When climbing peaks in the Alps, the High Sierras, or the Himalayas, you know you?re getting close to the top when the air becomes thin, it is difficult to breathe, and your nose suddenly starts to bleed. I remember trying to smoke a cigarette at 20,000 feet on Mount Everest. If you didn?t keep puffing it went out immediately because of the lack of oxygen.
I am starting to suffer from a similar woozy feeling from the US stock markets. I have long since quit smoking, but the higher the indexes go, the more light headed I feel.
Take a look at the chart below produced last Friday by my friends at StockCharts.com. It shows the NYSE advance-decline ratio smoothed by a five day moving average. We have since blasted through to a new high for the year. The last time we were this high in July, the S&P 500 commenced a 23% swan dive down to 1068.
If you failed to protect yourself from this gut churning plunge, there is a good chance your clients fired you at the end of last year and you are now trolling through Craigslist looking for new employment opportunities. If you did follow the advice of this letter at the time, you sold short the S&P 500, the Russell 2000, gold, the Euro, and the Swiss franc. That enabled you to make a bundle, and your clients are now showering new money upon you.
I was hoping a sweet spot would set up that would allow me to pick up some meaty short positions, like the leveraged short (SDS) and put options, once a squeeze took us up to 1,350 in the S&P 500. Looking at the slow, low volume grind we are getting, I may not get my wish. Instead, we may get a choppy, rolling type top at a lower level that frustrates the hell out of everyone. We could top out as low as 1,312 instead. Every hedge fund trader I know is just sitting on his hands waiting for a decent entry point to present itself.
Aggressive traders may start scaling in short positions from here in small pieces. Until then, discretion is the better part of valor. Only buy here if your clients have a long term view, a very long term view.
Today was a real head scratcher for long time market observers, including myself. Cross market correlations that have served me so well this year are breaking down, and their predictive power has suddenly gone blind. I blame this on the liquidity drought that has plagued the market since the beginning of the month that has confined markets to frustratingly narrow ranges.
There are many reasons for the sudden opacity. The usual seasonal flight to the sidelines seems more pronounced than in years past, as many managers attempt to put a dreadful year behind them. There is still $500 million in trading capital missing from traders who used MF Global as a prime broker. This is especially felt in the energy and metals markets where MF had such a large presence.
High frequency traders have also decamped for more fertile climes in the oil and foreign exchange markets. And we all know that the big hedge funds are getting redemptions, cutting them off at the knees until January.
I?ll give you a few examples. Falling stock markets almost always produce a rising volatility index. But today it fell as low as 23%, a five month low, and closed at only 25.4% even with the Dow off 66 points. The correlation between stocks and gold has been almost perfect since the summer. But the barbarous relic has been in free fall since yesterday with the S&P 500 essentially unchanged. Ditto with the Euro, which managed a two cent plunge today.
The larger question for traders is whether this is a onetime only breakdown in cross market linkages that will end in January, or is it the beginning of a more permanent continental drift. We will find out next month when the ?A? Team managers return to the market and volume recovers.
Let me toss an alternative theory out there. It appears that the year to date returns for all asset classes are rapidly converging on zero. That?s why assets like gold and silver with the great 12 month returns are having the biggest falls this week. The S&P 500 is now down 2.2% on the year, and the Euro is up a miniscule 1.1%. Gold is still hanging on to a 17% gain, while silver is up only 12%, both rapidly headed towards single digits
Is this the inevitable result of a ?no return? world? Sounds like I better stay out of the market in this performance sapping environment, lest my own profits go up in a puff of smoke.
https://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.png00DougDhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngDougD2011-12-13 22:12:022011-12-13 22:12:02Cross Market Correlations Are Breaking Down
The coming bear trap that I warned about last week sprung this morning on the non-subscribing unwary, triggering panic buying by short sellers in all ?RISK ON? assets. Oil (USO), gold (GLD), silver (SLV), copper (CU), and foreign currencies all moved in lockstep to the upside. The trigger was news that leaked out over the weekend that the International Monetary Fund would make available several hundred billion dollars to bail out the beleaguered European ?PIIGS?.
