This is it: we have a major top this week.

Frequent readers know that I watch sentiment and put a lot of stock in Investor’s Intelligence and Daily Sentiment Index surveys, and that when extremes in sentiment match with extremes in price, it is as good a trade as the market ever provides. Well, we have 3% dollar bulls today. The dollar is going to blast off from here and kill the stock and commodity rally and blow credit spreads wide open. It also appears that emerging market (including Chinese) stocks have already started stair-stepping lower.

The dollar vs. the euro, pound, Aussie and Loonie — a loaded springboard:

Chart from Yahoo!

I see three clear waves up from March in stocks and commodities (three is what you need for a complete countertrend move), with big B-wave moves down in the dollar and bonds, which now have the potential to blow right through their highs from last winter’s deflation trade. In stocks and commodities, the sell-off into early July was the b-wave (of 2 of C), where the hobby bears jumped in, and the rally since has crushed all but the most disciplined, patient and deep-pocketed shorts. On the cusp of the big 3rd wave down, this is definitely not the time to lose religion.

Commodities’ last gasp (indexes here):

Credit: Bloomberg.

Watch for VIX liftoff as well to add extra oomph to put portfolios.

Yahoo!

I’m sitting on puts on oil, silver, stocks, the euro and pound and calls on Treasuries. There are no guarantees in the market, so anything could happen, but I’ve never felt better being short (my puts are comfortably long-dated, of course). A sharp pullback might set us up for new highs, though I doubt it. I’m expecting a typical rollover at first, with increasingly jagged price movements (remember when almost every day saw 3% swings?), but not necessarily full-on crash conditions for several weeks to months.

Don’t trade like me (I’m a wild man), and good luck out there.

Addendum:

Here’s the much mentioned analogue to the ’29-’30 post-crash rally (image from D. Rosenberg at Gluskin Sheff — sign up for his free letters here):

About these ads

35 thoughts on “This is it: we have a major top this week.

  1. Mike,

    check out Kenny’s blog on technical analysis:
    http://kennystechnicalanalysisblog.blogspot.com/

    he has very interesting observations. Many significant technical events coincide within now:
    1. USD bottoming out
    2. VIX forming a huge falling wedge which has run out of time
    3. sentiment readings at extreme as you mentioned

    of course as the bonus, negative divergences are abound for quite somewhile by now.

  2. Neat. He labels his dollar chart the same way I would: big C-wave coming up. I hadn’t noticed that the VIX was a falling wedge, but yeah, it’s gone far enough.

    If this really is the big 3 coming up, lord help us all. Don’t forget to cash out while you still can and and get yer gold, guns and cigs!

  3. Hi,

    I’m reading your blog for the first time which I find very interesting. I pretty much agree with the whole view – very bearish – and see that you are short oil, stocks, etc. With exactly the same view, my position is actually : long VIX calls and long Euribor / Libor calls. Have you thought of those trades, if yes, why would you prefer for example a S&P put vs. a Vix call ?

    Cheers

  4. There’s more than one way to skin a cat. I like SPY puts b/c I can get them out to Dec 2011, but VIX or Libor calls are attractive too. I may even add some — I’m not done building my positions.

  5. These are the right questions to ask, especially today:
    http://www.blackswantrading.com/currency_currents

    But nowadays, people are just too dumb because of the green shoots.

    no. 7 is a very interesting question. My take would be that Japan has the largest pool of savings in the world, amounting to some USD 15 trillion (almost 4x their GDP, larger than the US economy). Your comments please, Mike.

    IMO, no. 1, 2, 5 & 10 are very attractive to be discussed in greater depths.

  6. Good observations in that link.

    I figure that the market respects the dollar and yen b/c they are the one-eyed men in the land of the blind. They represent the biggest economies in the world, and, perhaps more importantly, the lion’s share of the world’s private debt. They are what people have borrowed to speculate in other assets, so it makes sense for them to move inversely to those assets. The same fear impulse that drives down risk assets creates a desire for cash to repay debt (or get repaid).

