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. 

Beyond the Infrastructure Stimulus

You are seeing the optimists rave about the reopening, all that pent up demand, all that stimulus money.  And then the pessimists with their calls for raging inflation and a Fed that will be forced to tighten more quickly than the dot plots show.  

One thing you can always rely on Wall Street is herd behavior.  It is instinctive, pervasive, and hard to ignore.  If you read what they write, you would believe that the infrastructure stimulus will be followed by more big pork projects and stimulus packages in the Biden era.  They all believe the government will just keep pushing out more stimulus, no matter what.  Even when the GDP growth numbers will be high well into 2022, and even when the Republicans take over the House or Senate in the midterms and create political gridlock.  Oh, you say, no way, if the economy is doing great, the Dems will gain seats in 2022.  That's not what history shows.  Midterm elections have almost always been a disaster for the party in the White House for the last 40 years.  

It is a bit too soon to look beyond the infrastructure stimulus, but let's do that anyway.  It seems like everyone has the next 9 months of economic activity figured out.  Unlike the crack high of stimmy checks and pork direct to state governments, the infrastructure spending will be drawn out over many years.  Knowing how slow the US government works, it will take several months to even figure out what to build and where, much less start hiring, buying the necessary equipment and materials, etc.  Really the only big variable left until the 2022 midterm election is how hot the economy gets in the reopening.   Based on all the economic forecasts, most are expecting a booming economy for the next 12 months.  But what the 15 minute macro experts aren't considering is how the economy looks after the stimulus wears off, sometime in 2022.  

The developed world population continues to get older, and the demographics are unfavorable for maintaining high aggregate demand.  Add to that the lack of productivity growth and increasing welfare mentality from all the stimulus.  People in the US are now used to getting government handouts and fat unemployment compensation.  There is less incentive for these low wage workers to look for work or even care if they get fired.  With states now well funded after the 2 giant boosts of federal stimulus to fill their cash hoard, they can now splurge on all kinds of welfare.

When the government takes up a bigger part of GDP, capital is deployed less efficiently, because the government has no accountability.  Most voters vote for their party, no matter what.  Government waste, grift, and incompetence means that the return on investment on all the government spending is very low.  In many ways, the US is becoming more like Europe, except for one big difference:  taxes.  Europe actually tries to keep government deficits under control with high taxes and strict rules from the technocrats in Brussels.  

The US has given up on that "old game" of balanced budgets and taxes to pay for spending.   The new game, government spending fueled by debt that is bought by the Fed, is the magic bullet that suddenly US politicians have discovered as being extremely popular among the public.  It is a game that leads to eventual ruin, but in the beginning, it works great so they will keep doing it, but only under 2 scenarios:  

1.  A unified Democratic government OR 2. a Republican President.  Democrats need to have both the White House and both houses of Congress to pass additional pork stimulus because as we've seen already, Republicans will not vote for anything a Democrat President tries to pass.  But it doesn't work the other way around.  A Republican President can pass whatever he wants even if his party doesn't control Congress.  Because Democrats are always in favor of additional government spending, even if it requested by Republicans.   And that easily assures enough votes to cover even a few dissents from Republicans who don't support pork stimulus.

With the Republicans likely to win at least one House of Congress in 2022, that gives Biden about 18 more months to pass legislation.  And if the economy is as strong as everyone predicts over the next 12 months, it makes it unlikely you will get more stimulus after the infrastructure bill passes.  Will Biden start watching the stock market and try to support it by passing more stimulus if you get a bear market?  I wouldn't rule it out, but unlike Trump, Biden doesn't seem like a guy who really keeps a close eye on the stock market.  

 

About the current market:  I see that there is a growing divergence between the S&P 500 and a majority of stocks which are lagging the index.  You can see this most clearly in the retail and momentum favorites.  Just look at the YTD performance for the ARKK ETF, and the SPX.  Huge divergence there, from outperformance to underperformance.  And also bonds continue to stay weak.  Another negative.  I'm not shorting, but it wouldn't surprise me if you saw a sharp pullback down to SPX 3700-3750 within the next 2 months. 

On Yields, Inflation, Stimulus

Here are a few thoughts on the zeitgeist of the market. 

1.  Nasdaq is underperforming because of higher yields. 

A few years ago, not many people thought that low yields were great for tech stocks.  Everyone equated low yields with low growth, and thus bad for tech stocks.  The biggest ever tech bubble (not including this one!) happened as the 10 year yield went from 4.20% in October 1998 to 6.80% in February 2000.  

