Angel Falls

This is a monster waterfall decline.  The excesses that have been building up for years through central banks, tax cuts fueled by huge budget buster deficits, and finally investor complacency and exuberance after the US/China phase 1 trade deal are now coming home to roost.

Other than the Nasdaq bubble popping in spring of 2000, there has been nothing like this kind of selloff coming from an all time high.  Even the fall of 1987 had a small downtrend forming before the big waterfall hit.

You cannot compare it to October 2008 because the market was already in a bear market before the steepest decline happened.  And this is much much worse than anything we saw in 2011 or 2015.   The economy will be much weaker than anything we've seen since 2008, and its likely that it will be worse than 2008 because this coronavirus will probably come back even stronger in the fall, if it follows a pattern like H1N1 flu in 2009.  

There will be a playable bounce soon, but with this kind of selling, there could be margin calls waiting to happen and that could push this market even lower than where it normally would bottom.  SPX 2600 was a strong support level in 2018, but it was such a long time ago, it reduces its significance.  Of course there is a lot of psychological support at 2500, and above that, the February 2018 low at 2530.  So there are levels that traders will try to bottom pick here, and eventually one of them will stick for a multiday rally.  But the fundamentals are deteriorating so much and the economic picture is getting gloomier by the day, as the US government delays virus containment strategies in favor of trying to rescue the stock market.  That is a humanitarian disaster waiting to happen.

The plunge you are seeing overnight is the reaction to Trump's stock market saving approach, rather than a virus containment approach, which the stock market would actually prefer because it knows the longer the government delays serious action, the worse it will get for the economy.

For those who don't remember Nasdaq 2000-2002 bear market, it was a brutal one, and one that kept going and going.  SPX in 2020 is shaping up to be similar to Nasdaq in 2000, with a long bull market top forming followed by a sharp waterfall decline.

Right now, we're in a similar point as the middle of April 2000, which means that if this market follows the dotcom bubble path, then we should see a strong bounce within days, and then a retest at a slightly lower low in about 30-40 days.   

This being a Thursday, there is looming weekend risk and I am sure investors will not be looking to chase stocks higher heading into another headline driven weekend coming up.  But we are definitely in the panic capitulation phase now, and those are violent but usually brief.  I expect there to be a strong bounce next week, so the risk/reward is definitely getting more favorable for the bulls. 

Pricing in a Recession

The long feared recession which would make investors bearish is here.  There is no doubt about it.  The coronavirus will plunge the world into a global recession, as reduced consumer spending, job cuts, and reduced production will overwhelm any kind of fiscal response, which is usually a dollar short, and a day late. 

Contrary to what the so-called bond experts believe, the move in Treasuries over the past few days is not irrational, but a swift realization from the most efficient market on Wall Street that a recession is coming, and the Fed is going to zero in a hurry.  The emergency 50 bps rate cut from Powell was a screaming signal that the Fed is panicked and will cut aggressively to zero.  And bond investors remember how long it took for the Fed to go from zero rates to their first rate hike (7 years).  That is one of the reasons the yield curve is not steepening, the bond investors are chasing yield by going out further out on the to 30 years, the only part of the curve yielding above 1%. 

We are pushing forward a bear market due to the coronavirus economic shock, which is going to be in many ways, just as bad as 2008, but instead of financial danger, it is physical danger that people will have to deal with.  And that is something that hasn't happened since the Spanish Flu in 1918.  This coronavirus should be named the Wuhan virus, because it is the Chinese who have probably released the virus from their biological weapons lab, either through human infection or lab animal viral transmission.  Of course, there will be no concrete evidence or news coming out of China to reveal the truth, it will just be assumed that it came from wild animals at some wet market, which is hard to believe. 

Anyway, we finally have headlines and news which are going to more impactful than what Wall Street expects.  That is a rarity in an age of chicken little investors that get frightened by Iranian missles, small tariff hikes, and a little repo rate volatility.  The coronavirus is the real deal, it cannot be overexaggerated enough, because people are underestimating how easily this virus is being transmitted, with many passing it on to other without having symptoms.  It appears that China has gifted the world with a new viral disease that will have to dealt with on a permanent basis, as the characteristics of this virus make it hard to completely eliminate. 

The U.S. government approach of reluctant testing and trying to paper the problem over with tax cut proposals and rate cuts doesn't get to the underlying problem of virus containment.  This presents longer term and more severe economic problems where more draconian measures of quarantine and people staying home will be necessary (like what Italy is doing) to try to contain the spread of the virus. 

The longer governments wait to control the problem, the harder it will be to contain the spread.  This coronavirus economic shock will be long lasting seeing how easily it is spreading and with a lethality about 20 times that of the ordinary flu, which kills plenty of people as it is, even with a vaccine available.  When people stay at home and avoid crowds, stop going to the mall, movies, sporting events, concerts, traveling, etc, that has a huge impact on the velocity of money and the unemployment rate.

