A Choppy 2022

There are two main types of traders:  trend followers and countertrend traders.  If you try to be both, you usually end up getting the worst aspects of each.  I've been a countertrend trader since I started.  I've tried trend following and had limited success.  Its not say that countertrend trading is better than trend following.  There are good and bad aspects for each. 

For trend following, since you look for price confirmation of strength or weakness before entering, its easier to know when you are wrong and can stop out more easily.  If the trend goes against you, you are wrong, and you get out.  Take your loss and move on.  Its part of the system.  For countertrend trading, you are going against price action and buying when its going down and selling when its going up.  You don't know if you are wrong or if you are early.  In fact, the more a position goes against you, for a countertrend trader, theoretically the better the opportunity becomes.  It makes it hard to stop out of a position and take a loss.  

So overall, trend followers have big wins and small losses but a low winning percentage, while countertrend traders tend to have small wins and large losses, but a high winning percentage.  Most traders want a high winning percentage, so naturally most traders end up being countertrend traders with a high winning percentage (selling winners quickly), but taking big losses when they are wrong (holding on to losers).  

Obviously if you were countertrend trading in a relentless uptrend and you tried to short in 2021, you had a tough time.  And as a countertrend trader, there were few opportunities to buy a decent sized dip to put on size.  2020 and 2021 were favorable for trend followers, both in stocks and bonds.  In 2022, I am expecting a change with more choppy markets, shorter trends, and more fakeouts on both the upside and downside.  It should finally be a good year for countertrend traders, like a 2015, like a 2018.  Despite the big drop in early 2020, both 2020 and 2021 were great years for buy and hold investors.  With the SPX now at nosebleed levels, and with both monetary and fiscal policy less supportive, look for more air pocket drops and fewer V bottom rallies.  Fundamentals and valuations are big negatives and it is on the back of the mind of investors.  I can sense a little uneasiness among the bulls, even if they are still fully invested.  You can feel the lack of conviction among the bulls, as the Fed will soon be raising rates and Biden is having a tough time pushing out more pork in DC.

With most investors now conditioned to be bullish on stocks no matter what, and with above average bullish positioning among speculators and households, but with conviction that seems to be weakening, you have a formula for a 2015 type market.  A lot more weak hands in the market that will be pushing the eject button when the turbulence rises.  

Added to my SPX short yesterday, still have another bullet to put in the chamber, so will add that last bullet either today or on Friday.  Getting set up for early January weakness.

Year End Surge

They faked me out.  Monday Dec. 20 was bear bait and I took it and got too bearish.  It was just a springboard to new all time highs.  Sold the long way too early, and missed out on almost 150 SPX points in less than a week.  Big mistake, but this move to all time highs and heading towards 4800 does set up a good risk/reward short for January.  I took a starter position short SPX yesterday, with plans on adding later this week.  

With investors now focused on catching the year end rally and more up moves in January, you are seeing a lot of front running of seasonal trends and a reluctance to sell from 

1. Long term investors unwilling to sell due to tax implications of capital gains in 2021.

2. Year end portfolio window dressing from hedge funds.

3. Short term year end rally chasers.

There is also a big systematic JP Morgan equity fund that does the same quarterly zero cost collar at the end of each quarter.  With their short call position deep in the money and with a delta of 1, while their out of money put spread has a delta of 0, they will reset their collar at higher strikes for both, and with the accompanying dealer hedging, dealers will end up having to buy back a significant portion of their SPX short position, probably around $10B worth of SPX futures buying that needs to be done on December 31 at the close.  

This isn't a big secret, as options dealers and institutions that are well aware of these year end flows are going to front run this event.  In liquid times with regular trading volumes, $10B of SPX futures isn't so big that it moves the market a big amount, but during illiquid periods like now, they can have an inordinate effect on short term moves.  

Looking beyond the short term, into January, there will be quite a bit of pent up selling due to capital gains tax reasons.  Also, January is a strong month for fund inflows, but a very weak month for stock buybacks.  So if you consider that a wash, then the capital gains selling pressure early in January should favor the bearish side.  With bullishness rising quickly and short term players now leaning more bullishly, it sets up a situation where short term traders are offsides and selling into any January weakness, exacerbating the down move. 

Not looking for a break down to under 4500, but I see a definite possibility of a gap fill retest towards SPX 4560, which is more than 200 points below current pumped up levels.  At SPX 4800,  I would give much higher odds of SPX going to 4560 in January than 5000, even though 5000 is closer.  Don't want to add too early to the short, letting the year end flows play out a bit more, but I am getting ready to put on a sizeable SPX short this week.  

Going long Treasuries will also work, in my view, if the SPX sells off in early January, and is probably the safer play considering the liquidity flows from funds in January, but it gives you less bang for your buck, as the reward is greater from shorting SPX at all time highs.  I would not be surprised to see 10 year yields go to 1.30-1.35% in January.  

Its another gap up in the works, the strength is immense, so waiting for the dust to settle a bit before adding the short.  Who knows how far they take this thing, this market is so unhinged from past market behavior that you can't be self-limiting in your outlook.

Positioning Going into 2022

To predict the next year, you have to examine what happened this year and imagine how investors will react to future events.  Here are the main known events for the following year:

1. Fed tightening.  Powell has finally crossed the bridge into tightening and focusing on inflation, not employment.  He's given up on the transitory lie on inflation, now that he's been reappointed.  He is so late to tightening that to maintain a tiny shred of credibility on price stability, he needs to raise rates at least once.  This will happen even if you get volatility in the stock market (see December 2015) just because his reputation is on the line.  Not only his reputation, but the political forces are in favor of the Fed fighting inflation, not ignoring it.  

2. Midterm elections.  The results of the November 2022 midterm elections are almost like a fait accompli, with Biden at a very low approval rating and the natural tendency for voters to vote against the party in power in the White House.  With the Republicans look set to take over both the House and Senate, you will start to hear talks about fiscal austerity again.  Even if they win just one of the Houses of Congress, they will stop any attempts by Biden to stimulate the economy ahead of 2024.  This guarantees limited fiscal stimulus for 2023 and 2024, which will get priced in the closer you get to the election.  I am expecting the fall 2022 to be a tumultuous season, making this past September/October look like child's play.  Something similar to October/November 2018 is very much in the cards for 2022.  

Here is how the futures market participants are positioned as of December 14, 2021.

