Some bear capitulation...pullback now?

After taking it on the chin day after day trying to top tick the market for the past 2 weeks or so, the bearishly inclined trading community (which makes up the majority of traders today in my opinion) may have temporarily thrown in the towel. You can see this today as evident by the very low put/call ratio. Mind you, this is only one day....we could very well see these clowns pile into puts again on the first hint of weakness. However, I have to say that the charts look extended here when you look at how far the market is above the 200 DMA and the parabolic rise as of late. This suggests a breather at the very least is forthcoming. We're also starting to see "melt up" chatter which in the recent past has been a pretty good contrarian sign of  a ST top. The trading community is basically throwing their arms up in the air saying "you can't stop this market because of the fed" which means that even though they may have given up trying to short the market they still don't believe in it. That's been the story for pretty much the last 10 years.

So, assuming that lots of bears have temporarily given up, the market has lost a source of fuel right at a time when it's looking a bit parabolic and overbought.  As such, I expect to see the market cool off in the near future. For how long or how deep I don't have a good feel at this point.

But don't get me wrong....the underlying skepticism of the market is still there and we aren't seeing the type of exuberance that we saw in late 2017-early 2018. If the market drops 2-3% I expect to see pessimism ramp up again.

I expect pullbacks to be modest for now

Ok, so we got the "phase 1" of the trade deal signed which lifts some of the "uncertainty" from the market. I've said it before, this trade war is a fugazi. It's just a distraction/narrative for market participants to pay attention to. Ultimately, it's not going to have a material impact on the economy no matter how it's settled. Major downturns are not caused by this type of silliness. They are caused when a material underpinning of the economy unravels and spills over into other sectors. The US was never overly dependent on China, it's the other way around. Yes, the trade drama can cause significant ST noise but it's all just noise. Another thing that can cause a significant downturn in the market (but not collapse) is when you get too much enthusiasm from the crowd. This creates an overcrowded long exposure making the market vulnerable to a rug pull. A good example was the 1987 and 2018 declines whereby sentiment got overheated and the market had a serious rout with the economy still relatively fine i.e. not in recession.

I would speculate right now that we are in a position where a lot of "pros" and retail as well, are caught flat footed because they've been positioned rather defensively all year. The pros in particular are probably begging for a big pullback, but in such a situation were so many people are caught leaning the wrong way, it doesn't seem likely there will be one. I'm also noticing ST trader types and/or hedgers relentlessly trying to top tick the market because anytime the market shows even the slightest hint of weakness the put/call ratio spikes to 1 or thereabouts. This is creating yet another layer of support as these traders get their fingers burned over and over. You can see it the intraday charts. You can actually see a finger-like pattern in the chart which is indicative of shorts getting squeezed and stopped out. Maybe we''ll see a swift change in attitude shortly but until we do, don't hold your breath for a big pullback just yet in my opinion.

The main purpose of the stock market is to make fools of as many men as possible

In these politically correct times I suppose I should change the title of this post to "the main purpose of the stock market is to make fools of as many people as possible" but fuck being politically correct, the original title stands. This phrase which is the motto of my blog was coined by Bernard Baruch, a US business man of the early 1900's. It's the most accurate description of the stock market that I can think of. The stock market is seldom obvious, seldom does what the majority expect it to do and the reason why is because the market is already aware of and therefore reflective of common expectations, views, fears, ect. So, if you want to "beat" the market you have to position yourself for how those expectations will be changing in the future.

Throughout this bull run that began in 2009 there has been no shortage of worries, no shortage of calls from "experts" warning us about immanent doom. Where are the "permabulls" who are calling for outlandish upside like Dow 30,000  in the late 90s? There are none to speak of. Yes, you can find bulls but they are relatively modest and few in number compared to the doom and gloomers.

I'm in the advisory business and all I've been hearing since last year is this "late cycle" narrative from the wholesalers I deal with. Everyone's on alert for the next downturn like I've never seen before and the "pros" have been positioning themselves accordingly.   The inversion of the yield curve is what really got everyone going since it has historically signaled an immanent recession. I'm not going to divulge as to whether the yield curve signal was as strong or meaningful as in the previous instances due to global distortions. What is key to note is the frenzy of attention the inversion garnered as a harbinger of doom whereas in the past, the yield curve inversion was not as nearly paid attention to. It speaks to the underlying, deep rooted pessimism that still lingers from the 2008 crash. If we go by the motto of this blog, then we are probably not in the late cycle. It would suggest that the cycle still has at least 2 more years to go. When was the last time the investment "pros" as a whole correctly positioned themselves for "late cycle"? The answer is never. The 2008 collapse was a "surprise" just like every other major downturn. Another great example of a surprise was the collapse of oil prices in 2014-2015. How many "experts" were calling for "late cycle" oil prior to that collapse? The answer is 0.  Literally 0.

My point here is that the time to really get worried about the long term is when there are no worries! We saw that type of no worries feeling in late 2017- early 2018 when "global synchronized growth" was the common mantra and retail was pouring money into the market. This ultimately led to a 20% correction which wiped out the optimism reverting it back to the pessimism that had been persisting for years prior to it. 2019 was characterized by fears of an immanent recession which never came to pass. Now we are starting to see green shoots of a rebound as Global PMIs have been turning up, so called "progress" on the trade war has happened and the Fed cutting rates appearing to be on hold for the foreseeable future. Yet this budding optimism, if you want to call it that, is still quite fragile because there's still quite the concern about what would go wrong on the trade war front, the repo market,  politics, ect. The bottom line here is that there is still plenty of room for upside re-rating of expectations which would send the market notably higher in 2020. What the market does in the next few weeks is a tough call as it typically is.

The Rodney Dangerfield market - it still gets no respect

I know it's been a while since my last post. I would have liked to have posted sooner but I've been busy. Since my last post the market dipped as I had expected but it was a relatively minor dip and it wasn't too long before the market had a major rally and hit fresh all time highs, the main reasons of which appear to be the notion that the Fed has hinted that it will be on hold for some time,  trade "progress" is being made with China and jobs data suggesting that the US economy is not heading into a recession as many have been fearing all year long. So, does this mean that investors in general are finally embracing the market showing unbridled optimism? Hell no. All I see so far is pessimism unwinding and rather reluctantly so. We are still seeing no meaningful fund inflows. Aside from Trump, very few people in the media  have been celebrating/embracing this upside breakout to new highs. And I have not seen one market bear, not fucking one of these miserable, self righteous clowns come out and say "you know what, I was wrong and I've been wrong for so long that it's so embarrassing". I'm talking about clowns like Gundlach, Schiff, zerohedge and the rest of them. I find it hysterical that these jokers are still given all the attention they get over the years despite being so comically wrong over and over and over....and it does not matter if the market were to make a major top today, these guys can't come out and say that they were right but early. No fucking way, not when you've been bearish from DAY 1 of this bull market. I wonder how my millions have been lost or foregone by their followers. Do yourself a favor and NEVER listen to any of these clowns again if you have been. This is not to say never be bearish, but just don't follow these jokers. They will poison your mind. It's funny how I see some sarcastic tweets that say things like "thanks for QE and easy money the market is at new highs".  My response to that would be this....if you knew QE and easy money would bring the market to new highs WHY THE FUCK DID YOU NOT TAKE ADVANTAGE OF IT and then thank the Fed? Instead, you moan and complained about it! That's the same as spotting $100 on the street and not picking it up and then complaining the next day that you don't have $100! The excuses from the pessimists are pathetic. They are so wrapped up in their loser dogma and negativity.

The message I've been preaching here for years is that until we see evidence which strong suggests investors in general have FULLY embraced the bull market, the bull market will continue. Until we reach that point, there will be corrections, there will be scary moments but the benefit of the doubt has to go to the bulls  I realize this can be very difficult to believe in at times, I myself have had serious doubts at times. It's easy to doubt yourself especially during down days and negative headlines but this has been the correct way to approach the market. And if you're watching the market day by day, tick by tick it makes it even harder to follow this approach. It's also very difficult to correctly time every ST wiggle in the market. Now having said that,  you know I can't resist making a ST call on the market at times so allow me to indulge. The market would appear due for a least a bit of a consolidation here but I gotta tell you, everyone seems to making this call which to me means that any pullback won't be that deep at this time. Whenever you see ST trader types show complacency such as buying a lot of calls relative to puts, at the first hint of weakness you see them rapidly embrace the bear side again piling into puts. This is happening now as the market has been rolling over a bit here.

