Margin Calls: They Can Be Detrimental To Your Health.

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.

When I was managing a growth portfolio In 2007 I was already bearish and starting to position the fund for the downturn.  In September of that year John Mendelson from ISI walked into my office to go over some charts.  John is old school and has seen everything.  The first thing he said is: “These financials especially the money center banks and AIG look awful.  I have not seen charts like this in a long time.  When I look across the market there is something terribly wrong in this space.  One of these guys is holding the Old Maid.”  As it turned out many were holding the Old Maid but especially AIG.  AIG were the brilliant guys who sold all the CDS on the Sub Prime debt.  Classic example of a company management that had zero idea how the guys that ran the CDS department made their money and the actual risk that the firm was taking onto its balance sheet.

Lets fast forward 7 years.  Today we don’t have a real estate crisis but we have a looming sovereign debt crisis.  I have stated before that the CB’s will start to lose control when currency volatility picks up and when the Dollar starts to rise.  The dollars strength is not due to our economic strength but due to global deflation.  I just read that it is estimated that $7 trillion of emerging market debt is denominated in dollars.  Besides the levered speculators doing the carry trade that stand to get wiped out who else might not want to see a strong dollar?  I think the chart of Deutsche Bank (DB) is telling us that they may be holding the Old Maid.

The company’s bonds are not showing any distress yet but the long term stock chart is alarming.  The stock is close to taking out its 2012 low and the low from October.  This bank has the largest derivatives book in the world.  I think its safe to say the have been helping clients get short the dollar the last 14 years and my guess they have been along for that ride as well.  Since all banks are black boxes its hard to tell what is going on, but I suspect that the management of this bank has no clue either.  I can see traders getting paid millions to do all sorts of complicated derivative trades that looked profitable at the time but effectively made the bank very short dollars over time.  I don’t know if this is true but my gut tells me I am right.  Another case of traders pulling the wool over on the management figure heads.  Additionally it is in the public record that DB has awful systems and controls.  The Fed came out earlier this year and gave DB a failing grade in those two departments.

This stock is also only 8.5 points away from its 2009 lows.  If it breaks $28 I think we could see some quick downside.  Clearly it is not healthy for such a systemically large bank to have its equity performing like this and it could have broader implications.  I think DB could have this cycles Old Maid.  I will be looking to short this very soon.

In my opinion a strong dollar is very bad for risk assets and I would tread cautiously as this CB induced rally stalls out.

I am here to say that the central bankers are scared and won’t ever let the stock or bond markets go down again.  I would like every hedge fund to cover their shorts and go long the highest beta, lowest quality piece of crap you can find.  No more of this market neutral nonsense or hedging.  The average hedge fund has not done well this year.  You know you have underperformed the market this year and your clients are getting ready to fire you.  Some of you are negative and the market is up 10%.  Your clients can do that for free.  The only way you can win and redeem yourselves is to get maximum long this market and gun it into year end.

You must Ignore all the divergences that have built up over the year.  You must ignore the awful breadth and the narrowing of the market.  Don’t pay any attention to the DeMark 13’s on all the indices.  You must dismiss the volatility in the currencies and the strength of the dollar.  Pay no attention to crashing oil prices, all time high margin debt, widening high yield spreads and off the charts bullish sentiment.  You must redeem yourselves and you all need to get long.  Please do it tomorrow.  The Turkey/Santa rally begins tomorrow.  Don’t get left behind.

Food for thought.  What if we already had the Santa Rally?  That is crazy talk.  Please get long and lets get this party started.

The results are in.  Thank you for your responses.  Here are the results:

1) Four people said they have not ended it yet.  Have to love the conspiracy theorists.

2) Three people said they ended it because the markets are  going to crash anyway.  This way they don’t take the blame and can start it up again to show that they have some dry ammo.  Maintain the illusion of power.

3) Had no other choice.

4) Ended QE on purpose to fund the government and cause a strong dollar that would attract foreign capital.

5) Give the EU and BOJ a turn.

6) Not working so end it.

7) Ended it to maintain our standard of living.

What is interesting is that no one actually thinks they ended it because the economy is improving.  TraderX pointed this out and it is true I don’t know anyone who believes the official story.

I think it was reason 4.  They ended it to fund the government and prop up the dollar.  Prior to QE ending foreign investment in our debt was plummeting.  They had a choice between the stock market and the government.  I think I know who they picked.

The other thing that I don’t hear talked about much is the geopolitical aspect of ending QE.  As tensions mount with Russia and China a strong dollar hurts these commodity intensive economy’s.  Lower commodity prices hurt Russia the most.  There will be collateral damage which are the emerging market economies, leveraged speculators, stock markets and junk bond markets.  The Fed likely does not directly control the dollar.  If they were to do QE 4 they could potentially stop the ascent of the dollar but once the process gets going its hard to stop.  Reflexivity will be in action as the dollar goes higher more and more people will be forced to deleverage and that will beget more of the same and it will feed on itself until done.  Again this process could go quickly or slowly.  Only time will tell.

And yes I have been a few days early on the bounce ending.  However, we have made marginal new highs and we are extremely overbought.  Be careful out there.

The Mainstream meme for the end of QE is as follows:  The economy has improved and healed to the point where the Fed is comfortable with a normalization of it 6 year extraordinary policy measures.

Why do you think the Fed has ended QE?  I am curious to see what many of you think.  Do you agree with the above statement and if not what is your reason for the discontinuation of QE.  Let me know what you think.

On a side note, if Draghi does not announce monetization of sovereign debt tomorrow then we go lower in global markets.  If he does we go higher but the day of reckoning will only be temporarily delayed.  A mere threat to do it will not be enough to keep this Frankenstein market levitated.

