Thoughts on the Election

A lot of investors are now accepting that Trump will win the election, with a good probability of a Republican sweep of Congress.  I agree with the Wall St. consensus that Trump wins.  Harris is just not a popular candidate, and has much less name value than Trump.  Add to the fact that she's the VP under an unpopular President in Biden, who helped usher in a very high inflation period.  And she's a black female, which makes it the worst demographic to get elected for President in the US.  

Contrary to what many Democrats believe, white candidates have a built in racial edge over black candidates.  Male candidates have a built in gender edge over female candidates.  There is a reason that you've never had a female US President.  And you've had one black President, who only got elected because he ran against a female primary candidate and during a severe recession under a Republican White House, guaranteeing a Democrat win in the 2008 election.  

Harris will get the anti-Trump vote, and the Democratic vote, but she won't get much of the independent vote because of the above reasons.  Overall, it looks like Harris is very likely to lose, although I would still give her about a 10-15% chance of winning because the polls are close.  But I think polls still underestimate Trump's support because there are still lots of shy Trump voters who don't like to admit that they are voting for him because of his un-Presidential behavior, and he isn't politically correct.   

Under a Trump presidency, the Trump tax cuts get extended, some tax cuts are possible, some additional tariffs (unlikely as much as Trump threatens), and less immigration = slower population growth and labor force growth.  This will increase the fiscal deficit, increase inflation due to a combination of lower taxes and fewer workers, and lead to higher bond yields.  It seems some investors are jumping the gun, looking at history, and thinking a Trump win will be a repeat of his first term, when you had a roaring bull market in stocks.  This is only feasible if you have blockbuster earnings growth (unlikely without another Covid era money spew) or have a further expansion in valuations on top of already historically nosebleed levels.  All while bond yields stay high due to the inflationary impact of loose fiscal policy/higher tariffs/tighter immigration.  Odds are high that the next 4 years in the stock market are nothing like 2017-2020. 

Under Trump's easy money fiscal policy regime, demand is artificially increased which creates higher growth.  That higher demand has 2 release valves.  One is through the bond market.  The other is through the currency market.  If the Fed decides to stay vigilant against inflation by reacting to higher inflation with higher interest rates, then bonds become the release valve of this high pressure economy.  Yields go higher.  If the Fed decides to ignore the higher inflation, then the currency becomes the release valve.  Financial repression through negative real interest rates will weaken the dollar, leading to even higher inflation in a vicious loop that will cause a bear steepening of the yield curve.  Of course, if the Fed restarts QE, then the bear steepening is suppressed, at the cost of further dollar weakness. 

In the first higher yields scenario, you get higher bond yields and lower stock prices.  In the second financial repression, weaker dollar scenario, you have a wildcard.  It is hard to predict how that affects the stock market.  If commodities skyrockets along with inflation, that will make stock market investors nervous, and you could see earnings go up but valuations drop hard.  If inflation doesn't get raging hot like 2021/2022, then you could see stocks go up along with a weaker dollar. 

Powell will be Fed chair for at least the next year, and if he's a lame duck as would be expected under a Trump presidency, he will no longer have to play politics and will focus more on his legacy, thus try to keep inflation under control.  He will become more hawkish as a result.  If the stock market isn't in an entrenched downtrend, I would expect Fed funds rates to stay higher than what the STIRs market is anticipating, meaning that you should see only 2-3 more rate hikes from now till the end of 2025.  That will eventually catch up to the bond market, as the maturity wall for corporate bonds will be coming in 2025 and 2026.  Corporations will have to refinance at much higher yields than previously, and interest expense will continue to creep higher.  

I expect the stock market to eventually readjust to a return of a tighter Fed in 2025 by going down.  It may take a few months for this to happen as the initial economic bump up from having Trump elected should keep the stock market buoyant.  By the 2nd half of 2025, this short term Trump adrenaline shot will have to face the new monetary reality.  At that point, a 2nd half 2025 waterfall decline in an overvalued, overowned SPX will be matter of when, not if. 

You likely get a reprieve from hawkish monetary policy in 2026 if Trump does what I expect him to do, which is replace Powell with a dovish lackey for Fed chair.  But the financial markets are so short term focused that its not even worth thinking about till right before the Fed renomination decision. 