The only time we saw people in general show any love for the market for a sustained period of time was q4 of 2017 until Feb 2018 which was evident by heavy inflows to equity funds and anecdotal commentary from the financial media with their "global synchronized growth" mantra. At that time I was warning about this. By the time we reached the end of 2018, that optimism was wiped out completely and was replaced with pessimism. At best, we are at the point of neutrality now. We will see a return to optimism once it crystal  clear that the global economy is on the rise, political uncertainty is low  and all is well again, but at that point the market would probably be 15-20% higher. I said here before that you have to skate to where the puck is going to be not where it is now. If you wait for everything to be hunky dory you will miss out  most of the gains or even worse get in near the point where things start to head for the worse.

Let's talk about early 2018 for a second. At the time I was debating with myself whether the optimism  that was evident was a sign that the bull market peak was immanent.  I concluded that the market would probably have a severe correction but that the bull market could still be in tact because we didn't really see optimism turn to euphoria. You could argue that the bubble in bitcoin and cannabis stocks were symptoms of euphoria but they ware isolated pockets of the market since they didn't garner large scale institutional ownership. When you look at what caused the last few recessions it was the result of a major sector in the economy going bust which created a crisis that spilled over to the broad economy, that  can only happen if there is large scale exposure i.e. institutional ownership of the sector in crisis. We saw that happen with MBS in 2008 and the technology sector in 2000. Bitcoin and weed stocks were largely avoided by institutional investors/firms and so that's why I had hope that there would not be a major economic fallout when their bubbles burst. There is this notion that the next crisis could be from the corporate bond market of which there is a lot of low credit credit quality bonds that have been issued in recent years. Maybe that could be it, but I would suspect that until interest rates have a very notable rise, there's no need to worry about that for now.

The bottom line is that bull markets climb a wall of worry. So long as there are enough people worried out there it keeps expectations low and guards up which makes downturns in the market likely to be just temporary corrections. It's impossible to always know the timing of the corrections, how deep they will go and how long they last. The market is simply too random in the ST.  However, you still need to pick your spots. It's not wise to chase a market that has gone up in a straight line because after all, there is always going to be uncertainty. This is why I often use the words "likely" or "probably" because you can't know for sure what the market is going to do but the longer the time frame, the less "noise" plays a factor and so you should be making most of your bets on longer term time frames with strong conviction. It's also OK to not have any positions when there's no decent setups/entry points or when your conviction level is not strong either way. The market will always be there when you wake up the next morning.

Beware of bull trap

This move up we've seen out of the "trading range" doesn't feel right. Pull/call ratios have collapsed and bond yields have spiked quite a bit. I smell a trap...it feels too easy.  I've been mentioning lately how I felt that bonds yields were close to  a medium or long term bottom and so it's not too surprising to me to see this action but as I've said before, if you look at when notable corrections began, it coincided after a period of rising bond yields. Now mind you, one can make the case that since bond yields had declined so much, there could be plenty more unwind (rise) in bond yields before the market runs into trouble. That could very well be the case, however, it's all about risk reward. The risk/reward to go long when the market is overbought, put/call ratios have collapsed and bond yields have spike is simply not good. That's not necessarily an invitation to go short either but for a small ST downside play it's looking tempting. From a longer term perspective, there is still plenty of potential bullish fuel as fund flows continue to show cautiousness. There was a modest inflow last week which suggests maybe some folks are starting to poke their heads out from their hole..maybe.just in time for Mr. Market to whack it back down one more time before the real upside breakout occurs. I might end up being too cute here getting a little too fixated on the ST, but again, it's about risk/reward and I just don't like it here on the long side at this moment.

Deep thoughts

It's always a healthy endeavor to challenge your own views about the market and anything else that you have a belief about. After all, nobody can know with certainty what the future holds for the market and so to have an unwavering view is the wrong approach. It's quite often the case market pundits/gurus take a particular view on the market and dig in their heels no matter what, even when the market had made a complete and utter fool of them. Pride, ego, dogma all get in the way. To change their view and admit being wrong would be an act of weakness according to them. I've said this before, fuck pride and check your ego at the door. The market is not an exact science yet I've seen people act as if they cracked the code. Sometimes you will find a guru get a hot hand and for a period of times he/she looks like a genius only for them to go from genius to goat. This is why you should never take anyone's view's as gospel, no matter how right they have been in the past and why you have to own your own view. I do my best to synthesize my views by gathering objective info that has had predictive power, reading commentaries from people who have a good track record and by using experience/intuition. I've done this long enough to know that there are times when adjustments need to be made to my outlook or an outright 180 degree pivot i.e. an admission of being wrong.

I've been stating here for a while that I believe a bullish resolution will ultimately result here mainly due to evidence that indicates that investors in general have been primarily bearish/skeptical in the face of a prolonged market rally - this has been the primary thesis of my general bullishness during the entire bull market since 2009. The few times when complacency started creeping in, the market would eventually have a notable correction turning complacency back to fear/skepticism thus allowing the bull market to resume. But what if we are at a point where the economic fundamentals take such a turn for the worse that it would override the bullish implications of bearish sentiment? This is what happened in 2008. Bearish sentiment didn't matter because the fundamentals were so bad, mind you, 2008 was a 1 in 100 year type storm.  In a bear market when economic fundamentals are deteriorating, bearish sentiment is only natural and therefore loses contrarian implications until it reaches great extremes. The same can be said about bullish sentiment in a bull market.

Right now the economic fundamentals in the US are still generally good. There has been a lot of hysteria about the yield curve predicting an immanent recession but there has been no material signs of weakness in the hard data that would suggest one. Earnings are still growing and initial claims for unemployment insurance are trending flat/down for the past 12 months. If you look at previous recessions you will notice that claims had been creeping higher for the preceding 12 months or so.  So, as scary as the markets and headlines can be, it's critical to be as objective as possible. Can the yield curve be suggesting that we will soon see notable deterioration in the economy? It sure can, but  more supporting evidence needs to be seen and as I stated in prior posts, the fact that everyone is making such a big deal about the yield curve suggests to me that it won't be as effective in the recession call this time, much like how I remember in 2001 everyone jumping for joy when the Fed cut rates by 50 bps  because history showed that the market would be higher in 12 months.  But I would be lying if I said that I have no concerns about the yield curve. I do. It has to be respected but I would have to think that the thirst for positive yield around the globe must be distorting the message of the bond market to some notable degree however.

What really bothers me in the antics of Trump. When he bragged about the stock market making new record highs, that was quite cringe worthy.  I actually agree with his stance on China and his criticism of the Fed but the  manner in which he expresses his opinions are quite classless to say the least.  He seems to be going off the rails with his constant bashing of people and media on twitter which makes me think that one day he could somehow cause a black swan (orange swan?)  type of event.This is something that lots of people feared from the 1st day he took office. However, let's always remember this...despite Trump's hard line stance on China and the Fed you would have to assume he doesn't want to sabotage himself with elections taking place next year. I get the sense that all of these brutal twitter tactics could be just a front/posturing. He will end up softening his stance and get a trade deal done sooner rather than later I would suspect. Trump watches the stock market and uses it as leverage. He tends to announce higher tariffs when the stock market is near a high and then tries to sooth the market after it has come down. Ultimately, he wants a higher stock market and strong economy come election time next year. Trump could very will turn out to be an evil genius or utter buffoon which I'm sure lots of people already think the latter applies.

September has the potential to be turning point in the market with the FOMC meeting mid month and scheduled US China trade talks. Let's keep an eye on expectations for these. If people are too hopeful, we would probably see another downleg to this correction if there's anything short of a decisive rate cut and dovish stance by the Fed and/or meaningful progress on trade talks.

The most telegraphed recession? I wouldn't bet on it!

Recently the 2 and 10 year US government treasury yield curve spread became inverted creating all kinds of hysteria and fears about a recession, compounding the negative sentiment created by the trade war fears. Here are some headlines that appeared last Wednesday in the Globe and Mail.

"Inverted yield curve rattles investors wary of dying stock bull market"

"US Treasury bond curve inverts for first time since 2007 in recession warning"

"Countdown to recession: What an inverted yield curve means"

"Buying this dip is a losing proposition at this stage of the market cycle"

These headlines tell you the wall of worry is very much alive and well. If a US recession is immanent it would be the most telegraphed recession of all time! We know that Mr. Market doesn't make things this obvious. As per the motto of this blog which has held true over and over again, Mr. Market makes fools of the majority. The reason why is because the market is all knowing of whatever the consensus expectation is and hence it gets priced in accordingly.  All it takes is a little bit of news that goes contrary to the consensus and it will send the market sharply in the opposite direction. Furthermore, whenever there is a such a widely held concern/fear, you can bet that government authorities are well aware of it and will get motivated to take action to counter it in this post 2008 world. We are now hearing talks that European authorities are mulling over increased spending plans which is causing futures to surge as I type this. There is also hopes that Powell will hint at accelerated rate cuts in the Jackson hole meeting this week.

