War Panic and Liquidations

The war headlines are relentless.  That's all the market cares about right now.  That was one scary looking drop in the overnight futures on the Russian invasion.  WTI oil broke $100/barrel and was up over $8 on the day before dropping hard on news of more SPR releases and slap on the wrist sanctions on Russia.  The key to this market is oil.  If you get crude oil to stay under $100 and keep inflation from getting totally out of control, you can sustain a rally for 2-3 months.  If oil maintains its strength, the rally will have a shorter lifespan and will peter out after a few weeks.  

The market hates uncertainty, and now that its clear that US and Europe don't want to hurt themselves economically with any serious Russia sanctions, almost a best case scenario is opening up where war keeps the central banks from being too hawkish, but at the same time, weak sanctions allowing Russian oil and gas to flow freely throughout the world.  Its actually even a better case scenario than an agreement with Putin, because now that he has Ukraine, he's likely to consolidate his position, and wait awhile before his next move.  

The price action on Thursday was beyond my imagination, a one day turnaround that's uncommon.  It shows how much panic the overnight futures were pricing in, there were no real eager sellers once the US regular trading started.  Usually I don't put too much weight into one day of trading, but after so much selling and a big time break of the January SPX 4220 low, that quick of a reversal in the face of bad news and fear everywhere gives us a high probability bottom signal.  Put volume was through the roof yesterday.  Very heavy volume and it definitely felt like a deep cleanse to break that 4220 support and stop out the weak hands.  I have enough longs for now, and I have no plans to sell anytime soon.  My base case is that we've bottomed and washed out the weak hands, and there will be a sustained rally for the next 4-6 weeks. 

War Doom and Gloom

Its palpable now.  You can sense the fear, the gloom in the air.  Right as the SPX is testing the 4250-4300 zone, a hard support area from last fall and in late January.  The Fed is temporarily out of the picture.  Its Russia/Ukraine news, all day, every day.  Full blast.  You would think Russia and Ukraine were some kind of financial and economic hub if you saw the price action in global index futures over the past few days.  

When you are long and you see the futures plunging overnight, its natural to question your sanity for being long, when everyone out there is talking about the negatives in the market, the bearishness is the most extreme I've seen since spring of 2020.  This easily tops the 2020 election uncertainty, which feels like happy days compared to the war doom and gloom that you see out there.  My Twitter stream is filled with Russia/Ukraine 5 minute macro expert takes, about how Putin will take over all of Ukraine, etc.  You can only laugh at it if you want to maintain your sanity in this craziness.  Especially when you are long.  

Its a lonely place, expecting higher prices this week after seeing the news flow.  Its easy to feel like an idiot when all the scaremongers are out in droves spreading the bearish gospel, and seeing the market go down.  But intuitively, I get more confident in my position when I see this, when I know that fundamentally, war doesn't have negative economic effects, rather, they are expansionary, and because of the pansy Fed and ECB, who don't have the balls to raise rates aggressively while a war is going on with the SPX trading weak.  Sure, if the SPX was making new all time highs, they would ignore Russia, but when its trading weak, they won't ignore it.  They even metioned Ukraine in the Fed minutes, and that was referring to the situation 4 weeks ago.  So with things getting this hot in Ukraine, its a guarantee that 50 bps is off the table for the March meeting, and that's a win for the stock market, which was scared about a hawkish Fed more than anything before the Russia headlines took over  Of course, none of the bears screaming their war takes will ever mention that.  

I plan on adding more long exposure today, as the EU seems to finally be putting on sanctions on Russia, getting closer to the end of what will eventually be done.  Its not the war itself that causes stock market weakness, it is the lead up to the war that cause its.  This retest of the January lows feels scary to be buying, but with fundamentals actually better now than before things got heated in Ukraine (less hawkish central banks, now) its makes it a higher probability that the retest will be successful. 

