Something truly rare is happening in markets.
This is the biggest report I’ve written since November, maybe the biggest I’ll write this year. There are no memes here. There are no bite-sized “takeaways” or “market calls”. Traders should take the time to carefully study what I’m sharing, then actively monitor the charts on their own going forward, and decide for themselves if any of this is important. Most charts in this report are in WEEKLY time frame. The data won’t change if markets trade down this morning and rally in the afternoon. The picture won’t change if a hot microcap Stock is up 80% tomorrow. These charts and their key message has been developing for months (and years) and won’t change overnight. Those who fail to understand time frames should stop reading (and shouldn’t be trading in the first place).
This post is for traders and students of market history. This means two things: (1) Readers with similar interests are always welcome/encouraged to write back and share technical charts with any interesting idea. (2) Anyone looking to talk about the Fed, politics, liquidity, epidemics, inequality, 1929, debt, please don’t bother sending comments (they will be spam-filtered and not read).
Before we begin, I’ll reiterate what I wrote in my last post a month ago:
For those who started following my work recently, you should know that I spent most of 2019 reiterating my extremely Bullish case for Global Equities, including a cyclical resurgence theme led by Semis, Tech, Banks and Industrials. For medium-term investors who don’t care much about short-term 1-2 month swings, I should add that my view is that 2020 as a whole should be favorable for Equities. Having said that, I am not a long-term investor – and if you’re like me, an Equity & Macro trader that cares very much if the S&P moves 5-10% against me, then what we have right now is a potential big problem brewing.
In that January post, I showed the extreme complacency building in options markets, and wrote:
If history is a guide, the risk-reward over the next 1-2 months is moving towards “extremely poor”, and we shouldn’t rule out a compressed (front-loaded) decline either. All that’s needed is a “catalyst”, as always just a narrative/excuse to trigger deleveraging.
Maybe Stocks will continue to grind a few points higher, generating even more extreme signals in the coming weeks. Personally, I don’t think the odds favor such an outcome – instability is rising significantly and there’s enough pressure accumulating that anything could trigger the start of a corrective phase into later Q1.
Also in January, I shared several charts on my Twitter page specifically highlighting my concern for extreme euphoria in Emerging Markets and extreme bearishness on the Dollar. Below are two of them, and those who want to read further are encouraged to look through my other tweets from that period.
From January 15: “Emerging Markets. Looking for signs of excess in Stocks? Here’s one: This rally has seen +150k $EEM Calls purchased over Puts. The last time this happened was… never. EM traders have gone from “Sell everything” to Buying 3X the prior record in just a few months. That’s alot.”
From January 13: “Dollar. Positioning getting extremely lopsided – and could soon become a contrarian Buy. Even more important, the highly sophisticated FX Dealers are quietly amassing one of the largest Long USD positions ever. History suggests not to fade them, especially with Vol this low.”
It’s been six weeks since then – what has happened? The biggest consensus trades from late 2019/early 2020 – sell Dollar, buy Cyclicals/China/EM – have all been challenged or completely run over. Most markets experienced significant drawdowns and many still haven’t recovered:
Five out of the seven main S&P cyclical Sectors have barely made any gains or are down since their January highs (Comm Services, Energy, Financials, Industrials, Materials). The Dow Jones Industrial Average, the Dow Transports and the Russell 2000 are all flat/down as well. Even the mighty SOX, the LEADER of last year’s cyclical resurgence (and my #1 most Bullish view for 2H19), has stopped going up. Most international markets topped in January and never recovered, some haven’t made any progress in almost two months – and including FX returns, things are even worse.
This may feel like a great market if you’re a U.S.-based growth stock trader or reddit options yoloer going all-in, but in the real world where real asset allocation decisions are made, losses are stretching out far and wide.
In normal times, these past weeks should have been enough to reset some of the froth that had accumulated in certain markets. But a new consensus trade has emerged since then, and has become more crowded than anything that came before it.
TECH OR NOTHING
Below, the NDX weekly RSI rose above 81 in late January, and again above 80 this week. This is among the TOP 23 weeks since inception of the index, a period of 1,815 weeks (35 years). This means it’s a TOP 1.3% event (98.7 percentile). Extremely rare.
Here is a history of the priors – note that I’m marking the PEAK RSI value in each case. This is extremely important because as of the time of writing, NDX is threatening to close the week with another POTENTIAL confirmed turn down in the weekly RSI – in other words, another potential peak may be forming this week.
NDX weekly RSI peaks 1985-1995
NDX weekly RSI peaks 1995-2002
Last but not least, the *only* extreme NDX RSI since 2000 – in January 2018:
But it gets even worse.