Could these hopes of Stimulus and Jackson hole be premature? Yes, but it just goes to show you that all it takes is a little bit of positive news in this environment of entrenched negative sentiment to trigger a strong upside move in the market.

A good analogy to describe the market would be this. If you know you're going to get punched in the head, you will put your guard up to protect yourself. You would still feel the punch but the force of it will be blunted and you won't get knocked out - that is the equivalent of what's been happening to the market recently with the trade ware and interest rate hysteria. These concerns have been well known and well feared all year which is why the market has only corrected and not cratered every time there is a flare up of these fears. Investors/traders have had their guard up the entire year for the most part. The punches that knock you out are the ones you don't see coming.

Ultimately, I expect a bullish resolution to this but as I've said many times, the ST is always difficult to navigate because you never know what the headlines are going to be when you wake up in the morning or if  fickle traders will flip flop from being too negative to too positive. Chasing the market to either the upside or downside has been a disaster for traders during this corrective phase.

Let's talk about bonds again....as I type this, the consensus view is that low US bond yields are not only justified but a bargain because rates are negative in Europe and Japan. This view is coming AFTER when bonds have had one the biggest rallies in years and are extremely overbought on multiple time frames! It reminds me of the global synchronized growth consensus of stocks in early 2018 at a time AFTER the market was extremely overbought on multiple time frames....we all know how that played out. The question I have for the bond bulls is this....where the fuck were you a year ago when bond prices were much lower? Oh wait...you were telling everyone to avoid bonds like the plague because the fed was raising rates! You were telling people that bond prices were overvalued and that the 10 year yield was heading to 4-5%. You were telling people who owned balanced portfolios that they need to look for an alternatives for the traditional fixed income part of their portfolio.

Right now expectations for bonds are very high at a time in which they are very overbought, not to mention having received a ton of inflows, again, just like with stocks coming into 2018. This makes bonds ripe for a classic rug pull from Mr. Market.  At the very least, it warrants one to not make any new purchases of bonds. In my view bonds are in a position that is vulnerable to a strong reversal of its primary trend the moment there are signs of economic and inflation  upturns. I would expect that a year from now we will see bond prices notably lower and hence yields notably higher than they are now.

Is the trade war a fugazi?

Since my last post markets climbed to hit new all time highs before suffering a sharp but relatively shallow correction. When the market was at its all time high there was little celebration with the exception of Trump on twitter. Equity fund flows continued to be generally negative/flat. There was a bit of complacency in the put/call ratios and some measures of sentiment like Investor's Intelligence and AAII sentiment did perk up a bit but no signs of the type of high complacency we saw in early 2018 which ultimately led to a 20% drop in the stock market.

Let's look at what triggered this correction. It was once again Trump induced via a slapping of additional tariffs on China. It's arguable as to the exact impact of the "trade war" but from what I can see it's going to end up being a fugazi, i.e. a red herring, i.e. it's not going to matter much when all is said and done. Ask yourself what has been the main drivers of the US economy? Trade with China would have to rank low on the list. This bull market has not been driven by US consumers buying cheap goods from China nor will it ever be.

Look back to what caused US recessions in the past - they were home grown issues that were at the heart of the US economy. They were credit crunches mainly due to housing downturns with an notable exception in 2000 which was due to a tech boom gone bust. In 2015/2016 when the energy sector had a major downturn, that was a good example of something that could have caused a recession since it was a notable sector in the US economy, but it didn't because it turned out not to be a large enough sector to infect the broader economy plus lower energy prices was a boon for consumers and non-energy businesses. It seems highly unlikely to me that any fallout from Chinese trade wars would be large enough to derail the US economy because it simply is not large enough to matter. What it does do is create angst, uncertainty and hesitancy which results in these types of corrections. This trade war may delay capital spending to some degree but I doubt it will be material enough to matter.

Throughout these past 10 years we have seen all sorts of worries/problems that made everyone fret. For instance in 2010 it was PIGS, in 2011 it was Moody's downgrade of US government debt, in 2013 it was the taper tantrum, in  2015/2016 it was energy. Ultimately, none of these things mattered much because they were not material enough to derail growth in the US economy.

Remember all the worries last year about the  $4 trillion corporate refinancing tsunami that was to set to hit starting 2019? Well, thanks to plummeting bond yields, corporations and consumers are be able to refinance at quite favorable terms...and they can thank the pessimists for that! Higher interest rates were a headwind in 2018 and they are now a tailwind in 2019.

So far this recent drop in the market appears to be wiping out the green shoots of complacency that I mentioned previously. Put/call ratios are soaring and the VIX has notably spiked. Let's see how AAII sentiment turns out this week. History suggest AAII bulls will be running for cover. It's always difficult to pinpoint the ST direction of the market but so far this has the look and feel of a correction, not something nastier.

A few comments about bonds. They are currently at the most overbought level since July 2017 if you look at how far below the 10 year yield is from its 200 DMA (33% below!). At the very least this suggests bond yields should be close to a medium term bottom and maybe even a long term bottom. Sentiment and fund flows for bonds also confirm this. A year ago everyone hated bonds and there were no "experts" recommending investors buy them as the expectation was for higher interest rates. Now everyone seems to think that US bonds are a bargain even with the 10 year at sub 2% because of the $14 trillion in negative yielding bonds out there.  Always remember the motto of this blog...I will be looking to buy puts on TLT soon.

Bullish resolution to all this is likely

The thing I love about following the market is that it's like watching a never ending TV drama series. The characters change over time but the storyline continues endlessly. Big events can happen out of nowhere and you're often speculating what could happen next. Then you have times where you know a major turning point/resolution in the drama is going to take place as a confluence of events are all leading up to a major event - like the wars that took place in Game of Thrones.

We have this type of war-like event between the bulls and bears that is taking place right now, the winner of which will determine whether we see a major breakout or breakdown in the market. It pretty much boils down to this: bears are arguing that a US reccession is immanent as per the signals in the US treasury curve, weak PMIs, slow global growth and  trade-war angst.  Bulls are arguing that Fed rate cuts would help cure the slope of the yield curve which is more of a reflection of safe haven flows and disinflation. They would also argue that notable signs of credit stress are not there while employment and earnings trends are still generally boyant -  conditions you don't see at the onset of a reccession. Bulls will argue that much of the uncertainty out there is a result of self inflicted wounds that can be undone by authorities via interest rate cuts and a resolution to the US-China trade dispute. Bulls can can also argue that the stock market is flirting with all time highs which also flies in the face of an oncoming recession.

So, who is going to win this epic battle? If the bears are right and we get a recession we are going to see the market head a lot lower. The average market decline in a recession is about 40% from the peak. If we avert a recession and global growth turns up again we going to see a major breakout and blow way past SPX 3000.  If we go by the motto of this blog it would suggest that the bulls will ultimately win.

I've discussed ad nauseam how there has been a persistent disbelief in this year's rally of the stock market as per fund flows. There is no change in this notion as of today even as the market hit marginal new all time highs.  This skeptical notion is also supported by the general defensive positioning by global fund managers and the anecdotal cautious tone of the financial media. There are some pockets of froth in the IPO market but you would have a tough time making the case that investors in general are giddy about the prospects of the stock market and the economy when you look at where the money is flowing to overall.

The above chart says it all. The investing public's track record is TERRIBLE when they sell en masse like now especially when they are doing it contrary to how strong the stock market has been preforming. Forget about what the experts and media pundits are saying and even your own personal views; just simply do the opposite of the public when they sell en masse - they are dumb money  The current situation is similar to late 2016 when the market was making an all time time high yet the public was selling notably. If you recall, there were recession fears earlier in that year too. The market eventually broke out to the upside in a major way as global growth recovered and the investing public capitulated their negativity. It looks like things are shaping up to have a bullish resolution  this time around too. You can't pinpoint exactly when that happens but such a resolution is very likely to happen before the year is over. In the meantime there will probably continue to be short term noise to both the upside and downside to keep everyone on edge and so if you try to play the upside using "tight stops" you will probably not succeed.

Fear is a great motivator

The market has been drifting lower since my last post and is back to the lowest point since the decline that began in early May started. I've mentioned how sentiment has been moving towards a bullish condition and it has moved even further still, however, it feels like to me that the market wants to head lower and we could very well see a whoosh down as  "support levels" get broken but with sentiment already negative as it is, such a sell-off should lead to the type of extremes you see at intermediate term lows rather the beginning of something much worse.

What's troubling the stock market? Seems to be the bearish message of the bond market is becoming too hard to ignore as inversion sets in even further along with some weaker than expected economic reports and of course, the trade drama which might be contributing to the  weaker data. It would seem these troubles are largely self inflicted. The bond market is clearly telling the Fed that it made a mistake with its last couple of rate hikes. Trump is trying to bully China like he did with Canada and Mexico but China is not caving in. It might very well have to be the case for the market to have a breakdown of significance to light a fire under the ass of government authorities to take a different course of action as it did in December and in all the other major declines since 2008. Fear is a great motivator.

