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.
Thursday, May 16, 2019
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.
Monday, May 13, 2019
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.
"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.
Thursday, May 9, 2019
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.
Sunday, May 5, 2019
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.
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.
Sunday, March 24, 2019
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.
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.
Monday, February 25, 2019
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.
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.
Saturday, February 9, 2019
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
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.
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.
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