Don't buy the argument that the reason Nasdaq is lagging the small caps and SPX is because yields are going up.  Yields were screaming higher in 2018 and the Nasdaq easily outperformed the SPX that year.  The main reason the Nasdaq is underperforming now is because it is over owned and way overvalued compared to the rest of the stock market.  That rubber band got stretched way too far in 2020 and you are getting a mean reversion to more reasonable relative valuations between growth and value stocks.  

2. High unemployment will keep inflation under control.  

Inflation is a monetary phenomena.  Let's say you suddenly give everyone in the US a million dollars when unemployment is high.  The money is printed by the Fed and sent as stimmy checks.  300 million x $1 million = $300 trillion.  The current USD M2 money supply is ~$20 trillion.  So if you multiply the money supply 15x, then everything should be 15 times more expensive, and retailers selling at the same prices after those $1M stimmy checks are idiots and will immediately sell out whatever they are selling.  In reality, instead of giving everyone $1 million, they effectively gave everyone $10,000 (per capita stimulus over the past 3 months ($3 trillion in stimulus). There will be inflation, its just the government and the Fed that will lie about it through their manipulated CPI and PCE numbers.  

3.  Fiscal stimulus will keep coming.  

There will just be one more stimulus left for Biden (infrastructure), one that will be spread out over 5 to 10 years, and then expect the government to take its foot off the pedal in 2022 (economy will be hot).  And after the 2022 midterm elections (odds are very high that Republicans take over the Senate, as midterm elections always heavily favor the party not in the White House + built in Senate advantage for Republicans), there will be gridlock.  And there is NO way a Senate led by Mitch McConnell will give additional stimulus for Biden ahead of 2024.  That means barring some unforeseen economic catastrophe, 2022, 2023, and 2024 will be without additional fiscal stimulus.  That's at least 3 years where the stock market is on its own, and with Fed Funds at zero with a possibility of it rising, but very low possibility of it falling.  That is a disaster waiting to happen.  The market is a forward looking mechanism, it may be too dumb to realize that Republicans will take back the Senate in 2022 but it will definitely consider that possibility, especially if the stock market falters and the economy begins slowing in the 2nd half of 2022 as I suspect.   

 

On the current market, I am waiting for a bigger dip to buy SPX and RUT. SPX 3820 is my target entry point. Not interested in NDX at the moment.  Expecting the next rally to be led by small caps, energy, and financials. 

Powell Following Bernanke

Pansy Powell.  Since the scolding he took from both Wall St. and the stock market obsessed media for raising 25 bps in December 2018, he has been nothing but a Wall St. sell out.  Always giving what the market wants, even if he has to come up with ridiculous excuses and new standards for tightening.  Much like Bernanke from 2009 to 2013, until he finally tapered just as he was getting ready to exit, pulling the pin off the grenade just as he was passing it to Yellen.  

Powell is pulling off the same maneuver that Bazooka Ben did by waiting till the latest possible moment before tightening and disappointing the markets.  What is Powell's excuse this time?  Waiting for the data, BACKWARD LOOKING data.  

Here is how the Fed works:  forward looking data (basically financial conditions) that is showing weakness is a reason to ease (2011, 2019), but forward looking data that is showing strength is NOT a reason to tighten (2013, 2021).  Only backward looking data, in other words stale economic data, that shows big growth will cause the Fed to tighten.  

That means Powell will be doing this same dovish song and dance until the hot data starts coming in during the summer and fall, and then he'll probably float some trial balloons on tapering just to gauge the market reaction.  If the market doesn't blow up, he probably eventually announces a taper after the market expects it at the end of the year.  If the market blows up before year end, you can forget about the taper, and Powell will come up with another excuse about not tightening, such as not meeting their inflation target, or repeating the same garbage about inflation being transitory or unemployment rate is still too high, etc.  

At this point, the market probably wants a tighter Fed, contrary to what Powell thinks.  A tighter Fed would probably keep long end rates from going even higher because at least the Fed will have regained a tiny bit of their inflation fighting credibility.  And if long end rates are under control, that benefits the tech stocks, thereby helping the S&P 500.  But with Powell's short term thinking, he probably thought he did a masterful job pumping the markets on Wednesday and it lasted, for one afternoon, and then an immediate double barrel selloff in both the bond and stock market the next day.

The Fed are a bunch of hard headed doves, they even are slower to tighten than the BOJ, with their moribund economy.  It probably takes more market worries about inflation before the Fed finally gets the message and starts talking more hawkish.  

As I was watching Powell lob dovish word salad at the press conference, stumbling to find one lame excuse after another to keep the bazooka QE going without a hint of tightening, I remember mealy mouth Bernanke doing the same thing at every meeting  from late 2009 to the middle of 2013, when he was ready to unleash the taper grenade to Yellen while he took the credit for the economic recovery.  

