Short Term Game Plan

I initiated a short position on IWM about a month ago.  If you are planning on going short here don’t bother.  We are likley going to have a tradable bottom this week. The rally from this low is key.  If the rally fails or we go to an exhaustion high yet again then I beleive it will be essentially game over.  Look to cover shorts soon and go long for a trade.  Today I am doing nothing but counting cash.

Let me be clear.  This is a very dangerous time.  My bias is short.  In the counter trend rally and confirmation of failure I may go all in short.  Currently I am mostly cash.

In 1999/2000 the refrain was “It’s The New Economy”, in 2007 it was “The Great Moderation” and today we have “The Fed Has Our Back!”.  The omnipotence of central bankers has become supreme.  I would say 90% of the people I talk to, read about or watch on TV believe that the Fed is prepared to put a floor on the stock market.  What if the Fed’s omnipotence is an illusion?  Much of the power of the Fed comes from the belief of the participants in the market.  They do have the ability to coax the herd into one side of a trade.  However, once that process is complete they can’t prevent the inevitable contraction and bear market.  The Fed knows this but they dare not let the market in on that fact.  In the prior two corrections the Fed was easing aggressively and yet the stock market went down 50% both times.  Once we have a trend change I believe that the Fed will be powerless to stop the correction.

The pavlovian worship of the Fed reminds me of Ancient Egypt where central bankers have become the new High Priests.  In Egypt the role of the priest was very important in society. The Egyptians believed the gods lived in the temples. Only the priest was allowed to enter the sacred area of the temple and approach the statue representing the god or goddess. The people could pray at the gate or in the court to the Pharaoh where the Priests acted as a go-between the people and the gods.

Today in this market the most important day has become the FOMC meeting.  Most active market participants drop what they are doing and listen to the woman pictured above talk about dots.  Yes we talk about dots!  It is absolutely absurd when one steps back and watches these proceedings.  In Egypt the power of the Priest came from the illusion that they talked to the gods.  Today the Fed’s perceived omnipotence comes from the belief that these people actually know what they are doing and the misguided belief that they can prevent a correction from occurring.  The longer they stretch this market’s uptrend without a meaningful correction the worse the fall out from the inevitable correction that ensues.  These people do not posses magical powers and they are not able to warp nature and cycles.  As long as the stock market has existed we have had cycles.  This is currently the longest 4 year cycle advance in the history of the stock market clocking in at 66 months.  The two prior record holders were 60 months apiece in 2007 and 1987.

If you want to worship at the feet of the central banks be my guest.  I choose to be a heretic.  The marginal return of QE is diminishing and the Fed knows this to be true.  Remember they are ending QE in a month.  They need to pull back now so that when the collapse occurs they can step back in and be the saviors yet again.  The illusion of power must continue.

We don’t have a confirmed top yet but all the signs are there from divergences, declining breadth…etc, etc.  There are three ways this goes down:

1) We continue to push higher and everyone tells me I am an idiot.

2) We have seen the top and we are beginning an 18 month bear market.

3) We have seen the top or get a top soon that initiates a crash sequence like 1929 or 1987.

I vote for #3 because of all the central bank manipulation, leverage used to extend this advance and the lack of a meaningful correction to unwind sentiment.  A crash is defined as greater than a 20% correction within a two month timeframe.

On a side note I was talking to my good friend Tim Wood today who pointed out to me that the Hang Seng, NYSE Composite, Dow Jones World Stock Index, Dow Jones Transports Average, DAX, Wilshire 5000, S&P 500, Nasdaq 100, FTSE, and CAC40 all have intermediate term sell signals.  The DJIA is yet to give us an intermediate sell signal but my guess is that is not far behind.  Additionally, the emerging markets equities look like death.  The punchline is we that haven’t seen this many intermediate sell signals across different markets in awhile.  It may mean nothing or it may mean something.  Again I vote for the latter.  My guess is the torrid advance in the $Dollar has something to do with this worldwide action.  This is the longest stretch of weekly gains in the $Dollar since 1967.  A ten week advance!  The beach ball has been held underwater for 6 years by the Fed and it is starting to come up fast.  The release valve is the currency market and the $Dollar is the tell that a major regime change is under way.  The charts below are courtesy of my buddy Tim.  Enjoy the rest of your weekend and remember to go pay homage to The New High Priestess tomorrow.

