Negative Oil Price Bottom

When you see oil futures going from $6 to $16 after the oil "experts" on CNBC and Bloomberg say oil prices are probably going to go back negative, I tend to listen to the market and not the analysts. 

You had a classic panic bottom in oil, as the biggest oil ETF, USO, panic dumped a huge chunk of open interest in the NYMEX June Crude Oil futures and rolled it into July and August, effectively selling at the bottom and buying back less (July and August futures are more expensive, so they had to buy less when they rolled over the contracts). 

What happened on Monday was panicked speculators in the May futures who didn't have enough liquidity to sell their holdings as there weren't enough end users who were willing to buy from them, so it was a game of hot potato until prices got so negative that producers who actually were short finally decided to close out their positions.  May futures actually ended up settling at 10.01 when it expired on Tuesday, so that is the price that producers were willing to pay to take delivery, a better indication of WTI oil prices than the negative numbers on Monday.  But the financial media loves to sensationalize everything, so they ran with the negative oil prices story, and figured that since there is very little available storage in Cushing, the same thing would happen in the June contract. 

But there are still several weeks till June, and producers are not going to keep pumping oil and sending it to Cushing when they have to pay to do it.  Its just more cost effective to just shut in the wells.  And that's what is going on right now.  And with the negative price fiasco on Monday, the producers will be even more urgent about cutting production to avoid losses. 

The price action from Tuesday to now, with June CL futures going from $6 to $16 is telling the truth, while the oil "experts" talk about negative prices and tank tops like it's the latest hot fashion. 

I am no oil bull, I'm long term bearish on oil, but in the short term, prices went down not because of fundamentals, but because of irrational fear of negative prices.  The fear of future negative prices makes it much less likely to happen, as now the producers will be cutting more production than they otherwise would have.  This week went a long way towards speeding up the equilibrium between supply and post coronavirus demand. 

But unlike some of the irrational USO buyers on Robinhood or newbies who think that oil is now the bargain of the century, what will likely happen is that WTI oil will have to stay under $20 to keep producers from pumping out too much, and its very unlikely to see negative prices as oil in Cushing will just be diverted to other storage facilities, or on tankers, if the price gets too low.  So that will probably keep WTI oil between $10 and $20 for the next few months.

However, if after the lockdown is lifted and coronavirus cases start going up again, then all bets are off, not only for oil prices, but for the SPX and global equity markets.  The threat of a second lockdown will induce serious panic among not only oil traders but equity traders, and that could actually push WTI oil to near zero and SPX to retest the lows in March at 2174.  

But that's looking a bit too far out, in the near term, the anticipation of lockdowns being removed and people going back to work will keep a bid under both oil and stocks.  Also, OPEC+ plans on having another meeting on May 10 to talk about further production cuts so that's also another positive catalyst for oil.   Definitely not recommending going long oil, but don't recommend a short here either.  Same goes for the SPX, wait for the right levels, we are in the middle of the new range (2730-2870), so not a good risk/reward for either side short term.  Neutral here.

Fed Will Not Save You

Those betting on the Fed saving them if the economy stays bad don't understand who the Fed works for.  Their main constituent is not retail traders, or even long term stock investors.  They are working for the money center banks, big hedge funds that dabble in Treasuries, MBS, credit markets, and now private equity firms that need their junk bonds bailed out.  Powell is a private equity guy, he will never let them down.  He will do whatever it takes to guarantee that private equity firm owners (not necessarily clients) get big bailouts after the dust clears.  Mnuchin is the guy who hand picked Powell for Trump, so they are in this together.  Mnuchin is a vulture, he will do whatever it takes to enrich himself, and that usually doesn't mean letting current shareholders tag along for the ride. 

For a lot of the big banks, having companies restructure their outstanding loans and  debt so that banks get a big cut of the equity at the expense of current shareholders is very much in play for a lot of sectors such as energy, travel/leisure, restaurant chains, retail, commercial RE, etc.  The Fed will not come to the rescue of those shareholders when the money center banks stand to benefit from the fallout of these fragile broken companies. 

This stock market is whistling past the graveyard as the investing crowd has been conditioned over the past 11 years that any dips are buying opportunities and eventually it goes up, to new all time highs.  But the toxic combination of high valuations and horrible fundamentals in the stock market is not something even the Fed with unlimited QE can save. 

We are back to the US/China trade war angst levels of August 2019, or even worse, the FOMO "hot" economy top on January 26, 2018.  This market is expensive, and a lot of firms are facing solvency risk on a scale that hasn't been experienced since the Great Depression. 

There will always be doubters who get scared of shorting after big rallies, expecting an even bigger rally.  All I can go by is years of experience trading SPX based on news flow and gut feel.  Last Friday's opex euphoria in the overnight session on a "miracle cure" for the coronavirus did it for me.  The scale has been flipped from fear and loathing to irrational exurberance.  SPX 2880 was close enough to 2900 for me to enter the short side, especially with the opex peak usually followed by the post opex hangover as put protectionless equity holders suddenly realize that their portfolios are no longer hedged to potential huge downside risks in this bailout dependent crap economy and In Fed We Trust rally. 