The coordinated highly manipulated moves by the Fed and BOJ appear to have diverted disaster and moved the DJIA and S&P to new highs.  Since the rally out of the 2009 low we had not seen a topping set-up until this year.  Since March of 2014 we have had 4 including the most recent one which began on September 19th.  Each set-up has mysteriously disappeared.  What is interesting is that the time in between each set up is getting shorter and shorter.  All across the technical community people are in disbelief but one theme has emerged: the CB’s were aware of the dire technicals and they intentionally tried to avert disaster.  The question is have they succeeded?  This is not conspiracy theory as the BOJ stated in their press release that they will openly buy their stock market and foreign stock markets.  This is in your face open intervention that just happened to occur a day after the Fed ends QE.

This desire by the CB’s to subvert the natural cycles of the stock market and the economy in general reminds me of the Greek mythology tale of Icarus and Daedalus.  Daedalus and his son Icarus are trapped on the island of Crete by King Minos.  Daedalus is a great inventor and fashions wings made out of feathers and wax to escape from Crete.  Before they escape he tells his son not to fly too high because the he will anger the Gods of Mount Olympus and the sun will melt the wax.  Long story short the brain dead son Icarus is having a grand time and loves his new found power.  He gets so excited he ignores his fathers warnings and flies too close to the sun.  The Gods get angered and the sun melts the wax and Icarus plummets to earth and drowns at sea.  I knew my Greek mythology class would come in handy someday.  My point in telling this tale is two fold:

1) Man can not bend the laws of nature forever.  We are not Gods.

2) Icarus represents the stock market.  The wax is the debt or leverage that allows him to begin his climb but the higher he goes the more unstable the wax becomes and then poof it melts and we crash.

All stock market advances are due to advancing credit cycles.  All credit booms end and when they do so does the stock market advance.  What makes this tale so relevant is that the more that CB’s manipulate the market higher and fight nature (Gods) the worse the decline will become once it begins.

Lets go over some math.  The longest 4 year stock market cycle in the history of the market was from 2002 to 2009.  The advance was 60 months to the top and the total cycle from low to low was 77 months (Longer than other cycles by a wide margin).  We are currently in month 68 of this cycle.  So unless the they can stretch this cycle longer, which I doubt, it implies the low will occur sometime before July.  If we are in a secular bull then the average decline into a 4 year cycle low is 34%.  If we are in a secular bear market, which I believe, then we will take out the 2009 low of 666 on the S&P.  This bear market will be fast and scary.  I know this sounds insane and discrediting but it is what nature demands.

It is likely that Friday was the top of this trading cycle and that a nasty correction is ahead of us.  I cite the work of Andrew Kassen at SeeItMarket.com.  He is essentially using math to make a prediction that the next move of the market is down and it starts today.  The NYMO gave two readings above 80 last week.  When two are clustered the average decline following the signal day is -11.1%, the median is -7.4% and the range is from -4% to -30%.  The observations have been 9 since 2006 and 8 have resulted in declines that began the day after signal was achieved.

It remains to be seen if we crash but this market is on borrowed time and a nasty bear market is coming and it will be quick and brutal according to the math.  The crash is baked into the cake by the Fed and other central banks who have decided to mess with the Gods and have flown to close to the sun.  Oh by the way have any of you noticed that the ECRI WLI just dropped to -1.2%.  That is a recession warning.  We will likely be in a recession by Q1.  $80 oil has left much of the energy complexes debt impaired and this will feed into the rest of the credit market.  The strong Dollar is not a sign of health but a sign of tightening financial conditions and global deleveraging.  Oh by the way oil went down on Friday as the BOJ was shooting bazookas and that to me is a canary in the coal mine that this BOJ endeavor will not alter the path that we are on.  Good luck to all.  The decline begins soon.

They whiffed on the quarter and guided lower.  Revenue Growth is decelerating and losses continue.  They really don’t seem to give a hoot about investors at this point.  The is Bezos’ petri dish of wonderful consumer services.  I love the service.  The only problem is that they don’t make any money and they never will unless they want to slow revenue growth way down.  Cash flow is clearly a problem as they have $800 million less in cash on the balance sheet compared to Q3 last year.  Operating cash flow is a mirage because it is mostly float from their vendors.  As their growth slows the float available to them decreases as well.  The myth of self financing is coming to an end.  I suspect they will be using that $2 billion line of credit this holiday season to help them finance inventory.

The CFO leaving is really the key here.  He knows Bezos is stubborn and that he thinks its business as usual.  They have some of the worst financial disclosure on the street and the meme of deferring profits to invest in the future is total nonsense.  If the street actually understood accounting they would realize that investments are capitalized and depreciated over time and therefore you should be able to show a profit.  Walmart had 3% margins during their hyper-growth capex phase.  There were somehow able to make a profit.  So the question remains why can’t Amazon make a profit?  The answer is: they are selling $100 dollar bills for $99 dollars.  That’s why they don’t show a profit.  If the street and buy side actually understood accounting this charade would have ended a long time ago.  There was a time when Amazon made a profit but it was less competitive in the early days and they were not in a myriad of ultra competitive non core businesses.  The financial disclosure at AMZN is obtuse on purpose.  It is meant to fool everyone into believing the Emperor has clothes on.

The big question in my mind is what do the page one holders of AMZN do tomorrow?  I suspect some are realizing that all is not well in Seattle.  I think several years from now this will be a Harvard Business School accounting case study.  They will be teaching this: How did so many smart people miss this cash flow issue and why did investors put such a multiple on this business?  In a QE world where growth is scarce many were blinded to the revenue growth and bought the meme that they were investing for the future.

If this stock breaks down and closes below $280 I see clear sailing to the low $200’s over time.