Short term, it looks oversold and with the ECB meeting Thursday and FOMC next Wednesday, there will probably be a equity market bounce in the coming days, but I would use that bounce to either get short SPX or long Treasuries, even at these very low yields.  And the only way I would be playing the SPX on the long side is to wait for extreme oversold conditions to buy.  It will be easier to play the short side at least for the next few weeks. 

Stock market investors have forgotten what a real bear market is, expecting this to be quick and easy just like fall 2018 deep correction, or an August 2015-February 2016, or an August-September 2011 correction.  I just don't buy it.  The valuations are too rich, the yields are already too low, providing no risk parity benefits for long bond holders, and the economy will be much weaker than anything you saw in 2011, 2015-2016, or 2019. 

I will be trading with the assumption that we are now in a bear market, and that requires different rules.  It is something that most investors have forgotten or never experienced before, and I am sure will catch a lot of traders off guard in the coming months.   I'll get into that at another time. 

Stairway to the Basement

Jerome Powell pushed the panic button today and he has accelerated the eventual Fed funds ZIRP process.  It was not a matter of if, but when.  Powell decided that this was the right time to push the button, and I don't disagree.  And he probably knows that it isn't going to help much in this situation, as he admitted so in the press conference.  It is obvious for anyone that has any grasp of the magnitude of the economic consequences of consumer and business behavior in coronavirus infected countries how bad the economic data will get over the next 6 months. 

And the U.S. government has decided to be an ostrich, and pretend like the coronavirus is no big deal, with almost no testing, which assures that there will be very few infected numbers.  The CDC has been a cheerleader and have been totally incompetent since the coronavirus first hit the news, have tried to downplay the coronavirus almost as if to protect the stock market. 

This head in the sand approach can be a very short term positive for the market, as there will be less panic near term, as the number of coronavirus cases is kept low with almost no testing, until it blows up, and it can't be hidden from view any longer, when an outbreak occurs, at which point, the market will really panic.  Considering the government response to the situation, and the contagiousness of this virus as seen in other countries, an outbreak seems almost inevitable, and no one will know until hospitals are flooded with virus laden patients.
 In fact, for non-virus infected people, going to the hospital would probably be the most dangerous thing they could do, as it will be a literal virus factory at that point. 

Anyway, back to the markets.  The market is not dumb, which makes it harder than it used to be to make money.  Because it rightly has rallied bonds strongly off this 50 bps emergency cut.  The main benefactor of lower Fed funds rates is not stock investors, its bond investors.  Rate cuts during an epidemiological crisis are basically meaningless.  Isn't it unusual that the country with one of the fewest recorded coronavirus cases is the most aggressively easing?  It tells you how dovish and prone to ease the Fed is, and how reluctant Europe and Japan are to go to even more negative rates, as it is painfully obvious that the European banks can't handle even lower rates. 

The door is now wide open for the Fed to press on the gas, go straight to zero, and if there are any more drops in the stock market, a full blown across the curve QE.  That will obviously be dollar negative, as the rate differential between US and Europe will be about 1/2% and considering Europe's fiscal restraint relative to the US, it makes a euro a safe haven from MMT, where the US is already halfway there to embracing it to solve future problems. 

The volatility is through the roof, yesterday's high low trading range during regular trading hours was 5%, and as I write, there is a nearly 2% gap up mostly based on Biden's Super Tuesday wins.   I was looking to buy any dips today, but with such a big gap up, I will take a pass and wait for better opportunities.
 

Post Waterfall Templates

"History doesn't repeat, but it does rhyme."

Wow, that was a nasty week for the SPX.  Weekly close at 3338 on Friday, Feb. 21, to 2954 on Friday, Feb. 28.  If you look at the chart below, you will  see that a monster bubble popped, because we're back to more stable, but still very high levels for the SPX.  Over the last 4 years, as shown below, you've gone from SPX 2000 to SPX 3390.  That is on top of a move from SPX 1250 to SPX 2000 the previous 4 years preceding 2016.  I would call it the central bank money printing bubble, because bond yields have been going lower and lower the whole time, to an all time low 10 year yield of 1.12% hit on Friday, Feb. 28.

February 2016 - February 2020

We finally hit a level on Friday where there was buying support, as well as Fed support, with Powell issuing an unanticipated Fed statement that he is watching markets and willing to provide appropriate policy (i.e., jawboning rate cuts coming) response to the coronavirus.

We are close to Fed panic levels, which always provides a market backstop and rally on their first move.  For long time SPX futures traders, they will remember the Bernanke Fed emergency discount window rate cut on Friday August 17, 2007 after the panicky drop down to the SPX 1370 on August 16, 2007 (see chart below).  For even longer time SPX futures traders, they will remember January 3, 2001, when Greenspan cut interest rates 50 bps intermeeting and that proved to be the intermediate bottom of the down move and provided a 3 week face ripper rally. 

