Flashback of 2015

Just like 2014, 2019 has provided a huge rally in both the stock and bond market, feeding on the blood spilled by the bond bulls in the prior year (2013 and 2018 respectively).  That sets up a payback period in the following year, usually triggered by a big bond market correction.  In 2015, the correction happened from February to June.  In 2019, it is starting in September.  And it is likely to last a few months, so bond bulls, be prepared.  It will be choppy trading over the next 3 months. 

The top chart shows the SPX and 10 year yield overlapped from March 2014 to March 2015.  The bottom chart is the SPX and 10 year yield over the past 12 months. 

What isn't shown in the chart is what happened over the next 12 months.  And boy were they a rocky 12 months.  From May 2015 to August 2015, the SPX went from 2132 to 1867.  If 2019/2020 were to follow the same script after the bond market rally ended, it gives the market about 5 months before the bottom falls out of the market just like August 2015.   That approximates to February-March 2020. 

Nothing follows a script exactly, but the general concept is that bonds will no longer provide that great hedge against equity selloffs like it has over the past 9 months.  That eliminates a vital hedge which prevented investors from fully panicking out of the stock market during periods of weakness. 

So the stock market is now like a ticking time bomb ready to go off without notice, now that the low interest rate fuel has been used up. 

In fact, the August 2015 selloff was accompanied by a rather meek bond market rally, with the 10 year dropping only about 35 bps during the August 2015 waterfall decline. 

With the overvaluation being much greater now than in 2015, it is easy to imagine a waterfall decline in 2020 to be much steeper than the August 2015 decline.  There are a number of triggers that I can think of right now which will do it, the main one being the Democratic primary winner being either Elizabeth Warren or Bernie Sanders.  Odds of that are about 50% according to betting markets.  And the current polling shows Democrats ahead of Trump in the 2020 presidential election.  That would be a huge game changer as the main reason for the 2017 rally was a the corporate tax cuts, and a Warren or Sanders would likely raise taxes on corporations and the rich, which would be a huge negative catalyst for the stock market. 

We've had another big rally in SPX this week, thanks to positive trade talk.  Remember, the trade war is a distraction to what really matters.  The slowing economy, no earnings growth, and the potential of an anti-corporate welfare Democrat winning the White House in 2020.  There is resistance around the all time highs at 3025, but given the participation of small caps in this rally this week, there should be new all time highs coming up.  Still cautious on long term shorts, but I am getting much more constructive on putting on short term shorts because of the bond market weakness.   However, I will wait till after FOMC meeting and opex next week.