Time Arbitrage

There is a lot of noise in short term price moves.  Moves that are hard to predict because in the short term, a big institution or group of institutions suddenly deciding to increase or decrease their equity exposure will move the market for the next hour or two, or if they are looking to move very large size, for a day or two.  That could be in the direction of the intermediate term move, or against that direction.  The longer you go out in time, the less one or two big institutions can influence the direction of the market.  Its much easier to forecast what the overall crowd will do, rather than one or two of the big participants.  

Some may say that the longer out in time you go, the more exposure you get to news headlines and unpredictable events.  That's true, but most of the time, these news events don't affect the market for more than a few minutes or hours.  It is not common to get a market event that affects the market for more than a few days/weeks.  Covid type of market game changers are rare.  Even September 11 2001 doesn't come close.  In 2008, which could be considered a slow motion event, wasn't a black swan type of unpredictable market mover.  It was building steadily over the previous years.  The Russia/Ukraine war this year, which definitely caused the selloff to last longer than it would have otherwise in February/March, is already an afterthought compared to what is always on the minds of most investors: the Fed. 

Daytrading is profitable as long as retail investors are heavily involved in the market.  If retail is not active, daytrading gets a lot harder.  Daytrading against institutional order flow is possible, but much harder than against retail order flow.  Institutions are more disciplined, more knowledgeable, less predictable, and make fewer mistakes than retail traders.  The only place you will find retail traders making up a significant amount of the volume is in small cap stocks that are in play.  That is the only place where consistently large edges exist.  That is where beginner traders who are looking for an edge should specialize.  The big drawback from focusing on the small cap stocks is having to find shares to short, lack of deep liquidity (not being able to put on large size for more than the day that its active), and long periods of fallow periods with few opportunities when stocks are in a downtrend and/or retail speculation is subdued.  

But in order to play with the big boys and be able to scale up, one needs to trade markets where institutions dominate, and retail flows are mostly irrelevant.  These are usually macro markets that are covered by futures, such as stock indexes, fixed income, commodities, and currencies, and also large cap stocks.  That is where another type of edge appears which is not talked about much.  The edge from having longer time frames than institutions that trade frequently, in particular, hedge funds.  Hedge funds in particular are judged on a month to month basis, and extended drawdowns are avoided whenever possible.  Hedge funds always worry about drawdowns because it looks bad on their record and its frowned upon by their investors.  So they often get stopped out of long term positions that are in a long term downtrend.  These stop outs are not fundamentally driven decisions, based on investment merit, but based on risk management and fear of big drawdowns.  When you have investors that are making trading decisions based on risk management rather than fundamentals, there is an opportunity.

Let's call it time arbitrage.  This arbitrage comes from being able to enter positions that are currently out of favor and in extended downtrends, with some liquidations and stop losses exacerbating the trend.  These opportunities occur when something is fundamentally undervalued, but currently out of favor on Wall Street.  This arbitrage can also happen in the other direction, where a market is in a bubble and extremely popular, and fundamentally overvalued.  But usually its more difficult and more dangerous to try to short an overvalued market in a bubble than going long in a undervalued market that is in a bear market.  

In the current market, the only market which I see this time arbitrage opportunity is in bonds.  I see no long term time arbitrage opportunity in stock indexes or in commodities.  For currencies, there is definitely a long term opportunity in the yen, as its selloff is related to Fed policy, so highly correlated to bonds.  And buying Treasuries is a better expression of the Fed turning dovish on a weakening economy than going long yen.  

Yes, the best long term "time arbitrage" opportunity is in bonds, not because I think inflation will go down a lot more than market expectations.  Its because I believe the Fed won't be willing to hike as much as the market is pricing in, based on the global economy weakening, even though I expect inflation to remain sticky, due to continued commodities and housing inflation.  We saw in 2007 and 2008, in the face of rising inflation, mainly due to commodities, while the economy was noticeably weaker, the Fed was aggressively easing, and didn't care about inflation in that environment.  Now I don't expect a financial crisis or a great recession, but I do see a US/EU recession coming in 2023, like many are predicting.  That is another aspect of this opportunity which makes it interesting.  Its the fact that so many investors are now expecting much weaker growth or a recession by 2023, but most are not positioned for it, except for crowding into defensive sectors in equities.  But the best way to play economic weakness is not in defensive stocks, but in bonds.  They are for the most part eschewing fixed income, due to 1) continuous downtrend 2) Fed hawkish rhetoric 3) inflation fears.  

The investment flows out of fixed income and towards stocks have been sizeable since the beginning of 2021.  Investors were already historically overweight equities vs bonds going into 2021, with the flows since then, its become even a bigger overweight in equities.  This makes the weak equities scenario much more harmful for the overall economy, as the most dynamic part of the US economy is US equities.  Growth is low, without massive fiscal stimulus, so the wealth effect from equities is a much bigger factor than many are willing to admit.  So a few more hikes will cause stock market to go down even more, and thus, a weaker US economy via the reduced wealth effect channel.  That's not even factored into the leading indicators which are already rolling over hard. 

But the Fed is hawkish now, when the current Fed funds rate is 0.25-0.50%.  This isn't a tough time to be hawkish.  But the more important issue is this:  Will they remain hawkish after 3 rate hikes (50 in May, 50 in June, 25 in July), with the Fed funds rate at 1.5-1.75% and the stock market in a strong downtrend as the economy is clearly weakening (likely August/September scenario)?  That's not something many investors are considering at the moment, even though its probably the most likely scenario in 4-5 months time.  And no, I don't expect the bond market to be weak until August/September.  Unlike 2018, when the bond selloff was extended as the Fed slowly hiked 25 bps every other meeting, this time, they are looking to do 50 bps per meeting, so 4 times faster, plus a much faster QT than in 2018.  And leading indicators are more ominous now than in 2018, mainly because the economy didn't get so hot and inventory didn't get so bloated as they have now.  

I haven't entered any long term bond positions, but its the best market for those looking to play the long game, and can withstand short to intermediate term drawdowns (unlike hedge funds), with fundamentals that are unfavorable now, but will soon turn favorable. That's an opportunity for those willing to make a long term investment in an asset with a very bad looking chart that is in a slow motion liquidation cycle.  

Its brutal price action for the SPX.  It usually feels this way at the end of a downswing, unless of course you are in the middle of a protracted downtrend, which I don't believe is the case.  I could be wrong, but this looks like a deep dip in a 2-3 month countertrend up cycle that started in mid March.  I agree with the majority that the longer term picture looks weak, but disagree about the short term, mainly due to light fund positioning.  Still long, looking to hold for a couple of weeks.

Peak Fed Fears

This is about as hawkish as the Fed will get.  They are tripping over themselves to act like they weren't the same tools who kept pumping in $120B/month of QE and doing nothing but jawboning about transitory inflation to justify their inaction and stock market pumping for all of 2021.  The public loved it, as stocks skyrocketed, at least until their meme stocks kept going down while the inflation kept going up.  Then the public suddenly wanted their low inflation again, and the politicians got the message.  

No, the Fed won't be regaining their credibility on inflation with their sudden tough talk.  Actions speak louder than words.  And let's face it, they are only talking tough while the market is still calm.  When you get those nasty 10%+ corrections, like you saw earlier in the year, then the Fed suddenly get timid again, as seen by their 25 bps bb gun shot in March.  A whimper of a first barrel.  Its easy to sound tough on inflation and threaten 50 bps hikes while stocks are going up, its a lot tougher to do it while the stock market is entrenched in a nasty downtrend and pressure is on them to do less, not more. 

