Halfway There and Back Again: Thoughts on Year-End and 2021

It’s been four months since I last posted on this blog, and it’s time to put some thoughts on paper again.

First things first: it’s been a long year, and I hope 2021 is better for everyone.

Second: for new readers, at the top of this previous report you will find the standard disclaimer & brief background of my views over the last few years. While you’re there, I recommend catching up on the other archived reports.

Third: I am a portfolio & fund manager and key advisor to pension funds, hedge funds and family offices. If you’re an institutional investor looking to expand capabilities or rules-based discretionary strategies, and in case the Volatility in 2020 makes you look for new alternatives heading into 2021, feel free to reach out. I’m flexible and can adapt to your needs – I can quickly assemble a strong team or help an existing one, while working effectively with key persons. In the past I have also taken on full-time roles that go well beyond advisory work. If interested please get in touch here. Thanks for your support.

Today we’ll begin with some thoughts on Trading and more importantly, Risk Management. I believe this will be essential as we head into 2021.

I’ve been doing this for some time, and the most fortunate aspect of this game is that we get to learn constantly, every day.

One of the most important things I learned in my career is that there are two main successful approaches to both Investing & Trading: (1) Anticipatory and (2) Reactive.

In the investment & trading game, there is no universal right way for everyone, only the right way for you. You may focus on being Reactive and be very successful: for instance Momentum & Trend-following (if price does X, it might do more X). You may focus on being Anticipatory and be equally successful: for instance Value & Mean-reversion (if price does X, it might undo X). Some people are hard-wired to think one way or the other, and that’s ok. I know many great traders (on Twitter and elsewhere) who successfully demonstrate this every day.

Blending the two approaches, there are some legendary (and by definition extremely rare) Traders who switch style according to market conditions. They become more Anticipatory or more Reactive, adapting to the flow of the market. They are the Generalists. I was fortunate to spend many years learning from some of them, and they gradually became mentors, shaping my approach to markets as it is today. You’ll see why this is so important as we dive into charts later on.

Most traders manage only their own capital, and some aggressively push for high returns without any hesitation even if they undergo multi-week drawdowns of 20%, 40% or even more. “Long until wrong” mentality works for these traders who have no mandate constraints, but it’s not reality for most institutional managers.

For traders who manage outside capital or firm capital, constraints are a nearly universal problem. I’m going to focus specifically on the institutional world here, where I’ve worked my entire career. When you advise or directly manage institutional capital, drawdowns of 10% (or even 5% at times) are not acceptable. Period. This is your primary constraint. This means you swing only when the pitch comes straight down the middle, and then you swing for the fences. If the pitch comes slightly off, you have to pass. A great year is up 10-15% with a 2-5% max drawdown. A bad year is down 5% with markets down 20%, because you don’t get paid on relative performance. There are myriad other constraints like Liquidity, which is getting worse with each passing year. You get the picture.

As a result of institutional constraints, 95% of my time is spent on anticipating & evaluating upcoming risks, while 5% of my time is spent acting on trades that swing for the fences. It’s homework 95% of the time, in order to be ready for the 5% full swing at the bat. Few people are hard-wired for this opportunistic trading; most people want to trade all the time. For instance, I got a laugh when, after posting a concerning chart (remember the 95%), someone yelled “you’ve been short since 1932” (in hindsight that was the day the market put in a nice top). Some people want all my comments to have a “Buy” or “Sell”, but it doesn’t work that way – like I said, only about 5% of the time.

Now that we’ve set the table, let’s talk about markets. This is my 95% time also known as homework time. If some of these big ideas come to pass, there’s a tremendous opportunity to Anticipate OR React to each one. And remember: this moment is a snapshot in time. Who knows when I’ll publish the next blog, and conditions will almost certainly change. If they do, you better believe I’ll have adapted to them. So don’t get stuck in one mode of thinking – “MC said this was a Buy/Sell!” (no I didn’t). Look at the conditions I’m highlighting throughout the text. If conditions change, trade accordingly. Anyone can keep track of this with some discipline. There’s no secret sauce… homework wins the race.

CONSOLIDATED THOUGHTS ON EQUITIES

U.S. Equities continued to recover last week, and the tape improvement suggests the September correction might be over. But in the bigger picture, I am concerned for several reasons:

  • First, traders have begun looking past the U.S. election & other key Macro catalysts and started aggressively pricing a favorable, low-risk outcome. How long this honeymoon lasts, nobody knows. But in a span of merely two weeks, sentiment has swung significantly, from a contested/hard scenario to a landslide/easy-stimulus scenario. As a result, some of the most speculative areas (for instance Solar Stocks, many with little institutional liquidity) have moved vertically, driven by (yet again) massive Call buying and Retail flows nearly identical to the “reopening/trash rally” back in late May-early June.
  • That late May-early June rally was driven by all the worst-performing & bankrupt stocks, some of which went up hundreds of percentage points only to come crashing down a few days later, as the last Shorts were squeezed and Retail flow dried up. More on this later.
  • The final move into the June peak was a 2-3 week affair which at the time, produced a very convincing Breadth Thrust at the exact TOP of the market. None of the analysts I spoke to at the time could recall this ever happening before. It was certainly unusual. Last week produced identical Breadth Thrusts in many of the same indicators. And this week the upswing will match the June rally duration at its peak – which may or may not be important, but needs to be watched closely for clues.
  • In a year which has been characterized by Speculative bursts around brief/unsustainable narratives, the current burst just seems like more of the same.
  • Recognizing this as potentially still the same difficult regime is critical, as we move forward into the final months of the year and 2021.
  • Despite last week’s tape improvement, many of my core concerns from late May/early June (when many deep cyclical U.S. and EU Stocks peaked and still haven’t recovered), reiterated again at the peak in late August/early September, remain mostly unresolved:
    • The September correction merely reset an extremely euphoric and highly unstable market condition back to neutral. The market peaked at a “Spinal Tap 11” and corrected to a neutral “5”, which left plenty of room to go the full distance back to “1”. This was unusual to say the least. Dip-buying flows were never tested or challenged (in fact Buyers stayed in business as usual mode). Put Volumes never spiked – not even for a day. Throughout history, Stocks corrected far less than they did in September, and many of those pullbacks produced Fear readings that were multiples higher. This time markets dropped 10-15% and no one blinked. Something looks off.
    • Macro positioning imbalances remain at historic extremes and subject to a major disruption event – catalyst unknown. Specifically, Bond AND Dollar Speculators in Futures markets remain stubbornly Short one of the largest combined notional positions in history. This extreme Bond and Dollar positioning is a Major potential source of instability – with significant impact for all risk assets and particularly Equities.
    • This is especially dangerous because Stocks appear to be trading well short-term (the usual names making new highs, Breadth perking up again as mentioned), but key Macro catalysts remain far from certain and could quickly set off a chain reaction.
    • Accordingly, I’m not sure this is a time to be aggressively positioned in anything.
    • To be clear – I’m not as concerned, in comparison to January or February for instance. But I’m concerned about further shakeouts (or worse) in consensus areas, particularly Tech and especially as we head into 2021.
    • The next weeks will be critical to gauge the follow-through potential of the Stock market – particularly the response to the tape improvement – and *IF* another short-term peak materializes, a C-wave capitulation scenario could still unfold (catalyst unknown). Ideally, another decline could finish what has (so far) been only a “Halfway-There” correction. More on this later.
    • Alternatively, *IF* Stocks accelerate higher with no pause (which could happen, and we’ll see soon enough), Momentum could drive another year-end blowoff similar to 7 of past 11 years: 2009, 2010, 2013, 2014, 2015, 2017 and 2019 – all of which led to extremely volatile conditions for 3-6 months following the start of the next calendar year.