    Yes, Japan has a huge public debt load, but the interest is so low and their people have been so productive and thrifty that making the payments hasn’t been an issue so far. This won’t last, but when the deflation trade is on it doesn’t matter what will happen a decade from now. If you were in debt in the US in 1932 it didn’t matter that 10 years later there would be deficits over 100% of GDP and 10% inflation.

    The other points in the post are just sad. I’ve simply accepted the nature of government and the direction of history. They are what they are — at least times like this are good for bearish speculators.

  7. Alright, Goldman has finally announced that the rally is over! That’s their real message here — but should we trust them? They know that we know that AJC is full of shit, so why else would they still give employ to this woman but to mess with our heads? Arrgghh!! I say that they know that we know that they know that we know she’s full of shit, so it’s still safe to short!

  8. Could the fall in new accounts at E-Brokers be a sign of the times? Falling interest in the Stock Market …. loss of confidence? What is amazing is that retail investors are still piling on the buy leveraged ETF’s … I wish someone would do a study to show how many people actually make money using these “PONZI” ETF’s … ???!!!!??? Yet, human psychology and greed never change … just buy a PUT or sell short the damn SMH or QQQQ … so simple … but no, people have to get double leverage ….

    http://finance.yahoo.com/news/As-Market-Rose-EBrokers-Saw-ibd-2220114737.html?x=0&.v=1

    However the recent price action of USPIX and RYVNX heading into the 7′s and 8′s is a screaming indicator that these funds do nothing butgo down in the long term …. are ProFunds and Rydex going to do a REVERSE Stock split of these funds .. if yes, that could be bullish for the market …

  9. Careful. We consolidated a bit today, so there is still room to run if Mr Market so decides. I’m usually early in these calls for a turn.

  10. Who knows what AIG says tomorrow and the ADP Report on top of that … I still think the fall (if it happens) is 3 or 4 weeks away ….

  11. I think Libor calls are attractive. I think one way to do that is to short Eurodollar futures if one expect the TED spread to widen. I suppose that is a better recovery trade too if done with leverage assuming Bernanke withdraws liquidity, but it is mainly a TED spread trade. I also think going long on Australian T-bills (or whatever they are called) is good since a 150 basis point hiked is already priced in a year.)

    Take Mike’s warning seriously .. The sideways consolidation probably attracted some bears to take short positions and this will test them although they might have long enough time horizons so they can tolerate some loss. Also, Mike is indeed correct, maximum pain to that maximum number. I think the market needs to give more dopamine to some people on the recovery trade before the profit taking party arrives. I suppose most bears are afraid and looking for a “safe” entry point so the next “short squeeze” wouldn’t be so dramatic (if it happens at all); the major Darwinian flush of the bears is done (especially those bears that sold short in a moderately oversold market). Also people are expecting the market to collapse in the fall, not in August. The Darwinian flush will cause most bears to miss to the rally because they put a target top on the S&P that is too high. I expect a lot of volatility and whipsaw to burn dip buyers and people who shorted on oversold conditions on the way down.

    Mike, regarding crowded trades, do you have any detailed information on how crowded the US 2-10 steepener and Treasury shorts are? I think some Treasury bears covered, and the recent rise in Treasury yields are due to recovery expectations.

  12. I meant to say miss the sell-off… not the rally.

    http://www.marketwatch.com/story/sentiment-rises-back-up-to-dangerous-levels-2009-07-24

    Consider this:

    “Oh God no!!! Watch out for more green shoots coming from S&P (Sap the Poor) companies. They will report “better than expected earnings. Also another housing report with housing sales “up” on Monday and GDP is “better than expected” on Friday. More suckers pile into the markets and will take this BS market to 10,000. After all the smoke and mirrors clear, these sheeple must find direction and that direction is down. Then it is time to short the market. Hold off shorting until the coast is clear and you see no more “earnings” or “economics” reports from the government which are both fixed BS reports anyway. I had to stop loss my shorts after seeing more BS reports come out”

    Think like a goddamn trader for Christ’s sake!!!! Do you think shorting would be that easy? Relax, and acknowledge it was a “necessary” Darwinian flush of many bears that needed to happen before the rally ended. Of course, one could have shorted at S&P 500 950 early in June, which would have minimized losses if you were wrong. Having good technical skills allows one to minimize losses.