Never mind that the IMF immediately denied any such moves from multiple offices around the world. The tipoff that something big was coming was the strong performance during Friday?s stock market opening, ostensibly off the back of healthy ?Black Friday? figures, which rapidly faded at the close. I suppose the big money was too busy fighting turkey indigestion to maintain the ephemeral gains. Once the buying started during the Sunday Asian market hours, it was all over but the crying.
With many managers poo-pooing today's move, one has to ask if this is a one day wonder, a much needed 24 hour holiday from the deluge of bad news from the Continent?
The charts below suggest that this is more than a one day wonder and that there is more juice to go. Certainly breaking the 50 day moving average at 1,205 would be a positive development. At the very least, we should take a run to the old S&P 500 support level at 1,230, which should now pose substantial resistance. Break that, and the 200 day moving average at 1,266 comes into play, close to the three month highs we saw two weeks ago.
The interesting mover today was the Euro, which hardly moved at all, the ETF (FXE) gained a scant 0.53%. You would think that the troubled European currency would be the primary beneficiary of any rescue attempts. It wasn?t. This feeble response tells me that the Euro is fundamentally flawed, is still the currency that everyone loves to hate, and is looking at more downside than upside. That is why I didn?t join the lemmings this morning scrambling to cover shorts.
You would think that this was going to be a good day. Weekly jobless claims fell to 388,000, a new six month low. New permits for home construction in October were up 10.2%. The October CPI even fell by 0.1%.
But the second that Spanish bond yields spiked, it was all over but the crying. The S&P 500 opened weak, and then proceeded to plunged 25 points, decisively breaking a triangle to the downside on the charts that has been narrowing for the past three weeks. Once again, improving fundamentals in the US were trumped by contagion fears in Europe. If you don?t bounce off the 50 day moving average on Friday, then we?ll be on the Lexington Avenue Downtown Express to 1,150 or worse.
The ?RISK OFF? nature of the move across all asset classes could not have been more clear. Oil skidded by $5, gold gave up $65, silver pared $2.20, copper gave back 15 cents. Ten year Treasuries, which never believed in this ?RISK ON? rally for two seconds, received a nice little boost, but not as much as you might expect. Perhaps we are near a top in this most bubblicious of asset classes? In the meantime, the (TBT) was beaten like a red headed stepchild.
One cannot underestimate the impact of the bankruptcy of MF Global, which has deprived the market of $600 million of trading capital. It is particularly serious in the metals and energies, where MF was particularly active. Hence the gut churning moves. The peripatetic CNBC commentator and Tea Party founder, Rick Santelli, is finding out that ?let the chips fall where they may? means that all his friends on the Chicago CME floor get fired.
Strangely, the Euro, the currency that everyone loves to hate, was one of the best performing assets of the day, down less than a penny. The headline risk here is huge. Will the European Central Bank continue buying enough bonds? Forex traders tell me this is because of a number of temporary, one off factors like European bank repatriation of funds back into Euros to shore up their balance sheets and Asian and Middle Eastern central bank purchases of high yield PIIGS bonds. The second shoe has yet to fall on this beleaguered means of exchange.
Pound away at this market all you want, and it just refuses to go down. In recent weeks we have received a torrent of bad news from Europe, including the fall of governments in Greece and Italy, and the S&P 500 index keeps migrating back to the 1,260 level, as if attracted by some supernatural, magnetic force. It is no coincidence that this is where the closely followed big cap index is dead unchanged on the year.
At this stage, both traders and markets are worn out by the contentious and eye popping moves of the past four months, so we might expect volatility to decline going into the yearend holidays. But watch out for the upside surprise. Expectations are very low here, so the slightest positive development could break the market through resistance at the 200 day moving average. Think of it as the errant child you expect an ?F? from, and he brings home a very strong ?C-?.
The November-December time frame is historically the second most profitable part of the calendar, rising 70% of the time. Only March-April are better. We have a nice year end liquidity push setting up. Every momentum indicator I follow has markets healthy until mid-December. Think of the index as a coiling spring, building up energy for one last blast to the upside.
