“It’s not what you don’t know that kills you, it’s what you know for sure that ain’t true.”

I return to this statement over and over as I play the markets.  Mark Twain had unending wisdom.  The speculating public, usually not so much.  November’s stock market returns were a delightful 10% for the S&P 500 and an eye-watering 18% for the Russell 2000; thank you very much hard and fast sector rotation.

Major Indexes November Returns (12-2-2020)

Despite this, ambiguity still reigns supreme currently.  Context is critical.  So does the ambiguity matter to long-term investors?  No.  But if you’re swing trading any asset classes in these markets then the ambiguity matters a whole lot.

Let’s use some simple, classic technical analysis to better illustrate how muddy the waters have become.  We’ll start with the S&P 500.  Depending on your trend-line bias, there’s a few different ways to perceive current action.

SPX Weekly (12-2-2020)

It looks like a very legitimate breakout.  It’s been a hard chop since late July, but I thought we might see yet one more leg down to the high 3100s or low 3200s.  The reason for this was the curious inter-market activity among various asset classes.  Typical correlations weren’t holding up in November and the breakout just felt fake.  But therein lies the problem of using “feel.”  Obviously, I don’t just go with the gut when allocating capital but it has often paid to at least listen to it.

We know that one major, semi-new factor driving markets is option activity.  Never before has one had to care so much about option Greeks to simply trade the underlying.  Observe the enormous rise in single-equity options premiums as a result of the tidal wave of buying, most of that in Calls by retail and institutional.

Buy to Open Calls Spot Premium (10-18-2020)

Options activity has seen market makers make unparalleled purchases in the underlying stocks in order to hedge their Call sales books.  As a result, volatility has chopped right along with the markets as moves have been fast and furious.  So where is volatility possibly headed next?  Again, the trend lines paint a couple of different pictures.

VIX Weekly (12-2-2020)

We have the current liquidity flood and more coming in 2021 to support fund flows into risk assets.  There’s also the beginning of a sector rotational move into value.  I don’t think that’s a done deal yet.  I think growth i.e. tech still has legs left.  I hypothesize that the bounce in energy and small caps is only the first strike of sector rotation, but the growth of SaaS and big tech will soon parry in 2021 which should stunt recent returns in energy and small caps…at least temporarily.

The one asset class that continues to dominate my thoughts is the US dollar.  I’m reading tons of obituaries.  They feel premature.  A swift move up to the 95 area would not surprise me here; swift relative to its usual multi-month cadence.  A “swift-ish” move in the USD would drop a hammer on commodities, which wouldn’t bode well for the recent rotation into energy.

USD Weekly (12-2-2020)

The grains and sugar have been on an unfailing tear upwards.  Typical COT activity would have already seen correlated reversals in these crops.  I’ve seen insinuations that perhaps we’re in a regime change for those specific assets, but like the death of the dollar, that innuendo feels a bit premature.

For my own long-term portfolio of equities, I continue to evaluate the plays that many deem to have great forward looking prospects as not only technology evolves but society as well.  They may seem obvious, but it’s hard to shake what a well chosen play can mean for the potential of a portfolio.  This means gene-editing, cutting edge biotech, AI, data dissemination, and two of the oldest vices on the planet with tremendously long runways as a result of only barely being legitimized.

In the short-term, I think the commodity shorts present a most compelling current opportunity but so much rides on the USD’s anti-correlation.

If you really want to generate some returns with equities, consider after hours trading.  This has been widely reported on for a few years now, but just look at a recent chart put out by Bespoke to truly illustrate the marked difference in strategies.

Bespoke After Hrs. Trading Since Inception (Nov. 2020)

Of course, 2020 has flipped that on it’s head.  See below, but after-hours is starting to reassert it’s dominance.

Bespoke After Hrs. Trading Since Start of 2020 (Nov. 2020)

Stay sharp.  Recent choppy action may not be over just yet.  And with everyone predicting an amazing 2021, including myself, it might just take a little time to get the real momentum going next year.

Known Unknowns

                  Tight Spot

Speculators are on shaky ground.  We have known knowns, markets can either go up, sideways, or down from here.

We have our unknown unknowns, which are impossible to anticipate or plan for so you manage risk accordingly.