February 2019 - February 2020

August 2017 - August 2018

 Top:  01/26/2018 = 2872.  Bottom:  02/09/2018 = 2532.  Bounce Retracement Top:  03/13/2018 = 2801.  79% retracement.  Retest of bottom:  04/02/2018 = 2553.  52 days from first bottom. 

March 2015 - March 2016

Top:  07/20/2015 = 2132.  Bottom:  08/24/2015 = 1867.  Bounce Retracement Top:  09/17/2015 = 2020.  58% retracement.  Retest of bottom:  09/29/2015 = 1871.  36 days from first bottom. 

February 2011 - February 2012

Top:  05/02/2011 = 1370.  Bottom:  08/09/2011 = 1101.  Bounce Retracement Top:  08/31/2011 = 1230.  48% retracement.  Retest of bottom:  10/04/2011

 = 1074.  55 days from first bottom. 

November 2009 - November 2010

Top: 04/26/2010 = 1219.  Bottom: 05/25/2010 = 1040.  Bounce Retracement Top:  6/21/2010 = 1131.  51% retracement.  Retest of bottom:  07/11/2010 = 1011.  47 days from first bottom. 

July 2007 - July 2008

Top:  07/19/2007 = 1555.  Bottom: 08/16/2007 = 1370 .  Bounce Retracement Top: 10/11/2007  = 1576.  111% retracement.  Retest of bottom:  NONE.

Local Top:  12/11/2007 = 1511.  Bottom: 01/23/2008 = 1270.  Bounce Retracement Top: 02/01/2008 = 1396.  52% retracement.  Retest of bottom: 03/17/2018 = 1256 .   53 days from first bottom. 

October 1999 - October 2000

Top: 03/10/2000 = 5132 .  Bottom: 04/17/2000 = 3227.  Bounce Retracement Top: 05/01/2000 = 3982 .  40% retracement.  Retest of bottom: 05/24/2000 = 3042 .  37 days from first bottom. 

November 1986 - March 1988

 Top:  08/25/1987 = 337 .  Bottom: 10/20/1987 = 216.  Bounce Retracement Top: 10/21/1987 = 259.  36% retracement.  Retest of bottom: 12/04/1987 = 221 .  45 days from first bottom.  

 After reviewing past waterfall declines in the SPX/NASDAQ since 1987, all 9 cases above, with the exception of August 2007 (not a pure waterfall, but more like a stair step waterfall as it took 3 weeks from top to bottom), after the initial few weeks of choppily bouncing higher, they retested the lows.  And the retests were usually successful, as they either held previous lows, or made just small undercuts of the previous lows and bounced strongly from there.  Most of the retests occurred about 5-7 weeks after the initial low. 

If Friday was the low of this waterfall decline, which is likely but not totally certain, then that gives you a probabilistic road map on how things will play out over the next 3 months.  You should expect choppy trading, with a 40-60% retracement higher of the waterfall decline, before a retest happens, usually 5-8 weeks later.  Assuming SPX hitting a low of 2855 on Friday marking the bottom, then a 40-60% retracement of that low gives a probable top between SPX 3069-3176.  That is a wide range so its probably safer to wait at least 3 weeks to short the SPX, which is around the next FOMC meeting and March futures/options expiration.  That is probably the perfect time for a top to form, as after triple witching expiration is usually a bearish seasonal period.  Then the market should retest the lows sometime in the middle of April.  

There will be lots of trading opportunities over the next 3 months.  Having a guideline for what to expect (lots of choppy action, trending higher into March futures options expiration, and then post FOMC/triple witching hangover and downtrend.   The specter of more bad coronavirus news is what will keep the bounce limited, in my view, and thus out of the 9 cases examined above, I would lean towards a more bearish outcome and weaker bounce than the average post waterfall trade.  

Risk Storm

This what panic feels like.  This is worse than February 2018.  This is worse than August 2015.  This is almost as bad as August 2011.  I don't mention December 2018 because that was not a shock waterfall decline, this is.  When you go from low volatility to high volatility, that is what gets you.   It is the train that you don't see coming that runs you over.  When you expect a lot of trains to come by, then you are more careful and less likely to take big risks and get run over. 

I definitely didn't see this big of a move coming.  These waterfall declines are always low probability events.  And usually proceeded by a couple of months of volatile price action.  In 1987, the SPX topped out in late August, and crashed in middle of October.   In 2011, the SPX topped out in early May, and crashed in early August.  In 2015, the SPX topped out in middle of May, and crashed in late August.  All 3 of those waterfall declines were accompanied by tops that involved rising bond yields. 

