Bitcoin Contagion

Cryptos have reached critical mass.  It is now so heavily owned among investors, including hedge funds, that a big correction has contagion effects on stocks.  Its not big enough yet to cause lasting effects, but it has enough influence to affect the market for a few days if there is heavy selling, like we saw from the weekend to Wednesday.  At $1.5T for total crypto market cap, with this kind of volatility, it will cause forced selling not only of bitcoin, but of the other assets these funds hold.  It was $2.5T just a couple of weeks ago.  So a 40% drawdown in 2 weeks, yes, that will cause some reverberations in the stock market. 

Most of these bitcoin investors with deep pockets (not talking about the odd lot YOLO and HODL Bitcoin maximists) are long both stocks and bitcoin, most are not hedged enough with shorts to make up for the carnage of a margin call induced liquidation type market, which we got a short preview of in the morning.  

 

 The BTCUSD chart looks awful, but this morning, 5/19, it held the psychological $30K level, which is roughly a 50% drawdown from the top.  Also, $30K is the level where the first deep pullback in January held that level.  It could very easily go right back towards that $50K level once the panic selling subsides and the dust settles.  Its reached enough critical mass where it won't go out like an ARKK or the various speculative EV/biotech/meme stocks where the supply is growing much more quickly than the supply of cryptos.  

 

I have no skin in the game, except potential opportunity cost.   I don't have much interest in getting long, except for occasional knife catching opportunities like in the morning when it plunged on forced liquidation down towards $30K.  

 

The big trade I am waiting for is a big blowoff top to get short.   I missed the latest short sell opportunity because it wasn't a clean blowoff top situation that could be easier to game.  I see potential for the last up wave in the coming fall/winter which could take it towards the $90K-$100K zone.  I am just an interested observer for now.  

 

The SPX is turning into an interesting market now.  The uptrend has reached a level where there is resistance for investors to just blindly take it higher.  It is no longer lingering at the highs and giving investors a lot of time to sell up there.  Its testing the top of the range and getting right back down.  It spent very little time around 4180 on Friday and in the overnight session yesterday.  A change of character from the previous 2 months.  Still believe that BTFD is the best strategy to use, but now you have to be better at timing exits as yesterday's big drop in the afternoon and follow through selling in overnight markets shows.

 

There is some caution out there, although I see very little fear, except in BTC.  Even in those stocks that are down 60-70% that all the momo traders piled into in January and February are mostly clinging on with their diamond hands and rock for brains.  

On the topic of diamond hands, and Reddit wallstreetbets traders, I find it funny how they want others to not sell so that they can later sell at a higher price.  They somehow think that trading and investing is a team game, and if they join a "team", they will be more successful traders.  Trading is not charity work.  You don't get a medal for losing money by holding the bag so that insiders and other traders can get out at higher prices.  

Millennials may be the dumbest generation in the past 100 years.  At least the baby boomers speculated in higher quality stuff: real estate, tech stocks, etc.  The millennials somehow think they've found the key to making money by buying things with no intrinsic value (cryptos) or massively overvalued stocks of companies that don't make any money and have almost no prospect of ever making money.  And somehow they are proud of showing that they have diamond hands in the face of big losses, when in reality, they are just holding bags in some of the worst stocks out there.  

 

Lots of negativity today, with the big drop in bitcoin, and the taper talk coming from the Fed minutes.  Monthly opex is this Friday, so that could keep the market under pressure until then from all the negative gamma exposure. 

 

Luckily was able to sell most of my long SPX position yesterday before the big swoon, still had some left over, which I just decided not to sell in the hole this morning.  I will be looking to buy dips around last week's lows, SPX 4040-4050 area.  Basic view on this market is that its range bound, with SPX range of roughly 4050 to 4200. 

Trading and Risk

Trading reveals the truth.  Unlike other occupations, there is no politics.  Measuring performance is objective, not subjective.  There are no referees that can decide the winner.  There are no teammates to blame.  A psychological game.  Like golf or tennis.  You are out there on your own,  you are the one who is swinging.  How do you handle the risk?  That is all up to you. 

The most important aspect of trading is risk.  Its a risk business.  Trading is based off on risk and reward.  Here are the 3 types of traders based on risk. 

Type 1:  Low risk tolerance, low pain threshold, hate uncertainty.  Conservative about money.  

These are people who can't take the uncertainty and the ups and downs of the P&L.  The fear of the unknown.  I know a friend who started trading and within 6 months, he got panic attacks out of the blue.  Needless to say, he was someone who physically couldn't take the risk.  A lot of these poeple are the type who can't sleep when they hold a big position overnight. 

If you can't take the uncertainty, then most styles of trading probably won't work.  Maybe scalping or daytrading lower volatility stocks, but that's probably the most difficult way to make money in this business and the most competitive.  All the money that HFT firms and hedge funds like Renaissance Tech. pour in for research make them the apex predators in the shortest time frames. 

In order to get beyond the safer stuff, this type of person will need to size way down and make small enough bets to the point that the risk is tolerable and there are no sleeping problems while holding positions.  Most suited for conservative long term buy and hold investing.  

Type 2:  Medium risk tolerance, moderate pain threshold.  Somewhat aggressive with money.  

These are you moderates.  They don't have extreme views about investing or money, mostly practical.  Try to treat trading like a normal 9 to 5 job, want and expect steady income.  They can take moderately big positions without sweating it, but if they go all in, they feel the stress and have trouble going to sleep. 

They can be flexible and choose all different styles, but probably best suited for swing trading stocks.  Could be suitable for trading futures if they only use a small portion of their available margin.  

The best level of risk tolerance for longevity in this business. 

 

Type 3:  High risk tolerance, high pain threshold.  Gambler type, aggressive.  Risk seeker when it comes to money.  

