Wheeeee – what a ride!
As our Members well know, we had a classic "spitting cobra" pattern on our charts and we knew this week was the inflection and we knew it was likely to be down which is why, on Monday, we welcomed the greater fools to the BS Futures rally and Tuesday we discussed gravity, parabolas and what would happen when the Fed cut the thrust to our market rocket and by Wednesday morning, although I titled the column "Will We Hold It Wednesday – Fed Edition," my opening comment was:
Oh who am I kidding, we're already shorting!
We shorted the Nas futures at 3,000 (now 2,891) and we shorted the Russell Futures at 998.20 (now 957) and we shorted the oil at $99 (now $95) and, of course, we took all sorts of short positions in our Short-Term Portfolio and yesterday I called for cashing those in at noon, and we missed the final, afternoon drop but we used that opportunity to flip long on the Dow (DIA), GLD and TLT – playing for at least a bounce after two days of market carnage.
Of course we're expecting to get a bounce after this massive drop but a bounce is not a buy signal. Per our 5% Rule™, We expect the major indexes (as they are highly liquid) to move in 0.65, 1.25, 2.5 and 5% increments (and higher over longer terms) and it's not an EXACT science so, around there and we can see that behavior all week so far.
The total drop is right about 4% and 4% is the line at which a 5% move should bounce back to (about 1,584 on the S&P from 1,650) and that was right at the low of the day, just before the close. That's what caused us, at 3:05 pm in our Member Chat, to flip long on the Dow, saying:
Now I like the DIA Quarterly $148/150 bull call spread for 0.80, 30 of those in the STP ($2,400) and let's say well risk 50% ($1,200) with the $3,600 upside at 15,000. If the market goes lower, AMZN and NFLX will be very good to us (and maybe TSLA too!).
We had already cashed in successful short plays on DIA, SCO (long on the ultra-short), USO and TZA (long on the ultra-short) so a large part of this move was to balance our our still-short position on AMZN, NFLX, TSLA, SCTY, FAS and SBUX – all of whom had great gains on the day but were longer positions we wanted to hold over the weekend.
So the DIA spread was more to lock in our profits against a crazy move up than a bullish bet but we did play GLD and TLT to move up as they were both ridiculously low (as noted in Dave Fry's chart). After falling 550 points in 2 days, a 20% retrace is 110 points up and that's right where we're likely to open but that's just a weak bounce at 14,870 and we'll need to see that 15,000 line crossed again before we're impressed but that just so happens to be the target for our June 30th bullish DIA play (last day of Q2).
Then it's earnings season and who knows what's going to happen there but we're not enthusiastic, for reasons we discussed last Friday, when I pointed out that earnings this year have been artificially boosted by one-time R&D credits and were accounting for much of this year's income gains.
Going into this weekend, it's China that is our biggest concern as their markets are in a full-fledged melt-down that is all but being ignored by the MSM (much like 1M people protesting and rioting in Brazil – see 7:34 tweet for details) but, to some extent, they are doing much of this damage to themselves as their Central Bank is attempting to instill discipline on the system and clean up the massive "shadow banking" system in China, that has grown to be larger than the regulated banks and poses a huge danger to the stability of the system.
According to SocGen, credit growth in the world's most populous country has outstripped economic expansion for five quarters, raising the question of where the money has gone.
In the first quarter, for example, bank loans, shadow banking credit and corporate bonds together accelerated more than 20 percent year-over-year, while gdp grew less than half that much. The gap has been widening since early 2012.
The answer to where the money is going is a growing "debt snowball" which doesn't contribute to economic activity. The result is both companies and the public sector face burgeoning interest expenses. This fits with the theory first put forward by economist Hyman Minsky. His financial instability hypothesis showed how markets create waves of credit expansion and asset inflation, followed by periods of contraction and deflation.
So watch those bounce lines but let's continue to be careful out there, the quarter ends in 5 days and there's plenty of reason to keep things looking good until then but then it's earnings season and, as Buffett likes to say, we won't know who's swimming naked until the tide goes out.
Have a great weekend,
– Phil