Commercials (taking the other side of speculators) are now the most short in SPX and NDX for the past 52 weeks.  Let's take a look at how the SPX and NDX positioning looks compared to the the last 10 years:

SPX COT (Dec. 2011 to Dec. 2021)

Commercial positioning (in black), is short, but not yet at the extreme shorts of 2018.  So there is still room for speculators to get longer before you really get into treacherous territory.  

NDX COT (Dec. 2011 to Dec. 2021)

 Commercial positioning (in black) is short, but much less short than they were from 2012 to 2017.  However, current levels are similar to 2018.  

The speculator positioning will be something to watch in 2022 as it is showing investors getting bolder in taking long positions just as the fundamentals look to be getting worse.  At the very least, the tailwind of having almost no speculative long positioning in SPX and NDX futures for most of 2021 has gone away, and speculators will be feeling more pain and more likely to panic sell when you see stock index corrections.  

With the double negative catalysts of a Fed about to embark on a rate hiking cycle and a midterm election that will signal the end of fiscal largesse for 2023 and 2024, you are looking at a double whammy of monetary and fiscal tightening.  I hear the media talk about the Fed tightening, but almost no talk about the implications of Republican majority in Congress leading to fiscal tightening.  I am sure you will start hearing more about that as you get closer to the fall of 2022 and the polls start to clearly show the Republicans taking the majority in Congress.  

My general take on 2022 is the SPX topping out in early spring of 2022, with a waterfall decline sometime in late spring/early summer, volatile and wide ranges during the summer, perhaps making a double top, and then the beginning of a long downtrend and the start of a bear market in the fall of 2022. 

We are getting a late Santa Claus rally, as the market made one more scary looking dip on Monday to shake out the remaining weak hands before the year end rally.  With SPX futures near 4700, it is looking like most of the year end rally has been compressed into the past 3 days.  I am looking to get short SPX soon, as long as it is above SPX 4700.  I see very good risk/reward for a move back down towards 4520-4540 by middle of January.  Although I eventually expect the SPX to make new all time highs by February 2022, I am looking for one last scary looking dip towards 4500 in January, hopefully with lots of put buying to set up a strong rally into February.  

Expecting Treasury strength, SPX weakness starting from the last couple of days of the year and extending into mid January.  Will be positioning accordingly by early next week. 

No More Build Pork Better?

From March 2020, we've been on a relentless run of higher highs and higher lows, spending most of that time well above the 100 day moving average, and above the 200 day moving average since June 2020.  For 2021, its been shallow dips followed by steady rips.  But we've finally reached a price level where the market is struggling to make new highs, and you're seeing a sharp drop in speculative fervor, akin to what you saw in the spring of 2000, and throughout 2015.  

With the massive fund inflows in 2021, the crowd is now about as loaded up on equities, if not more than the peak of 2000, just as we're on year 12 of this secular bull market (the QE bull market).  History doesn't repeat, but it does rhyme.  And human nature has reared its ugly head again in the investment world, getting investors to get bulled up and pour almost all their stimulus money near the bubble peak.  This is setting up for a nasty long bear market in the years to come, as bubble valuations with slowing growth all but guaranteed (unless Democrats miraculously win the 2022 midterms) for the next 3 years.  

The bombshell news of the weekend is not Omicron, but Joe Manchin looking out for his political future and distancing himself from the Dems and Biden by refusing to say yes to the Build Back Better plan.  It should be renamed BPB:  Build Pork Bigger.  Its a cash giveaway and paid for with tax increases, which always gets heavy corporate pushback.  With Biden's poor approval rating, Manchin didn't want to hitch his wagon to that bus that's falling off a cliff.  Manchin may as well be a Republican at this point, he's not going to get re-elected supporting Biden.  He's in one of the most Republican states in the US, so he has to lean right any chance that he can get.  

There are some people trying to make the case that Omicron is a positive because it will outcompete Delta and other variants and make Covid milder.  Wrong.  Omicron is basically a new virus.  Its mutated so much from the original Covid virus that there is almost no immunity you get from it that protects you from other variants.  So you can have Delta and Omicron flourishing side by side.  Its not a competition.  Its just now two types of Rona that can get you.  

I don't expect Omicron to have much of an effect on the economy.  Most people have adjusted to the Covid rules and governments are going to be reluctant to go with heavy handed lockdowns due to their unpopularity.  So I expect little economic impact.

There is a popular poll done every weekend, and I was a bit surprised at the results:  

Usually after 2 straight down days going into the weekend, the crowd gets bearish.  But this was the opposite, the majority are buying the dip and expecting a Santa Claus rally.  When you see that many bulls as the market is trading weak, that's usually a bad sign. 

Despite the bearish signals, I still expect a Santa Claus rally, just because its been such a strong year in the market.  It probably starts sometimes this week, after whatever weakness you see today/tomorrow.  I would be looking to buy dips to sell rips.  You can't overstay your welcome both on the long and short side.  So when you get a good move, its better to be safe than sorry.  Better to take profits a little too soon than trying to squeeze out as much as possible from each trade and risk missing the exit ramp.  

I would be looking to buy dips down towards SPX 4520-4540 today/tomorrow, with a price target around 4650-4680 for later this week or early next week.  This bull is on its last legs, but its not going to die quietly.  Its going to go out kicking and screaming. 

Violent Swings

The S&P 500 is lingering close to all time highs but the intraday swings have gotten more violent.  Technical analysis 102:  Volatilty at the top of the range is bearish.  Volatility at the bottom of the range is bullish.  We are seeing the former at the moment.  

Even with the strong bullish seasonal forces that are going to be at work in the final 2 weeks of the year, the underlying tape is one of distribution by the big hands.  Yes, you will get your typical snapback rallies off a short term flush out, like you did after the Friday December 3 low, or Tuesday Dec. 14 low, but they don't last for long because the buyers aren't eager to chase this tape.  

Sentiment is a contrarian signal at the extremes, but with a lag when at a bullish sentiment.  In other words, the best times to buy are when sentiment is at the most bearish, but the best times to sell is not when bullish sentiment hits a optimistic peak, but when it is trending down while the market grinds higher after a sentiment peak.  

You are not going to get an accurate read on the health of this market in the last 2 weeks of the year.  The seasonal bullish forces are especially strong at the end of the year after a big up year, due to delayed capital gains motivations and portfolio window dressing.  Also, those that are the most eager to sell and reduce risk have already done so, taking out most of the urgent sellers for the last 2 weeks of the year.  