This is the most dangerous type of person to enter trading.  They are the most likely to blow up and get taken out of the game before they know what they're doing.  Big wins and big losses.  Usually have poor risk management, and don't have a long term view about the business.  No patience, always in a rush to make money.

These are your degenerate gamblers in the market.  The YOLO traders.  The options punters.  The WSB crowd.  The ones that want $500 margins to trade ES.  The ones who treat the market like a casino.  These are your free swingers.  Don't like getting walks.  Don't mind striking out.  They hate taking pitches, always looking to swing and hit the ball out of the park. 

Usually very stubborn and unwilling to take a loss.  Diamond hands.  Charcoal brains.  

Probably best suited for daytrading at a prop firm where they aren't allowed to take overnight risk.  At least when they blow up, its other people's money and not theirs.

 

Used to be a type 3 trader when I was young and dumb, a risk seeking trader, but as I've gotten older, and my testosterone has declined, I'm probably half way between type 2 and type 3.  Probably more risk tolerant than most traders except the WSB/Yolo/diamond hands/$500 ES margins crowd.   What type of trader are you? 

Sold most of my SPX long this morning, will sell the remainder either later today or tomorrow.  Was expecting a thrust higher on Monday, but that down day changes the picture.  Got a little bit too excited about the long side on Friday, thinking V bottom and straight line towards SPX 4200.  Expecting a tight consolidation of this bounce for the next few days and then another pullback to retest the SPX 4060 level, the closing low on 5/12. 

Already Back to Pre-CPI Levels

The VIX got jumpy, going over 28 on Wednesday.  The put/call ratios hit levels that was last seen at the end of February, when the market was worried about rising bond yields.  This time, the market is worried about inflation after the big CPI number.  And this uptrend is so strong, that even with the VIX spike and the inflation fears, the SPX wasn't able to touch the 50 day moving average which is rising fast. 

Yesterday, we saw the indices go up over 1%, and the CBOE equity put/call ratio was exactly the same as it was on Wednesday, when the SPX went down over 2%.  That is not common.  Usually you get a significant move down in equity put volume after a rally day like yesterday.  

There is still a lingering fear of the "pullback", the one that master armchair QB Tony Dwyer has been harping on for months.  I keep hearing all this talk about the market being overextended, needing a pullback.   Even from myself! That tells you how deeply ingrained it is into the psyche of investors these days.  And fear of inflation that is NOT transitory is the current excuse for the weakness.  

Watching the price action, the market is quite resilient considering the buzz around inflation.  I put on a long SPX position yesterday morning, I was initially thinking of a price target of SPX 4140 but we're almost there just 1 day after my entry.  I am not selling yet.  I want to give this trade more time to play out and see how far the bounce off the pullback goes.  I've seen so many V bottoms that its much more common for dip buyers to sell too early, not too late. 

With the strong bounce back in Treasuries yesterday and this morning, now to pre CPI levels for both stocks and bonds, in less than 48 hours, yet with the lingering inflation fears still with us, it feels like stocks want to go higher.  

I made the mistake of sticking strictly to my price target when I bought the SPX dip in late January and I sold way too early.  It might not be as good of a setup, but I don't want to make the same mistake again.  Sticking with the long side and letting it play out for a few more days. 

Blockbuster CPI print

 CPI came out hot today.  Even with the government lies and manipulation of the inflation number, the inflation number was big.  The Fed will say that its transitory.  You have enough lemmings on Wall St. who soak up all the drivel that the Fed spews out that a lot of people still think inflation is transitory.  If this kind of inflation is transitory, then by extension, and logic, life is transitory.  If inflation goes up in a staircase fashion, 20% one year, and then flat for 3 years, its the same as if it went up 5% per year for 4 years.  But in the first case, a 20% jump would be considered transitory, even though prices never went back down.  But in the second case, it would be considered 5% inflation.

These prices aren't coming back down.  Prices are sticky on the upside, and transient on the downside.  Transitory is an excuse for Powell to suck up to Biden.  To give Biden what he wants.  An overheating economy that will boost wage inflation and cause businesses to raise prices to stay afloat.

Jerome Powell is looking more and more political and less believable by the day, as the inflation keeps running hot, wages keep going higher, and his easy money policy is starting to backfire.  The main concern of the market is inflation, and its looking for any kind of action or even talk from the Fed to put out the fire before it turns into a raging inferno.   

I covered shorts into the selloff today and will look to get long any further dips from here.  After a very strong rally with no significant dips for several weeks, the first dip is usually bought.  This is that first dip.  The fact that market is selling off because of the CPI makes it less durable.   This fear based on inflation should not last for long.  Powell will not react to a hot CPI number, so its effect on Fed policy is basically zero.

5-30s Steepener

The nonfarm payrolls numbers disappointed the jobs data optimists with a huge miss from consensus.  You can expect more of the same until the crowd catches up with the elephant in the room:  people are choosing to be unemployed.  When you get a $600-$700 unemployment check ($300 federal + another $300-400 state unemployment benefits) every week for pretending to look for a job and you only make marginally more working 40 hours per week doing menial, tedious jobs, its an easy choice.  You have freedom, no Rona risk, no stress, and $600/week for watching Netflix, Youtube, ESPN, playing video games, trading stocks on Robinhood and Ameritrade, etc.  

There is an abundance of workers.  And they will start taking up jobs once the federal unemployment bonuses expire.  But not until then.  Don't blame the workers and call them lazy, they are making rational decisions based on government policies.  Blame the government.  This isn't just Democrats.  This also applies for Republicans, who signed off on everything last year, including the $600/week federal unemployment bonuses which were even more egregious. 

The US government is incompetent and inefficient.  There is so much waste that the only way the government can get any kind of economic results is to just throw trillions at it.  Brute force money.  So that's what's happening with unemployment benefits.  They are throwing money at the problem, and all it is doing is making it harder for businesses to find workers, especially lower skilled labor. 

So the knee jerk reaction to the big NFP miss was to assume that the economy isn't as strong as we thought it was, and to aggressively bid up bonds, especially short duration Treasuries.   You get a lot of information on days like Friday because you see what trades the hedge funds are clamoring to when they add risk.  The 5-30s curve steepener is the most popular fixed income trade among the hedge funds.  You can see this clearly when the funds, usually waiting for an event (FOMC meeting, NFP) to finish before adding to their position.  And the funds going to work on Friday managed to push the long end to the negative even after such a big NFP miss and a spike higher in bonds afterwards. 

Basic theory goes like this:  bad jobs number ---> dovish Fed ---> further delay of rate hikes ---> more inflation.  So buy the 5 year Treasuries, which are more sensitive to rate expectations, and sell the 30 year Treasuries, which are more sensitive to inflation.   

The hole in this theory is that the fixed income market isn't worried about jobs, its focused on inflation.  And even though the Fed is supposed to focus on employment and inflation, their 2 mandates, they really only have 1 mandate.  Let's get real.  Its to please the financial markets.  

So at some point, and we are getting closer and closer to that point, being dovish is not what the market wants, because the market doesn't want high inflation, and that is what the Fed is causing with their easy money policies.  And soon the Fed will get in tune with what the market really wants, which is tighter policy, because let's face it, the Fed are just slaves to the financial markets.  Both stocks and bonds.  That's probably when the short end of the yield curve will start to price in rate hikes more aggressively as the Fed starts to talk taper which in turn will get the market projecting a timeline for rate hikes. Probably starts happening later summer/early fall.

That is the fixed income pain trade.  A flattening of the yield curve, as the 5 year Treasuries start pricing in tighter monetary policy, with inflation expectations coming under control, keeping a bid to 30 year Treasuries.  Looking at the eurodollars futures speculator positioning, they've barely gotten started in putting on rate hike bets.  The positioning is neutral.  Based on how short speculators got in 2018, or even back in 2014 during the taper, the speculators (light blue line) aren't positioned for a eurodollars selloff.  

Eurodollars Futures COT positioning data

We are getting close to the infection point for the 5-30s yield spread.  I think its coming within the next 3 months, as the Fed gets closer to the taper.

SPX hit another all time high as the stock market expects the Fed easy money policy to go on even longer with the weak jobs number.  Bad news is good news forever.  It is the reality of the current financial markets.  The economy is of very little importance because it has no dynamicism.  Its moribund on its own so a static variable.  The only things that matter are fiscal and monetary policy.  So any data that increases the chances of easier fiscal and monetary policy is considered a positive for the stock market.  People are still unable to adjust to that reality, which has been ongoing for the last 10 years.  

I am still short SPX, small size, and looking to add when the time is right. 

SPX Beach Ball

You can't keep the sucker down.  Trying to keep the stock market down is like trying to keep a beach ball under water.  You had a selloff day yesterday, on no news, and then Yellen comes out and talks about overheating and rate hikes, and there you go, your mini me panic bottom at SPX 4130, and grind higher to close with just a small loss and then a decent gap up for the FU to the short sellers.

Hedge funds are selling, as shown by the BofA hedge fund client flows data. 

Surprising to see hedge funds selling so much. pic.twitter.com/A8Ix1ygffl

— Market Owl (@MarketOwls) May 5, 2021

 

I watch CNBC, I listen to podcasts, there are still a lot of people looking for that pullback.  And now the hedge fund data provides the reasoning behind the anecdotes.  The hedge funds have been selling the rally.  

So who's buying?   Its all the stimulus money.  That's the only logical answer.  We are talking about trillions of dollars printed out of thin air that is looking for a home.  $4 trillion is a lot of money!  Liquidity is overflowing, and Powell has his head stuck in the sand, in denial, trying not to rock the boat and crash this market so he can get reappointed.  The Fed is way behind and clueless, as usual. 

Since bonds are out of favor, that means funds going into money markets, stocks, and real estate.  And stocks and real estate are on fire.  Its just money that is out there, excess capital, looking for a place to invest.  This capital doesn't care if they are buying at all time high valuations, they want to invest, no matter what.  

The devaluation of the dollar from all this money printing is pushing the commodities index to the highest level since 2011.  Inflation is back with a vengeance, and it will be sticky, just because of the overflowing liquidity, rising wages, and lack of productivity gains. 

Shorting is just too tough.  You can't catch more than small pullbacks in this market.  Its still a BTFD market.  Amazing, considering we are on year 13 of the bull cycle since the bottom in 2009. 

The charts are still very overextended, as the SPX is way above its 100 and 200 day moving averages.  There is complacency, but top picking is hard.  Its actually easier to pick bottoms, even though it feels scarier.  

I still have a small short position, but definitely not going to be increasing my position, and will look to exit on the next pullback. Its still much better to buy dips than it is to sell rallies.  I just can't make myself buy this market when its SO overextended. 

Trading 102

1.  Take only as much risk as your body can handle.  Sell down to the sleeping point.  I remember taking risk like a madman several years ago, and I would wake up in the middle of the night after sleeping just 3-4 hours because my subconscious mind was thinking about what the market was doing.  Chest pain.  Insomnia.  Your body will let you know when you go over your risk tolerance level.  Its better to be healthy and poor than sick and rich.  

2.  Have a view.  There is that trading cliche:  Don't predict.  Trade what you see.  What does that even mean?  Its vague nonsense.  Every trade that you take is based on a belief that the price will go in a certain direction.  If you don't have enough conviction to make a prediction, you shouldn't even be thinking about putting on a trade.  Without conviction, you are just a sitting duck for stop hunting HFT algos looking to flush out weak hands.

