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.