There can be no denying that it has been a tough couple of months for the bears.
Since the middle of May we have chugged straight up with barely a pause along the way.
S&P 500 Index</a> </div>
However, I think things are finally lining up for the bears. I am already good and short so I can’t add to the trade in any meaningful way, but I am definitely going to hang tight.
Why I am more confident about the short side? For one, from a sentiment point of view, the bulls are really confident. Too confident. When either the bulls or bears start to make fun of the other side, my antennae immediately gets raised. Right now there is open mockery of anyone who is short. The Market Gods do not like that sort of talk and always seem to make sure to humble the over confident.
Today also marks the start of earning season. I don’t have an up to date chart, but I am going to post the old one anyway as the longer term trend does not change. Almost all the recovery in the stock market since the 2007/8 credit crisis has occurred during non-reporting earnings periods.
At the very least we might get a pause in the relentless march higher.
Yesterday I also mentioned that during the next two weeks we have no days with large $2.5 billion POMOs. This tailwind will also be removed from the market’s back.
And most importantly, I think we have a catalyst developing in Europe. I have consistently worried about the lack of ECB balance sheet expansion. Without a growing balance sheet, I think the European economy is going to sag.
Last month Draghi seemed to assuage these worries with his move to negative rates and promises to engage in Long Term Repo Operations. The European market was indeed placated for a time, but upon reflection has given up all the gains and is heading lower. I said it then, and I will repeat it now – no one knows the effect of negative rates on the economy and the market. This has never been tried in an economy of this size.
And most importantly, the LTRO balance sheet expansion is filled with so many conditions (to satisfy Germany) that most European banks are going to be reluctant to use it.
The ECB is making the mistake of trying to influence the economy by changing the price of credit during a balance sheet recession. As Japan found out during the 2000s, lowering the price of credit to zero has very little effect on the economy’s willingness to take on more credit. Also placing any restrictions on bank lending with the ECB programs is going to further reduce the private sector’s willingness to expand.
Europe is in midst of making all the same mistakes Japan made last decade. So far the current excessively easy policies of Japan and the US has allowed Europe to limp along. But as the rate of additional liquidity is slowly withdrawn, the problems will start to show up in Europe.
And yesterday that is exactly what happened. The European stock markets have started to lead the world stock markets lower.
Have a look at this chart of the European bank index versus the US bank index.
Euro Bank Index (white bar) vs US Bank Index (yellow line)</a> </div>
There was a pop when Draghi introduced negative rates, but since then European banks have sagged badly. The US banks have so far hung in there, but for how long?
If you have a look at the chart of the European bank index since the ECB meeting, it is far from reassuring.
Euro Bank Index trading since Draghi’s move to negative rates</a> </div>
Given the absolute orgy that is going on in most other stock markets, this is terrible action.
I have decided to re-enter the short side of the European stock market. I shorted some EuroStoxx futures. I am already too short, so I need to be careful, but I really think that this action is so bad I need to climb aboard.
Crude oil sentiment
One of my trading philosophies is to try to avoid “crowded trades.” I hate being part of the crowd. Sometimes this hurts me as I exit winning positions too quickly as they become popular. Or even worse, sometimes I fade the crowd in a foolish attempt to be smarter than the herd (like today’s short stock market position) and I get run over by the group.
The MacroTourist stupidly fading the group again</a> </div>
In an attempt to gauge market sentiment I use a combination of quantitative data and anecdotal tidbits. Almost always the two match up.
However there is a strange discrepancy occurring in the crude oil market that I cannot figure out.
Let’s first have a look at the long term chart of crude oil.
Crude Oil</a> </div>
After the disastrous plunge during the 2007/8 credit crisis, crude oil has been slowly trending higher. However the move has been slow and gradual.
Over the past couple of years, I have noticed a large contingent of crude oil bears develop. These guys are typically hedge funds that have seen many other commodities like gold and copper collapse as the Chinese economy has slowed down. When this fact is combined with the American shale oil revolution, these hedge funds have been actively betting on a lower crude oil price.
Although the hedge funds seemed to have finally gotten frustrated and given up on this trade, I have seen precious few advocate long positions in crude oil. I am a big energy bull and when I discuss this trade with almost everybody, I am met with skepticism and explanations about how technology is going to keep the energy problem contained.
Even if the speculators have given up on actively shorting the crude oil market, from an anecdotal point of view, there is no way that this is a crowded long trade.
But have a look at the CFTC data for long positions in crude oil by the speculators:
Crude Oil Spec Long Position</a> </div>
According to the CFTC, the long specs have almost doubled over the last year. I just don’t see that kind of speculation.
Maybe I am missing something, but when you look at the data it screams crowded long trade, but there is absolutely no confirmation of this sort of speculation amongst the hedge funds. Who the heck is long?
And when you step back and look at the data over the last few decades, it becomes even more perplexing.
Crude Oil Spec Long Position over the last few decades</a> </div>
Something strange has happened in the energy market. I don’t know if they have somehow reclassified the big banks as specs, or if there is really some sort of new category of player that is skewing the data, but I don’t think that the CFTC data is reflecting the market’s sentiment.
I might be foolishly dismissing a huge warning signal, but until I see more anecdotal evidence of the long side of energy being crowded, I am going to ignore the CFTC data. Right now, most people are too happy to tell me what an idiot I am for worrying about the price of oil. Until they agree with me, I am going to stay long…