Its a MAD market

Most investors are in M.A.D. mode.  What, me worry?  The market keeps grinding higher, and the shorts keep losing.  Unfortunately for those that are short, the window of weakness for the SPX is getting smaller and smaller.  Seasonal weakness has not played out for most of the last 2 months, despite the elevated net long positioning among asset managers and the complacency of the crowd.  The election has been ignored, and it seems most believe that there will be an end of year rally after the election is over.  On Twitter, the bears are dropping out like flies, as I've seen many throw in the towel as the SPX busted out to new all time highs last week.  

The bullish price action is uncanny as we are heading into the last few weeks ahead of the election.  Maybe its the strong SPX rallies post election in 2016 and 2020 that have investors complacent, one won by Republicans, one won by Democracts. It appears many believe that based on recent history, it will go up post-election no matter who wins.  However, if you asked investors if stocks would go up or down if the corporate tax rate went up from 21% to 28%, most would say they would go down.  And the Trump tax cuts are not something that automatically gets renewed if there is no legislation.  Those tax cuts are set to expire if the next President does nothing and lets them expire at the end of 2025.  And Harris will let them expire.  That plus other low probability risks to stocks such as raising the capital gains tax rate, which is possible in the small chance that Democrats sweep the election. 

On CNBC and Bloomberg, there is very little talk about the ramifications of the election.  The recent news surrounding geopolitics, strikes, hurricanes, and even the Fed have distracted investors from thinking about the big one:  the election.  And its the one that can actually have a meaningful fundamental impact on the future earnings of corporations and investors.  Maybe the market continues to ignore this risk all the way to the finish line on November 5, but I view that as a low probability scenario. 

Despite what looks like a ripe environment for stocks to pullback, the opposite has happened.  Trading is a probability game.  You can play the odds and make your bets based on historical tendencies in similar environments and still lose.  Sometimes history doesn't repeat itself.  Most good trades on the SPX or other major markets will be only slight favorites.  You just don't get a big edge trading such big, liquid instruments.  So you have to be able to withstand drawdowns, cut losses, and move on.  But you also have to be able to know when its too late to get out.  For mean reversion traders, often times the more stretched the rubber band gets, the better opportunity.  The moments when counter trend traders are losing the most are usually when the best opportunities occur.  Of course this is assuming that the trader has a valid winning long term strategy.  

The only way to get to the long run is if you survive the short run.  The only way to survive the short run is have proper money management and not make huge bets.  

The past week's COT data showed little movement among asset managers and commercial traders.  The large asset manager net long position remains.  The OCC data for last week shows both small and large options traders buying more calls and with bigger premiums than for puts.  The data came in as one would expect for an up week.  No real edge there.  Put/call ratios are generally low, but that is to be expected considering last week's price movements.  

There is a tendency for opex weeks to be bullish on Monday and Tuesday if we are at or near an all time high going in.  The is early week bullishness is usually reversed later in the week, as opex gets closer and options expire, leading to fewer ITM calls and fewer OTM puts outstanding.  This can trigger more outsized moves on opex day and for the following week.  This is what often happened during the monster up year of 2021, when you had lots of call option activity, which led to rallies up to the beginning of opex week, where options hedging forces led to selling later in the opex week, and sometimes spilling over to post opex Monday.  That would be my base case for this week's price action as many are bulled up going into this opex.  

With new all time highs and SPX over 5800, we have to temper our expectations for any pullback that comes this month.  Even with election risk coming to the forefront soon, the price action doesn't support a big pullback.  You usually have more bearish price action or more volatile two way trade at the highs prior to big pullbacks.  We are not seeing that now.  So while my original thesis was for a move down to SPX 5450 when initially short, I now think its likely that the most this goes down in October is 5600.  So I don't even foresee a 5% pullback from the highs ahead of the election.  The shorts will have to be satisfied with a graceful exit and/or minimal gains on a pullback, rather than any big profits.  2024 is the bull's year, and trying to make money on the short side has been trying to squeeze water out a rock.  2025 should prove to be a much different trading environment.  So for the bears, don't waste too many bullets trying to take down this super bull, save them for what should be more of a two sided market next years, with patient bears likely to get paid much more often than either 2023 or 2024.  

Still full short position, as I view any gains early this week to be taken back quickly later in the week.  Covering now and trying to reshort later is trying to be too cute when we are this far overextended with so much investor complacency .  The potential upside is more limited than potential downside this month, so its not worth it to micro trade.  Staying short.

