Interesting comparison charts for the SPX (blue) with China H-Shares Index (black):
Similar pattern seen with the Eurostoxx 50 over the last 2 years: SPX (blue), Eurostoxx (black)
Notice SPX going higher in July to October 2018 while both H-Shares and Eurostoxx traded sideways. Then the SPX crash from October to December 2018.
Seeing similar pattern of SPX rallying while both H-Shares and Eurostoxx trade sideways since early June. Another repeat of the pattern would lead to an SPX crash this fall.
This is an unsustainable trend of SPX outperformance vs the world. It has been going on since 2010. It reminds me of emerging markets outperformance vs SPX from January 2006 to August 2008. There is a nasty SPX bear market looming.
These are unusual times for the stock and bond market. The correlation between stocks and bonds has been extremely high for 2019. It is especially pronounced on FOMC meeting days, when Powell was more dovish than expected (January, March, and June meetings), and when Powell was more hawkish than expected (May meeting). Stocks and bonds rallied strongly in the dovish meetings, and sold off hard in the hawkish meeting.
Every time Powell has come out dovish, stock and bonds have screamed higher, the latest case being the Humphrey Hawkins testimony last Wednesday, July 10. The times when bonds have been weaker, which is few and far between this year, it led to a quick equity market selloff almost immediately (early May, this past Tuesday). Yesterday afternoon you had a dovish double barrel from Williams and Clarida which rocketed bonds higher which of course caused stocks to squeeze higher along with it.
It is now seered into the brains of equity traders that a dovish Fed is a buy signal. But this is not a sustainable pattern, because as I mentioned before, the low rates fuel which has been driving stocks higher is mostly used up. The stock market is going higher under the premise that the US economy is not weak, and therefore the Fed rate cuts are insurance cuts, which will ensure a longer expansion and continued earnings growth. Thus, any dovish words from Fed officials is taken as a positive for both stocks and bonds. The assumption is that the Fed rate cuts are a bonus for an economy that doesn't really need them, just added rocket fuel for the SPX.
I disagree with the assumption. Not because I am a permabear. I am looking at the leading indicators and they are all flashing red. That is despite a face ripper of rally over the past 6 months. Usually the leading indicators follow the stock market, as there is wealth effect from higher stock prices, as well as higher bond prices. But despite both stocks and bonds up huge this year, the US leading indicators are SURPRISINGLY weak.
In fact, the leading indicators are hovering near the lowest levels since 2010, despite a booming stock market.
The relative strength in utilities and consumer staples, and the relative weakness in financials and energy are flashing amber lights.
Next year, you have the uncertainty that comes from the 2020 Presidential election, where the possibility of a non-Biden Democratic president becomes a palpable threat to the status quo of corporate welfare. The short side is looking very appealing right now, and what better time than when most stock traders expect the Fed to save the market, when the insurance cuts are already priced into the market. In order for the Eurodollars and Fed funds futures market to price in more cuts, there has to be real stock market weakness, not just 3-5% pullbacks. I am talking at least 10% corrections. So I don't see anymore bonds up, stocks up action for the rest of the year. The correlations for stocks and bonds will become negative, as weak economic data is no longer treated as good news. Bad will be bad again soon.
We have now reached the "death zone", above 26,000 feet, where the air is too thin for long term survival. An area where trivial tweets can cause out of the blue selloffs. Yesterday, it was another maybe? tariff threat tweet from Trump. When the oxygen levels are this low, the body collapses under the weight of even the most insignificant bit of news.
After a 4 week pullback, the SPX bottomed on June 3, which was 6 weeks ago. That is in the general 5-6 week time frame where rallies end and stall out. Another ominous sign is the psychological break of the 3000 level, which pulls in more bulls to fall into the trap door lower.
The biggest negative for the current stock market is the recent weakness in bonds despite a super dovish Powell last Wednesday. Yes, the invincible bond market is finally showing signs of weakness as the recent economic data has beaten expectations. It is not hard to guess why recent economic data is coming in stronger. When you have simultaneous face ripping rallies in stocks and bonds for 6 months, the wealth effect is going to be double what it normally is. That is finally seeping into the data.