  13. Great info from Comstock: Deleveraging the U.S. Economy

    ” Many investors look at this deleveraging as a positive for the United States. We, on the other hand, look at this deleveraging as a major negative that will weigh on the economy for years to come and we could wind up with a lost couple of decades just as Japan experienced over the past 20 years. It is true that Japan didn’t act as quickly as we did but our debt ratio presently is much worse than Japan’s debt ratios throughout their deleveraging process.”

    http://www.comstockfunds.com/default.aspx?act=Newsletter.aspx&category=SpecialReport&newsletterid=1473&menugroup=Home

  14. Why is it that every damn TV show nowadays features the recession, job losses, lay off’s, emebezllers, bad stock brockers, tumbling markets etc …. is’nt this the most contrarian indication of a market bottom??? Hummm…

    Mike et all?

  15. Hey guys,

    just a reminder, the market could be a bit different than the one back in 1929. With the insane QE policies by the central banks around the globe, it could actually cause another bubble before it bursts, or it could be analogue to the one Japan has had.

    be careful guys.
    Ed

  16. Shorts should also fear a Japanese scenario (in the context of their portfolios); I mean that after the 1987 crash, the Japanese Nikkei index failed to collapse for two years. This cost George Soros to lose in the 1987 crash where he expected a financial crisis, but he shorted the Japanese stock market (and it was propped up and didn’t collapse) while he was long S&P futures with leverage. (If I remember correctly, it started to collapse once the Japanese tightened monetary policy.) I wonder if that is a likely outcome.

    Does anyone have information about how sensitive the S&P 500 earnings are to dollar strength? (About 30-40% of S&P earnings are international.) Are company hedges for a strong dollar enough to compensate for 10% dollar rally? Most “analysts” are discounting a dollar rally here, and perhaps the earnings would be low enough that no one can spin the lower earnings.

  17. Aki, good points about shorts being scared and expecting another squeeze. The old saying is, they don’t ring a bell at the top. Nonetheless, it’s always prudent to consider the worst.

    We did get some meaningful dollar strength vs. the pound and euro yesterday, and I see that it has held overnight. The S&P futures have also been weak ever since the market failed to snap back to the highs after the mid-day drop yesterday.

    China had a bad day today also: down 2.68%.

    Also, copper and silver made very sharp spikes that have corrected, and bonds are holding up (though not rallying yet).

    I expect bond strength and a tighter 2/10 spread going forward.

  18. Regarding my comments, I will clarify that I do not see S&P 1050 or 1100. It seems that the market is about to collapse since most people are expecting it to rise and will fall in the summer. However, it might go to S&P 1030 just to give people some dopamine to people on the recovery trade. Of course, pursuit for short-term profits can be disasterous, and good traders need to exploit hyperbolic discounting (explained in the link for those who do not know); people on the recovery trade are expecting to make a profit because the S&P 500 will go to 1050 or higher, and then it will collapse. Those traders hope to receive short-term gains while risking that the profit taking party will start (and this is inevitable) when they are long. Traders need to tolerate short term losses for long term gains.

    Yes, it is always prudent to imagine the worst such as the Nikkei in the late 1980s. That would require the illusion of a sustainable bull market, and I do not think this illusion will last for long. I think the current situation gives a nice margin of safety for being short (the sentiment and technicals give this trade a nice risk/reward.)