In the bond market, we are looking at a taper tantrum light scenario, similar to 2013, except this time, the bond market is wiser, knowing that the Fed will always be late to tighten and always willing to talk down any inflation as transitory, making it less likely bonds go into full blown tantrum mode.  And if it did, I'm sure Powell would make a rash decision to placate the markets with either an Operation Twist (Bernanke playbook) or yield curve control (Kuroda playbook).  Bonds look oversold now, so probably see a bounce soon, but heading into the summer, 10 year yields probably get closer to 2%, which would probably act like the 3% ceiling did back in 2013.  

As for stocks, if rates calm down, and I expect it will, you probably don't get a big selloff until the summer, when taper talk will start to get more media attention.  And with stimulus mostly done (infrastructure stimulus probably doesn't happen until fall), the stock market probably trades sideways over the next few months.  Its gone up a long way and bond weakness is probably enough to halt its upward march.  

But you can't ignore the stimmy effect coming over the next few weeks.  Stocks are now the most popular way to spend excess cash among the masses.  Its almost like a time machine back to 1999, except this time, its not the internet revolution that's doing it, its the stimmy revolution.  Human progress has stopped, and the governments will do anything to put lipstick on this pig before the whole MMT house of cards falls apart.  This MMT honeymoon period won't last for long, in the long run, there is no free lunch from money printing.

Artifical Forces > Natural Forces

Forecasting the stock market used to be about predicting economic growth, but now its about predicting central bank actions.  The two are related, but the Fed works with a lag.  When everyone can see huge economic growth in the near future, the Fed sees it too, but try to downplay it in order to keep pumping the markets.  They want to squeeze out every last bit of their easy money policies for as long as possible until the economic data undeniably shows the growth and they can't lie anymore.  

If it wasn't obvious since the Greenspan days in the 1990s, the modern day Fed could care less about inflation or jobs, their supposed 2 mandates.  They are short term thinkers looking out for their post Fed careers.  Obviously pumping the markets and giving huge favors to bankers is in their best interest for their Wall St. backed golden parachutes.  Don't blame the player, blame the game.  When the government recklessly wields its power, the influence of politicians and central bankers becomes enormous.  

The balance of power has shifted from New York and California to Washington D.C.   That has changed the game from focusing on natural forces driving the economy such as population, productivity, wages, etc. to artificial forces of fiscal and monetary stimulus.  When heavy handed government policies overwhelm the natural business cycle, they become the driver of asset prices, not the economy.  

The market is doing its usual job of front running economic and central bank decisions by 6 to 9 months.  It is no coincidence that with the Rona vaccine rollout well underway, with expectations of the majority able to get the vaccine by summer/fall, with all the stimulus working its way through the system, the bond market saw the future 6 months from now and promptly panicked, regardless of what Powell and company said. 

When the artificial forces driving the economy begin to recede, then the natural forces become more important in driving financial markets, at least until you get the next stimulus. 

With this in mind, the only carrot remaining for the stock market is not the reopening after the vaccines, but the infrastructure bill that Biden will be pumping soon.  The re-opening is now a risk asset negative event, as it will now force the Fed to either choose between:

1. Lose their credibility and the dollar by continuing their dovish talk and easy money policies or

2. Tighten policy by talking about tapering Treasury and MBS purchases.  

Since market participants are now used to getting the baby treatment and having a tantrum at even the slightest hint of tighter policy, I am sure the Fed will go out of their way to only talk about taper, and not actually go about doing it until its way too late and the economic cycle is near its peak.  Or they could actually start to taper but do it as such at excruciatingly slow pace that the market will quickly realize that the Fed will never hike again.  

If the Fed chooses number 1, by dragging their feet and talking about inflation being transitory and about unemployment still being too high, even with blockbuster GDP growth, the stock market will love it.  That will just increase the everything bubble even more and make policy normalization that much more of a nightmare when it happens. 

If the Fed chooses number 2, they will likely officially announce a turtle taper in the December meeting, but only after trial ballooning and testing the market response like little pansies for a few months before pulling the trigger.  The number 2 option is more likely, just because the growth will be so big and inflation talk so intense that even the cooing doves like Powell will feel the pressure to ease back on the throttle.  

The Rona is the only excuse that the Fed has left.  Once Rona is in the back burner, likely as the numbers settle down to a much lower plateau after the vaccine rollout, then the pretext for more stimulus is gone and the market will have to stand on its own, which means down.  

