My Deadline Has Arrived. But There’s Still Hope for All You Bears

Back on June 22, my post ran with the headline, You Have Until July 10 to Prepare for The Collapse – Here’s What to Do. I said then:

I have also warned you not to chase the recent rally. July looks like the month where the market should start to break down. That doesn’t mean that it will, but the risk is high and growing.  I would be out of this market, and for more aggressive traders I would be shorting the SPY, and even buying limited amounts of puts on it. I’d look at puts just in the money (just below the strike price), with about 5-6 weeks to go until expiration, to catch this next wave down.

I posted a chart from my trading platform and said this.

At the bottom of the chart you see the idealized cycle periods. The 13 week, 6-7 week, and 4 week cycles all align to the downside starting around July 10. That doesn’t guarantee a decline. It just signals that the cycle wave patterns will be most propitious for a decline at that time.

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Since then the S&P 500 has rallied from 2754 to 2794, a gain of 1.1%. It seems like a lot more doesn’t it?  That’s because it dipped a bit early in the period. Since closing just below 2700 on June 28 the SPX has risen a hearty 3.5%. The rally has been relentless, casting a pall over bears, and further cementing the complacency of bulls.

But despite these rallies, I’ve put together a variety of reasons why we probably shouldn’t be losing sleep over it… Although that’s easier said than done!

The Market Looks Bullish Up Close. But That Ignores the Bigger View from the Heights.

The market has now remained firmly rangebound for more than 6 months since it first climbed into the 2700s, with a 2 week foray into the 2800s in the second half of January. Since then it has been all chop and churn. The market has gone nowhere. People forget that. They only remember what happened this week and yesterday.

Meanwhile, every time the market races toward the bottom of the range, bears have perked up, and when the range racing has moved to the upside, bulls become more certain that the future is theirs.

But in fact, nothing has been proven. Yesterday’s slight breakout through the June high of 2791 has been reversed so far today, with the S&P 15 points below that benchmark as I write on Wednesday afternoon, July 11.

But alas, my deadline for the market collapse to begin has arrived, and a stable of puts that I have been buying for my own account over the past month is sitting with a loss of about 2/3 of the original value.

When I recommended buying those puts on June 22 with 5-6 weeks until expiration, it was with a standard caveat. That is that, if I’m wrong, not just ultimately, but on the short term timing, the positions may go to zero. So never bet more than you would be willing to lose. Options trading is like horse racing, with a finish line, or like betting on football or basketball games. When the final buzzer sounds, you are either in the money, or you are not.  It’s gambling, pure and simple, and not only good timing, but also risk management is key to long term success.

In this case, there’s still time for these to pay out profitably, but we are on the razor’s edge. A continuation of the rally from here would wipe out this bet. A sharp downturn is needed now for the bet to pay off.

So now the deadline that I suggested has arrived. Was I wrong, or just early? Where do things stand, and what should you do now with your money?

Back on June 22, I showed you the chart that suggested why I thought that July 10 would be an important date on the cyclical GPS map of the market. Like GPS, when we start out on a different route, the cycle map recalculates to account for the present conditions. We’ll take a look at the latest map down below, but first, let’s set the backdrop of where we are.

Ignore JM Hurst Here. Liquidity Drives These Markets, Not Fundamentals

JM Hurst, the father of modern cyclical analysis, told us in 1970 that cycles only account for 22% of price action. Most of the rest, he said, was driven by fundamentals. I have observed and worked with his theories in the real world over the past 48 years since I read his seminal work, The Profit Magic of Stock Transaction Timing. I’ve come to different conclusions.

I can’t quantify it, but my sense is that cycles, which seem to reflect the natural rhythms of most human behavior and mass psychology, account for significantly more than 22% of price action. How much I can’t say. In the very short run, there’s plenty of randomness, and market reaction to what I call news noise. That constitutes a meaningful part of daily price action.

But ultimately those moves do not affect the trend. They just throw us off course for a couple of hours, or at most a day or two. They create opportunities for entries and exits at better prices if we are confident of the trend. Traders say that they are “fading” the news, or a particular pundit with the ability to move the market.

I think Hurst also failed to understand that “fundamentals” don’t drive anything. Over the long run, the supply and demand for investment securities drive the trends. Fundamentals are just the fairy tales that market participants and the mouthpieces of the Wall Street mob in the “finanfomercial” media tell to explain their choices.

What drives those choices is money, or what we call “liquidity.” When there’s more money around, particularly more money in the hands of securities dealers, demand increases relative to supply and the prices of securities go up. When there’s less money around, particularly when central banks decide that enough is enough, the reduction of available liquidity curtails demand and the trend of prices of financial assets falls.

Today, at the same time, governments and businesses need and/or want to raise additional capital by selling securities, particularly debt securities, and particularly US government debt securities. So there’s more supply.

