Calm Before the Storm

 The volatility is the lowest since March, as the up trend continues and bears throw in the towel.  Fund managers are feeling the heat from being underinvested and have gradually increased their equity exposure.  

 From themarketear: 

 

Aside from a few week in June, equity positioning has been above average.  Also, data that I've seen from Hedge Fund Research has shown hedge fund returns increasingly correlated with SPX since June, meaning their equity exposure is increasing.  

On Friday, we saw signs of upside exhaustion in the Nasdaq composite as it went -0.87% while the SPX was +0.06%.  Russell 2000 was +1.59%.  Much like early June, the Russell 2000 is outperforming the Nasdaq after an extended rally.  Don't want to extrapolate from a sample of 1, but there was a violent pullback just a few days later.  

Rampant speculation in gold and silver are another sign of speculative fever, which are common near market tops.  See what happened in May 2011 with silver and the concurrent SPX price action. 

Another sign of the excessive speculation is the put/call ratios on a weekly basis, which is the now lowest since 2000.  Lower than February 2020, lower than January 2018, and only comparable period is the dotcom bubble era.  The call volume is overwhelming the market in MSFT, AAPL, AMZN, and FB, and much of that volume is retail.  Retail traders have fully embraced the tech is special zeitgeist and have piled into the most overvalued stocks in the market.  Now GLD and SLV have joined the call party in recent weeks and volumes are exploding there. 

Unfortunately, going forward, Robinhood is no longer releasing account holdings data to the public so we won't be able to get an exact read on retail speculation, but just by looking at the call volumes, you can get a close approximation of what they are doing. 

All this is happening before school reopenings which are huge potential breeding grounds for virus spread and of course the election, which will determing whether corporate tax rates will be going up or not, and determine whether Democrats will be able to win both houses of Congress and the White House to enact massive government spending.  

Probably the worst case scenario for the market would be a Biden White House with a Republican Senate, which would block or water down any fiscal stimulus measures.  And that is probably a close second to a Democratic sweep in the probability of it happening in November.  

The stock market has gone from monetary stimulus to fiscal stimulus as the mother's milk that feeds it, so the election is the most important variable in the coming months.  A close Biden victory over Trump would be the worst outcome for the stock market, because that probably means that the Republicans hold the Senate and can block any big fiscal stimulus bills.  Weak fiscal spending is now the kryptonite for the stock market.  

There is no organic growth anymore in the U.S., and basically the whole world, with all this debt, only a massive amount of additional debt can keep this zombie marching forward.  Without big deficit spending in Washington, there won't be a rising stock market.  The Fed's last remaining card, outright stock purchases would only encourage corporations to issue as much overvalued stock as possible to feed to the Fed, because the earnings won't be there to support the valuations.  

With so much uncertainty coming up in a seasonally weak time period for the stock market, after a nearly 5 month rally in stocks that have added over 50% to the SPX, near all time highs, I can't think of a much better risk/reward scenario for shorting the indices.  Maybe I am just old fashioned, thinking historical tendencies will repeat, and its not a new era.  We'll find out soon in the next 2 months.