Note: Below is the Daily Market Brief sent to subscribers before market open on February 3, 2016 and outlines the rationale for buying market weakness yesterday as well as gives context to the recent market action.
The financial crisis was called that for a reason. Banks were over-leveraged, their balance sheets collapsing due to falling housing prices which came as a result of easy money artificially inflating prices and getting people who had no business taking on oversized debt into homes they couldn’t ultimately afford. It was a giant central bank enabled easy money ponzi scheme. All the while central bankers where in denial about housing being a major problem. Leading the argument from ignorance was Ben Bernanke who then embarked on the largest rescue bet the world has ever seen. ZIRP and QE were all aimed at saving the banks. Not the consumer, the banks. This has always been a core truth.
And they used every trick in the book to do it including getting rid of mark to market so banks could survive using fictitious balance sheets.
Here we are 7 years later and banks appear in major trouble. The culprit? Well this time it’s the energy sector falling apart and related concerns about loan exposures are making the rounds. But worse, again massive derivative exposure is at the heart of global risk.
The worst offender is $DB with over $75 TRILLION in derivatives. Now I have no idea if there is any blow up risk with $DB, but its chart is a complete and utter disaster:
Complete, and utter disaster. Now the truth is all of us are operating from a position of ignorance, because we can’t know everything that’s going on. Nobody can. All we can do is assess risk/reward with the information we have.
As in 2007 with Ben Bernanke I now see Fed officials coming out and making ignorant statements in face of risk:
The recent stock-market selloff “is not all that unexpected” nor “necessarily worrisome” as investors were naturally going to readjust the pricing of risk in the wake of the December’s interest-rate hike, said Kansas City Fed President Esther George, on Tuesday. “Monetary policy cannot respond to every blip in financial markets,”
Clearly she’s not looking at charts of banking or energy stocks.
What blip? That’s a crash. Energy has crashed. Most stocks have been obliterated.
Now in principle I agree with her, the Fed should not be a permanent stock market rescue operation, BUT, they themselves have acted as such for years on end. And folks like myself have argued that all prices have become distorted as a result.
By avoiding the ultimate conclusion in 2009, namely that the banks were bust, they were propped up instead.
And it was ZIRP that kept them alive and QE that created artificial demand in stocks. Well here we are 6 weeks after the 1st rate hike and this is the state of the banking sector:
A complete horror show.
So like everyone else I have to look at this and ask: What is it that I don’t know? Are we facing a systemic risk blow-up here?
We either are or we aren’t and hence the outcome of all this seems rather binary.
We either continue on a 2008 like path:
or we are not.
So somebody is lying and I don’t know who to be honest. Stocks like $DB have to make anyone concerned.
Look, if a bank with $75 trillion in derivatives blows up it’s going to cause a major global wildfire. And the last thing I want to see are central bankers in denial that there is a problem in the first place.
My main premise then: A. $DB is too big to fail and they won’t allow it if they get ahead of it if there is a blow-up risk. or B. There is no blow-up risk and this entire dump is overdone, in which case we may see a massive rally at any sign of relief.
Crude got dumped again this week and is down 13% in 3 days. That’s the driver of fear here as well. Yesterday the word was Iran is adding to global market supply and OPEC can’t agree on a production cut. So I have to repeat: Until crude stabilizes these markets are under severe pressure.
Now, having said all this, I’m still pressing the long side, but with extremely tight stop management. It’s not pleasant to trade the long side here and tensions are high. The chop, as we discussed yesterday, is just absolutely horrid and it’s impossible to trust any price movement here.
So let me outline why I’m still looking to buy weakness here.
Firstly let’s note the inverse is still valid:
Yesterday’s dump accomplished a couple of things: We filled the Friday gap, we tagged the .382 fib in overnight AND we retested the pennant breakout from Friday:
So on this basis the retrace made complete sense and alleviated some of the overbought conditions we have with $NYMO:
In doing so we noted several potential positives:
$BPSPX kept climbing despite the sell-off:
And internals put in a sizable positive divergence with $SPX printing a falling wedge (bullish):
Add to the fact that $VIX could barely muster an inside day:
I have to then ask: Where’s the contagion fear?
Maybe markets are ignorant, or I’m ignorant, or both. I can’t say. But it appears to me that the crash risk here is not yet defined in the charts. Rather a retest of Friday’s rally.
I did not catch the short trade yesterday and I’m ok with that although I obviously would’ve preferred it. But I don’t need to catch every move. My job is to book gains & look for the best set-ups.
Today, it seems to me, is a key day. Will the analog continue or will it not?
It has every excuse in the book to do so with $DB falling below $15. A green close above the daily 5 EMA however could invalidate the analog. So I’m curious.
I’m also curious whether we will see evidence that $DB and crude could stabilize. My “gut” tells me that there is so much negative energy right now that any turn on these could produce an awe-inspiring rally.
But if it does this market may run into major confluence. I’ve outlined a potential scenario on stream yesterday:
The concern: Are we building a major bear flag here? Any rally from here would meet 3 fold confluence of resistance: The 50MA, the previously broken trend line and the .618 Fib. Timing is everything of course and this scenario requires such a tag to occur by sometime next week which also would seemingly invalidate the 2008 analog.
Hence it’s speculative, but technically appealing. So a rally to the 1968-1972 $ES zone would seem to be a good spot to aim for a convicted short trade, especially if it comes with a $VIX tag of its 200MA.
But, unless crude or banks stabilize here at least short term then none of this will matter.
As things stand the charts still permit for a cup and handle to form:
Frankly that pattern would be so large it could actually give us the January gap fill. It is currently the less likely scenario, it is the least expected scenario and frankly the hardest to trade for at the moment.
I was stopped overnight and re-entered long, I took some scales on the $ES on the subsequent ramp and then entered a long $YM position on the $DB scare in Europe.
I’m in essence still sticking with the buy the weakness mode, but, given chop, am much quicker to scale out on gains. Chop is still the primary MO while we are trading in an environment of pronounced ignorance: Nobody knows what’s really going on. Not nice, but so it is.
I need to see a close above 5 EMA today for me to see any signs of a deviation from the 2008 analog. My principle aim is to trade into 1968-1972 $ES for a potential flip to short.
After close I entered a long $CL position after the big dump into the mid $29s. So far so good as we are seeing a bounce back above $30. Let’s see if it survives the next report.
But let there be no doubt. Global markets continue to be at a key juncture here and I have a chart to prove it: