Covered Up by Fog of Trade War

Sometimes you just miss the entry.  Being overpatient can lead to too many missed good trades.  But this bull market has punished early shorts for most of its duration, so I took the cautious approach.  And who knows if this market would have dipped down so hard if not for the sudden tariff threats from Trump on May 5th.  It was right on the cusp of a monster short, but headlines got in the way this time. 

Although in my view, the long term trade to make is to be short US stocks (not even emerging markets or Europe anymore), because that is where the most overvaluation and the rosiest outlook is priced in. 

Shorting is not easy, because inherently the market has a tendency to rise over time, so you are fighting the odds, as long as valuations are not excessively high.  But these are one of the times where valuations are excessively high. 

There are some clues over the past few weeks, non trade war related, which are flashing red lights on this bull market.  First is the performance of the most economically sensitive sector, semiconductors, SMH ETF, compared to defensive sectors:  utilities ETF, XLU, and the consumer staples ETF, XLP. 

As you can see, the utilities and consumer staples are both up ~6% over the last 3 months.  Semiconductors are down ~4% during that time period. 

Another sign of a weakening economy is the 5-30 yield spread.  That is now ticking 62.5 bps.  It started the year around 50 bps.  The spread was in the 20s for much of 2018.   Bull steeping in bonds is one of the last signs you get before the crap hits the fan in the economy.  That is what happened in fall of 2000 and fall of 2007.  1 Year chart of the spread below.

The trade war is a distraction for what really ails this market, an economic slowdown.  Eventually it will show up with the dollar weakening as the interest rate differentials get pressured lower.  The best opportunity for short sellers is for a equity market squeeze higher on a trade deal, because it is not going to affect the economy as much as people think, and that would get rid of the last positive catalyst for this market. 

I am not going to get into game theory or trying to get into Trump and Xi's head, like the other 5 minute macro traders are busy doing.  All I know is that the market is very nervous about the trade war, which means that there will be an asymmetric response to positive and negative news.  Positive news will have a much bigger impact on stocks than negative news at this point.  That is the only enemy of the bear at this point.  All the fundamentals, even with a trade deal, favor the bears.