Already, you can see the eager beaver end of year rally players who bought at yesterday's close or in the overnight market getting tested as the exuberant overnight highs in SPX and NDX are a distant memory as the top Nasdaq names get smashed ahead of the Friday opex.  There is a lot of motivation for dealers to sell their long stock inventory as a lot of their short call inventory in AAPL, MSFT, etc. will expire at tomorrow's close (huge options expiration).  They will have to sell those stocks anyway, might as well crush the long call holders in the popular individual names in the process of flattening their books.  

The options volumes have gotten so big, that they are the tail wagging the dog.  Especially around the big triple witching options expirations happening every quarter.  Delta hedging from dealers is a huge driver of index flows these days, as shifts in IV and the effects of time decay play a major factor in changing the index put deltas outstanding.  In general, as the put deltas decline as the market either rallies and/or IVs drop as the monthly opex gets closer, the dealers have to reduce their short index position to stay delta neutral.  That is the primary force driving the market when the hedge funds are not splashing around in the market.  And often times, the hedge funds often are doing the same thing the dealers are doing as a market rallies, which is when you get explosive moves to the upside (i.e. yesterday after FOMC announcement).  

We've seen quite a shake out in gross positioning for hedge funds based on prime broker data over the last 3 weeks.  That should be enough to clear the way for a year end rally.  But remember, this year end rally is more about hedge funds having already done most of their year end selling, leaving the year end rally players, window dressers, and options dealers to dominate the price action in that vacuum.   I would not be surprised to see new all time highs being hit next week in that environment.  But it is a mirage.  The real action will return in January, and that should bring back the volatility that we've seen the last 3 weeks.  

Not much to say about the FOMC meeting and the Powell press conference.  The Fed will always do too little, too late, and they're just catching up to what they should have been doing 9 months ago.  They say 3 hikes for 2022, but those hikes, especially the 2nd and 3rd one, are conditional on the stock market staying calm.  Somehow I doubt the SPX will be so cooperative after having rallied 110% over the past 21 months based mainly on a super dovish Powell doing what the market wants.  If Powell tries to hike 3 times and/or talk tough while the SPX is trending down, you can almost be guaranteed of a long overdue and unanticipated waterfall decline. 

A Phase Transition

What a face ripper.  In less than 48 trading hours, the SPX has gone from 4500 to 4650.  That's why you can't play for downtrend continuation when the longer term uptrend is still intact.  Good things happen for the stock market when the 50 and 200 day moving averages are rising, no matter how bad the breadth is.  Breadth is a distraction.  People who mention it think they've discovered some secret sauce to predicting the future direction of the market.  What they've discovered is something that used to work in the past but doesn't work so well anymore because of the dominance of passive investing.  

Some will say that the bad breadth in the broader market has caught up to the SPX, causing it to go down.  No, what caused the SPX to go down was hedge funds getting crushed on their crowded longs, having to cut risk to stem the bleeding.  Add to that a newly hawkish Powell who acts like he doesn't have to worry about his job anymore, so he can talk tougher on inflation, and thus less supportive of the stock market.  

It feels a bit like the summer of 2007, when hedge funds were severely underperforming as the SPX was making new all time highs.  It feels a bit like early 2015.  With rate hikes and liftoff from ZIRP being priced in for the next 1-2 years.

Its a tricky juncture, a transition from a relentless uptrend to a choppy range trading environment.  A phase transition from laminar to turbulent flows.  Almost at the end of a bull market but the old bull still has its legs kicking, even as the lion has its jaws wrapped around its neck.  

Your mindset and view on the big picture is important when trading this type of market.  There is less regret when missing long entries, just because its a weaker market, less forgiving than before on early buys.  There used to be no regret when missing short entries, but now, there is some regret when I miss those premium short opportunities like you saw after the short squeeze on Powell renomination on November 22 towards SPX 4743.  It is a more balanced market.  I didn't even give it much of a thought to short SPX this year.  But now, shorting needs to be seriously considered in the trading arsenal for the SPX.  

I will be pickier when it comes to long entries, and also be more careful when sizing up on longs, knowing that a big waterfall decline is probably happening sometime in the next 6 months.  At the same time, I will now add shorting to the mix, taking advantage of those situations when the market has rallied and the crowd is complacent, to put out shorts and to buy puts.   

What sticks out in this market is how high the VIX has gotten with a less than 5% drawdown in the SPX.  Its a bit mind boggling, because it looked a lot more dangerous of a market in September than it does now, and the highest VIX close was 25.71 on September 20.  On December 1, the VIX closed at 31.12, and 30.67 on December 3.   

I have some theories about why VIX is trading so high versus previous strong uptrending periods, but the biggest factor is the changed behavior of systematic vol sellers.  It appears March 2020 took a big chunk out of the systematic vol selling community, and the remaining vol sellers are more conservative and less willing to sell volatility during risk off environments.  Another is the rise of options volumes, especially on the call side, juicing up the IV of those options, and as a byproduct, increasing the IV on the put side as well.  

Volatility has remained overvalued all year long, and its only becoming even more overvalued.  The recent VIX readings are reminiscent of 1999 and 2000, when actual realized vol was much higher than it is now.  If we ever get the realized vol of 1999 and 2000, who knows how high the VIX will be trading, perhaps 30 to 40?  

I can only imagine realized volatility rising as the Fed gets closer to its first rate hike, just like 2015, when the market preemptively sold off ahead of the first hike, a warning shot to the Fed that it better be careful.  I can picture a similar scenario in 2022, especially if the Fed speeds up its tapering and the market keeps pricing in a June 2022 rate hike.   

SPX is above 4650.  Stealing the RTH move as always on the upside.  I was hoping for a breakdown below 4500 to scoop up longs, but that's not happening.  I missed the move, and although I think we hit new all time highs by Christmas time, I will not be chasing longs in this environment.  

Yields look like they have made the top for this cycle.  A move above 1.75% 10 yr looks unlikely for 2022.  2.00% 10 year is a pipe dream.  With the power flattening of the curve, the Fed won't be able to hike much before they have to cry uncle and reverse course, high inflation or low inflation.  Economic weakness stops all Fed hiking cycles, no matter the inflation rate.  Expecting a very bullish 2022 for the bond market. 