As I have stated before, the economy is in a zombie-like steady state of low growth, the only thing that changes in this new economy are financial markets, so they are the only thing that matters. Employment numbers, inflation, retail sales, etc. are not barometers for the new economy. The new economy is the S&P 500 and bond yields. The higher the S&P 500, the better, and the lower the bond yields, the better.
There is no more dynamism in the economy. The central banks have printed there way to a steady state condition, where the lack of meaningful down cycles mean that there is not enough pent up demand for big up cycles. So the economy flat lines, with central banks feeding it more and more drugs to keep the dying patient alive.
We are getting closer to the end game for this bull market, as the drugged up economy can't generate more growth unless you get even more massive deficit spending (1 trillion is not enough) and even lower rates (2.1% 10 year is not low enough). On the fiscal side, there is not likely to be a fiscal stimulus until at least 2021, when we find out who the next President is, and betting markets are giving higher odds on it being a Democrat. As for even lower rates, I don't see the 10 year yield going significantly lower unless you see an earnings recession, which means that stocks are going to be in trouble anyway despite lower rates.
While I would like to see more optimism among the investment community to make it a slam dunk short at current levels, there are enough negative factors to overwhelmingly support the short side here. Macro hedge funds have more long equity exposure than average which is always a good sign that there is almost no upside left.
A few more days of slow trading will be enough to convince me to enter a short position. I have waited longer than usual just because of the strength in bonds, and that now seems to be ending. So I have my trigger finger on the sell button. I plan on entering a short before the July 31 FOMC meeting, which will probably be 25 bps and be disappointing for both stock and bond markets.
In 2018, Powell bought into the strong economy story and raised rates 4 times while continuing the balance sheet runoff. In 2019, Powell is buying into the economic slowdown story and will do rate cuts, coming up with any lame excuse he can find from the pile of BS reasons used for QE/rate cuts in the past.
Their favorite excuse is low inflation, forgetting the fact that most of the government inflation measures are butchered beyond recognition to print out a steady stream of low numbers.
In June, Powell came up with a new one: sustain the expansion. But lowering interest rates from 2.25% to 1.5% doesn't really move the needle. If he really wanted to sustain the expansion and be a leader, not a market slave, he would go straight to 0% Fed funds rate and jolt the economy for a few months. Cutting 75 bps as the market already expects isn't going to do the job, it will probably end up disappointing the stock market which is full of excitement and anticipation waiting for rate cut goodies.
Going to 0% will sustain the expansion, maybe for another 6-9 months, until the 2020 election gets closer, at which point the threat of an anti-corporate welfare President starts worrying corporations and thus, the stock market, and therefore the economy.
Powell has clearly shown that he is a slave to the bond market, more than the stock market. When the bond market was pricing in 3 more rate cuts in October 2018, he was still hawkish and only made a dovish pivot when both the stock and bond markets dropped a sledge hammer on his head to rethink his view.
Don't expect Powell to surprise on the hawkish side anytime soon. Fed chairmen are always looking in the rear view mirror when determining monetary policy. December 2018, and to a lesser extent May 2019, are firmly branded into Powell's skull. Those memories aren't going to fade away for a while, which means that rate cuts will be happening in July and September, and probably also October if the stock market doesn't make new highs.
Powell is a follower. Bernanke was a follower at first, and became a leader, a horrible leader, but a leader nonetheless. He regularly surprised markets on the dovish side, leading them to forecast continuous low rates, because he saw another Great Depression around every corner, because he was afraid of the deflation boogeyman that didn't exist, and because he's a coward who took the easy way out by pumping up the stock and bond markets, thus pulling forward demand, ensuring a lackluster economy for decades after his tenure was over.
You trade what is, not what you want. It would make for great trading to see a Fed that defies the markets by not giving them the rate cuts that they want, causing occasional plunges lower, to keep speculators at bay. Now its a Fed that just rolls over to whatever the market demands. The financial markets hold a gun to Powell's head, and he's scared shitless. Of course he's going to take the easy way out, and give in.
Let's not call it monetary policy anymore. Its a drugging. 100% Pure Adrenaline! Bunds hit an all time record low in yields at -0.40%. Behind the velvet curtain, after a lot of horse trading between Germany and France, the next ECB president is Christine Lagarde, so basically a retread from another corrupt institution.
