The Game Taught Me the Game

"The game taught me the game.  And it didn't spare me the rod while teaching." - Jesse Livermore, Reminiscences of a Stock Operator  

Speculation is tricky.  Its not like anything that you learn in school or in a how to book.  There are tens of thousands of books on trading and investing that are overflowing with advice on how to make money.  From experience, most of those books are useless.  Unlike most other skills, people who teach trading/investing are usually the ones who failed at making money in their supposed field of expertise.  That's why so many aspiring traders look for mentors, someone who will teach them the tricks of the trade.  Those tricks of the trade are eerily absent inside the thousands of books sold by the so-called trading and investing experts.  

Trading is a competitive game, where edges get diminished the more that they become known.  So most successful traders are loathe to write a book teaching everyone how they made money.  Or even starting a subscription service.  Or mentoring someone, who could become a future competitor.  That's why you are left with a landscape in the trading education community of a bunch of overconfident, low edge/no edge techniques that permeate and misteach a bunch of eager traders looking for shortcuts.  

As Jesse Livermore said, the game taught me the game.  The best way to learn is to get in the game.  Paper trading won't do it.  Real live trading and putting meaningful money on the line is the fastest way to learn.  Nothing focuses the mind better than having a bunch of money at stake.  I learned the most from my losses, although I don't recommend losing just for the sake of learning.  You have to learn from those losses, and not be hard headed.  You have to manage risk, to stay in the game and to keep learning.  It sounds trite, but risk management is the most fundamental, important, and necessary skill required in this game.  

If my view on this market are correct, the current environment will favor those who have experienced multiple bear markets, and have a less bullish view of the US stock market.  A lot of newer traders, and those with short memories, will be caught off guard.  Too many are positioned aggressively in equities, especially retail investors who are probably the most long on an asset % basis since 2000.  The household equity allocation tells a lot.  This was as of December 31, 2024, when the SPX was around 5900.  But even if you account for the correction, the equity allocation is still historically very high.  

These high equity allocations are facing extremely high valuations, on a forward P/E basis, which are likely overinflated considering the probable economic weakness coming over the next 12 months.  

Fundamentally, you have a Fed led by Powell that is not eager to save Trump and the stock market.  Trump while caving on a lot of the tariffs, is unlikely to completely give up and settle for the status quo, likely wanting some tariffs just to show that all this angst wasn't for naught.  So tariffs will still be a drag on the US economy even if you get trade deals.  

And fiscal stimulus is likely to come only in the form of tax cuts which will only be effective if they are large enough, which will come in 2026 at the earliest.  Its also possible that large tax cuts could spook the bond market and be counterproductive without a Fed that is willing to play nice and help absorb the extra Treasury supply coming from bigger deficits.  You could get a big rise in 10 year yields if the Fed doesn't restart QE if deficits get even bigger.   Powell is around till May 2026, so that's a long time for the stock market to deal with an uncooperative Fed.  

The recent rally has also resulted in higher short selling activity in the dark pools, tracked by the DIX index at Squeeze Metrics.  As you can see, over the past several months, a spike in the DIX has led to pullbacks.  

The COT data, which covered the down move from Tuesday April 15 to April 22, surprisingly showed a small increase in SPX net longs among asset managers.  The overall levels of net longs is still quite high, although well off the highs earlier in the year.  

Its looking like one of the worst environments to be long SPX.  The bulls have enjoyed a lot of success since 2008, and the down swings have not lasted long. The longest downtrend over the past 17 years is in 2022, when we had a 26% drawdown from top to bottom over 9 months.  That's mild for bear market standards.  And what's more important, was that bear market was followed by a huge move higher, from SPX 3500 to 6140 over 2.5 years.  That's a 75% move in 2.5 years.  No wonder the bulls feel invincible about the long term prospects for US stocks.  The HODLers are not in bitcoin, they are in the US equity market.  

I put on a short position late last week and look to add some more early this week to get to a full position.   The risk/reward looks favorable for short positions for the intermediate term.  There is renewed optimism coming from headlines showing Trump caving on tariffs and talking about trade deals.  The talk about the breadth thrust last week was pervasive, showing that technical traders are now bullish with SPX above 5500.  But we are just back to previous support levels which was the local bottom in March.  

There are factors that the bulls have in their favor.   There is relatively low net equity exposure among vol control funds and hedge funds overall with a lot of bearish sentiment showing in the surveys.  If you add the bullish and bearish factors, it appears that the bears have the edge.  If the SPX doesn't pullback within the next 2 weeks, I will reassess my view.  If I am correct, the SPX should start moving lower within 1 week.  

