Speculation Mode: ON

Today is almost three months since I last posted on this blog, and it’s time to put some thoughts on paper again.

Standard disclaimer for new readers: email replies containing charts, market history and thoughtful analysis are always welcome. Any responses discussing geopolitical events or theories of how the world should work will be spam-filtered and not read. Also a warning: anyone sending inappropriate or disrespectful feedback will be permanently blocked. I won’t even read them, because someone helps me filter notifications. Lastly, (1) anyone who fails to understand the time frames being discussed in this report should stop reading (and shouldn’t be trading in the first place) and (2) anyone who trades based on any information contained herein is fully responsible for their own decisions.

For those who started following my work recently: I’m a trader running a hybrid strategy with two core components: (1) Core Models which tend to have anticipatory (early) characteristics, and help identify potentially critical scenarios & market opportunities. (2) Technical Models which continuously scan a Global single Stock universe in order to confirm IF those scenarios are turning active and actionable (and only then, requiring me to respond). Together, Core Models help me lock into ideas early, and Technical Models help me with timing/implementation.

As a quick background, I spent most of 2019 reiterating my extremely Bullish case for Global Equities, including a cyclical resurgence theme led by Semis & Tech. Between December 2019-February 2020 I began posting some early concerns on Twitter, which culminated in two major reports (January 10 and February 21) noting some of the extremes that had triggered in my Core AND Technical Models simultaneously. By March the market decline was in full force but also transitioned into an unprecedented meltdown. I began getting constructive in early March, again noting the early Core Model signals developing, and by mid-March all of my Technical Models were aligning for a Major potential buying opportunity in Stocks. Between March 19 and March 24 most of my Model data began to turn up sequentially, suggesting the market was at a potential turning point to the upside.

For new readers, I strongly recommend reading all the 2020 free blog reports in order to better understand how we got here. They illustrate the signal process I’ve described and how I apply leading, coincident, and lagging signals to build evidence for a potential important shift taking place. More importantly, it will also help understand what I’ll show here today and the potential timing implications.

Let’s get to it:

Some of what you’ll see below is familiar, and not coincidentally, was discussed on January 10.

First let’s start with the Put/Call Ratio (y-axis inverted for all charts), which earlier this week closed at 0.40, the lowest in six years (June 2014), and the 29th lowest one-day print in the last twenty years, a 0.60% frequency event. This is extremely rare and indicates pure euphoria developing in the Stock market, but experienced traders know it’s only one data point – within a bigger picture that is still in flux. For those who want to study this further: Helene Meisler (@hmeisler), a respected market analyst & writer, recently posted a thoughtful analysis on this signal, which I recommend reading here.

Next, we see the 10-day P/C Ratio has collapsed to 0.501 – in the most extreme 1% of days in the last twenty years – and just exceeded the extreme 0.502 made at the February peak (which was just a few days before Stocks turned down).

Lastly the 21-day P/C Ratio was at 0.580 a week ago and has collapsed to 0.532 – now in the most extreme 2.7% of days in the last twenty years – and less than three cents from the extreme 0.507 made at the January peak (which was a month before Stocks turned down). Having fallen at the pace of five cents in just a week, it could tie January’s extreme soon.

Unlike the January post, I didn’t show the P/C 50d today, which is moving rapidly to overbought but hasn’t reached an extreme yet. Maybe it will do so in a few weeks, maybe it won’t. All we can consider is what’s already on the table today.

I shared the above P/C Ratio charts on Twitter and said “monitor very closely from here”. Experienced traders know what this means, but some people don’t. Here’s what it means plain and simple: First, Stock traders need to become more aware and sensitive to any holding, Group or Sector that begins to show weakness particularly if markets continue grinding higher (there seems to be some evidence of this already). Second, Macro traders will be looking at the broader environment for deterioration: any bid to the Dollar (which we want to monitor as discussed here, especially as bank strategists are now calling for a “dramatic fall” in the Dollar and “five to ten years” of declines), any increase in Rates Volatility (might be starting as well), any stabilization in VIX (watch 200dma + August 2019 highs 24-25 area) and any Equity Sector/Geographic weakness developing. The more evidence we get that things are deteriorating under the surface, the more pressure Equities will continue to ignore (as usual) and then release all at once. In Q1 it took about a month, and if the same happens here, Q3 looks like a potential problem. This aligns with signals I’ve started to see in some Core Models, for instance one noted here.