Same with the waterfall decline in February 2018, which also topped the previous month with rising bond yields in January 2018. 

This time, we had steadily falling bond yields as the SPX made an all time high, and then crashed, which makes it unlike anything anything we've seen over the last 40 years. 

The only way to make sense of the price action is based on the complacent market environment and the massive overvaluation which left it vulnerable to investors panicking during a decline.  But even in similar overvalued markets like 2000, you didn't have this kind of a shocking drop in the SPX. 

Now it is about trading levels here, and as I write, the SPX is trading at 2928 overnight, leaving it in no man's land.  There should be some support around the SPX 2820 level, which is the low in August 2019, and if we somehow go beyond that, then we are talking about the June 2019 lows at 2730.  With this kind of volatility and the likely forced selling that it will precipitate if we go lower, you cannot rule out those kind of moves. 

So if you are looking to play for a bounce, know that you can face a big drawdown before this market bottoms.  But when it does bottom, it will be explosive. 

As it is a Friday, and with weekend coronavirus headlines lurking, the panic will be thick when the US market opens.  I will be looking to buy any panicky dips down towards the 2820-2840 level if they happen today, and if not, I will just wait.  And an  incomplete flush lower today would leave this panicky market vulnerable to a panicky Monday. 

I won't go into the coronavirus as you've got a million newly minted virus experts opining their opinions on pandemic possibilities and macroeconomic effects, but my opinion is that the market wouldn't be trading like this even with bad coronavirus news if traders weren't so bullish after the trade deal late last year and flowing into the new year. 

It is tempting to try to catch the bottom but when things get this volatile, a lot of forced sellling usually comes out so buying early can be painful.  For leveraged traders, its better to miss out on some upside or even miss the bottom completely waiting for great low risk entries rather than put your account at risk of a big blowup chasing the bottom here. 

Coronavirus and Fed/Bond Backstop

The market is now paying attention with a bunch of coronavirus infections coming out of nowhere in Italy.  The markets pay attention when things hit Europe.  Asia is still a minor player in global finance, just look at the ES and ZN overnight volume during a Globex session, with Asia being quiet and Europe being much more active. 

It is now abundantly clear that the number of coronavirus cases in China are being vastly underreported, probably by a factor of 10, so it wouldn't be shocking that 1 million Chinese are infected, as this virus seems quite contagious, even more than the flu.  In the worst case scenario, which is a global pandemic, you will have a monster central bank response which would contain the downside to 15-20% lower from here.  That is still a big move down, but not a deep bear market like 2000-2002 or 2007-2009 type of move lower. 

These quantum moves, stair step down are symptoms of an overly complacent market that has been ignoring earnings fundamentals and has just squeezed higher on momentum and a select few group of loved stocks, ironically, both high growth (tech), and highly defensive (utilities).  Historically over the last 30 years, you have not had a big move down in 10 year yields leading a big move down in stocks.  You have had a plenty of times when big moves up in 10 year yields led a big move down in stocks (1987, 1990, 2000, 2007, 2011, 2015, 2018). 

That doesn't mean you can't have a 5-7% pullback in stocks while bond yields are trending lower and lower, like May/August 2019, or October/December 2014, January 2015.  It just would be nearly unprecedented for the bond market to be so strong ahead of a waterfall decline of greater than 10%. 

It makes me less bearish here despite the complacency among US stock investors and the speculative fever in some of these growth names like TSLA and SPCE.  The Fed backstop is a huge factor in containing stock market downside, and the coronavirus is a convenient excuse for central banks to lower rates and expand QE programs.  With US rates still well above zero, there is still a fair amount of monetary ammunition that the Fed can deploy on a bigger panic due to the coronavirus.  The bond market is obviously sniffing this out and running ahead of the Fed in building up rate cut expectations, which the Fed almost always has to meet, and if they don't, another Dec 2018 like tantrum will happen.  And Powell doesn't want to deal with that again. 

Expecting SPX 3200 to be a support zone where it is probably worth a small BTFD play in SPX. 

SPX = 1996 Chicago Bulls

The parabolic rally continues.  The S&P 500 acts like the 1996 Chicago Bulls, crushing all opponents in its way.  The coronavirus just added more monetary fuel to the fire, and has probably extended the bubble by a few more months.  This time, the crowd has it right in regards to the coronavirus.  They aren't buying it as a sustained negative, unlike the fearmongers out there who will always find a boogey man under the bed (U.S./China trade and repo in 2019, coronavirus in 2020) to get negative.  The coronavirus is a net positive, because it is mostly contained to China, and has prevented global central banks from doing any kind of tightening and instead has increased the odds of more easing this year. 

That is why you are seeing 10 year yields near the lows of last year, as bonds rally with stocks and only the industrial commodities have been sacrificed at the altar of the market gods, a pittance compared to the stock and bond markets. 