But we have our known unknowns to which I think it’s best to assign probabilities to, handicap if you will, in order to speculate through this tight spot.

Handicapping possible outcomes is no different than thinking in decision-trees.  Here’s a small example of where we could be at, but obviously one has to consider multiple trees and multiple outcomes.

Decision Trees I

From there, assign probabilities and ascertain next course of action with capital.

But with unknowns come fear.  Fear of loss.  Fear of being wrong.  Fear of career risk.  Fear of missing out.

My gut and the tape tells me it’s time for a correction.  The action last Thursday was the starting gun and we got off to a fast start.  I think big money pushes their shorts while also collecting profits on “longs” within the rally.

If this equities correction has legs, I think 15%-ish lower in the S&P 500 and 18%-ish lower in the NASDAQ is where we’ll find heavy support.  In my own handicapping, no new lows in this correction, but serious fear.

Don’t fight the Fed has been one lesson in this rally but but don’t fight retail, in the short-term, has been another.  None the less, I’d still assign the highest probability to that possibility on the far left in the diagram above.

And if we’re assigning letters to this one possibility, here’s your tilted-W.

               image

Have You Lost Your Mojo

Sad Mojo Jojo - Copy

Which side of the speculating-fence are you on?  Are you euphoric with gains from this rally off the low?  Thank you dumb money.

Or are you annoyed sitting in cash, position-less, and asking the market why is it not listening to you about this being a bear-market rally?  I see you smart money.

I was fortunate to have lost very little thanks to my hedges coming into 2020.  Partnered with basic risk management, returns on the year are flat.  Not great, but I’ll take the profits off the well timed trades to mitigate losses in the long-term buckets.  Bottom line, I missed this rally.

But the major indexes are up 40% off of their seppuku-inducing lows.  Are we in for more?  Is everything fixed?  Will we see new highs and then push on for an additional 30% to 40% more in gains?  I want every reader to remember just how great and unusual 2019 was for returns.

You could’ve made 30% in 2019 in your sleep with zero skill and no risk management.  We’re going to get back to back years of that?  Highly unlikely.

Is this rally legit?  Well if you sell and realize gains, then hell yeah!  But are we truly in the clear from a bear-market rally and more damage?  Who’s to say?  Just history.

Have a look at this chart that Macro-Ops put together.

Bear Market Rally Duration & Performances

Here’s another chart from BofA.  It’s already made the rounds and is dated at just over six weeks old, but have a look at the 3 columns specifically on the right.  Have a look at the dates and percentage losses that were still pending to the date of the actual, final low.

BofA Bear Rally Chart

The coast may be clear but 2020 has seen the most unusual market action in history.  I have no way of knowing if this is a bear market rally or a legit restoration of the bull that I’ve missed so far.  But my portfolio’s cash levels clearly mark where I stand.  And if the statistics above are not enough history imploring caution, then have a look at this chart near the end of the GFC in 2008/2009.

S&P 500 2008 Crash & Bounce Volatility

How many bottom-callers gave away healthy chunks of their stacks during that 6-month rundown?

The most successful, sharpest speculators on the planet are currently telling you outright where they stand on this market and it’s poor risk/reward set-up.  That has to make you pause even though the price action is the final arbiter.

People are trained to not fight the Fed, now.  Even dumb money is trained.  Everyone now “knows” that the tsunami of liquidity washing over the financial and corporate world will support equity prices.

It worked for the last 10 years.  It has to work now.  Right?

The stock markets are a discounting mechanism.  They see the future and the future is bright according to speculators, currently.

But let’s revisit the realities of the pandemic’s effects on spending and thus business earnings as well as viability to continue as ongoing concerns.

Tens of millions of people have lost their jobs regardless of whether it’s a furlough or a permanent termination.  How many people who retained their jobs have taken salary cuts of 20% to 30%, possibly permanent?  And somehow this is not going to have a long-lasting impact on business conditions?

The current, typical mindset seems to be something like this, “Just write off 2020. It’s a sunk cost. We’ll have vaccines soon. People are social distancing. And the government is propping up everyone. 2021 is definitely going to be a great year, economically, so let’s price stocks accordingly now.”