Chart 1: Most Breadth Thrusts throughout history were extremely Bullish for Equities, particularly because they came after an oversold condition with capitulation selling. For decades, they were one of the most reliable signals one could look for, and were almost always associated with the start of new multi-year Bull Markets. This began to change after the mid-2000s. Many signals still delivered spectacular returns, but others just led to short-term gains and more market chop, while a few even failed completely. Case in point, see the last two signals below had similar features to the one which triggered last week – they (1) did not occur after a major decline, (2) nor had any sign of capitulation selling. As a result, both signals failed to follow-through meaningfully and in fact led to multi-week pullbacks in the market. Again, for a Retail investor who doesn’t care about 5-10% drawdowns, those signals were ok. But remember what I said about institutional trading and drawdown constraints – and pay close attention to the next few weeks as this could morph into another weak signal. Any lack of meaningful follow-through in the market would be an important red flag.

Additionally, while on average the past signal returns were great, one doesn’t earn past returns. One needs to think independently, try to gauge what regime/context this is, and then figure out what is the appropriate risk to take. The signal in late 2018/early 2019 led me to accumulate one of my largest Long exposures ever, and I remained Bullish through most of 2019 (for those who remember). The signal in 3Q19 led me to become even more optimistic (even writing a blog post at the time), but note how it did not follow-through according to expectations, at least not initially (first red flag). The signal in June 2020 led me to pay close attention, because I was concerned about Stocks – but the signal was positive. Something looked off, and in hindsight it was a tactical top (second red flag). What about the current signal? Based on “2020 rules of engagement”, I’m leaning towards: this pitch doesn’t seem straight down the middle. So, I simply won’t swing. It doesn’t mean you shouldn’t – and it doesn’t mean the world will end. Being aggressively Bullish here could work. But it’s not for me, and I’ll follow my process (as you should follow yours).

Chart 2: Here is how some of my Core Active Management & Timing Models looked right before the last election (I took down exposure gradually from mid-August onward, after the Sell signals visible on the chart began to trigger):

Chart 3: Here’s how things looked by the end of the year (2016). Pretty much what one would hope for in a reasonably well-functioning Model – despite all the noise surrounding that election event, it was a perfect pitch down the middle and I took a swing (via a combination of Anticipatory and Reactive positions, as the bottom was being formed and later when it was confirmed with the turn).

Chart 4: Heading into this election, here’s how things look now. The Long side could work here, but it’s not exactly the same setup. And there have been many occasions where similar signals turned down from this neutral area for a second oversold Buy entry (for instance – see the bounces in March 2018 and November 2018). Maybe IF this turns down at some point, there’s a chance for a C-wave capitulation selloff. But for now, the Model is still climbing, so Bulls have the ball until the Model turns.

Charts 5/6: Macro positioning imbalances remain at historic extremes and subject to a Major disruption event – catalyst unknown. Specifically, Bond AND Dollar Speculators remain stubbornly Short one of the largest combined notional positions in history. This extreme Bond and Dollar positioning is a Major potential source of instability – with significant impact for all risk assets and particularly Equities. And don’t forget Bond Volatility is at record-lows, usually a sign that things might have gone too far in one direction – where an Anticipatory approach for some mean-reversion could prove useful.

Charts previously shared on Twitter:

*Note: Some think the Bond Shorts are basis trades but public research has debunked this, showing more than half of the market was wiped out in March and never came back (old cats don’t sit on cold stoves). And there are always curve steepeners/flatteners involved in the positioning mix, which is why the chart is adjusted for Duration. Overall the picture looks fairly clear, suggesting Bond Shorts and the narratives around them are very extreme.

Chart 7: Positioning is so extreme in fact, this chart from JPM shows Speculators piling into Rate Steepeners at decade highs. Not shown in the chart, I checked the full history and the last time this happened was in 2006-2007, right before Bonds embarked on one of the biggest rallies of all time. This is the same message reinforced in the prior chart – should a Bond rally scenario materialize it would force many panicked Shorts to cover.

All of this is important because Macro relationships matter and $ Trillions of Dollars of institutional money will absolutely care if a meaningful, sustainable Correlation shift occurs among Major Asset classes.

Chart 8: I shared this chart on August 24 with the following comments: “The Dollar and Stocks have moved like a mirror image since March. Their correlation has collapsed to near the most negative in history. In a liquidity-driven market, the biggest risk could be any drop in liquidity triggering a USD rally.” The Correlation isn’t the cause of the problem, it’s a symptom. This is a liquidity-driven market. In a liquidity-driven market, the Dollar functions as the global pressure valve. Adding Trillions in liquidity to the system, the Dollar falls, and money is driven into risk assets. As liquidity recedes at the margin (which is happening for a while now), the Dollar begins to chop sideways or even rally sharply, and Equities suffer. This same dynamic was in place for much of the mid-2000s and early 2010s – see the long periods of negative Correlation in the chart below. In summary, these Correlation regimes can last longer than most people are prepared for. Absent some major shift in global fundamentals, there’s a good chance this Correlation regime could last well into 2021, and prove to be the most important relationship to watch, for all investors and traders.

