October.  Just a rough guideline for what I project for now, things will of course play out differently.

If the Trump administration doesn't do mass quarantines and nationwide lockdowns no matter how bad it gets, then all bets are off and we could crash even harder. 
 
Getting ahead of myself here, there is still a lot of unknowns out there, but the feeling I get is that most Wall St. forecasters are still not taking down their earnings estimates enough this year.  In many ways, the GDP hit is probably going to be worse than what happened in late 2008/early 2009, just because back then, you didn't have mass sports and event cancellations or widespread travel bans.  The GDP numbers this year will shock people, too many are still in denial.  That is why there is still a lot of opportunity on the short side, after a brief oversold bounce plays out.

P.S. - Noticing the huge plunge in gold and 3-month LIBOR actually higher on the day despite the Fed cutting to zero.  Wow.  There is some serious liquidation going on here, be careful out there.

Angel Falls

This is a monster waterfall decline.  The excesses that have been building up for years through central banks, tax cuts fueled by huge budget buster deficits, and finally investor complacency and exuberance after the US/China phase 1 trade deal are now coming home to roost.

Other than the Nasdaq bubble popping in spring of 2000, there has been nothing like this kind of selloff coming from an all time high.  Even the fall of 1987 had a small downtrend forming before the big waterfall hit.

You cannot compare it to October 2008 because the market was already in a bear market before the steepest decline happened.  And this is much much worse than anything we saw in 2011 or 2015.   The economy will be much weaker than anything we've seen since 2008, and its likely that it will be worse than 2008 because this coronavirus will probably come back even stronger in the fall, if it follows a pattern like H1N1 flu in 2009.  

There will be a playable bounce soon, but with this kind of selling, there could be margin calls waiting to happen and that could push this market even lower than where it normally would bottom.  SPX 2600 was a strong support level in 2018, but it was such a long time ago, it reduces its significance.  Of course there is a lot of psychological support at 2500, and above that, the February 2018 low at 2530.  So there are levels that traders will try to bottom pick here, and eventually one of them will stick for a multiday rally.  But the fundamentals are deteriorating so much and the economic picture is getting gloomier by the day, as the US government delays virus containment strategies in favor of trying to rescue the stock market.  That is a humanitarian disaster waiting to happen.

The plunge you are seeing overnight is the reaction to Trump's stock market saving approach, rather than a virus containment approach, which the stock market would actually prefer because it knows the longer the government delays serious action, the worse it will get for the economy.

For those who don't remember Nasdaq 2000-2002 bear market, it was a brutal one, and one that kept going and going.  SPX in 2020 is shaping up to be similar to Nasdaq in 2000, with a long bull market top forming followed by a sharp waterfall decline.

Right now, we're in a similar point as the middle of April 2000, which means that if this market follows the dotcom bubble path, then we should see a strong bounce within days, and then a retest at a slightly lower low in about 30-40 days.   

This being a Thursday, there is looming weekend risk and I am sure investors will not be looking to chase stocks higher heading into another headline driven weekend coming up.  But we are definitely in the panic capitulation phase now, and those are violent but usually brief.  I expect there to be a strong bounce next week, so the risk/reward is definitely getting more favorable for the bulls. 

Pricing in a Recession

The long feared recession which would make investors bearish is here.  There is no doubt about it.  The coronavirus will plunge the world into a global recession, as reduced consumer spending, job cuts, and reduced production will overwhelm any kind of fiscal response, which is usually a dollar short, and a day late. 

Contrary to what the so-called bond experts believe, the move in Treasuries over the past few days is not irrational, but a swift realization from the most efficient market on Wall Street that a recession is coming, and the Fed is going to zero in a hurry.  The emergency 50 bps rate cut from Powell was a screaming signal that the Fed is panicked and will cut aggressively to zero.  And bond investors remember how long it took for the Fed to go from zero rates to their first rate hike (7 years).  That is one of the reasons the yield curve is not steepening, the bond investors are chasing yield by going out further out on the to 30 years, the only part of the curve yielding above 1%. 

We are pushing forward a bear market due to the coronavirus economic shock, which is going to be in many ways, just as bad as 2008, but instead of financial danger, it is physical danger that people will have to deal with.  And that is something that hasn't happened since the Spanish Flu in 1918.  This coronavirus should be named the Wuhan virus, because it is the Chinese who have probably released the virus from their biological weapons lab, either through human infection or lab animal viral transmission.  Of course, there will be no concrete evidence or news coming out of China to reveal the truth, it will just be assumed that it came from wild animals at some wet market, which is hard to believe. 

