Beware the Secular Trend’s Potential Short-term Counter Move

Right now the markets are at extremes.  Essentially all of them.  Current price action across a broad swath of sectors and assets classes strongly reminds me of the end of 2019 and beginning of 2020.

My gut tells me that a fear-event is near.  And my gut is being primarily led by current action in the US dollar.  Short positioning in the buck is extraordinary.

Record Short USD Positioning (Dec. 2020)

Yeah, yeah, macro-top-down, commodity bull, central bank largesse, and all that in regards to the USD but this is egregiously exaggerated.  Not that it can’t get more extreme, but consider the following charts.

Seasonality, courtesy of SentimenTrader, tends to be pretty strong in January for the buck.

USD Seasonality - ST (Dec. 2020)

With currencies, large fast moves in a short period are atypical but we live in a time of atypical.  Pairs always have to be acknowledged and the anti-correlation to the euro is at a bit of an extreme.  In the last decade, every time the Euro to USD line (white-monthly) has approached 2 standard deviations above the 25-month MA, then it’s been go-time for a USD rally (green).

Euro vs USD (Dec. 2020)

Does this mean a reversal is imminent?  Nope.  Does it mean additional portfolio hedging here is warranted?  I’d say it’s a prudent use of capital.

The long-term case for the dollar’s demise is well documented.  Goldbugs have been the longstanding voice of fiat destruction, but more recently, Ray Dalio has picked up the baton.  Sam Zell has now officially thrown his name in the dollar-destruction ring with this recent quip.

The single greatest risk that we are dealing with today is the loss of the U.S. dollar as the reserve currency.  If we keep doing what we are doing right now, I think it is 10 or 15 years away.

These investment legends are right.  The USD will in all probability lose 30% to 40% of its reserve status this decade.  And world markets as well as geopolitics will be volatile as a result.

Why do you think Bitcoin has jumped so hard?  That’s institutional fear of central banking monetary policy, not retail FOMO driving Bitcoin.  It’s palpable, but it’s ahead of itself in the USD and Bitcoin.

Nothing moves in a straight line and short-term counter spikes in any trend are as sure as sunrise.  I’m not implying that a fear-event has to rival Covid’s March spikes or we’re at a long-term top in equities.  Just saying that a short-term move to remove some excess is worth hedging at this point.

“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.

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.

Another Bounce or Not

Hmmmm.  What to do in a market like this?

For your long portfolios, my advice would be to sit tight.  The odds are strong that we’re in a multi-week bounce before another little shakeout.

SPX Thru 2018 Holidays (Nov. 2018)

I’d suggest getting long after the next move downward.  Market behavior suggests a rally into 2019.  It could be the start of the final leg of the melt-up as “late-cycle” keeps getting bandied about out there.  Over the past few years, the drill seems to be a quick move down followed by the exhaustion-bounce followed by another move downward before regaining the up-trend (weekly charts).

For the contrarians, it’s hard not to look at China and energy as two obvious areas for medium-term plays.  If you play in the markets at all, I don’t need to throw up charts to illustrate the performance of both sectors of late.  Tencent and JD could be easy moneymakers.  And the energy toll roads can provide a nice yield along with cap. gains on an oil bounce over the ensuing months.

EPD has the infrastructure footprint and financial efficiencies that begs for yield-starved investors who’ve been waiting for a better opportunity for entry.  However, the company’s price remains quite steady in the $20 to $30 range.

Oil’s price action looks exhaustive.  Fundamentals appear to bear out an inexplicable magnitude of this sell-off.  If institutional traders on the wrong side are able to quickly offload positions, then there may be enough support by energy bulls to resume an up-trend without extreme volatility.  I remind energy traders of what we saw in H2 of 2016.

I liked the Starbucks story, but it quickly got white-hot before I could position with my long portfolios.

SBUX Retrace (Nov. 2018)

Based on the trajectory over the last several weeks, it wouldn’t surprise me to see a retrace down to the $56 – $58 range.  That’s a good spot to get positioned if you’ve been eyeballing this world-class caffeinator.

In the quasi-cash-equivalent area, muni-CEFs have presented recent value with their widened NAV discounts.  The discounts have come off a few points as investors have taken advantage of the historically free money and positioned accordingly.  The big question mark is interest rates.

Does the Fed raise rates next month?  If so, that could renew selling action in muni-CEFs and widen discounts again.

Interest rate tape reading has rates looking a little toppy.  Not like they’re going to topple over as we know the Fed will raise rates which will force support.  But still, I like interest rate-sensitive funds here to drive a little yield for a bit in place of sitting on excess cash.

          IIM Current NAV Discount (Nov. 2018)

          JPS Current NAV Discount (Nov. 2018)

Remember, these aren’t long-term investments.  We’re talking about using them as cash-equivalents, but their volatility makes them decidedly un-cash-equivalent.  We’re speculating on additional points on your money earned relatively conservatively.  Mind your stops.  Protection first.

