Delta and China

The two fear variables of the day are the Delta variant and China.  It doesn't matter what I feel about both (non factors in the intermediate to long run), because they can bring about brief but sharp dips in risk assets because of the positioning and complacency.  

Institutions are what moves markets, the major markets anyway.  I am not talking about stocks like AMC or the small cap stocks that are daytrader plays and retail dominated.  And during the slow August month, ahead of the usually feared September and October, most institutions who are heavily in equities and with historically low bond exposure aren't likely to chase this market higher. Not after 17% up on the year in the SPX and near all time highs.  

And with no new stimulus checks and federal unemployment checks ending in September, the endless retail bid for meme stocks, and assorted Wall St. garbage should slow down in the coming months.  According to research I've seen the last couple of weeks, retail investors were big buyers of that dip on July 19 and have been big buyers of Chinese stocks that have been dumped wholesale by fund managers. I would guess their firepower will be more limited in the coming weeks.  

This week, we are starting to see the SPX struggle to make new all time highs and stay up there.  There has been some volatility during the overnight market hours, as we've seen fairly large drops during Asian hours only to see the dips quickly bought.  When you start seeing the intraday volatility go up as the market goes sideways after a big V move higher, it is a subtle warning sign that the next big move is much more likely to be down than up.  

I'm not interested in shorting the SPX here, I have a few individual stock shorts which will probably go down much more than the market if we get a move back down to 4250.  Even though I expect a parabolic move up in the 4th quarter, its likely that during the seasonally worst part of the year coming up, a consolidation between 4200 and 4400 is the highest probability scenario.  I am waiting for the dip but will not bet on it.  

I am noticing that commodities are very well bid and rallying despite the SPX going sideways this week and even with Delta and China scares.  From a big picture perspective, the commodities are the most undervalued assets as they've gone sideways for the past 15 years even though the USD money supply has tripled during that time period.  An explosive commodity bull market is probably just right around the corner. 

Short Selling Small Caps

I don't often talk about trading small cap stocks, because it doesn't really teach you much about how the bigger, more important markets move.  If you are shorting stocks, you are mostly reacting, not anticipating.  Its almost like a whole different world.  Trading futures and index options is a tough game, but one which I am involved in because of scalability and strategy diversification.  The edges in futures are much smaller than the edges you will find in individual stocks, especially retail driven small cap stocks.  

You have to consider who is on the other side of your trade.  Is it institutions or retail traders?  One has a lot more buying power and is much better informed than the other. If you look at the Stocktwits boards, you would think that the average IQ of a retail trader is in the low 80s.  Most of these daytraders have never read an SEC filing in their life.   Probably the extent of their research is looking at charts, doing some paper napkin analysis. 

You also see many shorting small cap stocks these days, especially the biggest gainers of the day.  Now these are your better educated traders, and a lot of them do fundamental analysis and have a good understanding about the float, dilution, SEC filings, etc.  But their Achilles heel is not ignorance, but arrogance.  Thinking that they can't lose, because they usually win, and refusing to take losses and holding on to a short that is going against them, which is much more dangerous than holding a long that is losing.  When you are getting short squeezed, your margin requirements go up as your account equity goes down, bringing on a margin call that much more quickly than holding a losing long position. 

It used to be less popular and a lesser known strategy back in the day before you had short biased educators like Tim Sykes come along and teach it to a huge pool of newbies.  In the old days when there weren't so many trading "educators" and stock alert services, there weren't that many short sellers in the small cap world. 

Back then, it was safer to short, with very few outlier moves.  There was a smaller pool of traders chasing these stocks and a much smaller pool who could get short squeezed.  So you didn't get the infinite short squeezes like a GME, AMC, etc, because the retail buying power for pump and dumps was just not as big as it is today.  The sheer number of daytraders is so much more now than at anytime in the last 20 years, they can overwhelm low float stocks with their cumulative volume for several days.  It is amazing to see so many ridiculous supernova parabolic moves since spring of 2020.  In this new era, the stock market is a literal minefield for the short seller.  I would only recommend it if you are super disciplined and can take your stop losses and never let losers get out of control.  Easier said than done.  Also, the borrow fees, short interest fees, and occasional buyins, usually at the worst time right before the stock is about to enter a 2 week downtrend. 

