Entering Stall Speed

This high flying airplane of my market is showing signs of entering stall speed.  Momentum is a self perpetuating phenomena where strength induces more fund inflows and more strength, until you reach a saturation point.  At that saturation point, the inflows are not sufficient to maintain the high altitude, and the stocks get dumped, with weakness feeding further weakness.  During this process, there are some wild down moves that match the steepness of the up moves. 

Reddit WSB favorites PLTR and HIMS, along with many other momentum favorites made spectacular tops this week.  It is not coincidence that this happened during an options expiration week.  Some of the other large cap momentum blowoff tops include RDDT, CVNA, NET, and WMT. WMT even became a momentum favorite this year.  Its valuation reached overvalued extremes that reminded me of the way it traded during 2000, in the midst of the dotcom bubble.  

What is more meaningful about this blowoff top is that most of them are not just from one sector being dumped.  These stocks cover everything from internet, retail, AI/government related, and autos.  

These momentum stocks are the fuel that feeds the animal spirits in the stock market.  When these momentum stocks are strong, it signals a robust overall stock market.  When these momentum stocks make blowoff tops, then the overall stock market is showing its weakness underneath the surface.  This weakness will not manifest into a downtrend right away.  The momentum stocks act as a canary in the coal mine, sending out warning signs of an impending end to uptrend.  

The longer the trend that these momentum stocks have enjoyed, the longer it takes for these warning signs to show up in sustained SPX weakness.  Since we've only recently witnessed a big top in these momentum names, there is a still time for the weakness to spread to the overall market.  Those with long term bullish views will view it as a healthy consolidation of the uptrend.  Those with long term bearish views will view it as a broad, choppy top that will lead to a bear market.  

I lean towards the long term bearish view, based on bubble valuations, bubble mentality (greater fool theory), and increasingly bearish macro headwinds.  These bearish macro headwinds involve lower fiscal deficits (tariffs, DOGE, and big capital gains taxes coming due this April) and tighter immigration policy.  The stubbornly high long term bond yields also add to this, as it makes home buying more expensive, reducing housing demand.  This is all happening as investors are still quite bullish about the US economy, thinking Trump's tax cut and deregulation promises will outweigh the above headwinds.  But these tax cuts and deregulation measures are still very abstract and would mostly just be a maintenance of a low tax regime.  US taxes are low for developed world standards.  This doesn't match the high government spending and interest expenses, thus you have huge fiscal deficits that are much higher than in Europe and Asia.  That was one of the factors in US exceptionalism, which has been conveniently ignored to  cheerlead the stock market.  

Even just a small downshift towards less government spending from minor cuts from DOGE and more taxes from tariffs is enough to put this high flying plane into stall speed.  The market started to sniff out this growing fiscal contraction with a Fed on the sidelines, prompting a recent rarity:  rising bond prices and dropping stock prices.  This happens when the market starts to place less importance on inflation and more importance on growth.  If this is the new regime, which looks likely, then you will see more negative correlation between stocks and bonds.  

The latest COT data shows a continuation of the same pattern of reluctant bullishness, as elevated asset manager long positioning doesn't increase much even during market rallies.  It appears we are entering a similar pattern as late 2021, as asset managers pare back extreme long positioning, even into market strength.  In hindsight, we now know that we reached the saturation point for asset manager positioning in late 2024.  This, along with the recent reversal in a number of momentum stocks, and the choppy and high intraday vol environment are reminiscent of early 2000 and late 2021.  History doesn't repeat, but it does rhyme.  

We got a nasty selloff on no news on Friday.  Those are the more bearish type of selloffs.  I would give it more meaning if it didn't happen on opex Friday.  But its just another sign that this market is now going to be a two way market, with both vicious rallies and vicious selloffs.  I did enter into a small SPX long position into the afternoon weakness (a bit early) on Friday, but I will be conservative and wait for more weakness to add to the position.  Playing small ball in this environment, until I see bigger opportunities.  Will now be looking to be more aggressive and earlier in entering short positions as the probability of extended rallies goes down in this chop environment.  

Iron Chin

This stock market keeps taking big blows and keeps on moving forward like a zombie.  Its got an iron chin.  You have to be impressed by the price action relative to the news flow.  

We came into last week with worries about reciprocal tariffs, which Trump warned about on Friday, Feb. 7, leading to a weak close.  That little news bomb took the SPX down about 1% in 2 hours.  Then the market grinded higher to recover most of those losses into the CPI number on Wednesday, which came in hot. The CPI  took the SPX down about 1% over a few minutes.  Then the market grinded higher to recover all those losses and managed to put on gains after the reciprocal tariffs announcement was more bark than bite.  