Powell's bathwater must be getting really hot again. He must certainly now realize he made a mistake hiking in December. How can he not with the 2 and 5 year treasury bonds only 10 bps or so away from 2%? So when will the Fed cut rates? Are they going to wait until it's painfully obvious (and too late) or will they have the stones to do it sooner? A sharp decline in the stock market could do the trick again. Futures market is putting the odds of a rate cut by 2020 at 80%! Is this the case of the tail wagging to dog or the other way around? Powell once believed he was the dog but last December showed it was Mr. Market who was the dog!

Let me circle back to sentiment again. If we ignore the inversions, trade drama and such and just focus on the sentiment stats, it would appear that any downside we do get from here should be relatively limited because sentiment is already negative. I read an interesting report  a couple weeks back released by Bank of America which showed that global fund managers as a group ($600 billion assets) were underweight equities by one standard deviation, overweight cash and overweight bonds (7 year high weight). If you look at the history of this report on the positions of global fund managers it has served as a great medium-long term contrary indicator.

All in all, what I'm sensing is that although market action and some fundamental metrics such as the bond market inversion are sending bearish signs, if we do get a breakdown in the market it should likely set the stage for a low rather than the beginning of something nastier. Let's take it one step at a time and adjust accordingly if need be. As mentioned last post, navigating the ST is a tricky affair. The shorter the time frame the more randomness plays a factor. There can be a lot of noise which creates whipsaws especially when you have the Donald and his twitter account.

Blink and you miss it

AAII sentiment did a big u-turn this week showing bulls dropping to 30% and bears spiking to 39%.  Since the correction that began in early May started, bond yields have dropped notably back to YTD lows and we've seen fund flows go firmly negative. Put buying has exploded too even in the face of the strength these few days including today.  All this make fertile conditions for at least a ST bottom and I suspect we've probably seen the lows of this correction and we should be looking for long entry point here. I know what you're thinking....it would have been nice to know this a few days ago when the market was lower and I agree.  The problem is the sentiment data I track  is released weekly which means you may not be able to react to it at the ideal time.  Admittedly, I was hoping for the market to get a bit more oversold too, but alas, the market doesn't always give you what you want. In recent years it's been more common to see the market do V shaped recoveries which is frustrating for me. What this means is that you gotta risk catching falling knives if you hope to buy near the low points. If not and you wait for confirmation first, it can be hard to pull to trigger knowing you could have bought lower or you fear a retest of the lows which never ends up happening. Staggering entry points could be a way to overcome this....use say up to 50% of your intended position to buy during major weakness and the other 50% only when there's some sort of  confirmation. 

It's also important to not get too caught up in the ST wiggles of the market and think  more longer term because the ST is often very tricky to navigate through. and riding the bigger trend is where you can make big money. I found a really nice nugget of information suggesting that this market still has a long way to go before we get to the point of too much optimism. I'll share that in a later post.

The message of the bond market

Yields on US 2 year and 5 year bonds are now at about 2.18% which is notably below the Fed funds rate of 2.50%. I've discussed the meaning of this before but I want to rehash my thoughts here. Historically, when we've seen this it's a signal that the Fed is going to cut rates in the not too distant future i.e. less than 12 months and such a thing would typically be associated with a response to perceived economic weakness and if such a rate cut happens after a campaign of rate hikes, it has typically been a signpost of the economy rolling over into a recession, but that hasn't always been the case. In mid 1995 the fed cut rates by 25bps after having hiked them continuously in 1994. At that time, the market was near all time highs and there was concerns over economic growth. After that cut the market continued to make new all time highs and never looked back for years and the fed still cut rates another 50 bps before they stopped.  Here's what a headline from the NY times said back then:

"Under mounting political and economic pressure to stave off a possible recession, the Federal Reserve reduced short-term interest rates today for the first time since 1992.
Investors in the markets had been awaiting this meeting for weeks, as speculation intensified about how the Federal Reserve might respond to a string of Government statistics that showed a sharp slowdown in business activity. Some Fed officials as well as investors had begun to worry that inaction could lead to a plunge in the stock and bond markets that might make a recession more likely."

No two periods play out exactly the same but there can be rhymes. Given the pressure that Trump is putting on Powell and negative implications of tariffs at a time when there are  concerns about the economy as it is, we could indeed see rate cuts sometime this year. I'm sure lots of people would call a rate cut madness when we are at record low unemployment levels and no material indications of a recession, but the bond market is saying that rate cuts are going to happen. I called Powell's last hike in December a mistake and the bond market is pretty much saying the same thing, but like in 1995, if the fed were to cut rates and thereby admit they over-tightened a bit, it doesn't necessarily spell doom. In fact, it could be opposite. Look at how the market reacted in January when the Fed simply  backtracked on their plans for further hikes in 2019.

As I've said before major downturns are preceded by greed/complacency which we did not see prior to this drop in the market. You could argue that we did see such greed/complacency in early 2018 which I was pointing out, but I just don't think that it was such an extreme to have marked the end and furthermore, after the December meltdown the complacency of early 2018 got completely extinguished and has been replaced with worry. With the Uber and other "unicorn" IPOs that have recently came out, you could argue that greed/complacency was creeping back in, but as I've been pointing out repeatedly, there's been no equity inflows and a general lack of exuberance from the pundits/financial media as well. And let's not forget the fact that the market was up 18%  in 4 months...at some point it had to rest otherwise we'd be on pace for a 50%+  gain in 2019 which is pretty much impossible.

I know much of what I stated is arguable. So many things are subject to one's interpretation but that's just the way the it is. The market is not an exact science.  So, what is one to do? I say be pragmatic and tactical. Look for buying opportunities when there's signs of extreme negativity/capitulation and sell when you see complacency. In other words, only act when you see a perceived edge. If not, sit on your hands. But you got to be anticipatory to some degree. If you just wait for everything to be rosy you'll miss out.

AAII buys the dip

One of the key sentiment indicators I track AAII, is showing complacency in the face of market weakness. Bulls actually increased this week to 43% vs only 23% bears (34% neutral). When AAII buys the dip like this it's usually not a good sign for the market in the short term and when it's 2:1 bulls vs bears it's not an ideal time to buy regardless.  We've also had a lot of IPOs lately and so when combining all this with the latest Trump hissy fit, we shouldn't really be too surprised that the market is correcting here. We have had a hell of run so far this year and at some point the market has to cool off for one reason or another. As always, I'll keep an open mind as to whether this is the start of something really nasty but I don't think so at this point given what I discussed in my previous post. We'll see how things unfold....I am not considering any new buys untill I see AAII get bearish again and the market gets oversold.

The song remains the same

I continue to be amazed how this market is still not attracting buyers from retail investors. Here we are at new all time highs (albeit marginal) and yet STILL no positive net inflows! Compare this run in the market to the similar one from Sept 2017 to January 2018 where there was heavy inflows. Of course, back then we had all the "Global synchronized growth" chatter whereas now there it's the opposite. It's comfortable to buy when things look rosy like back then,  but it's also more dangerous because as I've said here many times, it's all about expectations. When expectations are high, lots of people get in the pool and all it takes is slight disappointment for there to be a severe correction.  Now we a have a situation where the market is rising relentlessly yet expectations have been fairly low all throughout it. That makes the rally likely to be a sustainable one with any dips likely to continue to be shallow.  What will it take for people to jump back in? Probably clear cut signs that the global economy has returned to growth mode, but the market is forward looking and so by the time you wait for the all clear you will have missed a lot of the move. But wait a second, what about the bearish signal of the bond market? Government bond yields continue to be low and bears are pointing this out as a non-confirmation of this rally i.e. the bond market sees things differently than the stock market and that the bond market is smarter. Well, I have seen times when the stock market has been smarter. Take for instance the behavior of the stock market vs bond market after the recession scare of 2011. The stock market correctly rallied in 2012 and 2013 which was not "confirmed" by the bond market until the first quarter of 2013. Oh but there was QE  back then and yada, yada, yada. There perma bears like zerohedge and the like have been making excuses since day fucking 1 and must of cost people who follow them God knows how much.

The bottom line is as I said before, .major corrections start AFTER there had been a major rise in bond yields. The greater the preceding rise in bond yields, the greater the correction tends to be. We have only seen a minor pop in yields since the end of March which suggests any correction at this point would be minor; the same message being given by the non-existence of fund inflows. Continued low bond yields and lack of exuberance  from mom and pop investor suggests the market can still power forward a lot higher before it's all said and done.