Shorting pump and dumps was my main strategy for several years, but I didn't learn that much about trading because it was too "easy".  What I mean by easy is that if you could hang on to your short position, 95+% of the time, the trade would go in your direction, even if you got squeezed for a day or two before it did.  When you win more than 95% of the time, you develop bad habits, you get stubborn and hang on to losers because they almost always turn into winners if you can withstand the storm.  Of course during the rare times when they keep going up, you lose everything you made that year in one day.  Also, you don't learn anything about predicting stock price movement, because the end result of these pump and dumps is essentially a fait accompli. 

Shorting pump and dumps is a winning strategy, in a similar way that selling index puts is a winning strategy.  You are essentially short gamma.  You win most of the time.  But the few times that you lose, they dwarf the size of your wins.   If you can deal with the big losses, and not completely blow up, then its a great way to make money in the markets.  But again, you don't really learn that much from selling index puts or from shorting pump and dumps.  You don't develop any intuition about market direction. 

In the short selling world, there is a fine line between good risk management and being too careful.  If you are too careful, your returns will be low, and it will be bleeding out from repeated stop losses, covering at bad prices.  In that case, you never blow up, but you don't make all that much either.  But what's worse is if you don't manage the right side of the tail distribution, and cut off the outlier moves.  If you don't cut the losses at a certain point, then you are going to be taken out by a black swan move, such as this:  

A stock going from $4 to $100 over 4 trading days back in 2016.  I actually started shorting this in the 20s thinking it was overdone but by pure luck, I couldn't find more borrows, otherwise I would have gone in heavy.  I was able to withstand the storm, although it was quite painful.  I had to reduce my position near the top due to potential margin calls.  If I had short 25% of my acccount balance on DRYS at 20, and never reduced, I would have lost everything at the top at 100.  

There were quite a few blow ups among short sellers on this one.  What is interesting about DRYS is that the CEO George Economou was then able to dilute shareholders continuously on the other side of the peak, as retail bagholders kept averaging down, buying the dip, thinking about how much the stock is down from the peak, dreaming of a repeat of that monster move.  They provided the liquidity for the CEO to raise several hundred million and recapitalize.  He then was able to use his super voting rights to acquire the fully capitalized company after the dust settled.  Essentially all the retail bagholder money went to the CEO via the stock market.   

That shows you how greedy retail investors looking for big gains and looking in the rear view mirror provide the liquidity for these companies to keep selling stock after the pump and as it keeps dumping.  Its actually stock manipulation 101.  The higher a stock goes, the more it entices traders to buy as it goes down from the peak.  Most retail investors think a stock is cheap when it is down a huge amount from a recent peak.  A good recent example of this is CLOV, a Reddit favorite meme stock.  

CLOV just happens to have their SPAC lockup expiration in July, and I'm sure that big pump in June to over $28 has done them a huge favor in giving them willing buyers on the way down.  After seeing it go up to $28 like a bottle rocket just a month ago, retail bagholders have either averaged down, or new ones got lured in at 14,13,12,11,10,9,8 since it seems like such a big discount.  

The SPX is at an all time high, I am surprised, but not shocked.  Nothing shocks me anymore when the SPX is going up.  The buying power and liquidity backing it up is ridiculous.  I still think we are in a range bound market, with the lower bound around 4250, and upper bound around these levels, but I probably sound like an old pit trader complaining about algos when he can't adjust to the new markets.  CTAs heavily long, weak seasonal period for the next 2 months, and retail message board activity in SPY at very high levels are warning signs.

Chop Coming Up

 We haven't had a chop trade in quite some time, its been dip and run on the daily since the November 2020 election.  Over the past 9 months, SPX has gone from 3280 to 4380, or a 44.7% annual rate.  The valuations are sky high.  The momentum unbelievably strong.  But historically, the SPX usually back tests breakouts and don't normally go up in a straight line.  There hasn't been a lot of trade between 4250 and 4350, and its a bit of a volume vacuum.  I expect that vacuum to be filled with some choppy trade from 4250 to 4350 over the coming weeks.   

I don't expect a V bottom this time around like you saw off the June dip, just because of the lack of consolidation between the 4250-4350 area.  Also, seasonally weak time of the year, from mid July to early October, so you have almost 3 months when SPX makes almost no gains historically.  Still have Delta variant fear, and that probably doesn't dissipate until you get to lower levels and have more of a flush out of weak hands, or a few weeks pass by.  

Long term, its still setting up for a parabolic rise later this year, but my base case is for a choppy period for the next couple of weeks, and then assess the situation from there.  

