Bears Just Got A Hot Poker In The Eye!

I am not going to lie.  That was painful.  Luckily I had very good timing on entry and somehow I have managed to still be up slightly.  I may press my AMZN short.  The divergence in that stock from the rally is telling you something.  Their free cash flow is a lie and others are starting to catch on.  Their recent $6 billion capital raise is not to fund new endeavors like they said, instead they are hemorrhaging cash and those proceeds will be used to plug a hole.  Lets start a bear raid on AMZN.  Spread the word.  The recent divergence is all you need to know.

Now, Let’s have a serious chat.  I don’t care if you are a Bull or a Bear but something is seriously wrong with this market.  I am not here to be proven right or be a top caller for my own glory.  I am seriously concerned that a big storm is coming.  The moves in the currencies and commodities are out of this world.  And now they are coming to equities.  I want everyone to make money but I fear this volatility eventually resolves to the downside in a big way.  Last week I wrote about the VIX and that its speed is telling us something is off in the markets.  Here is a piece by Jared Dillon about the same thing and since he is an former options trader it should also make you think: http://www.mauldineconomics.com/the-10th-man/may-the-fourth

As far as I can tell, Janet’s testimony should frighten you a lot.  That was hawkish not dovish.  The Fed is so far behind the curve its not funny.  If she was really worried about what is going on she would have said so and hinted at QE4 which is every shorts fear.  She seems to be clueless that credit is disappearing into a black hole abroad and that contagion will be coming home soon enough.  There was a time when the US could have shrugged off this stuff in the past but globalization and the amount of debt in the system have made this global slowdown very dangerous indeed.  Nothing fundamentally has changed.  The periphery is a mess and a global margin call is well under way.  The next few months will be very interesting.  In the short term it looks like we rally but I am very suspicious.  Lets see what the next several trading days hold.

This market has killed everyone to different degrees this year.  Very few are winning much unless you managed to perform legal insider trading like Ackman or you are a pathological lying penny stock trading high school student that managed to con New York Mag into believing you amassed a $72 million dollar fortune.  The Play this year was to walk into your office on January 1st and buy 30 years bonds, put your feet up on your desk and watch the QE drama unfold.

I, on the other hand, have been stalking this top like a saber toothed tiger.  Slowly watching for set ups that make bulls yelp in pain.  Well, I am hear to tell you that I am exhausted and worn out.  I am up 5% for all my troubles YTD and would have been better off clipping bond coupons with 20% plus appreciation.

We have had 5 set ups this year that have not completed.  Prior to this year we have not had a single set up.  I was a bull then and I will become a bull again someday.  I am not a perma bear.  I believe in cycles and the natural rhythm of things.  I want to pick stocks but when the whole market is set up for a 50% plus correction stock picking is a moot point.

The Fed has really screwed this up royally as we sit at the end of 2014 in what is the most dangerous stock market set up in the history of the DJIA since its inception on May 26, 1896.  Why do I say that?  The longer you stretch a cycle through manipulation (yes QE is manipulation) the more likely you crash in both price and time due to the levered speculation that has built up over the last 5.5 years.  The mother of all margin calls is coming.  The commodity/oil crash is a prelude to what is coming to stocks.  Equites were crashing in October as well but as you know it took three Central banks to extend the rally out of the October low that was destined to roll over and crash.

Well I got news for everyone.  We have a new set up that looks even better than the September 19th set up.  The reason why is we managed to suck in even more poor hapless souls in at the top and most of the bears have capitulated.  There are no more natural buyers of stocks except the Central Banks.

So why am I pissed.  It is because I am gun shy due to the October CB surprise that foiled my plans to reap outsized profits in a very short period of time.  Because I am gun shy I don’t have as much exposure to the short side as I would like.  And even though I will make a lot of profit should we correct meaningfully it could be much more if my head weren’t rattled.  Many of you bulls should be very frightened because the Market Gods will not allow me to make obscene profits which means we will likely see a big correction.  That is how the market works.  It is messing with me big time.

