The Roller Coaster Climbs Again but to Where?

• This Week's Trade Ideas:

Bullish Ideas: None at this time.

Bullish Mentions: PLAY, SRE.

Bearish Ideas: Select Sector SPDR Financial ETF > XLF > $29.27 Last.  Buy the Mar. 23rd 29.5 Puts for $0.65 or less with a close or anticipated close below $29.19 in a down market with expectations for continued weakness in the financial and major indices.

Bearish Mentions: XLF, C, BAC, DFS, JPM, GS, PNC, AIG, V, EFA, HYG, JD, XLI, DIS, MGM, COP, HD, EOG, DFS, CBS.

• Market Overview:

Last week, we were more in wait and see mode after acknowledging that most stocks were short-term oversold and were likely to try to rally. We’re not sold on it “all being over”, so we still have to keep switching sides from bull to bear and back again if needed. We’ve been in a volatile consolidation so that makes sense really!

• Below the Radar:

This week’s BTR begins courtesy of Olivier Garret with 8 Reasons Your Portfolio Needs Crisis Insurance as he sees it:  The market may still reach new highs, but the risks are mounting. Personally, I’d rather sacrifice a bit of performance to protect the downside.

The reasons why we want downturn insurance in place now are:

Over the last several years, corporations have used leverage for financial engineering rather than boosting productivity. US corporate debt levels are at an all-time high (above $6 trillion or about 31% of GDP). This excess leverage is fine when interest rates are low, but it can be deadly in a recession. In addition, stock repurchases don’t have the same impact on profits than capital investments.

• Options Academy:

Most folks engage in spread trading because they prefer it to simply owning a call or a put. They aren’t comfortable paying decay by simply doing the latter and thus they engage in the former to collect decay instead. As many of you know, decay is the natural process that options with extrinsic value face on their way to expiration. That is, as time passes, they lose some of their TIME VALUE each day along the way. Despite folks knowing that options with time value do in fact decay, that understanding becomes murky when they travel to the land of spreads.

The Roller Coaster Climbs Again but to Where?

The Trade(s):

We’re noting this AGAIN!

… if you decide to become or remain involved, stay nimble!!!

That continues to apply!  When volatility picks up, as it has, a great deal of movement is compressed into a very short period of time when view relatively.  Adjustments and rolls need to be completed much more frequently than during other phases of market price action.

We strongly suggest viewing this week’s Advantage Point Morning Call webinar for full details with respect to these idea(s), last week’s and options education.

Week 6 of our Special Note:

The past several week’s special note read:

Things may yet sort out for the Markets and we’ll be back to All-Time Highs across the board an on our way to even more ATHs, but technical work remains to be done before we can issue the “All Clear”.

Realize that you may be operating in a fast-moving environment should you decide that to enter the markets.

We’re happy that we maintained this outlook as it has borne out.  We’ll continue to reprint this note as long as the markets remain this volatile!  So, once again, we offer:

….movement…is back in business it would seem.  Act accordingly!

Bullish Ideas: None at this time.

Bullish Mentions: PLAY, SRE.

Bearish Ideas: Select Sector SPDR Financial ETF > XLF > $29.27 Last.  Buy the Mar. 23rd 29.5 Puts for $0.65 or less with a close or anticipated close below $29.19 in a down market with expectations for continued weakness in the financial and major indices.

Bearish Mentions: XLF, C, BAC, DFS, JPM, GS, PNC, AIG, V, EFA, HYG, JD, XLI, DIS, MGM, COP, HD, EOG, DFS, CBS.

Outlook:

Last week’s Outlook concluded with:

Most stocks were short-term oversold and sort of still are even after Friday’s close.  We could be in for more rally attempts and then we’ll have to go from there…

Fortunately for us, that Outlook seemed to capture reality quite well.  We had many more stocks with a bullish lean as a result of the oversoldness of the markets.  This week, we’re near the opposite.  Many stocks are approaching short-term overbought, yet they still have momentum with them as we write.  We’re at the “go from there” stage we alluded to last week.  We have to stay on top of things to detect the next phase.  Do we rest and run again?  Or do we just keep going?  Or do we actually pull back?

Technicals:

Will be discussed in-depth in the Advantage Point Morning Call webinar.

Fundamentals:

These trade idea(s) and mentions are technically-driven.

(Editor's note: This trade idea may be updated periodically, in keeping with market conditions. It is intended solely for educational purposes.)

Recap of Last Week:

Last week was another week in which we were mostly happy.  Official bullish idea PYPL, did trigger and move up but it didn’t burst up the way in which we hoped it could if the markets remained in bull mode.  Additionally, nearly every bullish mention went up to some degree or at least didn’t fall.  That’s what we hope for when we identify the market cycle (bullish last week) and go with it.

There were many bullish mentions last week:

AMAT moved up nicely.

BIDU and BABA which fell nicely for us in the previous week, moved up strongly for us last week.

AABA and MOMO both moved up very strongly as did ICE, BLL, JBL, and ERI and CC, TD moved up but to a lesser extent.

LQD and AGG, which were both counter-trend possible turn arounds, didn’t move up but they didn’t fall either. 