If we do get that chop that I expect, that should take 10 year yields down towards 1.10%.  The bond market is confounding a lot of people, who can't explain the price action other than saying its short covering.  That's usually a sign of a strong market. 

SPX Rocketship

It looks like the SPX has reached an intermediate term ceiling at 4400.  The uptrend has been so steady, with only very brief corrections, but with 10 year yields down below 1.30%, the stock market propellant that is lower and lower yields is running out of fuel.  I am now expecting a range trade for the next 3-4 weeks, trading mostly between 4300-4400.  Post opex July until opex August is usually a seasonally weak time of the year, as Europe goes on vacation and lack of new buyers willing to take the market higher after such an extended run.  It is possible there will be occasional forays into the 4250-4260 zone, but those should not last for long, as that is rock solid support.  

The next few weeks could be the last decent opportunity to grab a seat on the $SPX rocketship below 4300, with a likely destination of 4700-4800 by year end.  

The sudden worries about the Delta variant, declining 10 year yields interpreted as economic weakness, and bad stock market breadth are the most common excuses I see for the selling.  Those seem like non issues considering how dovish Powell has been and the already overflowing liquidity as shown by the massive reverse repo cash balances parked at the Fed.  

The only way you can get sustained selling is if you get a very sharp hawkish turn from Powell in the next 2 months, which is about as likely as Trump saying that the 2020 election result was fair.  

I am hearing many "experts" opine about how market is overbought with a bad mix of high inflation, peak growth rate, bad market breadth, Delta variants, etc.  The pessimism, which never really went away earlier this year, has come back more broadly in the past week.  Put/call ratios are rising, hearing a lot of bearish market calls for the next 3 months going into a potential taper announcement. 

I don't expect this bearish psychology to really fade away until the fall, when you will have had enough time to consolidate the gains from the last several months, forming a base to propel into a parabolic FOMO chase for performance I expect in the fourth quarter.  Until then here is a simple game plan:

There is always a potential for an overshoot to the downside, but with the worry this thick, I would be surprised if it went below 4200 on any overshoots.  Maybe finally we'll have a range trade this year, favoring traders, instead of the steady upward grind higher that has been a gift for buy and hold investors.  

In strong uptrends like this, in a bubble environment, range trade doesn't last for too long, so I will probably just buy and hold as we get closer to the end of August. 

Wall of Worry is High

It didn't take much of a dip for the worry to rise.  All I can do is shake my head, at how easily equity investors start worrying about a pullback.  I don't even need to mention what they say on CNBC Fast Money, as they recently brought that permabull Tony Dwyer, notorious for being bullish all the time except when the markets are in a raging uptrend.  He's been looking for a pullback since March, 400 SPX points ago. 

Let's take a look at the CBOE equity put/call ratio:

 

Right back towards the high end of the range this year, when the market made V bottoms in late January, late March, mid May, and mid June. 

Bearish activity in options is confirmed by the ISEE call/put index. 

Powell came out on Wednesday as his usual over the top dovish manner, using different language this time to try to brainwash investors into thinking inflation is transitory.  If you could get inside his head, I'm sure he's on automatic QE pilot until reappointment, but he'd never tell anybody that.  

He'd never say the Fed is political, but his future is in the hands of Bazooka Joe Biden, who has basically become the puppet for the grand American MMT experiment.  Of course Powell will do everything to please his boss, and that's to be as dovish as all get out, regardless of the data or the markets. Once he gets reappointed, don't be surprised if he suddenly changes his tune and sounds much less dovish.

This is a grinder's market, you're not getting any easy setups right now.  The best trade is probably just being long the SPX, but its run up so far this year, its not easy to put on the trade, especially if you want to put on size.  

Treasury market is also tough, another strong market that refuses to stay down.  I'd also be a buyer of dips there.  

The best opportunities come when investors are getting shaken out, stopped out, but these days, the uptrend is so strong, the dips so shallow and fleeting, that's just not happening.  Tough.

Flooding the Market

You remember those video games with the secret code to get unlimited lives?   This market is using a cheat code.  Its unlimited liquidity.  If you need it, you get it.  Even if you don't need it, as seen by the $800+ B in reverse repos, you get it.  The Democrats are apparently working on an infrastructure bill, using reconciliation, to be able to pass unlimited pork with 50 votes.  

