What is truth? Even in just answering that most simple of questions, we might all (we certainly do) have a different answer. As a man of faith. I can point to scripture, or examples taken from my life that support my beliefs. Someone who believes something else or nothing at all, can probably find facts or perceived facts to support their conclusions. Don't worry, this is not about to become a theological work. Not in the least. Aesop is credited with saying "Every truth has two sides, it is as well to look at both, before we commit ourselves to either." Aesop was close, in my opinion, I just think that maybe truth itself might be fractured into more than just two sides. So, we dig, and we dig... forever in the pursuit of self perfection, or so we think.
It was Galileo who I believe said little on the matter while revealing a lot... "All truths are easy to understand once they are discovered, the point is to discover them." This leads us to another deep thinker on the matter... Nietzsche. "There are no facts, only interpretations." How perceptive? How perceptive, indeed. For it often said that the large banks set the tone for earnings season. I have never thought this to be true. It is often said that markets are forward looking. I do believe that markets try to be, at least those markets where there is still some room for fundamental analysis. It is often said that the "January Effect" is important in that this is where the year gets off to either a good or a poor start for equity markets. Most traders, including this one, approach the month of February with the same unease as they do September or October. Lastly, many still believe that financial markets efficiently decipher output after filtering the many various inputs that lead to any outcome. That, my friends, is now badly incorrect. The powers that be, have either by mistake or design, removed transparency from price discovery.
Once upon a time, markets were slower, and price discovery was a process. Perhaps then market output was indeed the forward looking result of all available input. High speed trading executed by powerful robots has reduced "the book" to a small scattering of "barely there" bids and offers that act as nothing more than "wake up" calls. One key purpose of the very idea of having an exchange in the first place was to bring together buyers and sellers with interests in the same securities in order to shed transparency on the forces of supply and demand in real time in secondary markets. Price was indeed "truth", or close to it. In markets dominated by transactions timed in microseconds, in securities where effort is made to disguise real interest on either side, there is no nice way to put this. Price discovery in this environment has become quite perverse. For it has often been said that price is truth. This maxim is no longer valid, no... not in the least. Price may indeed still be fact, as in you still have to meet your obligations... but let's not kid ourselves that there is any longer some kind of relationship between price and value. Or fact, and truth.
Tough week. Kind of. I mean, we are still close enough to the top of the charts, where a net long investor can not really complain. Thin ice? Since when have we not felt that we were skating on thin ice? Equity index futures, since opening lower on Sunday night have reversed higher quite nicely as the hours have passed. Then again, the "pajama traders" have long since surrendered control of their markets to the same algorithmic crowd that stole control of the regular session from thoughtful traders almost 15 years ago now, rendering overnight prices as sometimes meaningless, sometimes far less so.
For the last week of January, the Nasdaq Composite gave up 3.5%, the S&P 500 slightly less at 3.3%. Using the SPDR sector select ETFs as proxies, all 11 S&P sectors closed lower for the five day period. The top four sectors would all be referred to as defensive in nature. As short/gamma squeeze momentum trades stole the headlines, portfolio managers, specifically hedge fund portfolio managers took profits on long positions in order to pay for damaging losses on what were apparently unhedged short positions. The month of January closed up small for the Nasdaq Composite, and down small for the S&P 500. Monthly trading volume ended the month way above average for constituent Nasdaq Composite names, and still somewhat above average for S&P 500 constituents. Is the trade based on economic recovery still "on"? That depends. Though stalling of late, small to mid cap indices easily outperform large caps for the month. However, the transports badly underperformed the broader marketplace.
Good, Bad, or Careless?
Maybe we should call these funds "unhedged funds" as what has come to light are really rookie mistakes of incredible size made by seasoned market veterans that had to know better. Not kidding. A new trading assistant at any sell side firm would be fired for getting short anything that went the wrong way without having some kind of fairly effective exit plan in place. Don't tell me about track records. That was sloppy, and careless, and born of somehow getting lucky for far too long in a lengthy bull market. Were you good? Or just not using all of the tools available in order to exacerbate profit born of risk?
We have always had a term for this... "Bull market traders"... they are good as long as the market is good. A nasty turn of the worm, and boom... I try to remember their names. Sometimes I can still see their faces. I will at times leave a position unhedged, but in those cases, I maintain reduced exposure. I always know my worst case. Maintaining a large unhedged short position in the low priced stock of a corporation with a poor or outdated business model with aggregate short interest of more than 100% of the float seem smart to anyone?