Inverted Reality

The big event of last week was the inverted yield curve in the US (it happened with Canada too). I have stated here years ago that we should look for the end of the bull market when we see 2 things: Greed and tight money i.e. inverted yield curve which has preceded the past 7 recessions. So let's examine this. Is there greed out there generally speaking? The answer is no. People are fretting about slowing global growth and despite the market having been on a tear all year and now only 5% from all time highs, there's essentially no net inflows to equities from the public. Sorry but that's not greed, that's worry. Now, we did see flashes of greed late 2017 to January 2018 via the bitcoin frenzy and the herd embracing the idea of global synchronized growth but by end of the 2018 any sort of optimism was extinguished and since then it's been back to the wall of worry type behavior that has characterized most of the bull run since 2009. We've gone from the notion of global synchronized growth to a global slowdown whereby everyone seems to be waiting for the next shoe to drop. Could the inverted yield curve be this shoe?

There is no denying the bearish implications of the yield curve and I'm not taking it lightly, but the fact that everyone and their grandmother is fretting about it makes me think that either a) it will be a false signal or b) it will still be a while before the market tops out for good. When the yield curve inverted in 2006 there was hardly anyone mentioning it and it still took 12 months before the market peaked. In 1998 the yield curve inverted very briefly just before the fed aggressively slashed rates to avert the LTCM induced market meltdown. That gave what appeared to be a dying bull market an adrenaline shot for 18 months.  History does show that even when the inverted yield curve is correct in predicting a recession, the market didn't top until 3-12 months later and so by means is an inverted yield curve a good short term indicator. With algos now dominating the landscape and everyone still on edge, it's no surprise that there was knee jerk reaction to the inversion which I believe is the reason for Friday's sell's off. The slide will probably continue for a bit longer if I had to guess, but ultimately I believe the market will hit and probably exceed all time highs before the end of year.

Not enough people in the pool

Well, so much for my call for a consolidation. The market has barely taken a breath since my last post and it's been nothing but an ass whipping for the bears but now market is ST overbought again.  The common refrain I hear explaining the strength of the market is anticipation of a US/China trade deal, but how many times is the market going to rally for the same reason? I believe the more likely reason for the relentless strength is the continued high level of skepticism from market participants as evident by equity fund flows aided and abetted by trapped bears at lower levels who are capitulating one by one. Amazingly, net equity inflows are still pretty much 0 despite the SPX  now being up 13% YTD! I figured by now we would have seen at least a moderate weekly inflow, but no!  AAII bull bear ratio has been hovering from neutral to moderate bullishness, not showing the type of extremes that make for good short term selling opportunities. The put/call ratio has been declining but at any hint of market weakness it's quick to rise indicating yet again that too many trader types have their guard up. All in all that's wall of worry behavior folks and I know very well this can all change on a dime but until you see evidence of a lot more people getting back into the pool, history shows there won't be enough fuel to spark a decline of major significance i.e. 5%+.  What will get people back into the pool? Perhaps clear evidence that growth is resuming again or maybe concrete news that a US/China deal has been sealed.


Here's another thing to note which ties into the same notion that downside will be limited as it stands now. Long term bond yields have been relatively subdued during this rebound. Bears have been pointing out that this is con-confirmation of this rally as it is pricing in slow/contracting growth ahead. That could be true but it could also be a reflection of disinflation, excessive pessimism and/or  European fixed income money looking for better yields. The German 10 year is 0%!  Whatever the reasons are, the fact of the matter is that if you look at recent history, the vast majority of the market's major corrections have happened after there has been a period of  sharply rising bond yields not declining yields.

You know what this rally reminds me a lot of now?  2012.  Back then like now we coming off a major market low by which the market dropped 20%. Back then like now economic growth was at stall speed and risks of a recession were elevated.  Back then like now the market rose relentlessly yet bond yields stayed stubbornly subdued for months. So what ended up happening? It wasn't until finally in mid March of 2012 that bond yields had a significant spike.  The market topped shortly afterward and eventually had a 10% correction but after that it was upwards and onward again as bond yields sharply dropped again and pessimism rapidly returned providing the fuel for the bull market to resume.

Bottom line: The risk reward on the long side is no longer worth it in the short run but the underlying skepticism that exists make the prospect of a large correction unlikely as the way things stand now. I believe a juicy short side opportunity will present itself when we see at least 2 of the 3 things happen: bond yields spike, notable equity inflows and AAII bull/bear sentiment 2:1. Until then, keep trades small and nimble or don't trade at all....don't trade for the sake of trading and don't ever try to get "revenge"on the market for a losing or missed trade. It's OK to just stand aside and do nothing. The market is not going away...wait for the prime opportunities.

Weekend Thoughts

The market has had a slight pullback which shouldn't really be a surprise after such a blistering rally in January. People are citing weak growth, trade tensions as the culprits but you could use any excuse you want such as Donald Trump took 2 dumps instead of 1 on Wednesday...it doesn't matter, because at some point the market was going to back off otherwise we would be on pace for a gain of 100% for the year. So, as I wrote before, a good clue to what the next major move will be is to examine expectations/sentiment. AAII bull bear ratio hit 1.7 : 1 just prior to when the market peaked on Wednesday.  I would call that reading mildly bearish for the market for the ST, however, AAII sentiment can be very fickle and it wouldn't surprise me to see AAII bulls run for cover next week if the market pulls back more or chops.

Here's a chart that really stood out to me

Despite January being one of the strongest months on record for the market, individual investors as a whole have not bought into it. That to me suggests this rally from the December low is likely the real deal or at the very least has staying power for a while longer, since this type of disbelief by mom and pop investor has always served as a great contrarian indicator. If this was a bear market rally it would more likely be the case for mom and pop investor to quickly jump back in fearing they will miss the boat. Maybe that happens later on but until it does, evidence suggests to expect a bullish resolution to whatever type of pullback or consolidation that takes place.

The bond markets continue to send a strong signal that interest rates aren't going up any time soon and that monetary policy may in fact be too tight given that US 1-5 year bonds are all pretty much right at the fed funds rate with the 10 year closing in too. You could make the case that the bond market is expecting the next move of the Fed is to cut rates. At the very least it's saying the Fed ain't hiking rates anytime soon. For a rate cut to take place it would be a complete 180 turn from just a couple months ago and I would suspect this to only happen if there was a serious concern about growth or some systematic stress. The message of the bond markets is for me, the most significant argument for the bear case in the medium to long term. 

I believe the next little while could make for good  hit and run opportunities to play the downside i.e.  establishing bearish positions into strength and holding positions for no longer than a day or 2.  Better be careful and keep an eye on the put/call ratio though...you don't want to make such bets if too many others are doing the same. 

Skate to where the puck is going to be not where it is now

A famous quote by the great one Wayne Gretzky. This is the kind of thinking you need you apply to the market. Last year at this time there was all this talk about "global synchronized growth". Remember that? What happened if you embraced that and skated to where the puck was? Now this catch phase has been flipped on its head and what we hear now all the time is "global synchronized slowdown".

I read an interesting article about the recent annual World Economic Forum in Davos which brings together a collection business leaders, economists, journalists, ect to discuss major issues and topics that are shaping the global  economic landscape. It's a great way to take the pulse of investment sentiment/expectations and as such, use as a contrary indicator.  The author suggested correctly last year that there was a sense of euphoria which was probably a warning that a cooling off phase was due. In 2016 the author claimed the mood was one of worry as there was a belief the global economy was on the brink of a global recession due to the collapse in oil. This year according to the same author, the mood is downbeat again as worries about economic growth are to use his words, "palpable".  What this tells me is that the wall of worry is back and expectations are sufficiently low for the bull market to resume. What about the bear case? For the bear case to play out, you are going to need to see things unravel very quickly much like what happened in the fall of 2008 - not the same level of economic damage as 2008, but rather one thing after another going bad causing growth the plunge even more sharply. Can this happen? Sure can but that's not a bet I'm willing to make at this time.

You can be assured that the sentiment reflected via Davos is one that the authority figures of the world i.e. policy makers and Fed heads are well aware of and probably share. They have learned from 2008 for better or worse, that doing nothing and just letting the markets "sort things out for themselves" like what happened with Lehman, is not the way and so expect policy responses. I wrote late last year that the more the market goes down in the short term the better it may be in long run as it will send a strong signal to authority figures that something is wrong. It took Powell a slap to the face, a left hook to the jaw and a rear naked choke hold  by Mr. Market for him to eventually get the message and shift his policy stance. You can expect similar responses from other authority figures. China has announced stimulus measures and I expect to see European policy makers act very soon too as Germany looks to be in technical recession right now. The hard core permabears will moan and complain about this being yet another kick of the can wringing their firsts saying "just you wait and see how badly this will end!" but that can has been kicked for decades. You will make no money being dogmatic self righteous.. Ya, maybe one day it will end really badly but when? Probably not until we get to the point of maximum complacency where it becomes common belief that authority figures have found a way to repeal the business cycle. 