But there are still a few months left before the majority can get their vaccine shots, so we'll likely see limited downside until the summer, SPX 3700 at the worst.  With the bond market weakness, stock strength will be more limited as well, just because the weight of the now interest rate sensitive Nasdaq is so large.  It used to be utilities and consumer staples stocks that were the most sensitive to interest rates, now its tech stocks.  That's what overvaluation and too much popularity does for a sector, it makes it more sensitive to tertiary factors it used to ignore.  

As for the Fed meeting this week, I expect Powell to be mealy mouth as usual, trying to run out the clock with a 5 point lead in the fourth quarter, trying not to do anything rash to threaten his reappointment for a 2nd term as Fed chairman.  Powell is a politician first, central banker second.  He could care less about fomenting bubbles as long as they don't crash on his watch before reappointment.  

The market probably breathes a sigh of relief and we probably hit a euphoric peak over the next few days.  I'm not interested in putting on any big short positions until the re-opening, so probably until summer time.  Until then, will mostly play small looking to capture short term moves more out of boredom rather than any big edge.  There will be a time later this year to try to catch the big down move, no need to rush in yet.

By the way, I've been writing fewer blog posts mainly because from a trading perspective, I don't see much to do here.  If I don't put up anything for a while, its probably because there is nothing to say.  The joy of trading just for the sake of trading and the ups and downs is not there for me anymore.  I've been there, done that.  Looking back, the short term trading and trying to make money every day doesn't create wealth.  I do it to keep abreast of the market, not to make any kind of meaningful money.  Its about putting on big positions at the right time, holding on and catching big moves that make the difference. 

Inflation Hype is Real

I am not usually one to get caught up in the latest market hype, as its usually more fluff than substance.  I usually take the other side when the knuckleheads on CNBC get all excited about something.  But the rising inflation isn't just hype.  WTI Crude oil over $65, highest since 2018, when everyone was talking inflation.  Corn and soybeans at the highest prices since the drought induced price spike in 2012-2013.  Copper at the highest levels since 2011.  Lumber prices more than double 2017 prices.  US Housing market is very strong as there just isn't that much supply.  Yet you have the lying government inflation statistics showing low inflation.  And the Fed and their academic cronies saying that inflation is transitory because of base effects.  These aren't base effects.  They are price surges to multi year highs.  

And the reason is simple.  When the Fed prints so much money and the government pumps out so much pork, you will have a lot of dollars looking for a home.  M2 money supply is up 25% year on year.  That is ridiculous for an economy with an organic growth rate which is probably less than 2% real.  So you have a lot of excess dollars that have no economic use, so they go to either speculation or savings.  It seems like people these days don't really differentiate much between those 2.  Those new printed dollars will chase anything, stocks, bonds, commodities, real estate, bitcoin, etc.  You are getting a big time surge in inflation that is the strongest inflation impulse since the 2006 to 2008 commodity boom cycle.  

At the foundation of money, is confidence.  If people really start to lose confidence in the US government to maintain fiscal discipline, that naturally takes away a lot of demand for dollars and bonds in particular.  The Fed and the government may think they are having a free lunch as they pump out pork stimulus after pork stimulus one after the other, but that confidence in the dollar is being eroded day by day.  

Now Biden will go on to his next pet pork project, infrastructure.  Numbers anywhere from $2 trillion to $5 trillion are being thrown around like its casino chips at the blackjack table.  M2 money supply is roughly $20 trillion.  So each of these stimulus packages (avg. $2 trillion) are diluting the existing amount of dollars by about 10%, if the Fed monetizes all of the debt issuance.  At the current pace, the Fed is buy $1.5 trillion in Treasuries and MBS per year.  The Fed has told you repeatedly that they aren't going to be the ones spoiling the party.  In fact, they are the ones who want to spike the drinks with even more cheap liquor.  

This level of pork spending during peace time has never happened before.  And if Biden is off his rocker like I suspect he is, he will keep pushing for more spending until the inflation gets so out of control that even the Fed will have to stop pretending like inflation is low and get on top of it or let the dollar get crushed.  

And what about those economist blowhards whose BS is so overflowing that no one calls them out when they use terms like economic scarring.  It seems like these BS artists come up with a new term every few years to sound like experts.  When people go bankrupt or their businesses fail, they have to go look for a job.  While they are looking for a job, they are getting very generous unemployment benefits, almost as much or sometimes even more than what they would earn when working.  That money is spent.  People with money, and there are lot of them, start new businesses when they see the opportunity after others go bankrupt and the competition is weeded out.  Those new businesses require investment, which jump starts the economy.  