Just as it has been since the Greenspan bubble days, the financial markets are under control of the Fed, who got scared stiff in 2019 and the coronavirus is another excuse for them to probably ease again this year.  Without a coming recession, Fed rate cuts are usually a market positive, because the market is getting both lower rates and while maintaining earnings.  That is the type of market environment, a dovish Fed with steady earnings that feeds the animal spirits and blows bubbles.  Yes, the valuations are getting to ridiculous levels but until the bond market starts showing weakness, there is nothing for the equity bulls to be afraid of. 

Eventually these kind of parabolic moves with excessive stock valuations end badly.  But leveraged traders can't take a lot of heat so the timing has to be right in order to profit.  With the Fed ignoring financial stability risks of a growing stock market bubble, things can continue to get even frothier before things fall apart. 

Based on backtests since the Fed started QE, the best predictive tool for the SPX is 10 year Treasury yields.  Treasury yields rising over a 3 month period have been a leading indicator of future SPX weakness.  We are nowhere close to that scenario now.  That is why I wait, even if the uptrend seems irrational and unsustainable. 

Exasperation

I am sure I am not the only one who is surprised by the rocket ship that the SPX has been this week.  I expected a bounce after Friday's massacre, but only to last week's highs, not to all time highs.  I am seeing some similarities between 2014-2015 and the current period starting from last summer.  I remember there was quite a bit of optimism in early December 2014 after the V bottom off the Ebola/growth scare in October, and plunging crude oil prices.   It ended up being near the top of the SPX (price wise, not time wise), and you had a lot of chop and flattish trading from December 2014 to August 2015 before the massive waterfall crash.  I could see a similar situation here, just like late 2014, with bond yields are stubbornly staying low and trending lower despite a relentlessly rising SPX. 

I see very little upside in the markets now with Presidential election uncertainty looming over the market and with an overvalued and overbought market.  I see plentiful opportunities on the short side this year as any new all time highs this year will be met with lots of selling due to the potential news bombs later in the year, with Bernie Sanders being the biggest one.  Right now, most are assuming that Trump will beat Sanders but most polls about a potential match up between the two have Bernie leading by about 5%.

It looks like Biden is slipping lower and lower, as his rallying cry about electability and having the best shot at beating Trump goes counter to the lack of enthusiasm most independents and Democrats have about the candidate himself. 

The best case scenario for the market was a Biden vs Trump election in November, because both candidates are Wall Street friendly and unlikely to try to raise taxes.  A Sanders vs Trump election is a heads/tails situation, Sanders you lose money, Trump you make money outcome.  A Bernie Sanders win by itself isn't so bad, as long as the Republicans maintain 51 seats in the Senate.  But Presidential election history shows that Congressional races usually have similar results to the Presidential race.  So a Sanders win would probably mean Democrats have gained seats in the Senate, giving them a possible 50+ seats which is enough with the VP tie breaker vote to pass the socialist legislation that Sanders wants. 

But right now, it is clear that the markets are not focused yet on the election, since it is so far away and because most believe that Trump would beat Sanders and would only really be challenged by Biden, who himself would be market friendly.  So complacency all round on Wall Street these days but that usually doesn't last for long with these kinds of overvaluation and parabolic charts. 

Lastly, on the stock of the year, TSLA, it is a great trading stock, with wild moves in both directions now that it hit a blowoff top this week.  It will probably consolidate its gains for the next few weeks but I expect another surge higher making it go past 1000 with ease.  I would rather be a buyer of dips on TSLA than shorting any rallies.  It is still in the parabolic up phase in my opinion.  There isn't enough supply of big market cap momentum growth stocks like TSLA to satiate the demand coming from both institutions and retail.  This isn't like previous bubbles like TLRY or BYND, TSLA has a better story and more of an institutional and cult following.  The bubble will probably last a few more months.

Wuhan Coronavirus Paradox

They say that its not the news that's important for a stock, its the stock's reaction to the news.  Similarly, its not the news that's important to the stock market, its the global central banks' reaction to the news that's important.  And the market is making the high probability bet that this coronavirus scare will make the central banks more dovish even with stock indexes in the US near 52 week highs. 

Reduction in consumer spending due to the Wuhan coronavirus will be short term and temporary, eventually leading to a bounce back of stronger consumer spending in the future.  But any easing that central banks do in the short term will last way beyond any short term economic weakness, providing a lasting boost to the stock market.  When the Fed cuts rates due to a short term economic hit, they don't raise rates when the economy recovers.  They usually wait many many months and even a few years before they normalize rates back to where they were before the short term economic downturn. 

Just like the flu and SARS, the virus is at its peak when people's immune system is at its weakest, during the winter.  So when the weather gets warmer, beginning around April and May, the number of new cases will probably go back down.  And that's all it will take for people to believe that the worst is over, and then it will be back to business as usual. 