The longer term effect of a high deficit, negative real rates policy under Trump is political change.  There will be a different US president in 2028, and by that time, raging high inflation will cause immense pain to the bottom half of the population.  That would basically be handing the Democrats the keys to the White House and Congress in 2028.  Controlling inflation will be the priority among the masses and that will be when the Fed has to make a hawkish turn to accommodate public opinion.  A Democrat sweep will be waiting in the wings, and it will be accompanied with higher taxes and higher interest rates.  Again, this is a much longer term consequence of what is likely to happen over the next 4 years and is not something that is market actionable.  

It appears that the late Friday selloff was due to the telegraphing of an Israel strike on Iran over the weekend.  The unwind of the afternoon selloff has happened overnight, and we're right back to no-man's land.  This is a level in the SPX where neither longs nor shorts have much edge.  Although given my belief that there will be a Republican sweep in next week's election, I would rather be long than short from now till then.  Ahead of big events, the financial markets have a tendency to front run the expected result and squeeze out much of the post move juice that would have happened without the front running.  

I was hoping for a move lower ahead of the election on the uncertainty but too many investors have FOMO, and don't want to miss a rally on a Trump win, which most investors expect.  I got out of all shorts last week, on that small dip.  Seasonal weakness is now behind us, and after tech earnings this week, the corporate buyback window is wide open.  

It is tough to find a real edge here, because if there was a 100% probability of a Trump win, I would go long, but that's not the case.  There is some small probability of a Harris win, and that potential downside keeps me from chasing longs here.  I think its a bit late to be short here with the election only a week away.  Some may question the premise that a Trump win would be good for the stock market, and I agree long term.  Especially if bond yields remain high in 2025, which would be bearish for stocks next year.  But over the short term, the vol crush after a big event like a Presidential election being over would be enough to squeeze the SPX higher for at least a few days.  Even with bullish expectations that you have going into it.  

Bottom line, its not a good risk/reward spot for either longs or shorts for both stocks and bonds.  Some may be tempted to try to buy the correction in Treasuries but I see little upside near term there, and there could be one last reflexive dump in bonds after a Trump win.  If that happens, I would consider buying Treasuries for a short term trade.  Right now, I don't see much edge.  In the case that you get a move towards SPX 5750 this week, I would be a buyer of that dip.  Otherwise, likely to be on the sidelines. 

The Long Game

"Win or lose, everybody gets what they want out of the market." - Ed Seytoka

Everybody gets what they want out of the market.  Contrary to what they say, many people are looking to maximize thrills by betting huge and minimize the emotional toll of grinding through the ups and downs of winning and losing.  Trading is a game made for masochists.  Its not a game that will make you happy in the long run.  Being a trader is similar to being a drug addict.  It is hard to stop once you get into it.  It dulls the senses, making other non-trading experiences less interesting and fulfilling.  One of the greatest traders ever, Jesse Livermore, considered his life a failure and killed himself in the end.  

You get to choose whether you want to play a long game or a short game.  Those that want to play a long game will innately trade in a way to ensure their long term survival.  They can sense when they are in danger and betting too big, and reduce size and cut losses to live to fight another day.  Those that want to play a short game take huge risks and YOLO.  They are overconfident, but also know that they are living on the edge.  Its thrilling and exciting, but it doesn't last long.  They don't have the patience or the desire to play a long game.  

Why would anyone want to play a short game over a long game?  Its because of the emotional toll of trading.  The basic principle of this emotional toll is the pain of loss vs. the pleasure of gains.  It is widely known that the pain of a loss is felt greater than the pleasure of a gain.  Losing $10,000 will be much more painful than winning $10,000 is pleasurable.  Let's roughly estimate for gains and losses of equal amounts to be:   Pain of Loss = 2 x (Pleasure of Gain).  In order to emotionally break even, you have to have at least twice as many winners as losers (of the same size), or at least 67% winners to be emotionally "winning".  That is extremely difficult to do.  

Thus, to maximize the pleasure from trading, traders will often choose to incorporate a high winning percentage strategy, which means taking many small winners and letting losers run, in order to increase their winning percentage.  That's a formula to maximize long term emotional "gains", but not the formula to maximize long term financial gains.  Partially its because markets tend to follow trends more often then not, which means that letting losers run is a very bad strategy.  Its also because when you hold on to losers and cut your winners, the size of your losing trade becomes bigger relative to the size of your total account balance.  You end up taking bigger risks in the worse spots, and taking smaller risks in the better spots.  That is a long term loser of a strategy.  Yet, this is an emotionally appealing strategy from a reptilian brain wiring of win = good, loss = twice as bad point of view. 

