More Bounce or More Bust?

I’ve found over the years that not only does market analysis not need to be complex, but complexity often makes things worse. Our propensity to overthink is as dangerous as it is hard to resist.

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The joke at my old firm when I would get something wrong, or lament about having to stop out of a trade, was “you’ve got to get a lot dumber if you want to be a really good trader.” And, like most effective humor, there was more than a kernel of truth to it. My fundamental background made it very hard for me to avoid getting lost in the weeds. I’d typically either be putting too much weight on what were really second/third order effects or applying longer-term analysis to a much shorter-term trade horizon.

These days, I feel like I’m finally dumb enough to be a decent trader. As many of you have probably noticed, I try hard to keep things really, really simple. I focus on sentiment swings, positioning, and plausible narratives. I then match these thoughts up against chart and correlation patterns. What follows is what I’m seeing now.

One, negativity is still high. The Fear Greed index is only up to at 43, the VIX is above 40, and most investors missed this trade up and are seething. Currencies that sold off hard in the risk off move in March have not sufficiently reverted, in my view, based on the chart patterns, and a weak dollar narrative seems to still be building. All of these factors are positives. As a max, I could see the $ES_F (SPX front contract) get up into the red area on the chart below. I don’t think we can go beyond that in the near term without a burst of optimism from some sort of scientific breakthrough.

Front contract SPX
Dollar index BBDXY

But that also doesn’t mean we have to get up into that area at all. We’ve had a vicious rally—the kind one typically sees only in bear markets, making bullishness a much tougher call here than it was even a week ago. Yes, market participants are still very negative, but the payoff asymmetry has also become less attractive. And the dojis we saw on the charts Friday, after the surprise Fed announcement, are frankly not an encouraging sign. Moreover, there would be plenty of fundamental developments to build a plausible narrative with if risk assets started to sell off, especially as the Fed policy high of last week fades and the potential for a congressional standoff on further measures grows.

Fundamentally, as many have pointed out by now, it’s not about the amplitude of the initial economic shock, it’s about the prospect of its duration. In this regard, I don’t think the economic data we’re going to see over the next two or three weeks will shed much light on the question. But, again, there will be plenty of raw material on the data front available to feed a bearish narrative if the price action starts to turn sour.

On the virus front, the news is terrible, but terrible is now increasing at a slower pace, and we’re getting somewhat used to our unpleasant new normal. But the evidence trickling in from other countries’ experiences is that there will be subsequent waves to deal with here in the US that will persist until science and thoughtful federal planning can get us back to work safely. And we don’t have much to go on yet that tells us how effective the economic policy response is going to be once we do start getting back to work.

For me, what this meant in the Trading book is I have cut the size of my equity index long and will move up my stop on the remainder. I will be looking at other assets like silver, cooper and some of the bounce leaders for signs the rally is starting to die.

By late last week I had already shifted the bulk of my risk exposure to a dollar reversion trade. I will try and ride these currency positions as long as the weak dollar narrative remains a theme (EUR, MXN). On the Investment side, I will trim a beta position or two this coming week but will try to stick with the things like the homebuilders I added recently for the longer term. I hope the market will let me hold onto them.