Here is my game plan.  If the Fed were to do something crazy like QE4 this Wednesday I will cover and get so scary long it will make your head spin because then we will double this market inside of six months before a crazy blow off top.  If the Fed does nothing then we begin crash mode and after a big correction (20-25%) I will cover awaiting the QE4 announcement.  I may add to my shorts sometime this week if I can muster the courage.  Why do I think that if I add to my shorts the Fed does surprise QE4 and if I don’t we crash? Such a cruel mistress this market!

The collapse in Oil has been stunning and relentless.  When prices move this fast firms are caught offsides.  The speed in the VIX’s rise I believe is reflective of something that we are not seeing yet.  This oil price move is causing dislocation that is having second derivative effects.  Who is it?  I don’t know and I don’t care.  All I know is that we have a dangerous sell set up and after todays move in the VIX and market reversal my Spidey Senses are tingling.  Someone is holding the Oil Old Maid and the VIX is warning that it is potentially systemic in nature.  The previous spikes in the VIX this year occurred after more price erosion and clear bottoming signals.  We are not that far from the top and yet the speed of this move is alarming and I don’t have any bottoming signals yet.  I may be wrong but I urge extreme caution…this could get out of hand fast.

Last Wednesday I talked about a potential top Forming.  Well it looks like we have a top in place but the question remains: will it be more serious than a mere blip?  Today was a great day for the bears.  I expect some sort of bounce either tomorrow or Friday.  The real danger lies in the unsettling nature of the currency markets and the commodity collapse we are witnessing.  My gut says that it is moving into stocks now.  Many seem to have forgotten that QE ended in October.  I maintain that this has been a liquidity driven market and that liquidity is being drained from the system by the Fed.  We know this because the Dollar is rising, commodities are collapsing and bonds are ripping higher (notice the beautiful cup and handle formation on TLT).  Equities are the next domino to fall.  It is not a question of if but when and I expect sooner rather than later.  The other CB’s stepped in after QE ended and we embarked on one of the most historic V shaped rallies in the history of the stock market.  It only took three central banks to do it and save the equity markets from an October collapse.  The other CB’s do not have the same effect on global liquidity that the Fed does due to our reserve currency status and that is why I believe these attempts will not stick.

What is interesting is that most active managers have not participated in this rally.  High beta vs low beta stocks have under performed by 18% YTD.  The CB’s want Mom and Pop to think all is well with the world as we hit marginal new highs in The SPX, Dow and QQQ.  On average most of you who day trade or manage other peoples money as a long only or hedge fund have, for the most part, had an awful year.  I know its been a hard year but step back and simply analyze the difference between this year and last year.  The answer is the Karate Kid:  Wax ON…Wax Off! or as we know it QE On!…QE Off!  What worked last year has been a disaster this year because without the crack cocaine of QE we flip to Global Deflation and stocks have started to discount that throughout the taper.  The broad US indexes will begin to discount the end of QE shortly.  Soon the lie of this recovery will be revealed to Mom and Pop and then the real panic selling can begin.  But first the institutional herd is starting to stir and margin calls in Hedge Fund land are just getting started.

Watch the USD/JPY which appears to be reversing after a parabolic rise.  A strong Yen hurts the global equity and emerging market bond carry trade.  Moves in our stock markets are increasingly about flows and leverage not fundamentals.  This has been showing up in the divergences.

I bought more Puts on Monday that give me some more time and ability to capture a crash. A third of my portfolio is TLT and I am short AMZN.  I have lots of cash and I am getting ready to start adding more once we get a confirmed flip to a bear market.  I was up 20% coming out of the October low.  I was betting big on a crash in October but as you know I was wrong.  I am up only up 5% due to the ravages of Theta and an ill timed entry into AMZN.

My gut says this may be a top of significant import, however the CB’s are scared and can attempt to warp this sell set up with some more Hail Mary type passes.  Do they have any more Bazookas left?  I will not commit more capital until I have more evidence that The Top is in. I am in awe of how they saved us from a crash in October.  I don’t worship them and do not believe they are omnipotent but I now respect them.  Eventually they will fail to win in this fight to stop deflation because they are not Gods and the cycles will overwhelm them.  They always have.