To put it another way, the Fed has no guts.  They just want the glory.  As I mentioned before, they want gutless glory.  Powell is the farthest thing from Volcker.  He wants to be revered like a Volcker, but couldn't even carry his jockstrap.  Powell is the slickest, most political Fed chairman ever.  He will suck up to the Republicans when it serves his interest, and then flip back towards sucking up to the Democrats if that's what's necessary, even if he doesn't believe any of the crap that he spews out.  Powell folded like a cheap lawn chair in early 2019, under pressure from Trump, Mnuchin, and most of all the stock market.  And with his nomination up in the air in 2021, he did the gutless easy thing:  continuous pumping through QE and blatant lies on inflation as being transitory to goose the stock market, using the Rona as convenient cover, even as inflation and the economy were red hot.  

Powell hasn't changed.  He's still the same guy who folded in early 2019.  He's still the same guy who tried to win the nomination by spewing transitory inflation BS until he got renominated.  He will cave in under the pressure of a falling stock market + weakening economy and stop the tightening later this year.  Its not a matter of if, but when.  Will it be September? October? November?  My bet is on one of those 3 months.

So with that baseline assumption of a gutless Fed clearly stated, the Fed has slowly backed themselves into a corner.  They have to back up their tough rhetoric even if stocks go down, just to keep what little inflation fighting credibility they have left, after they lost a lot of it last year.  So with the Powell/Brainard hawkish talk over the past 2 weeks, they are signaling 50 bps in May and 50 bps in June, and if the stock market isn't falling apart by late July, probably another 50 bps in the July meeting.  If the stock market and or the economy is weakening, they either do 25 bps or pause and completely cave in. 

One of the reasons that investors are so skeptical of the Fed's sudden hawkishness is because they've always folded under the pressure of a weakening stock market.  See 2016.  See late 2018.  So to get their hawkish message across, they basically have to bring down the hammer and be over the top.  Otherwise, investors won't get the message.  Well, stock investors are finally starting to get the message, much later than the bond investors.  And from what I am hearing, even bond investors are still trying to pick the bottom, saying the high for yields is just around the corner.  But the price action and looming deluge of supply with a net $215B/month change from Fed buying to Fed selling Treasuries + MBS is a HUGE thing to overcome. 

The only way Treasuries will be able to have a sustained rally under the barrage of supply is if the economy or the stock market actually starts to noticeably roll over.  For the real economy, its still a few months away, as the fumes from the 2020/2021 stimulus are still there, with a decent amount of leftover buying power still available.  For the stock market, with hedge funds having low net exposure, and from the COT positioning data and dark pool activity (DIX index from @SqueezeMetrics), fast money speculators are lightly positioned in stocks at the moment.  There has been higher than normal dark pool short selling activity, meaning passive flows have been steadily buying since January, so about 3 solid months of continuous buying.  But with weak fundamentals (QT+rate hikes, weakening economy in 2nd half), speculators and hedge funds just getting back to neutral levels of stock exposure would be enough to bring back the window of vulnerability to this market.  About 1-2 more months of calm and rising markets should be enough to get exposure back to neutral levels. 

Just a note on the crowd: they are not as dumb as widely perceived.  They got the big picture right by being bullish for most of 2021, rightly noting that the monetary and fiscal largesse were big tailwinds and the economy would get red hot.  And they are right on the big picture now, noting that aggressive Fed tightening will likely lead to a hard landing and a possible recession, and be bad for stocks.  But trying to time when the stock indices will go down for several weeks to months is one of the toughest things to do.  Its much easier to time when the stock indices will go up.  Basic math tells you that since bull markets are much longer than bear markets, and stock indices usually drift upward, its going to be much easier to time a profitable long entry than a short entry.  

I expect further weakness in the bond market until the May FOMC meeting, where the Fed has to back up their talk and do 50, otherwise they might as well take their ball and go home.  Usually a weak bond market is bad for stocks, due to risk parity effects, but there was such a huge purge of speculative positioning in stocks from January to March, its going to take a while for the fast money/hedge fund crowd to get back to even neutral levels, which usually happens as long as the economy holds up over the next 2 months, which is the most likely scenario.  Coincidence and short leading indicators are still strong, while long leading indicators are getting weaker and weaker.  

I did buy SPX on Tuesday and Wednesday, looking to play for a short term bounce.  I will look to sell if it bounces back close to 4600. 

Its Right to be Bearish

There is an old saying that bottoms are an event, while tops are a process.  Fear is a much stronger emotion than greed (the new kids call it FOMO).  The action so far in 2022 is showcasing that, as the downtrend has been choppy, and this rally off the bottom for the last 2 weeks is catching a lot of investors off guard, holding too much cash.  They are right to be nervous, but its never a straight line when transitioning from a bull market to a bear market.  Tops are much choppier and take longer to play out than bottoms.  Tops are flatter, with prices hitting the upper end of the range multiple times before finally going down for good into a bear market.  During this topping process, investors actually get less bullish even though prices are trading in a range for several months.  For example, investors are much more bearish now than last November, when the S&P 500 was trading at 4600. 

There is a misconception about investor sentiment and psychology.  Most contrarians view a lack of bullishness as a positive and a sign that there is room for investors to get more bullish.  That assumes that the crowd as a whole are dumb and don't have a clue about fundamentals, and blindly get more bullish as prices go higher.  But investors as a whole aren't idiots, and are definitely smarter than they were even 10 or 20 years ago.  In the past, macroeconomic fundamentals were considered the most important variable for the stock market, when it was actually monetary policy.  The market now knows that the most important variable for the stock market is Fed policy.  Then comes fiscal policy, which is a distant second.  

Investors actually are sensing that this is not a good time to be in stocks.  This is based on the simple assumption that a hawkish Fed looking to do a bunch of rate hikes in a hurry after a huge move higher in stocks in 2021 is not a good thing.  And that's the correct view, even though it doesn't look so correct when stocks are screaming higher like they have for the last 2 weeks. 

 It was great time for stocks for all of 2021, as the Fed was way behind the curve, doing massive QE while CPI was printing 7% month after month in the biggest fiscal pork stimulus bonanza in US history.  Powell screwed up big time, although he'll never admit it,  mainly because he put his own political situation ahead of the facts, which he brushed off as transitory.  Now the Fed is so far behind the curve and the economic cycle that they don't have enough time to tighten sufficiently before the economy completely rolls over.  You will likely get lower inflation prints in the 2nd half of the year (ex food & energy) due to the weaker economy and less fiscal stimulus, not because of the Fed's tightening.  The Fed should already be at their so-called neutral rate of 2.5%.  

The Fed is so late that they are early.  That's right, they are so late to tighten that they won't be able to hike as much as they want before the crap hits the fan.  And no, the Fed will not be hiking when the stock market is going down a lot and the economy is quickly slowing.  Right now, the economy is past the peak but still in the gentle downslope part of the economic cycle.  When the leftover stimulus is mostly exhausted and higher rates and QT begin to curb speculative activity, the downside of economic cycle will gain momentum and at that point, the Fed will freeze, and then make a dovish pivot.  Similar to what they did in early 2016 and in early 2019.  This time, they will stop hiking rates not because inflation is under control, but because they don't want to take the blame for tightening the economy into a recession.  

