The Bigger Picture (SPY,FNV,DIA,UUP,DBC)


Executive Lounge, Options Trader Elite / Thursday, February 22nd, 2018

The Bigger Picture (SPY,FNV,DIA,UUP,DBC)

 

For some time now, we’ve been kicking up a big to-do about how the current market has lost all sense of the fundamental and is being driven exclusively by sentiment and cash flows.

 

And there’s no gainsaying that as we approach the final innings of history’s greatest ever bull market, we’ll see ever more money making chase after equities as they swerve higher and lower, as volatility ratchets up like Norse stretch rack and indecision in the bond market creates powerful cash surges between equities and fixed income.

 

That said, we want to reassure you that we still believe the major indexes’ best days lie ahead – but it won’t be nearly as smooth a ride getting there as we’ve seen over the last year.

We’re going to take a look at several discrete items now to acquaint you with our market thesis going forward.  But before we do, let’s first summarize the broad forces now at play in the system.

 

Push and Pull

 

The foremost driver of today’s capital markets remains the massive liquidity infusion of the last decade courtesy global central banks.  This single factor has set the underpinnings for the current bull market and will continue to drive asset prices of every stripe higher for the next year, at least, in our opinion.

 

The second force is a rising interest rate regime, which, by definition, should act as a brake on the foregoing slosh of liquidity – depending, of course, upon how quickly those rates ascend and how the credit market perceives it.  That is, will it be registered as an end to the nearly 40 year bull market in bonds and an obligation to sell at all costs, an understanding that could lead to desperate fluctuations in the price of every asset class until equilibrium is reached?

 

Or will it simply be seen as an opportunity to safely acquire yield after so many years of artificially induced zero interest rates and the tremendous imbalances that has engendered?  In that event, we would expect a more orderly decline and increased predictability across markets.

 

Third, is the equity market itself, now overbought, but trying to accommodate an extraordinary start to the Q4 earnings season.  The question here is whether earnings beats prompt momentum traders to once again trump the fundamentalists, or sky-high P/Es and a surer bet from the fixed income market will unseat the profit chasers and reward the bears.

 

Have a look here –

You have to go back almost a decade and a half to find a quarter when so many S&P 500 companies were topping Wall Street’s revenue estimates.  Earnings beats, too, are at near twenty year levels.

 

And this at a time when analysts were hiking their earnings expectations!

 

The dollar is the last force to be reckoned with, but we leave it aside for the moment, because it appears to be stabilizing at current levels.

 

The only thing remaining is a world order that’s currently undergoing a tectonic upheaval, one that will become increasingly difficult to predict and for which fewer and fewer investors will be able to correctly model.  As to that, we watch the story unfold with the rest of you…

 

The Modern Bull Hypothesis

 

Despite the various forces in play and the ample risks that abound, our thesis remains steadfast.  As we’ll show you below, the  current pullback, though sharp, will likely consolidate at these levels, before the next leg of the bull begins.

 

But first, we’ve a few trades to report.

 

We start with our February 1st initiative from Let’s Talk Dollars.  There, we urged you to purchase two (2) UUP September 21st 24 CALLs for $0.35 each and sell the DBC July 20th 17 CALL for $0.75.  Total credit for the trade was $0.05.

 

And today?

 

The UUPs trade at $0.38 and the DBC for $0.50.  Sell the former and buy back the latter and you fetch $0.31 on nothing spent.  Adjusted for minimal commissions offers you 107% in less than a month.

 

Next was our December 28th issuance from The Keys to the Commodities, which recommended you consider selling two (2) FNV January 19th (2019) 70 PUTs for $3.90 each and using the proceeds to purchase an FNV January 19th (2019) 85 CALL for $6.80.  Total credit on the trade was $1.00.

 

Finally, in our February 8th letter called Jimmy, We’re Stuck in a Market Maelstrom! we invited you to sell the DIA March 9th 256 CALL for $1.23 and the DIA February 16th 240 PUT for $1.36.  Total credit on the trade was $2.59.

 

The February 240 expired worthless, and today the March 9th 256 CALL trades for $0.69.  Buy it back and you walk away with $1.90 on $0.69 expended.  That’s 275% in a fortnight (7159% annualized).

And Now to This Week’s Trade

 

We start with a look at that craziest of all cohorts, those who write stock market advisories, and the people who track them at Investors Intelligence

And as you can see, the bull/bear ratio amongst these scribblers has fallen back to a more acceptable range, while those expecting a further correction have grown appreciably.

 

Sentimentally, therefore, we should be in for sideways to lower action in the weeks ahead.

 

As for sentiment on Main Street, the ham and egg crowd is showing signs of persistent stock fever, as evidenced in the last results of the American Association of Individual Investors (AAII) bullish index –

With a current read of 0.69, our feeling is the bulls are still pushing it, and we’ll likely see a retest of the lows set back on February 9th.

 

As to that, have a look now at a chart of the SPDR S&P 500 ETF (NYSE:SPY) for the last six months, with particular attention to the support and resistance lines that we’ve drawn in.

Right now, the broad market is finding its legs between SPY 260 and 275, and we expect that action to persist until a retest of the former lows is accomplished.

 

After that, it should be smooth sailing.

 

To that end, we’re writing a bullish PUT spread on the index that goes like this –

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Many happy returns,

 

Matt McAbby

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