As bad economic news is good news for the stock market in recent years, this will also make yields go lower, which delays the big stock market crash, because as I've mentioned many times before, a big selloff in the bond market is usually what is needed before you get a big selloff in the stock market.  The coronavirus will delay the bond market selloff. 

So the top for this stock market will have to wait, and even though it seems like Bernie Sanders has a very strong shot at winning the Democratic nomination, the market is distracted by this latest topic so it probably won't focus on the 2020 election at least for another month when the primary season gets much busier. 

Short term, the market is still vulnerable because of the parabolic nature of the rally, but with the way the bond market is trading, going up relentlessly, I just don't see a sustained selloff here, perhaps it could get down to as low as 3200 if traders really panic, but that will be quickly bought up and the uptrend probably continues because the Fed has your back, without a doubt now, because of this coronavirus.  Which is in an odd way, providing protection for the stock market via a easily scared Fed. 

Too Early = Wrong

Getting short earlier this month was way too early, so I was wrong.  But I am not giving up on the short side as the overbought extremes get bigger and the action in the hot tech names (TSLA, AAPL, MSFT, etc.) keep the market going higher while the small caps continue to lag behind.  This is reminiscent of the 1999/2000 tech bubble when the big caps and high growth names vastly outperformed everything else.  The big difference this time is the Fed is in an easing cycle, while it was in a hiking cycle in 1999/2000.  That makes this bubble more resilient than the one in 1999/2000. 

1970-1973 was another period where you had a small group of large cap high growth stocks (Nifty Fifty) leading the indices higher.  That also ended badly with a brutal bear market in 1973/1974. 

Unlike 1973 and 2000, the Fed is on the same side as the stock investors and speculators, making it that much harder to top out and transition to a bearish market.  The bond proxy names like utilities are also on fire, along with the high beta tech names, as bonds have remained strong.  So its not just the high beta stocks, but also the safety stocks that are outperforming here.  That's like an extra shield of armor this stock market has protecting it from any selloffs. 

That is why I've been keeping such a close eye on the stock/bond relationship over the past several weeks.  While the SPX keeps making new all time highs almost every day, the bond market has refused to selloff, and since the start of 2020, has managed to rally along with stocks, reliving the 2019 playbook of risk parity heaven, as stocks and bonds both went up strongly. 

The first sign of bond weakness will be the warning sign that the top is close.  We've yet to see that during this relentless rally.  There seems to be a lot of complacency not just in the stock market, but also in the bond market, as we haven't had a simultaneous nasty selloff in both markets since 2018. 

The strength in bonds has given me less conviction that there is an immediate sharp selloff, but it doesn't take away from my longer term bearishness based on overvaluation, lack of earnings growth, and a potential huge negative catalyst in the Democratic primary and later on the November election. 

Lastly, I know the latest news headline is the China coronavirus and fears of a pandemic.  I am sure if it gets really bad, China will do its best to cover up the severity of the problem so you probably won't know about it for several weeks.  There is a very small probability that if it starts spreading everywhere, you will get a big fear based selloff, focused on Asia, but the US trades like its an island unto itself anyway so in that scenario, I don't think it has lasting effects, it will just be a big dip that gets bought up. 
Most likely, this coronavirus gets less prevalent and is forgotten in a few weeks.

Start of Year Inflows vs. Lack of Buybacks

From the trading in the first 3 days of the year, the heavy buying at the cash open and the cash close hints at massive fund inflows into equities, and the strong bid under Treasuries during the first 3 days points to overflowing liquidity at the banks after getting past the end of year as well as beginning of year bond inflows. 

It is clear that the phase 1 trade deal has pulled in a lot of money into equities, with the Dec. 13-19 2019 week being the largest weekly ETF inflow on record, with massive inflows into a couple of ETFs that I've never heard of, IVE and IVW. 

Also, the past week covering the first 2 trading days of the year also had big inflows (Dec. 30-Jan 3, 2020): 

After investors were reluctant to put money into equity funds for most of 2019, by December, it was a turning into a flood of money going into equity ETFs, breaking all time inflow records.  But the liquidity coming from the corporate buyer will be low for January, as this is a very slow buyback month, with the buyback blackout period in effect for most companies till late January. 

As everyone knows, the headline these days is on Iran, and possible retaliation after the US strikes.  I wouldn't get too excited about a US/Iran military conflict causing a big selloff.  I have yet to see a war cause a sustained selloff in the stock market.  And even if there was one, its such a lopsided match that it would be like the Gulf War all over again if things did escalate.  I don't see consumer or business spending being affected in that case, and the extra government spending to fund the war would be like a stimulus package for defense companies. 

