Bernie, Bitcoin, Corona, China, and the Abysmal Chicago PMI
February 1st, 2020
Wow! On Friday, the Dow dropped over 600 points or 2.12%. Many commentators were saying this was due to a combination of bad earnings and fear of the coronavirus. But Caterpillar actually reported better than expected earnings, although weaker than expected revenue. You could argue that their pessimistic guidance scared the markets, but the exact same thing happened last quarter and markets rallied!
Apple, Microsoft, and Amazon all reported very solid earnings, while Facebook was weaker than expected. In other words, earnings are at least as good as last quarter when the stock market soared. This is why everyone is blaming the coronavirus for Friday’s crash. But it doesn’t explain everything.
The rational expectations efficient market hypothesis tells us that markets instantaneously process all information and reflect that information in perfectly priced stock valuations. If this were true, the market should have crashed earlier in the week, pricing in that corona could end up similar to SARS which had bumped several dozen basis points off of global GDP.
For example, in 2003, the SARS virus chipped at least 1% off of China’s GDP. If the market assigned a 50% probability that corona would end up as bad, China’s GDP will be (.50% to 1.5%)*(1/2) = .25% — .75% lower, accounting for the mythical “uncertainty.” Hence the World Bank downgrading global GDP.
The eternal optimists tell us, don’t worry, China was already going to grow 6%, 5% is no big deal! But the bears tell us that’s all we need to move from “bottoming out” or slow but steady growth to a recession is a gentle push.
Of course, the market didn’t want to immediately accept that because it would mean we are all but guaranteed a 2020 recession. The permabulls were just waiting for that little drop to buy the dip. Sure, China confirmed more coronavirus cases, but we already knew that there could be over 100k infected as of a week ago.
So, what really happened? Chicago’s Purchasing Manager’s Index, a measure of the manufacturing industry surrounding Chicago where any number over 50 is considered expansionary and any number under 50 is contractionary, hit an abysmal 42.9 (deep into contractionary) versus the expected 48.8.
Suddenly, the smart money realized that stories of a mere slow down or bottoming out are completely absurd. As billionaire distressed fixed income investor Howard Marks points out in his Mastering the Market Cycle, while the market may average 7% return per year, it rarely actually increases 7% in a year. Instead, we experience massive rallies followed by massive busts.
I’ve attached an image from Marks’ book so that you can envision what is happening here. Once the market reaches a peak, everyone convinces themselves it will go on forever. When things start slowing down, that’s when you should expect the slowdown to accelerate, not assume a bottoming out.
The rational expectations school is therefore always waiting for an “exogenous” event to trigger a recession. A completely random event that turns an otherwise perfectly functioning economy in equilibrium into a recession.
In reality, though, the coronavirus will be the scapegoat that triggered what was “endogenously” in the system all along. An extension of private credit fueled by a Keynesian tax cut stimulus that eventually ran out of fuel and was inevitably going to crash in on itself. US corporate debt from never-ending stock buybacks is the pile of wood ready to burst into flames as soon as the coronavirus metaphorically struck a match.
The 3-month 10-year US treasury curve inverted back in March 2019, which has a 7/7 track record of preceding a recession 12 to 18 months in advance. This is perfectly in line with the bearishness and abysmal PMI numbers we are seeing in the market.
A few months ago, economists assumed a 40% chance of recession in the next 12 months. That number had all but disappeared during the recent rally. When in fact, it had been growing all along. The higher the boom, the bigger the bust.
Black Monday
It seems pretty unlikely that Friday’s doom and gloom will be the bottom. When you get a drop that big, it is likely to continue, especially because there is little technical support for current valuations. Just like the few days before the infamous Black Monday of the 80s, we are experiencing major bear days and major bull days; 1% swings are the norm.
Essentially, it becomes self-fulfilling. Everyone knows that the market is crashing. This is what most momentum trading is about. The smart money was ready to short at the beginning and will be waiting to buy on a big reversal.
There are two potentially massive bearish catalysts happening on Monday. China’s stock market will open for the first time since coronavirus panic ensued; many are predicting a 10% drop.
Additionally, the Iowa Democratic primary is on Monday. Bernie Sanders is currently leading in the polls by a few percentage points over Joe Biden. As I’ve written before, the market is chronically underpricing the probability of a Sanders presidency. He has grassroots support unlike that of any other candidate. If Sanders has a strong win on Monday, we can expect the market to continue crashing through at least Tuesday.
What to Watch For
Above is a chart of the Dow going back to November. I’ve added several support points. As you can see, we blew past multiple support points on Friday. Since the rally started in November, the market has been nearly nonstop bullish. This also means that a pullback has less support to stop the bleeding.