Chart 9: As mentioned briefly earlier, the September pullback in Stocks was only a “halfway-there” correction in many key areas. For instance, S&P Daily Sentiment (data from trade-futures.com, one of the best subscription services for professional traders) bottomed at 44. For reference, before the last election it bottomed at 10. Most prior market corrections, even smaller ones in the 5-10% range, pushed Sentiment well below current levels. For instance in August 2019 a 6.8% pullback dropped DSI to 35, and in October 2019 a 5.5% pullback dropped DSI to 34. This time around Sentiment barely cracked below the halfway line – there was no real fear in the market. And the moving averages, including the one displayed in the chart, are still falling (after hitting the ceiling), a process which looks far from finished. Ideally, some more downside turbulence could help finish what has (so far) been only a “halfway-there” correction.

Charts 10/11/12: the September correction was highly unusual: dip-buying flows were never tested or challenged (Buyers didn’t even blink, and in some cases got more aggressive). Some Charts previously shared on Twitter:

  • This year, more than $15B flowed into the QQQ ETF alone. At one point just a few weeks ago this figure reached $19B. The first chart below shows $22 Billion in Net Flows over the last 12 months, one of the highest figures ever.
  • Nearly $50B has flowed into Tech Sector funds YTD (second chart below), non-stop record flows. Incredible how almost no net money went into 8 key Sectors, a winner-take-all market driven by extreme investor preferences.
  • In yet another chapter of the 2020 story that never ends, Calls on Tech Stocks and ETFs such as QQQ (third chart below) are still being bought aggressively – no fear at all despite the 14% drop in the market (and even bigger drops in key Tech names). Combined, this represents Trillions of Dollars in single-stock & ETF exposure.
  • Not shown, QQQ short interest is the lowest 2 years. The last time at similar levels was near the September/October 2018 peak in markets, a period characterized by significant complacency.

Moving along, here are some Global charts I’m watching as we head into Year-End and 2021. It’s not so clear this is a risk-on, “all systems go” environment just yet. It could turn out to be, but many areas remain in steep downtrends with no real evidence of a structural recovery. Their combined message matters, both fundamentally and for the longer-term health of the market:

CLOSING THOUGHTS ON MARKETS: YEAR-END AND 2021

2020 has been characterized by Speculative bursts around brief/unsustainable narratives. Narratives spread faster than ever, reaching consensus rapidly, running out of steam and reversing just as quickly. This doesn’t look like a Passive Management environment. Increasingly, it looks like an ideal world for Active Management. Adaptation is key.

In a world dominated by Passive investing, the price discovery mechanism may rely even more on the marginal Buyer/Seller, i.e. Active investors & traders. Combine this with (1) lower institutional-size daily liquidity and (2) a new generation of Retail investors who aren’t shy about trading highly speculative ideas, and the result is that Retail trading has grown to ~25-30% of U.S. equity market volume, according to major brokerage firm filings. A mere 10 years ago Retail traders were less than 10% of the market (if memory serves, this figure may have been closer to 5%). This is a stunning change, probably structural, and almost certainly accelerated by this year’s crisis.

Market dynamics are changing again, as they did in various phases throughout history. There’s enough evidence to suggest 2021 will require even more Active Management capabilities and resources, including effective, transparent rules-based systems for fast & flexible decision-making as markets shift.

Let’s imagine if Stocks were to go lower at some point, forcing policymakers to dish out more Liquidity. During such a panic, the Dollar and Bonds would perhaps rally sharply from forced Short-covering, while Stocks would lurch through a capitulation. Then right at the peak of the panic, a real cyclical recovery would begin, driven by a core fundamental global improvement.

Imagine for a moment, what Passive investor returns would look like if (1) the largest weight in Stock portfolios (Tech) were to decline significantly along with the rest of the market, (2) then underperformed in a fundamental recovery while beaten-down Deep Cyclicals (which no one owns) staged a historic rally, all while (3) Bond Yields rose sharply in tandem with growth expectations.

This combination would essentially be the most toxic Passive investing environment one can imagine. A fundamental cyclical Rotation might not carry enough market-weight to shield Equity indexes from the damage of an extended down-phase in mega-cap Tech Stocks. As a result, Indexed investors could tread water for an extended period of time. Passive investors are massively concentrated in these few Tech names whether they realize it or not. Trillions of dollars in Passive vehicles are tied to the least-diversified group of Stocks in the history of markets. Ironically, the whole concept of diversification for retirement has been thrown out the window. Any mean-reverting correction and subsequent extended underperformance in Tech, along with a rise in Bond Yields, would be a passive investor nightmare.

Will 2021 be the year for Active Management? No one knows, but I suspect maybe this time around just might do it. With Bond Volatility this low, it could just be a matter of time.

Just watch – and wait for the pitch to come straight down the middle.

Thanks for reading.

If you liked this post, please share it with colleagues, subscribe to the Blog to receive future updates, and follow me on Twitter for daily charts: @MacroCharts.

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).

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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.

If you liked this post, please share it with colleagues, subscribe to the Blog to receive future updates, and follow me on Twitter for daily charts: @MacroCharts.

Global Equities signalling Major Bullish Thrusts

In this report, I will discuss the following three topics:

(1) Exactly one month ago, I noted Emerging Markets were in a historic panic. Since then, they have slowly stabilized and rallied ahead of U.S., Europe and Japan. As I’ll present today, the rally in EM looks similar to the start of prior Major Bull markets.

(2) In a stunning new development, last week produced significant and compelling evidence that a Major Global Equity extension rally has ALSO started in the U.S., Europe and Japan. Today’s charts will show a powerful combination of Price & Breadth Thrusts has triggered simultaneously in every Major Global developed market.

(3) Throughout the report I’ll discuss potential implications of these signals, while also presenting various scenarios and areas of research going forward.

PART 1: EMERGING MARKETS TURNING UP FROM A HISTORIC BOTTOM

In chronological order:

On August 19, my EM Core Trend Model turned up from a historic oversold level. This was a critical signal I was tracking in my August report. I shared this chart on August 20 on Twitter, as critical initial evidence for a potential Major bottom in EM unfolding.

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Also on August 19, my Mexico MEXBOL Core Trend Model turned up from a historic oversold level. Similar turns identified most major bottoms since 2008 with only one failure (sideways from 4Q17-4Q18).