Anyway, we finally have headlines and news which are going to more impactful than what Wall Street expects.  That is a rarity in an age of chicken little investors that get frightened by Iranian missles, small tariff hikes, and a little repo rate volatility.  The coronavirus is the real deal, it cannot be overexaggerated enough, because people are underestimating how easily this virus is being transmitted, with many passing it on to other without having symptoms.  It appears that China has gifted the world with a new viral disease that will have to dealt with on a permanent basis, as the characteristics of this virus make it hard to completely eliminate. 

The U.S. government approach of reluctant testing and trying to paper the problem over with tax cut proposals and rate cuts doesn't get to the underlying problem of virus containment.  This presents longer term and more severe economic problems where more draconian measures of quarantine and people staying home will be necessary (like what Italy is doing) to try to contain the spread of the virus. 

The longer governments wait to control the problem, the harder it will be to contain the spread.  This coronavirus economic shock will be long lasting seeing how easily it is spreading and with a lethality about 20 times that of the ordinary flu, which kills plenty of people as it is, even with a vaccine available.  When people stay at home and avoid crowds, stop going to the mall, movies, sporting events, concerts, traveling, etc, that has a huge impact on the velocity of money and the unemployment rate.

Short term, it looks oversold and with the ECB meeting Thursday and FOMC next Wednesday, there will probably be a equity market bounce in the coming days, but I would use that bounce to either get short SPX or long Treasuries, even at these very low yields.  And the only way I would be playing the SPX on the long side is to wait for extreme oversold conditions to buy.  It will be easier to play the short side at least for the next few weeks. 

Stock market investors have forgotten what a real bear market is, expecting this to be quick and easy just like fall 2018 deep correction, or an August 2015-February 2016, or an August-September 2011 correction.  I just don't buy it.  The valuations are too rich, the yields are already too low, providing no risk parity benefits for long bond holders, and the economy will be much weaker than anything you saw in 2011, 2015-2016, or 2019. 

I will be trading with the assumption that we are now in a bear market, and that requires different rules.  It is something that most investors have forgotten or never experienced before, and I am sure will catch a lot of traders off guard in the coming months.   I'll get into that at another time. 

Stairway to the Basement

Jerome Powell pushed the panic button today and he has accelerated the eventual Fed funds ZIRP process.  It was not a matter of if, but when.  Powell decided that this was the right time to push the button, and I don't disagree.  And he probably knows that it isn't going to help much in this situation, as he admitted so in the press conference.  It is obvious for anyone that has any grasp of the magnitude of the economic consequences of consumer and business behavior in coronavirus infected countries how bad the economic data will get over the next 6 months. 

And the U.S. government has decided to be an ostrich, and pretend like the coronavirus is no big deal, with almost no testing, which assures that there will be very few infected numbers.  The CDC has been a cheerleader and have been totally incompetent since the coronavirus first hit the news, have tried to downplay the coronavirus almost as if to protect the stock market. 

This head in the sand approach can be a very short term positive for the market, as there will be less panic near term, as the number of coronavirus cases is kept low with almost no testing, until it blows up, and it can't be hidden from view any longer, when an outbreak occurs, at which point, the market will really panic.  Considering the government response to the situation, and the contagiousness of this virus as seen in other countries, an outbreak seems almost inevitable, and no one will know until hospitals are flooded with virus laden patients.
 In fact, for non-virus infected people, going to the hospital would probably be the most dangerous thing they could do, as it will be a literal virus factory at that point. 

Anyway, back to the markets.  The market is not dumb, which makes it harder than it used to be to make money.  Because it rightly has rallied bonds strongly off this 50 bps emergency cut.  The main benefactor of lower Fed funds rates is not stock investors, its bond investors.  Rate cuts during an epidemiological crisis are basically meaningless.  Isn't it unusual that the country with one of the fewest recorded coronavirus cases is the most aggressively easing?  It tells you how dovish and prone to ease the Fed is, and how reluctant Europe and Japan are to go to even more negative rates, as it is painfully obvious that the European banks can't handle even lower rates. 

The door is now wide open for the Fed to press on the gas, go straight to zero, and if there are any more drops in the stock market, a full blown across the curve QE.  That will obviously be dollar negative, as the rate differential between US and Europe will be about 1/2% and considering Europe's fiscal restraint relative to the US, it makes a euro a safe haven from MMT, where the US is already halfway there to embracing it to solve future problems. 

The volatility is through the roof, yesterday's high low trading range during regular trading hours was 5%, and as I write, there is a nearly 2% gap up mostly based on Biden's Super Tuesday wins.   I was looking to buy any dips today, but with such a big gap up, I will take a pass and wait for better opportunities.
 

Post Waterfall Templates

"History doesn't repeat, but it does rhyme."

Wow, that was a nasty week for the SPX.  Weekly close at 3338 on Friday, Feb. 21, to 2954 on Friday, Feb. 28.  If you look at the chart below, you will  see that a monster bubble popped, because we're back to more stable, but still very high levels for the SPX.  Over the last 4 years, as shown below, you've gone from SPX 2000 to SPX 3390.  That is on top of a move from SPX 1250 to SPX 2000 the previous 4 years preceding 2016.  I would call it the central bank money printing bubble, because bond yields have been going lower and lower the whole time, to an all time low 10 year yield of 1.12% hit on Friday, Feb. 28.