Wall Street and newbie traders are putting lipstick on a ugly fat pig, rationalizing the rally with Fed unlimited QE, Congressional bailouts, and a V shaped recovery in the 2nd half.  Rushing the reopening of the economy is the worst thing Trump could do, because that will just keep the coronavirus lurking around, ever present, without ever really getting of the threat.  Doing a half baked lax lockdown is the worst of both worlds.  Killing the economy and not eliminating the virus. 

Trump's short term thinking will probably mean the economy reopens in May, which the equity market, with its own short term thinking, believing that will help the economy in the long run.  But apparently no one learns from history.  Here is the infection graph for H1N1 in 2009: 

 With the coronavirus more widespread now, the second wave of infections will probably be even greater than the first wave if the economy reopens and people go back to work.  This risk is definitely not priced in at current levels, and it will be absolutely devastating for investors to see countries go back into lockdown, and under such a scenario, a big revaluation lower in stocks would occur.

The last 2 big rally days have been followed by big gap downs in the SPX.  You think the suckers are gonna push their luck again and try to squeeze the market higher to see if there are greater fools up there willing to buy?  I wouldn't put it past US stock investors, they seem to be the most resilient group I've ever seen.  But with the biggest buyer of US equities over the last 10 years (corporations) suddenly looking more cautious when it comes to stock buybacks, the supply/demand picture for stocks is suddenly looking a lot worse than at any other time over the past 10 years.

Of course, Wall Street will never tell you that, and say that expect a V shaped recovery based on pent up demand and Fed/Congress bailout money, never mind that millions of small businesses will be closed with masses of unemployed workers, and the global economy will be just as bad, putting a big dent into international earnings for the multinationals. 

Fundamentals are so bad, and downside so big, risk/reward is very lopsided in favor of shorts here.  We probably chop between last week's lows and last week's highs (~2730-2870) for the next couple of weeks, get bulls complacent, and then roll over to lower levels. 

Remdesivir Euphoria

I thought I had seen it all, but this excitement over a coronavirus drug ramping the SPX futures overnight into hyperspace was totally out of the blue.  If the market wants to get euphoric so quickly, then so be it.  I will gladly oblige to provide liquidity by taking the other side of the trade.  I shorted SPX overnight and looking to cover around the 2800-2810 level.   

A lot of the move has been exacerbated by delta hedge buying leading up to SPX options expiration which is at the cash market open today.  Just a short term trade here, looking for a gap fill. 

It has surprised me at how quickly the market has gone from fear to euphoria.  Actually, from euphoria to fear in February/March was also shocking, just because of the magnitude and quickness of the selloff.  This is just a manic market, that trades with absurd momentum on both sides. 


I am now off the sidelines looking to get back to work on SPX, this pig is just too fat to resist.

Volatility After a Big Rally

This volatility after such a big rally intrigues me.  It is not common.  A VIX at 41 after a 30% rally is unusual to say the least.  This time is different.  This is no V bottom.  It is a massive short squeeze + FOMO rally with questionable fundamentals.  After a 30% rally, how often do you see 3% daily ranges? 

I am more bearish now than I was last Friday at the same price levels.  Volatile down day on Monday, followed by huge up day Tuesday.  And now a big gap down today on no news.  The volatile chop is one of the signs of a trend change after a big move. The sector performance also shows a narrowing of the rally, with mostly tech stocks and defensives leading the charge, while the financials lag and the energy stocks stay weak. 

It is a fund flow FOMO driven rally, a lot of the short covering has already happened, its desperate fund managers putting money to work, fearing that they will lag the indices even more if they wait it out. 

From a fundamental perspective, the aftermath of the pandemic will be grimmer than most think.  A lot of small businesses will cease to exist.  Bars/clubs/live events/conventions/airlines/cruises/hotels/casinos/restaurants will continue to suffer until there is either herd immunity or a widespread vaccine available, which is at least 12 months away.  That has a chain effect on other industries.  Also, the psychological effect after such an economic shock will result in consumers having an increasing propensity to save which reduces the velocity of money and lowers GDP growth. 

Reduced cash flows will present solvency risks for many companies which will either lead to outright Chapter 11 bankruptcy or massive dilution of current shareholders through either secondary offerings or conversions.  The duration of the recession will determine whether many of these public companies can make it without dilution or big debt burdens. 

At current valuations, none of these risks are priced in.  A near V bottom scenario is what is being priced in here, with many using the Fed and government intervention as a green light to speculate in stocks.  No, it is a green light to speculate in bonds.  The Fed's put option is much higher for bonds than it is for stocks.  In order for the Fed to directly come to the rescue, we will probably have to break the March lows to get their attention.  Since I expect that to happen later this year, the Fed will be coming in to rescue stocks, and I am sure Powell will go overboard like he's been doing. 