On August 21, 67% of South Korea KOSPI stocks triggered a MACD Buy Signal. I tweeted this chart the following day: “Starting to show signs of life… Similar to some historic bottoms. Look for a base to form, setting up potential Major rally.”

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On August 23, 72% of Hong Kong HSI stocks triggered a MACD Buy Signal. I wrote: “One of the biggest spikes of all time. ALL TEN priors led to massive 6-12M gains. Only one made new lows first (2015). Look for a base to form, setting up potential Major rally.”

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On August 29, 60% of Mexico MEXBOL stocks triggered a MACD Buy Signal. This confirmed the Core Trend Model Buy signal that had triggered ten days prior. I wrote: “One of the biggest spikes of all time. Seen at some historic bottoms, including both final bottoms in 2008. Look for a base to form, setting up potential Major rally.”

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Taken together, the massive number of signals in EM were indicating strong signs of a historic turn, similar to the start of prior Major Bull markets.

But EM alone wouldn’t be enough to carry Global Stocks higher…

PART 2: MAJOR BULL MARKET THRUSTS IN U.S., EUROPE AND JAPAN

A BRIEF DESCRIPTION OF THRUSTS AND THEIR IMPLICATIONS

Several legendary market technicians such as Wayne Whaley, Marty Zweig and Walter Deemer have studied the behavior of Price, Breadth and Volume Thrusts. While there are many important variations and calculations, Thrusts ultimately all measure the same thing — a rare but extremely important moment in time when Stock Buyers (demand) are overwhelming Stock Sellers (supply) for a sustained period, usually a few weeks. This extreme Buying is typically seen after Major Stock Market bottoms but can ALSO occur as Stocks are breaking out from extended consolidation periods.

Which brings us to what’s happening today…

UNITED STATES

Last week, U.S. Stocks triggered their SECOND Major Breadth Thrust of the year. This is one of several Major Breadth Thrust signals I track for the S&P 500 index (this specific one is based on Wayne Whaley’s PTA work). The first Thrust came right after the December 2018 bottom, a Major rally initiation signal.

I shared this chart on Twitter on September 16, noting “similar strength was seen in 2013 and 2016 as Stocks broke out of identical 2-year ranges. A new Bull Market extension rally may have begun, marking the end of the 20-month volatile trading range which began January 2018.”

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Later that day I added that “the entire market is showing massive strength. NYSE Composite triggered only the 5th Major Thrust in over a decade. Note the base at the highs. Russell 2000 triggered only the 6th Major Thrust in over a decade.” [*Note my NYSE Composite data is for Common Stocks only, sourced from my own proprietary database going back to the 1940s.]

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Now let’s add some charts I’ve never shown before:

Last week nearly half of Russell 2000 Stocks spiked above their Upper Band – a potential rally initiation signal identical to the ones last seen in 2011-2013 and 2016. This is a textbook type of Thrust within the category of Price Thrusts.

Also last week, nearly a third of Nasdaq Composite Stocks spiked above their Upper Band – another textbook rally initiation signal similar to the ones last seen in 2011-2013 and 2016.

So many Thrusts triggered across the major U.S. Indexes & Sectors that it may be impossible to cover them efficiently in a single report. The key message is — that the weight of the signal evidence suggests the U.S. market is in broad directional alignment and starting a potential historic Bull Market extension run.

JAPAN

Last week, nearly 70% of Nikkei Stocks spiked above their Upper Bands – an extremely powerful Price Thrust (rally initiation) signal last seen 2009, 2013 and 2014 – the start of historic runs in Japanese Stocks. Many thanks to @Reflexivity27 on Twitter for giving me the chart idea here, originally using the TOPIX index.

Further on Japan, last week nearly 80% of Nikkei Stocks made a new 4-Week high – another extremely powerful Thrust (rally initiation) signal last seen 2009, 2013 and 2014 – the start of historic runs in Japanese Stocks.

These Thrusts are coming right after a historic capitulation in Japanese Stocks:

Japan has been completely abandoned by Foreign Investors. This mass capitulation is how the last two major Bull markets started. Last week’s Thrusts should mark the beginning of a historic revival in appetite for Japan Stocks, adding massive fuel to the Bull run. The Nikkei quietly gained almost +4% last week, the TOPIX almost +5%, and the TOPIX Banks almost +9%. Very few people were talking about this.

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Further, Nikkei Volume is now starting to wake up from its slumber (original chart here). Note the initial Volume spike turning the moving average back up. This is a potential Major rally initiation pattern similar to 2013, 2014 and 2016. The buying stampede may have begun, likely aided by Foreign Investors rushing back into the market.

Critically, note these Thrusts are triggering right as the Nikkei appears to be completing a Major base at the prior highs from 1994-2015. In other words what was previously resistance for three decades may now be support. Meanwhile note the Monthly MACD curling up, in preparation for what could eventually turn into a Bullish cross identical to 2016. This cross would likely confirm a massive Bull market extension rally.

The Nikkei’s massive three-decade base is even more interesting on a Weekly scale, adding the 200-week moving average as a trend gauge. Note how the Nikkei just formed a double bottom on its rising 200wma, an almost identical repeat of the 2016 bottoming pattern. If this historic base is complete, could we soon enter the STEEPEST part of the price advance? This would be compatible with a market that has been totally abandoned by investors and beginning to show historic Thrust behavior.

EUROPE

The DAX just triggered one of the biggest Breadth Thrusts of the decade.

To save space I won’t show the full Europe signal list here. Rather, let’s look at some new ideas — for instance, the unique trend potential that’s ALREADY in place in Europe:

Below, the DAX has already completed a Monthly Bull cross at the zero line. This is a potential historic opportunity in the making, not just in the DAX but also across the entire European continent, as every other Major index has also completed a similar pattern (SX5E, FTSEMIB, CAC, to name a few).

Looking at the DAX’s weekly chart, note the completed Base at the 200wma and now in full 1-2 launch sequence. This is the identical pattern noted in the Nikkei earlier. Also note the Weekly MACD crossing up from the zero line. All time frames (M/W/D) are aligned to the Bull side, with Major Thrusts in place, and almost no one has any European Equity exposure (see chart on EU Equity exposure here).

Taking a last look at Europe, note the SX5E weekly chart with a box consolidation at the 200wma. Similar to the DAX, the weekly and monthly gauges have also turned up. Europe could finally have the energy to break its multi-year resistance line and trigger a Major Bull Market extension rally.