You see, the Fed's main goals are not to maximize employment and have price stability.  They want to:  1. Protect themselves, to not receive any blame, so always doing what is politically popular (right now fighting inflation is politically popular)  2.  Keep goosing asset prices higher as long as there is no political pushback from high inflation caused by loose monetary policy.  

The Fed could care less about high inflation if it wasn't so unpopular amongst the public.  But since people actually don't like it when their purchasing power goes down due to excessive monetary stimulus, the Fed has to react to that.  If people didn't care much about inflation, the Fed wouldn't care either.  They are academics, but political academics.  There is no such thing as Fed independence.  That's a joke.  The Fed is like the 4th branch of the government.  

Sold the rest of my SPX longs, too early again, looking to have dry powder to buy into a pullback.  It looks like another one of those classic run for the hills rally towards previous highs.  Its been just over 2 weeks since the bottom before the FOMC meeting, but it feels like its been so much longer considering how much ground the SPX has made up.  Its only down 4% from all time highs.  There will be great opportunities on the short side, but you have to be patient and can't rush to get short.  It takes time for the herd to get their fill of stocks, and considering how low the net equity exposure is, it will take at least another month or two before it will be safe to short.  

Same goes for going long on Treasuries.  It feels like its still a bit too early to get long bonds because I still hear many people skeptical that the Fed can do so many rate hikes that are priced in.  Only when that skepticism turns into true fear that the Fed is serious about hiking 50 bps clips at each meeting, will you be able to finally get the weak hands out of the bond market.  Then it will be a safer spot to get long.  Until then, its a waiting game. 

Gutless "Hawk" Powell and Honey Badger Stock Market

The reaction to the news tells you a lot about a market.  The stock market is no longer the bear's punching bag.  Its punching back at the short sellers, who have aggressively sold bad news since the start of the year.  

On Monday, Powell reinforced his all talk, little action credentials.  The only thing that's changed from Wednesday to Monday is the SPX, which was about 200 points higher on Monday than last Wednesday.  If Powell seemed so concerned about inflation and was comfortable with hiking 50 bps, why didn't he do it last week?  He's been talking hawkish all year, but the reality is that the Fed funds rate is still 25 bps.  Its a joke. Gutless.  He's brave and will talk a tough game, but when it comes time for hawkish action, he does the bare minimum.  That's why so many are so skeptical about those Fed dot plots, which is just another way the Fed tries to act self-important, even though their forward guidance is useless.  Just 6 months ago, the Fed was predicting continuous QE and the first rate hike in 2023.  Completely wrong. 

Powell is excruciantingly slow in hiking even as he talks tough, like he's the next coming of Paul Volcker.  He made an obvious policy error, and inflation is out of control, but people still think he's doing a "good" job, because stocks are much higher over the last 2 years.  I wonder if the people who hold no stocks and are getting squeezed with higher inflation think he's done a good job.  

Anyway, on Monday, we did get a knee jerk move lower on the hawkish rhetoric from Powell, throwing around potential 50 bps hikes like Putin throws around nuclear bomb threats.  And yet the next day, the SPX squeezed higher above 4500 and even after yesterday's pullback, its still higher than pre Powell hawk talk levels on Monday.  And that's despite the bond market trading extremely weak and crude oil surging higher.  

Across that negative backdrop of weak bonds and surging oil prices, stocks are like the honey badger, they just don't care. Its been 10 days since the bottom last Monday, and the SPX has rallied almost 400 points from last week's low to this week's high.  The stock market is clearly showing that the big boys are underinvested and putting on equity exposure quickly, so as not to be left behind just in case there is a no looking back rally, which keeps grinding higher.  

There is nothing that motivates buying more than career risk, and getting destroyed by the S&P 500 while holding cash, as the market surges higher.  Even if the fundamentals don't justify buying at these levels, that doesn't matter.  Hedge funds are short term players, they can't think about the long term if they underperform so badly that they can't get to the long term if they face big redemptions.  

So considering the plentiful signs of an intermediate term bottom in stocks, continued weakness in bonds, and unreal strength in commodities, what is the plan?  Right now, the best play is to be long stocks, even if in the 2nd half of the year, I expect another waterfall decline.  The hedge funds are very underinvested, and with the strong rally in the face of bad news and bond market weakness, I can see the SPX going up to at least 4600, and perhaps even 4700 in April.  I did sell most of my longs on Friday, so I am one of those underinvested investors.  I will be looking to buy any weakness in the coming days, although I am not sure it will be coming.  

The speculation is starting to heat up as AMC and GME and other meme stock favorites are running hard, but I wouldn't consider that a contrarian signal yet.  We've had so much doom and gloom for so long, its going to take several weeks of grinding up action to get the majority back on board.  This looks like one of those extended countertrend rallies in a topping phase that tricks investors into piling back into stocks despite the deteriorating fundamentals.  Like the May to July 2000 rally, like the August to October 2007 rally (Look at a historical SPX chart to see what I mean).  

It seems to be more like 2007, mainly because investors seem more cautious and are aware of the downside risks, much more than they were in 2000.  So giving this rally a couple more months to play out, and by May or June, it should be a good spot to either get long bonds or short stocks.  UST 10 yr around 2.60% would be a very good long term level to get long, as there is a lot of resistance at that level.  Also, leading indicators are also rolling over and I doubt the Fed can get off too many more rate hikes before they start getting scared again as growth slows and they get scared of their own shadow as the 2-10 yield curve probably inverts.  But until then, stocks look like the place to be. 

Overextrapolating

Humans have a tendency to think about the present and extrapolate it into the future.  In the investment world, this tendency is reinforced by month to month performance tracking of hedge funds, mutual funds, etc.  No one wants to lose money in the short term, which leads to herd behavior and short term thinking.  When the herd is running away from stocks in a rush, driving prices lower, fund managers can't pretend like they are managing their own money and just hold their positions and wait for the storm to pass.  They have to worry about short term performance, about losing too much money because that could lead to redemptions.  So they have to sell some of their holdings, just to slow the bleeding, even when they don't want to. 

The war in Ukraine is a perfect example of an exogenous event which has made investors revise their global view and overextrapolate.  Not only about the economic side of things, but also the geopolitical side.  Economically, now most expect the war to cause inflation to rise and growth to slow, especially in Europe, due to the side effect of Russian sanctions.  Geopolitically, suddenly people think there is a pre World War II setup where you have the Allies and Axis powers, getting ready for war, this time with US/EU/Democracies on one side and Russia/China/Non-democracies on the other side.  

I disagree with that view.  But I feel like I am in the minority, with most people now expecting more wars and conflicts between the 2 sides.  There is a lot of inertia when it comes to geopolitics.  Especially when the current situation is close to the equilibrium.  The overwhelming advantage that the US/EU/Democracies have from an economic and military aspect makes it a lopsided contest, and Russia and China know this.  Sure, they are nuclear powers but before nuclear weapons are used, financial/economic warfare through sanctions and restrictions will be leaned upon, and those heavily favor the side with the bigger total economy and the one with the global reserve currency.  It only took a couple of weeks and the Russia economy is already in free fall because of the sanctions.  Holding the financial levers in a global war is a huge advantage.  