All the Iran news did was take attention away from the Democratic primaries starting in February.  So if anything, it has probably delayed the selloff that I am looking for by a few days.  Still bearish, and the US/Iran news has no effect on my market views.  Still expecting a selloff in mid to late January, with a price target for the SPX roughly around 3100-3150. 

Bull Hunting

I have been eyeing the short side since the phase 1 trade deal was confirmed in mid December.  I didn't want to jump the gun because of the seasonally bullish late December period, so I decided that if the SPX was at all time highs on December 31, I would short.  It didn't happen, but the equity fund flows coming in at the first day of the year have boosted prices to levels where I feel comfortable shorting. 

I have started the short SPX campaign this morning, putting on about half my position.  I will wait either for tomorrow or early next week to put on the other half, preferably on a good ISM index number coming out.  The time frame on the short is 3-4 weeks, looking for lower prices as the Democratic primary in Iowa gets closer (February 3).  Market doesn't like uncertainty, and right now, its a neck and neck for the lead in Iowa, with Buttigieg, Sanders, Biden, and Warren all between 10-25% in the polls.  

As we get closer to February 3, stock prices should get lower as the focus is on potential bad outcomes with a Sanders or Warren win in Iowa.  

A longer term short (3 months +) will have to wait, as we'll probably see a reflexive rally after the first major pullback from the big surge from October to December, so this short is to play January weakness ahead of the Democratic primaries, with stock buyback flows very weak as corporations are in blackout period and traditionally don't buyback much stock during this month.  

Setting Up for a Sell in January

There are a few things going for the SPX bulls that will last till the end of the year: 

1. Stock buybacks, which are large in December, averaging 10% of the annual buyback volume.  January averages 3%, the smallest amount for any month.  So we go from a big stock buyback spree in December to almost no buybacks in January. 

2.  Reluctance to sell stocks with big gains in the final 2 weeks of the year to delay capital gains taxes for 1 year.  This effect will be gone by January 2. 

3.  Portfolio window dressing for year end, after a big up year, most fund managers are reluctant to reduce their longs and want to show that they have a lot of long exposure at year end to their investors. 

4.  Seasonally, the last week of December is very bullish.  A significant part of that is psychological, as investors are in a better mood and less likely to sell. 

So why do I think it is setting up for a sell in January?  Because when you push things higher in December due to deferred selling due for tax reasons, stock buybacks, and seasonality, that gives you a bloated market that is higher than it should be. 

I have to admit that I didn't expect this kind of strength in the SPX in November and December.  I expected much smaller gains, but I underestimated how many weak hand investors were just waiting to buy once the US/China phase 1 trade deal was finalized.  Those fast money/weak hand investors are the ones that have been buying over the past week.  That sets up the SPX to a window of vulnerability in early 2020 when the above mentioned bullish factors disappear and the Democratic primaries get closer. 

The best time to put on an SPX short is probably December 30-31.  Waiting patiently and seeing a lot of opportunity on the short side next year. 

US/China Trade Tunnel Vision

It seems like traders have a really bad case of focusing on one thing, and the thing isn't even that important from first order effects.  I would like to offer a controversial take on the US/China tariffs.  They are equity market positive because they are bond market positive. 

The total value of the tariffs imposed on China is $88 billion, but that doesn't take into account the farm aid given out since the tariffs went into effect, which adds up to $28 billion.  So its a net $60 billion tax, which can easily be removed by either Trump or a new President after 2020 election.  The US government is running over a trillion dollar budget deficit, reducing that deficit by less than 6% with some tariff taxes seems like a pretty minor effect, no? 

And what has the Fed done after the markets took a dip in May and August?  3 rate cuts and QE4 or, QE lite, whatever you prefer to call it.  Of course, the QE was not called QE but just some massive buying of T-bills masked as repo operations to keep short term funding rates closer to Fed funds.  The reason you are getting the higher short term funding rates is because of the trillion dollar deficit, not because of some "plumbing" problems as some pseudo experts like to call it.  There were no "plumbing" problems when the budget deficit was half of what it is now, all of a sudden, the regulatory capital requirements is too burdensome and banks don't want to lend at Fed funds rates anymore? 

No, the banks are stuffed to the gills with T-bill paper, and that is tying up their reserves, so less money to go around for short term funding. 

And since the Fed is always going to come to the rescue whenever the market has a temper tantrum, in effect, big budget deficits in the future that naturally result in higher short term funding rates due to huge amounts of extra T-bill supply will be monetized by the Fed.  That is why in the short term, big fiscal stimulus is dollar positive, in the long term, it is dollar negative because it eventually leads to money printing.  That is in the first page of the Banana Republic 101 textbook. 

Anyway, the Fed has overreacted again to short term equity market weakness and come to the rescue.  That is why we are having a risk parity party this year, why SPX is making new all time highs, while the bond market remains strong. 