If you are selling stocks based on tariff fears, you are selling low.  There is no edge in chasing news based moves unless its for quick daytrades.  Those taking on positional shorts because of these little bits of "scary" news are going to be punished over the long run.  You always have to consider the price action relative to the news, and whether you are coming off of a purge or a pullback, or coming off of a period of complacency.  The pullback from mid December to mid January was lengthy enough for a strong uptrend to reset positioning to more neutral levels.  That gave the market some "immunity" to the bad news wave that you had over the past few weeks, starting with DeepSeek, and more recently, the tariffs.  

At the current juncture, despite being at all time highs, it doesn't feel like there is much excitement out there.  That make its tricky to try to time a short here.  Intuitively, it feels like a bear trap to short strength into a string of bad news that came out: DeepSeek, tariffs, and hotter inflation.  The resilience of this stock market doesn't make me super bullish.  It does make me reluctant to put on shorts though.  Cash seems like a good place to be right now, waiting for the bulls to push the market higher to set up a short opportunity.  

The COT data as of February 11 showed very little movement among asset managers.  They still are not rebuilding their long positioning that was rapidly reduced in December and January.  Their positioning is still a large net long, but not extreme like it was late last year.  Not much to read into at current levels.  Also, leveraged funds still have a large net short position, which usually needs to start going down to more neutral levels to get a steady downtrend going.  

The market feels like its quieting down from the spastic sharp down moves and steady grind higher recoveries over the past 2 weeks.  I expect the SPX volatility to continue to contract as the range trade narrows, leading to an explosion of volatility later in the year.  We are coiling up for a big move down sometime in the next 6 months.  You can sense that being long US stocks is becoming more of a sucker's game, as most investors now admit that stocks are overvalued, but they have to keep up with the indexes to keep their jobs, so they have to stay fully invested.  But you can feel their reluctance investing at these levels.  Its similar to what you saw in the middle of 2018.  The market did grind higher into the fall, and then went into a vicious downtrend that ended with a capitulation into year end.  I can picture a similar move playing out this year.  

We got an interesting move in bonds last week, as the CPI torpedoed bonds all in one day, but it quickly recovered those losses.  I hate to compare this bond market to those pre-2020, when inflation was never a true concern.  But it has the feel of 2014, when the bond market would shake off hot jobs numbers, regaining losses from strong economic news quite quickly.  It also happened to be the year that crude oil was slowly weakening.  The lack of strength in WTI crude is a positive sign for bonds, as you can't get people really scared about inflation until you see oil prices really go higher.  That's not happening here.  

Still maintain the small long SPX position, but I'll look to start selling this week.  The risk/reward seems about even here.  Short term neutral to slightly bullish.  Long term bearish.  

Being Desperate

“Most people overestimate what they can achieve in a year and underestimate what they can achieve in ten years.” - Bill Gates, Tony Robbins,.....

The market will seek out your weaknesses, find them, and test them.  One of those weaknesses is desperation.  Especially for full time traders.  When you have to make money, then you are trading from a weakened position.  Its easier to succeed when you want to make money, but don't need to make money.  

I've noticed that I've usually traded better when I've been winning than when I've been losing.  Its because losses affect your mindset differently than wins.  After losses, most traders, including myself, want to recover those losses quickly to get rid of the negative emotions that come from losing.  The bigger the loss, the stronger the urge to recover losses quickly.  This means trading from a desperate position, which is a position of weakness.  

After wins, most traders are not in a hurry to get into the next trade, because they already have a feeling of satisfaction from recent wins.  The bigger the wins, the stronger the feeling of satisfaction and the less urge to rush into the next trade.  This is trading from a position of strength, with no desperation.  

When you are not desperate, you don't take marginal or negative EV trades.  You don't sacrifice the optionality that cash provides by being stuck in those mediocre to bad trades.  When you have free cash, you have the option to take advantage of good opportunities that come along.  Just by not being a desperate trader, you can take advantage of more good opportunities because you aren't stuck in mediocre to bad trades.  

This is why I've noticed a streakiness to the results of not only my trading, but other peoples' trading.  The psychological aspect of this game is extremely important.  But since its so vague, and hard to quantify, it is underestimated and often ignored.  When I first started in this business, I gave little thought to psychology and emotions and mind control.  Its only after several years of experience and observation that you realize how psychology is such a huge part of the game.  

Becoming a full time trader is hard because of the need to make money.  Trying to make money in the markets is similar to trying to get a loan at the bank.  When you have enough money and don't need to make money, then it becomes easier to make money.  When you try to get a loan at the bank, its much easier to get a loan when you have collateral, i.e. real estate, to put up to get a loan.  If you have nothing, the bank doesn't want to lend to you.  If you have a lot, the bank will want to lend to you.  

If you really need to make money from trading, its hard to not  be desperate.  When you have lots of expenses, and no income except from trading, its nearly impossible to trick your mind into thinking from a position of strength when you are in a position of weakness.  Its why those that do make it as full time traders are mostly young traders, who don't have families, who have fewer expenses, and less to lose when blowing up.  The nothing to lose mentality actually can reduce the desperation of having to win.  And if you add risk management to that, then you have a chance to make it in the long run.  

