Bubble Gets Bigger

WW3 was avoided and the market squeezed higher last week.  The BTFD crowd won again, although a 1.5% drop is not much of a dip.  The bubble is inflating again, and that is both good and bad.  Bad if you are short, but good if you are long or in cash waiting to short.   This may be the best thing to happen for the shorts, as such a quick move higher means less possibility of a long term grind higher move.  Those long, slow meat grinder up trends are absolutely deadly for shorts, especially for bears who are long puts.   

In the short term term, there is not much positive for those shorting the market here.  The market shook off one of the worst seasonal periods of the year and just blasted higher last week.  The previous all-time highs didn't even act as a speed bump for this freight train.  Usually you see some hesitation and consolidation at the previous highs, especially after a huge drawdown.  But not this time.  This shows immense buying pressure and its not something I want to fade quickly.  The first half of July is the start of the 2nd half of the year.  Its a time when you tend to see a lot of inflows into stocks and historically the most bullish 2 week period of the year.  

Last week, the big winners were the AI names, especially NVDA, which was the strongest of the Mag 7.  Investors are chasing the highest beta names, as they believe those have the most upside.  The animal spirits are percolating throughout this market.  Its interesting to see though that the recent macro fund favorite, European equities, have been lagging badly for the past month.  It just shows that when investors get greedy, they like to go back to the most reliable and highest beta playbook: US big cap tech.  Haven't seen so much love for big cap tech since 2021.  

A lot of the buying in April and May came from retail investors, in June, a lot of the buying is coming from hedge funds.  Macro HF beta to equities has skyrocketed, and is near the highs in 2024.  

Nothing noteworthy in the COT data last week, asset managers are still reluctant to get back to aggressively long positioning.  Dealers got shorter.  Overall, still a bearish picture for SPX futures, but its been that way for several months.   

I see some tremendous long term shorting opportunities just as the economy is starting to show signs of slowing down (weaker housing market, labor market).  There is a reason that the Fed is starting to get more dovish.  Yet, most investors view the Fed's dovish turn as a big positive.  I would disagree, as monetary policy has lost a lot of its effectiveness with the mass mortgage refi's done in 2020-2021, and the huge budget deficits that provide so much interest income to the wealthy through Treasury issuance.  Lower interest rates = lower interest income coming from the US Treasury.  

Covered my shorts last week for a small loss, but actually excited to see this kind of move up as this bubbly price action sets up a much more volatile and opportunity rich environment later this year.  

WW3 = BTFD

"But as long as the music is playing, you've got to get up and dance. We're still dancing." - Chuck Prince, Citigroup CEO, July 2007.

"What the wise do in the beginning, fools do in the end" - Warren Buffett

World War 3 fears couldn't have come at a better time for retail investors.  They can now load up even more on the most speculative stocks at a discount to sell to the greater fools after the no WW3, no nuclear apocalypse relief rally!

The consensus view among the majority that I see on Twitter and the  financial media is that geopolitical events are usually buying opportunities, and that the recent crude oil rally won't last, and oil prices should go right back down.   It is true that most geopolitical events end up being nothingburgers, and those dips are usually buying opportunities.  But that's when there is actual fear that is generated during those dips.  Right now, we've yet to see real fear from the Israel/Iran war.  The VIX has rallied, bu the market has hardly done anything, only selling off in drips and drabs.  As of Friday's close, it was less than 2% down from the recent highs.  

Talk is cheap, so I don't fully trust anecdotal evidence.  I need to see it backed up by trading and positions data.  The put/call ratios have been subdued since Israel started its attack on Iran a couple of weeks ago.  There remains a lot of wild speculation in the most high beta, speculative names like CRCL and CRWV.  Bitcoin treasury plays that are small cap low float pump and dumps are still hot.  Retail investors love this stock market.  

It is getting late in this bull market.  Really late.  There is widespread retail investor participation.   Retail flows into the S&P 500 are above the everything bubble days of 2021.  You can see this in the huge rallies in highest beta and most speculative tickers.  One of the hallmarks of late bull markets is the lack of fear when you have pullbacks, even on "scary" geopolitical headlines.  When the consensus view is that pullbacks are buying opportunities, that is when things get dangerous.  

The institutional investors are also warming up to this market.  Despite the daily Middle East war headlines, investors in the NAAIM investor survey are now just as bullish as they were in February, before the tariff madness.  

EPFR fund flows data shows huge inflows into equity funds from June 11 to June 17, estimated at $38.1B for the week.  