Crude oil is also suggesting that the ?RISK ON? trade is alive and well, with $100 a barrel clearly in its sites, and after that $110. This has nothing to do with supply/demand fundamentals, or the rising consumption in China. This is purely the hedge funds and high frequency traders at work, getting a small assist from new nuclear worries over Iran and delayed production recovery in Libya. Keep relying on Texas tea for your risk direction.
Of course, you didn?t know that your job description was changed overnight to that of ?Head Italian Sovereign Debt Trader.? That is effectively what we have all become, with yield spikes for their ten year paper triggering asset fire sales in the US, only to see falling Italian interest rates send prices here soaring the next day. I think I liked Italy more when it was better known for great pasta, fine opera, and beautiful women. Keep using every Euro induced puke out to scale into long positions in American risk assets.
Ditto also for the Euro, which has become the currency everyone loves to hate. Forecasts for an end 2011 decline go all the way down to $1.29. That?s probably why it is bleeding so slowly. Any good news from Europe is prompting the European currency to rally back up to the top of a negatively sloping channel. Take these as the gifts that they are and increase shorts on the Euro through buying puts on the (FXE), or buying outright the inverse ETF (EUO). If the two charts below aren?t showing a head and shoulders downward move, then I deserve a trip to the guillotine.
If any of my three black swans decide to alight, it could be off to the races. Those include another surprise cut in European interest rates, a midnight deal by the Super committee, a sudden cut in Chinese interest rates, or all of the above.
I don?t want to confuse you here. I have not turned into a hyper bull. I just think we could get one last gasp to the top end of a multiyear range that could take us as high as 1,325 or 1,350 in the (SPX). The bill for this move won?t be due until next year. Haven?t we gotten good at kicking the can down the road? As my old friend and mentor, Barton Biggs, used to say, ?Always leave the last 10% of a move to the next guy.?
I?m sitting here with a mountain of technical analysis reports that are causing my desk to buckle this morning, all shouting ?breakout?, ?buy?, and ?uptrend?. So I?m wondering, ?is there a scenario out there where these might actually come to pass??
At this point I thought it might be useful to engage in what Albert Einstein called ?thought experiments? and come up with a New Theory of Everything. In any case, you have probably all figured out that I am a frustrated novelist. As my old friend and former mentor, Sherlock Holmes, used to say, ?Eliminate the obvious, and consider all other possibilities.?
First, let?s see how we got here. It was obvious to me that the market was overdue for a huge short covering rally that would take the index up 20%-27% off the lows (see my early September piece ?My Equity Scenario for the Rest of 2011?). That?s why I entitled my October 8 webinar ?The Short Game is Over.?
That is exactly what we got. Corporate earnings came in much better than traders expected, triggering a huge rush by underperforming managers to bring in some decent numbers by year end. We hit my target of the 200 day moving average at 1,275, a gain of 19.7%, and saw the second best month in stock market history.
Enter black swan number one. Last week, the hedge fund community established heavy short positions expecting a complete breakdown of the European sovereign debt crisis talks. But the bar was set so low they could only succeed. Ten minutes before midnight, we received an unexpected news flash about a comprehensive three part deal that was clearly a major leap forward. The Dow futures immediately gapped up 200 points in the overnight market.
That delivered the massive short covering rally on huge volume that generated all the technical green lights now on my desk. Conventional active managers panicked and stampeded to address substantially underweight positions which they achieved only recently at the market bottom.
So what happens next? In a few weeks, the Supercommittee reaches its deadline for achieving comprehensive budget balancing targets. Guess what? The hedge fund community is setting up large short positions in the run up to that day, betting that intransigent Republicans will refuse to agree to any tax hikes whatsoever, automatically triggering huge, deflationary spending cuts. The bet is that a market crash is a guaranteed outcome, similar to the one that followed the debt ceiling debacle in July.
Enter black swan number two. A smiling and deeply tanned John Boehner appears in front of the cameras at ten minutes to midnight, announcing that ?he went the extra mile? and ?reached across the aisle? and resurrected the $4 trillion deal he almost reached with Obama last summer before the Tea Party stabbed him in the back. The Dow futures immediately gap up 200 points in the overnight market, and a monster rally ensues, taking the S&P 500 up to its 2011 high of 1,367 by year end.