A huge majority of human beings have this emotionally reptilian brain (including me).  It means that most of us are not emotionally designed for optimal trading.  We feel pleasure from taking winners.  We feel more pain from taking losses than from holding losers in the hopes that they turn into winners.  The longer we hold on to losers, the harder it is to take those losses, especially after all the mental capital that was spent holding on and hoping that the losing trade would come back and turn into a winner.  

A disciplined, winning trading strategy usually maximizes pain (lots of losses) and minimizes pleasure (larger, but much fewer wins).  That is why trading successfully is for masochists.  You have to enjoy the pain of taking losses, with the long term view that your short term emotional pain will lead to long term financial gain.  A lot of traders know this, but subconsciously cannot follow this strategy because its emotionally painful.  For those who are emotionally invested in their trading/investing accounts, being disciplined and taking lots of losses is self-induced torture.  That is why many choose to bet huge, to YOLO, to get away from the grind of this self-induced torture.  It is the strategy that maximizes long term emotional happiness, but also maximizes the probability of blowing up. 

You don't have control over where prices will go, but you do have control over how much you bet.  In my early days in the markets, I thought it was all about picking the right direction, whether it be up or down.  And while being a good forecaster and predictor is important, its less important than knowing how much to bet.  You can be the best predictor of prices in the world, but if you are bad at choosing bet size, you will either blow up or make very little.  

It is during losing streaks like the one that I am in right now that remind me of the importance of money management.  Its sucks to be in a deep drawdown but you can't allow your emotions to take over.  If you do, you'll try to find a quick way out of this painful spot by betting big, to make that quick comeback, to feel much better again.  That is dangerous.  That is the psyche that destroys trading accounts.  Been there, done that.  During losing streaks, it can feel like Chinese water torture.  Taking short cuts to try to relieve the pain of losing is lethal.  In order to win in the long run, you have to be a masochist.  You have to accept short term emotional pain as part of the process to achieve long term gains.  

The latest COT and options data shows no major changes, investors are dug into their heavy net long positioning, with lots of call activity and its working, so I would not expect anything to change until you start seeing bigger moves up and down.  This upward grind during a seasonally weak time period is a horrible market for my style of trading.  The nosebleed valuations make any long term longs a poor risk/reward trade.  It feels like insanity to be short this market.  But historically, these type of overvalued markets with investors heavily allocated to equities occur near market tops.  But market tops are usually a process that takes many months before the trend changes, so we have to patient, but persistent in looking for the big down move.  Its a tricky balance to maintain, but there will be great opportunities for those with a bearish bias in the next 12-18 months.  

The bond market weakness is partially reflecting election uncertainty and the fear of a potential big selloff like you saw in the past 2 elections.  The bond weakness is also showing the unfavorable supply/demand picture for Treasuries.  The giant fiscal deficit means lots of Treasury issuance, much of that having to be taken in by non-public investors.  Until the Fed restarts QE, bond investors face this hurdle of heavy supply.  This supports the long term bear thesis which is predicated on equity valuations being extremely high relative to bond valuations.  

Equities are at the bottom of the corporate capital structure, and face the most risk during economic downturns.  Therefore, earnings yields (inverse of the P/E ratio) should naturally be lower than long term corporate bond yields, due to the added risk of equities.  With long term investment grade corporate bond yields around 5%, the fair value for earnings yields should be above 5%.  Or put another way, the P/E ratio should be below 20 in this high government deficit, heavy Treasury supply market.  But with an estimated 2024 S&P 500 earnings of ~$250, the current P/E ratio based on 2024 earnings is approximately 23.4.  Based on this metric, the market is at least 15% overvalued. 

Still stuck short and not looking to hold beyond this week.  Post October opex week is a seasonally bearish time of year.  With many already assuming that Trump will win, there is plenty of room for the crowd to migrate towards a more neutral positioning ahead of the election.  The market is pricing in a quite optimistic scenario and assuming that you will have a post election rally after a Trump win.  So many assumptions for the base case optimism on the Street right now.  If even one of those assumptions comes under question over the next 2 weeks, you can have a quick dip lower (likely to be bought immediately).  The bears have one week, perhaps two weeks max, before the probabilities shift much more favorably to the bull side.  I will let the shorts play out this week and get out.  Its been a terrible ride for shorts, but this pain will set up a much more favorable environment for shorts with the tenacity and patience in 2025. 