Volatility is Off the Hook

You are getting some wide intraday ranges in the SPX that is causing systematic selling, namely vol targeting funds and CTAs.  Also you have the news-based sellers that got nervous after some hawkish talk from Powell, and of course omicron headlines.  When was the last time you saw a puny headline from a CEO talking about Covid causing a huge plunge in afterhours?  That's what you call fragility.  After a bounce on Monday, the market was vulnerable to another down move, and any tiny headline was like lighting a match to a gasoline covered haystack.  

The end of month selling has been vicious during risk-off settings, as the September 30 and November 30 selloffs show.  In some of those month ends, there is a big JP Morgan fund that puts on an SPX collar (buying an out of money put spread and selling an equal dollar amount of calls), but in others, it seems like window dressing and position squaring due to balance sheet constraints.  Whenever you have price insensitive sellers in a risk-off environment, they can cause short term market plunges, as you saw after Powell officially retired his pet, the word "transitory".  

The best thing the bulls had going for it, a very strong up move in bonds during this selloff, due to a Fed that was quick to get nervous and turn dovish at a moment's notice, was quashed by Powell's focus on inflation.  His job is safe for another 4 years, so he's more willing to throw cold water on the bull's hopes, if it means maintaining some credibility on inflation and not being seen as a complete dovish pansy.  Plus, it seems like the politicians are feeling a little heat on inflation, and are willing to sacrifice a few hundred SPX points as long as it keeps inflation expectations somewhat in check, and keeps commodities prices down.  

You can play for the bounces, like buying in the hole after the big intraday plunge yesterday, but you need good entries to make the risk/reward compelling.  You also have to lower your price targets and holding times.  This isn't your raging bull BTFD market anymore.  We are entering the transition phase from mature bull to old bull.  Its a bit more treacherous to go in there and buy in the hole.  

In the short term, it doesn't look like this market is close to being done on the downside.  I would use today's strength to sell, in order to have the dry powder to buy on the next dip, which probably happens either Thursday or Friday.  With the market nervous about a faster taper and omicron, I don't see a sustainable bounce until you see more blood letting and risk reduction. It probably takes another week or so before it will be safe to hold for longer term swing longs.  

Big picture, we are now entering the transition phase where volatility rises and the market is choppier, so its now actually worth it to consider shorting SPX.  But also still a good market for dip buying.  So an ideal market for traders, but not a good market for investors that have a weak stomach.  

Technical support area is the September top zone, around 4525-4550.  Market abhors a vacuum, and there is an air pocket of very little trading between 4500 and 4550.  It would not surprise me to see one or two more waves of selling to take us down to that area.  I expect that area to hold due to year end dynamics which favor bulls in the last 2 weeks of the year. 

Dip Buying Getting Tougher

They don't give you many layups in the SPX these days.  If you don't have much time to buy the dip, then it's likely to rip.  If they give you a lot of time to buy the dip then it's likely to dip even more.  Dip buying SPX is profitable, and everyone is on to that game, so dips don't last for long, and you only get good prices when it looks the scariest, in the teeth of the uncertainty, ahead of a possible headline filled weekend, on a Friday.  

I was waiting with both hands to buy the panic selling on the Sunday night Globex open and everyone else had basically the same plan.  There aren't too many suckers selling in the hole in ES these days.  They've been fried over and over again for the past 18 months, and their capital has been shrunk to smurf sized levels.  On the other hand, the dip buyers keep making coin, building up their capital base, trading bigger, and a huge force in the market, causing big V bottom bounces as they buy with reckless abandon as soon as they sense that the bottom is in.  

Back in the old days, when you had a big down Friday with a weak close, you normally had panic hedge selling on Sunday night in the overnight futures as soon as Globex opened.  The fund managers that panic sell don't wait for Sunday night anymore, they do it on Friday at the close.  The markets are smarter than in the past, and you don't see easy trades on the buy side linger for long.  

At SPX 4580, the risk reward for a dip buy is very good.  Now with the futures showing SPX ~4635, the risk reward isn't that great anymore, and even though still likely to see higher before lower, the reward is smaller and there is more risk involved, as it can very easily get back down to 4580 within days.  

Oh, and that omicron variant, the headline of the day.  They sneakily skipped Xi and jumped to omicron.  The Xi variant sounds so much better than omicron.  WHO was looking out for you know who when they made that decision.  Anyway, the 5 minute virus experts are parading on Twitter with their quick takes, assuming that the omicron variant is mild and more transmissible, so supposedly better than Delta, leading to faster herd immunity, and "outcompeting" Delta.  This is based on hearsay from a couple of SA doctors who want to see omicron downplayed, so as to not make SA look so bad.  Its all speculation at this point, but the most likely scenario is that you get similar symptoms and severity as Delta, and vaccine evasion is probably slightly greater as the virus evolves to beat the current defenses out there.  Not much of a game changer, IMO.  Plus, I am sure they will start making annual changes to the Covid vaccines to boost sales and "efficacy".  

Hamfisted lockdowns are going to be fewer and farther between in the future, as the majority are sick and tired of being corralled like sheep and will voice their displeasure towards politicians, especially in places like the US, where you have a less "obedient" population.  Europe is in the middle of the obedience spectrum.  In Asia, they are on the other end of the spectrum and completely "obedient", and do what they are told, no questions asked.  So lockdowns in US are not going to happen, while they are very much possible in Asia and parts of Europe.  

Bottom line, for the stock market, its all about the Fed, and how hawkish they will be in the coming months.  Even though the Fed is always looking for excuses to delay tightening and to be dovish, this omicron variant isn't going to stop them from their hawkish turn unless you see global lockdowns (very unlikely).  In a counterintuitive way, all this fuss over omicron could give the Fed an excuse to be dovish again in December, leading to a face ripper year end rally.  That's not my base case, as Biden seems to actually be a bit concerned about inflation, and that concern should likely flow through to Powell and friends.  

I missed the dip buying chance on Friday, looking for a puke out in the Sunday overnight sesson.   Even though it looks like we'll rally till Wednesday, with beginning of the month inflows likely to boost the SPX, I won't chase this.  If it dips a bit at the open, I'll look to put on a moderate size long in SPX.  After a bounce this week, we should see renewed selling later in the week or next week to revisit 4580, and perhaps get down as low as 4550, the Sept. highs. 

Nu Sellers

The headlines are timely, aren't they?  Its almost as if the headlines were made to scare the public on the least liquid trading of the month, the day after Thanksgiving.  So much for that positive seasonality around Thanksgiving.  There are so many end of year rally bulls and seasonality "experts" who lose the forest for the trees.  