    Going short early June (S&P 950) was a nice trade even if you had a long-term time horizon because the overbought conditions (RSI at 64 and the market above the 200 day EMA — a technical situation similar to March 2002). When it was at 880, I acknowledged it was moderately oversold (but it was clearly not a panic oversold condition because the volume wasn’t there) and it wasn’t a good time to intiate short positions because the whipsaw potential was high, but the sentiment indicators (I look at Guy Lerner’s “Dumb Money Index”) did not trigger a bullish signal (a bearish reading on the dumb money index) as it was neutral. Investors were prepared for a sell-off by buying puts to protect against a decline in the S&P 500, but they were hedging, not expecting to profit from a market decline, so I did not interpret this as an overt bullish signal. It was unclear whether the market would rally or sell-off from the economic and earnings “news.” (If I were a global macro hedge fund manager with better information sources, I would have an analyst conduct a study to see whether short interest on certain stocks (particularly high beta stocks such as Whole Foods, Lennar, and Harley Davidson ) were at a near term high and try to test the hypothesis whether short interest is correlated to returns on the broad market to see if this can be used as a sentiment indicator with moderate predictive power.) Of course, during the rally, one can cover at a price below 950 and humbly admit you were wrong with equanimity, and acknowledge that the Darwinian flush needed to happen to provide an even better set-up.

  19. There you go … damn Job numbers came in good … AIG makes a profit …. DOW 10K is here by end of August …. this train is not going to stop now …. it will end though … just need some bad economic numbers … that’s it … to turn sentiment around …

  20. That’s right. The same good feelings that create the rally generate positive news (or at least less-bad news: BTW, how could the unemployment rate be down if over 200k jobs were lost and it takes an addition of 200k just to stay even?). I have never bothered to learn the nitty gritty of how these government numbers are put together.

    I am not expecting a crash right away, simply a topping process. Look at a 2 year index chart, or a chart of the 2000-2002 bear market, and see how rallies roll over slowly, often with a series of smaller sell-offs and rallies on the way. It takes a while before panic arrives.

  21. Mike,

    the signals got all messed up today. “Safe” assets, except for the dollar, are getting murdered, i.e. treasuries & yen. Stocks rally hard, but oil & commodity stocks are in general weak, given the big up in the S&P. Which sector is zooming, anyway?

    I suspect this is a case of a too crowded dollar-short trade getting wiped out, while stocks & risk assets in general actually still have much to run.

  22. hmm… actually it’s the banks rallying hard. Watch BKX. nevertheless, the confusion is still there: divergences within safe asset classes and within risk assets.

    yes, the dollar rallies hard (one “safe” asset class). but the yen tanks more than other currencies -> one other safe asset class is torpedoed. so, the yen index (XJY) must be crashing now.

    10-year treasury is absolutely raped, but the 30-yr not as bad (usually 30-yr is the worst raped if there’s massive rally in risk).

    BKX is apparently near to violating Daneric’s EW count.

  23. Aki does a good job summing up the dynamics here: smart traders who are long are just in it for 50-100 pts, with the intention of shorting at higher levels. I think this is a crowded trade, so I doubt we reach those levels, since the dumb money of course thinks this is a new bull market — that makes everyone in agreement that we go at least 50 pts higher. 10-30 pts, sure, the market can run away and diverge from commodities and the dollar for a few sessions, but it would not last. I agree that crapping out from here or just a tad higher would frustrate the most people.

  24. The runaway in financials and REITs is kicking a lot of bears while they’re down. I’d say this is a pretty good entry for REIT shorts — a lot of those must have negative equity in reality.

  25. Well, we’ve hit the first common Fibonacci retracement level (38.1%). We’ve now rallied 350 S&P points after a 904 point fall (1570 to 666). This is the best shorting opportunity since 12 months ago, IMO.

    Nasdaq is nicely lagging, and the dollar is looking good. China could have topped already. The chatter on the boards is of scared bears and confident momentum chasers.

    Next week could be brutal, maybe a drop to 950 before a rally to test 1000 again soon thereafter. Or maybe we slowly roll over and don’t break 950 til almost labor day.

    If this really is wave 3 down, it should be another 5 wave move, like wave 1. During the first wave, and even the second, most won’t believe the top is really in. Wave 1 could start from here, since the momentum guys would be buying in on the decline and there would be few shorts. It would be seen as a “healthy correction.”

  26. “That’s right. The same good feelings that create the rally generate positive news (or at least less-bad news: BTW, how could the unemployment rate be down if over 200k jobs were lost and it takes an addition of 200k just to stay even?). I have never bothered to learn the nitty gritty of how these government numbers are put together.”