Dumping Dollars

US assets are being dumped.  They are dumping US stocks.  They are dumping Treasuries.  The last 2 months have been a massive reversal of global capital flows which have gone from the rest of the world into the US for the past 15 years.  There are a lot of foreign investors overweight US assets and they are feeling the pain.  Not only are they losing money on the dollar weakening vs the local currency, they are also losing as the SPX goes lower along with long term Treasuries.  

This is a huge problem for the US government and for those with big allocations to US stocks and bonds.  Dollars are weakening despite the Fed remaining hawkish amidst Trump's trade war.  I am no Trump fan, but Powell is definitely playing politics.  How do you suddenly go from dovish and overcutting in a red hot stock market and easy financial conditions in the fall of 2024, to being hawkish and watching and waiting as the US economy weakens rapidly.  Powell should be fired.  He's the most political Fed chair in modern history.  He only cares about maintaining power, and he's taking out his grievance against Trump who won't reappoint him with hawkish policy while the US economy weakens.  Sure, Trump's tariffs are the main reason for the economic weakness.  But the Fed's job is to focus on the economy, not on fiscal policy.  

Here's a look at fund flows into US stocks:

Cross border inflows into US assets has been skyrocketing since the beginning of 2022.  There is a lot of foreign hot money in US stocks.  

YTD inflows into equities is ~$250B, that's in less than 4 months, approximately 2/3 of which is going into US equities, while the SPX has been going sideways and then down.  A lot of investors are caught offside here.  Not a  good sign for the rest of the year for bulls.  

The most risk-taking of investors are pumping huge amounts into leveraged long ETFs, with the biggest weekly inflows on record happening in the past week.  There are still a ton of dip buyers, especially among retail investors.  The buy the dip mentality is still going strong.  This mentality is not what durable bottoms are made of.  

Lastly, let's take a big picture look at the call/put ratio, or the ISEE index of opening calls to opening puts ratio.  This shows that we are at a historically elevated ratio for the index, still showing lots of call speculation.  

The long term fund flow and positioning data are all negative for the SPX.  In the short term, you can get counter-trend moves that get bulls excited again thinking the worst is over.  But the long term factors such as valuations, positioning, and speculative activity are all showing that we are in the early innings of this downtrend, not the late innings.  

I haven't even gotten into the fundamentals of the market, which are on shaky ground with Trump's infatuation with tariffs, and animosity towards trade with China.  China has the upper hand in this trade war, as Trump's pain threshold is much lower than Xi's.  Wall St. is already breathing down Trump's neck, along with his group of trade hawks in Navarro and Lutnick.  Wait till Main St. gets upset when the effects of the tariffs really hit home, and prices for imported Chinese goods skyrocket and/or are just unavailable due to lack of inventories.  

These tariffs will be so painful for the US economy that they won't ever gain traction, and Trump will backtrack quickly, or be forced to give up his tariff powers as Congress takes away his keys to the tariff controls with a 2/3 vote if he remains intransigent.  

Covered the short last week, as I was wary of holding shorts over the long weekend.  Unfortunately, I covered too early as we are getting a big gap down this morning, along with the long end of the Treasury curve selling off hard.  This is a terrible market to be a long term long in US stocks.  I believe we will be chopping around in a range between SPX 5150 to 5450 for the rest of the month, so we are closer to the lower end of that range at the moment.  I may nibble on SPX longs if we get some further selling after the cash open.  Will not chase longs higher.   Eventually after the chop for the next 2 weeks or so, I expect another sharp move lower towards SPX 4800-4850 in May/June.  

From Trump Premium to Trump Discount

The US stock market is in transition.  From a raging bull market, to what is likely to be a raging bear market.   From a market that is pricing in a Trump premium, to one that is pricing in a Trump discount.  

The initial euphoria after the Trump election victory is a distant memory.   Hopes for big tax cuts, deregulation, and a repeat of the 2016 to 2020 up move in the stock market was consensus.  It was perhaps the most bullish I've seen investors on US stocks since early 2000.  It doesn't take much to push investors towards a less optimistic view when they are that bulled up.  This time, it wasn't just a small little catalyst, but a big bomb going off with the Liberation Day tariff announcement.  

It was commonly viewed that tariffs were just used as a negotiating tactic to make better trade deals with foreign countries.  But it underestimates the desire for Trump to have the US go back to the old days, where it was one of the manufacturing hubs of the world, with a smaller trade deficit, and when high paying factory jobs were commonplace.  Of course, for those with any kind of insight into the world of manufacturing and production, the US just can't be cost competitive with China unless it jacks up the tariffs several hundred percent, and thus raising prices on almost all goods by huge amounts.  That's just not going to happen.  The market would break far before it even got close to that situation.  And if the market breaks hard enough, next thing you know, Congress will be taking the keys from Trump and taking away his tariff powers.   