Bearish idea, IP, plunged nicely but too quickly as it didn’t really give folks a chance to buy puts.  EPI was down initially but as the markets were in bull mode from Wednesday morning onward, it never had a chance to do much downside work nor did bearish mentions DFS and INDA.

Other recent bullish ideas and mentions, SWKS and MU for example, continued to really power higher as the tech obsession shared by many investors is back in style.

Last week, we were more in wait and see mode after acknowledging that most stocks were short-term oversold and were likely to try to rally.  We’re not sold on it “all being over”, so we still have to keep switching sides from bull to bear and back again if needed.  We’ve been in a volatile consolidation so that makes sense really!

The Nasdaq has already done it and more but the SPYs seem to be wanting to revisit the point of the breakdown (leftmost red arrow).  Two resistance lines (gold arrows) along with our upper Bollinger Band converge at just about the same level from which the SPYs broke down in late January.  That would seem to be the natural target for the rally/consolidation we’ve been in since the lows were registered in early February.  Another question we have to ask is:  Have we just barely exceeded the (what was a potential lower high for about a month) key level and now we’re about to pullback due to overboughtness in the short-term?  It’s definitely touch and go right now.  We’re back above the 50 SMA but the (rightmost red arrow) support line that converges with it could be pierced with just a little selling.  Do we rest and go?  Do we not even rest?  Do we drop?  We’ve got to continue watching…

Even after last week’s strong buying, the international scene still doesn’t look nearly as good as the USA, especially tech in the USA:

Yet…:

Europe and China, while better, still haven’t retraced their falls nearly as much.  If global money is flowing into equities, it seems to be plowing into US Tech Stocks more so than anywhere else!  We’ll see if that wise to do at these levels shortly!

Once we hit Tuesday, this week’s calendar stays consistently stacked and seemingly relevant.  We’re sticking with these releases as primers that can move markets the way the Wall St. Gang needs to move markets.  In other words, they’ll move stocks and tell us why they did afterward and use whatever take on the news they concoct to spin it.  The bottom line is that there’s plenty of fodder to keep markets in motion.

This week’s BTR begins courtesy of Olivier Garret with 8 Reasons Your Portfolio Needs Crisis Insurance as he sees it: http://www.mauldineconomics.com/editorial/8-reasons-your-portfolio-needs-crisis-insurance/zhb#

The market may still reach new highs, but the risks are mounting. Personally, I’d rather sacrifice a bit of performance to protect the downside.

The reasons why we want downturn insurance in place now are:

1. Stocks still have rich valuations today, especially the FAANGs. P/Es are high compared to historical averages.
   
2. Over the last several years, corporations have used leverage for financial engineering rather than boosting productivity. US corporate debt levels are at an all-time high (above $6 trillion or about 31% of GDP). This excess leverage is fine when interest rates are low, but it can be deadly in a recession. In addition, stock repurchases don’t have the same impact on profits than capital investments.
   
3. Interest rates are expected to increase as a result of the Fed’s tightening policies. Treasury issuances will likely increase over the next few years. Unfortunately, this may coincide with lower demand for US debt from both international and domestic buyers.
   
4. Higher interest rates will put pressure on demand for consumer goods and real estate. These are two critical drivers of economic activity in the US.
   
5. Many asset categories are currently in bubble territory and prone to downward adjustments: growth stocks, bonds, real estate in many markets, arts, collectibles, and luxury goods, and cryptocurrencies.
   
6. Geopolitical risks are not insignificant (North Korea, Iran).
   
7. Political gridlock in the US could lead to paralysis after the mid-term elections.
   
8. Heightened risks of protectionism and trade wars.

Next, (see if you can spot a theme 😉) we move on to a higher profile name in the form of David Stockman who is back yet again with more gnashing of teeth for the grist mill 😊.  He thinks the markets resemble a massive bull in a frantic search for a sharp pin:

http://davidstockmanscontracorner.com/the-everything-bubble-waiting-for-the-pin/

Among the many sharp edges of the pin are these:

1. the virtual certainly of a recession within the next two years and a typical 30%-50% drop in earnings;
2.  the epochal Fed pivot to QT (with other major central banks to follow) and the consequent massive drainage of cash from the bond pits;
3.  the mad man in the Oval Office and (among other follies) his swell new Trade War, which absolutely will get out of hand globally;
4.  the impending "yield shock" which will thunder through the financial markets when Federal borrowing hits $1.2 trillion in the coming year--on the way to $2 trillion+ annual deficits as far as the eye can see;
5. a deeply impaired underlying main street economy which is groaning under $68 trillion of public and private debt and a reverse robin hood financial regime that has left 80% of the population on welfare or struggling to make ends meet on earnings that barely keep up with inflation; and
6. the swaying giant red elephant in the global economic room---meaning China's historically unprecedented and freakish explosion of debt, manic building, monumental speculation, systematic lying and fraud and serpentine centralized command-and-control that is destined to end in a spectacular implosion.

