Guesses as to where we are in this correction

We’ve sold off very sharply in a short period. Many investors—probably the majority—think this is mostly technical and the basic global fundamentals have not changed. This group will be buying this dip. Others are worried that so much stimulus on a fairly full-employment economy will lead to inflation the Fed will have to stamp out, and, more concretely, fear the January Average Hourly Earnings number triggered a broader market realization of this. This group sees maybe a bounce, but more trouble ahead now that global central bank normalization is unambiguously on.

Behaviorally, after such a long, strong run, the BTD crowd is the more likely to prevail. The muscle memory is fresh. Traders like successful retests. And the overall case for this selloff being predominately technical is pretty strong. I’d cuff 75% odds that Friday was the bottom of this correction. And if that’s the case, it’s almost a certainty that we’ll be shocked at how fast market sentiment toggles back to the bull case.

Obviously, if this is wrong, the next leg down would likely be panicky and painful once investors realize it wasn’t.

However, if Friday was indeed the local bottom, my guess is that we rally back to or near the previous market highs. And it would be in the run up to those previous highs where we start looking for divergences to gauge the strength of the bounce. At least, this is the road map I am running with unless/until thing change.

For divergences, you’d want to look primarily to market internals. Advance-decline lines, new highs vs new lows, momentum indicators, these are the kinds of things you want to track. Vol needs to work it’s way lower too.

If you want to add risk here and are in a position to do so, I would recommend, as a general guideline, the sectors and names that held up best in the correction, not the ones that sold off most. It’s counter-intuitive for many of us, but strength tends to beget strength—even if constitutionally some of us are hard wired to shop for ‘laggards and bargains’.

Whatever you do, make sure you get your sizing and your stops right to manage that risk. Good luck.

Update on Bitcoin $XBT $BTC

I wanted to follow up briefly on the bitcoin post from December. 

To me it still looks like a bearish pattern has to finish playing out.  Just going by the pattern–and bitcoin has been textbook both on the way up and on the way down–it looks like there’s at least one good down-leg left.

The reason bitcoin has adhered so well to textbook stock patterns is because there are no fundamentals and the emotions run very high. Basically it gives you an exceptionally clean read on sentiment.

If you’re short, though, remember to keep your size in check because in this last bounce alone it has been oscillating between 10 and 14k. Makes it really hard to hang onto if you’re carrying any size.

Here’s the chart:

Daily chart of XBT

Good luck.



Tricks for Hanging On in a Melt Up

Human nature anchors on the high tick of mark-to-market gains. It’s virtually impossible not to. And this makes it excruciatingly hard to stay fully positioned during a melt up. Every intra-day dip, every tape bomb, every ominous indicator du jour begs us to lock in paper gains before they slip away.

Even if you are fully cognizant of this problem you can’t make this feeling disappear. But there are some modest tricks that can help you, at the margin, manage it:

For some people all of this is just too hard. It certainly is not easy for me, and I’ve been doing this for a long time. If you find yourself chronically under-invested because of a macro hair trigger, maybe passive investing or systems-based trend following is a better approach. Discretionary trading–especially in macro–is not for everyone. It’s better to go with what works best for your forma mentis. There is certainly no shame in that.

2018. You ready?

I hope this is the shortest 2018 post you will read. In my battle against overthinking, I’ve tried to boil this down to bare bones. Feel free to follow up with questions.

Here are the three thoughts to which I attach the most importance for 2018. Things never turn out ex post as neatly as you lay them out ex ante, but this is my base case/point of departure for the year:

We are probably underestimating the positive effect of tax cuts on earnings. I think we have two biases holding us back. One, many of us dislike the policy and reflexively want to short anything Trump does. Two, after the fantastic run the market has been on, it is hard at some deep intuitive level to believe it can continue apace. And if we really are underestimating the effect on earnings, multiples are very likely to continue expanding as well. The US has a disproportionately large effect on global market psychology, so this would also be very positive for risk assets around the world.

Easy to imagine a shortage of assets narrative emerging this year. Moreover, it might even be true. We know it’s probably true in bonds. Might be true in equities as well. True or not, though, it would provide good cover for multiples to expand further, and could open the door to some really ludicrous valuations down the road as well.

Solid global cycle + markets tend to go up over time = It’s still too risky to position bearishly.

Yes, I know markets always top on good news, and I know it’s going to end badly sooner or later. But we also have to remind ourselves that, over time, getting caught out long in a bear is a less costly than getting left behind in a bull. If you got out 3 or 4 years ago and let valuations and macro ‘possibilities’ keep you out, you’ve been in pain. I’m not trying to mock anyone with this, just pointing out that for institutional asset managers right now not enough beta is real talk.

So, bottom line is this is the backdrop I have to run with—or at least should try to run with—until abundantly indicated otherwise. In other words: be generous with the benefit of the doubt. Especially given that this is the phase when things could easily accelerate to the upside, as if often happens later in cycles. I know it’s natural for it to feel wrong to be bullish after such a run, but you’ve got to focus on playing the odds.