3.  You don't learn how to trade by reading books.  Market Wizards will not make you a good trader or investor.  People have this bias that books are educational.  Trading is the worst business to learn from reading books.  Most of the stuff is outdated and no longer working or just snake oil.  I enjoyed reading Market Wizards and Reminiscence of a Stock Operator, they were entertaining, not educational.  Nothing I read in those books apply to my current trading.  

4.  Experience is the best teacher.  You learn by doing in this business, putting serious money on the line.  Not by reading trading books, or joining some trading subscription service.  Occasionally I will pick up ideas off of Twitter, reading blogs or articles, listening to podcasts, but most of my ideas come from watching and trading the markets.

5.  Tops are a process, bottoms are events.  Indices can linger for weeks at the top and then suddenly drop in a hurry.  But indices usually only stay at the bottom for a day or two.  

6.  Investors extrapolate trends well into the future, without regards for sustainability.  Trend following used to work in the old days when prices didn't adjust quickly to new information.  But with so many trend followers and market watchers, prices adjust quickly, and often overadjust and shoot past fundamental value.  Trend following late in a trend is like picking up dimes in front of a bulldozer.  

7.  Daytrading provides an illusion of risk control because there is no overnight risk.  But the more trading decisions you have to make, the more likely that you will screw up.  And most daytrading edges are small in the bigger markets because you are competing with HFTs and predatory algos.  

On this market:  We got the 1st day of the month inflows into equities like clockwork, so letting the flows do their work and push up prices to levels where it is profitable to short.  Have a small short position, will be careful adding here, want to have dry powder for an even better short setup. 

Sell in May Coming Soon

It looked so great, with those wonderful, manicured earnings from AAPL, MSFT, AMZN, FB, and GOOG, but it seems like buy the rumor, sell the fact.  The price action for shorts is also constructive, as the market has consistently sold off of gap ups only to cut losses and gap them up on more "good news".  You can feel the weakness, even though the market is higher than it was last week. 

You had all those great earnings, a stubbornly dovish Powell, and Biden, the puppet for the MMT masters, talking about more spending bills, like a broken record player.  The Rona spending bills were touted as "relief, rescue, etc."  Now the egregious spending continues, now touted as "infrastructure".  Apparently, infrastructure also covers child tax credits, spending on health care, social programs, and other miscellaneous boondoggles.  They call it human infrastructure.

When you get a deluge of good news after a big run up and a marginal move above SPX 4200 to take out all the stops from the short sellers, and reverse hard like yesterday, it is a sign of saturation.  The longs have been slowly building up their positions and even the CTAs are joining in the party, as the research going around shows them as having similar sized long positions that you last saw in January 2018 and January 2020.  

With the seasonally bullish April out of the way, comes May, which has historically been a turning point for a lot of overextended rallies (May 2011, May 2012, May 2013, May 2015, May 2016, May 2019).  It looks like another sell in May scenario building up here.  I put on small short this week and will add more next week, hoping for any kind of 1st day of the month inflows to provide an opportunity to short more at good levels. 

Really the only thing that bothers me about shorting here is that there are still a few CNBC knuckleheads that are looking for a pullback (Tony Dwyer, 3rd time is a charm?, been looking for a correction since late March).  But the put/call ratios are staying low, and the next Archegos fearing chicken little traders/fund managers are either blown out of their shorts or rebought stocks at higher levels.  

Also 10 year yield looking like it is basing above 1.50% and reluctant to stay below 1.60% is another lingering bearish factor.  There won't be much stimulus talk for at least another couple of months, so that keeps away any positive catalysts there.  The reopening has been so well telegraphed and hyped up, that unless you get a deluge of people going out and spending, its probably going to be a disappointment. 

I have some thoughts on the yield curve, specifically 5-30s, and potential trades there but its not quite ripe yet, so if I see levels that I like, it will be worth mentioning.  In the post 2008 world, 5 year Treasuries are now historically rich vs 30 years, and it seems like most speculators are leaning too much into a bet that Powell dovishness means they have free cover for curve steepener trades.  I see a potential for a nasty unwind in the 2nd half of the year as taper gets closer.

Trading 101

Some observations from the battlefield.

1.  Overbetting is the quickest way to lose in this game.  A great trader with poor risk management will perform worse than an average trader with great risk management.  You can have a 90% win rate, and still lose it all if you can't control your losses on the 10% of trades that are losers.  Five 10% gains followed by one 50% loss doesn't put your account at even, but puts your account down 20%.  Eight 10% gains followed by one 80% loss puts your account down 57%.  A particular weakness for countertrend traders, options buyers, and those that average down / double down when losing. 

2.  Your job is not to try to make money every day.  Your job is to identify positive EV (expected value) situations and make bets accordingly.  Arrogance and overconfidence prevent one from distinguishing between negative and positive EV trades. 

3.  Trading on a longer time frame than the institutions is an edge.  Many funds, especially hedge funds, are very sensitive to short term performance, they do not want to have extended drawdowns.  That prevents them from taking a longer term view, and makes them take short term stop losses or chasing to keep up with the indices.  Taking the other side of forced selling and performance chasing and holding those positions until the fund managers either rebuy or unwind their position is positive EV.  This can take months and even years to fully play out.  E.g. Treasuries from October 2018 to March 2020, SPX from March 2020 to present, etc.

4.  Being a contrarian is not a strategy.  Fundamentals override everything.  If the Fed is irrationally dovish and many investors are bullish (December 2020 to April 2021), the stock market can still keep going up.  In February 2001, most investors were leaning bearish.  The stock market still kept trending down for the next 18 months

5.  Selloffs on news are usually more short lived and shallower than selloffs on no news.   e.g. January 2016 (no news) vs June 2016 (Brexit news).  October 2018 (no news) vs May 2019/August 2019 (trade war news). 