Germany figured the ECB is stuck at negative rates forever, so what was the point in putting their guy in there when he would be managing a monetary cemetery of opiate patients who died of overdoses.
As the SPX hits all time highs, the 10 year yield hits the lowest levels since fall of 2016. We have come full circle as the Fed has gone from an excruciatingly slow rate hike cycle to now being shoved in a corner by bond traders with a machine gun to their heads asking for 50 bps rate cuts ASAP.
This is how the patient, in critical condition, is being given massive doses of morphine, combined with uppers to keep them alert and awake, trying to force life into a dying patient. And it is working for now, as the SPX is at an all time high, even without a trade deal, just a can kick and delay of further tariffs. All that matters is that the bond market goes up, and that is enough to make stocks happy.
The last 2 years have told us one thing: monetary policy is the biggest game in town. The trade war is Division 3 college basketball. Monetary policy is the NBA Finals. Yes, it is much more exciting to talk about the trade war and look at what this politician says, and what that politician says. In the end, they are all nonfactors compared to printing presses at the ECB, Fed, and all the other central banks in the world. This is a money game. The central bankers have full control now, and they aren't going to give up their power easily. Only an eventual realization of the mess and a total riot from the masses can change the course of monetary history. Which means it won't be changed. The masses are idiots. They got what they deserved. NIRP forever in Europe, NIRP lite/ETF buyer forever in Japan, and a Fed that will soon follow course.
This is the reality of the current market. If bonds don't go down, then stocks can't either. Bonds are a huge part of investors' portfolios. If it acts like a super hedge like this year, there is no impetus to sell stocks. Just hold stocks, and hold bonds. That is what is happening among fund managers. These are the toughest markets to crack for the bears. Until I see some bond weakness, I dare not enter short stocks. Because investors are in a very strong position. Everything is working for them. Even long term worthless bitcoin has been going much higher this year.
These are nosebleed SPX levels, and the economy is weakening, but bond strength covers for all those flaws. Easily.
The 2 biggest factors for corporate earnings are economic growth and ........ interest rates. Most investors focus on economic growth and usually don't pay much attention to interest rates, because it works more subtly and with a lag. Also historically, economic growth was more volatile than interest rates, making it a much more important factor in determining stock prices.
However, since 2008, economic growth has been stable, but low. The business cycle has become the business flat line. Economic growth used to be a variable. Now it is basically a constant. That is what happens when you have a battle between downward forces of demographics/lack of productivity growth versus upward forces to growth from big tax cuts and deficit spending and a hyper proactive Fed looking to rescue financial markets with a firehose of liquidity at the slightest hint of a slowdown.
Since 2008, other than Fed funds rates, the yield 5+ years out have been erratic. In 2009, with ZIRP, the 10 year yield was as high as 3.90%. In 2012, with the same ZIRP, the 10 year yield went downt to 1.40%. And then up as high as 3.00% in 2013. And then back down to 1.32% in 2016. All while Fed funds rate was below 50 bps.
It is no longer economic growth that is most important factor determining stock prices. It is corporate welfare/regulatory capture and interest rates that are the biggest drivers. The 2 biggest catalysts for stocks in the last 10 years has been QEs and tax cuts. Those aren't organic growth factors. They are policy driven factors that have diminishing returns and limitations. The Fed cannot buy up all the Treasuries and MBS issued. Nor can the tax rate go to zero.
With trillion dollar deficits happening during the peak of an expansion, that tells you all that you need to know about the long term sustainability of current tax rates. This huge deficit, which puts an upward pressure on interest rates, has to be countered with loose monetary policy to maintain the expansion. Basically, the US will have to follow Japan and monetize its debt to keep growth where it wants it to be.
The bond market is sensing that the long term sustainable interest rate is much lower than current Fed funds rate given the weakening leading indicators, and the change in Powell's reaction function towards financial markets, specifically, the SPX. Jerome Powell is now in Bazooka Ben mode. If stocks goes up, talk dovish. If stocks stays flat or go down, act dovish, i.e., cut or do QE.
