Today, we talk about how the market’s bumpy ride continues and what its implications are on your trading.
Why we do this
We like to think we have a well-informed macro view. While we understand that trading is generally a short-term game, we also know that most traders have buy-and-hold investments, too.
The macro view informs trading decisions by providing us with a framework for market activity. It is less important for day traders, but swing traders can benefit tremendously from an objective, market-driven macro outlook.
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Now, on to this week’s issue!
About that crystal ball…
Over the past several weeks, we have been talking about the stresses facing the markets in 2022. Just last week, we invoked the 2000 film, The Perfect Storm, as a metaphor for current market conditions.
We were hardly the only ones to make this comparison. And this week, the theme was repeated by The Market Ear, as they challenged those who question the validity of the recent upturn in the stock indexes.
The Perfect Storm: The 13 damned of Q1
At the risk of oversimplifying the situation, we just saw 1Q set up as “the perfect storm” for the doomsday crowd to have their index ‘crash’ scenario play out. Instead, the S&P is now just a few percent off of the highs and the Nasdaq has climbed double digit % since mid-March. What’s the next move bears?
- Inflation at a 40-year high
- Hawkish central banks (“nine” + hike)
- The specter of “nuclear war”
- Ongoing supply chain disruptions
- Dramatic China slowdown
- European recession risk
- Curve inversion signaling
- Waning financial stimulus
- US Recession/stagflation risk
- SPX bearish “death cross”
- Commodity Spike
- COVID spike
- VIX spike
Courtesy of themarketear.com
“It’s different this time”
This is a mantra that has been repeated at every peak moment in every bull cycle, when evidence challenging the story of continued upward price movement mounts.
Those who insist that the recent market surge is the end of a correction in a continuing bull market, raise numerous arguments that the details listed above do not signal the end of this incredible bull run.
Each trader must decide for him or herself what is going on in the markets. You should never take anyone’s word for anything (not even ours!) when it comes to the economy or geopolitics… there are so many narratives out there, with so many different motivations that it’s extremely difficult to separate fact from spin when it comes to the “experts” we choose to follow.
Nevertheless, chart analysis shows us that patterns tend to repeat. Below is a picture of the year-to-date S&P 500 index (SPX) price (yellow line) superimposed over the price for 2008. Remember, signs of the impending collapse were in the air long before the bottom fell out of the market in September of that year.
Chart courtesy of themarketear.com
We remain convinced that the “perfect storm” conditions are brewing up a major stock market downturn sometime this year. While traders can still find long side opportunities in individual stocks, the prospects for long-term portfolio growth in stocks is not good.
Of course, a Fed reversal on quantitative tightening and interest rate hikes (already tepid at best), could spark another wave of buying. And there is still a lot of liquidity sloshing around the capital markets. So a “crack-up top” fueled by a further surge in inflation is not out of the question. But for savvy investors and traders, the time to prepare is now… not after the storm has broken.
Underselling volatility
Markets are notoriously shortsighted.
In January, we published an article pointing out the imbalanced risk-reward ratio on the VIX (volatility index on the price of SPX), trading then around 17, and suggesting the advantages of a long position. Shortly after that article ran, the VIX spiked to over 30, creating a big profit opportunity for attentive readers.
Today (Tuesday April 5), the VIX is at 21.04, up two and a half points from a cycle low of 18.58 on the 4th. Once again, we can only take note of the large potential upside in the VIX relative to the much lower probability of a sharp move down… even under the best circumstances, VIX is unlikely to fall below 16, while any unexpected shock could send it back over 30.
To say nothing of what could happen if a full-fledged market rout were to begin.
The chart below shows the gap between high yield corporate debt – the riskiest component of the corporate bond market – and the VIX (inverted).
The high purple line indicates a relatively low VIX print, while the yellow line shows HYG. A basic analysis tells us that the gap is much wider than normal, implying that one of two things must happen – VIX must go up (which would bring this line down), or junk bond yields must increase.
Chart courtesy of themarketear.com
Of course, both could happen.
Again, Market Slice has covered the Fed’s difficult challenge in sustaining low interest rates, so important to keeping the economy expanding and the stock market from imploding. For now, though, rates are still artificially low due to ultra-loose monetary policy.
This means equities are more likely to fall, and fall rapidly, as this gap closes.
In our view, with VIX trading below 22, there is still an opportunity to capture significant gains with limited downside exposure by going long the VIX. Note: This is not a trading recommendation. Readers are advised to do their own research and draw their own conclusions from this educational article!
Bubble, Bubble, Oil and Trouble
The “double bubble” in equity and bond prices is highlighted by developments in the global energy markets.
War in Ukraine has created new stresses in oil and natural gas markets, and inflation – already a factor before the war began – is adding fuel to the fire of soaring energy prices.
We talked about the opportunities in Crude Oil back in September, and again in January. We won’t restate our case for continuing increases in oil pricing today, but we will add one more piece of evidence to consider.
President Biden’s decision last week to release at least 50 million barrels of oil from the U.S. Strategic Petroleum Reserve – together with unspecified releases from allied nations bringing the total of reserve oil supply 180 million barrels – comes at a time when oil inventories are already perilously low.
Leaving aside the politics of this move, transparently designed to depress gasoline prices in the runup to the 2022 midterm elections, this move creates additional upside pressure on oil prices, since these reserves will have to be replaced with purchases from a supply now seriously constrained by the Ukraine war and Russian sanctions.
No one should be shocked by a politician making pragmatic short-term decisions without regard to the long-term implications. We’ve talked about unintended consequences a lot lately. But the term “cutting off your nose to spite your face” might describe this effort to drive down gas prices to encourage more summer travel, knowing that a) we are leaving the nation more vulnerable in the event of a serious energy shortage down the road, and b) saddling the post-election regime with yet another bill to pay, as the reserves will have to be replenished at prices that are likely to be higher than the $101 a barrel oil is trading at today.
You do not have to “go it alone” in the face of today’s daunting political and economic environment. FFR Trading’s Strategy Team is your partner in trading expertise and strategy development. For a no-risk portfolio evaluation, call us today at (800) 883-0524!
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