Many folks say that you can’t top when people are calling a top.  A seasoned sell side technical analyst for ISI many years ago told me that he never listened to what his clients or market pundits were saying.  He would say: “I am a bull…I am a bear…who gives a rats ass! How are you positioned?  Talk is cheap….all that matters is how the market participants are positioned.”  The sentiment indicators have been off the charts for months.  The number of bulls vs. bears as measured by Investors Intelligence are at lows last seen in 1987.  Many perma bears have recently thrown in the towel.  More importantly shorts have been bankrupted and openly mocked on CNBC.  Did any of you catch the Bill Flekenstein interview where this so called anchor mocked Bill?  It was shocking.  Does this mark a top?  No, but it certainly speaks to the positioning of the public.  The positioning of the institutional long only equity community is low on cash and high on beta.  Hedge funds gross of capital invested are 170% vs. the 168% top in 2007.  Then ask yourself how you are positioned?  Even Marc Faber our modern day equivalent of Eeyore said he hopes to lose only 50% of his money in a crash.  Think about that statement.  He is always calling for a top but yet he is in the market.  That is what long bull markets do.  They suck everyone in and then BOOM.

My Technical analyst friend and I were talking in February.  I asked him how close we were to the top?  He said: “We are in the top of the ninth.  I have never seen such confidence in the Federal Reserve in all my career.  Apparently many PM’s believe the Fed won’t let the market go down.  I was talking to one PM about the 87 crash…he stopped me and said I wasn’t born then.”  So how do you think the buy side is positioned?  I think everyone is long and strong.  Too long to be wrong.  With the Dollar strength (which is de facto tightening), QE ending and the wobbling of the credit markets equities are very vulnerable to a repositioning.  Liquidity is atrocious and if everyone has the same idea at the same time look out below.

Have we seen the top or a major top?  Maybe but we need more structural evidence.  My biggest fear is that this unwinds very quickly due to all the manipulation and intervention by the Fed.  In a battle between margin clerks and the Fed the margin clerks always win.

Watch the open tomorrow.  Good luck everyone.

The Dollar appears to have had an early four year cycle low in May and has since commenced to surge much higher.  It looks like the dollar wants to break out of its multi-year basing pattern since its low in 2008.  The dollar could be rising because we are the best house in a bad neighborhood or because deflation is beginning to overwhelm the central banks.  I believe a great deflation is commencing as the Fed withdrawals its liquidity from the markets: Commodities are collapsing to the downside, precious metals are hitting multi year lows, bonds have been ripping higher since December, emerging stock markets (EEM) are testing August lows and the Russell 2000 (IWM) peaked on July 3 and is now negative on the year.

A strong dollar is a sign of the Fed losing its battle with deflation.  In my opinion it is only a matter of time before deflation overwhelms the major US stock market indices.  Additionally many emerging market countries have issued much of their debt in Dollars.  A strong dollar is a complete disaster for emerging markets!  As the dollar appreciates it will increase the debt burden of these countries and this will cause their currencies to come under pressure.  This will in turn force levered carry trade players to sell emerging market debt and thus a virtuous death spiral will have begun.  As this leverage begins to unwind it will have knock on effects and we should see increased volatility in all risk on assets.

In our debt based fiat currency system it is important to remember money=debt.  The Fed is withdrawing credit from the system (QE is direct money injections).  Less debt/credit in the system means less dollars in the system and thus a bid for Dollars.  Once the reflexivity process begins it will feed on itself.  Margin calls and defaults are around the corner which will cause the dollar to rise further and in turn screw the emerging markets some more.  I am predicting the Dollar (DXY) likely rises 20-40% over the next 2 years.  In the very short term I am expecting the Dollar to pause and perhaps pull back before ripping higher.

Of course the Fed could announce QE 4 and try to prevent this from happening.  However, they know that QE is producing diminishing returns and they need to reverse the decrease in foreign purchases of treasuries.  We are currently in a financial war with Russia and China that may turn hot at some point.  A strong Dollar would crush Russia and put a dent in all their de-dollarization efforts.  I have no doubt that the Fed would choose funding the government over the health of the stock market all day long.  The belief that the Fed has your back will soon be put to the test.

Fun Fact: we have a confirmed Hindenberg Omen signal on Friday.  While not foolproof, it has historically generated a 25% chance of a correction greater than 15% between the date of signal and 4 months out.

I am still long my IWM 110 December puts that I put on at the end of August and September 4th.  If you own the emerging markets or anything with exposure to emerging markets I would urge extreme caution.  In my opinion the pain is just beginning there.

On September 11, 2001 I woke up in a Ritz Carlton Hotel room in Laguna Niguel California in the early hours.  I had fallen asleep with the TV on due to cocktails supplied to me by the good people hosting the CSFB Software Tech conference.  On CNBC they were showing one of the towers burning and talking about how a plane had flown into it.  As I was wiping sleep from my eyes, I saw the second plane hit.  Like many in our country I was horrified at the loss of life and extremely pissed off.  I wanted revenge.  When I got back to Boston I went to candle light vigils.  I began to wear an American flag on the lapel of my suite and I was known to utter statements like “Let’s turn their deserts into Glass!”  I wanted blood.  There was a pacifist in my office.  She and I argued about America’s response.  I made her cry.  I was a zealot.

