To BTFD or Not to BTFD

The market is in a topping process.  During the topping process, the increase in volatility while chopping is a sign of an imminent trend change.  We are almost at that point.  All the cockroaches are coming out.  The biggest one, China, will remain for the year.  Just as Europe was a monkey on the market's back for 2010 and 2011, China will be that monkey.  It will weigh down on markets if they get too exuberant.  I expect China to crash this year.

Then there are the unknown cockroaches that are brought out of nowhere, like the devaluation of Argentina peso.  And of course, the lack of earnings growth which is in the background, only brought into the forefront when investors get bearish.

When they start bringing out weird and new cockroaches, usually that is a sign of trend exhaustion, but we've only started this downleg yesterday!  So that confuses me, the market seems a bit nervous over a one day decline.  And now that we have the big gap down, we should see the end of this decline today.  Question is, do you BTFD at the open, or at the close?  I am not sure, but I know I still want to BTFD, until proven that it doesn't work.  I have my fingers ready over the buy button, we should bounce by next Monday.

So yes, BTFD today.

Treasuries and Bunds Diverge

The 10 year German Bund bonds have been much stronger than the 10 year Treasury bonds over the past 3 months.  The outperformance of the Bunds is unusual.  They usually trade together at a high correlation.  Even with tapering supposedly priced in, the divergence continues.

The market is sensing that the ECB is about to pull its final card, which is QE.  The most deflationary part of the world is in Europe.  And with interest rates at 0.25%, the only option is to QE, although supposedly it is against their charter.  If Draghi wants to QE, he will find a way around the rules and do it, like LTRO.  

With the relative weakness of Treasuries to European sovereigns, and Jon Hilsengrath squawking that Fed likely will continue taper despite the weak nonfarm number, there should be one last push higher in yields, sometime in February or March.  I expect another run towards 3-3.10% in the 10 year Treasuries.  That should coincide with a top in the US stock market and would be a good time to get long Treasuries, short ES, or short the USDJPY.

10 Year Treasuries

10 Year Bunds

Where the Action Is

If you are a futures trader, or, an FX trader, there is not much out there.  With low volatility, moves take longer.  The holding periods need to be extended to reach the same profit objectives.  That exposes a trader to more risk, as longer holding periods = more variance.

Commodities are in a bear market.  Unlike the equities market, a bear market in commodities brings much less volatility, not more.  Just as equity bull markets are dull and filled with slow steady uptrends with quick and sharp down moves, commodity bear markets are dull and filled with slow and steady downtrends with quick and sharp up moves.  So the worst possible market for futures traders is an equity bull market with a commodities bear market.

The action is in individual stocks.  In particular, biotech stocks.  The move is not driven by any individual fundamentals, but a sector shift to biotech, where an aging demographic worldwide is a positive.  The mania in the daytrader community now is to find the next ICPT, a stock that goes up 400% in two days.  The greed for highly speculative, and mostly suspect biotechs is reaching a level where you can start establishing long term shorts at these levels and sit on them.  Not one, but a basket of speculative, junky names that will eventually go much lower, regardless of what the stock market does.

The only problem is being able to find a borrow on many of these small cap names.  If you can borrow these stocks that pop on insignificant press releases and data points, and just sit on them, like reverse investments, you short and hold, waiting for the weight of the fundamentals to bear on the stock, as the rats jump ship.  I already have a huge boatload of names right now, its just a matter of which ones are the worst.  Just look at the YTD percentage gainers list, at least 1/4 is a speculative pump and dump play.

Reaction to Selloffs

You can glean valuable information on the strength of a market by how it reacts to a one day selloff.  The strong markets, like the S&P will shrug it off and use the down day as a spring board to higher prices.  That is exactly what happened.  You didn't even get a gap fill on Tuesday, and today we hit all time highs.  Despite the high bullish sentiment, you can see markets continue to make new highs.  It happened in March and April of 2010, and also January to May 2011.