A key difference between this slowdown vs 2016 and 2011 is that monetary policy is a lot tighter, relativity speaking and we're obviously closer to the end of the cycle. This makes the risk of the slowdown turning into outright recession higher vs those 2 previous times, but with sentiment sufficiently soured and authority figures now well aware of growth stalling/contracting and taking action, it would appear that the bulls have plenty of "outs" here.

Short term I could see the markets consolidating for a bit but I'll admit this is more guesswork than anything else. If the market works off the overbought condition without too much damage and sentiment stays at least neutral, we should see another leg up....wait and see/ 

My thoughts on the ETF movement

ETFs and passive investing has been all the rage these past few years and it's easy to see why. Stats show that most active fund managers can't beat their benchmark index and so it's better to just buy the index and save on fees as well. Seems like the smart thing to do right? It is, but think about what would happen if everyone just bought the indexes and nothing else. All that money pouring in would  hyper inflate the indexes on a bitcoin-like trajectory. In the short to medium term, fundamentals like p/e ratios and such wouldn't matter, it would all be about fund flows. So long as more money is coming in than is going out,  the indexes could soar to unlimited heights This is not unlike how bitcoin and other bubbles function, but as you know, all bubbles eventually burst and ALWAYS end badly. Obviously, not all the money is pouring into passive investments but there's definitely a big movement towards it in recent years. At what point do you call it a bubble and how do you know when the bubble is close to its peak? Very tough questions to answer because you can't really know for sure until after the fact, but there are symptoms of bubbles to watch for and anytime some investment strategy or sector becomes very popular with the general public you got the makings of a possible bubble.

Bubbles usually begin from sound premises which then get taken too far. The tech bubble that burst in 2000 originated from the sound premise in the mid 90s that the internet was going to revolutionize the world. The problem is that once something becomes embraced by the general public, greed and herd behavior can take things too far and whatever the sound premise was becomes a victim of its own success. I think we are seeing this play out with this movement towards passive investing but again,the key question is at what phase of the bubble are we in? Did the 3 month spike in inflows from November 2017-January 2018 mark the final top or is it just a temporary one? We will only know in hindsight, but my instincts tell me there's a good chance that it was not the final top and what we saw in December was a warning shot across the bow as to what will end up happening once the party is really over. For my hunch to be correct, it will hinge on whether this slowdown in the global economy can end soon and turn back up. If so, the bull market will resume and likely do so with a vengeance leading to what would likely be the final phase which could take 1-2 years to play out. In that final phase we would probably see ETF inflows surge once again with the SPX blowing past 3000. I'm not saying I expect this to happen for sure but rather that that it's a plausible possibility i.e. that the window of opportunity is there.

Try to picture yourself in 1998 when the markets dropped 20% 8 years into a bull market. Just prior to that peak the market was fundamentally very overvalued, more so than what it was at the peak of 2018 with interest rates notably higher back then too. Any reasonable person could have been inclined to believe that the bull market was over but it wasn't. Then just like now, the decline was largely due to global concerns while the US economy was relatively sound. I get that there's plenty of different circumstances now vs 98, but my point is that don't count out a bull market just because of valuations and its duration. Major global downturns which end bull markets like 2000-2002 and 2007-2008 have occurred when the US triggered it, not China, or Europe. It was the US that had the major issues which infected everyone else. Yes, this doesn't have to be a pre-requisite, but you have to be mindful of history and be open minded that this bull market can still be alive. So far as I've mentioned before, there is wall of worry behavior in this rally which supports this notion, but that could change. We'll just have to wait and see. Pick your spots and keep your emotions in check. Don't force trades.. .if you missed the bus another one will eventually come....the market is not going to disappear.

The wall is being built

First it seemed like Powel was reading my blog and now it's Chinese authorities lol! Just after I mentioned to watch for a Chinese stimulus package they announced one and now there's talk that a trade deal with the US is close, both of which helped fuel the rally this week. Perhaps this is why the market has been able to shrug off  bad earnings reports and embrace good ones. That's a nightmare situation for the bears and they've been taking it hard up the ass. Up until the last couple of days the put/call ratio was high throughout all of January. That tells me traders/hedgers have been fighting the the rally rather than embracing it. We saw AAII sentiment go from 1.3 bulls to bears to 1:1 bulls to bears despite the market being higher from last week - another sign of the rally not being embraced. Fund flows have been negative year to date despite the very strong start to the year - yet another sign the market has not been embraced. Now, mind you all of this can change in an instant but so far it suggest this rally has staying power i.e. any weakness would not be substantial.

Here's a chart that shows how margin debt plunged to the degree not last seen since the heart of the 2008 crisis.



This is a medium to long term bullish chart because it shows a significant degree of capitulation at the December low, admittedly notably more so than I had thought. Although November 2008 was not the final bear market low it was close to it and buying at that time would have paid off big time. Does this mean then that we could see a retest of the December lows in the near future? I wouldn't hold my breath. Back in late 2008 early 2009 it was pure economic chaos. We are far from that environment right now.

Bottom line: Wall of worry behavior with the market is back for now but it's always tough to chase after such a relentless move. If the sentiment dynamics don't change much I would expect any pullbacks to be relatively shallow.

What could go right? (revised)

I've been stressing the negatives I see out there lately and so in this post I will elaborate more as to what could go right and the evidence that suggests the December low was indeed a long term bottom.

There have been technical market stats that suggest the December low was a major washout event because the low was characterized by extreme selling following by extreme buying. This type of buying "thrust" is what you often see at a major bottom. Here's a comment from sentimentrader about a week ago:

The McClellan Oscillator has gone from -70 to +70 in less than 2 weeks. This happened 10 other times since 1962. All 10 saw the S&P 500 higher a year later. Its median return was +21.9%.

Stats like the above really makes me question bearish inclinations and rightfully so, but you have to take context into consideration. Questions that need to be asked are: At what point in the economic cycle did each of these 10 occurrences take place? What were monetary conditions like (easy or tight)? Was there any sort of government/fed intervention that accompany these signals? What about the stats pre-1962?" Without any context it isn't wise to blindly put faith in any one technical indicator. In addition, the trading environment of today's market is vastly different relative to the past given the dominance of algo trading and ETFs which can exacerbate volatility and may provide false signals. In January 2001 when the Fed cut rates by 50 bps I read about a statistic that showed when the Fed slashed rates by 50 bps or more, the market was up 12 months later every time except for 1929....that stat now reads "every time except 1929, 2001 and 2007."

I digress...I said that this post was supposed to be what could go right and so here are some positive headlines that could possibly transpire. The US and China reach a trade agreement and more importantly, China announces a stimulus package to boost its economy. The Fed doesn't raise rates at all this year and significantly slows or halts QT. European authorities resume their QE. The recent drop in long term mortgage rates stimulates home buyers and the US housing market recovers. If we see these things happen, it could end the global slowdown that's being going on. Let's also keep in mind that lower energy prices acts as a tax cut globally, although it will be drag on US and CDN energy producers.

Here is an interesting thing I came across. This  "Bear market Checklist" would suggest we did not see enough greed/euphoria to suggest a bull market top is in:

(chart removed due to copyright )

One critique you can make about this checklist is that the indicators used are arbitrary and some should carry more weight than others but despite this, it does suggest the strong possibility that the recent decline in the market could be a late cycle 1987 or 1998 type correction.

The bottom line here for me is that despite some ominous signs, the bear case is not a slam dunk. In the last 3 recessions there was a major sector that blew up which created enough damage to spill over into the general economy. In 1990 it was the savings and loans crisis, in 2000 it was tech bubble bursting, in 2008 it was the MBS/housing collapse. What could be the crisis this time? Could it be the massive amount of corporate debt refinancing that is scheduled to happen during the next 3 years? What if there is no single major crisis and we just simply see the economy roll over because of a multitude of smaller factors? We'll just have to wait and see.

Regarding the current earnings season, analyst expectations have been drastically reduced and in my opinion that's more of bullish sign than a bearish one

(chart removed due to copyright)

I saw this chart posted by someone on twitter who believed it was a bearish omen, but if you look at history you will see that sharp declines like this happened near bottoms or at the very least temporary bottoms like in late 2001 (after 911). Sharply lower expectations are bullish not bearish unless you have reason to believe that the lowered expectations are not low enough and will go lower still. That's not a good risk/reward set up given that the economy is not rolling over in a major way just yet. You can see that earnings revisions only got lower than current levels during the heart of the crisis in the fall 2008. The best time to make a bearish bet is when expectations are high not low.