Here we are on 9-11 2014 honoring the fallen victims.  And we should.  However, lets look at the facts.  We have spent several trillion dollars to invade Afghanistan and Iraq.  Many lives on both sides have been lost and our liberties stripped to protect us from so called terrorists.  After all the money spent and new departments (DHS, TSA) we are apparently no safer today than we were on 9-11 2001.  Over the last month we have been subjected to MSM and congressional fear porn about ISIS over and over again.  Apparently they are going to attack us on 9-11 and potentially bomb or nuke a US city.  Thirteen years ago I was unmarried and full of piss and vinegar and ruled by my emotions.  Today I have become extremely cynical and analytical.  I don’t know about you but I feel like a Mark in a giant Con Game.  It’s like I am waiting for Robert Redford and Paul Newman to come around the corner and rub the side of their nose and wink at me.  We live in an age of deception.  There is an all out assault on reality.  As I sit here writing this I have just received an email from a friend who has received intel from a cop in Houston.  The cop is saying that a large force of about 7,000 ISIS warriors is building in Mexico and is preparing to come across the boarder and attack.  I don’t know if this is true or bullshit.  Assuming it is true: is this what trillions of dollars gets us?  I don’t know what to believe anymore.  It is just really sad that this is the state of our country today.

I believe it is time for some of you to take the red pill and join me outside of the matrix.  If you want to take the blue pill and believe that our overlords are as American as Mom, baseball and apple pie then you should leave this page now.

I am going to present some facts without my opinion or commentary.  Many do not know that a third building fell on 9-11.  It was WTC building 7.  Here is the wikipedia version of what happened that day:

“On September 11, 2001,7 WTC was damaged by debris when the nearby North Tower of the World Trade Center collapsed. The debris also ignited fires, which continued to burn throughout the afternoon on lower floors of the building. The building’s internal fire suppression system lacked water pressure to fight the fires, and the building collapsed completely at 5:21:10 pm, according to FEMA,^[6] while the 2008 NIST study placed the final collapse time at 5:20:52 pm.^[7] The collapse began when a critical internal column buckled and triggered structural failure throughout, which was first visible from the exterior with the crumbling of a rooftop penthouse structure at 5:20:33 pm. The collapse made the old 7 World Trade Center the first tall building known to have collapsed primarily due to uncontrolled fires,^[8] and the first and only steel skyscraper in the world to have collapsed due to fire.^[9]“

Now view this video showing the collapse of WTC 7:

http://youtu.be/3ujWitEr-Ww

Come on down the rabbit hole….it seems to be getting deeper by the day.

The evidence is not 100% in yet but I believe the hand-off from the Fed to the ECB will not be enough.  Today we learned that the ECB will not be buying bank debt or sovereign debt yet.  So they did QE but not really.  Plus we don’t know the size of the program until October 2.  This stock market advance since 2011 has been about a crack cocaine high supplied from the central banks.  Todays reversal action tells me we are going lower.  The IWM (Russell 2000) looks like it has topped out at a lower high.  My guess is that volatility in currencies, stocks and bonds is about to rise and we should see stocks begin to sag nicely until we get a clarification from the ECB or the Fed is forced to step in.

The dollar has been on fire lately.  In days past a strong dollar would have been a sign of strength but in todays geared up super giant carry trade a strong dollar is a sign of deleveraging in my humble opinion.  Interestingly enough the dollar began its recent run at the beginning of July which also coincided with the retest top in the Russell 2000 which to me is a measure of risk on appetite.  The dollar is due for a near term top but I believe it made its 4 year cycle low in May and we are at the beginning of a major breakout to the upside after a multi year basing pattern.  I bought some IWM puts last Friday and  bought some more yesterday and I will be buying some more today.  Follow me at your own peril.  I really don’t care about the NFP report today.  It is noise compared to central bank policy.  I think the die has been cast and the central banks will need to step in again to prevent a correction…but maybe they want one this time?  Remember Janet did say small caps, social media and biotech stocks were stretched.

As a former growth manager I can tell you that most growth guys blew out of AAPL last year to chase the juice. Then juice rolled in March and AAPL started to work so they chased APPL right into the New Product launch. The constant institutional bid is now gone and they will become net sellers as the stock starts to underperform.  AAPL is no longer a secular growth stock and has transitioned into a trading stock. It is still big in the growth benchmark so that means momentum chasing growth stock managers will cover their underweight near the top and go underweight near the bottom.

Longer term smart phones will be commoditized and margins will collapse for the industry.  This looks like a classic double top. Comps will be tough next year and margins will be getting squeezed. In tech stock investing you always want to sell the launch of a new product. So you have numbers that are too high and growth stock managers just got done Buying to cover their underweight. This looks like a lay up long term short to me.

