A Big Picture Look at Tech Stocks and Treasuries

The 2021 trend of buying stocks, commodities, and bitcoin without a lot of consideration of risk while selling safety assets has been overwhelming. However, the trends that exist today aren't the same trends we will be talking about in six months or a year. They rarely are. The storyline can change dramatically in such a time frame. For instance, last March few could have imagined the S&P 500 trading above 4000 and the Nasdaq above 13,000 a year later. Yet, just as the masses were pessimistic about a stock market recovery last year the 2021 bulls are behaving as if corrections are mythical events that couldn't possibly materialize in what they deem to be a pro-growth economic environment. Today we have opted to take a step back to analyze the monthly chart of the 30-year Treasury bond and the stock indices. Doing so allows us to put today's storyline on the back burner to see how prices have behaved in similar situations in the past. To us, it appears as though the long-term prospects for the 30-year Treasury and 10-year Note are positive while stock market gains are likely to slow down, or even correct. U.S. Treasuries Although it has worked recently, bandwagon trading (jumping on the latest market fad) generally doesn't work. This is because trading futures is a zero-sum game and most people end up losing money. Thus, behaving in the same manner as the majority of market participants is often a good way to get into trouble. The monthly chart of the ZB U.S. Treasury Bond Future reminds us that trends spanning over several months can be thwarted by a trend that spans over years (or in this case, decades). Chart Source: QST According to sentiment readings, a mere 20% of industry insiders are bullish on the 10-year Note (anything below 25% is considered an extreme sentiment reading). Further, speculators have placed, and are still holding, large bearish bets. If something comes along to entice these traders to take profits, or if a price squeeze materializes, the rally could be surprisingly swift and relentless. Stock Indices Trading volume has died; the retail trading frenzy started losing interest a few weeks ago and the holiday weekend seemed to put a fork in it. However, the light holiday volume and an onslaught of positive news resulted in an ongoing melt-up. Such market conditions don't require positive fundamentals, good news, or any logical reason for gains, they are simply based on momentum -- inertia is difficult to stop once it has started. However, earnings seasons are known for trend reversals. When stock prices are lofty, investors can be difficult to please. I think it is fair to say prices are lofty given the P/E ratio of roughly 40 in the S&P 500. Nasdaq futures have been playing catch up to the S&P in recent weeks but has yet to produce a new all-time high. Should the index manage to break above the previous high, we suspect buy stop running and FOMO buying will push the index toward 14,500. But at some point, the market will need more than momentum to keep the ball rolling. Eventually, fundamentals will need to catch up with market prices, although we aren't sure that will be possible. At least not without an overdue correction. Chart Source: QST We suspect the S&P 500 bulls will be targeting 4135 but we continue to believe the bears will have a chance at turning the tide at this level. Chart Source: QST It is relatively rare to see the Relative Strength Index (RSI) on a monthly chart poke above 70 as we are seeing in both the Nasdaq and S&P 500. It is even less common to see an RSI at or above 70 on all three time frames (daily, weekly, and monthly), which is the case in the S&P 500. Such conditions don't guarantee corrective action, but it certainly increases the odds of such. In regards to volatility, implied volatility in the S&P 500 tends to be historically comfortable near 15.00 while the mean Nasdaq volatility is closer to 20.00. Both readings are approaching their comfort levels but we suspect they won't stay there for long. Although investors aren't currently cognizant of it, there is some risk of mean reversion trade in the indices regardless of how well the economic reopening goes. Further, Treasury implied volatility tends to increase dramatically when bonds and notes rally (this is the opposite nature of the stock index relationship with implied volatility). Thus, we are looking for an increase in implied volatility in that arena as complacent bond bears begin to feel the heat. Tech Stock Portfolio Hedge (Risk Reversal) In the Nasdaq, calls are wildly overpriced but puts are cheap! This makes it an opportune time to hedge a portfolio with risk reversals, which involve buying a put option and financing it through the sale of a call option. This strategy, known as a risk reversal, will hedge roughly $250,000 worth of Nasdaq-allocated stock for each lot traded. Hypothetical Example: Buy June E-mini Nasdaq 11,700 put @ 85.00 Sell June E-mini Nasdaq 15,000 call @ 85.00 Total Cost = 0 (Free insurance in exchange for giving up tech stock gains in the portfolio above 15,000) Margin Required = $10,500 This hedges portfolio risk below 11,700 while leaving an additional 1,200 points in additional gains (about 8.5%). If you don't own the underlying stock, this can be done as an unlimited risk (above 15,000) and unlimited profit potential (below 11,700) speculation.

A Big Picture Look at Tech Stocks and Treasuries

Trends spanning over several months can be thwarted by a trend that spans over years.

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