When you have so much complacency from truly excessive call buying, an overbought market that was 6 weeks from a V bottom, and in thin air above 4700, you are asking for trouble if you stay long.  Sure, you could get a nonstop grind higher like a December 2017 January 2018 move, but you can also get a move like today, an out of the blue massive gap down on a scary headline.  

Now I'm sure the bulls will say this is a black swan move, they couldn't predict that a new Covid variant would be coming and that the market would be going higher without the news.  If it wasn't the Nu variant, it would have been faster taper worries, or debt ceiling, or pre CPI jitters, etc.  Bad news comes around all the time.  Its just a matter if the market is looking for them and sell on it.  They usually don't.  This time, with the SPX in a vulnerable spot, they did.  

Its unfortunate that the headlines had to come out today, if it had just come out a day later, I would be loaded up on shorts and deep in the green.  I figured that they would keep the bears at bay on Black Friday, with the holiday cheer.  And would use that to my advantage to put on a big line of shorts.  Now what.  Its no man's land at 4620, not enough blood for me to buy the dip, but definitely not enough meat on the bone to try to chase it here with shorts and deal with a possible face ripper reversal (however unlikely I believe it to be).  So we wait, for that buy zone down towards 4560-4580, to BTFD.  Not rocket science, you have to stay out of the middle, and play at the top and bottom of the range, to minimize getting chopped up.  My paper napking charting below shows support just above the Sep. highs where dip buyers should come in to scoop up stocks on "sale".  

Looking at the Rear View = Big Problems

The gains have been massive in stocks, especially big tech, but even the crappy small caps that retail loves are still up big year over year, even if many are down quite a bit from their all time highs.  The same can be said for bitcoin, other cryptos, NFTs, commodities, real estate, etc.  Basically everything but bonds have skyrockted in 2021.  This leads to the temptation of looking in the rear view mirror, to extrapolate into the future.  But the environment is very different from the start of the year.  Instead of looking forward to a bunch of fiscal and monetary stimulus, the market is now looking at fiscal stimulus that is decelerating and will continue to do so for the next 3 years (Republicans winning 2022 midterm elections is basically a fait accompli), as well as a Fed that is on the verge of a hawkish pivot, as political pressure from high inflation eventually seeps into more hawkish rhetoric from Fed governors and eventually to Powell. 

Now that Powell has been renominated, he doesn't have to worry so much about placating Biden, and the financial markets.  He's totally sold out to Wall St., but he's also sold out to Capitol Hill and the White House, and inflation is the big worry now, not unemployment or economic growth.  

That being said, the window for Fed hiking is shrinking by the day.  You have to make the assumption that if the SPX is in steady downtrend, which I expect to start from the 2nd quarter of 2022, Powell won't start a hiking cycle, but will probably just do a token rate hike to try to maintain a tiny shred of credibility on inflation, and then pause as the US stock bubble pops and weakens the economy.  Powell in 2022 will be a lot like Yellen in 2015, but with inflation hot, not cold.  Yellen was expected to start a rate hiking cycle in the 2nd half of 2015 but she delayed due to the SPX waterfall decline in Aug/Sep 2015, and hiked once in Dec. 2015 and paused for a year before hiking again, only after the election and after the SPX was back to making new all time highs in late 2016.  

Unfortunately for stock market investors, I don't expect such a benign resolution for the SPX this time around.  Here are some reasons:

1) Bond yields are much lower this time around, providing less of that risk parity hedge for when stocks go down.  With the Fed very hesistant to go to NIRP, that will limit potential gains in bonds.

2) Less potent Fed due to high inflation.  Inflation is much higher from all that Fed money printing, gov't handouts, and pork stimulus.  Inflation is payback for printing all that money, and resulting distrust in the dollar as a store of value.  I know the USD is going up now, but that's because of overzealous hiking expectations and global fund flows to the US stock market bubble, not because of long term fundamentals.  Eventually, a massive dollar bear market like you saw from 2001 to 2008 is likely.  Higher inflation makes Fed easing counterproductive, as the Fed money printing will just go towards pumping up asset prices, which will result in higher food/energy prices and rents.

3) Bubble valuations and historically high household allocation to stocks vs bonds/cash.  Most investors are neck deep in US stocks, much more than they were in 2015 or even 2018.  So not that much dry powder left and lots of potential weak handed sellers when SPX enters a downtrend.  Don't forget that baby boomers are older now, they have a natural tendency to sell down stocks and buy bonds.   

4) Unlikely to see big fiscal stimulus like 2017 Trump tax cuts or 2020-2021 Covid gov't pork series.  With a Republican Congress from 2022-2024 and gridlock, expect fiscal impulse to be reduced significantly.  Since there is almost no organic growth in the US, corporate earnings will be flat to down and coming off of the highest valuations in US stock market history.  

5) Ebullient Wall Street sentiment towards stocks is similar to 1999, when stocks seemed invincible after a huge bull run.  It has managed to drag in the millenials, probably the dumbest generation of our times, who hated stocks from 2008 to 2016, and now love stocks since middle of 2020, especially egregiously valued meme stocks.  

So with the combination of bubble valuations, ebullient sentiment, fiscal drag from late 2022 to late 2024, and a Fed less able to go full bazooka stimulus (unless it starts buying stocks, another story for another day) due to inflationary pushback, you have a potent mix brewing for an impending bear market that lasts for years, not a couple of months.  2021 was the year to buy the dip.  2022 will be the year to sell the rips.  

SPX looks heavy the past few days, seems like Powell renomination relief rally that lasted a few hours was the top for this move.  Usually the day before and after Thanksgiving are bullish due to holiday cheer, but expect weakness starting from next week dragging out to probably the middle of December, with feared CPI on Dec. 10, and potential faster taper from a renominated and less nervous Powell on Dec. 15.  Also throw in the debt ceiling in the middle of all that to scare the chicken littles and you have a few negative catalysts lined up.  Getting tempted to put on shorts soon.  Feeling bearish.  Would like to see a one/two day rally towards 4700-4720 to lay out the short line. 