6.  Trade/invest with money that you can afford to lose.  If you need to make $3000, $5000, etc. per month to pay the bills, you will be desperate and force trades.  Blood money is scared money.  And scared money doesn't win in the long run.

7.  You have to have balls to make big money.  However, most people with big balls in trading don't know how to manage risk and prevent blowups.  There is a fine line between having balls and being reckless.  

8.  Taking the other side of retail investors is usually positive EV.  Once a stock/commodity/market gets popular with retail investors, it is overpriced, and soon to be in weak hands.  Put/call ratios, Twitter/stocktwits sentiment, and CNBC are a few tools to find out what is popular with retail.

9.  Fundamentals always win out in the end.  There is nothing that motivates a trader to learn more about something than to put money into it.  Look at charts to find ideas, study the fundamentals to figure out if the idea is good or bad.  SEC filings, COT data, historical price data, etc. are some places to look.

P.S.   Starting a small short today. Put/call ratios are low enough to confirm complacency,  seasonally weak period in stock market is almost here, and SPX way above 200 day moving average makes it likely that there is a consolidation in a range between 4000 to 4200 over the next few months. 

Many Looking for the Pullback

I am afraid that I am not alone when looking for a pullback from the sharp rally since the end of March, from SPX 3950 to 4180 in less than 3 weeks. Looking at finance Twitter, CNBC, Bloomberg, etc., it looks like the majority of the pundits are still looking for that pullback.  The investor surveys all show a lot of bulls, but I see many more looking for a correction or a pause and a consolidation period.  

Just because a lot of investors are looking for a pullback doesn't mean it can't happen, but it reduces the probability that the majority view plays out.  It makes me more hesitant to put on a short position here unless I get the ideal conditions for a short.  I mentioned it before:  a sharp 1-2 day rally to clearly break all time highs set last week.  A less favorable condition would be to short after a few days of more volatile chop that we've seen this week, from 4100 to 4170 for a few days, and then short near 4170.  

Nothing easy to predict right now when the volume goes down and emotions or forced selling/buying are absent.  

It seems like many of the former retail favorites in the biotech and EV sectors are bottoming out, with many rallying strongly off the bottom this week.  It seems like most of the weak hands that were on margin have been flushed out this month during the relentless down trend in the retail momo names like UAVS, MVIS, TKAT, BNGO, OCGN, etc. After so much carnage in those kind of stocks over the past 2 months, I don't expect retail traders to push these uptrends too far, and lots of overhead resistance from stuck bagholders who will gladly sell any further rallies from here.  

Its a tough market to try to make big gains.  I am looking to hit singles and doubles and not trying to swing for home runs on tough pitches.  The easiest market to trade these days is cryptos, so many amateurs and unsophisticated investors in that space, it is a totally different world.  An absolute casino, a poker table filled with fish.  In the stock market, most of the fish seem to have already been eaten by the sharks, or have fled to the more friendly waters of the crypto sphere.  

In the bond market, it looks like there is a big resistance level around 1.53% 10 yr and 2.20% 30 yr where sellers come out.  The bond market appears to be in a short term range between 1.53% to 1.68% on the 10 year.  Should consolidate for a few weeks. 

Crypto Exchanges = Glorified Online Casinos

The stock markets in most developed countries is dominated by the institutions and professionals.  You have small pockets of retail dominated flows, especially in speculative small cap names, but overall, institutions are the price makers.  

Cryptos are a whole another world.  Just by the way it trades and the speculative nature of the asset, institutions just don't have a lot of appetite for investing in it.  Also the regulations and limitations put on institutional investors prevent large inflows into the space. 

Due to regulations and the speculative nature of the cryptocurrencies, there are glaring inefficiencies in the market.  Especially the derivatives market.  

Each crypto exchange is like an island, with its own funding rates, spot prices, etc.  One thing I've noticed is that the exchanges with Asian origins, like a Binance, Houbi, Bybit, etc. have much more volume and speculation in the futures and swaps market than the exchanges with Western origins, like a FTX or BitMEX.  You can also see the difference in the funding rate differences between Binance and FTX over the past 30 days.

 

These are 8 hour funding rates, meaning to get an annualized rate, you need to multiply by 3x365 = 1095.  So on average over the last 30 days, to go long BTCUSD as a perpetual swap, on Binance you had to pay an annualized 80.0% rate to those short BTCUSD.  On FTX, that rate was high, but much less at 50.4%.  Similar differences between Binance and FTX are found in funding rates in ETH and XRP derivatives.  

Now these funding rates over the past 30 days are not sustainable, in my view.  Looking at past funding rate data, during less speculative crypto markets, like September/October 2020, the funding rates on Binance from BTCUSD were averaging 0.01%/8hrs, or about 11.0% annualized.  A decent positive carry, but not astronomical like recent times.   

Funding rates are determined by demand for long or short positions in the futures/swaps market.  If the speculators are eagerly looking to go long with leverage, then the funding rate has to go up to entice traders to short to keep the price in line with the spot market.   These high funding rates are a clear sign that there is rampant speculation on the long side with very little regard for the high cost of carry to hold those positions. 

I've also noticed that FTX tends to have slightly lower prices for the cryptos than Binance.  It seems as if the Western based exchanges have more short sellers,  arbitrageurs, and professionals looking to take advantage of these retail distorted markets than the Asian based exchanges.  In other words, there is a lot more dumb money in the Asian based exchanges than the Western based ones.  It just happens that the Asian based exchanges also have most of the volume and open interest.  

So it still seems like the dumb money is vastly outweighing the smart money.  I don't expect that to continue forever.  Eventually the smart money gets bigger, and the dumb money slowly bleeds away.  Just like during the poker boom from 2003 to 2007, terrible players were plentiful in the beginning, but by 2010, 2011, any decent stakes online game were mostly sharks waiting for a few fish to sit down at the table. 

