June 30, 2018

Weekly Summary

In the market, what is obvious, is obviously wrong. Along with that, comes the inability to know why the obvious was wrong. Take trade wars for example. It is obvious that tit-for-tat tariffs among trading partners is bad for business and bad for stock prices. Yet the insane anti-trade tirade that the Donald has unleashed on America’s friends and trading partners, under the false pretense of “security” (that way he can do it without the check and balance of Congress), has not crashed the market. Why? Who knows?

We can think of several reasons for this unreasonable market reaction but trying to explain why the market didn’t react as expected, teaches you nothing; it won’t make you any more prescient for next time. That the market wasn’t crushed by something that by all logic should have crush it, is explained by the fact that we are still in the midst of a secular bull market which is not emotionally ready to roll over and die. A year from now, the market may finally crash, and pundits will be screaming how they “told you so” (if trade wars are still an issue by then), but the truth is that by then it won’t be the same market and it will crash regardless of whether trade wars are a thing or not; by that time, the market will be looking for an excuse to crash. But obviously not this market.

There are a number of patterns that point to problems in the market sometime in 2019, but the cause of those problems is unknown and irrelevant to making money in the market.


Equities
Sentiment

The AAII survey had a big shift to the bearish side this week.

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The 8-week MA of the put-to-call ratio has made a down-spike which carries a 75% probability of indicating a local top in the SPX. This means that the pull-back in the SPX could still have further to go (see below under Technical), but is not a warning of major trouble.

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Up and down-spikes in the PE of the S&P 500 in ratio to the VIX, correspond strongly to local tops and bottoms in the SPX. The ratio has dropped and could be forming a down-spike, which always marks a bottom and subsequent rally (chart below).

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Technical

The long-term technical picture continues to strengthen:

  • The 8-month MA remains above the 12-month MA.

This pattern is similar to what happened during the 1998–2000 trading period. The only worry we have is that the ADX trend strength (black curve) has reached the down-sloping trend-line (dashed blue-line), which has acted as a turning point for the trend strength in the past. This indicator can, however, continue to rise above the blue dashed-line like it did in 1998 (chart below).

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Fundamental

For most of this bull market, we have constantly heard how over-valued stocks are, but when we look at the yield from the S&P 500 minus the risk-free yield on a 6-month Treasury, we see that the resulting net yield, while recently turned negative, still remains higher than at any time during the 1995–2000 tech rally, and higher than during most of the 2003–2007 housing bubble. That does not sound like over-valuation to us. From this perspective, stocks could go much higher, even if dividends stay stagnant (chart below).

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Another piece of ‘received wisdom’ that we constantly hear, is that the Fed raising rates kills bull markets. That “obvious fact” is simply not borne out by the evidence; markets rise along with rates (chart below).

It is not rising rates that kill bull markets, it’s too high rates that do the job. And over the last 35-years, what is considered “too high” by the market has been steadily decreasing (descending purple dotted-line on the Feds funds rate chart above).

The above graph also shows how the 10-year minus 2-year Treasury rate differential inverts (goes negative) 6-to-12-months ahead of market tops. The present slope of the decline in differential, places an inversion in the later part of this year, or early in 2019, which implies that we are not likely to see a new bear market until mid-2019 at the earliest (chart above).

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Oil

We closed our long USO position for a +12% gain because the technicals in oil were starting to get stretched. We will continue to watch oil for the next opportunity (chart below).

Gold

The long-term technical picture for gold continues to look weak:

  • The RSI has broken below its trend-line.

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Gold is normally negatively correlated to interest rates, but lately the correlation has been strongly positive as gold and rates drop in tandem. The dollar’s correlation with gold, on-the-other-hand, has maintained its usual negative correlation. In fact, gold’s price collapse is directly due to the dollar’s strength. If the dollar, either continues to rise, or pulls back to form a reverse head-and-shoulders before rising further, gold will experience pressure that could bring it down to levels not seen since 2016 (chart below).

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The commitment of gold futures traders report (COT) shows that the swap dealers (the gold market experts) reduced their net-short position by 20k to -23K contracts, while the money managers (momentum players) reduced their already historically low net-long position from +10k contracts down to 0 contracts. Normally, swap dealers are maximally long at market bottoms, and the money managers are minimally long at bottoms. Since that has been the situation for several weeks now, we would have expected a rise in the gold price, not a $100 drop. At some point the futures traders will have to “stop fighting the tape”. If that happens, there will be blood in the pits. A strong rally in the dollar would certainly do the trick (chart below).

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We wish our subscribers a profitable week ahead and ask that email be monitored for Trade Alerts.

Regards,

ANG Traders

Email queries to info@angtraders.com

Forty years of private equity trading, and still learning.

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