October 21, 2020

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We Are No Longer A Free Market, Yet We Are All Trading Stocks Like Nothing Has Changed

9 min read

It has been a number of weeks since I have written to you, my loyal readers, and I feel I have been remiss. The truth is the title above has been very painful to contemplate let alone publish. This notion has perhaps been the virtual boulder that needs to be rolled away, in order for me to get writing again. It is time to face facts that this market has been staked like a sapling in a greenhouse nursery, it can only grow straight and up. We know in our heart of hearts, especially those that survived the Dot.com implosion of 2000, that the rally we see is just not normal. It has not acted normal and that has made it very difficult to assess. Paradoxically, it has been pretty easy to make money in it. There will be a day of reckoning, but not now.

A Tree Cannot Grow to the Sky

What are the twin stakes keeping this rally vertical? On one side is Congressional Fiscal policy pumping trillions directly into our economy and on the other side is the Fed flooding the financial market with liquidity. I have been on record that I support this extraordinary interference in our free market system. The government shut down our economy and destroyed millions of jobs. We hear estimates of some 40% of small businesses that are not coming back. One major factor in the destruction was the essential service designation, and purveyors of groceries could remain open, so the super mega-cap retailers benefited while the little guy on Main Street was out of luck. I abhor bailouts, but these businesses were taken out by out government. Therefore the federal government needs to do everything it can to bring back small businesses. I am FOR the trillions being spent right now. That does not mean there aren’t unintended consequences, outcomes that will take decades to understand what arose from this largess. Still this is the situation we are in, and I believe both the Fed and the Executive/Legislative branches are doing a great job. Even this delay of the latest tranche of Fiscal action is all to the good. We SHOULD take this next tranche slow. It is time to start thinking about what will happen AFTER this is all over. All to the good, my job is to figure out what is going on with the stock market, and the stock market has been flying.

Shades of 2000

I made the mistake of assuming that the market is going to at some point behave like it has been for the last 2 decades. At some point valuation will matter and the market will sell down 5% to 10%, and consolidate. For weeks I kept saying, okay at this level we should have some kind of dip, yet the dip did not come. I pride myself on calling market moves, and believe that I have been pretty good at it, that is until recently. What I didn’t realize is that this time it was different, that the rules have changed, and that has changed valuations. Now the retail investor has rediscovered the stock market, and promoters were telling everyone that “Stocks Never Go Down”, and so they didn’t. People were truly partying like it was 1999 all over again. That is until this week, when for no discernible reason the Nasdaq corrected, down over 10%, I believe the fastest drop on record. A 10% drop is the very definition of the term “correction”. I am seeing many commentators casting about for a “reason”. The reason is very mechanical, the market simply ran out of buyers. Once the supply of buyers faltered, all those newbie retail traders threw their last available pennies on the pyre of a super extended rally. This was at the very tippy top of valuation, and so the rally reversed with a vengeance. When did we last see this action? Yup, 2000. I empathize with the psychic pain this is causing right now, the feeling of betrayal, and the deep desire to “Win the Money Back”. I am sure there are some that are trying to satisfy the margin calls. I am sure that some didn’t even realize what margins was, they just saw that they had this money to play with, and play they did. Now it’s time to pay the piper. I truly hope that most of these newly minted stock investors stick with it, and in spite of the losses learn about how stocks work. That markets DO go down, and that you need to plan for it. Or at least take a longer view and be an INVESTOR and not a trader. Some people are cut out for trading and speculating others are not. In any case, what happens now?

This is not 2000

The forces that are supporting this market are supremely powerful, and there are a lot of other factors supporting stocks. Productivity for one, the fact that much of corporate American can operate from home is a huge savings in cost, and efficiency. Here’s an example; recently there was a report published (a few weeks ago) that some $90 Billion (yes with a “B”) has been saved in commuting costs from the WFH situation (as in zero cost). There are a ton more savings, some less savory, such as the fact that a lot of middle management will be found to be redundant, since working from home flattens an organization. All the collaborative cloud tools, like Anaplan (PLAN) and Smartsheets (SMAR), also Slack (WORK) are taking the demand for middle managers out of the equation. This was already happening, but a crisis accelerates change. In this case, the productivity will hugely improve profitability, and hence stock prices. This is the very meaning of creative destruction. Many of these managers, I hope will go out and create new businesses, and hire more workers. With that, I want to make the case for NOT panicking. You are hearing from many corners that this is the beginning of a bear market. This is not true. Chartists that I strongly respect are pronouncing that the full measure of this sell off hasn’t yet been limned. I will let you in on a secret. I have observed time and again with those who only look at charts, when there is a big move, they assume that the move has further to go, and generally surface the worst cast scenario. Let me illustrate here with the QQQ ETF representing the Nasdaq 100 6-month chart