After financial/economic war, then comes a hot war using conventional weapons.  That also gives a big edge to the Democracies due to the US investments in the military. Technologically, from a militaristic standpoint, the US is the best. You can say what you want about incompetence in the US government, which is valid, but the US military through massive spending and investment over the past few decades has put them clearly at the top.  Its not a force that Russia and China want to antagonize into a world war.  There is a clear deterrent effect of the US military buildup which prevents a hot war between superpowers from getting started.  

I see some of the 15 minute geopolitics experts who are opining that because Putin gambled and invaded Ukraine with bad information, that Xi will do the same thing with China.  They are 2 very different countries.  Historically, Russia has started a lot of military conflicts.  China has not.  China has usually been on the receiving end of other countries' aggression.  Unlike Russia, which has some imperialistic ambitions, China seems more concerned about its economic position, and ensuring that it has a steady supply of natural resources to keep growing to become a first world country. 

So what about all the talk about China invading Taiwan?  China invading Taiwan is different than Russia invading Ukraine in the sense that there is no way the EU/US will put on heavy handed sanctions on China like they did to Russia.  It would be suicidal, because of the amount of Chinese exports that they depend on for their economies.  And the difference between China invading Taiwan and Russia invading Ukraine is that Ukraine is right on the border with EU countries that are also NATO members.  That immediately rings alarm bells for the EU and its allies.  Taiwan has no such borders.  And most countries don't even recognize Taiwan diplomatically as a country, like they do with China.  And with Xi set to be reappointed as Chairman for life this coming fall, I don't expect any risky moves like a Taiwan invasion before then.  So if it does happen, it probably happens in 2023 or later.  

We are getting some headlines about Russia and Ukraine making progress in peace talks.  Its the rational outcome for both parties.  Only through a peace agreement will Russia be able to get the West to lift sanctions, winning the war and occupying Ukraine is losing economically and politically.  Putin is not crazy, like many think, he just has bad information from incompetent sycophants who tell him what he wants to hear.  If he knew what would have happened before the invasion, he probably wouldn't have invaded.  So clearly taking an off ramp before his economy goes even further down the toilet is the rational choice.   

As for Ukraine, if they don't reach an agreement with Russia, they'll have to probably withstand another couple of months of artillery bombardments with the West making token donations of weapons and aid until Zelensky and his government get taken out by Russia, dead or alive.  Any deal that isn't totally egregious is better than doing nothing and eventually losing the war.  Ukraine cannot win the war militaristically.  They are totally outgunned, outmanned.  Sure the Russians also are taking significant losses, but their military can bleed for quite a while before they run out of manpower and firepower.  Ukraine cannot win a war of attrition, they just don't have the capacity.  

Of course, if neither side is willing to compromise to get a deal, then wars continues, but the pressure on both sides is building with each passing day to make a deal.  The alternative is worse for both sides.  

We have an FOMC meeting today, I see that many are expecting 25 bps and a hawkish statement and press conference.  So the bar is a lot lower than the last meeting, when many were still not so sure about Powell's stance.  They know now that he's taken a hawkish turn, so the expectations are more aligned with reality.  I actually think the FOMC meeting isn't that important right now, its not really a variable, its a constant and that is 25 bps for each of the next 3 meetings, taking the Fed funds rate to 0.75-1.00% range.  After that, it becomes a variable again.  I don't put much weight on what Powell says because he seems locked in for the next 3 meetings, and the balance sheet runoff is probably going to start either in June or July.  

The market cares about the war much more than this FOMC meeting.  Hedge funds have not been derisking like this (near spring 2020, early 2016 levels of net equity exposure) just because they think the FOMC will be hiking rates for the next few meetings.  Its from the unknown and economic doomsday scenario that they picture with a long dragged out war where Russian sanctions eventually result in much higher energy and food prices, and thus lower overall global growth.  

Still holding long, see some stiff resistance at SPX 4400, and strong support around SPX 4150-4200 area which has held the last few times down.  Bond market weakness is a definite negative, but I'm not sure how much of that is selling ahead of the uncertainty of the FOMC meeting, and how much is from a view that inflation will remain higher for longer due to the side effects of war.  If it is more the latter, that's not a good sign, because I expect commodity prices to be quite high for longer even after the war is over.  That's the biggest fly in the ointment for the stock market bull case.  But despite that, I still see a market that's oversold enough and de-risked enough to rally for 1 to 2 months from these levels.  A bear market rally of sorts, a counter trend rally that surprises a lot of investors. 

Of course, if you get peace and Russia leaves Ukraine, that event itself would get the animal spirits flowing for at least a few weeks, if not months.  I still view this as the middle of the topping phase, I don't expect a protracted downtrend until more rate hikes are behind us and investors are more complacent.  Right now, so many are cautious out there because of the war that when the war ends, a lot of money will be put into stocks, and its going to take more than a week or two, considering how much the funds seem to have sold down. 

Commodities Going Parabolic

During the past 3 weeks, since the beginning of the fears of a Russian invasion on Ukraine to actual war now, you have seen a shift in the mood from possible supply shortages if there is a war to pricing in a supply shortage for the next several months in crude oil, natural gas, metals, and grains.  The supply shortage coming from Ukraine unable to harvest and export grains is natural, and will be there until the war is over and Russian troops leave.  That is why the move higher in wheat looks much more sustainable than the move higher in energy.

The supply shortage coming from Russia due to embargoes and sanctions is artificial, and can be circumvented through exporting to non-sanctioning countries such as China and India, when possible (crude oil), although for natural gas exports, there isn't the infrastructure to export it to China or Asia through pipelines or as LNG.  

There is an assumption that Russia won't be able to export most of their normal 5-6 M barrels/day of oil due to Western sanctions.  But Russia still has the capability to export it, although at a steep discount to non-embargo countries.  Since crude oil is fungible, in that case, there is no supply disruption, as China/India will be substituting non-Russia crude imports with cheaper Russia crude imports.  The US can make warnings all they want about China buying Russia commodity exports, but they can't do anything about it, and it actually helps the White House, because China importing Russian crude helps to keep crude oil prices from getting completely out of control.  

 As for European natural gas supply coming from Russia, it looks clear that Europe can't take the pain of not importing Russian nat gas, no matter how bad it looks politically.  Because it will be even worse when natural gas prices go so high that it requires demand destruction from high prices, which is a politically painful way to match supply with demand.  That's why Germany has refused to put an embargo Russian natural gas. 

There is now a consensus belief that there will be an extended global crude oil shortage, and a European natural gas shortage.  But that's assuming an extended, drawn out war between Russia and Ukraine, and no deal between Ukraine and Russia.  Those are questionable assumptions because Russia has taken control of most of the south, and is steadily advancing towards Kiev, and with their artillery firepower and Putin being committed to taking over Kiev barring a peace deal where his demands are met.

If Putin takes over Kiev, the war is effectively over.  If he makes a deal with Zelensky, the war is over.  The likelihood of one of those things happening within the next 30 days is much greater than 50%, IMO.  The war coverage is clearly biased for the Ukraine side, just from people wanting to root for good vs evil.  But the reality is that US/EU are not interested in going to war with Russia over Ukraine, and without their direct military help, Ukraine is massively overpowered and will be overwhelmed by Russian forces.  Its a matter of when, not if.  

