Watching for possible blow-off top, then shorting into July
As my followers know, I've been mostly sitting in cash and silver waiting for sanity to return to this market. Y'all bought stocks, and all I bought was popcorn, and it turns out the joke's on me.
Here's how big the gap between price and fundamentals has gotten. On June 1, GDPNow reduced its Q2 GDP forecast to -52.8%. This is down over 10% in the last week. As stocks approach all-time highs, the US Congressional Budget Office forecasted a couple days ago that GDP over the next ten years will be about $7.9 trillion lower than previously forecast, and it may take 10 years for employment to return to pre-pandemic levels.
In corporate earnings, FactSet notes that the consensus estimate for 2020 SPX earnings per share has declined by 28.0% while $SPX price has decreased by only 6.2% since December 31. We are finally seeing a slowdown in downward estimate revisions, but it remains to be seen whether estimates have actually reached a bottom.
The forward 12-month P/E ratio for $SPX of 21.5 is at its highest level since January 2002, even as the risks are rising. We've added over $4 trillion in global corporate debt this year, even as credit rating agencies downgrade existing debt at an unprecedented pace. S&P Global has downgraded 247 issues in the last month and now has 1,287 on its potential downgrade list, surpassing the previous record of 1,028 from April 2009.
So what's driving the indexes upward? Three things: unprecedented speculation from zero-commission retail traders, Fed liquidity, and the hope of more stimulus from Congress. I definitely expect the disconnect between price and fundamentals to go away eventually, but the question is when it will happen and what the catalyst will be.
The combination of nationwide riots and technical resistance might cause at least a short-term pullback. We're now approaching some important resistance levels in both SPY and Nasdaq. SPY is approaching its top from March, and QQQ is approaching all-time highs. Generally I would expect a technical pullback from these levels and possibly the beginning of a big correction, and it seems like a lot of other traders are thinking along the same lines. We're currently seeing the largest futures net short position in SPY since 9/2015.
However, I've decided not to play this particular resistance level, because IMO the massive short interest creates the possibility of shorts getting crushed in a short squeeze. We've also entered a clearance area on the volume profile, which means there's not much resistance until we hit about 322. The 9/2015 high in short interest led to an 8% gain the following month. Only in the four months after that did SPY finally sell off 14%. It also seems possible that we'll get another Congressional stimulus package in the next month, including either another round of stimulus checks, or an infrastructure bill, or both.
Personally I am looking for the correction to start in late June or early July. In the last decade or two, June has been the last month of the bull market season, followed by seasonal weakness in July-September. June tends to be an especially strong month for tech stocks, and we're likely to see that pattern repeat this year. Waiting till July gives stimulus optimism and economic reopening optimism the opportunity to play themselves out, perhaps climaxing in a blow-off top as shorts get squeezed up to 322 ahead of the correction. Any parabolic move in SPY would be the signal to start shorting this market as we head into seasonal weakness in the summer.
Here's how big the gap between price and fundamentals has gotten. On June 1, GDPNow reduced its Q2 GDP forecast to -52.8%. This is down over 10% in the last week. As stocks approach all-time highs, the US Congressional Budget Office forecasted a couple days ago that GDP over the next ten years will be about $7.9 trillion lower than previously forecast, and it may take 10 years for employment to return to pre-pandemic levels.
In corporate earnings, FactSet notes that the consensus estimate for 2020 SPX earnings per share has declined by 28.0% while $SPX price has decreased by only 6.2% since December 31. We are finally seeing a slowdown in downward estimate revisions, but it remains to be seen whether estimates have actually reached a bottom.
The forward 12-month P/E ratio for $SPX of 21.5 is at its highest level since January 2002, even as the risks are rising. We've added over $4 trillion in global corporate debt this year, even as credit rating agencies downgrade existing debt at an unprecedented pace. S&P Global has downgraded 247 issues in the last month and now has 1,287 on its potential downgrade list, surpassing the previous record of 1,028 from April 2009.
So what's driving the indexes upward? Three things: unprecedented speculation from zero-commission retail traders, Fed liquidity, and the hope of more stimulus from Congress. I definitely expect the disconnect between price and fundamentals to go away eventually, but the question is when it will happen and what the catalyst will be.
The combination of nationwide riots and technical resistance might cause at least a short-term pullback. We're now approaching some important resistance levels in both SPY and Nasdaq. SPY is approaching its top from March, and QQQ is approaching all-time highs. Generally I would expect a technical pullback from these levels and possibly the beginning of a big correction, and it seems like a lot of other traders are thinking along the same lines. We're currently seeing the largest futures net short position in SPY since 9/2015.
However, I've decided not to play this particular resistance level, because IMO the massive short interest creates the possibility of shorts getting crushed in a short squeeze. We've also entered a clearance area on the volume profile, which means there's not much resistance until we hit about 322. The 9/2015 high in short interest led to an 8% gain the following month. Only in the four months after that did SPY finally sell off 14%. It also seems possible that we'll get another Congressional stimulus package in the next month, including either another round of stimulus checks, or an infrastructure bill, or both.
Personally I am looking for the correction to start in late June or early July. In the last decade or two, June has been the last month of the bull market season, followed by seasonal weakness in July-September. June tends to be an especially strong month for tech stocks, and we're likely to see that pattern repeat this year. Waiting till July gives stimulus optimism and economic reopening optimism the opportunity to play themselves out, perhaps climaxing in a blow-off top as shorts get squeezed up to 322 ahead of the correction. Any parabolic move in SPY would be the signal to start shorting this market as we head into seasonal weakness in the summer.