Canary in the Coalmine

Bonds are the canaries in the coalmine.  They are the first movers.  Many short term tops in the SPX are foreshadowed by an intermediate term move higher in yields.  After bottoming at 3.60% on Tuesday, Sep. 17, the day before FOMC meeting, 10 year yields are now 40 bps higher, 3 week later.  The 4.00% yield area should be short term resistance for 10 year yields, as the Fed is still hell bent on making a dovish mistake and boxing themselves into a bunch of rate cuts.  Political Powell, once again, is making another monetary mistake due to his greed, looking to stay in power by trying to prevent Trump from getting back into the White House.  This time, instead of delaying hikes, it is rushing and pushing forward rate cuts that are unnecessary.  

Bonds are calling BS on the Fed's rate cutting path, afraid of another dovish mistake on Powell's part, his 2nd in less than 3 years.  The aggressive steepening of the yield curve, the refusal for bonds to rally despite a bigger than expected 50 bps rate cut at the last FOMC meeting, and the firming economic data.  Powell is trying to put Harris in office to assure that he gets renominated for a 3rd term, with inflation ignored and concerns about a labor market that isn't even that soft, all pretense for big rate cuts to goose the stock market and odds of Harris getting elected.  

The only way to keep the long end under control is to stop QT, and do QE again.  With the monster budget deficits, there is just too much Treasury supply to keep yields under control without a recession.  Even with 50 bps whopper cuts every 6 weeks.  Powell is once again short sighted, looking out for himself and trying to pump up the stock market to curry favor among the rich and powerful, to get support for a renomination in 2025.  It is all but guaranteed that a Trump presidency will look to replace Powell with someone that listens to Trump, not ignores him.  And Trump can clearly see that Powell is being political, and will get his revenge by kicking him out in favor of a new FOMC chair.  That new chair will likely be even more dovish than Powell, looking to keep rates low no matter what. 

The whole premise for the post FOMC rally in stocks was that the Fed was going to be dovish, to support the economy and ignore inflation in order to try to boost the job market, and thus the overall economy.  A soft landing, or even no landing scenario.  But the big cut has become counter productive because long bond yields are going up, not down.  So it minimizes the monetary stimulus of the rate cuts.  And without monetary stimulus working throughout the curve, the stock market will not be able to hang out at these nosebleed valuations for long.  The euphoria can last a few weeks, maybe even a few months with a Trump victory, but ultimately it will fail under the pressure of sticky long bond yields above 4%.  

This bond weakness comes at a time when the stock market is facing the uncertainty of the election a month way, where odds are 50-50.  You cannot get more uncertain that a coin flip.  And this market needs a Trump victory.  There is no way Harris will extend those Trump tax cuts.  She has other ideas of how to bust the budget.  And no, it will not be as stock market friendly as Trump's budget busting plans, as it will funnel more money into the lower and middle class, igniting inflation again.  

Back to the stock market.  Last week, we saw a pullback in the US amidst geopolitical concerns as crude oil rallied a few dollars and VIX squeezing higher.  It was a very mild pullback, contained to SPX 5670, the top in July.  After the blockbuster, and heavily manipulated NFP numbers came down the pike, you got the reflex rally higher in SPX towards 5750, where it is now facing some serious resistance.  During the pullback, the put buying remained subdued, and the bulls were defiant.  The financial experts on CNBC stayed bullish, and have completely bought into the Fed put and soft landing theme.  I could feel the latent bullishness on Twitter as well.  Its a warning sign that there are a lot of bulls out there that still aren't prepared for the coming election volatility.  It increases my conviction that you have to put on shorts early this week, before everyone comes to their senses and realizes that they are paying top prices right ahead of some serious election risk.  

The COT data confirms the lack of concern and heavy bullish positioning.  Asset managers hardly reduced their net long positions in SPX and NDX futures.  They even increased their net long in Russell futures despite the weakness post FOMC meeting.  Dealers have gotten even more short, shortest YTD, as the small reduction in asset manager longs was more than made up for by a reduction in shorts from leveraged funds.  In total, a bearish picture from the latest COT data.  

Covered half of my SPX short before the NFP on Thursday, and looking to re-add the short today or tomorrow.  I don't think this market will give you much time to short the highs so I will be in a rush to short any rallies.  I am looking for a return of volatility starting later this week.  Will not be picky about trying to nail the top this week, because of the lopsided risk/reward at these levels for shorts.