Still holding the short position put on a couple of weeks ago.  The war headlines are a red herring that is taking attention away from what matters more in the next few weeks:  the tariff deadline decision.  We are heading towards the deadline with a lot of complacency on tariffs, with TACO being the meme of the times.  This provides an asymmetric reaction function to bad tariff news vs good tariff news.  Good tariff news may take this market up 2-3% over a few days.  Bad tariff news would like take the market down 8-10% over a few days.  I do believe it will be another TACO moment as the tariff deadline approaches, but I wouldn't bet on it with any long exposure.  At the same time, if the market pullbacks ahead of the deadline, I would not want to be short ahead of the decision.  

There hasn't been a big move yet, and it looks unlikely that we'll be getting that 5% pullback down to 5700-5750.  While I am longer term bearish, I recognize that Trump is likely to kick the can for the tariff deadlines on July 9, which will get rid of the uncertainty for a few more weeks.  And crude oil should eventually go down after the shorts all are squeezed out this week due to the war.  I expect the Fed to start getting more dovish as the economic data gets weaker.  You are already seeing some signs of internal dissent against the non cutting Powell.  Waller is trying to audition for the Fed chair role after Powell's term ends, and he's coming out super dovish.  

We are in the start of a short term bearish seasonal period after the big June triple witching opex and the start of corporate buyback blackout period.  Staying short for now, but will look to scale out of shorts this week on weakness.  

Kid's Hurdles

The Israel-Iran War will be over before you know it.  The market "overcoming" this event, effectively jumping over kid's hurdles, will be hailed as bullish.  I can already picture the bullish reaction if we get a short term bounce on Monday-Tuesday.   Those managing real money are not freaking out about a war that will last a few days.  Even if it lasted a few months, the fund managers would NOT care.  

Israel knows that it can get away with a lot of war crimes (anywhere) as long as Iran's crude oil export capacity is not touched.  That's a red line they are not going to cross.  Iran's leaders also realize that if they do anything adventurous that would cause a spike in oil prices, it would make regime change even more likely.  So the most likely scenario is a nothingburger for the financial markets.  And the markets are pricing in that fact, by not doing much.  It may freak out some headline focused overleveraged day traders and 0DTE options jockeys but its not going to move the needle for fund managers.  

The war will get a lot of air time and coverage by a hyperbolic media that will try to make it like its the start of WW3.  And I'm sure a lot of bulls will buy into the belief that this is an unstoppable bull market that can overcome anything, including the threat of WW3!  All of a sudden, instead of war being a negative catalyst, it will make people even more bullish on the market.  Of course, getting even more bullish just 2% from all time highs, at historically sky high valuations, with economic growth slowing, and with a tariff off/on switch active in the White House.  The overriding view that I see on Twitter these days is BTFD, TACO, dips on geopolitics is always a buying opportunity, nothing stops this train, etc.  Retail has been brainwashed into believing that the US stock market is invincible.

The 2022 bear market has done nothing to discourage these retail stock gamblers who fashion themselves as long term investors in high growth stocks, with no regard for valuations or fundamentals.  In fact, the 2020 Covid flash bear market and 2022 bear market may have emboldened these punters into believing that if you don't sell during a big down move, stocks will always comeback quickly, and go much higher quickly.  The thought of an extended bear market is the farthest thing from their minds.  This attitude coincides with the highest allocation to US equities in the last 75 years.  Higher than 2000, higher than end of 2021.  

The more you experience the markets, the more you realize that irrational herd behavior can be rampant in the short run to intermediate run.  But this usually results in a painful payback for that behavior in the long run.  

Nothing noteworthy in the COT or put/call ratio data for last week.  The bullish forces from the June quarterly opex are soon to be behind us, and I expect a post opex hangover after the huge rally from the April lows to the June highs.  Lots of calls options are in the money, that will soon expire, forcing dealer selling, and most June put deltas have already evaporated.  We are also entering the stock buyback blackout period in late June, which will eliminate a lot of the positive buy flows for US stocks.  These seasonal factors show up in the performance historically for the 2nd half of June, which are among the weakest of the year.  

The tepid reaction of the Treasury market to the Israel/Iran War shows how little safe haven demand there is for US Treasuries.  The world is awash in Treasuries after the blowout annual budget busters from the US government since 2020.  The unwillingness for Treasuries to meaningfully rally without a big stock selloff means that a stocks up, bonds up scenario is highly unlikely even in a Fed cutting cycle.  This bond market weakness is an incremental negative for stocks.  Bonds continue to trade terrible and I don't see it improving much until you get closer to the end of Powell's term, when the bond market tries to price in a much more dovish Fed from May 2026 onwards.  

Last week, we finally reached my target price level for a good risk/reward short at SPX 6050.  I entered a short SPX position around those levels and plan to hold the short position for several days.  