Of course, the higher this market goes, the more potential downside builds.  At the earliest, I don't see a top till early February.  At the latest, mid March.  That being said, I only see upside of about 30 S&P points, or up to S&P 1875.  And downside much greater, down to 1750.  So still in waiting mode.

Whacks Out of the Blue

Well, that certaintly wasn't expected.  I've been saying that with high bullish sentiment, it doesn't increase the odds of a down day, just the magnitude and speed of a down day.  We got that initial strength off the gap down on Monday and plunged with vigor that we haven't seen since early December.  Of course, we get the gap up from the dip buyers eager to buy any dip but the dip doesn't tempt me to buy.  Sure we could go right back up, I never underestimate the strongest market in the world.  But have no confidence being bullish in this market.

I am leaning bearish, but want to express that through either a short USDJPY position or short Nikkei/Hang Seng.  At least in those other markets, when you short, you don't have to fight the stock buybacks.

The Invisible Hand Overnight

7 points is not chump change in the ES these days.  To see that happen overnight has meaning.  And there is an eerie tendency for these creep up moves higher when markets are quiet before an event.  Maybe one of the most understudied and useful phenomena in trading.  The trading before a big event is driven by strong factors that are often predictable.  These creep up moves higher are driven not by a desire to get long ahead of an event, but by the absence of sellers.

By the way, leaning bearish on the market, otherwise, I would have gotten long yesterday afternoon to sell at 8:29 AM ET today.  Also think the number disappoints, solely due to numbers being bumped higher and high expectations, rather than any particular insight.

Making a Bearish Bet

There are a few different ways to take a bearish position on the stock market.  The most direct way is to short the S&P 500.  I don't want to do this.  The next best thing is to short an international equity market.  This is a good idea, especially when you can choose one that is continuously weaker than the S&P.  China is a prime example of this.
Then you can go short something like the USDJPY which trades with a high correlation to the equity market.  This is also another good idea, and one that I prefer over shorting the S&P.

Then another option is to go long Treasuries.  This is something I like to do when I can avoid big economic reports, but the nonfarm payrolls cause huge moves to the Treasury market, so it is something I prefer to bet on when there is no jobs report or Fed meeting on the horizon.  The last option, the one with a moderate level of correlation, is to short commodities, in particular, crude oil.  But crude oil has already dumped huge from the top and I see limited downside near term.  

Right now, if I were to make a bet on the downside for the US equity market, I would choose in order of preference, 1. short USDJPY 2. short China 3. long Treasuries 4. short crude oil 5. short S&P 500

Very resilient market, volatility is very low, I see no big down move until we start seeing more intraday volatility.  Waiting on that bear suit, getting it pressed and dry cleaned at the moment.

Bear Suit Ready

2014 is the year to start being more aggressive on the bear side.  I held off in 2013 because of the tremendous momentum, and we still have that going for this market.  But now, the overvalued levels and complacency are obvious.  The bullish sentiment is extremely high.

Tops are a process, while bottoms are usually short, quick events.  So I am sure that we'll be chopping back and forth around these price levels, but the sign that I am looking for is more extreme dips and rallies.  In other words, more day to day volatility than what I have seen so far.  I want to see the chop like 2000, 2007.  We haven't seen that chop yet, so I can't be too aggressive.  I expect to see some of that chop soon.

I am looking for opportunities now to get long bonds and short stocks when we have those 3 day rallies off a quick pullback.  That was something that I was unwilling to do in 2013.  Now stocks are sufficiently overvalued to where I am more comfortable going short and staying short.

For today, I am bearish and expect a close near the lows of the day.