    I do not know if the 200k figure is necessarily true right now, but it is nit-picking. I object with that figure because immigration is probably down, and you are using a figure when there is relatively high immigration.

  27. Sorry to rain on your parade but wasn’t this like two months ago when you declared “Reflation fade vindicated?” And how about the treasury trade when you declared “Buy bonds” at 4%. With yields again approaching 4% how’s that workin out for ya? I guess shorting PM’s has been a real winner too with you January ’09 call for a “disappointing fall in Gold” yet to materialize. Please go do something else you are good at because you clearly are not at this. Don’t mislead people.

  28. Given your disrespect you don’t deserve a reply, and are no longer welcome here unless you’re more polite and start making some actual contributions to this blog.

    Regular readers know that I’m fine with other points of view, but not rudeness — for instance I have a lot of respect for Aki and am glad he’s here, though he and I have very different political views. However, the above comments did prompt me to ruminate over the last few months. So, mostly for my own benefit, here is a kind of recap:

    The reflation trade was a good short when I called it at the end of May and first week of June. It was vindicated with a nice fall into the first week of July, but has since rallied back and is setting up an even better short (since guys like JB above are now so confident). Anyone who was short stocks, copper, oil, silver and went long bonds and the dollar from early June did very well (every asset named here did what I said it would). Since then, the strength of the recovery in commodities and the new lows in the dollar have surprised me, but that’s what stops are for.

    The bond long from early June was a particularly good trade, as bonds rallied nicely from exactly when I made the call to sell TBT and buy TLT (the day the 10-year touched 4.00%). I made very nice gains on my calls and 10-year notes. Bonds have retraced much of that rally, but remain above their June lows, and holders of TBT are still down about 7%. That was one that actually worked out perfectly for me trading-wise, since I sold at the top and sat on the sidelines until last week.

    And yeah, PMs were a real bitch in January, but they have not made new highs like everyone expected, and presented good shorting opportunities in Feb and June, which I noted at the time, and are again good shorts at these lower highs this month. And yes, gold will likely disappoint for a long time. $600 is still not out of the question.

    I don’t claim to be a trading wizard (I’m much better at making intermediate-to-longer term calls than the mechanics of charting), and I’ll admit to my mistakes — I totally f-ed up what should have been an epic silver short from June to July, shorting at 15.65 but covering at 13.90 and leaving big gains on the table, when a simply trailing stop would have been far better. I also went long silver with only a small position at 12.45 (2 ticks from the low) but wimped out again at 13.20 (again, a trailing stop would have given me another buck). Taken from when I turned bearish, to bullish to bearish again, silver should have been well over $5 in gains, and as good a set-up as it was, I should have taken larger positions — but making good calls is different from making good trades.

    Copper has been equally frustrating, stopping me out flat after falling from 2.30 to 2.10, and again denying me an entry a few days ago when I tried to short it at about 2.62. Ditto oil last week, with multiple stop-outs there. Not to mention hogs — my bottom-picking attempt in June didn’t work out, though I’m even more interested now.

    I noted here that I was long the 10 year note last week at 95.12 — well, I booked nice gains on some calls from 1 20/64 to 2 2/64, selling at the top at the end of the week. I bought them again this week at 1 20/64 but was stopped out Friday at 1.

    Actually, it’s funny — the trades JB mentions were among the few highlights of the last few months. They were all solid calls. I wish I had stuck to them and been more patient about shorting crap like restaurants and retailers that just kept going up, and waited until at least late May to start buying back my long-term SPY puts (though I bought very few until June, and have only in the past couple of weeks built it into a large position).

    I guess my lesson should be to stick to trading the high-probability macro waves — it is easier to gauge mood and trend on large asset classes than in particular stocks. And when you see readings like single digit bulls or bears and charts with clear levels for stops, have the guts to take a large position so that your calls make you good money for all your work.

    Actually, that brings up a sort of rule for myself: if you are not confident enough in a trade to blog about it, don’t take it. I didn’t post about about all the losing stock trades I entered last spring (I only mentioned them in passing comments) — that should have been a hint that I didn’t have much to back them up.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Connecting to %s