Approaching the Apex

We are approaching the top of the mountain.  For anyone who's climbed a big mountain, the closer you get to the top, the greater the sense of excitement,  achievement, and euphoria.  This is what is happening in the US stock market.  You can sense it from the return of complacency (TACO trade), speculation in risky assets like bitcoin, and even seeing the beginning of a move towards low quality, like the Russell 2000 (massively outperforming SPX in the premarket).  

With Russell 2000 lagging so badly over the past year, when it starts outperforming after an extended rally, its often a sign of investor exuberance and excessive speculation.  The Russell 2000 is a different barometer than it was in the pre 2020 era.  Before 2020, the Russell 2000 usually outperformed coming out of bottoms as risk seeking investors flocked towards the more speculative and higher beta small caps.  Back then, Russell 2000 would top out before the SPX and Nasdaq, acting as a canary in the coalmine signal of waning upward momentum.  No longer.  Now Russell 2000 outperformance is a sign of investor complacency and exuberance, happening after extended rallies.  

Tops take time to form, which make them tricky to trade.  Tops breed complacency.  Bottoms breed fear.  The tops that lead to bear markets (not just corrections) usually have the following attributes:  

1. Consistently high inflows into equity funds/ETFs and speculative high beta stocks showing increased retail investor interest in stock speculation/investing.  (Check) 

2. Big gains in the stock indices over the past 2-3 years.  (Check)

3. Historically high valuations.  (Check)

4  Economic growth decelerating. (Check)

5. Investors getting less bullish as uptrend flattens out and gets choppy, but still staying fully invested.  (Check)

We reached a peak in investor bullish sentiment in December 2024, after Trump winning the election.  There was euphoria over future tax cuts and deregulation and hopes for a repeat of the SPX performance during Trump's first term from 2016 to 2020.  The Fed meeting last December where dove Powell left the room and hawk Powell returned was the beginning of the topping phase.  The SPX reached higher highs in February, but investors were getting less bullish as tariff news started to come out.  Usually bullish sentiment tops out before prices do.  There is often a delay of several months before dropping bullish sentiment eventually shows up in the SPX with a big selloff.  

In the 2000 top, investor bullish sentiment actually hit a peak in December 1999, when the original dotcom bubble bellwethers YHOO and AMZN peaked.  The Nasdaq continued to go higher until March 2000 but that was led by second wave of dotcom bubble stocks like CSCO, various semiconductors, and speculative biotechs.  Just as NVDA was the first wave speculative leader of the 2023-2024 boom due to AI, it topped out before the second wave of more speculative stocks like quantum computing, PLTR/APP type of pseudo AI names, and of course bitcoin, which are still going.  

You are seeing a second wave in the bitcoin froth with various junk small caps starting bitcoin treasuries, leading to one day jumps in their stock of hundreds of percent (SBET, NAKA, etc.).  We are finally getting some big IPOs in the bitcoin sector, with CRCL and STRD.  This is all happening as the US economy is noticeably slowing, with historically nosebleed valuations.  

Tops take time, but they don't last forever.  The most extended top was in 2000, when the SPX chopped violently in a range for 8 months from December 1999 to August 2000.  Then the bear market started in earnest in September.  In 2007, the SPX went most sideways from June to October, so 4 months in a choppy range before the start of the bear market.  In 2021-2022, the SPX went mostly sideways from September 2021 to March 2022, about 7 months trading in a choppy range before the bottom fell out and the bear market really got started.   So the 3 most significant tops in the past 25 years took approximately 4, 7, and 8 months to complete before a bear market really got started.  

The SPX is no longer in a clear uptrend, but in a sideways chop, with long term moving averages flattening out.  It has been 6 months since bullishness hit a peak last December, and we've been in a choppy range ever since.  Given how much time we've gone sideways, something has to give.  If my thesis is correct and the current market is forming a meaningful top, history says that there is not much time left before a bear market starts in earnest.  

Given that its been 2 months since the SPX bottomed in April, enough time has elapsed for many traders to get back to previous net long exposures.  Retail investors have consistently been the most bullish on this market.  That is 2000 type of stuff.  That is a bad long term sign, as they are historically even worse market timers than the institutions.  The TACO trade, less fear about tariffs, more calls for all time highs, and increased complacency among investors are signs that the market has priced in a lot of good news and optimism.  It took some time, but hedge fund net flows are now back to beginning of the year levels, and above levels seen at the all time highs in mid February.  There is now ammo for both retail and hedgies to panic if we see a significant correction in Q3, which is my base case.  

Private client equity allocations at Bank of America show historically high levels.  Only the crazy speculative period in 2021 tops the current levels at 63%.  This is potential fuel for a nasty bear market if private clients just get back to just average levels of 56%.  