I am getting a sense that more and more investors are looking for this rally to continue for several more weeks, with the lazy view that the Fed and government will have their back.  That is a terrible investment thesis and shows a complete lack of understanding of what drives equity prices in the medium to long term (fund flows, valuations, future cash flows).  Companies are going to drastically cut back on stock buybacks, the biggest source of US stock buying over the past 10 years, and will have reduced cash flows, requiring either debt or equity issuance.  Those are negatives that many are ignoring for fear of missing the V bottom, and another 2019 like rally off the lows. 

The coronavirus is a game changer that is not only relevant for 2020, but will have lasting effects into 2021.  There will be more fiscal pork stimulus, but its only partially filling the economic hole.  Both production and consumption will be drastically reduced, something money printing will not solve. 

Positioning Vs. Fundamentals

After the furious rally last week that took SPX from 2488 to 2790 in 4 trading days (that's 12% in 4 days), a lot of investors are in shock and awe.  Usually you get these kind of explosive short term moves off of panic bottoms, but there was no real panic when the SPX went down to 2440 two weeks ago.

The one thing that last week showed was that there is a lot of risk capital available to be deployed, thanks to the the trillions that the Fed has already printed up and injected into the bond market.

Jerome Powell has decided to outdo Bazooka Ben Bernanke.   He is pumping out the various Fed giveaway programs with reckless abandon after receiving praise from his Wall St. friends and an endless pool of stimulus loving bulls.  The Fed syncophants believe the best way to solve a health crisis is to just print up a bunch of money and give it away to the Treasury and corporations.

Even during a pandemic, the US response has been trickle down, let the Fed and Congress give money to corporations and boost the stock and bond markets, hoping that eventually the money flows down to those waiting on the $1200 stimulus checks and who are standing in line at the food bank to pick up stale bread and years old canned food.

There has been a clear divergence between the real economy and the financial economy.  Just look at the SPX vs USO (WTI crude oil ETF) chart.  Over the past month, USO is down 27%,  SPX is up 9%.  

In the short term, the stock market movements are based more on positioning and fund flows and less on fundamental changes in future earnings.  Right now, most investors are not well positioned for further moves higher in SPX, and most funds will be forced to increase their beta in order to keep up with the averages, for fear of getting fired for underperformance.  Not many managers get fired for losing 30% when the SPX loses 30%.  But to lose 30% when the SPX is down 10% will get many fired.   Career risk is at the forefront of the minds of those fund managers who are chasing the SPX higher.

So in the short term, the motivations of the fund manager looking to keep his job is overwhelming the deteriorating fundamentals.  Yet while the SPX rocketed higher, the VIX didn't go down much, because even during the huge rally over the last 4 trading days, you had a big drawdown when the SPX gapped up to 2750 only to close at 2660.

Based on the extreme strength in the SPX last week, the fund managers have more money to put to work, a lot of them don't like to chase big up markets, so when things settle down, the "reasonable" fund managers will be there to support the market on any dips.  We bottomed on March 23.  The bear market rallies usually last 5-6 weeks, if it is really extended, it can go on for 8-9 weeks.  Right now, its been 3 weeks since the bottom, so there is still more time left to go in this bear market rally. It takes time to draw in the more reluctant bulls into stocks, which is why the counter trend rallies can last for several weeks.

Just looking at time, I expect a top to this bear market rally in early to mid May.  Looking at price, we've already hit the 50% retracement (2784) of the move from 3393 to 2174.  A 60% retracement would add another 122 points to the targe to 2906.  From a time perspective, you likely have 2-3 weeks more left in the rally.  From a price perspective, when you have already hit the 50% retracement with this much time left for the bear market rally, its likely that you will hit the 60% retracement level.

Short term over the rest of April favors the bulls.  May will be the time to try to play the short side for the bears out there. 

Longer term, over the rest of the year, bears have the tailwind and fundamentals working in their favor.  A lot of equity market strategists are still expecting a strong second half rebound this year, which is a fantasy.  That difference from consensus is what creates the opportunity.

I am on the sidelines, let the fund managers chase this sucker higher, and let the eager beaver bears get squeezed a bit before going in for the kill. 

Savage Face Ripper

Just savage.  They took a knife to the bear's heart in the overnight SPX futures Sunday and twisted it during regular market hours.  That last burst out of nowhere was probably a mixture of short covering and some pension rebalancing.  And now we have another monster gap up after a monster up day. 

This is why you cannot overstay the short side because of these vicious counter trend rallies after a waterfall decline.  This one in particular is one of the biggest face rippers I've seen in my trading career. 

If you can't understand why we're going up so quickly, then don't trade it.  I am not trading this one here, its not a typical post waterfall move, and it kind of sneaked up on the bears after looking weak last week.  Can't explain why this thing suddenly decided to break the 2450-2630 range with such savagery, but you have to stay out of the way when you are wrong.  Being stubborn and refusing to take losses in this business will destroy you. 

