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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May 18

How to trade the Trump volatility

By Jani Ziedins | End of Day Analysis

End of Day Update:

On Thursday the S&P500 recovered a portion of Wednesday’s big crash. It was comforting to see the selling take a break as the supply of nervous sellers dried up. One day is certainly not enough to call this a bottom, but this is definitely a step in the right direction.

The turmoil started Tuesday night when a memo surfaced alleging Trump pressured the FBI director to drop the investigation of a former member of his administration. This ultimately resulted in the appointment of a special counsel to investigate the Trump White House. At best this is a huge distraction that will affect Trump’s ability to govern. At worst it could lead to his impeachment.

To this point the market has largely ignored the Trump circus, but this SNAFU poses the largest threat to the Republican’s tax cut and regulatory reform agenda. Since this is the foundation of the post-election rally, anything that threatens it also puts recent gains in jeopardy.

So far Trump has not been accused of doing anything illegal. This leaves the odds of impeachment low, especially in a Republican controlled congress. But Trump’s political capital is quickly evaporating. Lucky for him the Republicans in Congress share many of his same goals. While Trump might not get his Wall and the tax cuts might not look like what he proposed, Congress will still put bills on his desk and he will sign them. This continues to be the most likely outcome and after this brief bout of anxiety, the market will come to this realization too. That is why today’s selling took a break. Most likely this is nothing but a blip on our way higher.

That said, we might not have seen the bottom of this dip just yet. These things usually last more than one day and it is definitely premature to call the pullback over. If we were truly oversold, we would have seen a more decisive rebound Thursday. Instead we bounced a little bit and then mostly traded sideways through the remainder of the day. That tells us a lot of traders were not read to jump onboard the rebound.

Trading-wise we need to see the market hold Wednesday’s lows for a couple more days. If we don’t get a second leg lower by Monday morning, then this selloff is dead and we can start looking for the next trade. But if prices slip Friday morning and undercut Wednesday’s lows, expect that to trigger another wave of reflexive defensive selling. But rather than be the start of something bigger, this will most likely be the last push lower before a capitulation bottom. This would be a better place to be buying stocks than selling. Remember, risk is a function of height. This is the lowest prices have been in months making this is the safest time to buy in a while. Remember, we make money buying discounts, not paying premiums.

Jani

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May 11

Why today’s selloff failed

By Jani Ziedins | End of Day Analysis

End of Day Update:

Thursday provided a dramatic ride for the S&P500. We started the day with the biggest losses in several weeks. Within minutes of the open we undercut 2,390 support and that triggered a wave of reactionary stop-loss selling. But just as quickly as the selloff started, the rush for the exits stalled and we bottomed near 2,380 support. And just like that, the selloff was over and we spent the rest of the day climbing out of that hole. While we didn’t quite reach breakeven, the intraday reversal was impressive and told us most owners continue to believe in this market and won’t be spooked out so easily.

The biggest headline continues to be Trump’s dismissal of the FBI director. While the media is making a huge deal out of it, the stock market doesn’t care that much. Even at today’s lowest point, we were still within 1% of all-time highs. Hard to call such a small blip panicked selling.

While it felt awful in the moment, all selloffs feel that way. If they didn’t, no one would sell and we wouldn’t dip in the first place. But given how quickly we bounced off the lows, that tells us few owners were spooked by this price-action. Most owners have been rewarded by patiently waiting for higher prices and every bounce makes it easier to hold through the next dip. This confidence is infectious and the VIX is hovering just above all-time lows as traders continue to believe in this market’s strength. While it is easy to claim this market is too complacent, the harder part is figuring out when that complacency will become a problem. At the moment complacency is keeping supply tight because owners are not selling and that is propping up prices. While this might be the calm before the storm, the calm can last for an extended period of time. It is good to be cautious, but shorting just because the market is complacent is costing a lot of smart people a lot of money.

Expect prices to be resilient as long as owners remain confident. Until some headline comes across that makes the crowd start second-guessing their optimistic outlook, expect every dip to keep bouncing. Even though the market is vulnerable with so many people standing on one side, we need a significant event to trigger the panic. Until then the smart money is sticking with the rally.

Jani

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