2021 Preview Stocks, metals, and Crypto

 

Dec 30 2020                        Market Commentary, Stocks, BTC/ETH, Metals

 

People are excited about markets. Sunday morning, I looked at my phone around 830 am and saw that I’d received texts from two different people. I text about markets every day… but before 830 on a Sunday only happens when there is genuine excitement.

 

Going back 3 years, to late December 2017, the S&P was trading ~2900. As I write at 3740, up ~29% in the last 3 years. The incredible fall and rise in 2020 aside, markets seem to be moving up high single digits on an annual basis. Have you seen the sell-side list of price targets for the S&P in 2021? They’re all higher! Average target price? 4042. That imputes a consensus expectation of 8.5%, right in line with recent history. These expectations all seem quite muted given more recent history, but we’ll see.

 

I was taught to pay attention to the breadth of rallies. One of the concerns about the post March rally was the amount of money that flowed into FAANG, TSLA, a select few names. As summer turned to fall, the recovery trade was in full bull mode. Now the rally is broad. That’s a welcomed sign for those sitting in index funds. Since the big names represent such a large portion of the S&P weightings, you find yourself in a situation where a few volatile stocks can dictate the short term fate of the whole index. As the rally broadens, that risk lessens.

 

 

Crypto

There are lots of narratives out there about BTC. If you are considering investing/trading in BTC, I’d recommend that you only follow two of those narratives.

1)  Reputable people/organizations are buying

2) Regulation and the impedements for interested parties who have yet to dip their toe progresses

 

I would avoid listening to any of the talk about “hedge for inflation”, “hedge against central banks losing control” or whatever other reasons many of the die-hards may state in their buying. It is not to say they are necessarily wrong in their thinking. They may be right in time. But BTC hasn’t been widely traded for very long, and the evidence certainly does not support that it’s a safe haven. It does not necessarily “diversify” your portfolio either.

I remember vividly last March when BTC made its lows around 4-5k. I had written a post on linkedin not long before called “why I’m not selling at 13500”. Standing in my kitchen, receiving texts from an old trading friend reminding me that “BTC is going to 0, where is your stop?”, I remember feeling physically sick. I still believed in the story, so I never sold, and bought some at higher levels after things seemed to stabilize. But that experience has led me to operate with the belief that “Bitcoin is a hedge for nothing”. If I’m considering future buys/sales, it will not be to “hedge a portfolio”. If you are thinking in this way, unless you are talking small single digits, I suggest you reconsider. Please recall that at those lows, BTC was the worst performing asset on the board. Lot’s of volatility, not a safe haven if stocks are to sell off.

 

But there are a few things BTC (and eth) has going for it.

1) Big names buying- A few years ago, the debate was “will this thing last”. When Paypal, Square, and insurance companies are buying and making it accessible through their platforms, it’s not going anywhere.

2) Legendary managers/traders touting it’s virtues. PTJ and Minerd to name a couple. If you step in, at least you are amidst the company of some of the best. The “this is a scam” logic that was prevalent a few years back is dwindling

3) Regulation- This may frustrate some of the early adopters. The more regulation imposed, the less “decentralized” it may seem. But if the concern is price, then regulation has the potential to be a good thing, because it creates a path to allow new buyers to enter a market. Looking at the news, my take is that everything except for BTC and ETH is at risk. They are the darlings, and have/will have their own CME futures contracts. You see what’s going with XRP…. Once liquidity providers start pulling because of regulatory crackdown, the damage is done regardless of whether they are indeed compliant. As for Stablecoins, the treasury dept recently stated they should be used in a way that “effectively manages risk and maintains the stability of the U.S. domestic and international financial and monetary systems”. No one said anything like that about BTC or Eth. Takeaway? Regulation will likely make alternatives to ETH/BTC less attractive, while simultaneously making it easier for a wider class of investors to invest in BTC/ETH.

 

BTC Options: You can check out the price of options on Deribit. Unfortunately, at this point it’s a lot harder than you might think to get into the options game. Very few of the retail brokers are allowing for trading of BTC at all, let alone the options. The margins are currently prohibitive, and I have heard that a number of FCMs currently lack interest in supporting traders looking to get into the market. That I think above all is why you see fairly light CME volumes. I assume that will change in time, but we’re not there yet.

 

Nonetheless, we can see where the options trade on Deribit. No surprise given the recent volatility, the options are juiced. As I write with BTC trading 26,500, the 36,000 calls expiring in 60 days are 1500+ bid. When option trading becomes more universally available, it’s going to be a big deal. There will almost certainly be interest as the amount of premium is to great to pass up for those longer term holders. Sure, they’re priced where they are for a reason, but consider that you can collect (1500/26500). That’s 30+% on an annual basis. That feels like a lot given that those writing covered calls wouldn’t be called away unless it moves ~10k in 60 days. With active options markets, the potential for interest and participation in the crypto markets will grow. I find it frustrating that I can’t trade these options, as selling calls against part of the position would allow me to better justify the size of the holding from a risk management stand point. We’ll get there, but it’s early days.