Russia Risk and Psychology of War

Market participants are funny.  I am reading Russia takes from a lot of investors which doesn't make much sense.  A lot of people seem to think that Russia invasion of Ukraine is the biggest risk to the market, but they think that the risk is underpriced.  All people are talking about is Russia/Ukraine.   They are dominating the headlines.  And that's been the main reason we've had violent moves up and down over the last few days.  Its the main reason people have been buying puts.  Yet the Russia risk is underpriced?  

It gets back to the primal instincts of investors who are scared about war.  They equate human tragedy with stock market tragedy. 

Fed rate hikes seem trivial when compared to a war between Russia and Ukraine.  But Fed rate hikes are much more important to the stock market than war.  Its a much worse environment for stocks with a hawkish Fed and no war than a neutral Fed that can't hike aggressively with a war going on.  Investors tend to forget that this is a money game, not a news game.  Having bad news doesn't mean the stock market will be weak, and having good news doesn't mean the stock market will be strong.  But pumping a lot of money into the system usually means the stock market will go up.  And draining a lot of money from the system usually means the stock market will go down. 

Yet based on what I am seeing, investors are complacent about a hawkish Fed and think the Fed won't be able to hike much or meaningfully reduce their balance sheet but are scared that a Russia invasion would be a black swan.  Black swans don't happen when everyone is aware of it, with quite a few who are scared of it.  They happen when the event is either unknown or considered inconceivable.  

A lot of short term trading isn't about fundamentals but predicting whether a move is sustainable or unsustainable.  Fears based on war are not long term sustainable.  In the short term, the stock market can be inefficient and irrational, but in the long term, it finds its efficient, equilibrium level.  War doesn't hurt corporate earnings, in fact, it often helps corporate earnings for certain sectors (energy, materials, defense).  But you don't hear much about that, its just this instinctual fear about war that seeps into stock market.  

We have Fed minutes today, so I am sure that will get the nervous short term traders looking to sell or short ahead of the minutes release at 2:00 PM ET.  Stocks plunged on the last Fed minutes release in early January, so I'm sure not many are optimistic about what the Fed will have to say this time around.  Once we get past the Fed minutes, I don't see any more events that could be bear catalysts.  Except for World War 3!   

Got long SPX on Friday and Monday, looking for a bounce towards 4500 and higher by next week.  Lot of put volume in ETFs over the past few days, and investors seem to be leaning bearish and are getting more and more hedged.  I am just playing the range for now, don't expect any big moves in either direction.  If we can get back up to SPX 4550 and higher this month, I will consider a short position. 

Start of World War 3?

Suddenly, after ignoring all the other warnings from the US about an imminent Russian attack on Ukraine, the market, on a Friday afternoon, after already going down due to high CPI and hawkish Fed talk, starts plunging.  You get lots of hedging via put options going through (options volume was high), and now people are worried about World War 3.  There is nothing like war to get people scared.  You can't make this stuff up, the market is both inefficient and irrational because its ultimately controlled by a crowd of human beings.  No matter how much the market has been controlled by the "algos", humans will always be the ones behind the controls turning on and turning off the algos. 

A move down from SPX 4590 to 4490 wasn't enough to get investors to panic and buy puts and Treasuries, but a move from 4490 to 4400 on World War 3 fears was enough to get them a little panicky, and buying puts and Treasuries.  Those are 2 ingredients that are important for any short term bottom:  1.  Falling yields 2.  High put volume

It doesn't hurt the bull case for the next few weeks now that war in Ukraine is now a concern.  Ukraine chicken littles reducing equity exposure is a positive.  The less weak hands there are, the less panic there will be when there is weakness.  What does hurt the bull case is that the next month's CPI, ECB, and FOMC meetings are still a month away, which is a dark cloud of uncertainty hanging over this market.   

Who knows, if Russia attacks Ukraine, Pansy Powell could delay a March rate hike, which would be bullish for stocks and bonds.  We all know that throughout its history, the Fed uses any excuse it can to delay rate hikes, and to speed up rate cuts.  So counterintuitively, Russia going to war with Ukraine could take the market's biggest worry off the table, which is aggressive Fed rate hikes. 