The last 36 hours of trade has wrecked my forecasts, and its back to the drawing board, to contemplate what's next.  My theory on why we're rallying so hard is the absurd amounts of Fed liquidity ($125 billion/day = $2.5 trillion/month rate) is lifting all boats, as the money finally goes out of bonds and cash and into stocks.  Plus, let's remember, the $2 trillion bailout is just giving people and corporations/small businesses free money and that money is looking for a home.  And when you can't spend it or would rather not go out, then its quite convenient for those who get the money to buy stocks with it. 

All these gigantic bailouts increase the money supply, because debt is not being repaid, in fact, debt is increasing and being monetized by the Fed, so it is helicopter money.  And the Fed isn't even shy or bashful about it, the Powell Fed is the most aggressive money printer in the history of the U.S., by a mile, and I wouldn't be surprised if the Fed became the biggest buyer of stocks if the SPX breaks 2000 and enters a steep bear market.  In fact, I would be surprised if the Fed DIDN'T buy stocks. 

Not easy to make sense of these rapid moves, so laying low for now, waiting for an opportunity to short again, but want to wait for the upward momentum to die down a bit. 

SPX 2450-2630 Range

Let the cows graze for a bit, no need to go for the kill right here.  Shorts: don't get too greedy just yet. 

This week has defined the supply and demand levels that will likely prevail until April options expiration (April 17).  Based on the trading action since the bottom on Monday, March 23, the panic zone is SPX 2200-2400.  The post oversold reflex rally range now seems to be roughly 2450 to 2630.  That means that we are close to the bottom of this range, and aggressive traders can either go long here, or for those more conservative and bearish leaning, cover shorts and wait for stocks to bounce again before putting on shorts again. 

For the next 2 weeks, based on the price action, it should be two sided trade without a big up or down trend.  You can thank (or curse) the Fed for bailing out the longs and extending the bounce for longer than it normally should last.  That is why I don't see another big thrust lower until you rebuild the complacency in the market. 

But the fundamentals will come to bear on this market.  The coronavirus has wrecked a lot of corporate balance sheets, future cash flows, and lowered the risk tolerance of institutions.  This is like 2000, 2007/2008, where institutions rethink the proper amount of long term risk that they will take and that long term positioning has yet to be purged to more realistic levels. 

The next thrust lower should be a realization of the new fundamentals of this market and a repricing of equities to a more reasonable valuation.  Let's not get ahead of ourselves, we need to chop some wood and create the potential energy for the next move lower.  Right now, it seems like most of the bear fuel was exhausted in the big down move over the last 2 days.  Neutral here, and recommend bears to cover their shorts to reload higher next week. 

2600+ Sell Zone

"Nature abhors a vacuum."

The market also hates a vacuum. From November 2016 to January 2018, the market took a straight line with almost no dips from 2200 to 2700. Since then, there has been very little volume traded between 2200 and 2600. Now is the time to fill the hole.

And it is happening in an environment of discomfort, as most of the holders of equities are in some level of pain. When investors and traders are in pain, they make more mistakes than when they are comfortable. That is why I've always considered bear markets VIP (Volatility Increases Predictability) markets. For most investors, it is starting to get stressful, but there are still many that are in denial of what is happening, expecting (hoping?) for a quick recovery in the second half, believing that the coronavirus is just a short term blip.

This virus is a monster.  A Chinese lab created monster.  No wonder it lasts so long in the human body, and passes to other without symptoms.  And is selectively deadly, wrecking the body's immune system, causing cytokine storms and ruining a lot of people's lungs permanently even when they survive it.  Those knuckleheads who think its just like the flu are probably the ones who are spreading it to others without even knowing it. 

All you need to look at is crude oil to see how much the economy has been wrecked by this pandemic.  And to those who say that its because governments have been too careful and gone to unnecessary lockdowns, the alternative is much worse.  Blatant neglect would lead to catastrophic numbers of cases and hospital visits, with hospitals filled beyond capacity, having to turn away coronavirus patients.  That case would force all but the hardest headed corporations to force their workers to stay at home, and work from there, if possible.

So no, lockdowns are not a cure that is worse than the disease.  Neglect and hoping it goes away is the worst strategy, and it is something that many governments tried before giving up when the number of cases started to skyrocket and hospitals became swamped with virus patients.

Let's not forget that just 5 short weeks ago, the SPX was trading at 3390, with rampant speculation in stocks like TSLA and SPCE.  It was a full blown bubble.  So you can't compare this to 2008 in that sense, because in 2008, stocks were already in a downtrend and valuations had come down to reasonable levels.  That is not the current situation.  Valuations do not support the current treacherous environment where many firms will be on life support unless the government gives direct cash injections.  And while that may happen, it is no guarantee.  And usually the conditions for receiving government cash are not favorable for the current shareholders.

We have rallied for 5 trading days since last Monday's bottom.  That is usually the extent of the oversold bounce before you get another sell wave come up.  With month end rebalance of pension funds ending today, the demand for stocks should drop starting in April.  I am a seller here. 