If you think of these cryptos like currencies, it really makes no sense.  They are basically all valued against the dollar, and if you lend out bitcoin, you get anywhere from around 5 to 10% annualized depending on where you lend it.  So its a high yielding currency.  So in that scenario, high yielding currency spot prices should trade at a premium to forward prices vs the dollar, to account for the higher yields.  But in this speculative driven world, bitcoin and all the other cryptos are trading the exact opposite, with spot prices much lower than forward prices.  The contango in that market is steep, anywhere from around 10 to 25% depending on the exchange.  And in the perpetual futures/swaps market, the interest rates are even higher, if you average out the past 90 days. 

The inefficiencies in the market pricing all originate from the lack of sellers in the derivatives market.  There is a large pool of speculators looking to get long with leverage in the cryptos but very few looking to get short.  So what you end up with are very high funding rates for long positions.  And a huge positive carry for holding shorts, especially in the more speculative coins like DOGE and XRP.  

Due to US regulations, US based investors are not allowed to trade in the crypto derivatives market.  Binance and Huobi, the 2 largest exchanges, don't accept US clients for their main site which includes futures and swaps.  This keeps out a huge pool of capital from participating in the market, keeping the prices less efficient than it otherwise would be. 

There are downsides to cryptocurrency trading.  These exchanges, even the biggest ones, are sketchy in comparison to traditional brokerage firms where rules and regulations keep fraud under control.  You have supposedly had hacking incidents, where tens of millions to hundreds of millions worth of bitcoin have been stolen.  I would view those incidents less as hacking and more like outright stealing by insiders.  So these are not safe places to store vast sums of money.  The crypto exchanges are the wild wild west.  They are basically glorified online casinos.  And if you've ever gambled at an online casino, most are scammy beyond belief and probably rigged. 

People often argue whether bitcoin is a currency or a store of wealth.  I view it as neither.  Bitcoin is the most widely accepted casino chip in the crypto world.  Closely followed by tether.  So if you have bitcoin or tether, you can play in the biggest unregulated casino in the world.  Bitcoin is just like casino chips, you need it to play the game, because the game won't take dollars directly.  

If the game of cryptocurrency trading loses popularity, the demand for the chips in play, bitcoin, and tether, will fall accordingly.  That would lead to a lower price for BTCUSD, which in turn would make the game less attractive to play because most people don't like to keep playing games when they lose money.  In the end, it will be mostly the die hard crypto traders that remain, just like at a local casino, where mostly the compulsive gamblers remain late into the night.

I am getting a bit more interested in putting on an SPX short as we get closer to 4200, but we still haven't seen that steep parabolic rise that would be a signal of an impending reversal.  Its probably a positive risk reward to short at SPX 4180, but there is definitely a possibility that there is a stop run above 4200 before it reverses hard and goes back down towards 4000.  I may put on a small short this week and add more if we get that spike higher. 

Slow and Narrow Rally Like August 2020

 This market has been slowly going higher on very low volume, very little excitement after breaking out above previous psychological resistance at SPX 4000.  This reminds me of the slow August 2020 rally where retail traders took a break after a manic June and July where they took stocks from $5 to over $50, they were having a field day and then suddenly in August everything got quiet and the daytraders traded much less.  The chart also has similarities: breakout, low volume, narrowing breadth, distance from the moving averages, etc.

SPX Breakout above 3400 in August 2020

  Back in August 2020, the market had made a huge rally and was hanging out near the all time highs at SPX 3400 and finally busted out above that level in the last week of August.  That breakout above 3400 lasted less than 10 trading days, and resulted in a sharp correction in September. Of course, there were a lot of worries about the coming election in November 2020 so you had a catalyst for investors to reduce risk.  

SPX Breakout above 4000 in April 2021

This time, the SPX has broken out above the psychological 4000 barrier with ease and on low volume, just like the breakout in August 2020 above 3400.  We are on trading day number 9 after the breakout, but this time, there is no negative catalyst that I can foresee (Fed trial ballooning taper?) in the coming months that would gets investors nervous.  It seems clear that the Fed doesn't want to say they will taper until they see the hot economic data coming in for a few months.  That probably keeps them on taper delay until at least July or August, and probably more likely till September.  

So if the August/Sep 2020 blowoff top is going to repeat, it will have to happen on its own, without any known risk off catalyst.  And as the sharp rally in early September 2020 shows, the last part of the top was the steepest, as the SPX went from 3480 to 3580 over 2 trading days before plunging to almost 3300 in less than a week.  

I am looking for a similar steep blowoff top rally in the coming days, to get a good risk/reward short.  If it just grinds higher day after day like the last week, will just watch and wait.  In this kind of super bull market, you can only take perfect setups on the short side.  Otherwise, you risk getting slow boiled in the pot like the frog that's oblivious to the slowly rising heat.  

Also noticing a very subtle shift in tone from the Fed, as the repeated market talk about inflation has finally seeped into the knuckleheads at the Fed.  As more and more get vaccinated and the economy reopens, the Fed will either have to change their dovish stance or be viewed as completely out of touch with reality.  As much as the Fed hates to get hawkish, they probably hate it even more to be viewed as a bunch of idiots who don't get it.  

Its been 4 weeks since the 30 year yield hit a high of 2.50% and has since grinded lower from there.  These bond bear markets work in waves.  The first sell wave from early February to mid March took the 30 year from 1.90% to 2.50%.  After a 4 week consolidation period, its pulled back to 2.30%.  It looks like the second sell wave will start any day now, and the next sell wave will be the one that probably takes the 30 year well above 2.50% and the 10 year yield close to 2.00%.  I expect this next bond sell wave to have a bigger impact on the SPX than the last one, as the SPX is much higher and way more overextended than in March.  It looks like a sell in May and go away setup coming our way. 