So, all in all there's enough evidence to suggest that the bull case could be salvaged here and that the wall of worry may be in fact be rebuilding. I 'm still not giving the bulls the benefit of the doubt here but I can't give it to the bears either.   Color me market agnostic once again. As such, I think it would be appropriate to use a more active/tactical approach to the market until the picture becomes clearer.

Call me a flip flop if you will, it would not bother me a bit. You should not be loyal to any one side of the market and be willing to change your mind quickly if warranted. I see so many "gurus" make a call and stubbornly stick by it even when it's clear they are been wrong. It's because of pride and ego. Fuck pride when it comes to the market and check your ego at the door. The market doesn't give a fuck about your pride or what you think it should be "rightfully" doing. So many bears complain about about the Fed and government propping up the markets. That's like complaining about getting body checked in hockey. This is the way it is and instead of complaining, embrace it.  You don't like it? Then don't play.

Wait for premium set ups and don't press positions in either direction when the market becomes overbought/oversold. Let's see how people's expectations evolve as the markets go up and down and act accordingly.

So you wanna be a bear?

If you believe in the bear case you need to be aware of 2 things 1) The market ain't gonna make it easy for you to profit on the downside 2) you risk getting brainwashed by the permabears and miserable SOBs becoming one yourself. These are people who for one reason or another want the world to collapse and are always negative. You will not make money in the long run being a miserable fuck. When the markets are crumbling it's easy to get lured into believing the doom and gloom propaganda thinking that the world is going to end.  Don't be one of these losers.

Getting back to point 1). A bear market can have rallies that last several months. The more oversold the previous decline, the longer then ensuing rally could be. It's arguable that the rebound from last February's low was a bear market rally. Anyone who pressed their bearish bets or shorted the first rally from that low got smoked and no doubt wiped out/capitulated by the time October came around.  Look at how the market traded after it crashed due to 911. Although the market was still in bear mode, it fully recovered from that crash and then some. For the ensuing 6 months after the 911 low, bears got thier nuts crushed.

The market did get quite quite oversold in December and so don't be surprised if this rally lasts longer still after perhaps a pause. As I've stated before, it's very difficult and treacherous for both bulls and bears during a bear market because the headline risk is on both sides. You got weakening fundamentals on one hand and policy responses on the other. And in the early stages of a bear market the fundamental data is not uniformly weak as there will still be some positive data coming out that gives false hope - kind of like getting summer weather in early October. Then there's of course the possibility that December was indeed the bottom and the bull market of 2009 is resuming....we will only know in hindsight. I'm still not giving the bulls the benefit of the doubt here but I'm respectful of the notion that it could have indeed been the bottom because until we start to see weakening leading indicators translate to declining overall corporate earnings, the bear case is by no means assured and should not be fully embraced.  Slower earnings growth would not cut it - there has to be an outright contraction. At the end of the day it's earnings or the lack thereof, that drives the markets. Markets will always attempt to anticipate and front run turning points in earnings trends...sometimes it does so correctly, other times it doesn't!

Given elevated put/call ratios throughout this recent rally including today, it shows that too many bears have faded the rally and are helping to fuel it as they get squeezed and stopped out.  Now that the market is ST overbought I suspect that there will be a pause coming soon and I will be watching to see how people react to it. If markets go sideways for a bit, it may lure enough people back in before springing the trap door again. AAII bull to bear ratio is now at 1.3 to 1 and so the pessimism from Joe Q investor has unwound quite a bit.  If the bull/bear ratio gets closer to 2:1, it would be more indicative of an immanent intermediate term top.

When I get conflicting signals like this I step aside. Wait for that hanging curve ball before swinging. 

Weekend Thoughts

I know I've been posting a lot lately and that's because I'm trying really hard to sort out my thoughts. Let's assume for the moment that we are in a bear market. If that's the case the market is going to be treacherous for both bulls and bears alike. If you look back at the charts of the last 2 big bear markets  you will see them littered with plenty of sharp erratic dead cat bounces along the way down like the slope of a jagged mountain side. When despair becomes acute and bears  pile in, the market tends to stage vicious "hope" rallies often due to some sort of policy response/shift from authorities i.e. the fed or the government. However, it often takes several policy responses before the economy is able to finally turn around and so the hopes eventually turn to despair again.

If we are in the early innings of a big bad bear market, there's a good chance we will get a multi-month rally that retraces a significant amount of the initial first down leg. The rallies from March 2001- May 2001 and March 2008- May 2008 come to mind. Will we see the same thing this time around? If the market analog from 2007-2008 continues we will see the market retest the December lows sometime in about 1-2 months as bad economic news starts to appear. With earnings season to begin shortly that could be the catalyst...we'll soon see. I don't want to hang my hat on this analog though..

In terms of policy responses, we just saw the first one in that the Fed is now open to not raise rates this year and not have its balance sheet reduction on autopilot. If we are indeed in new bear market and on the brink of an economic contraction, this policy response is just the very beginning and we will end up seeing the Fed slashing rates aggressively before it's all over. Seems crazy to think this doesn't it? Look at the 5 year bond yield in the US which is at 2.5%. It is just about same yield as the 30 day T-bill rate which is about 2.4%. The bond market is pricing in that short term rates for the next 5 years on average will not be higher than present levels. If the economy is expected to be so strong, which would imply higher inflation and therefore higher interest rates, you would NOT see the bond market give this signal. Granted, bond market expectations can change but this type of signal is rare and has happened just prior to economic peaks.

I've seen bullish investors state that when the yield curve gets flat/inverted like this, you don't have to worry about it for another 6-12 months if you look at history. Well, I would buy that argument if the yield curve got inverted as the economy and the stock market was humming along nicely as it did in 2006 and the other times it happened.  That didn't happen this time around. The yield curve rapidly flattened  in the last couple of months due to weak global economic data with the stock market already well off its peak. This to me says that the danger is rather immanent and not 6-12 months away.

I know I could be wrong about all of this. What if I jumped the gun and the global economy and US somehow manage to skirt a recession?  I don't have a problem with being wrong but it's all about the probablities and the risk/reward set up. To position yourself for a bullish resolution to this (aside from a ST rally) when you see Fed complacency, ominous signals from the bond market, weak housing  and weakening  PMIs 9 years into an expansion, it is simply not a good risk/reward set up.

Near the January peak last year I mentioned that there were flashes of euphoria and there was complacency.  However it was not to the same degree that I remembered at the peak of 2000, but who's to say that 2000 should be the benchmark and that we have to see that type of giddiness to mark the peak? No 2 cycles are exactly alike and as I mentioned the other day, I believe there was enough bear market sign posts spotted to signal a bear market has arrived.

There has been a few similarities with investor behavior recently compared to that of 2000. In the last couple of years there was a big rush into ETFs similar to the rush of index mutual funds leading to the peak in 2000. Index fund investing has an appeal to it because of the low fees and the stats showing how they beat the majority of actively managed funds. The problem is that once any particular strategy becomes popular it eventually loses its effectiveness and will backfire. The motto of this blog always applies.We saw a big rush to robo advisors and commercials from Questrade bashing the traditional adviser telling people they could retire 30% richer by just investing on their own. This was reminiscent to the discount brokerage commercials in 1999 and 2000 telling people how easy it is to invest on your own and buy stocks. We saw people go crazy over bitcoin whereas in 1999-2000 it was internet stocks.

In terms of the economic climate, today is similar to 2000 - record long expansion, record low unemployment. However at the peak of 2000 there was this talk about the new economy and that the old boom and bust nature of the economy may no longer apply. We certainly didn't see that sort of arrogance but I don't think we necessarily have to in order to mark a top.

Whether I turn out to be right or wrong, one thing's for sure is that this is going to be a very interesting year in the market. If I'm wrong and this is just another 1998 type scare then I would suspect the market will go up over 20% this year.

The slope of hope

Back in December I wrote this:

Powell could have just hiked in December  and said "since the last time I addressed you, we have seen some signs of decelerating growth and a marked decline in short term inflationary pressures.  As such, we are going to be much more flexible with our original plans to hike rates next year and unwind the balance sheet."

In today's discussion with Yellen and Bernanke, Powell has now changed his stance by saying more or less what I said he should have said back in December.  He says now he's listening to the message of the markets and that the Fed will be flexible. That's a much needed first step in the right direction. However in my opinion, the Fed and market watchers in general are still too complacent in the face of what is clear evidence of a slowdown. They believe that despite the stock market dropping 20%, the slowdown in China and strong signals from the bond market indicating that rates are too high, the US will do just fine in 2019.  Having a complacent Fed is not a good thing. Back in mid 2007 when problems first started to surface in the US mortgage market with subprime, Bernanke's response was that this was a small part of the mortgage market which will be contained. We all know how that story played out.

What a change in attitude we're seeing now compared to what we saw from 2009-2012 when the Fed was super accommodating and alert to danger. Any hint of a problem and the Fed was all over it while market watchers/pundits were always quick to call the end of the bull market.

