Weekly Update: 3.2.18

The WTF Market is Here Till AFTER TAX Day: Here's The Plan


Dear Subscriber,

As I was riding my road bike up a steep grade yesterday I was, of course, congratulating myself and my team on the genius moves we made to MAKING MONEY on the sell-off and holding onto our winners with a huge upswing on Monday. I called the the "As goes Micron so goes the market" market and Micron did everything right and still closed down 8% from the Friday move.

What does this mean? Well I also noticed as I got to 7,000 foot elevation on my bike workout the air was getting a LOT thinner--which is a good metaphor for most of our stocks that at 3-4-9X higher in value (and in EPS earnings) than they were 1-3-5 years ago. 

Note to self: I ALWAYS hate that proud feeling . . . cuz I pride myself on NOT being emotional on the markets. Today was my penance for sure. 

WTF happened? That is what my trading desk guys told me via texts: WTF? Besides short-term profit taking off a monster Monday, I'd say we are obviously STILL in price correction mode which means:
1) The LAST to get smacked in a correction are the leaders--tech and financials--and financials were smacked for the LAST 10 trading days first and now the final leg of the valuation correction will be the 26% of the S&P 500 valuation aka technology
2) High P/E multiple and stocks 30%+ over their 50-day moving average technology stocks got clobbered like Tesla and Netflix
3) The autonomous vehicle and enabling chip/technology stocks got hit on Nvidia news of halting live testing so that hit Alphabet Nvidia and AMD (shoot me now for NOT taking that $12.75 spike on buyout rumor)
4) The Facebook data inquiry infected all the social media stocks and they face a regulatory reckoning
5) The 10-year bond is telling the stock market that there IS no insipient inflation on the way and that "global synchronous" GDP expansion has not rolled over but is not accelerating
6) The sinking dollar...which should be going UP in value with higher Fed Funds rates is still sinking
7) Which is making oil prices (in $dollars of course) HIGHER but the energy stocks have "spit out the bit" and have actually gone DOWN. I literally cannot remember oil E&P stocks go down when oil prices are up almost 15% in 2018. That price action worries me a little. 
8) Our Transformity Macromarket Recession Risk Index moved lower to 16.3 with the lower US first-quarter reading by the Atlanta Fed now just 1.8%--we take the NY Fed GDP number of 2.85% GDP and blend them...but still 1st quarter GDP estimates have to come down.

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9) The QUARTER ENDS THURSDAY with the market closed Friday--so today was the day to sell shitty stocks to get them off your books. 
10) BIG profits from last year mean BIG taxes for traders that have to be paid by April 18th. At the margin they are sellers of the stocks with the most profits from LAST year...which are many of our companies. As a guy who has paid some mid-six figure tax bills in my day I can tell you this: I waited till the LAST friggin day to sell stocks or borrow against them to pay those bills! 

KEY POINT:  Buckle up--there is NO REASON to expect volatility to fade--here is why. AS I have shared many times on this journey since 2013 but more in the last 12 months, the markets and money managers are in a game of chicken and musical chairs.  On the one hand, IF they take off risk TOO EARLY, they vastly underperform the S&P 500 index and the get their assets under management (AUM) taken away. They are on a razor edge here...and unlike us most are long only and DO NOT HEDGE (which I continue to think is insane BTW).

Conversely, IF they stay too long at the party, and especially with leverage (not OUR problem thank with our hedges and long options closed) the average hedge fund is DOWN for the year and last year while we were 63% up THEY were up about 8%.

In today's thin air (i.e., high P/E valuations for the market leading Tech stocks) active money managers have to REALLY thread the needle...which is WHY we see this volatility now that the "Short volatility trade" is over (which as I have mentioned many many times is why 2017 was SO FRIGGING weird i.e., below 10 VIX for most of the year.)