Tonight it looks like the oil market wants to retest the $64.38 level which is the 61.8% Fibonacci support from the 2008 low.  We tested it last Monday and it bounced but it has lately slid lower over the last week.  If we should take out that level with conviction then we are going to the low $50’s to test the next Fibonacci support.

I was thinking about writing a piece on Oil and its detrimental effects on the debt markets and the economy and how equities will implode.  There are plenty of other people who have written on the subject over the last several weeks and they make a compelling fundamental case that is bearish for equities.  Rather I decided to investigate the long term relationship between oil, the dollar and equities and boil this all down to simple math.  Math is elegant and less subject to the vagaries of fundamental debate.

I consulted my buddy Tim Wood who was also pondering this question as well.  We looked at the Dollar:Oil Ratio and noticed some curious chart patterns.  This ratio peaked out at around 9 in 1998 and has been decimated by the Feds efforts to reflate since the tech bubble implosion in 2000.  The ratio bottomed in 2008 at around 0.50.  In the financial crisis the ratio spiked back up to 2.6 as the dollar rallied and oil imploded.  Since 2011 the ratio has stabilized at around 0.75 and has based.  Since the middle of the year the ratio has slowly gathered speed and lately exploded up to 1.37, a level not seen since 2009.  What does this have to do with equities?  Since 1985 the Dollar:Oil ratio has had a negative correlation of -0.71 with equities meaning that a rising ratio suggests weaker equity prices over time.  In the financial crisis years 2007 and 2008 the correlation was -0.84.  Sometimes the correlation in any given year is low from closer to zero correlation to -0.50.  In general this is not a good timing tool for equity tops or bottoms.  However, from eyeballing the data the correlation tends to be stronger when there is a second derivate change like we are experiencing now.  Violent moves tend to suggest more inversely correlated moves in equities.  The graph below is courtesy of Tim and shows the ratio in blue and the DJIA in black.

What is rather interesting is that YTD the correlation between the Dollar:Oil ratio and equities is a positive 0.60.  Yes that is correct it is positive!  So that begs the questions is it different this time?  Sure anything is possible or is it more likely the the relationship has been temporarily warped by three of the worlds largest central banks promising or pumping new candy into the system after the Fed ended QE.  If you believe that the correlation will mean revert to its long term -0.70 then 1 of 3 things needs to happen.  Oil needs to rally back to $110, the Dollar needs to fall substantially or equities need to correct a lot.  I don’t see the first two happening given the damage in the Oil chart and the strength in the Dollar chart.  The equity chart looks strong now but the internals are awful and there are numerous divergences that I have talked about before that, if not for the CB intervention, we would have seen stocks a lot lower by now.  The question as always is: can the CB’s deny mother nature?  My bet is they must pay the piper at some point and this analysis suggest we are closer than you may think.

We have a possible set up for a tradable top that triggered today.  This is the fifth potential topping set up we have seen this year.  Prior to this year we were in a full fledged bull market and these set ups were not present.  Do I trust it? Not sure yet.  I wanted to make you aware primarily because this market is so dangerous right now.  Our Central Banking Masters have really gummed up the works and the margin call that occurred in the oil complex may be coming to the the rest of the market soon.  Each time we have had a set up occur, it has been wiped out but it did result in a minor correction with the Sept/Oct swoon being the most recent one.  This market has been trying to set up all year for the top.  The Fly mentioned that we have been in a stealth bear market.  He is correct!  The one thing that you need to understand is that each set up that is wiped out by the CB’s sets up faster and faster each time and requires more Herculean efforts and monetary candy from the CB’s.

At some point the market will one day ignore the monetary stimulus and then fear will set in and we will be witness to an epic margin call.  I am not going to add shorts until we are off a bit from the highs.  We should be a nearing a short term top that may develop into something more meaningful.  Stay Tuned.

