Janet Yellen-“I See You!”

This note is to Janet Yellen, her other Central Bank Proxies and you my fellow investors.

We have what looks like a left translated intermediate cycle top unfolding.  Rather than bore most of you with what that means I will be brief: It is very bad and means the market should fall apart here and correct.  It should take out the December low and then some.  However, I am a suspicious man and I also believe that Janet and her cadre of traders and technicians see this set up as well.  If they were to act to erase this set up they need to do so soon.  I expect a few well timed phrases and perhaps some rapid fire E-Mini Futures buying via a proxy either tomorrow or Thursday.

The invisible hand is no longer invisible.  I see you Janet! Make your move!  However, if you intervene and the rally fails to stick then you have lost control.  If you do nothing then we know you are finally letting this market go.  If you succeed in your meddling then we shall be seeing this same scenario playing out again in a few weeks.  It looks like we are getting close to forcing your hand.  Let it fall and be free of this burden or announce QE4 too soon and risk the dissolution of your institution by having to explain to a Republican Congress why another QE was needed if the economy was so good.

As I and others on this site have mentioned recently the only play here is to be short until the market is much lower and Janet has cover and more data to announce QE4. Then get long for one last hurrah.

The market forces of deflation are finally forcing your hand Janet.  How are you going to play this? We see you Janet!

Strange and bizarro days indeed!  We had a set up that was quite precarious and dangerous that could have turned into something very ugly.  As I warned in my last post the central banks will not go gently into the night. With only a five day decline of 4.5% they completely freaked out and trotted out Fed Governor Evans from Chicago who said “If we raise rates now it would be a catastrophe.”  Magically futures ramped and we are off to the races again.

I was talking to a technical guru on Tuesday night and he said the Fed is likely to intervene soon because this market has the potential to just fall apart.  It was creepy how quickly he was proven right.  If you are a bull you need to ask yourself does Evans statement and timing make any sense whatsoever?  Why would it be a catastrophe? Why his very precise timing for a statement into a mere 4.5% decline?

Lets get real for a moment shall we.  Something is not right here at all.  By their actions, I now believe that the Fed is absolutely petrified of what they have created and for some reason they can’t seem to just let it fall apart now.  Why do they keep levitating this market?  What are they waiting for?  They must know that eventually they will fail and what they are doing is only making matters worse.  The speed of this market is very concerning.  I think they fear a crash in equities similar to what is happening in oil.  The volatility we are about to see this year is going to be epic.  After this intervention it is clear to me that we are going to get spinal tap “it goes to 11” volatility.  Strap on your hard hat because we have just entered the danger zone.

Why have they stopped QE?  The economy is not better.  Clearly without QE the asset markets fall apart.  Do they think Japan and the ECB can carry the water?  Or is there something more nefarious going on here?  I will wax philosophical on this subject in a few days.  There is definitely something happening here- what is is ain’t exactly clear yet.  What we are witnessing is the greatest illusion of all time.

The Fed will need to constantly try to prevent a market collapse more and more often. I expect more Evan like actions to be the norm going forward.

The 10 year bond yield has had a 10% decline in the first 4 days of this year which is the biggest move ever recorded for a start to the year.  Dana Lyons pointed out that the second biggest move we had at a beginning of a year was in 2008 and it was 5%.  This is why the Fed is freaking out.  However they continue to talk about an economic recovery.  I got news for you we never really had a true one and the spell that most of the investing public is under is about to be broken.  The recovery was driven by a credit reflation that produced mal-investment that can’t possibly produce enough cash flows to service the debt.  You see deflation was always built into the cake.  It was only a matter of time until it became visible to us.  Bonds are screaming deflation.  Most of what you read about our economy or see on TV is garbage.  Watch asset prices as they tell the real story.  Bonds and commodities are veritas while stocks are a mendacium.  Stocks will be joining the veritas club soon enough.

Punch Line: No. We do not have structural confirmation.

Is a bear market coming? Yes it is and it may have started as of December 29th, however, as we have all learned, the central bankers are resolved to fight deflation at all costs so maybe they can push out the day of reckoning further.  However, what is different this year is that the Fed ended QE in October and passed the baton to the ECB and BOJ.  Last year according to JPM about $1 trillion in sovereign debt was monetized between the Fed and BOJ.  This year JPM estimates about $1.3 trillion of sovereign debt will be monetized between the ECB and BOJ.  Two problems with this:

1) The ECB has not officially announced QE yet.  In addition both Germany and Greece are throwing their own wrenches into the works.  It is a long time between now and January 22 when the ECB will let us know their decision.  So we have a POMO air pocket that continues to age.

2) Is QE from a non reserve currency powerful enough to levitate the US and Global stock markets?  I say no way as the rising $Dollar and crashing oil price are proof positive that QE or the threat of QE from the ECB and BOJ are not enough to re-inflate the asset markets.

Bottom Line: I Expect QE 4 from the Fed to be announced at some point in the next 6 months.  How low does the market have to go? Down -10%, -20%, -25%? I expect us to take out the December lows in the near term.  After that lets reassess.  Nothing the central banks do from here on out should surprise us.

The only sure thing is that volatility is to be expected and embraced.  Stock pickers beware! It is macro time again and lots of cash is advised unless you can trade well.

Side note:  When I was at my old shop that managed trillions of dollars in 2008 and 2009 the constant chatter about fundamentals was a complete waste of time.  In my morning call I listened to the Repo desk (read on liquidity) and the High Yield guys (credit market read).  As things started to tighten I went to the bunkers and when they gave the all clear I bought hand over fist.  We may be entering this type of period.

Happy New Year!

Predictions for 2015:

1) Volatility is back in a big way.  Eventually the market should resolve lower due to the deflationary forces sweeping the globe.  However, the Central Banks will not go gently into the night and should continue to try and prevent the next financial crisis through actions and Jawboning at the right moments.  I expect violent swings both up and down and I intend to profit from all moves.  10% swings will become the norm.  This should be a traders market this year and much profit is there for the taking.  Nimbleness and flexibility will be key.

2) Active Managers will continue to get slaughtered. Correlations should rise dramatically as beta, sector positioning and cash cushions will matter more than stock picking.  More flows will continue to get squeezed into SPY, DIA and QQQ.

3) The Dollar (DXY) will correct lower soon but eventually ends the year at 105.  The largest margin call in the history of the world has begun.  The periphery (emerging markets) will continue to experience serious damage.  This will eventually spread to the Core (developed markets), however the wild card is a potential US stock market blow off top as capital flows seek perceived safety.

4) The Ukraine CIA puppet regime will launch a major military strike against the rebels in the East in Q1 and will be defeated.  Russia and Putin will make Washington and Obama look like incompetent fools.

5) Major Fraud and Corruption scandal will be exposed in Washington this year.

6) Ebola will make a comeback.

7) ECB does not do QE in Q1 as Germany kicks and screams but they eventually relent and agree to do it in Q2.

8) Social Unrest will continue to rise and we should unfortunately see 1960’s style urban riots across the country this Spring and Summer. NYC has peaked and will descend into a crime infested shit hole as the police go on strike.  DeBlasio will resign in shame.

9) The Central Bank Omnipotence meme will begin to be questioned as global market volatility rises violently.

10) ISIS will launch an attack against the Homeland or it will be made to appear that an attack was launched.  The end result is the same which is more money for the security and military industrial complex.  Also a great distraction from the incompetence and corruption of the Federal Government.

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.