A Hawkish Pivot

At the November FOMC meeting, Powell was about as dovish as you could be for someone who was starting to normalize policy.  He's transformed from his straightforward tell it like it is style from 2017 and 2018, to word salad mealy mouth statements used to appease the financial markets, and thus receive praise.  I don't know if he's being honest (unlikely) and is completely incompetant, or is just being Machivellian (more likely), doing whatever it takes to please the markets, politicians, and get renominated and maintain his power.  Mainly telling bold faced lies about inflation.  

You can tell inflation is starting to get to Biden when he's begging OPEC to increase supply and keeps threatening SPR oil releases in coordination with other nations.  Biden's poll numbers are about as bad as the worst moments for Trump, and he never really had good approval ratings.  Its getting clearer and clearer that the general public is starting to feel the pinch from higher prices, especially those that don't own stocks.  And even as out of touch as Biden is about the public mood, this inflation is so over the top hot that its even getting his attention.  

And when inflation starts worrying the President, then it will start worrying the Fed.  Because the politicians are the ones that pick the Fed governors.  There is no such thing as Fed independence.  Politicians don't want to see inflation go any higher, and if they had to pick their poison of higher inflation / higher stocks or lower inflation/lower stocks, they would probably pick the latter now.  That's usually not the case, and that's why the Fed is usually dovish.  

The politicians and central bankers, the liars that they are, have already tried to talk it down, pass the buck, and blame the inflation on everyone but themselves and their inflationary policies.   But there is only so long that you say transitory inflation until even the dumbest of the Fed believers see through the BS and get sick of hearing it.  

The nonsense about supply chain problems due to Covid is repeated so often that everyone believes it as gospel, not be questioned.  They say inflation is due to lack of goods supply, lack of labor supply, not due to excessive demand from bazooka stimulus.  Since its a supply chain problem, they say, it can't be solved by fiscal or monetary policy.  No one questions the logic.  If it was a supply problem, how do you get so many earnings beats and so few misses?  Shouldn't the lack of supply limit consumption and cause revenues and thus earnings to go down?  How many revenue misses have you seen?  Shouldn't S&P 500 revenues be down if supply chain problems were so bad?  Shouldn't retail stocks be getting destroyed?  Why are revenues and earnings so strong?  

Anyway, back to the market.  Very resilient and hanging tough near all time highs, Covid "bad" news was good for about a few hours of overnight weakness on Friday, and then people realized that these "soft" lockdowns are good because it slows down monetary policy normalization, and keeps them dovish, while having almost no effect on the overall economy.  Russell 2000 has been a very noteable laggard, and that's not bearish.  Its only bearish if you get Russell 2000 weakness along with bond market weakness, and that's not happening yet.  With the year end bullish forces at work, as long as 10 year stays under 1.70%, you are going to have to either have a serious flattening of the curve from a Fed hawkish pivot or a black swan to take this sucker down for more than just a retest of the early Sep. highs at SPX 4550 for the remainder of the year.  Betting on anything more than a quick 100 point pullback with shorts is getting greedy and begging to miss the exit point and get caught in a meat grinder higher till year end. 

That doesn't make me bullish, I do expect a sharp pullback of 100-150 points sometime in the next 3 weeks, with call activity over the top and complacency everywhere, and with bullish sentiment seeming to wane a bit from very bullish levels, which is actually not good for short term returns.  Still, I would rather be reactionary and be a buyer of the dip rather than try to predict when this solid uptrend turns and gives you a good short trade.  But it is getting tempting to try on a short for a quick gain sometime later this week, as we're approaching a window from post Thanksgiving to the 2nd week of December where seasonality is neutral. 

M2 is the Force

The most important variable for asset markets is the supply of money.  Monetary policy is important, but its fiscal policy which can really ignite M2 supply growth.  We had QE1, QE2, and QE3 that were nearly the same pace as that of the past 12 months, but the money supply didn't grow much because of fiscal tightness brought on by the combination of a Democrat president and Republican Congress from 2010 to 2016.  Also, politicians actually thought about the deficit back then, unlike now when deficits don't matter.

Take a look at the M2 supply growth for the US, Euro Area, Japan, and China for the past 5 years.  The US sticks out like a sore thumb.  The firehose of free money was unprecedented and the pace is still double what you are seeing in Europe and Japan, and pre-2020 US.  

Here is China vs US M2 supply for past 10 years:

China, which is notorious for printing huge amounts of money to paper over debt problems, has printed at a much slower rate than the US over the past 10 years, and especially since 2020.  Usually emerging markets are supposed to print a lot of money because there economies are growing faster, and the demand for money is greater.  But its the other way around, with the US going into bazooka mode and staying there.  And most of that money is not going to productive use or investment.  Its just a money spew, which ends up being recycled into the stock market, cryptos, real estate, etc.

It used to be China that had an inflation problem, now its the US.  Its not rocket science.  The more money in circulation, without a concurrent increase in production, increases prices.  All these 5 minute macro takes about Covid and supply chain problems leading to high inflation ignore the most important factor.  The massive increase in M2.  Like a knucklehead, I ignored this for most of the past 18 months.  But there is a reason that the SPX, bitcoin, commodities, etc. keep going up.  The rate of M2 growth is much faster than new equity/crypto/commodity supply growth.   As long as the M2 is growing at these rates (still 12%/year in the US), all dips in stocks will be buyable, and its going to hard to make money on long term short positions.

With the Covid stimulus mostly wearing off and the Fed reducing the pace of QE, the M2 supply growth should slow down considerably in 2022.  And with the horrible poll numbers for Biden, even with SPX at all time highs, the Dems look like they are doomed in November 2022 midterm elections.  That assures gridlock in Washington for 2023 and 2024, which is like an eternity for the stock market.  A Fed that is going to end QE and start hiking in summer/fall of 2022, with fiscal stimulus expected to be shut off for the next 2 years will definitely have a big impact on the money supply growth rate.  I expect M2 growth to go back down to 5-6% by the end of next year.  At that pace, the SPX becomes vulnerable to quick drops and waterfall declines, like 2011, 2015, 2018. 

SPX is back to being a boring market, as we've found a stabilizing level around 4700, where supply and demand seem fairly balanced.  I see no edge for either side here, but would take the other side on a 2-3% move.  Especially on the long side.  Buying dips is a much more effective strategy than selling rips.  With the market up huge this year, and the combined effect of portfolio window dressing and reluctance to sell at year end due to realizing capital gains 1 year earlier, the wind is at the bull's back.  