On the Fed QE

In an era where trillion dollars get thrown around like its no big deal, people are not focused enough on how enormous this Fed QE is.  The daily rate of $125B on Treasury/MBS purchases is almost twice as big as the monthly rate of QE during QE2 and QE3.  So on a daily basis, the Fed is currently buying 30 times more than past QE operations.   No wonder bonds refuse to go down this week as stocks rallied and pensions rebalanced out of bonds and into stocks.  The Fed is now the axe in Treasury market, dominating the money flows.
I vastly overestimated Powell.  Not to put it too bluntly, but Powell is a pussy.  He has no balls.  And no tact.  What he is doing now is 30 times worse than what Bernanke did.  Monetizing the debt is short term thinking and passing on the pain into the future.  Debasing the currency to try to drive long term interest rates from 1% to a few basis points doesn’t improve the economy.  It just breaks away bit by bit, the world’s confidence in the dollar as a reserve currency.  No one wants to hold dollars if its value is rapidly depreciating against real assets.

What Powell is doing not only a dereliction of duty, and a violation of the Fed charter, he’s speeding up the demise of the US dollar as the reserve currency.

The coronavirus, while a very deflationary force in the medium term, will not be an economic deterrant forever.  It will fade away, either through a vaccine or worst case scenario, global herd immunity.  Once its effects on the economy go away, what are you left with?  A bunch of junk on Fed’s balance sheet or hidden in SPVs at the Treasury.  And this is not like TARP.  Back then, the Fed actually had a lot of room to lower medium to long term rates through QE and ZIRP, thus providing plenty of monetary stimulus.  Now even the 30 year yield is barely above 1%.  Unless the Fed decides to go negative, which would only hasten the dollar’s demise, they are almost out of room to drive rates lower.

Last time the Fed did QE, rampant inflation didn’t show up because the budget deficit declined steadily after 2010 until 2016.  Trump changed all that, and his tax cuts along with increased government spending blew a huge deficit during an economic expansion.  One thing politicians have realized is that voters don’t really care about the deficit, but they do care about taxes.  So taxes have been cut while spending has increased.   That's why it was so easy for Congress to pass a 2.2 trillion dollar fiscal stimulus bill.  People don’t care about the deficit because there have been no negative consequences so far from it.  Dollarization of world trade has assured of there being a constant source of demand for dollars.

But the US is taking its reserve currency status for granted.  It takes a lot for the world to move on from the dollar to another currency but actively debasing the currency is the first step in losing that trust.  There is a reason that the world went on a gold standard and stayed under it for so long.  Inflation was devastating many times throughout history, so the only way governments could gain trust in their currency was to back it with something that couldn’t be printed and had a finite and limited supply.

If the Fed doesn’t retract all its excess money printing and rapidly shrink its balance sheet after the coronavirus recession is over, they are opening the door to  government abuse of deficit spending having no consequences on interest rates, and thus high inflation.  This time is not like the Obama years.  Deficits really don’t  matter now.  The way inflation blossoms is not just through debt monetization, its through massive debt issuance + monetization.  We will have both ingredients in the future.  Plus reduced globalization which was a deflationary force in the developed world.  That is an inflation powder keg waiting to be lit.  Inflation will be coming in the next expansion, and with force.

SPX 2200 to 2600

Rough range estimate for the next month for SPX 2200-2650.  That means the middle of the range is 2425.  Right now, as I am writing, the SPX future are trading 2525.  It above the middle of the range.  As a rough rule, don't do anything in the middle, and sell 2550-2650, and buy 2200-2300 for the next 30 days.  It is not common to see a huge rally like we did yesterday, and then straight gap down 100 SPX points.  That is a new normal.  Buying rallies at the close are being punished the next morning like I nothing I have ever seen in my lifetime in trading. 

These are vicious bearish markets, and there is no positive catalyst now, with the fiscal pork stimulus behind us, and another one won't be arriving for at least another couple of months.  The only real positive I see is the dollar weaker this week, which is a sign that the rush for cash is mostly over.  Now its just a burnt down stock market with bottom pickers looking over the rubble for "bargains".  One month after a generational top in the stock market doesn't usually generate a "bargain". 

The huge bear market rallies will shake the convictions of the bears, and will excite the bulls, but its the crack cocaine of trading.  Sure the high is great, but it doesn't last.  This bear market rally didn't even last 3 days, before gapping down 100 SPX points!  That's almost 4%!  Before the cash market even opens.  Wild. 

This week has sucked in a lot of traders into the bullish side, calling bottom, and trying to play for a rally.  They are the ones that are puking it out early today, and its a warning for the next month:  don't chase strength, because it will come back down in a hurry.