The declining Treasury yields in May due to the above mentioned factors was the fuel that the stock market needed to come back this month, once the weak hands sold. But a lot of this fuel has been used up, as the 10 year is nearing 2%.
In other words, stocks currently need the 10 year yield at 2.15% to maintain SPX 2880. Previously in the fall of 2018, stocks could maintain SPX 2880 with a 10 year yield above 3.00%. It is taking lower and lower interest rates to maintain current stock valuations. This can't go on forever. The stock market is the gas guzzling Land Rover. Lower interest rates are the fuel. If the Fed doesn't deliver with easy money soon, the stock market will have a panic attack. Just like December 2018. I do expect Jerome Powell to deliver the goods, giving the market what it wants, having learned his lesson in December about fighting dovish market expectations. But he's a bit less predictable than Bernanke, so there is a slim chance he could trigger another rush to the exits for stock traders.
One thing is clear though. Whatever Powell does in June or July meetings, the financial markets now have him by the balls, at their mercy. He will have to be their slave, or else.
With all the negative news flow and deteriorating fundamentals, the main reason stocks didn't selloff more in May was because of risk parity. Bonds acted as a super hedge for stocks, earning yield and rallying huge, providing a downside buffer for stocks. Most investors own both fixed income and equities, so their whole portfolio determines their wealth, so their wealth didn't take much of a hit even with equities going down in May, because of the strong bond rally. And that means less nervousness, less forced selling, and a support for the stock market.
When you see bonds barely moving while stocks are getting hammered like October 2018, that sets up a carnage like you saw in December 2018. It is also why the stock market rally in the first 4 months of the year was so strong. Usually when stocks go up 20%, bonds are getting crushed, dampening some of the wealth effect. But not this year. Bonds have been strong, regardless of equity strength, providing a double boost for investors' portfolios.
The market is now pricing in 100 bps in rate cuts for the next 18 months. That seems priced about right, given the current economic situation and the Fed's historical tendency to panic when there is even a hint of a slowdown.
Unfortunately for the stock market, a lot of bond market rally fuel has been used up to helps stocks in the past month. Which means that even if the Fed cuts a few times in the next year, its not going to have much of a stimulative effect.
That makes it all the more attractive to put on a SPX short position on any kind of positive trade news. Because that would probably delay the Fed rate cuts, which are much more important for the market. So in an odd way, that would be more bearish for stocks. It could just be delays in China tariffs and the market will absolutely love it, giving it hope of a future trade deal.
At this point, the bar for China tariff delay is very low, the bar for a trade deal is very high, and would require the SPX to get to at least 2650 before it catches the attention of Trump and his administration, where they start lowering demands from China to get a deal.
China tariff delays are going to be the new China trade deal.
It is short squeeze mode, and it has been a face ripper. With the weak nonfarm payrolls report, that is a positive for stocks. It just means bond yields will stay low even if stocks go up. Great short term news for stocks.
Powell folded again. That shouldn't be much of a surprise to those who learn from experience and recent history. Those who learn by reading Bloomberg, WSJ, and CNBC, well, they were probably a bit surprised. A weaker SPX, a raging bond market, and the Fed will follow the markets, or else. And Powell isn't dumb enough to challenge the markets again, after his December experience.
Interest rate hikes work with lagged effects, as corporations gradually have to reissue debt and renew loans at higher yields. Since rate hikes happened over a 2 year span from 2017 to 2018, they will start having maximum effect this year. Add to that the fading fiscal stimulus from 2018, a US equity market that is probably in the top 5% in valuation in its history, and you have a powder keg that is about to blow up.
No, a move from SPX 2950 to 2730 is not blowing. I am talking a move down to 2100 over the next 18 months. I choose 18 months because that is how much time there is left till the next US Presidential election. If the economy weakens over the next year like most leading indicators are suggesting, that will put the nail in the coffin for Trump's chances at getting re-elected. Again, that is what history and experience suggests. The last 2 U.S. presidents that failed to get re-elected were Jimmy Carter in 1980 (bad economy) and George Bush Sr. in 1992 (coming out of a bad economy in 1991).