The S&P has now soundly got rejected off of 4600 resistance the last 2 times up there.  I doubt this market has the strength to get back up there in the next few weeks.  But that doesn't mean this market can have a strong bounce off around strong support in the 4300-4350 zone.  I put on a starter long position near the close on Friday, with plans on adding more today, on further weakness.  Not looking for a huge up move, but a reflexive bounce up to 4500 is doable. 

Taking Head Out of Sand

The equity crowd finally seems to be getting it:  Dove Powell is not coming through that door to rescue the markets.  It only took relentless pounding from stock jockey Bullard who kept sending the message repeatedly.  Powell doesn't want to do the dirty work.  He has his underlings to do it for him.   He's a coward and unwilling to speak the truth, instead being as mealy mouth as possible so as not to "hurt" the stock market, while still trying to sound tough on inflation.  But he doesn't want to act tough on inflation, unless there is political pressure to do so.  And Biden and Congress is putting on that political pressure. 

Powell is no dummy.  As he was spewing the transitory BS, he probably knew there was a good chance that inflation was going to remain sticky, but he couldn't say that, because he didn't want to upset the stock market before his reappointment decision.  After horribly mismanaging 2021, he's now under the gun.  He doesn't want to hurt the stock market, which makes him look bad, but he also has to give the image of a banker who is actually worried about inflation.

Now freshly reappointed for 4 more years, he can be a bit tougher on the stock market, although if he could get away with it, like Kuroda at the BOJ, he would stay at zero forever.  But he can't.  Unlike Japan, the US money supply situation is much, much different (just look up Japan M2 vs US M2 over the last 20 years).  Plus, Powell's main priority is not maximizing unemployment and keeping inflation under control, its winning brownie points from the White House and Congress.  His urge to please his political bosses means he has to look like he's tough on inflation, when he's been anything but that throughout his tenure. 

Yesterday's CPI number isn't anything extraordinary, it was a bit higher than already high consensus estimates.  But for some irrational reason that I have a hard time understanding (short covering?), there was a big rally for 2 days ahead of the number.  So SPX was basically at the top of the range, 4590, right before the number came out.  It was set up for disappointment. 

Now you have a situation where the market has gotten a bit overboard, from being too complacent about Fed hiking, thinking Powell will be one and done, to being too worried about a 50 bps hike, and even an inter meeting hike, which isn't going to happen.  10 year yields are now over 2%, but more importantly, 5 year yields are at 1.95%, as the yield curve is getting very flat, very quickly.  7-10s is at zero.  5-30s is at 36 bps.  It has only been this flat in 2018, just as the Fed was finishing its rate hiking cycle, not starting it.  Much like the 2004 to 2006 rate hiking cycle, when Greenspan was late to start hiking, and very slow to get to the final Fed funds rate of 5.25%, the market was pricing in a bunch of hikes before Greenspan even did his first rate hike in June 2004.  The interest rate market is screaming to the Fed to hike aggressively, pricing in more and more hikes, despite the equity guys hoping for one and done.   you are late, and you will be hiking a lot, because you are late.  

Even with all these hot inflation prints, the Fed is still doing QE!  LOL.  And if Powell could have gotten away with it, he would have stayed with the turtle taper of $15B a month, not letting him hike until July!  If it wasn't clear during Greenspan and Bernanke's days, its obvious now:  Fed is always in a rush to ease, and always way too late to tighten.   

We have given back the last 2 days of rallying in 1 day.  At one point, the SPX was rallying aggressively after the open and had filled the gap, but it crapped the bed again on Bullard comments and more selloffs in the bond market.  With so much angst now about Fed rate hikes, and so much priced into the March meeting, I can't imagine anything but a weak SPX going into early/mid March.  If that's the case, we can see that retest of 4250-4300, which is my base case scenario.  The put/call ratio was surprisingly low yesterday, so it seems like short term investors are still believers in the V bounce.  