The bond market seems to have found a support level around 1.65-1.70% 10 year yield.  But the sentiment on bonds is poor, and there just isn't the demand to push it to much lower yields.  On the other side, speculative positioning is somewhat short, which means there isn't much weak handed money in bonds to push the yields much higher than 1.70%.  We're probably in a 1.40%-1.70% range for the next few months in 10 year yields.  Unless you get the unlikely event of the Fed speeding up the taper and pulling rate hikes forward, I see almost no chance of 10 yr going above 1.70%.  

Learning from Mistakes

2021 was a golden opportunity to be long US stocks for anyone who had a solid big picture view of how a bubble plays out.  Going into 2021, I was too enamored with not being caught long at the top of a massive bubble instead of recognizing that less than 1 year removed from the Covid "bear" market, it was highly unlikely a meaningful top would be made so quickly after such a huge flush out.  Even if you had a repeat of the brief Dec. 2018 to Feb. 2020 bottom to top cycle, that still gave you 14 months from the March 2020 lows, or until May 2021. 

The biggest clue that this bubble would be extended was how the Fed reacted to the growing bubble in 2021.  Powell remaining over the top dovish as the stock market kept going higher and higher and the economy was heating up was the most obvious sign that the bubble would get a lot bigger in 2021.  

February 2020 was the only meaningful top that was made while the Fed was not in a tightening mode, and it probably wouldn't have happened if not for a black swan event.  The only other instance of a big stock market drop without a tightening central bank was in the summer of 2011, when it was the tightening of the European financial system as sovereign yields for the PIIGS skyrocketed, a market driven tightening, not a central bank policy driven one.  A tightening nonetheless, the most important ingredient to form a meaningful stock market top. 

In hindsight, everything looks clear and obvious.  In the heat of the moment, in the middle of the battle, its never that easy.  Its much easier to make the right decisions as a Monday morning quarterback than trying to make the right reads while 300 pound linemen are trying to pummel you into the ground.   

The market was there offering loads of money and I was content with being short term focused and conservative, taking 5 dollar bills when I should have been collecting 100 dollar bills.  Finally in September/October, there was another golden opportunity, even though at the time, there was a lot of chop that made it "feel" scary to get long.  The disgust from my previous poor exits was enough motivation to make the right play.  The key was not getting in too early in buying the dip, which allowed me to hang on and not getting shaken out in late Sep./early Oct. as the market chopped violently from SPX 4300 to 4400.  

The first thing on my mind was to not sell if the trade went in my favor.  On my mind was those previous well-timed dip buys that didn't amount to much because I sold way too early, afraid of giving it back on another pullback.  This time, I gave the long trade plenty of time to work.  Even then, I sold a portion way too early, but thankfully, rode most of it to the 4650-4700 range.  The key was resisting the urge to microtrade, the bane of my existence, even as I thought that a quick 1 day pullback was imminent (it didn't happen until October 27).  Losing the arrogance of thinking that I was smart enough to time and predict every little move made me do nothing but just stay in the trade and let it play out.   

To this day, even after seeing the SPX go way higher after I sell so many times in my career, I still get that urge to sell after that quick profit on the initial portion of the V bounce.  It has to be the psychological crutch of aiming for steady, consistent moderate gains, instead of less common, but much bigger gains.  Even as I thought that I got rid of the salaryman mentality a long time ago, there is a seed deep inside my psyche that still wants to make consistent gains on my terms, instead of taking what the market gives me, whether it be big or small, plus or minus.  

There are zen like aspects to surfing the markets, if you try to force your will and style on the market, you limit yourself and close off the enormous potential that is out there.  Its like taking a boat out only to stay near the shore, content with catching little fish in quick daily trips, instead of going out into deep waters, looking for the big fish, going for the big catch in long multiday trips.  

I am all out of my SPX longs.  I could probably eek out a few more points but I just see too much call buying and complacency, as well as the upcoming options expiration and ensuing post-opex risk.  Also, the time window from the early October lows has played out, as we are 5 weeks from the blastoff point, and 6 weeks from the lows of early October.  Also the renewed weakness in Treasuries is another headwind.  Its a seasonally strong period, so not really interested in going short, but the risk/reward seems neutral to slightly favoring shorts.

Crypto Creep

Like mission creep, similar things happen in the investment world, where initially a product is thought of as one thing, but then as the price advances, new things are attributed to the product, giving it 'superpowers'.  Cryptocurrencies are a perfect example of a new investment, hard to value, with questionable fundamentals, that is initially treated like complete speculation, like Beanie Babies, like tulips, but as it goes higher and higher, and the uptrend shows more staying power, you get more and more believers.  

1) In the beginning, its the geeks and the paranoid idealists who view cryptos as an alternative currency that takes power away from governments and decouples money from the State.

2) Then you had the 15 minute macro experts who suddenly thinks blockchain is the next big technology and therefore makes bitcoin a good investment. The logic isn't questioned, its just repeated.

3) Next, you had the first big wave of speculators who see bitcoin going up, see others investing in it, and start piling in (2017-2018).  Its still considered a fringe asset among institutions, and not something that most consider as part of a balanced portfolio. 

4) After the Fed and US government goes bonkers and floods liquidity everywhere in 2020, speculation catches fire.  Suddenly, the markets go from fear of deflation, to fear of excessive money printing which gives bitcoin the digital gold label.  It is now considered an inflation hedge, a hedge against the devaluation of the dollar.  

5) Bitcoin goes parabolic and assorted coins trading for sub pennies are heavily pumped and start going up huge, and pump and dump scams show up.  Crypto mania is everywhere, hedge funds and institutions are getting involved, an ETF is made, with more in the works.  Shells of deadbeat small cap companies change their business to crypto mining, "defi", NFTs, or another crypto related buzzword that's hot among lotto retail speculators.  

Cryptocurrencies are the perfect asset class for those looking for juice and to get rich quick.  They can rationalize their investments with simple Fed brrr memes and by believing that institutions will begin to add them into their portfolios.  The most important aspect is the juice.  If bitcoin didn't have explosive price moves, the retail speculators wouldn't be playing it.  When you don't have a lot of money, 10% a year in stocks just won't make you rich.  

It is the mentality of the times.  That's why you are seeing such explosive growth in call option volumes since the summer of 2020.  And most of the volume isn't even in the monthly options, they are crowding into the weeklies, the ones with the most gamma/$ premium.  The riskiest and cheapest options that decay the fastest but provide the most bang for the buck.  Its a full blown lotto mentality in the financial markets.  