Its a MAD market

Most investors are in M.A.D. mode.  What, me worry?  The market keeps grinding higher, and the shorts keep losing.  Unfortunately for those that are short, the window of weakness for the SPX is getting smaller and smaller.  Seasonal weakness has not played out for most of the last 2 months, despite the elevated net long positioning among asset managers and the complacency of the crowd.  The election has been ignored, and it seems most believe that there will be an end of year rally after the election is over.  On Twitter, the bears are dropping out like flies, as I've seen many throw in the towel as the SPX busted out to new all time highs last week.  

The bullish price action is uncanny as we are heading into the last few weeks ahead of the election.  Maybe its the strong SPX rallies post election in 2016 and 2020 that have investors complacent, one won by Republicans, one won by Democracts. It appears many believe that based on recent history, it will go up post-election no matter who wins.  However, if you asked investors if stocks would go up or down if the corporate tax rate went up from 21% to 28%, most would say they would go down.  And the Trump tax cuts are not something that automatically gets renewed if there is no legislation.  Those tax cuts are set to expire if the next President does nothing and lets them expire at the end of 2025.  And Harris will let them expire.  That plus other low probability risks to stocks such as raising the capital gains tax rate, which is possible in the small chance that Democrats sweep the election. 

On CNBC and Bloomberg, there is very little talk about the ramifications of the election.  The recent news surrounding geopolitics, strikes, hurricanes, and even the Fed have distracted investors from thinking about the big one:  the election.  And its the one that can actually have a meaningful fundamental impact on the future earnings of corporations and investors.  Maybe the market continues to ignore this risk all the way to the finish line on November 5, but I view that as a low probability scenario. 

Despite what looks like a ripe environment for stocks to pullback, the opposite has happened.  Trading is a probability game.  You can play the odds and make your bets based on historical tendencies in similar environments and still lose.  Sometimes history doesn't repeat itself.  Most good trades on the SPX or other major markets will be only slight favorites.  You just don't get a big edge trading such big, liquid instruments.  So you have to be able to withstand drawdowns, cut losses, and move on.  But you also have to be able to know when its too late to get out.  For mean reversion traders, often times the more stretched the rubber band gets, the better opportunity.  The moments when counter trend traders are losing the most are usually when the best opportunities occur.  Of course this is assuming that the trader has a valid winning long term strategy.  

The only way to get to the long run is if you survive the short run.  The only way to survive the short run is have proper money management and not make huge bets.  

The past week's COT data showed little movement among asset managers and commercial traders.  The large asset manager net long position remains.  The OCC data for last week shows both small and large options traders buying more calls and with bigger premiums than for puts.  The data came in as one would expect for an up week.  No real edge there.  Put/call ratios are generally low, but that is to be expected considering last week's price movements.  

There is a tendency for opex weeks to be bullish on Monday and Tuesday if we are at or near an all time high going in.  The is early week bullishness is usually reversed later in the week, as opex gets closer and options expire, leading to fewer ITM calls and fewer OTM puts outstanding.  This can trigger more outsized moves on opex day and for the following week.  This is what often happened during the monster up year of 2021, when you had lots of call option activity, which led to rallies up to the beginning of opex week, where options hedging forces led to selling later in the opex week, and sometimes spilling over to post opex Monday.  That would be my base case for this week's price action as many are bulled up going into this opex.  

With new all time highs and SPX over 5800, we have to temper our expectations for any pullback that comes this month.  Even with election risk coming to the forefront soon, the price action doesn't support a big pullback.  You usually have more bearish price action or more volatile two way trade at the highs prior to big pullbacks.  We are not seeing that now.  So while my original thesis was for a move down to SPX 5450 when initially short, I now think its likely that the most this goes down in October is 5600.  So I don't even foresee a 5% pullback from the highs ahead of the election.  The shorts will have to be satisfied with a graceful exit and/or minimal gains on a pullback, rather than any big profits.  2024 is the bull's year, and trying to make money on the short side has been trying to squeeze water out a rock.  2025 should prove to be a much different trading environment.  So for the bears, don't waste too many bullets trying to take down this super bull, save them for what should be more of a two sided market next years, with patient bears likely to get paid much more often than either 2023 or 2024.  

Still full short position, as I view any gains early this week to be taken back quickly later in the week.  Covering now and trying to reshort later is trying to be too cute when we are this far overextended with so much investor complacency .  The potential upside is more limited than potential downside this month, so its not worth it to micro trade.  Staying short.