Zelensky is starting to waver on his firm stance of refusing to compromise on certain issues when negotiating with Putin.  He may be seeing the writing on the wall, and is between a rock and a hard place.  If he acts rationally, he would accept the deal from Putin and remain in power, give up trying to get into NATO/EU, although with the dark cloud of Putin hanging over Ukraine, but not directly taking over.  Taking the deal from Putin is not a get out jail free card, it's basically just kicking the Russian can, but he's buying time and avoiding regime change.  If he decides to keep fighting, eventually he'll lose to Putin, get taken out dead or alive, leading to more destruction and a humanitarian disaster from artillery fire in the coming weeks and months. 

Stating the obvious, the Fed and ECB are not what's keeping this market down.  Investors are reducing equity exposure because of the uncertainties of futures sanctions and second order effects of effectively shutting off a big part of Russian trade out of the global economy and explosive moves higher in commodities, fearing that tips the economy towards a possible recession.  

If we get a resolution to this war, the market will go much higher than current levels, given how much hedge funds have taken down net equity exposure, and how much fear there is in the market.  This level of fear is not sustainable for long.  Its not an equilibrium situation, because eventually those that wanted/had to sell have already sold.  

Still long, and nursing losses, but I just don't see a big economic impact from high commodity prices that many believe.  Spending on fuel and wheat is just not a big part of consumer spending in the US/EU.  And the extra money that they do spend just gets recycled to commodity exporters who will have more money to buy financial assets. 

Nuclear Risk

The VIX is pricing in nuclear war risk, as the realized vol is badly lagging behind implied vol over the past 4 trading days.  Overnight VIX levels are trading at 33.8.  A VIX of 32 implies daily 2% moves.  Since last Friday, the SPX has moved the following:  -0.24%, -1.55%, +1.86%, -0.53%.  If you are counting the current level of the futures, the SPX is down a little over 1% this week.  

The divergence between realized and implied vol eventually converges to its historical level, which is around 3-5 VIX points.  Right now, over the past 4 days, that IV to RV premium is hovering around 15.  These kind of bloated implied vols are usually present around big events, like a 2020 Presidential election.  This time, the event is something that is everyone's biggest fear:  nuclear war.   

The market got a big scare when a Ukranian nuclear plant got hit and a fire broke out.  Eventually the fire was put out, but you still have the leftover nuclear jitters and of course weekend war risk, which is now being priced in as the futures sink pre-market.  

During the past 4 trading sessions, the divergence between the Eurostoxx and SPX has been dramatic.  Europe is making lower lows, and has broken the Thursday 2/23 Russian invasion panic low, while the SPX is still trading above 4300, well above last Thursday's levels.  A lot of risk is being priced into European equities, and much less is being priced in for the US.  It seems like the US stock market is considered a relative safe haven for risk-on flows, less affected by the repercussions of the war than Europe.  

We are still chopping around in the 4300 to 4400 range over the last few days, almost like a mirror image of the chop that we saw between 4280 and 4430 in late January.  This time, the fear is more palpable, although the realized vol is less.  If the market stabilizes and stays within this 4300-4400 range, the VIX will naturally drift lower as the IV-RV relationship converges to its historical relationship.  

On Wednesday, Powell all but put 25 bps rate hike in stone for March, but seems to be considering the aftereffects of Ukraine, which probably takes out 1 or 2 rate hikes he would have probably pushed through if there were no geopolitical risks out there.  Marginally lower rates and less aggressive Fed talk should keep the Fed from blowing up this market in the intermediate term.  But if the market rebounds too much, then I can definitely see Powell going back to hawk Powell mode. 

I am seeing a steady flow of elevated ETF put volume relative to calls throughout this week, as investors get more hedged.  We have a big options expiration in 2 weeks, so there will be a lot of put deltas that will either evaporate to 0 if the market goes up or stays still.  Barring nuclear armageddon, dealer hedging flows (delta, vanna, charm) are a net positive for the next 2 weeks, and should provide steady SPX buying, and the flows will be even heavier if the VIX starts to go down. 

Lots of things are in favor of the bulls at the moment, even as it looks scary right now.  Well hedged market, bullish options flows (barring nuclear war), reduced fast money net equity exposure, and lots of fear.  

Given how much fear there is in the market, I expect an extended rally from these levels over the coming months, as investors slowly increase their equity exposure as they put the war behind them and focus on less "scary" things such as inflation and Fed rate hikes. 

Is Putin Mad?

Its easy to get caught up in the Russia/Ukraine news and market implications, but every 15 minute geopolitical expert has pined their views over and over, so I'll give you mine a bit later in this post. 

I was listening to a Quoth the Raven podcast yesterday, with guest Ben Hunt.  He was talking about the Ukraine war, and how prices/valuations are determined by stories, and one of the stories that the market often repeats is when it faces an obstacle, and volatility increases and prices go down. But eventually, the market overcomes the obstacle, and during that process, stock prices go up.  

That made me think about the obstacles for the market in 2022.  First, it was the Fed turning hawkish, starting with the Fed minutes from the December meeting released in early January, which started this downturn.  And it continued as the market kept pricing in more rate hikes and stock jockey central bankers like Bullard giving his 2 cents and talking more rate hikes, multiple hikes.  Bullard even got specific, saying he would like the Fed funds rate to be at 100 bps by July 1.  

In the middle of all this, the market was thrown another obstacle, the Russian invasion of Ukraine, which many suspected for several weeks before it eventually happened, despite denials from Putin the whole time.  People were mocking Biden for scaring the market by saying that Russia was getting ready to invade, and it wasn't happening right away.   

As the negotiations between Putin and the EU/US kept failing, and the US intelligence kept repeating news about more and more Russian troops at the Ukraine border, the market was sensing a war could happen any day.  And with any bad news, it usually comes out overnight, and the futures tend to have a kneejerk selloff, and it did last Thursday.  And it did it again on the Russia central bank asset freeze/SWIFT ban, stoking up counterparty risk fears, and talk about another Lehman 2008 / Covid March 2020 moment on Sunday overnight/Monday morning.  And yesterday and today, another one with crude oil surging higher as Russia can't seem to sell its oil, even though oil falls outside of the scope of the sanctions.  

At this point, it seems like a total mess, but if you look at the SPX chart, while the news seems much worse now than it did in late January, we're basically back at those late January price levels of SPX 4280-4400.  But now, sentiment is much more bearish, there's been more time for fast money fund managers to reduce their equity exposure, and you have the market much more prepared for further downside.  The news flows seems much more horrible, but here's probably the most important difference:  bond yields are much lower, especially the last 2 days as the market is now pricing in a less hawkish Fed and ECB with all the geopolitical uncertainties.  Lower bond yields are a positive, a less hawkish Fed and ECB are a positive, even if it only lasts a few months. 

So you have less hawkish central banks even with oil surging way above $100.  Bond yields are much lower.  And investors are much more bearish.  Yesterday, I was listening to CNBC Halftime Report, and 2 of the guests were both looking for the market to chop around these levels, even looking for a retest of last week's lows, but they expect that the market will eventually go higher after a few weeks, after the Fed raises rates.  Its seems they are not fully invested.  Well if they are going to wait for the bad news to stop, or for the market to stop caring before increasing their risk exposure, then they'll have to pay higher prices for the certainty.  