However, widespread impairments to income will lead to widespread impairments to business operations.

Have a look at the credit downgrades from Q1.

041520-SCO-Credit-Downgrades_5e9744cba4085

Bankruptcies are going to happen.  Capital will be lost.  Is that being appropriately discounted right now?

Right in line with the credit downgrades, let’s take a look at the HY option-adjusted spread.

HY Option Adjusted (May 2020)

We’re in a recession.  The BEA will report this.  And yet spreads are diving.  Well the Fed is buying HYG and JNK.  Don’t fight the Fed.

But let’s look at HY’s default rate versus debt to GDP.  You see that wide mouth?  It’s going to chomp and the likely path of convergence lies with the default rate moving upwards.

Debt to GDP vs Default Rate (May 2020)

And what about leveraged loans and CLOs?  Approximately half of the the leveraged loan market, $600 billion, is securitized via collateralized loan obligations.  Between downgrades and further business earnings impairment, wait till CLOs begin acting like 2008 CDOs.  Will it be a positive or negative for equity prices?

Let’s keep it simple and return to equities with a final look at the pure concentration of capital in this Q2 rally.  Here’s the BofA chart that’s played out by now.  It doesn’t seem to matter that capital is concentrated because this time is definitely different.

Market Concentration (Apr. 2020)

These stocks support the work-from-home new economy so it’s all good, but let’s take a look at a SentimenTrader chart.  After all these years, SentimenTrader continues to generate so much value at such a small cost.  Literally, every player subscribes to it; even those that already have Bloomberg terminals and the best info-flow money can buy.  Chart is dated 5/13/2020.

SentimenTrader - Concentrated Rally (5-13-2020)

Not a pretty picture but we’re almost 2 weeks removed from that signal and the market is up almost another 10%.  Not trying to mine the data but I just can’t shake the nagging feeling that a selloff is imminent.  And by imminent I mean within weeks if not days, just not tomorrow.

Based on the concentration levels then it would stand to reason that the NASDAQ will truly indicate when a correction is to begin.  With the 5 stocks (FAMGA) up above representing 45% of the NASDAQ vs 20% of the S&P 500, look for weakness in the NASDAQ to indicate a trend change.

Once a correction starts, I could see 8200 as a solid support area.  This would put the NASDAQ about 13% below from current prices.  For those of you that missed this rally, some Puts on the QQQ followed by some jumping into quality long positions once that 8200 level is reached will be a good way to make up lost ground in your P&L for 2020.  This would be just above a huge price area of recent purchases, noted below in the chart.

$COMPQ Support Level

Hard to fight this rally.  I know.  But if you want to get that mojo back along with some of that lost capital, it might pay to be bold.

Watch Out for Quicksand

What did you always see in movies with a quicksand scene?  Hero and fellow adventurer plodding along through the forest.  Hopeful and intent on making it to the lost temple of treasure, but cautious for danger.  Then all of a sudden…up to their ribs in quicksand and a rapid descent into panic.

Well that’s how the stock markets kind of feel right now, except there’s an unusual amount of calm.  I get the sense that an air pocket can develop to rip 8% to 10% of value from equities.  It would be fast and temporary.  I firmly believe the stock markets will keep moving upward and I actually think we’re going to have a strong Fall and Winter.

I don’t have any charts or article links to share; just a gut feel backed by anecdotal evidence.  Let’s briefly review the negative factors that one would have surmised to have a higher impact on the broad stock market:

– Repo rates flash-spike up to 10%

– Momentum Factor crashes with Value Factor spiking

– Saudi oil processing plant attacked affecting 5% of total world output

– The 10yr. Treasury took a hard spike downwards

– Fed and ECB are cutting rates

I mean all of that just happened in the last 2 weeks and the closing range on a weekly chart in the S&P 500 is right around just 1%.  It doesn’t feel right.  I suspect we could see a delayed reaction to these negatives, which will be exacerbated by the algos.  That’s how we could see a 2-week down-spike.

All the Bears will claim they were right within that first week and the next GFC is surely here.  Then the second week traps the Bears as the Bulls take over by the end of that second week.  I think if we see action like that then it sets the stage for a V-bounce and the start of the next leg in this Bull market to new highs over the holidays.