Mind Bender

Investors have a way of bending reality to back up their current position and outlook.  You heard all kinds of pseudo scientific rationalizations from economists about economic scarring, a term that was just made up to try to support their view that the economic recovery would be slow and prolonged.  I don't hear that anymore.  Also a new letter was used to describe the recovery, no V, no U, a K.  I don't see anything doing worse after the vaccine rollout, so that explanation should also be thrown in the garbage bin.  Now almost everyone is on board with the roaring inflation call, due to fiscal and monetary stimulus, and all that money printing.  The go to answer to explain stocks and bitcoin going up. 

Most investors believe that the main reason that we are seeing this huge bull market is because of monetary and fiscal stimulus.  I also hear a lot about the M2 money supply growth over the past year.  So let's look at the M2 money supply chart for the US and Euro zone for the past 5 years.  And compare the SPX vs the Dax over the past 5 years.  

M2 Money Supply 5 year chart

SPX (red/green bars) vs DAX 5 year chart

While the US is blowing everyone away in the money printing department over the past year, most of that occurred in March and April 2020, since then, the M2 money supply growth rate is similar for the US and the EU. 

And the often ignored aspect of the inflation fears is that it eventually leads to the Fed reacting to the market.  Expect the USD M2 money supply growth to slow down sharply if the Fed follows through with taper and interest rate increases like the market expects (1 rate hike priced in by Dec 2022, 3 rate hikes priced in by Dec 2023).   Under the market priced scenario, the US will once again fall behind Europe in M2 growth in 2022 and 2023, just like it did from 2017 to 2019, as shown in the M2 chart above.  

You don't hear too much about money printer goes brrrr when talking about the Euro area.  But Europe has printed just as much as the US over the last 5 years. 

The beginning of the end of most bull markets is an increase in interest rates.  That's not just for the Fed funds rate, but for interest rates across the curve. That is a market signal that money supply growth in the future will likely slow down as the Fed tightens monetary policy.  Right now, the Fed is not pushing back on the market pricing in 4 rate hikes by Dec 2023, just repeating their mantra that they need to see real data rather than forecasts before they change their stance.  We'll be seeing the hot data come out in the GDP numbers in the 2nd half of the year, and then what?  Powell will be running out of excuses to keep the easy money flowing. 

In most cases, the Fed follows the market.  It usually takes a few months for the hard heads and rear view mirror Fed governors to catch up, but they eventually do.  Everyone on Wall St. is forecasting a big jump in GDP over the next 12 months, so when the forecasts turn into real data, the Fed will be changing their language.  

That will be enough to change the current Wall St. paradigm of the Fed money printer goes brrr, weakening investor psychology just as the stock market is at the most overvalued levels in history.  Not a good combination.  

Longer term, I don't believe the Fed will be able to raise interest rates, mainly because of their reaction function vs SPX.  With the SPX going up so high and getting more and more fragile as it goes higher, it would get crushed during the prelude to the interest rate hiking cycle, which would be QE taper.  Not many share my view, the Eurodollars market certaintly doesn't, as the first rate hike has been brought forward to 2022, contrary to the dot plots showing the first rate hike in 2023.  

I can picture the following scenario in 2022, which is contrary to what both the stock and bond market are showing:  

1.  A hot economy that leads the Fed to start tapering in the beginning of 2022, but a stock market crash happening in the middle of 2022 which stops the Fed in its tracks, preventing the Fed from completing their QE taper, effectively reversing the market's rate hike forecast and opening the door to yield curve control.  A real taper tantrum, not the weak one we got in 2013. 

2.  Republicans winning either the House or Senate, or both in the 2022 midterm elections, assuring that there is no more fiscal stimulus until November 2024.  Economy weakens without the drug of fiscal stimulus.  

3.  A bear market starting in 2022, and continuing into 2024 due to a lack of fiscal stimulus, and the Fed going to yield curve control and back to full blown QE unable to stop the bear market.   

Current market doesn't entice my interest, so thinking about what happens in 2022 and beyond.   A dull market, grinding higher every day to new highs on low volume, in a seasonally bullish month.  No thank you. 

I am not a masochist, I've mostly avoided fighting this bull market.  However, we're getting closer to a point where it is worth a shot to put on a short for a sell in May and go away scenario.  Was thinking SPX 4150 to start the short campaign, but probably won't be willing to put on big size on the short side until its closer to 4200.  And this is just for a short term pullback (3-5%), nothing major like 10% on the downside. 

As crazy as 4200 is, this sucker probably goes even higher later in the year (4500?)  just because of the bubble dynamics and the infrastructure stimulus carrot still in front of us.  You probably need to see the infrastructure bills passed AND the Fed trial ballooning a taper before you see a halt to the uptrend.  That's likely not happening until September, at the earliest.

Microtrading

Microtrading.  The bane of my existence.  Not talking about trading with a small amount of money or micro futures.  Talking about overtrading, trying to catch every little wiggle in the market.  Selling before your final price target, just because you "think" that there will be a pullback very soon.  Or because you "think" that the market has gone too far too quickly.  

Trying to catch the micro moves as well as the macro moves.  Sometimes it's successful, but often it takes you out of great trades with just small wins.   Is the market that inefficient in short time frames that a retail trader can beat the HFTs?  

I've been trying since I've become a trader and overall, I am a net loser when it comes to microtrading.  I haven't gone through the calculations, but just from memory, I can remember quite a few big moves that I've missed by selling too early (most recently in the SPX in early February).  