And frankly I like the embedded odds that the Fed won’t make a disruptive policy error. They could, but the market in the aggregate has convinced me that it’s still clinging to too much expectation/hope of one. Also, for the first time in a long time, you can’t dismiss out of hand the risk of inflation upside, making bonds a much more balanced bet. Lastly, if/as we move out the risk cycle from here, I would expect it to continue to impart a bearish bias to the dollar.

Basically, if these points are even close to being right, that’s AYNTK.

So you want to short bitcoin? Here’s your road map.

Do you think bitcoin is a bubble? Do you think the speculative crypto fever has broken? After last week’s price action, a lot of people—myself included—think the answer to these questions is Yes.

None of us really knows if this will prove to be the case. After all, bitcoin—the de facto benchmark in the space—has declined by 30% or more probably a dozen times since its inception, coming back stronger each time.

But this time feels different. It feels like a bubble. The fever in the post-Thanksgiving moonshot ran hotter than we’d seen before. We also began to see a robust supply response.  Bitcoin futures were also introduced, allowing investors to short or hedge their holdings for the first time. Maybe it’s a coincidence the ATH price in bitcoin came just before brokers allowed customers to short the futures last Monday morning, but I wouldn’t bet on it.

Bubbles are complex dynamics. What they all have in common, however, is they require emotion to truly go parabolic. Moreover, the less we understand the object of the bubble, the greater the scope for greed and FOMO to fill in the blanks. It’s much easier to make a bubble out of TSLA than it is out of GM.

Accordingly, we’ve seen a lot of creative crypto narratives recently. But scrutiny brings knowledge, and knowledge kills bubbles. And over the past few weeks we have started to figure a few things out.

1.  You can be simultaneously bullish on blockchain and bearish on bitcoin.

2.  The supply of crypto tokens is not de facto fixed. If prices hold up, a rush of upside-capping supply is almost a certainty.

3.  Even if crypto currencies settle down and eventually become an adoptable medium of exchange, it’ll likely be emerging tokens, not bitcoin that will win that race by being quicker, more efficient, and more practical

So, if you believe that we’ve likely seen the highs in bitcoin and you want to go short, how do you go about it in a responsible way?

First, bitcoin is volatile. It’s annualized volatility is over 100%, implying daily moves up or down of over 6%. Second, bitcoin exchanges are open 24/7, but bitcoin futures follow regular Globex hours. Third, the exchanges have integrity risk (e.g. Mt Gox) and the futures have 20% collars. These last two factors increase gap/discontinuous pricing risk for those who trade the futures, even though I suspect these factors represent more risk for long positions in bitcoin futures than for short ones.

In sum, you have to be extra careful with bitcoin in your sizing and risk management.

I see two ways to play a bitcoin short. First, the longer-term play. In my experience the smart way to play bubbles is to short when the momentum fades on the first bounce after the fever breaks.

Here are two recent bubble charts, the NASDAQ 1998-2002 and Silver 2009-2013.

NASDAQ 100 (Dotcom bubble) 1999-2002
Silver (precious metal bubble) 2009-2013

You will see that the charts of the NASDAQ and silver (precious metals) share a  basic pattern: parabolic, fevered top, followed by a sharp drop and then a weak, protracted bounce channel as investors attempt to “recreate the magic”.

So the long-term play is to wait until the momentum in the bounce attempt has faded and it breaks down out of the bounce channel. This could come a lot faster in bitcoin because arguably the understanding of the underlying asset is more nebulous and the illusion factor was higher. But you never know. You have to size it small and hope you make the right call on the entry point.

Nearer term, the opportunities to short seem cleaner. Here are charts of XBT intraday over the past 31 sessions, and daily, over the past year.

Bitcoin, intra-day, last 31 sessions
Bitcoin, daily, over the past year

You can see on both charts there is heavy overhead in the 15,000-16,000 area. Going up into that area and then breaking down from it would be a logical trigger for a short. You could then set your stop and position size based on some rule that defines a violation of that pattern (e.g. two closes back up into the bounce channel).

The other near-term scenario is where bitcoin tries to get away from you on the downside. Given the faith-based nature of the asset, it is entirely possible that we get very little bounce here, and bitcoin continues to tumble. The dramatic fall late last week took less time than it does to say “cold storage”, leaving a lot of trapped sellers. Moreover, we knew NASDAQ and silver weren’t going to zero, but we can’t say the same about bitcoin–at least not with anywhere near the same degree of confidence. The odds of a continuation selloff are high.

So this is what you can do. Bitcoin closed at 14,240 on Friday, after an intra-day low down near 11, 000. If we close below 14,240, you can short it, betting that the unwind is not over. Again, you have to set a stop that makes sense at that point in time, and size your position accordingly. And you need to be mindful that it is quite possible bitcoin will trade weaker when the futures maket is open than when it is not. But you should not be afraid to chase. If it is truly a bubble, and the fever has now broken, there is still a lot of potential downside–however viable you might believe the underlying technology to be.