Inflation Talking Heating Up

 With crude oil relentlessly going higher, along with the grains and industrial metals, the bond market is feeling the heat.  Its the reflation trade, part 86.  We've seen this story before.  Anytime you get a weaker dollar, commodities going higher, and lots of money printing, the inflation alarmists come out of their bunkers to recommend that you sell bonds and that a commodities super cycle is coming.  

I am one of those inflation alarmists.  But I never took any action because I was focusing on stocks and wasn't looking at the big picture.  But now is not the time to act on those views.  Same with going long stocks, as the inflation talk has weakened the bond market to the point where it is going to start being a negative for the stock market.    

Most big selloffs in stocks were preceded by a big selloff in bonds from anywhere from 1 to 5 months before it happened.  If this bond weakness goes into June, that sets up a potential waterfall decline scenario to occur from anytime from July to December.  

We are seeing some of that bond weakness spilling over to stocks.  I wouldn't be a buyer of this dip until you get closer to SPX 3860, the previous high in January.  Don't expect any big selloffs just yet, still feels like too many people are looking for that 10% correction and stimulus pump is still ahead so no big flushes until at least the first Biden stimulus is passed.

Russell 2000 is the Leader

 In 2020 the Nasdaq 100 was the leader.  After the election, and with the market looking ahead towards more fiscal stimulus and the "reopening", the Russell 2000 has become the leader.  The driver of short term price moves, the fast money, are overweight the Russell 2000 and underweight the big caps.  They are overweight speculative and cyclical stocks, and underweight low beta and defensive stocks.  

The Russell 2000 still looks strong, it has tripled the upside of the SPX since the January 29 low.  But a little bit of a change in character has happened since Wednesday.  The Russell 2000 has lagged the last 2 days.  

Nothing to be too worried about now, but something to keep an eye on because Russell 2000 is now the leader, and a lagging Russell 2000 is a signal of buying saturation among the fast money crowd.  That is when the market becomes vulnerable to sudden flush down moves.  

It is too late to buy, and a bit too early to short.  If I see the Russell 2000 continue to lag even as the SPX is going up, that will get me more interested in putting on a short position.  2 days of lagging performance in a flat market isn't much of a sell signal.  I need to see more, and preferably lagging RUT while the SPX is going up, not down.  When markets sell off, the Russell 2000 will almost always underperform the SPX.  So I need to see RUT lag when markets are flat or going higher.  

Still not getting much of a signal from the bond market either.  And Powell is a chirping dove, which was confirmed this week.  Powell has been completely neutered by the market.  He is an eunuch.  He will not change his tune easily, so that makes it tough to play for anything more than short term pullbacks on the short side.  

Past bear markets and waterfall declines (except 2020) were all preceded by Fed rate increases (1929, 1973-1974, 1987, 2000, 2007, 2018).   So you've got to be aware that you probably aren't going to get a bear market until Powell signals tapering. 

Put/call ratios are grinding lower, but as I've mentioned before on Twitter, retail call buyers are skewing ratios much lower, and they are not drivers of overall market direction, so you have to normalize for that.  Low put/call ratios will not give you a big warning signal anymore unless that persist for several days near 52 week lows. This week is a start, but need to see more of it next week.

Didn't Sit Tight

“It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine--that is, they made no real money out of it. Men who can both be right and sit tight are uncommon.”- Reminiscences of a Stock Operator

The above is my favorite quote from Jesse Livermore's book.  It is harder to sit on a winning position and hold than to sit in cash and hold.   Especially for the counter trend trader, who by definition, is looking to sell after a rally and buy after a selloff.  That is the one big advantage of trend trading over countertrend trading:  bigger winners.  

There is a price to be paid for having the optionality that cash provides.  When stocks keep going higher, you are left in the dust, pounding sand at the thought of "what if, I just held a few more days..."  

There is a big difference between making money in trading and trading well.  I made money last week taking advantage of a great dip buying opportunity, but I didn't trade it well.  I sold earlier than I originally planned and didn't give the market sufficient time to make even more just by sitting on my positions. On to the next trade, to try to execute better the next time. 

We are in the late 1999/early 2018 style sell bonds buy stocks rally phase.  This is when bond and cash holders feel like suckers for either being flat or losing money in bonds and envy those that are all in on stocks.  I am already envying those who didn't sell last week on the V bounce and are still holding longs.  I am paying the price in lost profits, which is still painful to experience when I knew the bubble would keep getting bigger, and I decided to try to play for the optionality of going to cash to be able to buy a dip.  And that dip will be coming from much higher prices, with no guarantee of reaching my desired entry level below SPX 3750. 

The speculation is rampant, as biotech is the main recipient of speculative cash flows.  The Rona stimulus package, is not really stimulus but dollar debasement.  When the stimulus is paid for by Treasuries that the Fed will eventually monetize, that is pure dollar debasement.  It benefits people who spend dollars quickly, and punishes those holding cash to spend at a later date.  That is the main effect of the stimulus.  In other words, all these huge spending packages do is cause inflation, and the market has caught on to that realization.  As crude oil trades even stronger than the SPX despite the lockdowns and Rona still almost everywhere.  The commodities market will be the long term winner of this dollar debasement.  The losers will be the conservative savers who parked their money in bonds. 

Not Rocket Surgery

 Do you want to talk about GME and Reddit, gossip and repetitive takes from the finance "experts" or do you want to talk about something that actually matters for the overall market?  The game is not that complicated, but many of us make it so.  Most of the time, simple logic is good enough. 