Those negative events were enough to halt the down-move in treasuries and stave off a correction in gold, but I think that’s also temporary.  Instead of a flight to safety placing a bid underneath longer Treasuries and gold, we could see a flight to cash.

Again, this is only a gut feeling but it keeps nagging me right now.  If this gut feeling becomes a reality, it could look something like this.

SPX Possibile Air Pocket (Sept. 2019)

Plenty of ways to play that action alone in equities but when you toss in Treasuries and precious metals, it could be a trader’s delight.

Oh, and one last thing on the repo rate spike.  It’s not just a little plumbing issue. That spike up to 10% mattered.  It’s a tell.  If it didn’t matter why exactly would PIMCO say,

In our view, the repurchase (repo) market, where banks and broker-dealers can obtain overnight collateralized loans from intermediaries, is a critical barometer of the health of the financial markets.

Tread lightly…at least temporarily.

Hey Gold, Don’t Get Cocky!

Gold Fever - Article Header

Seen this movie?  If not, it appears to be starting another theatrical run.

With the recent action in gold, the precious metals bugs are all stirred up.  Price action has been constructive.  Big time asset management names are mentioning it and the metal is definitely conveying a message.  New songbirds are putting their price calls out there for short-term and long-term destinations.  The old songbirds are putting their same old calls out there as they suffer permanently from the fever.

There’s no fever like gold fever, and I’m an expert in the symptoms.

We’re already seeing the $10,000 and up per oz. calls for gold.  What’s funny is you see the same old reasons for why precious metals are going to boom.  Everybody was selling the same handful of points in the last gold bull run and those same points are being tossed out there again as if they have meaning or truth.

– Negative real interest rates

– Excessive debt loads

– Accommodating monetary policy by central banks

– US Dollar losing value via debasement

– Inflation expectations

– Supply shortcomings

This is folly.  These are not reasons for anything; merely convenient sales pitches that still work on the zealous subset of speculators that are looking for either a reason to stay devoted to the precious metals or believe an amazing amount of money will be made by a small speculation.

From a technical analysis standpoint, it’s time for a rally and the price action hasn’t disappointed thus far.  However, technical analysis has virtually no merit any more due to the advent of the internet.  This has been statistically proven.  Tape-reading still has merit in conjunction with technical analysis and fundamental analysis, but it takes real talent and luck to fight the machines.  Here’s a Captain Obvious chart of gold proving higher prices in the making.

Snarky Gold Chart (7-13-2019)

But there’s only one thing that could potentially drive the price of gold and the precious metals to those high price levels so blithely forecasted.  Here it is in plain, bold English:

A HIGH PERCENTAGE LOSS OF RESERVE STATUS IN THE USD

That’s it.  I believe that to be the only driver that will get gold up over $5,000/oz. or higher.  Something in the order of the USD losing perhaps 35% or more of it’s reserve status which will coincide with decreased use of dollar-settlement in international trade.  Or said another way, chaos.  Because if the rest of the world decides to shift part of the USD’s reserve status to another currency whether it’s gold, Bitcoin, SDR, yuan, etc.; you can bet those in power in the US will be wreaking havoc as a result.  This will be adjoined to the financial/economic chaos that will already be in place.

There still exists old-world faith in the precious metals, and blockchain currencies do not have enough cumulative faith by investors to reel in allocation decisions.  This is the path for significantly higher prices in gold, silver, and the PGM complex; potentially even for the commodity complex.

Regime changes in currency reserves are not fast.  They don’t just happen like a stock market correction.  Many powerful and wealthy nations have a vested interest in the USD maintaining it’s ultimate reserve status.  Just bear that in mind as we watch the dynamics between all asset classes, markets, economies, and countries play out in real time going forward.

It’s tough to visualize if you can’t foresee a world where the USD loses place and face.  But hell, don’t take my word for it.  Google and consider the opinions about the subject of some of the most powerful financial insiders in the world:  Larry Fink – Head of Blackrock, Ray Dalio – Largest principal in the largest hedge fund in the world, and Mark Carney – Head of the Bank of England.

Ain’t no fever like gold fever.  Keep your wits goldbugs.