Below is an updated version of the chart I shared February 10 on Twitter:
The NDX/SPX ratio weekly RSI is in the TOP 11 weeks of all time. Over a period of 1,815 weeks (35 years), this means it’s a TOP 0.6% event (99.4 percentile). Similar to the prior charts, nearly all extreme overbought cases led to immediate relative & absolute losses – the only major exception was the Y2K Bubble, which extended higher only to collapse disastrously. Overall this doesn’t make it any less concerning.
To be clear, I don’t think we’re in a Bubble (yet) and I’m not saying a Bear market is coming. Time frames matter. History strongly suggests a sharp and violent shakeout is a reasonable base case over the next few weeks/months, in order to clear weak hands and eventually continue an even-more-parabolic ascent. Again this is extremely important because as of the time of writing, the NDX/S&P ratio is also threatening to close the week with another POTENTIAL confirmed turn down in the weekly RSI – in other words, another potential peak.
Unfortunately it gets even worse.
Something truly rare is happening in markets.
This is an updated version of the chart I shared February 10/18 on Twitter:
The Tech/SPX ratio weekly RSI just made a new ALL-TIME intraweek record (30 years). History being made – it’s never done this before. This prompted me to write the following earlier this week: “Tech has been invulnerable to bad news. A sharp repricing may seem impossible – mean-reversion could make it inevitable.”
Again, similar to the prior charts, most prior cases led to immediate relative & absolute losses. There were two minor exceptions in 2017, which still led to losses, albeit much smaller.
One important addendum before we continue:
Beware of spreadsheet traders with hidden agendas, who will invariably run these momentum signals and say that “on average, markets didn’t fall that much X days after”. Or the usual quip that there’s not enough historical signals to be robust. Or that past extremes are meaningless in today’s markets. These are largely inexperienced analysts (not traders), usually with an emotional need to be right, and think that running a linear regression qualifies as understanding how markets work. Markets aren’t linear (especially at the extremes), don’t trade in fixed time intervals, and certainly don’t follow average returns. Which is why I’ve hand-written all the prior cases in each chart. There is no debating the forward path of each prior signal, each case is clearly illustrated. Spreadsheet traders offer a lot of average stats (useless) but have very little in-depth understanding of historical Stock movements, because tables will never be substitutes for an actual inspection of the chart. Regardless of what happens next, historic cases led to significant losses with extremely negative skew, and any table showing average returns “weren’t that bad” is at best uninformed/lazy, or intentionally misleading. One can torture the data all they want, but they can’t change the chart. That price line is set in stone.
In summary, Markets trend strongly and should be respected, but they also *mean-revert spectacularly*, especially in the 1% of cases where Momentum gets historically extreme. Just be aware of this risk, even if the consensus seems to be completely ignoring it. Awareness is the first step to being prepared for a change in markets, should it come around.
Related, any permabull making an aggressive bet on another benign outcome, is just as irresponsible as permabears who have fought this rally for years. And there seems to be a growing number of the former:
A Bloomberg article last week (“Frenzied Speculators Propel Surge in Options Trading”) stated that:
Volumes for contracts tied to single stocks have surged in the past six weeks to all time high levels, according to Goldman Sachs. The growth has been so staggering that trading in the derivatives by notional value is almost on par with volumes in the underlying shares themselves. Spurring the growth are bullish wagers on Tesla, as well as mega caps that wield heft in the S&P 500 Index unseen for 20 years (Amazon, Apple, Alphabet and Microsoft).
It’s not just Option Volumes, but Skews are also being pushed to previously unimaginable heights: Call Skews in a number of key Stocks exploded higher last week – some hit the highest in data history (15 years). The prior record spikes were just before the major top in January 2018. Meanwhile flows into some Megacap Tech and Growth ETFs hit record highs over the last few weeks. Rampant speculation is in full display.
UNDER THE SURFACE, BREADTH IS NOT OK
Breadth may be one of the most misunderstood indicators out there. Rather than go into an extended discussion, or show the dozens of Markets/Sectors/Regions that have already peaked, I’ll just submit the following:
NYSE Breadth has been below 50% for almost a month now, even while the index hovers near the highs. This index contains 1,884 issues and is fairly representative of the broad market, including many Stocks that some people may not consider “American”. In that case, I submit the second chart below, showing the Nasdaq Composite which contains 2,709 issues and is even weaker than the NYSE Composite. Breadth is not good. It doesn’t mean the market has to collapse, but there’s enough vulnerability where any minor decline could be enough to trigger a significant downtrend.