We are getting a bunch more stimulus thanks to the Democrats' die-hard belief that government spewing cash to individuals, state and local governments, and for pork projects somehow makes the Rona go away.  And with budget reconciliation, the Dems only need to please their most conservative Senate member, who is Joe Manchin.  So you are going to get a lot of pork for West Virginia and for whoever gives him the financing for his campaigns.  That's the price Biden has to pay to ram through a stimulus bill with only Dem votes.  

So we are going to get at least one more stimulus bill jammed through with only Dem votes, so its probably going to be close to $1.5 trillion.  Half of that money is going into a black hole that has no connection to Covid relief.  A lot of that stimulus money will flow towards the stock market.  Because most of the money will end up going to people/corporations that don't need it, so what do people and companies do when they get money from heaven they don't need?  They invest it.  And most of it ends up either in stocks or bonds.  

In order to finance this stimulus, they will issue Treasuries, so you have Treasury issuance to give people money to buy stocks and bonds.  So you have net increase in bond supply, and a net increase in stock demand.  So until the stmulus works its way through the system, or is sufficiently front run by the market (not there yet), you will have net upward buying pressure in stocks and corporate bonds, and selling pressure in Treasuries.  

So the best strategy for the next few months while the stimulus hits the economy is to either buy the US stock indices, or sell Treasuries.  

Sure, in the short term, you will have fluctuations, but if you look beyond that, the upward pressure on stocks will come to bear.  

The short term is a hard time frame to predict, but as you look beyond a few days and weeks, the longer term supply and demand factors play out.  That's why I'm still holding my long SPX position, although I will be looking to reduce it in the coming days because the weakness in bonds is an early sign that the rally will soon top out.   

The quick V bottom on Monday and rallying strongly into Tuesday tells me that a lot of investors were waiting for the all clear to buy the dip.  Now that SPX is closer to all time highs, its a bit harder to predict the next move.  I do eventually expect much higher prices in March, but will there be another dip before that, or will it just keep going higher with minimal pullbacks along the way?  That is a harder question to answer.  

Its hard enough to predict the destination over 2-3 months, but to also try to predict the path to the destination is almost impossible.  It is trying to seek perfection and the markets usually don't reward perfectionists, just speaking from experience.  

But selling some of my position near all time highs frees up the dry powder that I could use to take advantage of any dips this month.   If you don't sell, you don't have the free cash to take advantage of the buy the dip opportunities.  So the plan is to sell about half either today or Friday and keep the rest for much higher prices.  And if there is another sharp dip like last week, then I will use the cash freed up to buy again.  Rinse and repeat.

Finger to the Wind

 A small minority make money in the markets.  So by that logic, you cannot do what the majority if you want to win in the long run.  Not talking about investing, but speculating.  Investing is safer, but almost always not life changing.  Speculating is riskier, but has a much higher probably of making life changing money.  

That is the basic principle that I follow when I make trading decisions.  And since I'm not trading in the pits or talking to clients, I need to get information.  Information about what the majority are thinking, trying to figure out how that will affect the market.  Information is the most valuable thing in this business.  Charts alone don't tell you much.  You need to know what people are thinking if you want to improve your predicting skills.  And experience from remembering past instances with similar investor behavior and thoughts, with similar charts.  

I don't watch CNBC and read Twitter for fun.  Its a job.  There isn't much joy in watching a bunch of so-called experts with little to no skin in the game making market calls with irrational confidence.  Its like hearing from the armchair quarterback sitting on his couch calling into a sports radio talk show acting like he knows more than the head coach about every little detail. 

So that brings me back to the current market.  This is not like June 2020 or September 2020.  We are in a full blown bubble now, and there are positive catalysts (stimulus) ahead, not high uncertainty events (the election).   That makes any selloff different, because most investors want to be long ahead of a stimulus bill passing, unlike ahead of an important election.  So that itself makes the selling more likely to be shorter in duration that what you saw in fall of 2020.  

Ok, so some may be thinking about February 2020 again.  Again, a very different situation.  The economy was getting worse, not better, as it is now.  And once again people were looking ahead to the uncertainty of the Rona, now there is the uncertainty of how much stimulus will be passed, which is a totally different kind of uncertainty, an uncertainty that the market likes to have.  

How about January/February 2018?  Again, a totally different situation.  Powell was super optimistic on the economy and a little worried about inflation, now he's somewhat pessimistic on the current economy, and not worried about inflation.   Maybe we'll get a different Powell in the 2nd half of the year, but he's still not going to change his tune until you see mass vaccination done and the economy fully reopened.  

And then we can go to the anecdotal things that I heard last week.  Worries about a correction, too much retail speculation, hedge funds under pressure and needing to sell longs because of their shorts getting squeezed, Fast Money bearish in the short term and looking for a pullback.  Those worries might have more merit and accuracy if this was actually a weak market and not one in an extremely strong uptrend.  In an uptrending market like this with few big pullbacks, last week was the first 4% dip we've had since late October, you need to look for long opportunities not short opportunities.  This market still hasn't given you many chances to buy at a meaningful discount from all time highs.  That usually means that there are a lot of dip buyers who've been waiting to get in and haven't been able to until late last week.  The first meaningful dip after a long uptrend is a good risk/reward buying opportunity.  

I am long SPX and will probably keep it for several days, at a minimum, and may hold some to play for a blow off top sometime in the spring.  Won't be trading in and out of the position, will just hold here just in case we get that V bottom to new all time highs again.  Good to see that the bulls got a bit scared on Friday, it clears out the weak hands and makes its more favorable for the long side over the coming few weeks.