The energy patch has just experienced a gigantic margin call.  Oil was down around 4% last night before todays rally.  We finally got a bounce at the 61.8% Fibonacci support level from the 2008 low.  If we should decisively break that level over the coming weeks then we are headed to $50 oil.  This is what I call a crash.  The devastation in some E&P equities has been equally as spectacular.  For example, one stock, Sanchez Energy (SN), was $34 in September, $18 last week and $10 today.  This rapid selling was a forced liquidation or what an old fashioned stock broker would call a margin call.

In 1929 one could own a stock with just 10% down.  We all know that mere retail mortals can’t do that today.  However, other demigod market participants can lever up to 1929 levels with the help of their friendly prime broker or through the use of derivatives.  The bottom line is that the leverage in the system from Fed QE has been the fuel for this stock market and quite frankly all asset classes.  We have reached maximum debt where credit creation can no longer keep market forces at bay.  Eventually the investment that the debt was used to create needs to produce a cash flow to service the debt.  Commodities and currency volatility are the early warning indicators that a great debt deflation is coming our way.  A giant global margin call is beginning and you just witnessed its start this fall.

In the summer of 1929 the manic depressive speculator Jesse Livermore noticed that commodities were collapsing and he surmised that a gigantic deflation was coming.  Commodities were the tell for him that the Bull market in stocks was ending.  He sold his holdings and went short.  The rest is history.  The Bull market of 1929 was a credit induced orgy much like this one.  I believe that this Bull will crash just like 1929.  Except, I now believe that we could possibly loose 30-50% in a week or two due to the fact that our genius policy makers have stretched this market beyond all natural cycles and the HFT microstructure of this market.  Is this an insane prediction? Perhaps, we shall see.

The question is when can this happen? This week? Next week? Next year?  Hard to say given the palpable fear that our cabal of global banking overlords are emitting and their dogged determination to deny mother nature her due.  Could we get a mega blow off top? Sure, nothing at this point would surprise me.  However, the action in the energy patch last week and the AAPL flash crash today due to a large seller are previews of what our future holds once the herd is scared and heads for the exits.  Eventually mother nature will exert her influence and it will be fast, brutal and short lived.  The longer they stretch this cycle the worse the subsequent correction.  Avoid being the victim of yours or other peoples margin calls.

Currently it is being reported that there are 170 protests in cities across the nation in response to the acquittal of Officer Wilson in the death of Michael Brown this August. One narrative that the MSM is trying to paint is an old one: black people are angry over the acquittal and are burning and looting.  This is a false narrative!  The message they are trying to send is that black people are crazy and don’t care about the truth.  They want white folks (as Obama would call them) to fear black people and side with law enforcement.  This narrative is BS and too simple.  The other MSM narrative is that the all the protestors are noble victims of white racism.  This too is a false narrative.  When I was watching the protest in August I saw plenty of white faces in the crowd.  And I see white faces today.  This is not just a black vs white issue.  I see people both white and black people really pissed off about the power of the state and their economic plight.  Yes there are some thugs and undoubtably some agent provocateurs string up violence and vandalism!  The police should arrest them and try to keep the peace.

This protest is a flash point for many to lash out at the system.  I have had the luxury last year to take some time to travel the country on a road trip without my wife and kids.  It was an eyeopener.  Our country is beautiful and full of great people.  However, our country is also falling apart and the people are pissed.  As I chatted it up with people across the land, it became apparent that they feel like they have been screwed.  There is a deep resentment of Wall Street and Washington.  Surprisingly about 1/3 of the common folk knew what the Fed was and thought they were handing money to rich folks.  Not so far from the the truth.  Ten years ago 95% of these people did not know that the Fed even existed.