In summary, the following quote from my January 10 report applies similarly today: “If markets continue to grind higher, they’ll likely generate some of the most extreme chart signals in history. It’s already happening in the Options markets, where extreme & historic complacency is now in full display:” It happened then, and the market held for another month, weakening under the surface and finally collapsing. With momentum still relatively strong today, it wouldn’t be surprising if a similar sequence played out. Again, this is my best guess using available information we have today. If you’re reading this from a future date, it will look easy in hindsight, but that’s illusion talking… and it’s never easy.

THE BIGGEST CONCERN

I spent the last several weeks noting the extremely lopsided Buying flows into ETFs focused on Tech, Healthcare, Growth (which is basically Tech & Healthcare) and High-Yield Credit. My Twitter feed has all those charts for reference, including this one updated below:

Everywhere across the ETF world, this “all-in” speculative behavior is in full display and growing.

Professional managers are all-in too. Below, Equity Mutual Funds are nearly tied for the highest exposure to Mega-cap Growth Stocks in a decade. This is consistent with the massive ETF buying of Tech, Healthcare & Growth – and it seriously challenges the consensus view that this rally is “hated”. Most importantly, these Funds represent Trillions of Dollars in managed Assets, far bigger than the Hedge Fund/CTA cohorts. Not shown but equally important, NAAIM fund manager data from this week also confirms this, as some Active Managers reported the highest exposure in months (and in the case of a subgroup, years).

Adding fuel to the fire, it seems every day a chart goes around showing Robinhood traders in a feeding frenzy over the latest fraud/bankrupt company and triggering a huge squeeze. They’re piling so aggressively into low-priced Stocks that the Volume in the Nasdaq Composite made a new record high this week:

To get a sense of the explosion in Speculative trading taking place, below is the Volume Ratio between the Nasdaq Composite and the S&P. (**Once again credit goes to Helene Meisler for the idea behind this chart, which she runs a variation using the NYSE Composite here.) This seems far from a pessimistic, risk-averse market. Maybe at this pace there will even be another classic contrarian magazine cover like the ones in Q1, who knows.

But what MOST concerns me here is, despite clear evidence that rampant speculation is all over the place in the Options, ETF, Mutual Fund and Retail flows, every day I continue to hear this rally is “hated”.

Even worse, over the past few weeks a new consensus has emerged that “Everyone is Short” Equity Futures. It’s one of the reasons I wanted to finally write today, and attempt to show what’s really going on.

While it’s true that Dollar Short amounts in Equity Futures are high relative to history, as a percentage of Open Interest, Speculators are Net Short an insignificant amount (just 1% of OI).

The most that Speculators were Short recently was just 2.2%. On one hand, it’s true that 2009 & 2018-2019 started with Net Shorts in a similar range of 2.2%-2.4% [purple dots] and the market rallied strongly. But it’s not entirely true as the Shorting in 2009 and 2018-2019 happened after the bottoms were in. This is particularly visible in the 2018-2019 case, note the light blue shaded area shows Specs put on Shorts several months after the bottom was already in.

In summary, a Net Short Futures position of 2.2%-2.4% of Open Interest didn’t have much historical significance for the most part. Overall, current positioning isn’t even close to the Bearishness seen at most big market lows of the last 20+ years. Compare the current levels to the [blue dots] – on average, Major lows were formed with Net Shorts at 5-10% of Open Interest – far bigger than the figures today. And addressing the “elephant in the room” – Specs were correctly Net Short throughout the entire 2008 decline and then turned Long into 4Q08-1Q09 as most of the decline was over.

So don’t put too much weight on a single data point suggesting “Everyone is Short” Equity Futures – especially when the weight of the evidence suggests investors of all stripes are now aggressively positioned in Stocks (and getting more so with each passing day). Hedge Funds & CTAs are the only groups still underinvested/neutral, but even they could change very quickly, in a flat market (which has happened before). The powder isn’t as dry as many seem to think here.

Keep a close eye on what the next few weeks bring. I believe markets could enter a window of critical importance, so it will be important to focus on the key signals as they come together. As before, I’ll share them here and on Twitter as they develop — so stay tuned.

Thanks for reading.

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