Trade deal or no trade deal, the US economy will follow Europe, Japan, and the emerging markets into slowdown. Today's ADP number is just another piece of evidence, after the weaker ISM and PMI numbers. The bond market has been sniffing this out for the past month, and has gone into overdrive in a bond short seller seek and destroy mission.
We are in one those rare, exquisite moments for an equity short seller where the risk/reward is absurdly good. With all the clues that the leading indicators, valuations, and the bond market are giving, it is a no brainer to short the Fed rate cut rally. And that is what yesterday was. A realization that Powell is more dovish than what his underlings have said over the past few weeks, many who have been in denial about the Fed having to cut rates.
The Fed is always reactive when entering the rate cut cycle, but with financial economy essentially the only dynamic part of the whole global economy, their lag times compared to past cycles (2000, 2007) will be less, and I fully expect Powell to either cut 25 bps in June meeting (if SPX is under 2750), or signal that a rate cut is coming very soon (if SPX is over 2800). Between 2750-2800, he could go either way.
In either case, that will provide the last sparks to an oversold short covering rally which started yesterday. If things go according to plan, that should set up a good long term shorting opportunity in early/mid July. May was just a small preview of things to come. September and October will be the main event.
Well, that was random. Trump pulled that one out of the rabbit's hat. With the limited cards that he can play without having to go to Congress, the good ole tariff card was pulled out.
Are we going back to the 1930s with the tariffs? No, because back then, trade protectionism was popular. Now, clearly, with the 15 minute attention span of the public, any negative reaction in the stock market makes it unpopular. Which means that these tariffs that are popping up left and right will either go away before November 2020, or we will have a Democratic president starting in 2021.
In either case, the tariffs will be removed. But here is the thing. The economy is going downhill over the next 2 years, regardless, tariffs or not. Tariffs will just give it that little extra push down the hill, so instead of going downhill at 55 mph, it will be 60 mph. The destination is the same, the speed at which it gets there will be slightly different.
There is a perfect storm brewing which has little to do with the trade war, and lot more to do with the fading fiscal stimulus, limited monetary easing ammunition, increasing equity supply from big IPOs, and business cycle that is ripe for a down leg. The Fed going from 2.25% to 0% will not be enough because that will probably only take the 10 year yield down to about 1.5%, which isn't going to be a game changer from the current 2.2%.
There is no natural demand. It will be up to governments to run huge budget deficits and have their central banks do full blown QEs to keep this ship afloat. It will happen of course, we've seen that movie before, but the Fed will probably wait until its too late before they go full blast with the liquidity.
The best potential opportunity for a trade is to get good news on the trade war, and have the market rally for a couple of weeks. At that point, you can set up a free fire zone on the short side.
It looks about as bad as it can get with the news flow. There is probably an oversold bounce coming next week.
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.
Yesterday, Trump started to feel some heat of the backlash against tariffs and he relented by delaying auto tariffs for 6 months. It is a preview of things to come with China. It has been my view that this 10 year old bull market will end with a whimper, on no news and no blowoff top. Ending with just classic chop at the top with a saturation of demand for risk assets leading to a lasting downtrend.
The trade war started by Trump at the height of the stock market in early 2018, was initiated with confidence and a belief that the US stock market was invincible, and could withstand tariffs on China. That ended up being true, because the SPX ended up making higher highs, and only was taken down by higher interest rates and hawkish talk from Powell.
The whole strategy of Trump is to threaten and then delay, delay, delay, and then threaten and delay, delay, delay. He wants to score political points by being tough on China, without the pain of a lower stock market from higher tariffs. So what would be his ideal strategy? Talk tough, threaten China, and then delay and delay to placate the stock market.
Right now, we are in the talk tough and threaten phase of this trade war game. The next phase will be to delay and act like there is progress by having talks with China to try to boost the stock market.
A clue to yesterday's comeback from another gap down open was not the headlines on auto tariff delays, but a super strong bond market which protected fund managers via risk parity. When bonds are falling, stocks are on their own, but when bonds are rising strongly, that is a wind at back of fund managers, as they have protection from their bond proxies and fixed income holdings.
