The Nutella Market (XLB,XLK,TLT)
There’s very little in this world that can compete with thickly spread Nutella on a crispy rip of focaccia. Hell, just dip that sucker into your oversize jar and give her an uncaring hack-snort swallow…
And let the goop fall where it may.
Is that life, or is that life?
Unless, of course, you keep it up for too long, and it sends you to the oncology ward with a prep for chemo.
Don’t Do It!
The market has begun to act as if all is sweet and simple again, as if a dollop of the Ferrero hazelnut-cocoa genius was already stuck to its palate, blood-glucose levels were frenzied and a titanic insulin shock was fast approaching.
When you see the biggest names on the street hitting new highs, or coming to within a whisker of their records, you know that it’s only a matter of days before the next spasm of buying is upon us and the indexes, too, begin logging all-time bests.
This is the phase when rational discourse is abandoned, trust in the past and all it has brought becomes a religious tenet, and money is thrown fastball style at the same big sexy names that got us this far.
Take a look at the following unbelievable data from Standard & Poors regarding how much of a contribution each of the following companies have made to this year’s rise in the index –
It’s almost unimaginable that just four stocks could comprise a full two thirds of the index’s rise since New Year’s. But it’s true. And it speaks volumes of the mindset we’re dealing with as we head toward the final blowoff geyser top that will eventually make every bull market IN HISTORY look like a mere coke bottle fizz experiment.
Manias of all Shapes and Sizes
What we’re currently looking at is a game where the concentration of holdings on both Wall Street and Main are increasingly funneled toward the sexiest brands, a great number of which are represented on the chart above.
As the process accelerates, we’ll see the indexes bursting skyward without rhyme or reason, even as a breakdown in breadth takes the vast majority of stocks to the dung heap – all under the cover of financial media fireworks and fanfare and a cheerleading section that’s long on special effects and play by play, but short on common sense.
So what can we do?
Unfortunately, we at the Modern Bull are stuck in something of a trap. On the one hand, we’re unable to fight the tide; we’re not central bankers. On the other, we lack the clout required to convince the masses that they’re wrong.
So, we can either follow the crowd by favoring those names that have an established winning record, or alternatively, we can seek out those winded, out-of-shape companies that are losing altitude and short them, an exercise that comes with a considerable measure of risk.
Or better yet, we can do both, employing our preferred long/short approach, buying the bigwigs and selling the no-names, in an effort to profit on outperformance.
And that’s what we’re attempting today, but not before we take a good look at an open trade…
It was launched last week in a letter called Bond. Lamest Bond. There, we examined the daily, weekly and monthly charts for the biggest long bond ETF (TLT) and saw dark clouds everywhere. Expecting an imminent decline, we recommended that you sell the TLT January 17th (2020) 119 CALL for $6.65 and buy the TLT January 17th (2020) 119 PUT for $6.80. Total debit on the trade was $0.15.
And today we’re vindicated. With the CALL trading at $5.65 and the PUT at $8.20, we say shut her down. Buy back the former and sell off the latter and you walk away with a tidy $2.40 on just $0.15 spent – in a gol’darn week!
That’s a gain of 1600%.
And now we turn our attention to this week’s bet.
With those four stocks contributing to the overwhelming majority of the broad market’s gains – and the tech sector itself responsible for VIRTUALLY ALL OF THE YEAR’S MOVE (see chart below) – we feel it’s prudent to stick with the winners. That is, we see very little reason to do anything but remain on the bandwagon, and long.
Have a look here –
This, too, comes courtesy of S&P, and shows the sectors that have contributed to the year’s rise. IT is the clear winner and a slam-dunk for the long side of our trade.
Yet in picking a match against which to play the tech standouts, a problem arises, and it looks like this –
- Do we go with the worst performers, the group whose returns have lagged badly year-to-date, and run the risk of a wham-doggie rally as the street rotates out of tech into, say, consumer staples?
- Or do we focus on a sector that possesses the lowest short interest ratio, thereby minimizing the risk involved in a squeeze that leads to massive outperformance against the techs?
Have a look here –
As the chart details, all sectors have seen an uptick in short interest, but in the techs, materials and financials it has been negligible, meaning that if a broad squeeze higher were to occur, it should be felt roughly equally amongst all three of those sectors.
As to which of the two – materials or financials – is less likely to challenge tech dominance, we rely on recent performance as a guide.
And it’s to the materials that we turn our focus, because it’s there we see consistent underperformance over the intermediate to long term.
Have a look –
This is the Technology Select Sector SPDR ETF (NYSE:XLK) plotted against the Materials Select Sector SPDR ETF (XLB) going back a year and a half, and it clearly displays the aforementioned, consistent performance lag.
Our strategy this week is simply to ride the trend for a few more months, taking advantage of what we see as an impending burst higher for the tech stocks, alongside a sluggardly climb for materials.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
Wall Street Elite recommends you consider selling the XLB July 20th 60 CALL for $1.30 and buying the XLK July 20th 70 CALL for $1.36. Total debit on the trade is $0.06.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
With kind regards,
Hugh L. O’Haynew