Eventually, there will be a resolution to the war, Russia can't fight forever.  They can't even produce most of the military equipment and weapons without importing high tech parts from the EU.  They'll eventually run out of conventional firepower.  So they go nuclear after that?  Putin going nuclear basically assures the end of his regime, and he knows that.  There is already so much global backlash at Putin due to the Ukraine invasion, imagine how much worse it will get if he uses nukes.  The whole Western world will be looking to eliminate Putin from power, dead or alive.   

Really that's the only uncertainty left for this market, whether Putin goes nuclear or not.  And that's a black swan event, but there is no incentive for him to do that unless he wants to go out with a bang.  But based on how scared he is of Covid and how far he literally distances himself from those around him, I don't think he's looking for a death wish.  Even as delusional as he is, he knows that going nuclear will be the riskiest move he's ever made, with a substantial probability that it ends his regime.

Many are saying Putin is a mad man, unpredictable, and apt to do crazy things.  He's not mad, he's just out of touch with current events.  His inner circle are a bunch of yes men who don't give him an accurate view of what's happening.  He invaded Ukraine because he thought it would be easy, the world wouldn't really care, and would let him take it without consequences, like the other small wars that he fought before.  And even with sanctions, he won't change his view, unless he feels his reign is in jeopardy.  He was so secure that he would stay in power, that he didn't even consider the risk that a Ukraine invasion could possibly backfire and potentially lead to his downfall.  

I don't know how much he's going to invest in the Ukraine war, but at this pace, he won't be able to go on for long.  Eventually they'll run out of conventional weapons and military equipment.  Unless China steps in to provide it to him.  Don't think Xi will want to do that, considering how much the world is against the war.  Plus, China is a net importer of energy and commodities, so this war is hurting them economically.  Unlike other dictators like Xi and Kim, Putin doesn't have the same logistical capabilities to get his population completely under control.  If the war drags on and the Russian economy falls into a depression, there could possibly be uprisings or a coup. 

I have a full SPX long position and just waiting out the turbulence.  Bond market strength is a positive, and its a much bigger factor than crude oil prices rising.  Financial markets are a rich man's game.  Higher oil prices negatively affect poor people, not rich people.  Bond prices affect rich people, not poor people.  Higher oil prices are a stock market negative if and only if it makes the Fed more hawkish.  Based on the moves in the bond market, it appears that the market is sniffing out a less hawkish tightening cycle due to the Ukraine war.  That's the most bullish development I see over the past 3 days.  Much more important than any Russia SWIFT ban or Russia default concerns. 

War Panic and Liquidations

The war headlines are relentless.  That's all the market cares about right now.  That was one scary looking drop in the overnight futures on the Russian invasion.  WTI oil broke $100/barrel and was up over $8 on the day before dropping hard on news of more SPR releases and slap on the wrist sanctions on Russia.  The key to this market is oil.  If you get crude oil to stay under $100 and keep inflation from getting totally out of control, you can sustain a rally for 2-3 months.  If oil maintains its strength, the rally will have a shorter lifespan and will peter out after a few weeks.  

The market hates uncertainty, and now that its clear that US and Europe don't want to hurt themselves economically with any serious Russia sanctions, almost a best case scenario is opening up where war keeps the central banks from being too hawkish, but at the same time, weak sanctions allowing Russian oil and gas to flow freely throughout the world.  Its actually even a better case scenario than an agreement with Putin, because now that he has Ukraine, he's likely to consolidate his position, and wait awhile before his next move.  

The price action on Thursday was beyond my imagination, a one day turnaround that's uncommon.  It shows how much panic the overnight futures were pricing in, there were no real eager sellers once the US regular trading started.  Usually I don't put too much weight into one day of trading, but after so much selling and a big time break of the January SPX 4220 low, that quick of a reversal in the face of bad news and fear everywhere gives us a high probability bottom signal.  Put volume was through the roof yesterday.  Very heavy volume and it definitely felt like a deep cleanse to break that 4220 support and stop out the weak hands.  I have enough longs for now, and I have no plans to sell anytime soon.  My base case is that we've bottomed and washed out the weak hands, and there will be a sustained rally for the next 4-6 weeks. 

War Doom and Gloom

Its palpable now.  You can sense the fear, the gloom in the air.  Right as the SPX is testing the 4250-4300 zone, a hard support area from last fall and in late January.  The Fed is temporarily out of the picture.  Its Russia/Ukraine news, all day, every day.  Full blast.  You would think Russia and Ukraine were some kind of financial and economic hub if you saw the price action in global index futures over the past few days.  

When you are long and you see the futures plunging overnight, its natural to question your sanity for being long, when everyone out there is talking about the negatives in the market, the bearishness is the most extreme I've seen since spring of 2020.  This easily tops the 2020 election uncertainty, which feels like happy days compared to the war doom and gloom that you see out there.  My Twitter stream is filled with Russia/Ukraine 5 minute macro expert takes, about how Putin will take over all of Ukraine, etc.  You can only laugh at it if you want to maintain your sanity in this craziness.  Especially when you are long.  

Its a lonely place, expecting higher prices this week after seeing the news flow.  Its easy to feel like an idiot when all the scaremongers are out in droves spreading the bearish gospel, and seeing the market go down.  But intuitively, I get more confident in my position when I see this, when I know that fundamentally, war doesn't have negative economic effects, rather, they are expansionary, and because of the pansy Fed and ECB, who don't have the balls to raise rates aggressively while a war is going on with the SPX trading weak.  Sure, if the SPX was making new all time highs, they would ignore Russia, but when its trading weak, they won't ignore it.  They even metioned Ukraine in the Fed minutes, and that was referring to the situation 4 weeks ago.  So with things getting this hot in Ukraine, its a guarantee that 50 bps is off the table for the March meeting, and that's a win for the stock market, which was scared about a hawkish Fed more than anything before the Russia headlines took over  Of course, none of the bears screaming their war takes will ever mention that.  

I plan on adding more long exposure today, as the EU seems to finally be putting on sanctions on Russia, getting closer to the end of what will eventually be done.  Its not the war itself that causes stock market weakness, it is the lead up to the war that cause its.  This retest of the January lows feels scary to be buying, but with fundamentals actually better now than before things got heated in Ukraine (less hawkish central banks, now) its makes it a higher probability that the retest will be successful. 

Russia Risk and Psychology of War

Market participants are funny.  I am reading Russia takes from a lot of investors which doesn't make much sense.  A lot of people seem to think that Russia invasion of Ukraine is the biggest risk to the market, but they think that the risk is underpriced.  All people are talking about is Russia/Ukraine.   They are dominating the headlines.  And that's been the main reason we've had violent moves up and down over the last few days.  Its the main reason people have been buying puts.  Yet the Russia risk is underpriced?  

It gets back to the primal instincts of investors who are scared about war.  They equate human tragedy with stock market tragedy. 

Fed rate hikes seem trivial when compared to a war between Russia and Ukraine.  But Fed rate hikes are much more important to the stock market than war.  Its a much worse environment for stocks with a hawkish Fed and no war than a neutral Fed that can't hike aggressively with a war going on.  Investors tend to forget that this is a money game, not a news game.  Having bad news doesn't mean the stock market will be weak, and having good news doesn't mean the stock market will be strong.  But pumping a lot of money into the system usually means the stock market will go up.  And draining a lot of money from the system usually means the stock market will go down. 