There is a huge source of pent up demand looking to be released once lockdowns are eased and vaccine rollout goes through most of the population.  With all this pork, this will end up becoming the hottest economy since post World War 2.  

If the Fed does nothing for the next 6 months, which is the base case and what probably happens, by the end of the year, they will be back to where they always end up, keeping easy monetary policy for too long, ignoring inflation, and fomenting bubbles.  They will be way behind and end up with some token tapering before the cycle self combusts from the bubble getting so big that it pops spontaneously and the Fed will be back to pleasing the market with gobs of more free money.  Wash, rinse, and repeat.  Since 1998.  

The speculative juices are flowing again, as bond yields stabilize and the stimulus checks are coming over the next few weeks.   Those stimmy checks are going to be used to buy a lot of junk stocks over the coming weeks, so investors are front running the stimmy fueled dumb money.  Everyone is sucking on the government teet now.  Biden will give 'em more when it runs out. 

Powell Pause

 The stock market has high expectations for the Fed, even as the bond market is lowering its expectations. You are getting these knee jerk intraday selloffs but they don’t last for more than a day.  We’ve seen these intraday V bottoms from lower lows, one last Friday, as the end of the month stock selling and bond buying poured in, and this Friday, as the short term panic from a strong jobs number and a weakening bond market and residual disappointment from Powell not giving Wall St what it wants took it down briefly to near levels where I was waiting to buy, only to see that buying chance disappear.  

I don’t think this bounce in stocks is going to last as the bond market weakness should keep it the buyers wary.  Perhaps its investors not wanting to be left in cash as the Biden pork package gets passed this month.  If thats the case, then I expect a sell the news reaction after Biden signs the pork bill.  

There are still a few potential negative catalysts as the 3/10/30 year Treasury auctions come up next week as bond demand has cratered with crude oil and commodity prices continuing to rise as the strongest major market in the world.  That commodity market strength and strong jobs number will keep some pressure on Powell to not cave in to Wall St demands.  Although we all know he eventually caves in, its just a matter of at what point.  And it seems like Powell isn’t scared of the 10 year above 1.5% and SPX at 3800.  Probably need to get to closer to 2% 10 year and a SPX that is below 3600 for it to catch Powell’s attention.  

As for now, I am waiting for lower prices to buy either stocks or bonds.  

Bonds are Controlling this Market

You get these type of markets about once every 4-5 years.  They are not common.  A sharp bond selloff after a parabolic bull run the previous year.  November-December 2016.  June-July 2013.  May-June 2009.  The bond selling is front running either an economic recovery or a fear of a change to a tighter Fed policy.  By the time the economy actually starts getting better and Fed is getting tighter, the selling is usually over and bonds are actually a good investment again.  

In all 3 of those instances, 2009, 2013, and 2016, there was a lot more rally left in the stock market.  But I have a feeling this time is different.  The financial markets have gotten smarter.  They now mostly ignore ecoomic data releases like the nonfarm payrolls report and ISM and CPI reports.  They know now that its better to have a weak economy with a very loose Fed than a strong economy with a tightening Fed.  And its the best to have a strengthening economy with a loose Fed (like now) at least until the bond market stops playing along.  

Last week, the bond market stopped ignoring the insanity of the government spending $2 trillion more every few months without any tax increases.  It started realizing the consequences of the lopsided supply/demand dynamic with a Fed keeping purchases the same as Biden goes on a spending spree.  Bond prices have to go down when there is more supply, inflation rising, and commodity prices making 2 year highs.  

What is interesting about the stock market is that its at such a high level compared to past bond market panics, that it is having a hard time shrugging off the selling in bonds.  The S&P 500 feels very weak, even when it made that big move higher on March 1.  It felt more like automatic first day of the month inflows pushing prices higher than where the natural buyers and sellers are at.  

A lot of picking the right direction for the market is based on that gut feel, the intuition gained from watching AND studying markets for several years.  And its still tough, because the market always provides the most liquidity for the wrong side of the trade.  Its always easier to get long weak markets and to get short strong markets.  Strong markets don't give longs much time to get in.  That's how November to February felt like.  Now its a different ball game.  It still doesn't feel like a weak market, but it does feel more balanced than the previous 4 months, when bulls were clearly the stronger side.  

One of the most important lessons that one can gain from these type of markets is that avoiding the big drawdowns and flush moves lower is the most important part of trading.  Its not about hitting home runs and offense.  A good defense goes a much longer way than a good offense.  Good defense with a mediocre offense will give you a chance to making a living at this game.  Good offense with a mediocre defense is asking for trouble and a blowup is just a matter of time.