Usually don't want to short a bounce after such a big waterfall decline, but its looking more and more likely that we'll be seeing a lot of weakness over the next few weeks.  If we can revisit the 4560-4580 area on a bounce within the next 2 weeks, I will be looking to put on a short to ride down for a potential retest.  Just watching and waiting for the right spot, don't ever like shorting after a big selloff on/Fed talk. 

Forming the Volatile Range

The past week provided information towards what the next 4 weeks of trading should be like.  The volatile chop range between SPX 4270 and 4430 was resolved with an explosive move to the upside to 4590, signaling the bottom was found for the intermediate term.  That move gave us the upper bound of the new range, 4590.  The selloff on Friday likely formed the lower end of the new consolidation range, but its still to be determined, as the pullback is just 2 days, and could last another couple of days.  In the bigger picture, we're still trapped in the post waterfall decline/fear based volatile trading regime.  That means we're likely to have a retest of the 4250-4300 zone that was defended by the bulls sometime in the next few weeks, after the countertrend consolidation runs its course.  This consolidation could run anywhere from 2-4 more weeks of trade between roughly 4420 to 4600.  After that consolidation, I am expecting another strong selloff testing the support zone around 4300.  

That selloff in late February/early March will likely be fueled by demand for March quarterly expiration puts ahead of the first Fed rate hike on March 16.  Last week, the ECB also threw their hat into the rate hiking ring, hinting at a rate hike later in the year, as they follow the Fed like headless chickens, looking for direction.  The big dates for March are the ECB meeting on March 10, and the FOMC meeting on March 16.  Investors will be wary of loading up on stocks in front of those potential fear events, creating an environment for a risk off selloff. 

The relentless rally in crude oil is more meat for the bears, as higher commodity prices will keep the central banks on a hawkish path, talking tough and eventually having to act tough.  Those hoping for one of those 2021 style V bounces are still looking in the rear view mirror, and not adjusting to the new environment of higher inflation leading to central bank action, not central bank inaction.  

In 2021, Powell was still stubbornly dovish.  He's made a hard pivot towards the hawkish side, and expect him to signal more rate hikes at the March meeting, in order to get the market to keep the May rate hike on the table.  At the moment, March is automatic, but May is still up in the air.  Unlike 2015 when Yellen put in a one and done crying rate hike, Powell is facing higher inflation and rising commodity prices, with much more excess liquidity than back in 2015.  3 straight rate hikes in March, May, and June cannot be ruled out.  After June, Powell probably starts QT at the July meeting and doesn't hike, but probably will go back to another hike in September, with hints of quarterly hikes until they reach ~2% Fed funds rate.  That's my base case scenario.  Of course, a vicious stock market waterfall decline during those hikes could derail Powell's plans, but its going to have to be SPX under 4000 before Powell gets the message from the market and pauses. 

Europe is still reeling from last week's hawkish message from Lagarde.  European government bonds got destroyed last week.  Its funny how investors criticize negative rates in Europe as being counterproductive but then freak out when the ECB actually signals rate hikes to start getting out of negative territory.

On the bullish side, you had commercial hedgers cover SPX and NDX shorts and undo the massive sales of the previous week.  Also, in dark pool activity, the DIX (dark pool index) remains very elevated, showing smart money investors are still accumulating shares.  These type of continuous elevated DIX levels were last seen in the spring of 2020.  So its a real battle of bullish positioning data for the past week, and continued hawkish signals from central banks amid rising energy prices.  