Despite the strong jobs report today, which is a lagging indicator,  we still have negative signals from forward looking indicators especially the bond market along with an ongoing global slowdown which appears to be picking up steam. It's great that the Fed changed its stance and moved towards flexibility which they were painfully slow in doing,  but it would appear that they already made the mistake of tightening too much.  The Fed went from "we are going to tighten 3 times in 2019" to  "we might take our time before tightening any further". The message of the bond market is "you will be cutting rates before you raise them" which shows that the fed is still well behind the curve. History suggests you listen to the bond markets and not the Fed. History suggests that being long term bullish when the 2 year bond yield is at or below the Fed Funds rate is not the right posture to have, 3rd year of the presidential cycle or not. How can anyone truly put faith into such nonsense?  I'm shocked to see how so many so called "professional" money managers have been mentioning this.


We will see how this ends up playing out. I've been around long enough to know that  bear markets have violent rallies which can last anywhere from a day to a few months to destroy bears that have piled in and to clear oversold conditions while luring in sidelined money afraid of missing the bottom. Such rallies are usually sparked by hope, in this case hope that the strong jobs report and this change in the Fed's posture is going to somehow negate the negatives we've been seeing and lead to better times. Pretty weak reason for hope if you ask me.  Bull markets climb a wall worry, bear markets decline on a slope of hope.

Market has Powell in a rear naked choke hold

Apple laid an egg and Manufacturing data showed a sharp drop. As a result, 2 year bonds are now  about 12 basis points BELOW the fed fund rate which hasn't happened since early 2008.  The 10 Year bond is closing in on 2.5%. The message is now loud and clear - the fed needs to cuts rates and do it NOW. The bond market is signaling that there will be a very swift drop in economic activity which is going to catch everyone off guard. Don't expect the jobs report tomorrow to reflect this as jobs are a lagging indicator.

Powell is now caught in a rear naked choke by Mr. Market. He tried to show everyone how tough he was, that he wouldn't be pushed around and now he's fucked. He will be forced tap out soon. I guarantee you this guy is not sleeping well.

Danger in 2019

There's an expression that goes "history doesn't repeat but it can rhyme". Well, there is quite the rhyme I see when comparing how the market looked like in the first few months after the peak in October 2007 vs October 2018. I'm not a fan of market analogs because no 2 time periods are alike but  but damn the similarities are uncanny! It's as close to a reply as I have ever seen with the main difference being that after the peak in October 2007 it took an extra month for the market to drop about 19% vs what happened this time around ...but just look at the significant peaks and troughs as circled...it's crazy scary how similar they are! It should also be noted that the VIX hit a high of about 37 near the January 2008 low whereas it hit about 36 at the December 2018 low, yet another important match!

2007-2008

2018-2019

So, let's have some fun with this analog and see what it predicts in the next couple months. According to the 2008 analog (not shown in the chart above) the market could have a little scoot higher before it will start to rollover and retest the lows which should happen within 1-2 months but I wouldn't put much faith in this analog playing out exactly the same way.  There are however some important fundamental and psychological similarities with 2008 and now.  First off, as I had discussed in a previous post there are significant signposts to indicate that a new bear market started in October. There are some holdouts but in my opinion there's enough to indicate that the bull market could have very well ended. There is currently not the same degree of economic weakness now compared to the start of 2008 but the global economy has indeed rolled over with the US Fed rather oblivious to it and still in tightening mode which in in my opinion is the most critical thing you need to have to kill a bull market.

Given what I see from the forecasts for 2019 by the "experts",  it is generally expected that there will be no recession and therefore the market will have a sizable rebound as valuations are now more reasonable along with this being the 3rd year of a presidential cycle which is historically market positive. That's not the sort of wall of worry type of expectation you would want to see. Granted, Wallstreet strategists typically have a bullish bias but in my opinion, there is too much bravado in the face of the decline we have seen. There are negative folks out there which is to be expected after a 20% drop, but I don't get the same run for cover feeling I got in 2011 when the market dropped 20%. Seems this time around  there are much more people inclined to view this as a buying opportunity rather than a signal to get out. And this time around we have a clueless Fed head in Powell who is pondering how much he should raise rates this year when in 2011 and other times the market dropped 20% and had a bullish resolution to it,  the Fed was on the ball and accommodating.

In February 2008, rates on 2 year treasuries were notably below the fed funds rate - a screaming signal that the Fed had to cut rates immediately which they did end up doing in March of 2008. The yield on 2 yr treasuries is presently at  2.5% which is the same as the Fed Funds rate - it's not a screaming signal but is still a strong signal that rates are too tight. It's suggesting that the Fed won't raise rates for 2 years and that implies a significant slowdown in the economy is coming at the very least. The bond market is telling the Fed it was wrong to tighten in December and that rates need to come down. Unfortunately, it looks like ego will make Powell very slow and reluctant to issue a mea culpa until its too late.

Greed and tight monetary policy. I've been saying for years, that's what kills bull markets. Did we see greed at the peak? We did see it in bitcoin but not in stocks in general, but we did see complacency. Monetary policy is not officially deemed as tight until the yield curve inverts however the curve is very flat and parts of the curve have inverted. As I mentioned with my previous post, because interest rates were so low for so long there will likely be a higher than normal sensitivity to rising rates and that could mean that the classic signs of yield curve inversion may not be needed to signal that monetary policy is too tight. A lot of those who are still bullish on the market are saying "relax, we have nothing to worry about until the yield curve inverts and even then the stock markets doesn't peak for another 6-12 months".  I think this is yet another sign of complacency given the emerging signs of weakness we are seeing in the economy. The consensus for a while has been that a recession won't happen until 2020. Well, how many times do the experts call a recession correctly? I can't recall if this has ever happened! Recessions and major declines by nature catch most people off guard.  "I didn't see this coming!" will tend to be response afterwards.  My guess is that a recession happens either in 2019 or in sometime after 2020. There is enough evidence to suggest that we can indeed get a recession in 2019. Still too soon to say for sure but the evidence is mounting.

Remember what I said about expectations when it comes to making bets and how the herd is often slow footed in acknowledging a change in a trend. In my opinion, expectations for the market is too high given weakening fundamentals and tight monetary policy. The Market can surely bounce further here after that December thumping but until fundamentals and/or the Fed change direction I don't expect rallies to be sustainable in the long term. If the US and China manage to secure a trade deal that should provide a relief rally but I don't think such a rally would be sustainable either.

By the way, Trump just said that the market decline in December was a "glitch". If you are bullish that should make you cringe!

I'm still going to be opened minded about how the market plays out this year but I can no longer give the bulls the benefit of the doubt as I have in the past. I believe you will need to have a trading approach to make money this year with the willingness to play the downside. The best way to play the downside is with put options because your risk is limited whereas if you short stocks the fear of unlimited losses and margin calls can do you in.

It's all about expectations

When it comes to betting on sports or the markets, you can make outsized returns by finding situations when expectations are very low or high when recent evidence suggests it shouldn't be. Often times high or low expectations are justified and so being contrarian for contrarian's sake won't work. Great betting opportunities will present themselves when the crowd is slow footed in reacting to evidence of an emerging trend because it has been so used to the prevailing trend or gets caught up in hype. In such situations you get to make a bet at a very favorable risk/reward ratio. Such situations don't happen very often. You need to be very patient and objective when analyzing the facts. .

Take for instance the bet I made on Liverpool FC to win the Premiere League title this year. Odds makers had given Liverpool only a 1 in 4 chance of this happening. I saw this as a major mispricing for the following reasons: 1) In the last third of the previous season Liverpool were arguably just as good if not better than the crowned Champions Manchester City and even beat them head to head. 2) Liverpool's run of good form late last season allowed them them to make it to the prestigious Champions League Final and only lost because of 2 horrific errors by their goalkeeper. Despite the unfortunate loss, this likely gave Liverpool the confidence to believe that they are one of the best teams in the world. 3)  Prior to the start of the current season they made significant acquisitions (including a top class goalkeeper) and were dominating games in the pre-season. 4) At the start of season start Manchester City's top player Keven De Bruyne was seriously injured and expected to miss 2-3 months.

So, the evidence suggested to me that coming into the season Liverpool were arguably just as good as Manchester City yet odds makers heavily favored Manchester City to win the League title again and only gave Liverpool a 1 in 4 chance to win. This bet was a steal. The market was very slow in appreciating the major turnaround in Liverpool and just how good they are relative to Manchester City because it based expectations on the distant past rather than the recent past and present. With half the season remaining, Liverpool have a commanding lead in the league and it's now theirs to lose.

In my next post I'll discuss what I believe are the expectations of the stock market in 2019.