This past weekend, Trump caved to Apple and the mega cap tech companies that rely heavily on Chinese outsourcing.  It was Trump showing that he reached his pain threshold, and was feeling the heat.  It also gives China more leverage, as it shows that Trump is a caver, and while crazy, will back down if the stock and bond markets start panicking like they did last week.  Which forced Trump to both delay tariffs by 90 days, and then backtrack even further with more tariff exemptions.  

Of course, Trump didn't want to sound weak, so he tried to talk back his exemption, saying it wasn't an exemption, but a reclassification to another bucket of tariffs which are at a lower rate.  Howard Lutnick came out on the TV circuit to try to tamp down the enthusiasm, saying that tariff exemptions were temporary.  For those that know Lutnick, he is probably the biggest brown noser in the business.  What he's saying is what Trump wants to hear, and what Trump believes.  The stock market doesn't want to believe in that reality, instead hoping that Trump fires Lutnick and Navarro, so the stock market can go higher.  Trump is far closer to Lutnick's view than Bessent's view.  While the market seems to love Scott Bessent, as he tries to placate the market  every chance he gets, its not what Trump's really thinking.  Trump wants tariffs, and wants to keep using the threat of tariffs to exert his Presidential powers.  That's not going away.  

With the gap up today, investors are assuming that Trump has showed his hand, and his mettle, and its a weak hand.   He's clearly not willing to stand up to the stock and bond markets to push his trade agenda when they are having a tantrum.  As much as he wants to reduce trade deficits and bring back manufacturing jobs to the US, he doesn't want to experience the pain and pressure of being responsible for a big decline in stocks, with growing anger from his corporate base.  

While Trump caving means that markets are less worried about big tariffs, he's stubborn and so obsessed with being at the center of the action, that I expect another tariff tantrum just so he can be the center of attention again.  He enjoys being both the arsonist and the firefighter who puts out the fires that he starts.  

Last week's panic move lower, and subsequent huge rally higher on the 90 day tariff delay was a classic waterfall decline, followed by the strong reflexive bounce.  You saw similar action in August 2011 and August 2015.  The current situation is worse than both.  Not only are investors more complacent than back then, they are also much more heavily exposed to equities, making it likely that last week's move lower was a prelude to a new bear market, rather than the starting point for a re-newed bull market.   

The COT data released Friday showed a significant, but not overwhelmingly big reduction in asset manager long positions in SPX.  If you zoom out on a 5 year time frame, the current asset manager net positions in SPX is still on the high side, but no long extreme.  It is still way higher than most of 2022 and 2023.  

SPX Asset Manager Net Position

The commercial net position is still relative neutral, despite the big selloff, and way off the highs that you saw from mid 2022 to late 2023.  

SPX Commercial Net Position

Last week, you saw the stock guys on CNBC start talking about bonds.  They only talk about bonds when something bad is happening in that market.  Once again, we witnessed long term Treasuries fail to provide a hedge to equity market weakness.  Its now the 3rd time in a row, the first in 2022, the second in late 2023, and now where Treasuries sold off hard as equities sold off hard.  Instead of acting as a hedge, long term Treasuries have acted as piece that adds more downside volatility in the portfolio in times of stress.  The golden days of Treasuries providing a positive yielding hedge to equities are long gone.  That's bad news for financial asset investors that could use the diversifying benefits of a negative correlating asset that provides positive returns like bonds did from 1981 to 2020.  That era appears to be over, as we now live in an era of fiscal dominance.  

I believe that for the rest of the year, you will be transitioning to pricing in a Trump discount, a much bigger one than what happened post Liberation Day.  Trump has only a few cards that he can play when trying to push around the stock market.  Its either big tax cuts or big tariffs.  Despite him caving on tariffs over the past few days, he won't want to give up on that card, not when it gives him so much power.  And he loves being the center of the chaos, where he seemingly controls the outcome.  Its a power trip for him.  He's not going to give that up in order to placate investors and CEOs. 

Anecdotally, I still see a lot of investors eager to try to catch the rebound, expecting a continued rally when tariffs are out of the headlines.  You have seen a huge amount of retail dip buying this year, and  that has continued into the waterfall decline.  With the Fed unwilling to bail out Trump on his tariff mess, and with big tax cuts and deregulation a more distant and uncertain catalyst, there doesn't seem to be the fundamental backdrop for a sustained uptrend.  We will see bounces and big bear market rallies, but the damage has been done.  Its looking more like the fall/winter of 2000, the spring of 2022.  The beginning of a bear market.  

I entered a starter short position after the 90 day tariff announcement rally, and remain short.  I am looking to play for a 2/3 retrace of this rebound off the panic lows, expecting more volatile chop in the coming weeks.  Not looking to put on any big positions in this volatile market, especially on the long side.  Playing small ball until I see a fatter pitch.  I do think you will get a magnificent shorting opportunity sometime this summer.  Until then, looking to just stay in the game, and trying to hit singles.   