This is only the beginning of what I believe will be many civil disturbances over the years to come.  If you want to continue to believe the fairy tale that the economy is doing well go right ahead.  I know the truth and can see through the fog of propaganda.  Democrats were thrown out in a thrashing we have not seen in decades.  If the economy were swell this would not be happening.  The long bond yields and commodities are singing the truth as well.  Equities will eventually succumb to the forces of deflation.  The bottom line is that people, not just black people, are pissed off and are itching for change.  Our institutions of government and finance are about to be fundamentally changed.  However, change usually only comes with great pain.  The next few years will witness immense change.  We are living through historic times.

The hunger games have arrived.  If you are currently living in the Capital City (work on Wall Street, Washington or the C Suite) your world is going to be rocked.  For the other 99% it already has and they are not to pleased.

We were very close to a complete crash only a few weeks ago.  The PTB saw this and they freaked out.  What we have now is a coordinated baton passing from Fed QE to other CB QE.  So far stocks have rallied in response.  The question that should be on all of our minds:  Will this enough to keep the party going on for longer or is this a bull trap?  The dollar is the reserve currency of the world and QE has a much more dramatic effect on liquidity than these other actions that have been announced.  The ECB has legality issues and there seems to be a split on QE there. Draghi needs to deliver soon as jawboning will loose its effect.  China’s recent actions are not meant to provide stimulus but to prevent a credit meltdown in their economy.  My guess is that these actions won’t have much of an impact on liquidity and the markets should peak out soon. Remember the Fed started easing aggressively in 2007 and 2008 and they could not prevent what unfolded.  What the CB’s are doing is preventing the damn from bursting for now but is will burst eventually.  Deflation is coming and they can not prevent it.

So far bond yields and high yield spreads have not confirmed this rally.  Additionally we have commodities crashing and the dollar continuing to rise.  Global growth is slowing and eventually the earnings of US companies will be affected.  Liquidity in both equities and fixed income is abysmal.  Investor sentiment has gone back to wildly bullish again.  I don’t know how much longer the party can go on for but I do know that each round of free money is having less and less of an effect.  If it did commodities and junk bonds would be confirming this reflation.  If these divergences can be reversed I will join the party.  However, the sheer panic in these CB announcements should be an alarm bell that we are coming to the end game.  The end game is a crash of epic proportions.

Bottom line: I underestimated this action by the other CB’s.  I have been wrong so far.  I am now flat on the year.  I am still mostly cash with some put options and some stock shorts.  My best guess is that we are near a short term top and I might add some tactical sniper shorts. It remains to be seen if we test the October lows this year or if we get a shallow correction.  I am looking to go long TLT in a big way soon.

Other than the usual dreck, the FOMC minutes revealed that maybe its OK if stock markets go down.

“… members considered the advantages and disadvantages of adding language to the statement to acknowledge recent developments in financial markets. On the one hand, including a reference would show that the Committee was monitoring financial developments while also providing an opportunity to note that financial conditions remained highly supportive of growth. On the other hand, including a reference risked the possibility of suggesting greater concern on the part of the Committee than was actually the case, perhaps leading to the misimpression that monetary policy was likely to respond to increases in volatility. In the end, the Committee decided not to include such a reference.”

Source: FOMC minutes

I believe the Fed just took away your binky.  Please don’t cry.  No more Bulltard stick save comments.

It would not surprise me to see the market weaken considerably from here.  I am not going to bore you with technical mumbo jumbo but the bottom line is I think we are making a near term top.  The IWM has rolled just like it did in September before the Dow and S&P collapsed.  How fast and how far we fall remains to be seen but the deflationary backdrop is alarming.  The amount of HY debt that is becoming impaired in the commodity complex is frightening.  HY is not confirming this rally and it will spill into the equity markets at some point.  I bought more IWM puts on Monday (Still lots of cash).  I have burned some of my profits by reloading too soon before the BOJ nonsense but I am still up 10% YTD.  I think the Santa rally has already occurred and now we retest October lows.  Could I be wrong? Absolutely!   However, when I look at positioning I see that people are off-sides again.  The Fed just told you that they are OK with more volatility.  I ask you are the markets priced that way?  Are levered players ready for more volatility or do they need to take down some gross? Good luck.