Nothing noteworthy in the COT data or the put/call ratios last week.  Asset managers made small reductions in net long positions in index futures, and dealers reduced some of their net short positions.  Bond yields have stabilized around 4.5%, which is good news for risk asset holders.  It looks like we got the fear based bottom in both bonds and stocks in January after the hotter than expected NFP number along with the pre Trump inauguration jitters on tariffs.  

Last week began with tariff news at the start of the week, and ended with tariff news at the end of the weak.  These headlines ignite 1-2% moves, but they don't last.  The more often you get these headlines, and the more predictable they become, the less they will move the markets.  It appears a lot of selling was front run on Friday afternoon ahead of the potential announcement of reciprocal tariffs.  If tariffs are the worsㅅ thing that can happen to this market, then that's not really bad news.  Tariffs are easily taken off, and their effects are overrated.  Especially if you get all those tax cuts that Trump is looking for.  

Still holding a small long position, not looking to make any big moves here, in this narrowing range.  Although if I didn't have any position, would be taking a long position on any tariff fear induced dips this week.   

Lowering Expectations

Once again, the market gets kneecapped by news, this time, something that was kind of expected.  Everyone knew that tariffs were coming, just not sure when and how much.  The reaction to the news is a bit surprising, since this wasn't completely unexpected.  It shows you how much optimism was priced into the market after the Trump win, as everyone was talking about the good things coming, and not much about the potential bad things coming.   We are still working that off, with these violent gap down moves, showing you how bad it is to be long stocks when there is so much enthusiasm.  

Its been 1.5 months since the beginning of the real shake out, starting from the December FOMC meeting.  Usually, these shake outs and pullbacks last about a month.  But this one has been so choppy with big moves in both directions, that its not a typical pullback.  Its more of an off/on selloff that would normally be completed in less than a month, but with the intermittent face ripper rallies, you've not been able to get a real purge of the saturated positioning that was present a couple of months ago.  

With this latest piece of "bad" news, we are getting closer to the end of this choppy correction.  This is not a stable condition for the market, to have these huge gap downs and then equally huge face ripper rallies right afterwards.  Eventually you either blast higher and resume the uptrend, or the market keeps going lower, really flushing out the weak hands and scaring investors.  

From an economic viewpoint, there should still be an initial boost from the Trump win with more investment spending and looser credit and regulatory conditions at the banks in the next few months.  It makes it likely that you will have at least a bounce from these selloffs, or more likely, a typical resumption of the uptrend after a corrective period.  

Tariffs are overrated and overhyped.  Because they are unpopular, they are unlikely to stay on for the long term.  Most of the US population doesn't like higher prices for imported goods.  Most of the US population won't benefit from any trade protection coming from tariffs.  And most of the US population doesn't like lower stock prices that are coming from tariffs.  Since most of these imported goods can't be substituted by goods produced in the US, it just ends up being a tax on consumption and production.  From past history, Trump is likely to declare victory over his tariff strategy after he gets some token concessions.  

Its actually a better thing for the market to have the tariffs come out from the beginning, in order to lower expectations for the coming quarters for economic growth.  The expectations were a bit too lofty going into 2025, with irrational expectations of strong growth coming from de-regulation and future tax cuts, with very little concrete evidence.  Now investors are slowly coming back to reality, with the DeepSeek news and now tariffs driving away a lot of that unbridled enthusiasm, and keeping the trend on a more sustainable path.  

The string of big gap downs and bad news is actually a bad thing for the bears in the short to intermediate term.  There was a risk that if you didn't get any bad news, and the market kept going higher after the bottom in mid January, you could have had a nasty blowoff top made in February/March, leading to a much bigger correction.  Since the SPX has been contained below 6125 on the rallies, it means that the selloffs don't have as much fuel, and won't be as long lasting.  You just haven't had enough time for the weak hands to build up big long positions again, like they did in early December.  

The COT data as of last Tuesday, didn't show any big changes in positioning, with asset managers adding a small amount to their net long positions.  Looking at the ISEE index, you can see that the enthusiasm has been pared back to more normal levels of call buying.  

The excessive optimism has been pared down and you are back to more neutral levels of sentiment among investors.  You can see that in the NAAIM exposure survey.

The bond market has stabilized closer to 4.50% after selling off to 4.80% 10 year yields.  This should help stocks from going down much further.  The bond market doesn't seem to be fazed by tariffs, which shows that speculative positioning is much lighter and you probably have CTAs short bonds here, which adds potential short covering fuel for bonds if inflation isn't as sticky as many expect for 2025.  

Still holding the small long position from last Monday, I may add to the position if there is a further selloff from the current levels in the coming days.  Leaning bullish, but not a great risk/reward so keeping positions small.