IN SUMMARY,

The weight of the evidence suggests Global Markets are in broad alignment and starting a potential historic Bull Market extension rally. Short-term moves notwithstanding, markets are sending a powerful message of strength which should be respected.

Historically, prior Bull Markets typically ended with epic rallies, usually lasting several months and with every region in the world participating. While it’s impossible to know if this Bull Market will follow the same script, one thing seems absolutely clear – almost no one is ready for such an outcome.

I believe this theme is of such critical importance, I’ll continue to focus on these major signals and share what I’m seeing here and on Twitter — so stay tuned.

Thanks for reading.

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Emerging Markets in a Historic Panic

There’s no other way to describe what’s currently happening in Emerging Markets.

To get everyone up to speed, I will start this post with some charts I shared on Twitter over the last week, and then share some new charts (never seen before), tying everything together at the end and making the case for a major potential opportunity in EM.

In chronological order:

On August 6, 61% of Stocks in the South Korea KOSPI Index hit oversold RSIs. Only two other times in history were more oversold: (1) The four trading days from October 24-29 2008 which included the KOSPI’s exact final bottom of the Bear market (October 27). (2) The only other day, October 29 2018, was the exact day the KOSPI bottomed last year. So far, August 6 was the exact day of the bottom in KOSPI for this year.

Also on August 6, 47.23% of Stocks in the South Korea KOSPI Index made new 52-Week Lows. I shared the below chart on Twitter with the following comments: in nearly 20 years, just ten days had more than 45% of Korean stocks at 52-Week Lows. August 6 was the 9th most oversold day in data history. The most recent spike (2018) led to an +18% rally. The other spikes (2003, 2008, 2011) led to career-making rallies.

On August 13 and 14, a historic 76% of Stocks in the Hong Kong HSI Index (H-Shares) hit oversold RSIs. This was one of the most negative extremes ever. Incredibly, H-Shares were nearly as oversold as their 2008 lows. Including last week, in the last 18 years just seven total days had more than 75% of H-Shares with Oversold RSIsLast Tuesday and Wednesday were the #5 and #6 most oversold days in history. After those spikes, a common pattern was for the market to spend some weeks forming a base, eventually transitioning to a multi-month rally. So far, August 14 was the closing low in the H-Shares index.

Now let’s look at some NEW charts that I researched and saved specifically for this report today:

My Emerging Markets Intermediate Breadth Oscillator is extremely compressed. Similar to the prior charts, this indicator shows the net amount of EM Stocks declining has reached nearly historic oversold levels. In most prior cases, this created a “ball held underwater” situation where EM Stocks ultimately responded with an extremely sharp rally. In some cases, a historic rally.

EEM ETF. Here too, we are witnessing history being made. This is the most liquid, most popular EM ETF in the world. And its NAV discount has reached one of biggest extremes of all time, indicating EM traders want to “sell at any price”This panic condition has produced some of the biggest bottoms in history, including the exact 2008 low, which was just barely more extreme than today.

My EM Core Trend Model is at major oversold Buy levels, already below the region where all EM bottoms formed since 2009. It’s important to mention that risk remains elevated while the model is still declining. Still, I’m looking for a turn up in the model to provide a clue that an important bottom has been made. The oversold conditions are so broad and historic, it’s possible that EM (particularly H-Shares and KOSPI) are bottoming before U.S. Markets. Hold that thought for now and I’ll talk more about this later.

As would be expected from a panic of this magnitude, the outflows have also been proportionally historic:

EEM Net Flows. Widespread selling should lay the groundwork for a bigger recovery later this year, as funds are forced to chase the recovery. Any residual price declines from here would likely make the capitulation even more extreme.

EWH Net Flows. Massive & historic outflows, second largest on record. Since this ETF’s inception 23+ years ago, the record outflow was back in 2013 during the Chinese bank liquidity crisis, when overnight SHIBOR spiked. Social mood and panic may be approaching similar proportions.

MCHI Net Flows. Biggest panic on record.

IEMG Net Flows. First outflows ever.

Next is a chart overlay of the H-Shares Index with USDHKD Risk Reversals. This shows that a wave of China Bear tourists are betting heavily against the Hong Kong Dollar in the currency options market, highlighted by the extreme and historic spike in Risk Reversal pricing. Historically, similar panics led to major bottoms in H-Shares and huge recovery rallies. I originally shared this chart on Twitter on August 14, with the following added comments: “Hong Kong’s leadership warned last week the city risked sliding into an “abyss”. With social mood and markets in mass capitulation, the bar for a recovery is very low.”

Finally, let’s take a look at two critical price charts I am watching.

HSI weekly chart held the nine-year horizontal shelf and the 200wma, closing last week with a potential Bullish hammer.

Last but not least, note how the EEM chart is potentially tracking for a bottoming scenario. I’ve been updating this scenario in real-time on Twitter over the last few weeks. Note the potential wedge structure in play – which could be missing a final mini-flush lower followed by Bullish reversal. It doesn’t have to play out exactly like this, but overall I think the message is that EM and particularly Asia Equities are close to a turn (and may have already bottomed for the most part).

IN SUMMARY,

Emerging Markets are in a historic panic — particularly Asian Equities which represent the bulk of Global EM market cap.

A major cluster of signals is coming together at this critical time, with the potential to form a historic bottom.

Additionally, since EM has been completely wiped out, it could be bottoming before U.S. Stocks. This happened many times throughout history. (*most famously, in 2001-2002 and 2008-2009). It also happened most recently in December 2018, when EEM made higher lows and continued to form a base while the S&P plunged another -16% in three weeks. I think any residual lows in U.S. markets over the next few weeks would help draw well-developed sideways/basing structures in EEM, EWH, EWY and FXI — setting up a Major Global Equity rally later this year. I believe this theme is so critical to monitor, I will dedicate the next several weeks to track and share everything I’m seeing here and on Twitter — so stay tuned.

Thanks for reading.

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Stocks and the Current Environment

Starting with some thoughts I tweeted on June 17:

Here’s a chart showing how extreme the selling/capitulation has been:

This is absolutely historic selling. Remember DotBust? Lehman? This is even more selling than seen at the depths of those recessions.

If a global recession is coming, it will be the most widely anticipated in history.

Everyone finally sold out perfectly at the top.

I’ve lost count of how many charts look like this, most at historic extremes. Every time I send one out, 90% of the responses are “this is 2008, crash coming”.