Rules. I have written to you in the past. Rule number one... For longer-term short side investment... I get hesitant about shorting stocks once short interest rises above 8%, and I just don't do it once short interest rises above 10%. How does anyone go home at night or over a weekend with a large, unhedged short in a name that makes my rules seem like something from another era. Know what? Maybe I have never been worth something ridiculous, but my rules have at least proven themselves accretive to my own longevity. I'll take that and sleep at night. Rule number two... don't' be a pig. Have target prices and panic points on long positions? Of course you do. That's Trading 101. The rule stands for short-term short positions as well. You have all seen me make money on the short side at times in Tesla (TSLA) and Netflix (NFLX) on short-term trades even during big "up days" for those names. You have all seen me lose money short-term in those names without actually getting my face ripped off. Why? See rule number two.
What we have established is that these fund managers who have been badly damaged by recent market action apparently took no action to hedge their positions, nor did they understand the value of placing target prices and panic points on their positions. Just what were they doing while learning this game? Because it sounds like they didn't learn a darned thing.
1) Q4 U.S. GDP turned in quarter over quarter, seasonally adjusted, and annualized growth of 4%. This not only disappointed, the growth appears to have ebbed over the final two months of the year putting the U.S. economy in a position of weakness going into 2021.
2) Johnson & Johnson (JNJ) revealed results from late stage clinical testing of the firm's Covid vaccine candidate. Effective enough at 66%, but not nearly as effective as the "Messenger RNA" vaccines produced by both Pfizer (PFE) and Moderna (MRNA) . Though effective (and convenient) enough to have a positive impact on the spread of the virus to include the new variants that we know of, this has been taken by markets as a disappointment.
3) The increased participation of the "retail investor" has made it's aggregate presence felt in last week's squeeze play across names such as GameStop (GME) , AMC Entertainment (AMC) , and others. These kids just need to find themselves a better (my opinion) online broker. Lesson learned by Wall Street? Retail investing is growing, and will continue to do so as long as so many remain unemployed. This means that the analytical crowd will not have people and robots studying social media mentions and trends even more so than they do know. Lesson learned by retail investors? If you are not paying commission, then you are not the client. Someone probably pays for your data, or your order flow, and that someone is your broker's client. You are nothing more than the product.
1) Fed Chair Jerome Powell basically continues to insist that short term rates will remain where they are, and the FOMC will continue to purchase whatever the U.S. Treasury needs to borrow until inflation targets are more than reached, and labor markets have come close to fully recovering. We'll have to be careful here. While it was a good thing that Powell and former Treasury Secretary Steven Mnuchin had for the most part, a good working relationship, there will likely be an even more comfortable relationship between Powell and the incoming Treasury Secretary Janet Yellen. My fear here is that as monetary policy becomes even more aligned with fiscal policy, at some point we come too close to "Modern Monetary Theory", which in my opinion lays out benefits in simplified fashion, without pausing to understand the consequences of a potential loss in the purchasing power of fiat currency. People are not minions. They will react to devalued goods and services with a loss of value determined through the free market process.
2) A handful of Republican senators have brought forward talk of a $600 billion stimulus/support bill. Obviously, this is far short of the $1.9 trillion that President Biden is looking for. Senator Bernie Sanders, chair of the Senate Budget Committee, told ABC News yesterday (Sunday) that 'The Deo\mocratically controlled House will take the first steps to passing a relief package through the reconciliation process, which requires a simple majority to pass both chambers, this coming week." This is what markets are focused on this morning.
3) Adaptive behavior. This is the greatest two way risk to the marketplace right now. How will retail investors react to their new found power? Surely money will move, but as labor markets improve, does this aggressiveness taper? Hedge funds are already modifying behavior. Supposedly (according to the Wall Street Journal). Melvin Capital has lost 53% year to date, now with $8 billion under management, down from more than $12 as of year's end. This is after accounting for a $2.75 billion infusion from investors Citadel, and Point72 became necessary last week. The piece points out that Melvin has deleveraged itself down to 2014 levels. If such behavior is broadly pursued across the industry, this will mean more pressure on successful long positions. You all saw the sideways response of Microsoft (MSFT) and the profit raking seen in Apple (AAPL) in response to two of the greatest quarters in the history of quarters.
...Adapt, overcome and carry on with the mission. Easy? No. It was never supposed to be. By the way, according to FactSet, fourth quarter earnings season is absolutely humming, and Q1 projections are moving higher. all as the forward looking PE ratio for the S&P 500 has moved from almost 23 times to "just" 21.5. Sentiment among professionals has weakened as earnings have improved. All in all, I see this as positive. But it may have to get more "positive'' before I can trust it. Know what I mean? Now, go forth and rock.
Economics (All Times Eastern)
09:45 - Market Manufacturing PMI (Jan-F): Flashed 59.1.
10:00 - ISM Manufacturing Index (Jan): Expecting 59.8, Last 60.7.
10:00 - Construction Spending (Dec): Expecting 0.8% m/m, Last 0.9% m/m.
The Fed (All Times Eastern)
14:10 - Speaker: Boston Fed Pres. Eric Rosengren.
Today's Earnings Highlights (Consensus EPS Expectations)