We then go into January with a market that looks very toppy and expensive. Active managers and talking heads complain bitterly that this is all short covering not justified by the fundamentals. But hey, a dollar made a short covering market buys just as much Jack Daniels at the bar as one made from long only buying. Hedge fund managers bet the ranch that a new market crash is coming, taking it back down to the bottom of the range 300 points lower. Traders are salivating at the prospect of making a killing, and active managers hurriedly move to underweight positions again.
Enter black swan number three. The People?s Bank of China announces in a carefully worded statement that its campaign to end rampant real estate speculation has finally succeeded. Developers have been seen cutting prices on new apartments coming on the market as much as 25%. As a result, the risks to the Chinese economy are now to the downside, and the central bank immediately cuts interest rates by 0.5%.
The Dow futures immediately gap up 200 points in the overnight market as the mother of all short covering rallies explodes. Commodities, like copper, coal, platinum, and palladium go through the roof. BHP Billiton (BHP), Joy Global (JOYG), Freeport McMoRan (FCX), Union Pacific (UNP), and Caterpillar (CAT) go bid only. Oil soars. The S&P 500 touches a new all-time high at 1,565. A major hedge fund manager jumps off the top of the Empire State building and crashes into a taxi on 5th avenue driven by an immigrant Nigerian taxi driver. His pockets are fill with trade confirms showing gigantic short covering losses. There is a twisted grin on his face.
OK, the Nigerian taxi driver was a bit much. But I will tell you one thing for sure. This flock of black swans absolutely has not been discounted by the market, and has a much higher probability than the market?s many armchair strategists, pundits, and seers realize.
Personally, I put the odds of all this unfolding at one in three. If we do manage to claw our way up that high, we will be at the top of a 13 year range for the market. Then the greatest shorting opportunity of a generation will be on the table because the Great Crash of 2012-2013 will be just around the corner.
There is a very high degree of risk involved in trading. Past results are not indicative of future returns. MadHedgeFundTrader.com and all individuals affiliated with this site assume no responsibilities for your trading and investment results. The indicators, strategies, columns, articles and all other features are for educational purposes only and should not be construed as investment advice. Information for futures trading observations are obtained from sources believed to be reliable, but we do not warrant its completeness or accuracy, or warrant any results from the use of the information. Your use of the trading observations is entirely at your own risk and it is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with your broker and make your own independent decisions regarding any securities mentioned herein. Affiliates of MadHedgeFundTrader.com may have a position or effect transactions in the securities described herein (or options thereon) and/or otherwise employ trading strategies that may be consistent or inconsistent with the provided strategies.
We may request cookies to be set on your device. We use cookies to let us know when you visit our websites, how you interact with us, to enrich your user experience, and to customize your relationship with our website.
Click on the different category headings to find out more. You can also change some of your preferences. Note that blocking some types of cookies may impact your experience on our websites and the services we are able to offer.
Essential Website Cookies
These cookies are strictly necessary to provide you with services available through our website and to use some of its features.
Because these cookies are strictly necessary to deliver the website, refuseing them will have impact how our site functions. You always can block or delete cookies by changing your browser settings and force blocking all cookies on this website. But this will always prompt you to accept/refuse cookies when revisiting our site.
We fully respect if you want to refuse cookies but to avoid asking you again and again kindly allow us to store a cookie for that. You are free to opt out any time or opt in for other cookies to get a better experience. If you refuse cookies we will remove all set cookies in our domain.
We provide you with a list of stored cookies on your computer in our domain so you can check what we stored. Due to security reasons we are not able to show or modify cookies from other domains. You can check these in your browser security settings.
Google Analytics Cookies
These cookies collect information that is used either in aggregate form to help us understand how our website is being used or how effective our marketing campaigns are, or to help us customize our website and application for you in order to enhance your experience.
If you do not want that we track your visist to our site you can disable tracking in your browser here:
Other external services
We also use different external services like Google Webfonts, Google Maps, and external Video providers. Since these providers may collect personal data like your IP address we allow you to block them here. Please be aware that this might heavily reduce the functionality and appearance of our site. Changes will take effect once you reload the page.