The Higher They Go

The rubber band is stretching.  The valuations are reaching nosebleed levels.  The higher they go, the harder the fall.  The tailwind of lower interest rates has been exhausted.  Increasing budget deficits to fuel economic growth is not politically possible anymore.  Where are the corporate profits going to come from?  We are already seeing S&P 500 profit growth slow to low single digits, with Q4 estimates going down.  There is no catalyst.  Asset price rises have minimal effects on consumer spending behavior, otherwise, you would see retail sales up huge with the surging S&P.

For the developed world, the demographic dividend of a growing population of middle aged, economically active consumers aged 25 to 50 has flatlined.  Look at the table below for the U.S. population, rising from 2000 to 2010, overall, but the 25 to 44 year population growth is negative.  Those over 50 are growing rapidly, but they spend much less money than their younger peers.  The age 25 to 50 population was growing rapidly for most of the past half century, providing an upward drift to the global economy.

Sex & Age Group

2000 Population

2000 Percent

2010 Population

2010 Percent

2000-10 Change

2000-10 %Change

25 to 44 years	85,040,251	30.2	82,134,554	26.6	-2,905,697	-3.4
45 to 64 years	61,952,636	22.0	81,489,445	26.4	19,536,809	31.5

The situation is even more dire in Europe, and is in a crisis state in Japan.  That is why Abenomics will fail, because the domestic demand is not there, due to an aging population, and exports do not increase enough to make up for it even with a weak yen.  The Nikkei is in a much more precarious state than the S&P 500.  It has the most potential for a nasty unwinding as there is the double whammy of the long USDJPY trade unwind as the global economy weakens.  Remember, USDJPY was at 120 back in the 2000s because the carry was enormous when Fed funds rates were at 5% and Japanese short term rates were at 0.25%.  There is no carry to holding USDJPY long, it is just hope that JPY weakens more than USD.

The emerging markets are not the answer, they already offer up enough exports for the developed world's now flatlining needs.  So the emerging markets only answer is to grow domestically, to increase consumption, but that happens on the back of better wages, but you only get better real wages if you add more value, otherwise it is just inflation.  Or if you get better wages and don't add value, that just kills corporate profitability.  And the key for the emerging markets, China, is no longer able to grow without unsustainable rates of credit growth, something that new Chinese leaders are finally realizing.

According to Soros's theory of reflexivity, market participants have a bias that affects market prices, and vice versa.  The bias gets reinforced as the trend continues, until the bias is questioned, and then proven false, as the weight of the fundamentals comes to bear on the marketplace.  Right now, the bias is the omnipotence of central banks for providing high returns for equities.   This bias is in an advanced stage, with QE in the US in its 5th year, ECB LTROs used, and Japan trying to massively devalue their way to prosperity.  The fundamentals for equities are dreary, but this has been overshadowed by the current market bias and strong price action.  But with the valuation extremes and overall bullish positioning of the investor community, I see very limited upside, and lots of downside.

Central banks wield the most power in the bond market, not in the stock market.  With limited upside in bonds, traders are chasing stocks.  But I view it in a different way.  Without strong global economic fundamentals, I see limited downside in bonds because tapering will stop, and then eventually lead to increases in asset purchases at the first sign of weakness.

The perception has overwhelmed reality.  2014 will be the year when investors question their bias of buying equities because of central bank support.  This should lead to choppy markets, with risk for a big drop in the 2nd half of the year.

Ignoring Bond Yields

The market is in the see no evil stage.  We have 10 Year Treasury yields at 3%, extreme bullish sentiment, low put-call ratios, and the Santa rally.  What could go wrong?  And January is a bullish month, so they are just buying 'em here.  I can't follow the crowd so easily.  It makes me nervous getting long these markets, more than going short.  I don't want to be short here either, but I will look to short this bloated market when we get to January, given that we don't go down much for the next 3 trading days.