Comment:
A little more research reveals that while short interest in futures was high yesterday, short interest in the actual equities is extremely low-- in fact, near five-year lows. Also, short interest fell off sharply today, with the put/call ratio closing at about half of yesterday's level by one measure. So I think I was quite wrong about there being short squeeze potential.
Comment:
I am glad that I didn't try to play this resistance level. We got blowout ADP payrolls data the other day and a blowout jobs report today. The much-better-than-expected unemployment number suggests that the disconnect between price and fundamentals is not as wide as advertised, and that the bearish economic forecasts may be somewhat overblown.
Whereas lots of agencies have been reducing their forecasts in recent weeks, the ECRI weekly leading index has been climbing and continues to do so. The ECRI has successfully predicted the last few recessions and now have successfully predicted this recovery, so I am going to be following their forecasts a lot more closely in the future. They seem to have a model that really works.
This morning after seeing the huge surprise in jobs numbers pre-market, I bought some short-term QQQ and SPY calls that are up 50% already.
One loser from today's jobs report may be REITs, as the jobs number caused a spike in mortgage rates that will be bad news for housing and real estate demand.
Whereas lots of agencies have been reducing their forecasts in recent weeks, the ECRI weekly leading index has been climbing and continues to do so. The ECRI has successfully predicted the last few recessions and now have successfully predicted this recovery, so I am going to be following their forecasts a lot more closely in the future. They seem to have a model that really works.
This morning after seeing the huge surprise in jobs numbers pre-market, I bought some short-term QQQ and SPY calls that are up 50% already.
One loser from today's jobs report may be REITs, as the jobs number caused a spike in mortgage rates that will be bad news for housing and real estate demand.
Comment:
Rather than shoot for my 322 price target, I went ahead and took profit at the slightly safer and less ambitious 321 mark. These SPY calls brought me 140% in a single day. We may even see a continuation of the parabolic move on Monday, but parabolic moves generally end in tears, so be safe and happy trading, everyone!
Comment:
Alright! So we did get our blow-off top and a significant correction after a surge in new coronavirus cases, weaker-than-expected CPI and continuing jobless claims, and a record 11.7% increase in US private debt this quarter.
Mnuchin went on TV today to say we can't close the economy again, but I actually do expect some more closures at the state level. The ICU bed and ventilator shortage in Arizona is scary, and I know a lot of states are watching the situation there closely. So the stock market doldrums could continue for a few weeks as states weigh what to do.
With Congress now slated to consider more stimulus in early July, I think we could see these mid-June doldrums followed by a late-June recovery on stimulus hopes. In fact, it's even possible that a significant stock market downturn could lead Mnuchin to push for new stimulus earlier than that, as he hinted in his TV appearance today.
I have already taken a couple nibbles on this market as SPX reached 3030 (although I took them in QQQ rather than SPY, as I think tech will outperform). I will look to buy more as SPX reaches the 2800 level.
Mnuchin went on TV today to say we can't close the economy again, but I actually do expect some more closures at the state level. The ICU bed and ventilator shortage in Arizona is scary, and I know a lot of states are watching the situation there closely. So the stock market doldrums could continue for a few weeks as states weigh what to do.
With Congress now slated to consider more stimulus in early July, I think we could see these mid-June doldrums followed by a late-June recovery on stimulus hopes. In fact, it's even possible that a significant stock market downturn could lead Mnuchin to push for new stimulus earlier than that, as he hinted in his TV appearance today.
I have already taken a couple nibbles on this market as SPX reached 3030 (although I took them in QQQ rather than SPY, as I think tech will outperform). I will look to buy more as SPX reaches the 2800 level.
Comment:
Obviously the "reopening trade" is over, and we're getting a very significant pullback today, which you might call the "reclosing trade." Europe is blocking travel from the US, the cruise lines have all extended their suspension of operations, Disney employees are petitioning to keep the park closed, and restaurants in Phoenix, Houston, Jacksonville, and Seattle have reclosed. Texas is just days away from being out of ICU beds, Arizona has been over ICU capacity for a couple weeks now. The chart of transmission rates at rt.live makes clear that this thing is getting very out of control, very fast.
At the same time, there's some bad economic news: the IMF reduced GDP forecast for the US by nearly 2%. The $600 unemployment benefit expires soon. Weekly bankruptcy filings for June 13-19 were more than double the recent weekly average, and commercial mortgage bond delinquencies exploded in May. The housing market has been a bright spot, but residential mortgage delinquency is sitting near 8.5%, and August 31 expiry of the moratorium on foreclosures could bring a reckoning. Basically the whole economy has a looming solvency issue.
At the same time, there's some bad economic news: the IMF reduced GDP forecast for the US by nearly 2%. The $600 unemployment benefit expires soon. Weekly bankruptcy filings for June 13-19 were more than double the recent weekly average, and commercial mortgage bond delinquencies exploded in May. The housing market has been a bright spot, but residential mortgage delinquency is sitting near 8.5%, and August 31 expiry of the moratorium on foreclosures could bring a reckoning. Basically the whole economy has a looming solvency issue.
Comment:
Oh, and I forgot to mention tariffs on Canada aluminum and a looming trade war with Europe. SPX targets 3025 and 2800.