To think that one is able to beat the HFTs and institutions by trading index futures for scalps and day trades (not talking about retail dominated small cap daytrading plays, which is very doable) requires: 

1) a lot of ignorance

2) a lot of arrogance

3) being a trading genius

Most people would agree that there are way more ignorant and arrogant daytraders than there are genius daytraders.  

I often hear from futures traders that you only need to make 1 point per day trading ES (SPX) to make a living.  It sounds so easy, but I wonder how many futures daytraders average at least 1 SPX point per day in profits over their career.  

This trading game isn't easy.  It eats up ignorant and arrogant traders and spits them out after taking all their money.   Most of the time, is it is a negative expected value (EV) game, due to slippage, bid/ask spread, and commissions.  

Its just as important to avoid negative EV situations as it is to catch positive EV situations.  The more you know, the better you get at identifying negative EV and positive EV situations.

About the current market.  I underestimated the buying power in SPX.  I thought there was no edge buying the dips down into the 3800s in March, which ended up as great dip buying opportunities.  Instead, trading smaller and focusing on individual stocks where there are still decent opportunities.  Nothing great out there.

The reduced enthusiasm among the retail trader crowd has actually made shorting daytrading plays much safer.  All those losses in March on those retail momo favorites took the wind out of the sails of the retail trader.  They're not chasing small cap crap stocks like they used.  That makes these pumps much more fleeting and easier to short.  

I am sure the animal spirits among the retail favorites will return again, but the beating that they took over the past several weeks has left a mark.  Its going to take some time before the beatings fade away from memory and they chase random pumped up 4 letter symbols again.  

The SPX ripped through 4000 like a hot knife through butter.  A bit surprised how effortless it was for it to bust through that round number.  It feels like we will top this month, but have little confidence in attempting a short here, only a true blowoff top towards 4150 this month would entice me to put on a short. 

Stimmy Spirits and Powell the Bartender

There are just some markets where you have to be either flat or be long.  Being short is just asking for trouble.  The SPX is one of those markets.  It doesn't meant that you can't make money shorting the SPX.  Its just the odds are not in your favor most of the time.  The odds are in your favor for shorting only a small percentage of the time, usually after a long period of losses for SPX short sellers.  

I do see a golden age for US index short selling coming in 2022 but we need to get past this stimulus fueled run which probably keeps the bull market intact until the fall. 

That exuberance is lacking in many of the retail favorites like TSLA and all the other EV, biotech, and bitcoin stocks.  It seems like all that extra supply from secondaries and new SPAC issuance has siphoned off a lot of the momentum money, overwhelming the demand.  TSLA and all the other momo names are still egregiously overvalued and are still disasters for long term investments, but they have come down quite a bit and could have a strong dead cat bounce at any moment.  

It is a bit like we've just passed the mid 1999 phase of the bubble, if we're going to use analogs.  That's when the Fed raised the Fed funds rate and bonds started trading much weaker.  That means there is probably another 6 to 9 months of upward trending move left for this bubble.  

This time, even with the Fed in full denial about future tightening, if things go as planned, expect Powell to start using more hawkish language as the reopening is going full blast, which is effectively like the first rate hike back in June 1999.  These days, the Fed is so slow to even talk about raising rates, that the mere talk about a potential taper is akin to the first rate hike in a tightening cycle back in the 1990s.  

Kid Gloves.   The Fed has kid gloves when it deals with the market.  It is the parent that spoils its child, conditioning it so that if it doesn't give the child ice cream or candy every few hours, it goes into a temper tantrum.  That child is the US stock market.  It owns vast real estate inside the heads of all the Fed governors.  

In these kind of animal spirits type of markets, when the head bartender, Powell, is providing nearly unlimited booze to the party animals, you get persistent bubble behavior.  Powell has been on the job at Bar Fed for the last 4 years, and he was scolded and hounded in year 2 for taking away the drinks and closing the bar down too early.  He learned his lesson from his boss, the SPX and the institutional Wall St. machine that whines and cries for easy money.   He's now on automatic pilot, the other way, providing free flowing spirits to the drunken sailors, loaded to the gills with stimmy cash.

Under these conditions, it makes it harder to use past history as a guide for future price movements.  There is still a lot of value in using historical data and statistics, but their usefulness is diminished when you get this kind of M2 money growth (unprecedented since World War 2) simultaneous to the biggest everything bubble we've ever seen.  

There is no doubt that some of money from the $1T and $1.9T Covid pork stimmy packages passed in December and March is getting pumped into US stocks.  Its hard to say how much, but I don't think its a coincidence that you are seeing monster fund inflows into equity mutual funds and ETFs this year.  

Over the next few months, most of the stimmy money will be deployed and that's probably when you get the blowoff top and exquisite short moment.  Obviously, I have underestimated the risk appetite for stocks of stimmy recipients, both institutional and retail.  And a LOT of this money spew is spilling into the hands of institutional investors, who are immediately going to work buying US stocks.  

You can't trade the market that you want, you have to trade the market that is.  As much as I hate to see the US government spew money everywhere, debasing the dollar  during the biggest bubble of our lifetimes, you can't deny its effects.  Shorting the SPX at this time is fighting against forces that are bigger than we've ever seen before.  This is no joke.  That is why you are seeing speculative garbage like NFTs and cryptos rocket higher.  But there is an end to the pork, as I mentioned in the last blog post.  You just have to respect the buying power of the bulls until most of this fuel is used up.  And that will probably take a few months.  

In the meantime, there will be short term spots to take tactical swing short positions, or longer term swing long positions, when one side gets too crowded, but nothing worthy of making a big bet.  The bigger and better opportunities will happen after the reopening and right before the Fed starts talking more hawkish.  Still a while away from that.

I am still expecting a sharp pullback soon, just because how overextended the SPX is above the 100 day and 200 day moving averages, and the exuberant atmosphere among index investors.