In the current environment, there’s less money around, so demand is weakening. That’s the only “fundamental” that matters. It may not feel that way on the heels of this rally, but let’s not forget that the markets have gone nowhere for the last six months. That’s a sea change from the relentless bull moves that preceded this period of diminishing liquidity.

In addition, there are more securities around because the US government in particular made policy decisions to massively increase the amount of debt it issues over time. This adds supply to the investment market.

But the US government isn’t the only one. Businesses, both nonfinancial and financial are adding securities to the market hand over fist. And not just debt securities.

The papers and TV touts talk about the massive amount of corporate buybacks of equities, reportedly running lately at about $600 billion per year, a record rate.  That takes supply off the market, and it is strategically placed in companies that have the highest weightings in the Dow and S&P. So the market averages rise from time to time when those buybacks are being executed. In the short run, anything can and does happen.

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Manias take time to die. The big February selloff from the very tippy top of the market was a historical weirdo. Never has a market crashed beginning a day or two after it hit an all-time high.  There’s always been a warning period of at least several weeks, or even a few months, where the market weakened technically before crashing. The February plunge was too much too soon. It was merely a warning shot across the bow.

As a result, the market has spent the last few months backing and filling.  There have been downdrafts due to the Fed and US Treasury pulling money out of the markets. Then there have been rallies, driven by the corporate buyback game and manic borrowing on margin.

In the corporate buyback game, C suite mob bosses enrich themselves by using the corporate piggy bank to buy back the shares that they had issued themselves at lower prices. This isn’t just me speculating. The SEC has confirmed it.  The bosses do this at the highs in their stock prices to line their own pockets, not to benefit shareholders. Corporate buybacks have only been this high once before. That was at the top of the market in 2007. Shareholders were left holding the bag.

Other drivers are the increased use of leverage, aka margin, at the peak of the mania. Loans issued by brokers and shadow banks have been surging to all time highs. But debt! Huh! Yeah! What is it good for! Absolutely nothing! The market can’t get out of its own way. All those corporate buybacks, all that financial debt, and the market is still stuck in a range.

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Source: Federal Reserve H8 and S&P

I’m Holding My Puts Until Expiration. But What You Do Is Your Decision

So, am I wrong about this market being headed for the graveyard? We don’t know yet. The market is rangebound, and one of my nostrums about rangebound markets is that the more often a range is crossed, the thinner it becomes. There are fewer buyers and fewer sellers within the range as their orders and strategies are fulfilled each time the range is crossed. So prices tend to cross the range quickly and easily. It’s all sound and fury and much ado about nothing. It’s only when the market reaches the edges of the range that we see exactly where supply and demand are situated.

Yesterday, we reached the top edge of the recent range. Suddenly, overnight, the players found a piece of news that they could sink their teeth into–a catalyst. The Trump Regime announced $200 billion in additional tariffs on Chinese goods. The futures instantly plunged.

Coincidence? Are “fundamentals” the driver here? Or is this a case of the fundamentals of liquidity, the supply and demand for money and securities, exerting their long term influence just at the edge of the range. This is where heavy resistance in the form of a wall of supply stands. In other words, is it a case of, “when the market is ready a catalyst appears?”  I’ve seen that happen all too often in 50+ years of observing markets to dismiss it out of hand as a coincidence.

Below is an update of the chart I showed you from my trading platform a few weeks ago. I’ll allow you to consider it and all of this data along with everything that you are seeing, hearing and reading in the finanfomercial media. Then watch the market over the next few days and weeks. There’s something  happenin here. What it is ain’t exactly clear.

spxtoday

I think we’re going to find out. Soon. It’s up to you to decide what to do now. I’m going to hold my puts until expiration in the next couple of weeks. If the market doesn’t sell off, I’ll take my lumps and re-evaluate in the days ahead, and let you know how I plan to handle the next phase of this market, whether it’s the collapse that I expect, or the continuation of the mania on ever flimsier support.

If you’re interested in the short side, you can look at our ideas here, or check out Shah Gilani’s put play research and recommendations in Zenith Trading Circle.

Sincerely,

Lee Adler

2 Responses to “My Deadline Has Arrived. But There’s Still Hope for All You Bears”

  1. Lee…Great discussion on current market conditions, liquidity, and Hurst cycles. Two questions: 1) Respect for the technicals — you have previously discussed how if the market breaks 2800, the next logical stop is the highs. Why are you going to hold your puts? You have discussed the story of how your colleagues used Hurst cycles to go from $10,000 to $909,000 — then blew it by deciding they knew more than the technicals. Does not one have to follow the discipline? Why the “exception” now? 2) Do you have any idea how long these S&P 500 buybacks can continue? Does Trimtabs? Does S&P Capital IQ? Without the approximately $680 billion in buybacks this half of 2018 — you would have already been at the Wiley Coyote moment. Again, great article and just wanted to provide the key questions engendered. Thanks.

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