ASSESSMENT OF GLOBAL MARKETS
Speaking for myself personally, this doesn’t read like a healthy environment where taking extreme risks is likely to be rewarded.
U.S. Ten-Year Yield is in full collapse. Can Stocks continue to float away if Yields breach the 2019 lows? At what point does this trigger a sentiment reaction?
U.S. Ten-Year Yield (continued). Here is the weekly chart:
AUDUSD weekly. Same question: what happens if this continues to trend lower for a few months?
Even in the U.S., the Dow essentially topped in January at log-channel resistance, with a magazine cover no less.
NDX managed to extend +4.8% from its January highs, only to test log-channel resistance, trigger historic RSI extremes as shown earlier, then yesterday right on cue came this magazine cover:
But it’s well beyond the cute magazine covers, and risk looks quite real:
Currency Volatility is rolling up from multi-decade lows.
The MSCI EM Currency Index topped in January and after a small failed bounce is beginning to collapse again.
Similarly, EEM made a failed breakout in January, and then a failed bounce to horizontal resistance in February, and now the daily trend is potentially turning down in full force.
Now look at USDCNH showing WEEKLY trend initiation, after BASING at the old highs for months. This may be one of the most important charts in the world right now, because of its enormous potential impact on cross-asset Volatility.
In summary, FX Volatility is rising from multi-decade lows. The Dollar is just beginning to initiate uptrends, accelerating from huge bases against most Major & EM Currencies (if I put all the charts here, I’d never finish this report).
Meanwhile all the various Global Equity Regions, Indexes and Sectors remain completely fractured, having topped 1-2 months ago. Bonds are rallying, Commodity/Cyclical Currencies are falling sharply, all hinting at a sharp deflationary backdrop. In this environment, what do you think is going to win out? Do all these forces now repair themselves and Tech continues to rally unabated? Does Tech just get “overboughter”?
VIX daily. Take a look at the massive, picture-perfect base forming here. Along with Daily cross up yesterday. The VIX bottomed in November, this isn’t an overnight thing. It takes months to build this kind of structure, with this potential energy – Forever and a Day. Like I said earlier, this isn’t going to change if Stocks fall in the morning and rally in the afternoon, or what Call options are being pumped today. There is something far bigger at stake here, and most traders are blissfully unaware. A number of Volatility charts looks like this. It’s not an isolated event, it’s widespread.
The VXN daily chart deserves a special mention. Look at the perfect stair-stepping pattern developing, and the base almost fully complete. Again, anyone who trades for a living will understand that this isn’t a CALL for anything to happen. All it says is IF Stocks are ready to start moving lower in the next few weeks, with Volatility exploding higher, this is pretty much a picture-perfect location where that behavior could start.
WHERE DO WE GO FROM HERE?
The story is still being written and there’s no way to know in advance. Anyone looking for absolute truths is in the wrong business. This is trading, where edges matter and risk control is everything.
All we know from history is:
- Comparable historic weekly momentum led to extremely sharp, violent shakeouts in Tech in particular.
- Corrections lasted weeks or even months, oftentimes the first leg down was the most violent, a common trait with extreme momentum signals. I encourage everyone to study the individual RSI signal dates showed earlier, and see (1) Which ones topped in January-February after Stocks ran up 10-15% the first weeks of the year (for instance 2018), (2) Where did Stocks correct on a chart basis (what was the prior support), (3) Did markets trade NEGATIVE for the year at any point after that? (4) How high did realized & implied Volatility go? (5) Perhaps most important of all, how much did Tech & NDX fall vs the broad S&P and Dow (what was the Beta)?
I hope this has been a helpful glimpse at markets from a slightly different perspective than what you may have seen elsewhere.
Markets appear unstable here. Very little is needed to unleash pent-up Volatility pressure. Relative factor Volatility and correlations could also rise, but in my view the biggest risk is a violent deleveraging of crowded consensus which has become deeply entrenched in U.S. markets and particularly Tech Stocks. I firmly believe that IF such a scenario materializes, it may present a unique opportunity to Buy growth Stocks in a moment of broad panic perhaps in the next few weeks or months.
Things may look easy now but it’s never easy inside the arena. Being concerned about markets here feels extremely difficult, even with overwhelming evidence suggesting problems are becoming too big to ignore. Time slows to a halt, watching the excesses accumulating for weeks and then converging onto a single point in time. It takes forever for a turn to materialize. And then it takes just one single day – and then everything changes.
Thanks for reading.
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