Yet based on what I am seeing, investors are complacent about a hawkish Fed and think the Fed won't be able to hike much or meaningfully reduce their balance sheet but are scared that a Russia invasion would be a black swan.  Black swans don't happen when everyone is aware of it, with quite a few who are scared of it.  They happen when the event is either unknown or considered inconceivable.  

A lot of short term trading isn't about fundamentals but predicting whether a move is sustainable or unsustainable.  Fears based on war are not long term sustainable.  In the short term, the stock market can be inefficient and irrational, but in the long term, it finds its efficient, equilibrium level.  War doesn't hurt corporate earnings, in fact, it often helps corporate earnings for certain sectors (energy, materials, defense).  But you don't hear much about that, its just this instinctual fear about war that seeps into stock market.  

We have Fed minutes today, so I am sure that will get the nervous short term traders looking to sell or short ahead of the minutes release at 2:00 PM ET.  Stocks plunged on the last Fed minutes release in early January, so I'm sure not many are optimistic about what the Fed will have to say this time around.  Once we get past the Fed minutes, I don't see any more events that could be bear catalysts.  Except for World War 3!   

Got long SPX on Friday and Monday, looking for a bounce towards 4500 and higher by next week.  Lot of put volume in ETFs over the past few days, and investors seem to be leaning bearish and are getting more and more hedged.  I am just playing the range for now, don't expect any big moves in either direction.  If we can get back up to SPX 4550 and higher this month, I will consider a short position. 

Start of World War 3?

Suddenly, after ignoring all the other warnings from the US about an imminent Russian attack on Ukraine, the market, on a Friday afternoon, after already going down due to high CPI and hawkish Fed talk, starts plunging.  You get lots of hedging via put options going through (options volume was high), and now people are worried about World War 3.  There is nothing like war to get people scared.  You can't make this stuff up, the market is both inefficient and irrational because its ultimately controlled by a crowd of human beings.  No matter how much the market has been controlled by the "algos", humans will always be the ones behind the controls turning on and turning off the algos. 

A move down from SPX 4590 to 4490 wasn't enough to get investors to panic and buy puts and Treasuries, but a move from 4490 to 4400 on World War 3 fears was enough to get them a little panicky, and buying puts and Treasuries.  Those are 2 ingredients that are important for any short term bottom:  1.  Falling yields 2.  High put volume

It doesn't hurt the bull case for the next few weeks now that war in Ukraine is now a concern.  Ukraine chicken littles reducing equity exposure is a positive.  The less weak hands there are, the less panic there will be when there is weakness.  What does hurt the bull case is that the next month's CPI, ECB, and FOMC meetings are still a month away, which is a dark cloud of uncertainty hanging over this market.   

Who knows, if Russia attacks Ukraine, Pansy Powell could delay a March rate hike, which would be bullish for stocks and bonds.  We all know that throughout its history, the Fed uses any excuse it can to delay rate hikes, and to speed up rate cuts.  So counterintuitively, Russia going to war with Ukraine could take the market's biggest worry off the table, which is aggressive Fed rate hikes. 

The S&P has now soundly got rejected off of 4600 resistance the last 2 times up there.  I doubt this market has the strength to get back up there in the next few weeks.  But that doesn't mean this market can have a strong bounce off around strong support in the 4300-4350 zone.  I put on a starter long position near the close on Friday, with plans on adding more today, on further weakness.  Not looking for a huge up move, but a reflexive bounce up to 4500 is doable. 

Taking Head Out of Sand

The equity crowd finally seems to be getting it:  Dove Powell is not coming through that door to rescue the markets.  It only took relentless pounding from stock jockey Bullard who kept sending the message repeatedly.  Powell doesn't want to do the dirty work.  He has his underlings to do it for him.   He's a coward and unwilling to speak the truth, instead being as mealy mouth as possible so as not to "hurt" the stock market, while still trying to sound tough on inflation.  But he doesn't want to act tough on inflation, unless there is political pressure to do so.  And Biden and Congress is putting on that political pressure. 

Powell is no dummy.  As he was spewing the transitory BS, he probably knew there was a good chance that inflation was going to remain sticky, but he couldn't say that, because he didn't want to upset the stock market before his reappointment decision.  After horribly mismanaging 2021, he's now under the gun.  He doesn't want to hurt the stock market, which makes him look bad, but he also has to give the image of a banker who is actually worried about inflation.

Now freshly reappointed for 4 more years, he can be a bit tougher on the stock market, although if he could get away with it, like Kuroda at the BOJ, he would stay at zero forever.  But he can't.  Unlike Japan, the US money supply situation is much, much different (just look up Japan M2 vs US M2 over the last 20 years).  Plus, Powell's main priority is not maximizing unemployment and keeping inflation under control, its winning brownie points from the White House and Congress.  His urge to please his political bosses means he has to look like he's tough on inflation, when he's been anything but that throughout his tenure. 

Yesterday's CPI number isn't anything extraordinary, it was a bit higher than already high consensus estimates.  But for some irrational reason that I have a hard time understanding (short covering?), there was a big rally for 2 days ahead of the number.  So SPX was basically at the top of the range, 4590, right before the number came out.  It was set up for disappointment. 

Now you have a situation where the market has gotten a bit overboard, from being too complacent about Fed hiking, thinking Powell will be one and done, to being too worried about a 50 bps hike, and even an inter meeting hike, which isn't going to happen.  10 year yields are now over 2%, but more importantly, 5 year yields are at 1.95%, as the yield curve is getting very flat, very quickly.  7-10s is at zero.  5-30s is at 36 bps.  It has only been this flat in 2018, just as the Fed was finishing its rate hiking cycle, not starting it.  Much like the 2004 to 2006 rate hiking cycle, when Greenspan was late to start hiking, and very slow to get to the final Fed funds rate of 5.25%, the market was pricing in a bunch of hikes before Greenspan even did his first rate hike in June 2004.  The interest rate market is screaming to the Fed to hike aggressively, pricing in more and more hikes, despite the equity guys hoping for one and done.   you are late, and you will be hiking a lot, because you are late.  

Even with all these hot inflation prints, the Fed is still doing QE!  LOL.  And if Powell could have gotten away with it, he would have stayed with the turtle taper of $15B a month, not letting him hike until July!  If it wasn't clear during Greenspan and Bernanke's days, its obvious now:  Fed is always in a rush to ease, and always way too late to tighten.   

We have given back the last 2 days of rallying in 1 day.  At one point, the SPX was rallying aggressively after the open and had filled the gap, but it crapped the bed again on Bullard comments and more selloffs in the bond market.  With so much angst now about Fed rate hikes, and so much priced into the March meeting, I can't imagine anything but a weak SPX going into early/mid March.  If that's the case, we can see that retest of 4250-4300, which is my base case scenario.  The put/call ratio was surprisingly low yesterday, so it seems like short term investors are still believers in the V bounce.  

Usually don't want to short a bounce after such a big waterfall decline, but its looking more and more likely that we'll be seeing a lot of weakness over the next few weeks.  If we can revisit the 4560-4580 area on a bounce within the next 2 weeks, I will be looking to put on a short to ride down for a potential retest.  Just watching and waiting for the right spot, don't ever like shorting after a big selloff on/Fed talk. 