The most bullish thing I see now is bonds rallying huge and not selling off even during the equity market rally the past 3 days.  But that bullish factor pales in comparison to the economic realities that most investors are still too complacent about.  A government stimulus program doesn't replace the economy.  The hopes are too high for all this stimulus, as if its a magic elixir that will paper over most of the economy's problems.  Don't buy it.  The damage is a lot deeper and long lasting than most believe.  It will play out all throughout the year, and that will present a lot of opportunities on the short side, and a few on the long side.  After the 3 day rally, its bear time coming up. 

Pork Barrel Rally

We are getting that big oversold bounce which many have been waiting for.  From an overnight low of 2174 on Monday to an overnight high of 2498 on Wednesday.  324 point range in 2 days, which is 15%.  These enormous moves are coming as the  economic realities collide with  monetary and fiscal stimulus to create confusion among investors.  Wow, did Congress put in a lot of pork in that bill, and $500B of an opaque slush fund for who knows what. 


With the $2 trillion pork barrel fiscal stimulus package out of the way, it is actually safer now to sell short, because one of the biggest positive catalysts is in the rear view mirror.  Sure, there will be more fiscal stimulus, but its going to take at least another few weeks before that happens.  That gives bears a lot of runway to run wild in this market.  The fundamentals have deteriorated much more than investors believe.  The consensus that I hear is that the coronavirus economic shock will last 2 quarters and then GDP growth will go up huge as the pent up demand drives the economy later this year. 

I disagree with that consensus.  I don't believe the pent up demand will be all that great, sure, there will be more savings built up this year as consumers aren't spending, and that is a source of potential growth, but a lot of that will be used to pay down debt.  And that savings is likely to be used much later than people think. 

If I had to choose an academic to trade, the last group I would pick would be the economists.  One of the first I would choose would be the psychologists.  Because a lot of what moves the stock market and the economy is psychology.  If you see how much of a panic a large portion of the population is in right now, you will understand that they will not be quick to spend their savings when they've just been laid off or had their businesses closed.  Sure, eventually they will get back to normal spending habits, but it will take a lot longer than 6 months, more like 18-24 months based on previous recessions, and this is much more severe than any we've had before, so it will likely take even longer. 

Another thing investors are overlooking amidst all the money printing and fiscal stimulus is the valuations of US stocks.  Stocks are not cheap.  We are in the midst of the worst economy in 90 years and the market is still priced as if things will get right back to normal.  

I am reading a lot of articles and comments on Twitter about how this is a generational buying opportunity.  I don't know if I am the one who is taking crazy pills, but the Price to Book and Price to Sales ratios are higher than they were from anywhere between 2008 and 2013.  So for a full 5 years, valuations were lower than they are now.  Recency bias with the massive overvaluation post Trump tax cuts skews peoples' perceptions of value.  And I don't buy that because Treasury yields are lower, valuations should be much higher.  If that was the case, Europe and Japan should be the most expensive markets in the world. 

I would urge caution buying after rallies, I don't see a sustained bounce until we see more capitulation.  Just not seeing it right now. 

Fed Banana Hammer

Here it comes again, another Fed money printing operation to try to save the stock market and suppress interest rates.  After failing to pump up the futures in the previous 2 announcements, the Fed has just stopped pretending that they are putting  limits to their money printing and have signaled unlimited QE. 

Anytime time you use the words unlimited when its comes to printing money to buy bonds, that will catch the attention of stock investors.  Fed will even buy asset backed bonds backed by worse than junk student loans.  The Fed's balance sheet has gone from taking US sovereign risk to taking on credit risk from students, small businesses, and corporations. 

The big banks will have a field day securitizing all kinds of junk student, and small, medium, and large business loans to sell to the Fed at a hefty premium, pocketing the difference, taking their piece out of what will be a steadily depreciating dollar. 

The Fed is getting closer and closer to the day where it will stop pretending like its not Japan and will start doing QQE, buying equity ETFs and perhaps even individual stocks if the US public is dumb enough to give them that kind of political power. 

Those who decry socialism are the ones in charge of getting the US closer to it, as the Fed is making a mockery of the situation, hell bent on printing their way out of a health crisis, paving the way for the US dollar to lose reserve currency status as it becomes more and more of a banana republic. 

There is no going back once you make these precedents.  These programs will be around for a long long time, and more likely than not, be permanent facilities.  Just like when you start a path towards financial repression, it is a trap that is impossible to escape, as the Fed tried for a couple of years raising rates and look what has happened.  Stairways higher when raising rates, elevator plunge lower when cutting rates and implementing QE. 

It is a perverse situation because of the coronavirus, over the next 12 months, demand for commodities will be way down, and that will keep commodity prices in check and it will make it seem as if all the money printing didn't have any adverse effects. 

Expanding money to a whole new group, including students, small businesses, and corporations of all sizes increases the number of potential borrowers by orders of magnitude, which is potentially massively inflationary if not taken back right away when things normalize.  And I have a feeling that once the Fed becomes everyone's sugar daddy, they won't be able to go back to normal and take back the money.

