Think back to exactly one month ago. At the time fear was running rife through the markets. Anyone who suggested the world wasn’t ending “just didn’t get it.” (What a wanker! - February 08/2016 MacroTourist post.)
Now, some 150 S&P handles higher, suddenly everyone believes the only direction for stocks can head is up. Yeah I get - markets make opinions, not the other way round. But the market wasn’t going to zero a month ago, and it’s not going to infinity now.
Although it is difficult to be on the other side of the throbbing masses, the recent manic chasing (both ways) will put many investors in the poor house. From deeply oversold, we have now exploded to massively overbought.
During the past decade and a half, the only time we have been more overbought was during the 2009 initial rip higher off the lows.
This is not 2009
Maybe you look at that stat and take solace. After all 2009 ushered in one of history’s greatest bull markets. Could this recent ferocious rally be the start of another bull market?
Of course anything is possible in this age of Central Bank madness, but I would contend that 2009 was significantly different than the current environment. At that time stocks were cheap, and had suffered more than a 50% correction. Last month at the lows, stocks were barely down 15% from the highs. Not only that, but by almost any metric, stocks are far from cheap.
In 2009 the Federal Reserve was embarking on a series of market friendly quantitative easing policies. In 2016 the Fed is desperately trying to normalize their perceived aggressive monetary stance.
Risks are skewed one way - down
The chances of February 2016 being the start of a roaring rally is quite low. Unless the Federal Reserve does a dramatic U-turn, any sort of “risk on” environment will be quickly met with more Fed tightening. Instead of there being an embedded “Federal Reserve put”, it is as if the Fed has shorted tons of calls. The risk reward is skewed to the downside.
But, but, but…
My negative stance will no doubt get met with much push back. I can hear all the reasons now. There is no alternative, the Bank of Japan and ECB are aggressively monetizing their balance sheets, rates are still extremely accommodative in the United States…
All of those reasons are fine, but they are well known and built into the market.
And as for the recent rally, it is one of the junkiest rallies I have ever experienced in my years watching markets. The stocks rallying the hardest are the ones most shorted. Although the stock averages are up, this rally has been extremely painful for most managers. Everything that was “supposed” to go down has been exploding higher.
As usual, the hedgies got out ahead of themselves
Here is my take on what happened during the past couple of months. As usual the hedge funds saw a good trade and took it way, way too far. The whole oil / commodity collapse accelerated at the turn of the year. Realizing many of these companies were in desperate trouble, and that China was in no position to turn it around, the hedgies smelled blood and leaned hard on the sell button. The decline accelerated, which only convinced the hedgies they were correct in their analysis, and they shorted even more. Don’t forget all the dire talk about oil going to $20, $15 and even $10!
They are probably correct in their forecast of many of these energy companies inability to survive. But the crowded nature of their trade has created a face ripping rally. This is why even though stocks are rising, few managers are performing well. Most hedgies are getting chopped up with this intense volatility within sectors.
Peeling off my crude oil longs
I had been bullish on crude oil as I felt there was way too much pessimism in the marketplace. But we are now $12 off the lows, and suddenly I am hearing all sorts of forecasts about how breaking through $40 will unleash the next bull market.
It is time for me to quietly leave this position. My bullish crude oil call is no longer non-consensus. I fear the recent rally is the result of hedge fund short covering, and that after they have covered (and maybe even gone long), the price of crude oil will drift back down.
As less energy companies are forced into bankruptcy, more supply is kept online. This will keep the medium term price of crude oil lower. Ironically the market’s recent embrace of energy companies will ultimately cap their upside.
Time for caution
Many market pundits are currently adding to risk as the road ahead suddenly seems clear to them. This is my cue to leave, and in some instances (like stocks), take the other side.
I am usually early, and it would not be at all unusual for me to suffer through the bottoming process only to leave the true meat of the move on the table, but I just don’t buy this is the start of new bull market (in either crude oil or equities). This is a short covering rally. Nothing more, nothing less. The problem is that short squeezes only roll over when the last short (ie: me) has covered his position. So for the bulls out there - be happy there are still knobs like me fighting this rise.
Thanks for reading,