Forming the Volatile Range

The past week provided information towards what the next 4 weeks of trading should be like.  The volatile chop range between SPX 4270 and 4430 was resolved with an explosive move to the upside to 4590, signaling the bottom was found for the intermediate term.  That move gave us the upper bound of the new range, 4590.  The selloff on Friday likely formed the lower end of the new consolidation range, but its still to be determined, as the pullback is just 2 days, and could last another couple of days.  In the bigger picture, we're still trapped in the post waterfall decline/fear based volatile trading regime.  That means we're likely to have a retest of the 4250-4300 zone that was defended by the bulls sometime in the next few weeks, after the countertrend consolidation runs its course.  This consolidation could run anywhere from 2-4 more weeks of trade between roughly 4420 to 4600.  After that consolidation, I am expecting another strong selloff testing the support zone around 4300.  

That selloff in late February/early March will likely be fueled by demand for March quarterly expiration puts ahead of the first Fed rate hike on March 16.  Last week, the ECB also threw their hat into the rate hiking ring, hinting at a rate hike later in the year, as they follow the Fed like headless chickens, looking for direction.  The big dates for March are the ECB meeting on March 10, and the FOMC meeting on March 16.  Investors will be wary of loading up on stocks in front of those potential fear events, creating an environment for a risk off selloff. 

The relentless rally in crude oil is more meat for the bears, as higher commodity prices will keep the central banks on a hawkish path, talking tough and eventually having to act tough.  Those hoping for one of those 2021 style V bounces are still looking in the rear view mirror, and not adjusting to the new environment of higher inflation leading to central bank action, not central bank inaction.  

In 2021, Powell was still stubbornly dovish.  He's made a hard pivot towards the hawkish side, and expect him to signal more rate hikes at the March meeting, in order to get the market to keep the May rate hike on the table.  At the moment, March is automatic, but May is still up in the air.  Unlike 2015 when Yellen put in a one and done crying rate hike, Powell is facing higher inflation and rising commodity prices, with much more excess liquidity than back in 2015.  3 straight rate hikes in March, May, and June cannot be ruled out.  After June, Powell probably starts QT at the July meeting and doesn't hike, but probably will go back to another hike in September, with hints of quarterly hikes until they reach ~2% Fed funds rate.  That's my base case scenario.  Of course, a vicious stock market waterfall decline during those hikes could derail Powell's plans, but its going to have to be SPX under 4000 before Powell gets the message from the market and pauses. 

Europe is still reeling from last week's hawkish message from Lagarde.  European government bonds got destroyed last week.  Its funny how investors criticize negative rates in Europe as being counterproductive but then freak out when the ECB actually signals rate hikes to start getting out of negative territory.

On the bullish side, you had commercial hedgers cover SPX and NDX shorts and undo the massive sales of the previous week.  Also, in dark pool activity, the DIX (dark pool index) remains very elevated, showing smart money investors are still accumulating shares.  These type of continuous elevated DIX levels were last seen in the spring of 2020.  So its a real battle of bullish positioning data for the past week, and continued hawkish signals from central banks amid rising energy prices.  

Don't Have to Swing

The stock market is a no-called-strike game. You don't have to swing at everything you can wait for your pitch. - Warren Buffett

Its probably more profitable to just look at the market 1 hour a day at the US market open and then shut off the computer.  When you are constantly looking at the charts, watching CNBC, reading whatever they have to say in Bloomberg,Wall St Journal, Twitter, etc., you get ideas.  And when you get ideas, you feel like you have to do something.  A lot of times, those shorter term ideas have no edge, and are a distraction from bigger picture, longer term trades, which have an edge.  Most of the time, in the big markets like equity indexes, Treasuries, commodities, there is nothing new and what is a good buy remains a good buy, and what is a good sell remains a good sell.   For long term trades, the day to day movements usually don't change the  picture.  

In investing, you don't have to buy or sell.  Its not baseball, where there are called strikes and you can strike out by not swinging.  But as a full time trader, its hard to just sit there and do nothing.  Most of the time, there will be something good to invest in for the long term.  In those cases, you should already have long term positions which normally don't change based on day to day movements.  If you are already long and have a full position, there really isn't much to do.  And if its a bad time to invest in stocks or bonds or commodities, then you should either be in cash, or if you are aggressive and have a strong signal, be short.  

Looking back at my biggest losses, they came from premature entries.  Eventually most of the trades would end up being profitable, if I was able to hold on, but I wouldn't be able to hold on.  I would get in too big too early, and not be able withstand the drawdown and either puke it out at bad prices, or feel so much stress from the underwater position that I get out at the first opportunity to limit the damage, only to see it go much further in my favor after I get out.  It happened on Monday, when I sold at 4460, only to see it go up another 50 points in a few hours, and then another 50 points, 24 hours after that). 

If I had just done nothing until the opportunity became so good and the urge to put on a position became so great that I couldn't resist, then instead of getting long at 4560 down to 4470, I would have just waited a couple of more days and would have been able to buy in the 4300s.  It doesn't always work out like that.  But often you will get a great opportunity that you can't take full advantage of because you bought it when it was just a good opportunity, and it went down even more.  

Straight down, volatile chop for a few days, and then straight up.  Sick.  Got into a short during this volatile environment, after a big drop, on the rebound, breaking one of my rules for this type of market.   Now looking for a graceful exit.  Too early to short, too late to cover. 

FB dropping 23% on an earnings miss.  NFLX dropped 25% on an earnings miss.  AAPL goes up 7% on an earnings beat.  GOOG goes up 8% on an earnings beat.  There is a definite imbalance there.  I haven't seen these kind of monster drops on earnings misses since the dotcom bust era.  These are game changers.  The SPX is going to live or die with big cap tech.  Energy stocks aren't going to move the needle, no matter how strong they are.  2 of the 6 big megacap tech names have cratered, and have left a mountain of bagholders in its wake.  FB and NFLX are now broken stocks.  NVDA and TSLA are so ridiculously valued that their demise is really only a matter of time.  AAPL, GOOG, AMZN, and MSFT are the big boys that are still left standing.  One by one, the pillars of the SPX are being taken out.  

Sometimes we think of the SPX as this abstract monster that has a life of its own, but its an index.  Its performance depends on the biggest stocks in it.  And those are megacap tech.  When those tech stocks no longer warrant those big P/E multiples, then you have a problem.  They have been the momentum stocks of this decade.  If the momentum goes in the other direction, the growth guys don't want to touch them anymore, and they are still too expensive for the value guys.  The worst of both worlds.  

The supporting evidence that we've seen a major top in the SPX is growing.  The market usually doesn't go down in a straight line and there will be extended countertrend rallies.  Trading from the short side is difficult, so you have to be pickier when choosing your entry points.  So while I see the signs of eventual doom for stocks, I'm not excited about the short side yet.  Looking at the investor surveys, it is clear that a lot of investors have gotten cautious, so its not a great spot to be short.  Put/call ratios are still elevated, even during the strong bounce this week.

The ideal setup, and something I expect to see in the spring, is an extended countertrend rally that reduces the number of bears, increases the number of bulls who think the worst is over, and complacency returns.   That's the time to strike and layer into a big short position and buy index puts.