Stock Market Volatility Reflects Systemic Instability

January 17, 2019

The post-Christmas stock rally extended through Wednesday as the small-cap and tech stocks led the way, with the Russell 2000 up 14.3% and the Nasdaq up 12.5%. The SPX and Dow Indices are up 10.4% and 10.1% respectively. During the stretch between December 26th and January 17th, the Russell 2000 index experienced only two down days.

Make no mistake, this is primarily a vicious short-covering and hedge fund algo momentum-chasing rally. It’s a classic bear market move with the most risky and most heavily shorted stocks experiencing the greatest percentage gains. But the rally has also been accompanied by declining volume. When abrupt rallies or sell-offs occur with declining volume, it’s a trait the conveys lack of buyer/seller-conviction. It also indicates a high probability that the move will soon reverse direction.

As you can see in the chart of the Nasdaq above, volume has been declining while the index has been going nearly vertical since January 3rd. This is not a healthy, sustainable move. The Nasdaq appears to have stalled at the 50 dma (yellow line). The three previous bounces all halted and reverse at key moving averages.

The global economy – this includes the U.S. economy – is slipping into what will turn out to be a worse economic contraction than the one that occurred between 2008-2011. As it turns out, during the past few weeks Central Banks globally have increased the size their balance sheet collectively. This is the primary reason the U.S. stock market is pushing higher.

Official actions belie official propaganda – If the economy is doing well, the labor market is at “full employment” and the inflation rate is low, how come the Treasury Secretary convened the Plunge Protection team during the Christmas break plus Jerome Powell and other Fed officials have been softening their stance on monetary policy? Despite assurances that all is well, the behavior of policy-makers at the Fed and the White House reflects the onset of fear. Without question, the timing of the PPT meeting, the Powell speech and the highly rigged employment report was orchestrated with precision and with the intent to halt the sell-off and jawbone the market higher.

In truth, the economy is headed toward a severe recession and I’m certain the key officials at the Fed and White House are aware of this (perhaps not Trump but some of his advisors). I suspect that the Fed’s monetary policy will be reversed in 2019. Ultimately the market will figure out that it’s highly negative that the only “impulse” holding up the stock market is the Fed. For now the perma-bulls keep their head in the sand and pretend “to see” truth in the narrative that “the economy is booming.”

Both the economy and the stock market are in big trouble if the Fed has to do its best to “talk” the stock market higher. The extreme daily swings are symptomatic of a completely dysfunctional stock market. It’s a stock market struggling to find two-way price discovery in the face of constant attempts by those implementing monetary and fiscal policy to prevent the stock market from reflecting the truth.

The Fed and Trump are playing a dangerous game that is seducing investors, especially unsophisticated retail investors, to make tragic investing decisions. As an example, investors funneled nearly $2 billion into IEF, the iShares 7-10 year Treasury bond ETF, between Christmas and January 3rd. This was a “flight to safety” movement of capital triggered by the drop in stocks during December. Over the next three days, the ETF lost 1.3% of its value as January 4th was the largest 1-day percentage price decline in the ETF since November 2016 (when investors moved billions from bond funds to stock funds after Trump was elected).

No one knows for sure when the stock market will roll-over and head south again. But rest assured that it will. Cramer was on CNBC declaring that the “bear market” ended on Christmas Eve. It was not clear to me that anyone had declared a “bear market” in the stock market in the first place. But anyone who allocates their investment funds based on Cramer recommendations deserves the huge losses they suffer over time. Don’t forget – although the truth gets blurred in the smoke blown over time – those of us who were around back in the early 2000’s know the truth: Cramer blew up his hedge fund when the tech bubble popped. That’s how he ended up on CNBC. So consider the source…

The “bears” may be in brief hibernation, but will soon emerge from their den – While the market is still perversely infused with perma-bullishness, this latest rally is setting up an epic short-sell opportunity. I have my favorite names, which I share with my Short Seller’s Journal subscribers, and I try to dig up new ideas as often as possible. My latest home run was Vail Resorts (MTN), on which I bought puts and recommended shorting (including put ideas) in the December 2nd issue of my newsletter. MTN closed yesterday at $185, down 33.6% from my short-sell recommendation. To learn more about this newsletter, please click here:  Short Seller’s Journal information.

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