TWTR looks so overextended, and toppy now, it reminds me a bit of TSLA in May, but I don't see the same upside for TWTR.  First of all, TWTR has a much bigger market cap that TSLA.  Second, TWTR will also have a lockup expiring in the coming months which will provide plenty of supply to dampen the price rises.  TSLA didn't have that.  I can easily see TWTR getting greedy and doing a secondary while there stock is sky high and further adding to the supply.  Social media stocks are a bubble, and you have to treat them as bubble stocks.  Fundamentals eventually will matter, but it is more about supply and demand right now.  

Balloon Gets Bigger

It is a game of chicken now, dare to short a freight train?  With the big news from the Fed out of the way, the investors will be piling in, and we have gotten a monster relief rally and pretty big gap up.  I see the low put/call ratios, the high levels of bullish sentiment, and  overbought conditions, but I don't like to short around Christmas.  It usually doesn't go down this time of year.  I will revisit the short side with more conviction in the early parts of January.  Right now, there is little incentive for longs to sell, when they can wait till January and avoid capital gains that they have for 2013.

It will be a slow time for this market, not much to do, but wait for January.

Bond Long Squeeze

The 10 year yields are squeezing higher this morning, and it will be a huge headwind for the stock market.  Yesterday was fast money traders looking to catch any rally, and shorts being squeezed intraday by the HFTs and eager beaver longs.  There will be payback for a senseless rally in the coming days and weeks.

Taper is huge news, no matter how much the bulls shrug it off as being inconsequential.  The Fed dovish talk doesn't matter, what matters is that they are actually reducing bond purchases, the lifeblood of this market.

With the taper now starting to roll, I am extremely bearish on this market.  This is a huge fundamental change, and no, it was not priced in because most were expecting a taper to start in January or March, depending on the data.  Fed has said the data is strong enough to taper.  That is a game changer and we will feel the selling pressure in January.

Lots of Fed Hope

It is puzzling to me how there is so much talk of taper, yet, hardly anyone expects the taper to happen at this meeting.  The consensus got throttled with the Fed no taper announcement on September, in particular, the ES and Treasury bond shorts.  So I am betting that there are almost no fast money shorts going into this meeting, in ES or ZN / ZB.  Fool me once, shame on you, fool me twice, shame on me.

Well, everyone is not going to be fooled this time, so the vast majority expect no taper, and I am one of that majority.  However, I don't expect much of a pop in stocks on that news, because it is pretty much consensus.  In fact, I expect a small pop, and a vigorous selloff going all the way into triple witching Friday.  So I would be a seller on any pop that comes right after the no taper announcement.  I don't expect any pops on the no taper news to last for more than an hour.

As I have said before, the Fed has always acted more dovish than consensus.  They sometimes talk tough, but they NEVER act tough without a 100% telegraph of that tough action.

Strange Overnight Price Action

Seemingly a huge stop order got triggered in the overnight session and we were down more than 10 handles at one point, but amazingly, we gapped up big and are running even higher.  These are not normal moves, hard to explain, other than everyone wants to get long ahead of the No Fed Taper rally.  Feels like most are not expecting any taper, and at the same time, expect a rally off that news.  The market has not priced in anything close to a taper in December, so if we don't get tapering, I really don't see a rally lasting at all.

Today is a head scratcher, I think we will be higher tomorrow, so I am just watching and waiting for a buying opportunity which probably won't come today.

Study TWTR's Price Action

If you want a lesson in trading super charged, momentum bubble stocks, print out the 30 minute chart for the past two weeks in TWTR and put it away for future reference.  This is eerily similar to the May price action in TSLA, just without the catalyst.  No catalyst, and you get a move of 40 to 59 in two weeks for a $20+ billion market cap company.  That doesn't happen often.  It reminds me of the dotcom boom, except without the satellite plays that fueled so many other tertiary names.  This is just TWTR going solo, leaving behind the rest of the momos in the dust.

The takeaway from the May surge in TSLA and the December surge in TWTR is that in order to fuel a huge move higher, you need a small float, large and vociferous short interest (probably most important!), a popular product, and huge growth potential.  Mix it all up and you get a formula for an explosive move higher.