Yet the financial system has been so corrupted by the central bank's long-running regime of financial asset inflation and price falsification that it no longer recognizes anything that is important, fundamental and persisting. Instead, owing to the cult of an ever rising stock market, Wall Street is hopelessly enthrall to recency bias and context-free short-term deltas in the incoming monthly data.

The latter are virtually meaningless under today's central bank driven Bubble Finance regime, of course, because the direction of economic causation has been reversed.

The above material is just part of his piece that’s worth the full read if you want to remain on the Roll Your Options Express!  If not, at least take a look at these two graphics from Stockman (visual pins).  He sees the growing-still income inequality issues combined with the growing-still welfare state as the mombo-combo that collectively drive the squeezed formerly-middle-class folks to use pitchforks to prick the bubble:

And now onto Chris Hamilton who sees trends in future population demographics a tilting things in a rather negative way: https://econimica.blogspot.com/2018/03/the-most-important-economic-chartsarent.html

You can read and see all about it at the link above but here’s his conclusion for the cut-to-the-chase crowd:

The global economy is set to continue increasing its capacity to produce more and produce it more efficiently.  However, excluding Africa, the populations capable of childbirth and their offspring are set to accelerate their declines...and resultant global consumption hopelessly overmatched versus the significant overcapacity being created.  Significant depopulation of young populations is a given while elderly populations continue exploding.  Only through this lens can one understand the true problems facing an economic system premised on infinite growth.  We are at the end of an epoch and the hopefully the beginning of another...the confusion in the interim and messy attempts to sustain the old system shouldn't be surprising, although these attempts haven't a chance to succeed.

And now…onto other interesting graphics we came across over the past week.  The public’s take on matters is often viewed as contrarian by trading and investment professionals.  Keep that in mind while viewing these:

The public is practically off the charts optimistic right now.  The best readings we’ve seen post Great Recession.  And, their outlook is quite possibly the rosiest on record:

Naturally, with business owners being super optimistic and having a very positive outlook, they’re planning to expand which means hiring which means Wall St.’s supposed dread fear, wage inflation, could be back on the menu:

All this is finally happening very late in business cycle and potentially very late the bull market cycle.  Better than never but this abundant optimism may be just a tad too late.  As we’ve been noting over the past month or so in Market Overview, the international scene isn’t clicking the way it once was and seems to be decoupling from the USA.  To wit: https://www.themaven.net/mishtalk/economics/synchronized-global-growth-is-ending-shocks-come-next-UHgNBas_q0Gdfl7USPIAbA

If you’re concerned at all with the USA possibly being the “last man standing”, please read the full entry from Mike Shedlock.  On the other hand, these graphics from the piece serve quite well to drive his points home:

Less than 50% of the world’s economies are now producing economic data surprises. Realized economic data following suit in the months to come would remove the tailwind of ‘concerted economic growth’ for risk assets and central banks. Emerging markets may be first on the list to experience higher volatility.

There’s already signs of a slowdown if we look outside of the USA:

Here’s what’s happened in the past when things have begun to collectively slowdown:

Shedlock concluded rather ominously:

We’ve got to Keep on Banking and Rolling!

Three of the most popular options spreads are calendars, verticals and diagonals.  There are many variations on all three but we’re going to cover them rather conventionally to make a point about spread trading.

Most folks engage in spread trading because they prefer it to simply owning a call or a put.  They aren’t comfortable paying decay by simply doing the latter and thus they engage in the former to collect decay instead.  As many of you know, decay is the natural process that options with extrinsic value face on their way to expiration.  That is, as time passes, they lose some of their TIME VALUE each day along the way.  Despite folks knowing that options with time value do in fact decay, that understanding becomes murky when they travel to the land of spreads.

Let’s take a look at a few snapshots of the aforementioned popular spreads to illustrate our very basic but critical point.  We’ll assume that we’re bullish for all three spreads and please note the Yellow Arrows that point to the spread type and the profitability of each spread at 3 distinct dates given a certain price.  We moved the price simulation point to a very profitable spot to illustrate things further.  The blue shapes on the profitability graph show the price we chose, and it is contained within the blueish rectangle as well so you can check out that exact point if you wish.

First, the Calendar Spread:

Now, the Vertical Spread (aka “Bull Call”):

Finally, the Diagonal Spread (aka the Diagonal Call Calendar):

Please note the DRAMATIC difference in profitability that occurs in EVERY spread from the early dates on to the latest date with the final date being the Expiration Date in all cases.  This really tells us all we need to know about using spreads, even properly constructed spreads (and these are just that).  Spreads that rely on time passing for us to collect decay to become significantly profitable, will not yield a strong “instant payoff” even if the stock’s prices reaches our ideal price level or beyond in the short-term.  From the author’s perspective, this is a MAJOR DRAWBACK of spread trading in markets that continue to consistently provide more than enough movement for more direct profitability.

Sometimes seeing is believing.  If you like the idea of collecting premium, that’s fine.  Just be prepared to wait things out to profit from time decay.  If you like the idea of get in, get out.  Keep it simple.  Keep it clear cut.  Stick with what works!

If you have questions, ask away in this week's Advantage Point Morning Call webinar.