Don't Have to Swing

The stock market is a no-called-strike game. You don't have to swing at everything you can wait for your pitch. - Warren Buffett

Its probably more profitable to just look at the market 1 hour a day at the US market open and then shut off the computer.  When you are constantly looking at the charts, watching CNBC, reading whatever they have to say in Bloomberg,Wall St Journal, Twitter, etc., you get ideas.  And when you get ideas, you feel like you have to do something.  A lot of times, those shorter term ideas have no edge, and are a distraction from bigger picture, longer term trades, which have an edge.  Most of the time, in the big markets like equity indexes, Treasuries, commodities, there is nothing new and what is a good buy remains a good buy, and what is a good sell remains a good sell.   For long term trades, the day to day movements usually don't change the  picture.  

In investing, you don't have to buy or sell.  Its not baseball, where there are called strikes and you can strike out by not swinging.  But as a full time trader, its hard to just sit there and do nothing.  Most of the time, there will be something good to invest in for the long term.  In those cases, you should already have long term positions which normally don't change based on day to day movements.  If you are already long and have a full position, there really isn't much to do.  And if its a bad time to invest in stocks or bonds or commodities, then you should either be in cash, or if you are aggressive and have a strong signal, be short.  

Looking back at my biggest losses, they came from premature entries.  Eventually most of the trades would end up being profitable, if I was able to hold on, but I wouldn't be able to hold on.  I would get in too big too early, and not be able withstand the drawdown and either puke it out at bad prices, or feel so much stress from the underwater position that I get out at the first opportunity to limit the damage, only to see it go much further in my favor after I get out.  It happened on Monday, when I sold at 4460, only to see it go up another 50 points in a few hours, and then another 50 points, 24 hours after that). 

If I had just done nothing until the opportunity became so good and the urge to put on a position became so great that I couldn't resist, then instead of getting long at 4560 down to 4470, I would have just waited a couple of more days and would have been able to buy in the 4300s.  It doesn't always work out like that.  But often you will get a great opportunity that you can't take full advantage of because you bought it when it was just a good opportunity, and it went down even more.  

Straight down, volatile chop for a few days, and then straight up.  Sick.  Got into a short during this volatile environment, after a big drop, on the rebound, breaking one of my rules for this type of market.   Now looking for a graceful exit.  Too early to short, too late to cover. 

FB dropping 23% on an earnings miss.  NFLX dropped 25% on an earnings miss.  AAPL goes up 7% on an earnings beat.  GOOG goes up 8% on an earnings beat.  There is a definite imbalance there.  I haven't seen these kind of monster drops on earnings misses since the dotcom bust era.  These are game changers.  The SPX is going to live or die with big cap tech.  Energy stocks aren't going to move the needle, no matter how strong they are.  2 of the 6 big megacap tech names have cratered, and have left a mountain of bagholders in its wake.  FB and NFLX are now broken stocks.  NVDA and TSLA are so ridiculously valued that their demise is really only a matter of time.  AAPL, GOOG, AMZN, and MSFT are the big boys that are still left standing.  One by one, the pillars of the SPX are being taken out.  

Sometimes we think of the SPX as this abstract monster that has a life of its own, but its an index.  Its performance depends on the biggest stocks in it.  And those are megacap tech.  When those tech stocks no longer warrant those big P/E multiples, then you have a problem.  They have been the momentum stocks of this decade.  If the momentum goes in the other direction, the growth guys don't want to touch them anymore, and they are still too expensive for the value guys.  The worst of both worlds.  

The supporting evidence that we've seen a major top in the SPX is growing.  The market usually doesn't go down in a straight line and there will be extended countertrend rallies.  Trading from the short side is difficult, so you have to be pickier when choosing your entry points.  So while I see the signs of eventual doom for stocks, I'm not excited about the short side yet.  Looking at the investor surveys, it is clear that a lot of investors have gotten cautious, so its not a great spot to be short.  Put/call ratios are still elevated, even during the strong bounce this week.

The ideal setup, and something I expect to see in the spring, is an extended countertrend rally that reduces the number of bears, increases the number of bulls who think the worst is over, and complacency returns.   That's the time to strike and layer into a big short position and buy index puts.