It would be nice if these bouts of mass speculation in high beta names and call options were a precise timing tool, but unfortunately, they are a better tool for timing tops in those names than in the broader market.  What is happening is probably the last speculative wave of this bubble that precedes the final top in the SPX, with a lead of 3 to 6 months. 

One thing to watch is the rates market.  5 year yields are trading at another 52 week high, and the market is back to pricing in more than 2 rate hikes in 2022.  The hot CPI number wasn't shrugged off by the bond market this time, like it has been so many times this year.  Part of that is because 10 yr yields went down to the 1.40-1.42% support area, the day before the CPI, and also the terrible 30 year auction afterwards.  But an additional factor which is being underestimated is the sudden concern about inflation from Biden.  And Manchin.  Politicians are getting more concerned about inflation and less about employment.  Political winds are shifting, and they will affect Fed actions in 2022.  

I thought that the Fed would be slow to act to hike in 2022, but I am beginning to change that view, based on the politics.  Its a midterm year, and while a lot of people love it when asset prices keep going up, there are more people who don't like to see gas, food, and rent going up.  If commodity prices keep surging higher in 2022, like I expect, that's going to put Powell (probably renominated soon) under more pressure to raise rates.  Still don't expect him to speed up the taper or hike until after tapering is over (June), but he's probably hiking at the very next meeting in July.  It doesn't matter if Powell hikes in July or September, because in either case, I don't see him hiking in early November, a few days ahead of the midterm election.  Not necessarily because of the politics behind it, but because the market will probably have a steep drop before that meeting.  So the most likely scenario is a July or Sep. hike, pause and then second hike in Dec., as long as you haven't entered a bear market by then, which is a possibility.  Its either lights out after the first hike or after the second one, in my view.  I don't see this level of optimism, the super bubble valuations, the extreme overweight in US stocks among investors to be able to continue more than a year from now.

I have sold most of my SPX long, still have a some left that I wasn't able to get out of at good levels so I am holding and looking to dump next week on a bounce.  The first 2% dip after such a strong run is usually bought, and the recent highs are often retested.  It looks like the first dip is over, and likely to see a reflexive bounce and another call buying frenzy early next week as we go back towards all time highs.  The times to fear a big parabolic rise is after months of a rising market, which isn't the case now.  That September/October correction purged the positioning enough that this market probably won't crash back down after a big advance like a January 2018 or even a September 2020. 

Another Call Option Wave

Stocks aren't giving the speculators enough juice.  They are reaching for lotto tickets in the form of call options. This is late cycle behavior, ala 1999, 2000.  That being said, unlike 1999 and 2000, the Fed is still adding liquidity into this party, not taking it away.  A big difference, and the main reason the top will be more extended than back then.

The volumes are well above average, and put/call ratios are well below average.  The only exception is TSLA, which for some reason, has fairly high put/call ratios for such a favored speculative stock.  The two that stick out above are AMD and F, which traded more options than both AAPL and TSLA. F seems to be catching the electric vehicle frenzy, and AMD has become a WSB favorite lately, as seen by message activity tracked by stockquant. 

AMD, TSLA, LCID, AMC, and NVDA are WSB stocks.  That's 5 of the top 10 options volume leaders for Monday driven by the Robinhood crowd.  Retail has been piling into their favorite stocks since the beginning of month. This is not necessarily a sell signal for the SPX, but its a long term sell signal for WSB stocks.  After the last time you had a retail trader frenzy in call options, you immediately saw those stocks top out, but the SPX just kept going higher.  Obviously, there is a huge difference between SPX at 3900 and SPX at 4700, and you can't extract too much info from a sample size of 1.  But with put/call ratios this low and volumes so high, the market usually has a difficult time squeezing even higher and usually chops and consolidates its gains for a few weeks.  That also matches with the typical pattern of break outs to a new all time high after a deep and extended pullback retesting the breakout point (SPX 4550) within 1 to 2 months.  

But with Powell regaining control of the bond market and repricing hiking odds for 2022 and 2023, the can has been kicked a little bit further down the road, giving investors more room to drive up stocks to even more insane levels after this speculative fervor cools down.  Powell is intent on not repeating the 2018 tantrum, taking a painfully slow turn for monetary policy, nurturing this bubble even more.  He's still not caving to the media pressure to take inflation more seriously and do quicker rate hikes.  His dovish backbone is like a ramrod, its not bending to the pressure put on by inflation hawks which are growing substantially in number.

His press conferences are basically Lagarde Light.  Full of nonsensical gibberish, cringeworthy rationalizations for reckless monetary policy.  And Wall Street loves him for it.  He's figured out the game and its not that complicated.  Be dovish when it matters.  The default setting is dovish.  Be hawkish every now and then when no important decisions are imminent so as to look "balanced".  Watch the stock market go up and be treated like a maestro and a great "manager" of the economy.  Much like how Greenspan was treated from 1987 to 2000.  

Tapering QE is not going to pop this bubble.  It has to be rate hikes, and the threat of more rate hikes that does it.  That gives this market at least another 6 months of runway, not necessarily to keep going up, but not to enter a downtrend.  It could go up or sideways till QE is finished, but I see almost no way SPX goes into a noticeable downtrend without a significant repricing of the yield curve to reflect a more hawkish Fed and more persistent inflation (8+ rate hikes priced in by 2024, 2% 10 year yields.).  It could happen, but I doubt it.  It would be betting on a massive underdog without getting good odds. 

Big picture, long term, we are getting more confirmation that this bubble is sucking in a lot of souls, and the payback will be immense (if the Fed doesn't come in with guns blazing with another bazooka QE to rescue it) on the other side.  When this bubble does pop, it will be a good thing for society.  A society built on speculation and perpetual bailouts and money spews is one that rots the system from the inside.  The side effects is a labor shortage because people are unwilling or don't need to work, instead speculating and living off their gains in meme stocks, call options, cryptos, etc.  It breeds more dependency on government handouts, when the bubble pops and the economy weakens.  It makes people lazy. 

I sold some of my SPX position yesterday, and will sell more this week and eventually look to sell it all by early next week.  It is still too early to make a high conviction bet on the short side, even though I expect a pullback after November 19.  Even at these overbought levels, the odds are still not good enough for shorts.  Its just not a good time of the year to make bearish bets, when fund managers are chasing performance and long term investors are loathe to take profits before year end and bring forward capital gains by 1 year.