That is contrary to the 5 minute macro analysts out there who think that a strong bond market signals a weaker economy, and thus a weaker stock market. It doesn't work like that anymore. This isn't the 1980s. With the business cycle all but killed by central banks, the economy is basically in a static state of low growth, so a strong bond market doesn't signal much, except that investors are making money on their bonds which provides them protection and makes them less likely to sell their stocks.
China is in no rush to make a trade deal. Their backtracking on making changes to Chinese law shouldn't be a surprise. It would have been a surprise if China gave up their legislative powers to the US just to get back to the status quo of no tariffs and free-for-all technology theft and piracy. China, unlike the US, is willing to blatantly intervene in their stock market to support consumer confidence. Xi doesn't have to worry about elections or the economy. He is president for life. He is on a completely different time table than Trump. Trump is worried about the economy in 2020 because that will determine his fate in the next election. Xi is only worried about securing his power, which he has a firm grip on. Just like it is popular for Trump to be tough on China, it is popular for Xi to be tough on the US. The Chinese are much more nationalist than Americans, so it is an easy sell to the Chinese public to wage a trade war with the US that they can blame Trump for starting.
From a game theory perspective, the only way a trade deal gets done is if Trump caves in and signs a weak US China deal that doesn't really change anything. And that is what the market wants and is expecting. Its just that the time line for that getting done has been extended, since the only real catalyst for a deal is a weakening stock market, which will make Trump more anxious to do a deal.
Paradoxically, a weaker US stock market will eventually lead to a higher US stock market. If the SPX stays above 2800, Trump will feel comfortable enough to drag this out and hope that China blinks. But China won't blink.
SPX is on a mission to test 2800, the last support zone during the post March FOMC pullback. The market is in show me mode now, the BS about constructive talks is not going to do it anymore when the actions speak much louder than words (China just retaliated with their own set of tariffs on US goods starting June 1). The uncertainty on trade is toxic for this market, and hedge funds are long enough that they will be forced to puke out their positions lower, and won't be able to buy the dip.
Expecting a test of SPX 2800 this week, likely sooner than later.
Promise a great deal. Extend deadline. Get mad. Add tariffs. Promise another great deal. Extend deadline. Get mad. Add more tariffs.
We were supposed to have a trade deal with China already and the SPX was supposed to top out and selloff after the good news spike. Instead, we are getting the worse possible outcome if you are a bear. An extension of a trade deal positive catalyst, kicking that "positive" catalyst can further down the road so the market can still have that carrot hanging in front of it. The supposed nirvana of a stock market that doesn't have to worry about a trade war and can keep going higher because Powell folded like a cheap lawn chair and promised not to raise rates.
You have to give China credit for waiting Trump out, making him mad, and realizing that the US consumer will just bite the bullet and buy cheap Chinese goods because even after a 25% price hike, its still cheaper than the alternative. At least until US corporations move their supply chains to another country, something that will take years to get done, and probably something they would rather not spend money on, instead focusing on more important things, like using their cash on stock buybacks to boost stock prices so insiders can dump shares at inflated prices, and to meet stock price based incentive bonuses.
Don't expect a trade deal anytime soon, as long as the SPX stays above 2800. If we start going down violently, which is possible because this market is so overextended and it seems like hedge funds are finally back in the pool, then you can start thinking about Trump panicking and putting together a China friendly deal he will brag about as being a great deal.
Expecting weakness in the 2nd half of the day, no one wants to hold longs over the weekend, with most now realizing there will be no trade deal progress. The Chinese are waiting it out, shrewdly, to get under Trump's skin and force his hand.
Staying underwater, waiting days and weeks for the kicking legs, conserving physical and mental energy. This is the life of the cold blooded predator. Let the eager shorts go after the hard prey, the fast and healthy. We wait for the easy prey, slow and hurt. This bull is old as sh*t, but still healthy as a horse. But there are some signs of weakness creeping in. Like the point guard whose lost a step and can't get by his defender like he used to. Like the quarterback whose lost a little zip on the long ball and can't hit his receiver on time on deep throws.
Up until Powell opened his mouth last week, the up trend off the December 24 bottom has been too steady and strong for there to be a good risk/reward short.