And unlike most economists and market forecasters, I don't believe there will be a strong second half rebound, because I don't think the coronavirus will completely go away and a vaccine, if an effective one is developed, won't be ready for mass production till the middle of next year.  So that is at least 12 months of economic uncertainty.  That will be negative for commodities and stocks.  But in 2021, if an effective vaccine is ready for mass production (likely, but not definite), the pent up demand will boost economic growth for a few quarters, and that's when the inflationary effects of these Fed actions will appear, with a vengeance. 

But that is a while away, something that most of you don't even have to think about because the deflationary effects of this coronavirus are so massive that they will mask the effects of any kind of crazy inflationary monetary and fiscal policies over the next 9-12 months. 

I have been waiting for an ideal time to buy, hopefully into a mini panic, but they don't come around easily when the Fed is in there hammering away trying to prevent full blown panic.  I can only go by levels which I think are low risk entries, long and short, if they don't come, I will have to wait.  It is frustrating to miss your entry levels and then see the market go in the direction that you expected, but that's part of the game. 

I do expect a sell the news reaction to any kind of phase 3 stimulus bill that gets passed in Congress, so I definitely will not be buying ahead of that or right after that event. 

If there is no low risk long entry this week, the next best trade will have to wait a few days, which is to short a pension fund rebalance stock rally at month end. 

Economic Catastrophe

Things are very bad out there.  That is why these rallies are getting sold after just one day.  The stock market extrapolates the current situation and the longer it goes on, the further out it extrapolates.  It's 4 weeks of nonstop selling, and eventually investors adapt, and for one, they don't rally stocks on a Friday afternoon in anticipation of a central bank intervention.  They sell them off on a Friday because they got their heads handed to them the following Monday when they bought the strength on a Friday afternoon. 

I find it laughable when investment analysts think this will be like 2008 for economic growth, trying to factor in a strong rebound in Q3 and Q4 2020.  Unless they are fortune tellers and can tell how prevalent the coronavirus will be in the fall and winter, then they are just making wild guesses.  The number one thing that will stabilize this stock market is not a bigger bailout or bigger Fed QE, but a decision by the federal government to have a month long nationwide lockdown to try to eliminate the coronavirus.  2 weeks is too short.  A month may be too short.  The incubation period can be quite long for this monster of a virus. 

This brings me to a Wall St. psychology chart about where we are in the cycle:  We are definitely past the denial stage, and probably in the middle of the panic stage, but not yet at capitulation.  So getting there, but I would like to see few bottom pickers and more consecutive down days before I feel comfortable going long. 

Its easier to predict a bottom when there is continued selling without rally attempts.  But there continues to be a rally attempt every couple of days, so sustained selling is cut off, making it hard to pick a bottom off a capitulation point.  So we keep getting these one day rallies that give investors hope only to take it away the next day.  I want to see sharp sustained selling for 3 days to really get to a panic point and attractive price levels, but the dip buyers are stubborn and insistent on not missing the V bottom. 

Right now, as I write, the SPX futures are trading 2270, which is near the week's lows, on a Friday.  If we can get a sharp move lower next week, that will open up the door for a strong rally into the end of the month as pension fund rebalances from bonds to stocks will be massive at the end of this month.  From Morgan Stanley:

Now MS are joining GS with the >$150bn of equity buy flow that will happen into month-end. That is on par with what CTAs sold on the way down....Could we get a "crash" on the upside in a massive bear market rally squeeze?

“MS QDS estimates $160bn of global equity needs to be bought and even more fixed income sold for pensions and asset allocators to rebalance portfolios over March month-end. With this flow generally starting roughly 5-days before month end and peaking at the end of the month, it should build by mid next week"

And ideal buy area would be the 2015 highs of SPX 2130 before the August waterfall decline.  There was a lot of resistance in that area.  The market likes to fill a vacuum, and there wasn't much time spent between 2200 and 2600.  I think that will change this year.  

Sunday reopen will be interesting in S&P futures. 

Liquidation Continues

The bond market is revolting at the size of the proposed fiscal stimulus.  Giant moves in the Treasury market, especially the long end, are wreaking havoc with risk parity and relative value funds.  I am hearing rumors, from reliable sources, that a huge hedge fund (one of the biggest) is facing massive redemptions while its performance has been hammered this year.  Also hearing rumors of 2 other hedge funds that are big players in the levered fixed income space that are having to reduce risk levels
0 by huge amounts due to the Volcker rule regulation on VAR targeting.

If SPX futures are lock limit down, one would think that Treasuries would be rallying strongly, but bonds, especially the long end, have been quite weak and it trades like there are funds in bad shape and forced to liquidate their positions.  As I've mentioned before, this type of action happens in the panic phase of a downtrend, which we're clearly still in, considering the lack of sustained buying pressure after an up day.  Investors are using any rallies to get liquid, reduce equity exposure, and hunker down preparing for the worst.

It looks like SPX 2370 wasn't the bottom, because this market trades like it wants to test much lower levels before stabilizing.  With 3 horrible gap down Mondays in a row, investors will be extremely nervous heading into the weekend with all the bad news out there and panic widespread, so I expect more selling for the rest of the week. 

