Market whispers: Why I shorted the market today
Markets: Deciphering the latest macro signals and market cues for investors
Well, I did it folks. Today I shorted the market.
To be more specific, I shorted the Nasdaq.
In this post, we will discuss why I did it…aka signals that convinced me that we are in a near term top. I will explain the short trade that I placed and my action plan around it…it’s not that complicated, btw. And we will wrap up with how I believe markets will perform over the next few weeks leading into the new year.
I understand that this post contains many “predictions”. I prefer to call them “guesstimates”…informed guesses using macro data and some technical signals.
Please note that I am not a licensed financial advisor. Do your own due diligence. Read the disclaimer at the bottom of this email.
Let’s dive in…
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Why?
My portfolio has hit an all-time high two days in a row now. Today, it closed up +78.96% for the year. While this situation gives me joy, it also provides food for pause, reflection and possible risk management action.
So, I dove into the charts and market data to better understand what investors, traders and portfolio managers are up to. This is what I found:
Stocks are very overbought right now
Consider the daily chart of the SP 500 below. The orange line in the bottom RSI section and the white vertical lines mark several times over the past two years when the RSI is signaling a topping condition in the market. Now we are back up there in the overbought stratosphere.
The tech heavy Nasdaq index is showing the same pattern. See its chart below with similar white lines marking when it was overbought followed by a near term dip. Again, we are at those lofty levels now.
Another way to look at these overbought conditions is the chart below. It shows that about 18% of SP 500 stocks currently have an RSI of more than 70. Whenever this has happened before, markets tended to reset lower.
Some of the drops on these charts have been quite severe, while the shallowest of them, from Q2 2023, were about -3 to 4%. That’s good enough for my current short trade.
I also looked checked several stocks in my portfolio and on my watchlist. I quickly noted that many of them are showing similar overbought patterns. These included MNDY, SHOP, NFLX, MELI, CRWD, SNOW, NET, TWLO, ROKU, DDOG, ARKK, ZS, SQ, FOUR, SNAP….to name a few. As you can see from this selection, the FOMO (fear of missing out) has spread to many sections of the market - tech, financials, small caps and consumer stocks. If I keep looking, I am sure that I will find this kind of froth in other verticals too.
VIX is acting “wierd”
SpotGamma pointed out this interesting situation on Twitter this morning. For most of the trading day, the volatility index VIX was up while the SP 500 was up too. This kind of divergence usually does not happen and could be signaling elevated risks in equities. A textbook trading red flag.
2024 macro could already be priced in
The US Feds have a tough job because their actions impact people and businesses around the world. They do not take their decisions lightly and, almost always, use data to forecast economic conditions and tweak interest rates. They deserve more respect than they receive.
That said, I get concerned when they give too many speeches. Especially, when those speeches are not coordinated, when they do not stick to the talking points and when they send conflicting and confusing signals to markets that hang on their every word.
In Jan 2022, I wrote that the US consumer is stronger than they say they are. They have a higher tolerance for inflation of up to 3-4% and will keep spending, which in turn would support the US economy.
Then in early July 2023, I predicted that the FOMC had one last rate hike in them and they would pause after that. I also wrote that the first rate cuts would happen in mid 2024. And I have always maintained that the Feds’ 2% inflation target is an arbitrary number that is not based on any economic magic. I suspected that the FOMC would change their inflation target to something higher than 2%
Well, here is how things have played out so far:
The Feds did that last rate hike in late July 2023.
They have since paused rates at those levels and in fact signaled multiple times that they do not feel the need to raise again.
Consumer sentiment hit a 2-year high in July 2023 and surveys have shown a 14% decrease since then…BUT…we should look at what consumers are doing and not focus only on what they are saying. They continue to signal confidence in their financial future by spending more than ever before on goods and services.
Preliminary estimates show that the US consumer spent a record $9.8B during this Black Friday + 7.5% yoy. On Cyber Monday, they spent over $12.4B +9.6% yoy. These totals are higher than pre-pandemic levels.
More than 14.6M travelers who passed through US airports during the Thanksgiving week. This was again much higher than pre-COVID levels.
We should keep in mind that more than 90% of US homeowners either own their home outright or have a fixed mortgage rate of less than 4% (yours truly included).
Yes, credit card debt is rising, now over $1T resuming a higher trend from pre-pandemic levels. Default rates have also risen above pre-pandemic levels…BUT…the US consumer is in a much better place due to a very strong jobs market and, again, their biggest debt item, housing, is well in check.
In fact, delinquency rates are lower than as far back as 2012.
There are 1.5 jobs per unemployed person in the US.
Jobless claims are at historic lows from decades ago and continue to range around the 200k per month level.
The NFIB index which represents the health of SMBs (small and medium sized businesses) still shows that businesses are thriving. SMBs contribute about 44% of the US GDP and about 50% of employment in this country.
This is all good news, right? Yes, BUT..the problem is that the markets and even some US Fed members are getting ahead of themselves by perhaps declaring victory pre-maturely.
On Nov 2nd and 3rd, the rate-hikes-are-done narrative started gaining traction.
On Nov 14th, we got another benign US inflation reading which added further fuel to this thinking. Markets zoomed higher and long term interest rates tanked.
Tomorrow, we get the Oct month-end update on the PCE index, the FOMC’s favorite inflation indicator. It is expected to continue its downward trend. Markets are already pricing this in today.
The latest BofA fund manager survey shows that almost 80% of them have moved to the same side of the boat, expecting lower short term rates in 2024. They have, in Nov, quickly positioned their portfolios accordingly.
The everything rally party was on…the SP 500 gained more than 8% in Nov MTD. As per Bloomberg, it has done this only 8 times in 100 years!
Then yesterday, a US Fed official said, in one of these many speeches, that rate cuts could happen as early as Q1 2024. The financial media and fintwit picked up this story and FOMO went up higher…
Another Fed official said that they could think about changing the inflation target of 2%…hah…I knew it!
Bill Ackman declared that he is expecting the first rate cut in Q1 2024. Be aware that he is known to speak his book…meaning what he says and what he does are not always the same.
And this morning, we read that meme stock trading in GME (Gamestop) is back in vogue. Perhaps Hollywood needs a sequel to the movie that was released this Summer.
Markets have crept up, stocks have been bid higher and investor portfolios are logging new all time highs.
It is time to get cautious again.