Jun 08

Is anyone paying attention?

By Jani Ziedins | End of Day Analysis

End of Day Update:

It was an exciting day for politics on both sides of the pond. We started the day with a General Election in the U.K. and capped it off with Comey’s testimony before a Senate committee. These two events were widely anticipated by pundits and news junkies for weeks. But it seems someone forgot to send the memo to the stock market. Given the market’s tepid, almost boring price-action, it looked like any other boring summer trading session.

Luckily for us boring is a good thing. It means traders are calm and not overreacting to headlines. Rather than sell nervously ahead of uncertain events, most traders are confidently assuming everything will blow over and this isn’t worth worrying about.

It’s easy to see why the market shifted to this half-full outlook. Every defensive sell over the last few years was a painful mistake. After getting burned three, four, and five times by prematurely selling a dip, traders learned their lesson and now confidently hold any and every dip because it will bounce like all the others before it. And so far that strategy has worked brilliantly. In fact the lack of defensive selling has gotten to the point that dips are measured in hours and tenths of a percent. Blink and you’ll miss them.

I miss the old volatility. I made a lot of money buying steep discounts from traders overreacting to headlines. People would dump their stocks “before things got worse”, but typically that was as bad as it got and we rebounded when things turned out less-bad than feared. But these days it is hard to find bargains when traders are demanding premium prices for uncertain times.

It was easy and safe to buy a dip when the market overreacted. Risk is a function of height and the lower we went, the less room there was left to fall. Buying at $80 is always less risky than buying at $100. But the opposite is true here. Long gone are the days of buying at $80, or even $100. Instead sellers are demanding $120 for an imperfect product. Good for them if they can sell at $120, but the thing is most are greedily holding for even higher prices. Their confidence is keeping supply tight and propping up prices, but these premium prices mean there is far less margin for error. We’ve gotten to the point where need to hit the ball out of the part just to keep this rally alive.

While this market makes me nervous, the path of least resistance is clearly higher. If we were vulnerable to a crash, it would have happened by now. There have been plenty of excuses for traders to sell defensively. But when no one sells the headlines, they stop mattering. These things rarely end well, but they also last longer and go higher than anyone expects. I don’t trust this market, but it will most likely continue creeping higher for the foreseeable future.

This post-election rally was built on expectations of tax cuts. Nothing else matters. Corporate tax cuts, repatriation of overseas profits, more money in consumers’ pockets. That is what propelled us from the November lows. But expectations are high. Maybe a little too high. What happens if Trump and Republicans fail to deliver on their generous promises? It won’t be pretty. Right now the stock market is giving the benefit of doubt to Trump and the Republicans. But there is a good chance the tax cuts won’t be as impressive as hoped for and we will stumble into a sell-the-news dip. Tax cuts are what got us to these heights and they are also one of the few things that can knock us off this perch. Keep riding these waves higher over the near-term, but bailout as soon doubt about the size of the tax cuts starts to creep in.

Jani

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Jun 06

Are things a little too good?

By Jani Ziedins | End of Day Analysis

End of Day Update:

The S&P500 finished lower for a second day, but the losses were minor and we are still well above the 2,400 breakout. The lack of material selling tells us most owners are more inclined to keep holding for higher prices than taking profits. Even though there are several ominous headlines floating about, it doesn’t matter if no one is selling the news. While conventional wisdom tells us markets are complacent just before they collapse, what conventional wisdom often forgets is those periods of complacency last far longer than anyone expects. The path of least resistance definitely remains higher, but expect the rate of gains to remain slow. While confident owners keep supply tight, we are running out of people willing to throw new money at these record highs and that is keeping a lid on prices.

Just because the path of least resistance remains higher doesn’t mean we shouldn’t be shifting to a defensive mindset. Even though I expect prices to continue rising over the near-term, we have never been closer to the market’s top. It’s been a great ride since the 2009 Financial Crisis bottom and I’ve been long-term bullish the entire time. As the saying goes, be greedy when others are fearful. Up until last year the market was afraid of its own shadow and traders thought every bump in the road was leading to the next market crash.

But eight years later, those traumatic memories are fading and being replaced with fear of being left behind. Starting last year the market experienced a major shift in sentiment as we went from a nervous, half-full outlook to this confident, half-full assumption that everything will turn out alright. Long gone are the fears that a Fed taper or interest rate hike would derail this market. Instead we have gotten to the point where the market is fairly blaze about an investigation into our president that could end in impeachment. While I agree the chances of this outcomes is remote, the consequences will be catastrophic for a market that is built entirely on Trump’s promised tax cuts.

It isn’t hard to see why most traders shifted to this half-full mindset. Every defensive sale over the last eight-years was a mistake because the prices rebounded even higher a short time later. After the third, fourth, and fifth time of feeling stupid by selling prematurely, traders learned it is best to hold through these periods of uncertainty and spooky price-action. And so far every trader who has become patient and confident has been rewarded as we climbed to record high after record high. It has gotten to the point where almost no one is reacting to headlines anymore. Rate hikes are no big deal. Missing employment expectations is met with a yawn. Heck, this cynical market finished in the green following the latest terrorist attack. Even a scandal that threatens to derail the Trump administration was hardly good for more than 24-hours of selling. Traders have been conditioned to hold through every dip and as a result no one is selling ominous headlines. The lack of supply means we stopped dipping at all.

While this complacency makes me nervous, I know it is foolish to call a top. This will go higher and longer than even the bulls think possible. The thing is this isn’t about predicting a top but finding good enough. To recognize the risk/reward is no longer stacked in our favor. That this is a better place to be taking profits than adding new positions.

I’m certain this market will keep going higher over the near-term, but I doubt this is the last time the market will trade at these levels. I don’t know when or why the next bear market will happen, but it isn’t unreasonable to expect our next bear market to cut 30% out of the market. That means even if we rally another 1,000 points and peaks above 3,400, we could still find ourselves tumbling back to these levels. The key isn’t about picking the top, but finding a level that is good enough, taking profits, and waiting for a better entry point. It is impossible to buy a dip if we are fully invested and ride our positions all the way down.

The post-election rally is built entirely on expectations of tax cuts. The market has been more than willing to give benefit-of-doubt to Trump and the GOP, but if they fail to deliver, expect the market to give back a huge portion of those gains. Given the high prices and low implied volatility, this might not be a bad place to look at a black swan trade. Buy longer-dated, out-of-the-money puts. While they will most likely expire worthless, the costs are relatively low and the payoff is huge if things turn out worse than the market is hoping for.

Jani

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