The amount of selling is off the charts, the intensity of this down move is something I've never seen before.  This is more intense selling than October 2008.  I will venture to make a guess which might surprise people but is going to be pretty obvious when you think about all those laid off or not working:  the economy will be weaker than 2008/2009.  Whole sectors of the economy are being annihilated.  That never happened in 2008.  That is not priced in at current SPX levels.  The US market is still richly valued. 

The more I read about the coronavirus, the harder it seems it will be to contain.  About half of those who catch it show no symptoms, but can still pass on the virus to others.  And it is very contagious, and very deadly for the elderly and those with existing medical conditions.  The US is taking too much time to enact a strict virus containment policy.  The US should be following the steps of Italy and Spain and put the whole country under lockdown, only allowed to go outside for groceries, and absolute necessities, health care, or required work.  That is the only way to contain this.  And I doubt that is what the federal government will do until the number of cases has gotten huge and harder to control. 

The bear market rally off the bottom will be explosive, its just seems more likely to happen from lower levels than here, perhaps SPX 2150-2200.  If I miss the bottom, its ok, shorting the bounces is the safer play anyway. 

Rush to Cash

What you saw from Wednesday to Friday was a classic liquidation panic a la October 2008.  There was nowhere to hide being long.  Treasuries, which would usually thrive under a panic risk off scenario, were getting liquidated as a source of funds to raise cash.  That is a sign of extreme stress in the financial markets, when the most liquid safe haven asset gets sold to raise cash.  And not just any cash, but the dollar, as in a normal risk off scenario, the positive carrying currency gets sold (dollar), and the opposite side gets bought (euro).  But in times of extreme stress, where US dollars were needed, the dollar rallied huge off the initial carry currency selling to reverse most of its previous losses.  Crazy times. 

 In fact, as the SPX was melting down from 2880 to 2480 in 2 trading days, 10 year Treasury yields went up from 0.39% to 0.84%.  It was an even bigger bloodbath in 30 year bonds.  Risk parity funds were getting crushed this past week, which is something that has only happened to this degree in October 2008 and February 2018.  And February 2018 was not because of fears of a global recession, but an inflation scare.  So this situation has more similarities to October 2008, when Treasury yields were actually going up during the steepest part of the decline from October 6 to October 10. 

March 2020

October 2008

As you can see from October 6 to October 10, 2008, as the SPX plunged from 1100 to 840, the 30 year Treasury yield actually went up from 3.94% to 4.14%.  Long term Treasuries lost safe haven status in favor of cash. 

For those who are still stuck in BTFD mode and complacent from past shocks like February and December 2018, August 2015, August 2011, they will be in for a big surprise.  Those past shocks were short term financial corrections that had no effect on the US economy.  This will have a huge effect on the US economy.  This is not a market correction.  This is an economic correction that will lead to many credit downgrades, equity dilution among the energy, airline, and travel/leisure segment of the market, and much lower overall SPX earnings due to consumer retrenchment.  QE4, Fed commercial paper funding facilities, or repo injections will not change that.    Neither does the fiscal stimulus that will be coming, barring a giant helicopter drop of money out of Congress, which is doubtful considering the Democrats' reluctance to paper over the problems during an election year in an epidemiological crisis. 

This is not like anything we've seen since 2008, and before that, 2000.  This market is an odd mixture of October 1987, April 2000, and October 2008.  I am still trying to get my head around how the markets will trade for the next several months, and my base case would be something like this: 

After a liquidation Monday, there should be a bounce afterwards, but Monday could get quite ugly so hard to predict levels beforehand.  If it bottoms at 2350-2400, which probably give us an idea of the bottom of the new range, we should chop violently sideways till late March, and then make a push to retest the lows and break them marginally, probably down to 2300 area.  And from there, I expect a strong rally into the summer as the market hopes that the worst is over as coronavirus fatigue sets in.  Then as the market realizes that the economy is not doing as well as it expected, there should be renewed vigorous selling into the fall, and probably new lows for the year in October.  Just a rough guideline for what I project for now, things will of course play out differently.

If the Trump administration doesn't do mass quarantines and nationwide lockdowns no matter how bad it gets, then all bets are off and we could crash even harder. 
 
Getting ahead of myself here, there is still a lot of unknowns out there, but the feeling I get is that most Wall St. forecasters are still not taking down their earnings estimates enough this year.  In many ways, the GDP hit is probably going to be worse than what happened in late 2008/early 2009, just because back then, you didn't have mass sports and event cancellations or widespread travel bans.  The GDP numbers this year will shock people, too many are still in denial.  That is why there is still a lot of opportunity on the short side, after a brief oversold bounce plays out.

P.S. - Noticing the huge plunge in gold and 3-month LIBOR actually higher on the day despite the Fed cutting to zero.  Wow.  There is some serious liquidation going on here, be careful out there.