 

Gold/Silver- One of the big narratives around particularly gold has been tied to BTC, and the idea that BTC replaces the need for gold. They both have limited supply and can act as stores of value, but BTC can be used for payments and is much cooler. There was likely a real impact from this narrative, as there have been outflows from GLD, the best proxy for retail interest in Gold. While I’m tempted to say who cares, it can’t be overlooked as Western retail demand tends to be the primary driver of the gold price. That all being said, I have found that gold is typically better to buy when no one is interested. When people start getting excited about gold, I get cautious. One only has to look at the history of how the hedge fund community fairs vs the dealer community to know that speculatively finding good entry and exit points has not been the forte of retail or the “sophisticated” buy side.

 

 

Above is a weekly chart of gold back to early August when it made its all time high just shy of 2100. There was a clear downtrend that ensued thereafter. Right now it appears the downtrend has stopped, at least temporarily. I like to pay attention to setups where an up or downtrend appears to stop and consolidate. Out of a consolidation pattern, moves (when they do happen) tend to be greater in either direction. Think of consolidation as a sign that both buyers and sellers are generally in agreement about price. When one side gains an advantage, the other side is wise to back off and wait for better prices. If gold manages to trade above 1900 for a day or two, that should give us some confidence that the medium term downtrend is over and that our near term downside risk is limited.

 

Like gold, silver peaked in early August. It dropped faster and has been in a consolidation pattern, as opposed to gold’s more clearly defined downtrend. If it can clear the 28.5 level, there is serious room to run to the upside. The following chart shows Silver (green and red bars) overlayed with gold (purple) since they both made all time highs in 2011. It is not news that silver has massively underperformed in the last few years, but if it is to play catch-up, there might be a big trade here.

 

 

Notice the red line going across the chart above. This was the ~1525 level in gold that had served as support for close to 2 years after it broke down from its 2011 high. Once that level broke, gold began a multi year downtrend. Look at what happened in 2019 when gold (purple line) got back above this level. 6 years of resistance had given way and gold took off like a slingshot to make new all-time highs.

Silver still hasn’t broken through the support that gave way in 2013. Above 30, SI will have clearly broken that long term resistance. Gold managed to make a new all time high ~6 months after the break.  An all time high for silver would imply a ~66% move.

None of this is investment advice. If you are looking for trades with asymmetric risk reward setups however, SI seems like it is worth the attention.

 

Happy New Year to Everyone, and best of luck in 2021.

 

-Ben

Big picture Context following swiftest sell-off since the financial Crisis (2/29/2020)

Context in Markets 2/29/2020

Following the swiftest sell-off in equities in over a decade, I thought I would share some general thoughts about the state of the markets to provide context following last week's roller coaster.

Above is a chart of the S&P 500 going back to 2010. At 3,000, the S&P now trades at three times the price of it's 2010 low, and nearly 5x the 2009 lows.

Notice the simple line on the chart to give a sense of the uptrend the market has been in since. Don't call this technical analysis! I am not drawing arbitrary lines to make wild price predictions or calculations. I'm just showing the history of prices. This line  shows the general speed at which the S&P has moved higher over a 10 year period. Notice how each time price went above the line sell orders came in and brought prices back in line with the longer term trend. Why am I pointing this out? Just over a week ago the S&P was trading further above its 10 year trend-line than ever before. Prices are not obligated to stay within a trend, but it is worth noting that stock prices were trading the highest in 10 years relative to the trend before the swift sell-off.

Then, while the market was making highs around 2/19, there was an increasing awareness that the numbers of Covid-19 cases in China were being understated, and that it was spreading. I for one remember being more shocked that stocks had not sold off sooner, than I am now that they did. Stocks were overbought on the short term, and there is increasing evidence that the risk (Covid-19) the markets more or less shrugged off, is a real. That is a bad scenario for stock prices in the short term.

One of the things about the Covid-19 that poses a challenge for pricing of assets in general is that it is unfamiliar and unpredictable. Aside from it's novelty, the implications are essentially impossible to calculate. Even if we knew for certain when the virus would be fully contained, predicting the response of individuals is a fool's errand. I for one watched myself change my mind on what activities I might and might not do rapidly in a 3 day period. If I can't figure out what I want, how can I venture to create a model for how 6 billion others' behavior might change?

A few times in the last week I thought about the Asian Contagion of 1997;
 https://en.wikipedia.org/wiki/1997_Asian_financial_crisis

While I know nearly nothing of the specifics of the Asian Contagion, I remember the lesson that chain reactions can be set off from seemingly contained incidents. In the context of the Covid-19 scare, it is hardly unreasonable to worry that short term stagnation in commerce could lead to insolvency for some (governments/corporations). Companies with significant short term debt obligations could default setting off a chain reaction that could reverberate far beyond the companies themselves. We will see some companies whose most painful days may be ahead of them if supply chain disruptions lead to delinquencies debt payments. Personally I am wary of the energy sector, where producers with high debt obligations are facing declining prices amid global supply concerns.