Take this next chart as an example:

Pretty self-explanatory. I shared it on Twitter with the following commentary:

The Russell 2000 has seen a historic wipeout in positioning (like everything else). Traders have completely abandoned this index, perhaps using it as a “hedge” against other holdings. Look at the bottom panel, showing Small Speculators in a historic selling capitulation, matched only by 2008. Extremely contrarian Bullish.

Then I added:

Now look at all the bottoms in the last 11 years. Small Traders were capitulating/selling in all of them. Forget Stocks for a moment. When Small Traders do this in any market, emotions are the primary factor. Avoid emotions, they are the enemy.

Here are some of the responses I received after posting these two charts:

“It says we are in 2008 all over again”

“Small Specs are smart money, this is right before a giant crash”

“Doesn’t matter, liquidity is falling and nothing can stop it”

“There is nothing but talk about how bearish everybody else is. Kind of funny”

“Translation: smart money leaving, dumb money overpaying”

Only one person responded to the first chart with the following:

“Looks like all were great entry points”

Every day since Stocks bottomed in early June, I continue to be surprised by how extreme the mood has become. And it’s not just the data. Even just talking to people it’s clear that a deep fear/anger has taken over. Emotions are at historic extremes.

I’ve kept a trading journal for over two decades. This is a shortened version of what I’ve observed these last few weeks:

  • Since Stocks bottomed in early June, it’s been a relentless rally only surpassed by the extreme reluctance to embrace it. Every single day it’s the same story, veiled in some fresh argument:
  • First I was told the rally was fake because it was all short-covering and not real buying. Then it was supposed to fail at resistance, as traders bought massive Puts and investors sold their longs (what little they had left) down to the bone, pushing my models to extreme oversold. As June FOMC approached, Stocks had supposedly gotten ahead of themselves and would peak on the Fed announcement. Then I was told Stocks barely rose after the announcement, which indicated buyer fatigue. The next day when Stocks exploded higher again, I was told the Fed was manipulating rates on behalf of the White House. Now with the S&P grinding highs “it’s too late to be bullish” (this is from an actual headline that came out last week). To top it off, on the day of the breakout last week, traders pulled billions out of SPY because they felt like being even more in cash.
  • Mass insanity is the only way to describe the last few weeks. The Bearish narrative is so entrenched that it still hasn’t adjusted to the fact that Stocks ran to new highs in almost a straight line. Bears were promised a recession, a deflationary bust, a trade crisis to last “the rest of our careers”, an “uninvestable anti-Tech mood”, “Tech’s glory days are over”, and “don’t take any risk in 2019” (these quotes are from various media articles published during this rally). And now, with Stocks at the highs the same people who missed the whole move say “it’s too late to be bullish”.
  • Paul Tudor Jones once said there is no training for the last third of a Bull market. There are very few people left in the business today who saw both the 2006-2007 Housing/Commodity/EM Bubble and the 1999-2000 Tech Bubble in real-time. The current environment is the complete opposite of those periods.
  • If the Bull market HASN’T ended, then it’s missing a classic “final third”.

Back to the same chart from earlier, adding some red lines:

This is the third time in this Bull market that Stocks recovered from a large correction but investor selling continued relentlessly. In 2012 and 2016, the selling persisted until Stocks had already pushed all the way back to previous highs. The following years were both massive extension rallies.

I can already hear the feedback…

“But it will end in tears just like [insert favorite year here] all over again, Short everything!”

Maybe it will end in tears. But I’m not sure that it has to end right here. One thing we can all agree on, is that history repeats itself. Just don’t forget it can also repeat itself on the upside.

IN SUMMARY…

This is one of the most extreme environments I’ve ever seen. Though I am far from certain, I think the path of maximum pain is higher. Stocks & Commodities are rising, the Dollar & Bonds may be headed lower. Central Bank liquidity is coming back, not just in the U.S. but all over the world.

Meanwhile against this backdrop, Stocks just posted the biggest first-half gain since 1997. You know what else last happened in 1997? Stocks broke to new highs with more individual investors leaning Bearish than Bullish (AAII survey). Who knows, maybe it’s time to dust off the old diary from the 1997-1999 “last third”, just in case.

Thanks for reading!

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The Most Important Force in Stocks

Tell me if you’ve heard this over the last ten years:

“The economy of [X] is more dependent on debt than ever before”

“Companies are issuing record debt to buy back stock, this will end badly”

“Debt is too high and the [economy/markets/savings/wealth] will [explode/implode]”

“The Bond rally is telling us something bad is coming”

Extra points if you’ve heard all of these from a market guru, famous economist, TV personality, ivy professor promoting a book, or ex-hedge fund manager with a blog.

Let me start by saying that markets don’t operate on absolutes. I’ve been trading for 25 years. In the arena every single day. In the middle of this organized chaos, I hear academics every day, taking turns shouting from the gilded seats, trying to be the one who predicts what happens next (always loud and full of confidence).

There is a simpler truth to markets. One that academics/noise-makers cannot grasp, yet all successful traders inherently understand: Sometimes things matter, other times they don’t.

A trader’s goal should be to constantly discard everything that doesn’t matter, so that what’s left is essential.

Let’s try this now, using a historical chart:

Top panel, S&P and 10-Year Yield. Bottom panel, 1-month Net Change in 10-Year Yield (2006-2019).

Now let’s add vertical red lines for every time the 10-Year Yield rises significantly over a 1-month period:

Looking above: see the spike in Yields in June 2007? That was the largest since 2004 (not shown). How about mid-2013, the Fed doing QE3/Infinity but the S&P still traded sideways from May to October, because Yields spiked three different times? Or 2015, Yields spiked twice and Stocks traded sideways for a year. Or most recently in 2018, Yields spiked in January & September and Stocks collapsed both times.

(Also notice above, how spikes have become far less frequent since 2013.)

Nothing works 100% of the time, and Yields have spiked on occasion with Stocks moving higher anyway (2016 a prime example). Nevertheless, over the last 15-20 years, rising Yields are usually bad for Stocks.

Now let’s add vertical green lines for every time the 10-Year Yield falls significantly over a 1-month period:

Recently on June 3 2019, Stocks may have formed an important bottom, after 10-Year Yields fell -47bps over the prior month. In the last four years, only one day had a bigger 1-month net drop in Yields: February 10 2016 (-51bps), which was the day before Stocks bottomed.

Once again nothing works perfectly, but Stocks generally do well after Yields fall sharply. So let’s go back to the start: is the recent Bond rally telling us something bad is coming?