We are all being bombarded with Main Stream Media (MSM) stories and images of ISIS or ISIL as Obama refers to them.  I am not going impose my view of what I think this group is or what they are about.  Rather, I am going to pose some questions that our friends in the MSM should be asking to help us all get a better understanding of what is exactly going on here.

Questions:

1) Lets start with the above AP photo of the convoy which was taken supposedly as they were entering Mosel and obtained a central bank and military equipment.  Who took this photo? Was it an AP employee or was this provided by ISIS to AP?  Where did they get the convoy of trucks that look to be of the same make and model?  Very stylish jihadist’s wouldn’t you say?

2) Where do they get their weapons from?

3) Since we must know where they are why can’t we bomb them into oblivion like we did Iraq in 2003.  Anyone remember shock and awe?

4) Who is their leader, really?  Why did we let him go from prison?  Yes he was in our prison.

5) How did he learn to outsmart the world’s greatest military and outperform all generals in U.S. history?

6) How does ISIS avoid NSA surveillance?

7) If we don’t know where they are how do they avoid military and government satellite surveillance and tracking?

8) How does the mainstream media and all the CIA pundits on TV know so much about how dangerous ISIS is yet they know nothing else like where they got their weapons from or how they were created?  Its as if they sprouted from the sands like zombies in a very bad movie.

9) There are 20,000 ISIS rebels: how do they feed, clothe and maintain supply lines?  Their logistical sophistication seems advanced. Have you seen the clips of them firing artillery and now they fly captured jets.  Who trained these pilots?  Who trained them to operate tanks?

10) How is it that they are in Jaurez Mexico getting ready to attack us without our trillions in homeland security spending nipping this in the bud?  Why the F-ck are we giving money to these Federal agencies that would let this happen if true?

I could go on and on but I think you get the point.  The politicians, experts and MSM all have a story and narrative to craft.  If you use your brain and think then their narrative does not make much sense.  What I do know is this: If ISIS attacks the homeland then all politicians and the heads of the FBI, CIA, DHS, NSA all need to be fired or voted out of office for gross negligence.

Since my last post not much has changed in the battle between the bulls and the bears.  Markets remain overbought and extended since the rally out of the August 7th low.  The divergences from the IWM and the DJIA remain (DJIA did not reach a new closing high).  Its still to close to call but we either melt up or just simply begin to fall apart soon.  I am biased towards the fall apart soon scenario due to the delicate technical structure of this market and the fact that the taper ends in October.  People hope the ECB steps up and does QE but I have my doubts as to weather that will plug the hole of the Fed’s lack of QE.  The market is simply tired and pooped.  Since the taper began the second derivative of this market has shifted to one of price deceleration.  The DJIA is up about 500 points after 8 months of work this year.  The last two times the Fed ended QE the markets started to rollover and corrected nicely.

Since hedge funds are now the marginal player in the market heavily shorted expensive stocks are out performing cheaper stocks so the market seems to be inflicting the most amount of pain on the maximum number of participants.  I think this is why the Dow is lagging and the Nasdaq is hitting new highs.  Geopolitical noise is starting to affect company fundamentals in Europe and I suspect earnings revisions down will commence soon on multi-national firms affected by Russian sanctions.  This market is very resilient but it should be interesting to see if can handle going cold turkey from free basing QE rocks.  How low do we go?  That remains to be seen but a correction of 10% or greater is needed if you are a bull or bear because the longer this advance goes on without an unwinding of some of this froth the greater the chance of an epic crash that will make 1987 look like child’s play.  I think everyone should be rooting for a pull back.

The market appears to be at a very important juncture.  We have gone to new highs on the S&P and the Nasdaq.  We are flirting with new highs on the DJIA.  However, the IWM which is a proxy for risk continues to lag.  I use the DJIA when I talk about the market because it has the longest trading history.  Since the bottom in 2009 there has not been a topping set-up in the DJIA according to the way I look at the world until this April and July.  Once the set-up completes the top is in and it is game over.  We have not seen the set up fully complete yet.  The set-up in April was negated and the July set-up is in danger of being negated very soon.

To get bearish in the short term, we need to see the DJIA fail soon and start to roll over.  It can even go to a new high but it would have to roll very quickly.  We are in month 65 of the current 4 year cycle advance which is the longest 4 year cycle advance in the history of the DJIA.  In addition, tapering ends in 48 trading days.  The next 6-8 trading days are very important.  Should the topping set-up disappear there is a chance this market goes into full on melt up mode for a grand finale.  Hedge funds are underperforming the market YTD and active mangers are sucking wind and they are behind their benchmarks.  If we melt up a huge performance chase could ensue.  However, I remain a skeptic since the last two times the Fed ended QE the market rolled quickly and they had to reload QE.  Cash allocations are a good decision right now as it gives one options should we get a resolution soon.