The good news for traders in the long term is that stock market overvaluation sets up future volatility which should make things interesting for 2020 and 2021.  This bull market is unlike a lot of the past bull markets because it is being fueled by stock buybacks and not retail and institutional inflows.  So the only way to get a sustained bear market will be to weaken the cash flows at corporations enough so that stock buybacks are reduced.  That can either happen through a weakening economy and thus weaker revenues and earnings or through higher taxes.  If a Democrat wins in 2020, there will be a lot of pressure to fund spending by increasing the corporate tax rate and income tax rates on the rich. 

So if you think the Trump Twitter bombs and trade news headlines are nervewracking, wait till the market reaction to the release of Presidential poll numbers and Democratic primary results.  2020 and the election will make 2019 and the US/China trade war look like a walk in the park. 

Fundamentals: What Me Worry?

This may be the trickiest stock market of all time.  Usually when you have a stock market bubble, with extreme overvaluation, there is a lot of euphoria surrounding it.  There is nothing close to a feeling of euphoria.  Even when stock investors were at their most optimistic, both in regards to the stock market and the economy, January 2018, you didn't get a feeling of euphoria.  It was just widespread complacency as volatility selling was en vogue.  Now, everyone knows that the global economy is slowing, and will be slow in 2020, but that hasn't stopped the SPX from making all time highs almost every day over the past 5 weeks. 

We haven't had a deep correction this year.  The May, August, and October pullbacks all stopped after 6-7% moves.  What was more surprising during those downturns was the reaction to them, instead of treating them like a normal pullback with relatively little fear, there was definite sense of gloom during those brief periods. 

Some are saying that the recent breakout higher in the SPX is because Elizabeth Warren is falling in the polls.  I don't think traders and investors are thinking that far out.  It still seems like everyone is focused on US/China trade, and the global central banks, to a lesser extent.  But it is interesting to see that the person benefitting the most from Warren's slide in the polls in Peter Buttigieg, who's been compared to Alfred E. Neuman by Trump.  What Me Worry? 

The only true guiding light in this kind of market is sticking with the view that the stock market will not go down hard unless the bond market is showing overt weakness.  And at no point in 2019 has the bond market shown overt weakness.  Therefore, you could never be short with conviction.  That is why I rarely tried to short this year, sticking by the conservative principle that there must be real bond market weakness before you get real stock market weakness. 

Those who have ignored the bullish signs coming from the bond market have probably shorted stocks regularly this year, seeing the stock market go up despite a weakening economy, no earnings growth, and high valuations.  More and more, the economy is having less of an effect on the stock market while the bond market is having a bigger effect.  This makes sense when you realize that debt has grown enormously over the past 20 years while the financial markets have become more closely aligned with the economy.  With very low population growth and almost no productivity growth, you have a moribund economy that can only find growth through financial repression, i.e., forcing investors to take more risk and increase the velocity of investment capital by going from Treasuries to corporate bonds and then to stocks and private equity.  That push is fueled by the central banks buying the Treasuries and MBS, giving investors the cash to buy riskier assets. 

So naturally, lower bond yields will keep the Ponzi scheme going longer as corporations have lower interest payments, and can issue more bonds at less interest expense.  Those bonds being sold to investors helps fund the massive stock buybacks which are the backbone of the demand for stocks in the SPX.  But at some point, bond yields are so low that unless they go negative, (very unpopular and unlikely in the US as they hurt the banks), you aren't going to have a meaningful impact on investor behavior with incrementally lower yields.   We are not at that point yet, but I would guess that if 10 year yields get below 1%, further decreases in yield will have diminishing positive effects for stocks. 

At that point, earnings will be all that matters, and that will be dependent on economic growth and margin expansion, both which don't look to be future positive catalysts for stocks. 

If we step back from the news cycle and take a long term view, there is really no good place for a long term investment in either stocks or bonds.  Which means that you can't sit on a 60/40 stock bond portfolio and ride the risk parity gravy train like you have been able to for the last 35 years.  And when investors are not making money, they get more nervous, and volatility rises.  So that should make the next 10 years much more volatile than the previous 10 years.  2009 to 2019 has been a great 10 years for long term investors.  It hasn't been so great for most traders.  Even with all the quants and HFTs making the markets more efficient, it should be a more favorable environment for traders in the coming 10 years when investors are dealing with losses more frequently.   Nothing provides a catalyst for volatility like losses. 

Of course, the global central banks and governments could go on an MMT printing and spending frenzy over the next 10 years and make everything go higher in nominal terms.  While I see that as a distinct possibility in the US, I doubt that has the support from citizens in most other countries. 

First day of December, and we are seeing one of those rare days where the bonds are noticeably weaker while stocks are flat.  If we get further bond weakness while stocks trade either sideways or down, it will be the first sign that we are making a top.