This market is running on the back of massive debt, once consumed then what manipulative game will the FED introduce.

 This market is running on the back of massive debt, once consumed then what manipulative game will the FED introduce.

Stocks remain just shy of their all-time highs despite the mega-warning signals that these levels of sheer euphoria suggest a counter trend correction is imminent. I have been suggesting that markets are in or may be headed for a mega bubble all of the preconditions for a mega bubble are in place. Financing costs of new-debt to subsequently use it to buy-back-stock are at record historic lows, new participants are being drawn like moths to a flame into markets, and the combination of significant accumulated savings and low prospective returns on traditional assets have created both the means and the desire to engage in massive speculative activity! In the months ahead, investors will need to pay close attention to the risks of a monetary policy reversal, massively rising equity valuations, and the rate of the real post-pandemic recovery.

The past 5-7 months can best be characterized as a period of unprecedented market extreme optimism and pure euphoria... As I pointed out previously in my weekend write-ups, there was a wave of bullishness due to recent news, with (3) Covid-19 vaccines showing promise against a backdrop of FED manipulated zero interest rates, a record fiscal deficit, and an ultra-dovish Janet Yellen soon to be in charge of it all.  Another way of describing it is extreme euphoria, the likes of which surpass even the dot.com bubble. Naturally, stocks have taken the recent news flow very well, with prices hitting record highs despite traveling at significantly elevated nosebleed valuations. As I have discussed before, the November-December rally has been driven by the most shorted hard-to-borrow equities, taking the SPX-500 to technical levels not seen in many many years, like we saw back to 2000. The November-December rally was clearly a short-covering rally. As the most shorted stocks were up 28.48% in November alone while the SPX-5000 was up about 11.1%.  

The Goldman Sachs “most shorted” index of stocks is already up 13% in 2021 and more than 200% over the past year.  The Goldman Sachs Most Shorted Index’s RSI reading over 85, only eclipsed by June 20, 2018. Short sellers like myself have been put on the endangered species list 😊 and are now almost extinct, and the fuel from squeezing the shorts appears to be running quite low now as looking as short interest is the lowest in over 15 years for the SPX-500.

However, it is not just forced short covering that has been driving the meetup: as massive derivative action activity in the options market is purely “euphoric” a huge source of potential dislocation. As of this past week call volumes were 6x normal, and even more striking: call buying has just gone parabolic and now represents about 47% of NYSE total volume the highest level ever. While at the same time, the put/call ratio is at multi-year lows.

The euphoria is not just in calls, it is everywhere with 90.5% of SPX-500 stocks now trading above their 200dsma reaching an overbought level last seen in 2014. This flood into equities has pushed the forward P/E of the SPX-500 back to and above 2000 levels. This is also a function of the surge in money growth. We have seen across a wide variety of indicators this market euphoria is increasingly disconnected from fundamentals and real economic variables. With the massive disconnect between markets and the economy stretched extremely tight like a rubber-band, investors have basically gone all in stocks hoping that the largest and biggest bubble in stock history keeps inflating!

In the recent past, the euphoria was always bounded by the upper limit reached during the insatiable buying spree of the dot.com bubble, however within the first week of 2021 is when we went off the chart parabolically. Citi's latest Panic/Euphoria model hit a record reading of 1.83. 

Citi’s chief economist Tobias Levkovich wrote last Friday when looking at market returns following previous euphoria extremes, there is now a “100% historical probability of down markets in the next 12 months at current levels.” Interestingly I have found repeatedly that in the near-term the market tends to do the opposite of what consensus expects it to do and right now consensus among even the most bullish is that the next move in stocks should be lower which is why the fact that Citi's call for a selloff becoming consensus, make me wonder if the next move in stocks could be higher instead. I saw that the latest Goldman Portfolio Research Strategy report, that Goldman's Risk Appetite Indicator (RAI) reached a reading of (1) this week and this was the highest level in over 4 years and just shy of an all-time high after a large increase in overall risk appetite since 2020/Q4.

As Goldman explained, this was largely on the back of significant growth optimism for 2021, and while they expect monetary policy to remain very dovish and supportive, “we see less potential for much more positive impulses from here. Following the news of successful Covid-19 vaccines, growth optimism has broken out and shifted further into positive territory since 2020/Q4 as markets have become significantly more optimistic on the prospects for reflation.” Goldman has in essence basically repeated what Citi said last week, warning that from RAI levels close to “1” the asymmetry to add risk is unlikely and subsequent equity returns, especially in the near term, tend to be more negatively skewed and there is an increased risk of drawdowns. At current RAI levels the market is more vulnerable to negative growth or rate shocks in the near term, such as monetary and fiscal policy disappointments or negative Covid-19 news.

The increased spread of Covid-19 has definitely negatively impacted consumer spending, underlined by dismal U.S. retail sales reported on Friday. Poor U.S. consumer spending data last week helped Treasuries trim some of their recent steep losses. The more sober mood, in turn, boosted the safe-haven U.S. dollar, catching a potential short squeeze as we have seen that speculators increased their net short dollar position to the largest since May 2011 in the week ended January 12^th the dollar index firmed to 90.79, its best level since 12/21/2020, and up from its recent 2-1/2 year trough at 89.206. Yellen is expected to affirm the U.S.’s commitment to market-determined exchange rates when she testifies on Capitol Hill Tuesday (no shit...this is always the Treasury mantra). She will make clear the U.S. does not seek a weaker dollar for competitive advantage!

 

Unfortunately, global coronavirus cases approached the 95 million mark, while the U.S. death toll from Covid-19 neared 400,000.