Friday's price action was positive.

Some companies will certainly feel the pain more than others, but the broader indexes gave reason for hope. (3 year S&P 500 chart below)

The bounce off of the low yesterday occurred at 2850. 2800-2900 really served as the battle zone for S&P price since the beginning of 2018. It is generally encouraging when you see a level that served as resistance act as support when it tests that level from the upside. The size of the bounce (150 handles by end of day) is also encouraging for the bulls.

It is worth re-iterating that (notwithstanding dividends) at Friday's lows, S&P holders were EVEN over a 25 month period. While the August 2019-Feb 2020 rally may have gotten a bit ahead of itself, the last two years have not been a one way train. I think the 2019 returns on the S&P created a misconception of what has been going on in markets in the wider context. The S&P was up ~30% in 2019, but that is misleading performance. September 2018-end of Dec 2018 the S&P gave back 500+ handles (a similar sell-off to last week's, just spread out over months). The recovery from early Jan 2019 back to the levels of the Sep 2018 highs made up the bulk of the 2019 performance.


The absurd post financial crisis attitudes towards market volatility that have become the norm

I have recently read a number of posts about how this move is a sign that our markets aren't healthy. That is preposterous. The Post financial crisis investing public has been spoiled by a Fed/government that has been incredibly accomodative. Despite the fact that indexes are up multiples from where we were just a decade ago, a 5% pullback in markets is enough to get the pundits/politicians acting like its 2008 again. And I suppose why not. If people vote with their wallet in elections, why not sound the alarm bells every time it looks like your equity portfolio might take a hit? While I can understand "the why", the reasoning and excuses for this level of fear is unwarranted. Just because the fed has all but destroyed volatility in markets, does not mean that volatility is bad. Volatility in markets is healthy. This isn't the early 1900's where crashes were frequent and the extreme swings created challenges for the stability of business. This is a 10-15% correction that happened quickly in a market that had gotten ahead of itself and faced a major unknown that could disrupt global supply chains. Sell-offs are a part of any bull market, and nothing about last week's price action tells me markets are "unhealthy".

These markets are in fact much healthier than the 2011-2014 markets. While both markets have been the beneficiary of accomodative policy,  the former saw far less volatility on a single stock level than the markets of today. Back then, QE/broader policy was a tide that allowed all boats (stocks). Today's market often brutally punishes stocks that miss earnings/ rewards those that beat expectations with double digit % returns. While (notwithstanding last week) volatility has been low at the index level, the volatility on the underlying stocks has been tremendous. I remember when people used to say commodities were not suitable for trading for most investors because of their volatility. Now, the FAANG names, TSLA etc are far more volatile than most metals/commodities. Traders need to know that at the single stock level there is plenty of risk, but from a market perspective, this is healthy.

Big picture for US equity investors

There is still money on the sidelines, and the rally from August to recent February highs took place amidst a backdrop of generally bearish market sentiment. Some have argued that the recent wipe-out was due in part to levered longs who were out of the market looking to catch up with performance (forced to liquidate accelerating the sell-off). It is worth keeping an eye on equity flows. If there are massive inflows to equities, it is wise to be aware of the increased risk that there will not be buyers to provide support on a down-move. When there is money on the sideline/bearish sentiment, longs can feel more comfortable knowing that if converted, those bears/sideline money can bring the demand needed to push prices higher. This may be what took place towards the recent peak... but as is commonplace... those converts get to the party just as it is about to end.

The one clear defining characteristic of the markets from 2009- now is an accomodative backdrop. I think it is safe to say that a friendly rate environment will persist at least until next year's elections. At the simplest level, this is good for equities because there is so little yield in bonds. If you want returns, there just aren't that many places to go. On the flip side, with rates this low, the fed's toolbox has shrunk. That puts investors at greater risk as even with the will of the people/fed to act, their tools may be too blunt to stop extended sell-offs and stimulate the economy. In that world, you can still be bullish equities, but reasonably expect  more frequent sharp draw-downs along the way.

There are always unknown unknowns, like Covid-19 that change the entire investing picture. Unfortunately, aside from some insurance against extreme events, there isn't much we can do to predict. Even then, that insurance doesn't always work out (I thought I'd be selling gold at 1800, not 1580 this week). But if a business friendly/ accomodative Fed is the characteristic of this bull market, I would see anything that serves to disrupt that as the biggest knowable risk. Populism is on the rise globally, and thus predictability of election outcomes decreases (Brexit, Trump election were not accurately handicapped). While I would rather spend my time doing anything but watch political news, I will be keeping an eye on how the odds shift for Democratic nominee and ultimately the general election. As discussed previously, it doesn't take a lot for post 2009 stock owners to kick and scream with fear at the smallest sell-off. If there are any major shifts in expectations along the way about who will be president, I would expect to see markets to become more volatile.

Feel free to ping me if you'd like to discuss any of the above. Enjoy the weekend.

-Ben