The major support is around 27500, which was around the high in mid-2019, which took nearly 2 years to breach. I, like many others, turned bearish too early. Many of us became bearish in late October, when we expected the market to crash. Instead, we got promises of a fake Phase 1 trade deal that was enough to cause the recent market rally. If the Dow breaches these levels, watch out below.
However, as I learned the hard way, it is important to not get overly bearish. Even if we are about to have a recession, Bernie Sanders is going to be president, the coronavirus will lead to the apocalypse, etc., the market may or may not drop 5%, 10%, 20%, or more. It likely will not drop all at once (although drops are usually much faster than climbs).
Therefore, we should look to be bearish until we see a major pivot point reversal. For example, in the above chart, you can see that the second major drop in early October was actually a bullish signal. The market was crashing, but quickly reversed and started the bull rally that we currently find ourselves in.
So what we are looking for is a major turn around; perhaps a drop of 200 points in the Dow followed by a reversal of at least 100 points. When that happens, you know to be bullish for a short term play or to close out your bearish positions. Importantly, the reversal must be accompanied by some fundamental catalyst, as opposed to a smaller technical profit taking.
Some examples of fundamental catalysts: Perhaps Trump is acquitted, although that should already be priced into the market. Perhaps Trump tweets that we are enacting tax cuts 2.0. Perhaps some economic data turns out much better than expected. Keep a close eye on Investing.com’s economic calendar. Hopefully, we get some good news about the coronavirus because no ethical bear wants this to be the recession catalyst.
Also, Dow Futures and the Chinese stock market opening should give us an early warning. Maybe things are oversold. If so, futures should give us an indication. I’ll update this article tomorrow by midnight to see how the Chinese stock market and Dow futures are reacting.
Bitcoin, Gold, AMD, Caterpillar
If China’s stock market crashes on Monday, I will be surprised if Bitcoin doesn’t explode. Back when bitcoin dropped to $10k, I was foolishly bullish. I argued that there were fundamental reasons to go long bitcoin. Interestingly, most of those catalysts are still there. In fact, we are closer to the halving cycle, we are closer to a possible recession, and we are closer to the Federal Reserve having to cut interest rates.
This is the long term chart of bitcoin’s price. We can see that it is long term bullish (higher lows) and medium term bearish (lower highs). However, we can see clearly that since the peak of June 2019, bitcoin has steadily declined.
Finally, it looks like bitcoin bottomed out in the upper $6000s/lower $7000s. Notice that short term, the trend appears to have reversed towards the bullish direction. We’ve breached out of the bearish symmetric triangle and are poised for an explosion. Now looks like the time for a long term entry point.
Considering a shorter-term play, I’m buying now and looking to sell at June 2019’s $14k peak plus or minus a couple of thousand. If we can’t breach $9500 in the next couple of days, I will go back to the sidelines. But based on the macro environment, I would say now is the time to be a bitcoin bull.
Looking at the weekly chart of GLD going back to pre-Great Recession, we see that GLD is encountering support turned resistance from 2011–2013. Short term, gold is hitting a multi-year high and there’s no reason to assume that will stop in this environment. As many have argued, the Fed is on pause with an asymmetric bias towards cutting rates. This can also be bullish for bitcoin.
AMD’s earnings weren’t actually that bad, but the technicals indicate something eerie on the horizon. I had to zoom out AMD’s chart going back to the 1980s based on a recent CNBC article I read. A trader is arguing that the recent pullback from earnings could actually be a good buying opportunity.
He argues that $47.50-$48.00 is a decent level of support because it is the high from 2000. But I certainly wouldn’t argue that the previous peak is resistence turned support yet; quite the opposite. It seems like we had a blow-off top and will soon correct.
On the shorter term, we can see this peak and pullback looks like it could be similar to what we experienced back in September. There’s not much support right now, so I think AMD could be in for a rude awaking. Personally, I am hedged 3 puts to 2 calls. Since I bought these after earnings, I got them when implied volatility was low. By the end of the day Friday, both calls and puts had increased in value.
Finally, I argued Caterpillar was a good short, a couple of weeks ago. After earnings, I’ve gone short again. It looks like the momentum is towards a strong bearish correction. I’m looking to reverse this position and go long as soon as the Dow hopefully bottoms this week.
All of this could change rapidly. I plan to post a new article as soon as things become clearer. Follow me @TheMoralEconomist.
Disclaimer: This content is for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained in this post constitutes a solicitation, recommendation, endorsement, or offer by myself to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. The opinions expressed in this publication are those of the author.
Published at Mon, 03 Feb 2020 01:09:09 +0000
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