The Last Gasp

As you know by now, I think we are in the final stages of the topping process in major markets.  This is going to be a multi-month affair.  I suspect the top and crash begins later next year, but so do many other pundits, pros, and bloggers which makes me leery.  There’s nothing worse than contrarian consensus by large groups in the game of speculation.

Like its predecessors, the crash won’t look like one at first.  Sure, players will get scared and react but then we’ll see a bounce off the first initial move to the downside.  This will be an opportune time to liquidate positions to make a final cash raise to either capitalize during the crash or wait for the inevitable value opportunities that will arise.

There is a set of indicators that go along with this move downward and bounce that has proven efficacy as a guide.  It’s the 5 month and 10 month Exponential Moving Average (“EMA”).  Observe.

SPX - 5 & 10 Crossover (10-10-2016)

These aren’t magic indicators.  I’m not saying they are guaranteed to work.  I’m only saying they’ve proven themselves as guides when a real bear move has begun.  There are a multitude of economic and financial indicators that I also like to use along with anecdotal evidence, too.  Keeping an eye on this particular set of EMAs however can potentially keep your losses to between 10% and 15%, assuming you act.

In a bear market where there’s the potential for a halving of portfolios, I’d say 15% in losses is solid.

Volatility in the biggest asset classes will be unimaginable.  The algorithmic, high frequency trading operations in combination with central banks have broken all markets.  There will be no liquidity for the big timers when the bear begins.

HFTs are the true market makers and all algorithms are written to pull away and sell when bottoms fall out of markets.  Look at the S&P 500 in May of 2010.  That was really the first indication that markets would never liquidate in a typical fashion ever again, until HFTs are properly regulated, taxed, or removed from existence in markets.

There are plenty of examples between May of 2010 and now, but the move in the pound sterling at the start of October provides such a fine illustration.  What’s more liquid than the currency markets of the most developed and powerful Western nations?

Nothing.  And yet still we see the destructive power of HFT on any market.  Does this look normal in a power currency?

Sterling Madness (10-16-2016)

In earlier Asian trading, the intraday damage was even worse.  Observe this bit of madness.

image

These moves are a product of liquidity being immediately vacuumed from the asset classes where all the largest players play.  This will happen again and again when the markets make their final turn.

You can liken it to a hull breach for an astronaut in space without a suit on.  One second astronaut HYG is floating around the lab in a jump suit, happily conducting experiments with OPM.  But OPM in high-yield instruments in a low-yield environment can be a volatile material if not handled appropriately in a proper setting and an explosion occurs breaching the hull, sucking HYG out into the liquidity-free vacuum immediately to death.

Did I say liquidity?  I meant oxygen.

You get the point.

Coming back to what a last gasp means; it means there will be a final run in risk assets to squeeze out the final profits of this bull.  Many, including myself, have called it a melt-up, but I grow weary of the term.

Please don’t be fooled by some of the ignorance being freely proffered out there that we are in the early years of a cyclical bull, similar to 1982.  We are not.  The evidence is broad, clear, deep, and obvious.  One needn’t a fancy finance degree or years managing wealth in order to see this.

The end game is here, but not before that last gasp for profits that I keep describing.  I suspect that many of the sectors that powered this bull market prior to 2016 may reassert themselves to take us home.  Why is that?

Interest rates.  Plain and simple.

Those with access to leverage at these historically low rates will borrow capital to fund buyouts and takeovers which will drive asset prices upward.  The upward move will then draw in speculators looking to hop on the trend or front-run it.  This quest for yield whether in debt, equity, or private equity i.e. IRR, will be the fuel for the last gasp up in asset prices.

Despite what I think may happen in semiconductors or social or biotech or emerging markets as risk-on gains speed, keep your eyes on the one asset class that has taken out all comers in 2016.  The Rocky Balboa asset class for the year.  You know what I’m referring to and this is even with the recent sell-off.

2016 Performance Chart (10-16-2016)

Precious metals.  You don’t have to love them or hate them.  Opinions don’t have to be binary.  Be agnostic when speculating.  Follow the trends.  Follow the money.  More importantly, follow central banking and political lunacy.

Let’s look at one more chart that potentially validates that this bull market is long in the tooth.  It depicts the times over the last 50 years when payouts to equity investors have exceeded  profits.

Total Payouts via ZH (10-11-2016)

You can ignore what is glaringly obvious or you can prepare.

Speaking of obvious, let’s begin to wrap this post up with another pithy little ditty of a quote, this time from one of the world’s great speculators.  It’s been reprinted time and again, but it’s simple yet brilliant message is timeless.

I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up.  I do nothing in the meantime.

– Jim Rogers

I haven’t touched on trading since the summer and I just wanted to share some set-ups that appear to potentially be building little piles of money in a corner waiting to be picked up.

Keep an eye on these sectors, either short or long:

Short:  sugar, energy(big 3), US dollar, and technology

Long:  grains, bouncing precious metals, and the pound sterling

Despite your opinions, never forget about counter-trend rallies, even in the face of what appears to be an unstoppable trend.