There has never been such an expansionary fiscal and monetary policy by a nation in modern history.  Even World War II spending pales in comparison to the trillion dollar spending bills + bazooka QE combo.   The market distortions are not only hitting stocks, everyone's favorite asset class, but its hitting bonds.  10 year yields from July 1 to July 8 went from 1.48% to 1.25% on a short squeeze of epic proportions, as the stock market basically went nowhere, with a very brief dip that was bought aggressively by the ravenous dip buyers.  

There is so much excess cash flowing out there that any minor dips are quickly bought up.  This reinforces equity investors to just hang on, and not sell weakness.  Almost every time that stock investors have sold weakness, they have made a mistake.  Eventually, they learn their lesson.  If fewer and fewer investors sell weakness, then the market can't really go down.  And over the last 15 months, bullish and optimistic investors have made most of the money, so the ones that have the most money at the current time are the ones that have been bullish, and continue to be bullish.  

The money is not only concentrating towards the wealthy with big stock portfolios, but its concentrating even more among the most bullish of the wealthy, who have been buying the dips and continue to add to their stock holdings.  And they are getting ample support from the Fed.  

You can't fight the money.  If you are going to be short, you have to be selective, choosing the stocks where retail investors are oversaturated, and are stuck holding the bag.  The meme stocks like AMC, SPCE, GME, CLOV, WISH have rolled over and retail traders are notoriously poor at cutting losses, which means these turds, which have no fundamental value, will keep going down until most of these bagholders can't take it anymore and finally sell.  

The Robin Hood crowd has gotten too greedy.  They should have been happy with what they made on GME and AMC, but they tried to run their game on other stocks like CLOV, WISH, and SPCE and it never gained critical mass.  There can only be so many meme stocks because these Reddit traders have a finite amount of capital.  And from the looks of the stock charts that I see where retail is crowded in, that capital has been shrinking, while the $SPX keeps going higher.  

Even though I expect the SPX to go much higher this year, in the short term, it just looks to be too much, too fast.  But I definitely wouldn't fade it.  There hasn't been a lot of call volume lately, so the put/call ratio is not at extreme lows that you often see at the tops.  So even if it does pullback, it probably is like what you saw last week, 1 or 2 down days, and then a surge back towards all time highs.  

CPI number comes out today, I don't think its going to be a market mover for the SPX, but after the 2 day selloff in Treasuries, it wouldn't surprise me if bond traders buy after the number comes out. 

Greed Season

The SPX these days is usually hovering around all time highs.  This market is not giving dip buyers much of a chance to get in.  Once again, whatever intraday pullback you get is quickly gobbled up by the underinvested, as you saw on Tuesday, and then back to all time highs on Wednesday.  We are getting a big gap down today but days like today are the exception, and have been rare this year. 

The breadth of the overall market has been poor, which many market participants have noticed.  There are those who look at the breadth, and say that the rally is narrowing and breadth is bad, so the market is vulnerable to a correction.  That may have been the case in the old days, when the Fed actually tightened monetary policy when the economy got too hot and inflation too high, but that's no longer the case.  

The Fed is the 800 pound gorilla in the room smashing all the past statistical work on the stock market into worthless little pieces.  The Fed supplies the fuel, it doesn't direct it.  Its up to investors to decide where to shovel all of that liquidity.  And it doesn't matter if that liquidity is going to large caps or small caps, growth or value, it will lift the overall market, one way or another.  

Its missing the forest for the trees by trying to parse the breadth data and warn about a coming correction when the Fed is pumping $120B/month, and the US government is pumping out trillions of stimulus.  And Biden is not done, he's looking to push out even more pork, and label it infrastructure to make it sound like its actually a worthy investment, when in reality, most of that money will eventually end up in the stock market! 

Even though a lot of investors have now gotten wise to the stock market game, realizing that the economy doesn't really matter, what matters is how much liquidity and stimulus there is in the system.  There are still a large subset of investors who actually think the real economy is the most important factor in determining stock prices.  They get excited by high growth.  The reopening, reflation, etc.  That's the old game.  The new game is all about stimulus, monetary and fiscal.  There is no organic growth anymore, which exacerbates the importance of the central banks and federal  governments.  Otherwise, this economy is stuck on zero, no growth without the stimulants and free money.   

When you have a Fed this easy, with growth this high and with no hint of a change of monetary policy anytime soon, of course you are going to get rampant speculation and money flowing to the stock market.  Of course there will be no fear.  Its greed season.  