Here is the canary in the coal mine that has had me worried since the first leg of the correction: and I am WATCHING closely:  Deutsche Bank.  DB has by FAR the world's largest derivatives trading desk and principal exposure to custom derivatives contracts in the world (YES the D Word again). DB has more derivative book exposure than the entire annual GDP of Germany--WHO the heck KNOWS what real net exposure they have but clearly the got killed on the other side of the "Risk-Free Volatility Trade". Total non derivative assets are $1.7 trillion down from $3 trillion in 2008.  IF bank falls much more the German Government aka the Bunde will, of course, step in and rescue it--which would take $trillions and cause a panic.  This chart tells the story...it's down 40% since late January. 


Action to Take: STAND BUY I said on Friday last week "If we don't bounce off the 200-day as per usual we will protect ALL profits." We bounced...and failed. 

ACTION TO TAKE: Check your Email--and don't panic! There is NO recession risk here...this is a correction of the estimate of 15-20% earnings growth in S&P 500 stocks that got PRICED IN with the melt-up into the tax act and then in January with the 8% surge from giddy civilian investors adjusting their 401k assets to stocks.

We are flying by the technicals and we NEED A CAPITULATION day to shake out the rest of the weak hands and scared to death latecomers. I always hate writing that but ALL of us have very expensive educations in the stock market...they don't. The earnings reports start to the rescue 3rd week of April...I can't tell you if the traders are going to ride in on Monday after Easter and position for those very positive earnings reports or not...SO we will let the technicals tell us.

What are we looking for?

  1. UNDER 30 Relative Strength Readings for SP 500, Dow and Nasdaq

  2. BIGGER than average volume down days--the "flush"

  3. VIX over 25 but 30 better

  4. CRAZY put option to call option volume and prices--which we are are getting close to

We GOT that last Friday but the news of China and Trump White House talking nice on Sunday whipped up the frenzy on Monday before with could get off some long options. The melt-down today makes me grateful we did not obviously.

Without the insane levels of volatility killing option and futures selling, and with slow but gradual excess cash aka liquidity being drained out of the bond and equities markets by the Fed/UK aka "reverse quantitative easing" or RQE for short, pricing models and algorithmic trading get more slapdash or tight. ADD IN the $5 trillion of money in equity index funds and the role of the market in equity "price discovery" is determined now at the margin by individual shareholders. At 3;45 the index trades come into square the ETFs and THAT IS WHY we see the wooshes UP and DOWN on these big up and down days. SOMEHOW that final 20 minutes of index price and position squaring HAS TO get "arbed out" meaning hedge funds start trading it so much that the impact gets reduced.

Oh yea...the LIBOR Interbank Rate is now at 2008 levels and have risen 38 days STRAIGH...for a variety of strange reasons with ONE BEING there is going to be a UNITED STATES version introduced this Summer. BUT...I won't bore you with the details except to say--the US is selling $300 BILLION in debt tomorrow and Thursday. These high LIBOR rates make it VERY EXPENSIVE for Japanese and European bond buyers to hedge their bond positions. So expensive they could pass on the auction. IF CHINA wants to play rough with Trump and pass on the auction--THAT could be a bond market disaster and THAT would spook investors too. You can read all the gory details here at Bloomberg.com

Hang tough--we have made a boatload of money this year versus the hedge funds, money managers and most investors which of course warms the cockles of my cold heart. It's too bad we don't have a Trump Behavior Hedge...so far the only one that works is to not believe ANYTHING out his mouth the first time...at least on trade tariffs which at this point is now proven to be a market buzz kill. We all know how much El Trumpedo LOVES tweeting about the Trump Stock Market. My guess is he got Treasury Secretary Munchkin out Sunday to rescue the markets--that behavior is very predictable.

PS: I am about to launch an a Transformity Investor PRO service that takes equities and options buying AND SELLING to a new BIG TIME level. If this bull market has 1-2 years to go as our Macro Market Index says, there are going to be GREAT opportunities to SELL options at these trading peaks and buy puts and vice versa on these capitulation bottoms.  Just like we did with Micron options last week. This service will be daily and very hands on...but based on the last 6 months of real life testing I think we can add 30-40% ADDITIONAL profits to your long-term capital gains with this new service. 

Drop me an email at tsmith@transformityresearch.com if you want to be in the initial group. We have to limit the size to 50 or so members to make sure we are not moving options prices and everyone has enough to go around. 



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