Canary in the Coalmine

Bonds are the canaries in the coalmine.  They are the first movers.  Many short term tops in the SPX are foreshadowed by an intermediate term move higher in yields.  After bottoming at 3.60% on Tuesday, Sep. 17, the day before FOMC meeting, 10 year yields are now 40 bps higher, 3 week later.  The 4.00% yield area should be short term resistance for 10 year yields, as the Fed is still hell bent on making a dovish mistake and boxing themselves into a bunch of rate cuts.  Political Powell, once again, is making another monetary mistake due to his greed, looking to stay in power by trying to prevent Trump from getting back into the White House.  This time, instead of delaying hikes, it is rushing and pushing forward rate cuts that are unnecessary.  

Bonds are calling BS on the Fed's rate cutting path, afraid of another dovish mistake on Powell's part, his 2nd in less than 3 years.  The aggressive steepening of the yield curve, the refusal for bonds to rally despite a bigger than expected 50 bps rate cut at the last FOMC meeting, and the firming economic data.  Powell is trying to put Harris in office to assure that he gets renominated for a 3rd term, with inflation ignored and concerns about a labor market that isn't even that soft, all pretense for big rate cuts to goose the stock market and odds of Harris getting elected.  

The only way to keep the long end under control is to stop QT, and do QE again.  With the monster budget deficits, there is just too much Treasury supply to keep yields under control without a recession.  Even with 50 bps whopper cuts every 6 weeks.  Powell is once again short sighted, looking out for himself and trying to pump up the stock market to curry favor among the rich and powerful, to get support for a renomination in 2025.  It is all but guaranteed that a Trump presidency will look to replace Powell with someone that listens to Trump, not ignores him.  And Trump can clearly see that Powell is being political, and will get his revenge by kicking him out in favor of a new FOMC chair.  That new chair will likely be even more dovish than Powell, looking to keep rates low no matter what. 

The whole premise for the post FOMC rally in stocks was that the Fed was going to be dovish, to support the economy and ignore inflation in order to try to boost the job market, and thus the overall economy.  A soft landing, or even no landing scenario.  But the big cut has become counter productive because long bond yields are going up, not down.  So it minimizes the monetary stimulus of the rate cuts.  And without monetary stimulus working throughout the curve, the stock market will not be able to hang out at these nosebleed valuations for long.  The euphoria can last a few weeks, maybe even a few months with a Trump victory, but ultimately it will fail under the pressure of sticky long bond yields above 4%.  

This bond weakness comes at a time when the stock market is facing the uncertainty of the election a month way, where odds are 50-50.  You cannot get more uncertain that a coin flip.  And this market needs a Trump victory.  There is no way Harris will extend those Trump tax cuts.  She has other ideas of how to bust the budget.  And no, it will not be as stock market friendly as Trump's budget busting plans, as it will funnel more money into the lower and middle class, igniting inflation again.  

Back to the stock market.  Last week, we saw a pullback in the US amidst geopolitical concerns as crude oil rallied a few dollars and VIX squeezing higher.  It was a very mild pullback, contained to SPX 5670, the top in July.  After the blockbuster, and heavily manipulated NFP numbers came down the pike, you got the reflex rally higher in SPX towards 5750, where it is now facing some serious resistance.  During the pullback, the put buying remained subdued, and the bulls were defiant.  The financial experts on CNBC stayed bullish, and have completely bought into the Fed put and soft landing theme.  I could feel the latent bullishness on Twitter as well.  Its a warning sign that there are a lot of bulls out there that still aren't prepared for the coming election volatility.  It increases my conviction that you have to put on shorts early this week, before everyone comes to their senses and realizes that they are paying top prices right ahead of some serious election risk.  

The COT data confirms the lack of concern and heavy bullish positioning.  Asset managers hardly reduced their net long positions in SPX and NDX futures.  They even increased their net long in Russell futures despite the weakness post FOMC meeting.  Dealers have gotten even more short, shortest YTD, as the small reduction in asset manager longs was more than made up for by a reduction in shorts from leveraged funds.  In total, a bearish picture from the latest COT data.  

Covered half of my SPX short before the NFP on Thursday, and looking to re-add the short today or tomorrow.  I don't think this market will give you much time to short the highs so I will be in a rush to short any rallies.  I am looking for a return of volatility starting later this week.  Will not be picky about trying to nail the top this week, because of the lopsided risk/reward at these levels for shorts.