Maybe.

Or maybe despite the loud chorus of sideline crisis-callers, the Bond rally may have just saved the economy (and the Stock market) yet again.

For this entire Bull market, yield declines of this magnitude have created huge runways for Stock prices to recover.

Bull trends die from inflation scares, not disinflation scares. Some of the biggest Stock corrections in recent years came after Yields rose sharply.

Equities love low-inflation/disinflationary growth. If there’s one “truth” in investing, this could be it. Disinflationary growth has kept this Stock Bull market plodding along for longer than anyone thought possible.

For more than a decade since this Bull market began, Stocks have been repeatedly hit with disinflation scares (mostly due to the Dollar rallying, like this year). Those scares pushed Yields sharply lower, clearing the way for Equities to recover, eluding the crash-callers each time. This latest Bond rally could rekindle the same old Bullish force for Stocks, right when the academics are rushing to call it a bad omen yet again.

Thanks for reading!

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Closing my Long USD positions

A quick background on my Dollar view:

I started buying USD-EMFX in March based on (1) my trend models suggesting a major potential move, (2) short-term momentum quietly shifting in favor of the Dollar, and (3) crowded carry positioning and extremely low volatility likely to blow up simultaneously and force deleveraging.

My main fundamental premise was that the economy was doing fine and the market was way too dovish on the Fed. At the time, consensus was looking completely the other way. The narrative was all about the “friendly Fed”. It all went out the window when Powell said low inflation is “transitory” on the May 1 FOMC – which in hindsight was also the day U.S. stocks topped and reversed.

What I’m seeing now that makes me want to rethink my Long USD view:

The Dollar’s rally is getting extremely stretched from a quantitative trend perspective. I thought it would take several months to achieve this, but it took only two. This was one of the most explosive Dollar rallies in such a short period of time, particularly against EM currencies.

The move looks unsustainable at this point – for instance here is the trend strength in USDKRW, which was my biggest Dollar-EMFX position until yesterday:

Here is the same chart for USDCNY. Look what happened to prices historically after similar extremes. A whole lot of nothing. Maybe it’s time to sell some straddles.

The Dollar’s strong momentum could have residual upside, particularly versus Asia on lingering trade war concerns, but I think it would be part of an “M-top” structure, where it chops sideways for a bigger Weekly momentum turn.

For instance, this is a USDKRW chart I tweeted yesterday:

In the chart above, note the M-top patterns in 2014, 2015, 2016 and even 2018 when the MACD got this elevated and rolled over. Incidentally the MACD finally crossed down this morning.

In summary, overall this Dollar move was much more extreme and sharp than I envisioned. Maybe this means it has more to run, particularly if the trade war escalates. Or maybe (I think) it’s close to pricing in a full-blown crisis. Asian FX & Stocks look particularly priced in, having experienced massive outflows in recent weeks. The adjustment looks mostly finished to me, and I prefer to take my hard-earned profits and move on to another opportunity…

I think the next big opportunity is to find the bottom for U.S./China stocks and get aggressive on the Long side. I’ve had this view for a couple of weeks, prices are getting close to my ideal levels and sentiment is almost in the basement. And if the Dollar’s momentum starts to slow, I think it could help underpin Stocks at the perfect time.

Thanks for reading!

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Approaching Tactical Bottom in U.S. Stocks

CORE MODELS

Extreme oversold signals suggest Tactical bottom approaching over the next 1-2 days. Look for reversal to confirm.

This is one of my Core U.S. Equity Risk models. It’s almost fully oversold and very close to a Tactical Buy signal. This suggests an elevated probability of a sharp retracement rally starting soon. This may be the first of two oversold signals similar to the 2016 structure I’ve been expecting (the second one later in October-November).

My Options Gamma Model also very oversold. Positioning may have gotten too negative and is vulnerable to a squeeze.

Several of my U.S. Core Flow models are also extremely oversold. I run several flow models for U.S. markets. Many are scraping the bottom of the barrel here. I haven’t seen a capitulation of this magnitude since February 2018, which is remarkable for a small correction of just 5% so far.

SCENARIO

PRICE

S&P may have residual downside to 200dma and lower band at 2750-2780 area. An undershoot could target 2720 but is less likely. Not shown, NYSE Composite and many key cyclicals are already at respective 200dma and lower band support. Looking for sharp rally possibly to the 2900 area (5-6%).

S&P Daily RSI has reached my minimum target for this initial leg. This is identical to the 2016 period. The market may need 1-2 stabs lower but I’m on high alert for intraday reversals. Stocks have four more days to finish the week. This is a long runway with models so oversold. Any rally later in the week could quickly feed on itself, especially with Gamma this negative. Stocks could still finish the week with a powerful weekly Hammer or bullish reversal.

TIME

S&P E-Mini has a pending Buy Setup that should complete in two days if the market just trades sideways from here. There is also a major Bradley Cycle Date on May 16, the exact day of the potential setup completion.

Adding it all up, this two-day window through Thursday looks like a potential setup for a Tactical turn. Accordingly I am switching my own trading bias to Buy on residual declines over the next 1-2 days. This is my personal trading plan based on my own objectives and risk tolerance, and not an investment recommendation. While I don’t think this is THE bottom, I do think Volatility will remain high and the potential for a sharp squeeze is increasing.

Thanks for reading!

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The Current Stock Market Correction

In late April, nearly four months into a historic Stock rally that began in late December 2018, I tweeted some Summary thoughts and suggested plan for Q2-Q3:

I proposed two core ideas at the time. In this note today, I will focus on the first idea — Stocks. My reasoning is based on some charts that really stood out to me at the time:

First, Stocks were very extended in late April and likely to switch to a volatile mean-reverting regime. On April 29, I tweeted the below chart, showing the S&P Technology sector’s trend strength at one of the highest in history. I added that “a major corrective phase is likely to occur this year, lasting several months. Could be a topping process like 2000. Or (as I believe) a multi-month big volatile consolidation similar to 1991, 1995, 2004, 2012.”

Note the red boxes I drew above. When Stock prices move significantly in one direction for a relatively short period of time, they exhibit very high trend strength. Eventually, this reaches an extreme and the strong trend is vulnerable to exhaustion. The result is a return of two-way volatility, usually a violent sideways consolidation. This is what the red boxes show. And that was my best guess in April for what was coming.