February 2016 - February 2020

We finally hit a level on Friday where there was buying support, as well as Fed support, with Powell issuing an unanticipated Fed statement that he is watching markets and willing to provide appropriate policy (i.e., jawboning rate cuts coming) response to the coronavirus.

We are close to Fed panic levels, which always provides a market backstop and rally on their first move.  For long time SPX futures traders, they will remember the Bernanke Fed emergency discount window rate cut on Friday August 17, 2007 after the panicky drop down to the SPX 1370 on August 16, 2007 (see chart below).  For even longer time SPX futures traders, they will remember January 3, 2001, when Greenspan cut interest rates 50 bps intermeeting and that proved to be the intermediate bottom of the down move and provided a 3 week face ripper rally. 

February 2019 - February 2020

August 2017 - August 2018

 Top:  01/26/2018 = 2872.  Bottom:  02/09/2018 = 2532.  Bounce Retracement Top:  03/13/2018 = 2801.  79% retracement.  Retest of bottom:  04/02/2018 = 2553.  52 days from first bottom. 

March 2015 - March 2016

Top:  07/20/2015 = 2132.  Bottom:  08/24/2015 = 1867.  Bounce Retracement Top:  09/17/2015 = 2020.  58% retracement.  Retest of bottom:  09/29/2015 = 1871.  36 days from first bottom. 

February 2011 - February 2012

Top:  05/02/2011 = 1370.  Bottom:  08/09/2011 = 1101.  Bounce Retracement Top:  08/31/2011 = 1230.  48% retracement.  Retest of bottom:  10/04/2011

 = 1074.  55 days from first bottom. 

November 2009 - November 2010

Top: 04/26/2010 = 1219.  Bottom: 05/25/2010 = 1040.  Bounce Retracement Top:  6/21/2010 = 1131.  51% retracement.  Retest of bottom:  07/11/2010 = 1011.  47 days from first bottom. 

July 2007 - July 2008

Top:  07/19/2007 = 1555.  Bottom: 08/16/2007 = 1370 .  Bounce Retracement Top: 10/11/2007  = 1576.  111% retracement.  Retest of bottom:  NONE.

Local Top:  12/11/2007 = 1511.  Bottom: 01/23/2008 = 1270.  Bounce Retracement Top: 02/01/2008 = 1396.  52% retracement.  Retest of bottom: 03/17/2018 = 1256 .   53 days from first bottom. 

October 1999 - October 2000

Top: 03/10/2000 = 5132 .  Bottom: 04/17/2000 = 3227.  Bounce Retracement Top: 05/01/2000 = 3982 .  40% retracement.  Retest of bottom: 05/24/2000 = 3042 .  37 days from first bottom. 

November 1986 - March 1988

 Top:  08/25/1987 = 337 .  Bottom: 10/20/1987 = 216.  Bounce Retracement Top: 10/21/1987 = 259.  36% retracement.  Retest of bottom: 12/04/1987 = 221 .  45 days from first bottom.  

 After reviewing past waterfall declines in the SPX/NASDAQ since 1987, all 9 cases above, with the exception of August 2007 (not a pure waterfall, but more like a stair step waterfall as it took 3 weeks from top to bottom), after the initial few weeks of choppily bouncing higher, they retested the lows.  And the retests were usually successful, as they either held previous lows, or made just small undercuts of the previous lows and bounced strongly from there.  Most of the retests occurred about 5-7 weeks after the initial low. 

If Friday was the low of this waterfall decline, which is likely but not totally certain, then that gives you a probabilistic road map on how things will play out over the next 3 months.  You should expect choppy trading, with a 40-60% retracement higher of the waterfall decline, before a retest happens, usually 5-8 weeks later.  Assuming SPX hitting a low of 2855 on Friday marking the bottom, then a 40-60% retracement of that low gives a probable top between SPX 3069-3176.  That is a wide range so its probably safer to wait at least 3 weeks to short the SPX, which is around the next FOMC meeting and March futures/options expiration.  That is probably the perfect time for a top to form, as after triple witching expiration is usually a bearish seasonal period.  Then the market should retest the lows sometime in the middle of April.  

There will be lots of trading opportunities over the next 3 months.  Having a guideline for what to expect (lots of choppy action, trending higher into March futures options expiration, and then post FOMC/triple witching hangover and downtrend.   The specter of more bad coronavirus news is what will keep the bounce limited, in my view, and thus out of the 9 cases examined above, I would lean towards a more bearish outcome and weaker bounce than the average post waterfall trade.