I feel compelled to give the dark side of the equity market a shot. We all know what happened to Aunt Beru and Uncle Owen when they defied the power of the dark side. I don’t want to end up like them…
As for my timing, I am not sure why I want to give this spot a whirl. Maybe it is the fact that my twitter stream is filled with smug bulls openly mocking all the bears. Maybe it is the record low in the volatility indices. Or maybe it is the absurdly lopsided put/call ratio readings.
There are a ton of indicators that show that this rally is extended, vulnerable and risky. You can basically take your pick of worrisome technical signals.
Yet the continual steady grind higher has created an attitude of invincibility amongst market participants. Even the bears have given up trying to pick a top and instead are spending their time creating jokes like this:
Over the years I have found that markets often turn at the point where the good or bad news is fully accepted by the market place. To me, this is what it feels like right now. Even the bears have succumbed to the power of this bull market. No one can imagine the stock market ever correcting again.
This is the signal that it is time to put some shorts out into the market. I am long a good slug of index puts already, but as stocks have moved higher, my delta has been steadily decreasing. It is time to push that delta back up through outright shorting of index futures.
I am not going to stand in there and fight the market too aggressively, but it feels to me like we are due for a pull back that catches everyone unaware. Shorting into yesterday’s strength seems like a good place to put on a position.
Most traders like the market the higher it goes, and hate it as it heads lower. I know it is not a popular strategy, but I prefer to do the opposite. Trading this way is hard to do because it is lonely. But the best times to sell are when you are going to be made fun of the most for selling.
I am not sure if this is one of those times, but I am going to try it out. I am shorting a medium size position of S&P 500 and Nasdaq futures into the recent strength. If we rally into new highs, I will let it go against me for a few days, or even a week before I pull the rip cord on the stop. I can’t expect to time the top perfectly, but I have been patient about putting out some shorts, so I can afford to sell into strength instead of trying to puke on the way down with all the other market chasers.
S&P 500 trading</a> </div>
Punting on short XLU
I believe that the next big market dislocation is going to start in the bond market. In essence I think that the worlds’ Central Banks will continue to run monetary policy at levels that are too easy until the bond market revolts.
This financial repression is causing a lot of investors who would traditionally be long fixed income to buy riskier equity investments. Often these investors have been substituting utilities and other higher yielding equities for the bonds that they would usually be buying.
This has caused a mini-bubble in equity yield plays.
These higher yielding equities will be especially vulnerable to inflation, and the eventual higher interest rates. The fact that a lot of investors don’t understand the risks in these stocks, I think there is a potential for a big dislocation in this sector.
I am buying long term cheap puts on the XLU utilities ETF.
XLU Utilities ETF</a> </div>
Will Draghi’s moves be enough?
A couple of weeks ago everyone was focused on Mario Draghi and the ECB. Europe continues to circle the drain towards deflation and all eyes turned to the European maestro Mario Draghi to once again weave his magic to save the day.
Draghi did indeed come up big – surprising the market with a large easing package and making the unprecedented step towards negative rates.
But Draghi did not engage in full blown unconditional QE, and his program had a lot of strings attached to it. In a balance sheet recession, companies and individuals are caught in a vicious circle of debt deflation. Changing the price of credit, even to nominal negative levels, is often not enough to change the overwhelming desire for debt to be paid down. There is simply no demand for credit – at any price. That is why you need to force feed it into the system. Draghi’s conditional LTRO program is not going to cut it. The banks are simply rolling over their existing liabilities without making new loans. Access to credit with all sorts of conditions is not going to dramatically change this dynamic.
In a worrying development, the ECB’s balance sheet continues to shrink.
ECB Total Balance Sheet</a> </div>
Given the lack of credit growth, it is no surprise that despite the negative rates, the Euro currency is actually rallying.
EUR Currency</a> </div>
Since the historic ECB meeting earlier in the month, EUR has actually been quietly grinding higher.
This is even as the German bond market pushes to new lows in yield.
German 10 Year Yield</a> </div>
Europe continues to slip into deflation. The rally in the bond market, the lack of ECB balance sheet expansion and the firm EUR are all signs that Mario Draghi’s bold plan is not going to be enough.
I am long a little piece of EUR, and I am going to think about maybe also shorting European equities. Although the recent moves by the ECB were bold, I don’t think they are bold enough.
I might be not giving Draghi’s recent moves enough chance to work through the system, but don’t forget that negative rates have never been tried in such a large economy. These are uncharted waters. Don’t assume you know what will happen. If someone tells you they know how such a large economy will react ignore them. No one knows how this is going to play out. For now, I am going to watch closely, but I am worried that it is not heading in the right direction.