This is where I think the Nasdaq 100 will likely find support, about less than 4% from where we are now. Now let me pull back and show where technicians are looking for the Nasdaq to fall…

The above is the 1 year chart and the prior peak is the high we achieved pre-Covid. As you can see we are looking at a full 13% further fall on this chart. This is not hysteria, Charting orthodoxy will dictate that true support during a deep sell-off will come from the previous breakout. I get that, but there is no new news yet to propel the market down so hard. The sharp selloff was due to the hangover from juicing of the market upward. I maintain that finally, finally the market has returned to some rationality. Look, I am not saying that we go back to breaking out to new highs, we probably will shoot back to test the previous high creating a double top which will bring in a lot of selling. What I am saying is, we now will trade in a channel for a while and not dive to recession level on the indexes. Let’s all take a deep breath on that one. So here is what I want you all to do, watch the VIX, watch the Dollar, and watch the 10 year. You may have noticed that the VIX has already receded from the mid-30’s to 28-27 in a hurry. If the VIX starts creeping back up, especially when the market is rallying, please reduce your risk. We need the dollar to be stable if not going lower, and we need the 10 year to remain level. If you don’t know what the VIX is, or how to follow it, then you need to educate yourself, PRONTO. You know that anecdote of people sitting around the table, if you can’t identify who is the sucker, chances are YOU are the patsy. Hopefully you understand what I am getting at. You want to play trader? Learn the ins and outs of trading. Also, don’t be a dang fool and trade on margin, please!

Something surprising that I learned from Barron’s today, the Robinhood kids discovered options!

Options are a great tool and like any tool they can be constructive or destructive. What I read distressed me. Traders new to options are buying very near dated calls, that are out of the money. That is betting like a degenerate gambler, stop, just stop that right now! Look there are times I am sure that it makes sense to buy near dated calls, for very specific tactics. But if that is the only way you are using them, i promise you, you will lose. If you don’t use call spreads for the majority of your options trades, then you and I are just not aligned on call options. I have to thank all of those people bidding up the near dated calls though because when I spread my calls I only spread 3 and 4 weeks out so thank you very much for making the so juicy! I am spreading my calls and generating up to $100 and sometimes more per contract. If you spread that over dozens of options contracts that expire every month you have a nice revenue stream for not much worry. Again, think about the table analogy, and don’t be a patsy. If I like a company, this is what I do, in fact let me use a real life example, I am long calls on DraftKings (DKNG), if you go back several months in my articles you’ll see that I have been long calls since it was a SPAC. I took a really long expiration at the time: January and have been selling calls against it for months. Every 3 weeks like clockwork the calls expire and pocket like $100 per contract. I always wondered why the premium was so high for such a near date expiration. I thought I was up against some pros on the other side. Now I realize it’s someone who has no business blowing their cash. Consider yourself warned, and just stop…

As was my custom here are some trades I am in, or going to be in this week

I am long Azek (AZEK) they’re a home improvement play. They just announced a secondary and the stock did not sell off. That tells me the institutions are buying, so I am buying

Another trade I am not in yet but am going to try and get into this week is the used car sales business. I read that 40% of the rise in the CPI was due to a jump in used car prices. That tells me that this market is robust. I am thinking of playing it via Vroom (VRM). VRM is a recent IPO and they sold off very hard during their first earnings report. In my experience stock market participants are very cruel to first time earnings companies. There was also a lot of noise in the report due to the pandemic as well. Finally they just announced a secondary, and the stock sold off a bit but it wasn’t a massacre. I think this will be a good medium-term speculation.

Thank you to all those that reached out via alternate means to encourage me to come back and start writing again…

Disclosure: I am/we are long AZEK, DKNG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long AZEK via far dated Call options that are spread. I also intend to get long VRM. I am also long DKNG via call spreads

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