Stocks are now correcting, but I believe we are still in a Bull market. One can never been 100% certain in markets, but I think a Bull market is still the most likely scenario. Note in the prior chart — in 1991, 1995, 2004 and 2012, Stocks rallied strongly and then consolidated bullishly for several months, ultimately moving higher.

I also think this is more likely to be a single digit correction, not another severe decline like last year. To illustrate why I think we’re in a Bull market, and why the correction should be relatively mild, I present the chart below: in late April nearly 80% of S&P stocks were trading above their 200dmas. The key condition to evaluate is: is Stock Breadth ABOVE or BELOW the 50% line?

At the time, I tweeted this chart and wrote it’s “reminiscent of the 2016 rally which reached 78% before two pullbacks that held above 50%. This is very positive longer-term. Market likely to correct through time, maybe 5-10% downside volatility next 3-6M.”

Further, notice above that the most violent declines of the last several years: August 2015, January 2016 and December 2018, all shared the same weak Breadth characteristics under 50%. (In fact this is a recurring feature of virtually every big Stock decline of the last 100 years.) Even late last year, note the red “X” in October-November 2018. That’s where Breadth failed to exceed 50% and soon after, the market collapsed in a second selling wave.

For reference, here is the same Breadth indicator from 2005-2009. Note the 2008 Bear Market began when the indicator failed under the 50% line. I marked it with a vertical line below. Soon after that, Stocks finished their topping process and began to decline in earnest. When I look back at the chart from April 2019, it’s a long way from any serious weakness and still looks like a Bull market.

I’ll add more charts next, but it’s important not to forget this simple concept illustrated above. In markets, I believe the simplest ideas are the most powerful. What is simple is often misunderstood. When I started in markets, I thought the most complex indicators would give the best results. I searched far and wide looking for answers. In those early years, my quest for more information led to an advancement in my theoretical understanding, but yielded few practical insights. When I decided to refocus on the right things, everything changed. The most important lesson I learned in those early days was: the market had been communicating the message all along, and simplifying my focus allowed me to listen.

Now let’s go one step further.

The next chart is from an idea I tweeted on May 7, where I noted the “Nasdaq Composite with roughly half its Stocks trading >200dma (red series), similar to where the initial rally topped in April 2016. Intermediate breadth weakening, just 56% trading >50dma (blue series). When this breaks below the 50% line, a correction is likely to be underway.”

Unlike S&P Breadth which as we just saw earlier, got very high at almost 80% of Stocks > 200dma, the Nasdaq Composite Breadth was much weaker and still under 50%. Below is an updated version of that chart. Note that 200d Breadth never did get above 50% and now 50d Breadth is moving back under the 50% line. Not surprisingly, we’re starting to see Volatility creep up again.

There are some striking similarities between the current market and some important prior periods. Let’s look at what they are, and what it could mean.

On May 2, Michael Santoli of CNBC noted the following on Trading Nation:

“As S&P 500 sits at a record, nearly a quarter of stocks are still stuck in a bear market […] at least 20% from 52-week highs.”

This weakness is important to study and discuss. I made this chart to illustrate the idea, with some of my own annotations and thoughts added. What we have is a market that rallied back to prior highs, similar to 2012 and 2016, but many Stocks are still more than 20% below their own highs. In other words, the Trend is strong but Breadth participation is weak.

What happened in 2012 and 2016? Stocks spent months basing near the highs, with two separate pullbacks each time. Exactly like the volatile “red box” consolidations from the very first chart, where we talked about the Trend strength being too high and the mean-reversion that ensued. Everything is tied together and related.

Corrections come when uptrends become extended and Breadth can’t keep up. In 2012 and 2016, the result was that Stocks needed time to rest and gather the energy to move higher.

First, let’s look at 2012:

Now let’s look at 2016:

And back to today:

What could this all mean, and what could we see from here? Following the Summary thoughts shared at the top of this note, here are some ideas I’m carefully balancing and considering, while remaining focused on the bigger picture (and keeping it simple):

  • We may be more than halfway through this correction in terms of price. If the 2012 and 2016 interpretations are correct, and we remain in a Bull market as I believe, the S&P index could perhaps bottom in the low 2700s.
  • Historically, Stocks went through mean-reverting phases that lasted 3-6 months and we’re still not even a month into this one. So it seems we could still be in the very early stages of this process, in terms of time.
  • This could provide plenty of opportunity to slowly accumulate good Stocks as weak hands lose patience, get frustrated or shaken out.
  • It seems the market’s goal here is to frustrate Bulls and Bears with a lot of erratic price movement, while ultimately making little net progress either way.
  • Because of the extreme volatility of 2018, some may fear this will become another massive decline. Since Mr. Market never makes things easy, a sideways range could be equally if not more difficult to deal with.
  • Looking back at history, the good news is that once 2012 and 2016 were out of the way, the following years were excellent for Stocks. The S&P advanced 30% in 2013 and 20% in 2017.
  • Those great advances weren’t a coincidence. Stocks had worked off their extended condition through time, while Breadth improved gradually and individual names began to catch up.
  • When Stocks had finally gathered the energy to rally again, the breakout came and they never looked back. Maybe we’ll see something similar later this year, when everyone becomes exhausted of the headlines and volatility.


Thanks for reading.

If you liked this post, feel free to share it with colleagues and subscribe to the blog to receive future updates. I’ll be revisiting this theme and many others over the next months, on my Twitter account and in bigger thematic pieces here.

Welcome to Macro Charts!

Look for regular content here soon! Feel free to subscribe if you’d like to receive future posts.

Here is an initial outline with some topics & ideas I might write about more regularly:

  • Single-topic posts such as comparisons between historic market environments, a chart run of a topic I’m exploring, scenarios/probability analysis and risk management.
  • Data analysis & Model discussion using unique and practical datasets I’ve created over the years.
  • Some educational resources. For instance, how I learned to use market indicators more effectively, common myths & misconceptions about markets, and links to relevant academic research.
  • Weekly Summary of my Tweets in a convenient single archive.
  • Short Commentary on a recent market development that could be important (most aren’t).
  • Bigger thematic reviews tying major markets together.
  • Suggestions and ideas received from readers.
  • Stories and experiences from trading global markets over 25 years.

Why am I doing this?

  • It’s a small world and I’m always looking to meet smart people with diverse interests.
  • Keeping a blog diary and reviewing it later on helps improve my process and my thinking.
  • Paying it forward: maybe some of what I’ve learned can help or inspire someone on their own path to success.

Look forward to this new and exciting journey.