But over the past several days, we got a few good signs that this up trend is getting closer to the end.
1. We broke out to a new all time high, but came right back down under 2900, in volatile back and forth action over the last week. A fake break out.
2. The Fed told the market that it isn't ready to do a preemptive rate cut, which is what the bond market and the equity market were both starting to expect. That increases the likelihood that the Fed will keep rates too high for too long until the US economy reaches the point of no return and heads downhill.
3. Bonds have stopped going up along with stocks. This is the big one. Since 2000, you have had drops of greater than 20% in the SPX only when bonds were going down while stocks were going up. In spring of 2000, summer of 2007, and spring of 2011, you had bond market weakness while stocks were going higher before waterfall declines a few months later.
One of the main reasons stocks continued to go higher so relentlessly this year is because bonds were also rallying at the same time. That is straight out of the early 2016 playbook. When risk parity is working so well, there is no incentive to sell stocks when bonds are acting as a perfect hedge that provides both interest and capital gains even while stocks are going up.
Unlike what most paper napkin/5 minute macro experts think, a weak bond market is not a sign of a healthy stock market, it is a sign that monetary policy will be getting tighter to fight the up trend. Conversely, a strong bond market is not a sign of an unhealthy stock market fighting economic fundamentals, because it means that monetary policy is getting looser even as the stock market goes up.
It has only been a few days, but I am finally seeing the relentless bond rally since November 2018 slow down, just as the SPX is at nosebleed levels, with complacency rising, and as the uptrend is starting to flat line. If the SPX stays under 3000 for the next 2 months, that will probably mean that the equity market is saturated with bulls and the weakening economic fundamentals will come to bear on the market.
With so many hedge funds underexposed to equities during this relentless rally, they will be adding exposure and providing buying support on pullbacks for the next several weeks. But once that phase is over, and hedge funds are back to normal to high exposure levels, the SPX will be vulnerable to a waterfall decline like December 2018. That is the time to start the short campaign.
Been quietly observing the markets and this bull run off the Dec. 24 low has been powerful and stunning. I have not been short, as I mentioned in my last blog post a month ago, if the SPX went above 2850, the topping process would be extended and take longer time to play out. The next few weeks are safe, even though we are in stock buyback blackout period, because the window for a selloff is closing, as the market rarely drops big during the middle of the earnings season, especially when it has been in a strong uptrend leading up to it.
This has been one of the most unorthodox rallies that I've ever seen. An overvalued market with the economy clearly slowing, as the earnings revisions have been revised lower and the global economic data has come in weak for months now. So bonds have been strong, and the defensive sectors like utilities and consumer staples have been leading, with cyclical stocks lagging. That started to change in March, as the reach for beta was on, and tech stocks have been relatively strong since.
This market is latching on to Chinese stimulus hopes and anticipation of a 2nd half rebound, ala 2016. You see more bullishness about emerging markets than the US, even though the US is where the supply demand fundamentals are most favorable, due to the buybacks.
I just don't see the pent up demand to lead to a 2nd half rebound as the US economy has been overstimulated and the secular growth weakness from low population growth and income inequality are only getting worse. What the last 2 years has been is a huge distortion of the stock market cycle with a massive money drop to corporations used to fuel stock buybacks, keeping US stocks well bid. Perhaps it will take a Democrat to win in 2020 for a change in corporate welfare policies and more regulation to keep corporate profits under control.
I am getting more tempted to start a short, but I think its better to be a little bit late than to be a little bit early putting out my line. What still bothers me is that CNBC Fast Money is still not really buying into the rally, and based on data that I have reviewed over the past couple of weeks, hedge funds are positioned heavily in cash and have been mostly sitting out this rally. Usually, you need hedge funds to be more fully invested before a big waterfall decline. So I don't see a big down move anytime soon, until the hedge funds start loading up, which they probably will if the market just chops back and forth in a few percent range over the next 3 months. Then you will be set up for a big plunge. At the same time, the fundamentals are horrid so unless another bubble gets going, I don't see how this market can go much above SPX 2940, the all time highs.
It is going to probably be a boring couple of months of tight range trading coming up, but that should set up a nasty surprise for investors in the 2nd half.
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