Crashing

It is full blown panic out there.  VIX will likely open in the 50s.  The market is starting to price in a global recession as the tariff fears take over.  This level of panic is almost as bad as Covid in March 2020, and worse than you saw in August 2015 or August 2011.  You can even bring up October 1987 now that you are getting another vicious Monday premarket gap down.  This a rare situation with only a few precedents.  When you are getting global margin calls with investors overextended in US equities, you cannot rule out even further panic from here.  

If you are long stocks, the main priority is to manage risk and survive the storm.  You will have plenty of opportunities to make back these losses if you can just avoid blowing up.  Blowing up here takes you out of the game when the opportunities are the greatest.  Even if its makes the road to recovery longer and more tedious, you have to trade smaller.  Its not about being a hero anymore.  Its about survival and living to fight another day.  

After a waterfall decline since the Trump tariff announcement, you've gone from nearly 5700 on SPX down to 4800 at the lows in overnight SPX futures in less than 3 trading days!  That's a 15% move!  That is already off a move from 6150 to 5700 over the previous month.  From February highs to the Sunday overnight lows, it has been a 22% down move.  A bear market already in less than 2 months.  This is almost as fast as the Covid drop in 2020, and Black Monday in 1987.  You also had nearly as severe and fast a drop in August 2011, during the European sovereign debt crisis.  This time, bigger picture, this is a more bearish longer term situation.  

In 1987, you had a nearly parabolic SPX rally from the start of the year, so the markets were quite overbought by October.  For mostly technical reasons, and probably because the market needed to consolidate those huge gains, without any ground breaking news, the market crashed in October.  Up till 1987, you had a steady bull market, but nothing that had the kind of overwhelming investor interest or the high equity exposure that you saw in 2000, or even early 2020.  So post crash, the bottom was basically in, but the bounce was relatively weak considering the huge drop.  You only had a 1/3 retrace of the big move lower in the ensuing bounce.  You also had a retest of the lows about 50 days later, which was successful and the uptrend continued.  

In 2011, you had the SPX recovering from the 2010 correction, which was quite deep, and the markets were not very overbought when you started getting market jitters about European sovereign bond yields, in particular, the PIIGS, Portugal, Italy, Ireland, Greece, and Spain.  It came to a head in August as the market completely panicked and fell 15% in less than 2 weeks.  You didn't get an immediate recovery, but had a super choppy range bound trade from the next 2 months, culminating in a bottom in October, which set up a huge rally that lasted 6 months.  

In 2020, the markets were in a steady uptrend after the deep correction in late 2018, as Powell started cutting rates and the markets got more and more bullish on the global economy going into 2020.  The markets were not very overextended, so the Covid crash proved to be a lasting bottom, a generational buying opportunity given the overwhelming Fed and the government response to the pandemic.  2025 is nothing like this.  So I would not expect anything close to this kind of recovery off the crash.  

With these 3 precedents, one would expect there to be a strong bounce once this crash stops.  The question is when the crash stops. Its probably going to happen sometime within the next 36 hours, but a lot of damage is possible during that time.  You can't try to pick bottoms here.  You have to put on positions that can withstand an adverse move and still be left standing.  That's the only way to trade this market.  Using calls to play for a bounce is very risky, and you may not get rewarded after the bounce, considering the sky high options prices, both calls and puts.  Options are overpriced here, and I wouldn't buy calls or puts at these ridiculous levels.  

Usually I will look at the put/call ratios and the COT data to get an idea of how positioning has changed, but the COT data is only as of last Tuesday, which doesn't include the waterfall declines of Thursday and Friday.  Next Friday's COT release will be much more informative to see how dealers, asset managers, and small speculators reacted to the carnage.  We did see huge volumes as expected in puts and calls last Thursday and Friday, but that doesn't tell you much.  The put/call ratios spiked higher, which is expected for big down days.  

Stuck with a small but deeply underwater SPX long.  Just holding on and will look to sell on a bounce and try to play the chop over the coming weeks.  I am looking for the bottom of the new post crash range to be defined in the next 36 hours, and the top of the range to be defined 1-2 weeks from now.  Post crash, you can't expect any persistent trends because the fundamentals and valuations aren't supportive of a sustained rally from here.  There is no Fed coming in with a big bazooka like 2020, or even 2011.  The market will be whiplashed by tariff headlines, which won't lead to sustained moves from here, as there is now a Trump discount in the equity market, which will take a long time to eliminate.  Trump has clearly showed he doesn't care about the stock market, so investors will be less willing to pay up for US stocks.  US exceptionalism is officially over.