The latest COT data was a mixed bag, as asset managers meaningfully decreased SPX long positions even though the market went higher for the week ending June 3.  However, small speculators increased their long positions.  

You saw something similar as asset managers decreased SPX long positions as the SPX grinded higher in late 2021, as the SPX was making a meaningful top.   

Last week was brimming with weak economic data, which was mostly shrugged off.  The feared nonfarm payrolls report is behind us, and tariff fears are much diminished with Trump recently having a good call with Xi, opening the door for chicken little longs to buy as there is now more "certainty".  Now expectations on tariffs are too bullish, as most assume the drama is over.  While that's possible, knowing Trump, he loves to shake the tree to become the center of attention again and then be the one to play hero and make trade deals, pause tariffs, or try to pump stocks by saying its a good time to buy, etc.  He is both the arsonist and the firefighter.  All the while being the center of attention, which he craves.  I expect him to throw a wrench into the TACO trade before the July 9 deadline for the tariff pause.  With the amount of buying and re-risking that's happened over the past 2 months, I expect a sharp correction for the next 2-3 months.  

Still not yet at that exquisite short moment, but we are getting close enough that I would rather be a bit early than try to time the top perfectly and miss this golden shorting opportunity.  Thinking the most likely scenario is a top around SPX 6050 after the CPI release and a short term pop in both stocks and bonds on that data point.  But I'll probably start scaling into shorts into any strength this week starting on Tuesday and adding till the end of the week.  For those with a bearish bias, this week will be the time to strike.

TACO = Complacency

They're talking about the TACO trade.  Looking in the rearview mirror.  Again.  Yes, Trump always chickens out.  But it's a red herring.  It assumes that this is a good stock market to invest in if Trump doesn't go through with his tariff threats.  That is a news-centric view of the market that ignores long term fundamentals, positioning, and recent investor flows.  

With the rise of the retail investor, market viewpoints have gotten more short term, less fundamental, and more news-driven.  The percentage of volume coming from retail is much higher now than it was even 10 years ago.  Its probably higher than it was even in 2000.  It breeds short term logic and causes kneejerk market reactions.  

Last week you saw Trump back off within days of the tariff threats he put on the EU.  It led to a huge gap up.  Then you had another monster gap up in the works after the Court of International Trade, whoever the hell they are, said that Trump's tariffs were illegal.  By the way, these judges are part of the swamp, as they will do anything to further corporate welfare, in order to boost the stock market.  Its irrelevant because Trump will chicken out anyway on the tariffs.  But still, it shows you how deeply entrenched corporate lobbyists are in all branches of government.  The market reaction to that kneejerk rocket higher in the overnight session was valuable information.  The market sold the news relentlessly, taking back all the gains in the regular market hours.  

The same thing happened to NVDA, as it gapped up much higher after better than expected earnings, only to see all the gains evaporate on Thursday and Friday.  The market is starting to feel heavy above 5900, as good news is not being followed by sustained strength.  Its quick moves higher that are now faded.  

It has lowered the bar for entering short positions in the coming weeks.  Still looking for that exquisite short opportunity if SPX breaks above 6000 and the paper napkin chartists get even more bullish, but it might not happen.  Early June is a bullish time of the year seasonally, and the systematic and CTA funds are still either short or have very low equity exposure.  But the discretionary funds and retail crowd are back to high equity positioning.  

The NAAIM sentiment survey shows institutional investors are back to being very bullish.  

The COT data showed large speculators adding to longs.  We are seeing signs of long saturation in the SPX price action.  There could be one last gasp rally in June due to systematics jumping on to the bull bus.  Or it could be that we've seen the top already for this move in the overnight market on that tariff ruling from the Court.   Hopefully we get that last gasp rally as that would set up a really great short entry for the big move lower that should happen in Q3.  

What was the most interesting part of the COT data last week was in the Treasuries.  Across the curve, small speculators added big size to their net long positions.  This is counter to the weakness that we've witnessed in May for the long end of the curve.  They are buying the dip heavily in Treasury futures.  Small speculators tend to be wrong so it does make me begin to question my thesis of economic/stock market weakness leading to Treasury market strength, especially in the long end of the curve.   In any case, its a bit of a bearish sign for bonds, and even for stocks.

2 Year T-Note Futures

10 year T-Note Futures

Ultra Treasury Bond Futures

On the sidelines but looking for a good spot to get short.  The bulls are on borrowed time here.  Retail investors are complacent and heavily invested in stocks, and the price action is getting heavier.  Institutions are a bit cautious, but still way above average net long positioning if you go back to a 20 year window.  Lots of economic data coming out in the next 10 days, it may help form a top if its better than expected and the cautious bulls finally get on board.