I have over thought this SPX rally, trying to avoid the big dips by getting in and out quickly on the swing long trades, when I should haven't been such a chicken little and just rode the wave, just accepting any drawdowns as temporary.  I would have made so much more.  That's history.  With yields going lower and lower, even with new all time highs in the SPX, its providing a huge tailwind to the market.  

Looking forward, I'm stuck on the sidelines hoping for a pullback down towards 4220-4240, to buy before the move back up.  The seasonally strong period in July lasts through the tech earnings season.  Once we exit the seasonally positive time period, by early August, ahead of the potential taper talk by Powell at Jackson Hole in late August, you could get a taper fear based pullback which would be a perfect buy setup. 

Money Spews

The Fed has created this monster, with some help from Congress and the White House, where the bubble gets so large, that popping it creates so much pain that at any sign of market weakness, they will quickly go back to the same Rona playbook of multi trillion dollar fiscal/monetary combo bazooka.  They know nothing else other than spewing money and basking in the glory and praise from the brainwashed media and investors who measure their self worth by looking at their account balances.  

The bubble mentality has gotten so pervasive that a popping of the greatest bubble ever created would create immense pain not just financial, but also emotional and psychological.  That pain will quickly cause the crowd to be outraged and demand the government come to the rescue, which means more money printing and stimulus to "solve" the problem.  The only solution to this bubble popping is more money spews.  They will do a few rounds of $2,000 (why not $10,000? $100,000?) stimmy checks regularly. They want the stock market to keep going up.  They want meme stocks to stay hot.  They want to see bitcoin go to $1,000,000.  

Its insanity, and the end result will be high inflation that the government will lie about to say its low.  Stagflation with the real GDP growth masking the fact that all the nominal increase is inflation, not growth. 

I am amazed that with this hyper sensitive ultra dovish Fed, the majority of investors think that the Fed will be able to raise rates back up to 1.5%, as shown by the Eurodollars December 2024 contract, priced at 98.40, which is effectively a Fed funds rate ~1.5%.

That is 5 to 6 rate hikes over the next 3.5 years, with probably 1.5 years of that spent talking about tapering, doing a turtle taper, and after that, probably delaying rate hikes further if the bubble has popped and the stock vigilantes demand the Fed to pause and/or go back to QE.  Even in the rosiest scenario where the economy stays strong, the bubble has not popped, and the Fed hikes 3 times a year, it would take almost 2 years from December 2022 for them to get to 1.5% Fed funds by December 2024.  So basically the Eurodollars market is pricing in the rosiest scenario as the average of the possible outcomes by December 2024.  

Do you really think this massively overvalued and stimulus addicted stock market can stay calm when the Fed is not doing QE and is hiking rates?  There will be some serious withdrawal effects from the QE + fiscal stimulus drugs.  The market has to just sneeze and Powell would fold like a cheap lawn chair if the SPX dropped 10% and stayed down. 

By pouring more gasoline on this raging bonfire, the Fed is creating such a huge bubble that they've reached the point of no return.  They can't normalize.  Even talking about tapering gets the market nervous.  Imagine actually finishing the taper, no QE with trillions of new Treasury issuance every year, that the market has to buy up, along with the never ending supply of SPACs, plus rate hikes.  At these bubble levels, with so much investor participation, that's a train wreck waiting to happen.   

This is easily a much bigger bubble than 2000.  Just the sheer amounts of liquidity, the breadth of the price increases in assets, either real or perceived, is mind boggling.  Cryptocurrencies, NFTs, sports cards, meme stocks, shitcos, etc.  

But as big as this bubble is, with so much liquidity sloshing around, any big drop in the market probably gets bought up quickly just because there is so much excess cash, expecting the Fed to come to the rescue, like what happened in January 2019, when Powell made his dovish pivot.

The strength in the SPX is amazing.  I sold too early, like all the other times I bought the dip.   Just watching how effortlessly this market goes up, and expecting nothing but an explosion higher after the taper announcement, whenever that happens.  Taper fear is the only thing that is keeping this bottle rocket from going parabolic.  

Hoping for one more lasting dip to buy before the parabolic phase.  I may or may not get it, but if I could buy SPX at the June 18 opex expiry close at 4150, that would be a gift.  Maybe some pre taper jitters could get us there, or some rehash of the Covid Delta variant scare or whatever, just to get the market down for a few days before it pops back up again.