The action in equity markets this past week suggests that some serious damage has been inflicted on the bullish trend. Is the damage serious enough to mortally wound the bull? It is far too early to tell. That said, we continue to believe that equity markets are at the forefront of a major topping process that will ultimately lead to some serious declines in the months ahead. Headline indices could conceivably eke out a marginal new high during this topping process but for our bearish thesis to hold, we would like to see further equity market weakness in the weeks immediately ahead.
We have shown in the chart below our interpretation of last week’s trading in the S&P 500. The first notable pattern was on Tuesday 8th when the market traded quite strongly higher during the morning, taking the market to a new intraday all-time high. However, strong selling later in the day left in place both a down close on the day and a potential bullish failure. Having traded in such a narrow range for the prior three weeks, this one day spike high and reversal appears to be a classic sign of market exhaustion. The downside action later in the week has only enhanced the appearance of the reversal pattern, especially with the break of support from the three month bullish channel.
Chart 1 – S&P 500 Daily Chart
If we take a step back and look at a weekly chart of the S&P 500, we can see a key reversal week last week (new high but lower close on the week). The bulls will argue that the long term trend remains higher, and that last week’s trading is simply part of the natural ebb and flow of a bull market. They may well be right as they have been especially since the panic lows from Q1 2016. However, every market trend (bull or bear) has to start at some point, and perhaps last week’s high was the start of a larger corrective process. That is our working thesis.
Chart 2 – S&P 500 Weekly Chart
Last week, we highlighted the building negative divergences in the market, which really should be considered as increasing fragility. The chart below shows that underlying fragility in a different way, measuring new 52 week highs and lows on the New York Stock Exchange. We have highlighted the growing negative divergence between new price highs in the S&P 500 and the number of stocks making new 52 week highs. What we find remarkable is that on the Friday of the same week that the S&P made a new all-time high, and with the index down only 1.6% from Monday’s closing all-time high, only 14 stocks on the NYSE were able to make a new 52 week high. This lack of strength among individual stocks is quite stunning given the recent performance of the headline indices.
And not to labour the point too much, the expansion in the number of stocks making new 52 week lows on such a modest decline in the market only enhances the bearish feel to the market, in our opinion. So, as noted above, to increase our conviction in our bearish thesis, we would like to see price head lower in the weeks ahead accompanied by increasing numbers of stocks making new 52 week lows, a decline in the number of stocks trading above their own 200 day moving average, and a widening of credit spreads.
Chart 3 – S&P 500 with new 52 week highs and lows
Although many market commentators like to try and find reasons for market moves, we not only prefer to measure underlying fundamentals, we actually try and filter out some of the “news”. Indeed, some would say that price is THE biggest fundamental, and that the events of the day are made to fit around and used to explain price moves. So although we will note that the declines in global equities coincided with news of escalating tensions between the US and North Korea, we go back to our thesis that the underlying health of the market had been deteriorating for some time and valuations are in bubble territory. Furthermore, the market had been ignoring simmering tensions between the two for a some time anyway, and although the narrative of markets falling on news of increasing tensions is entirely plausible, we contend that it could have been any negative news item that kick started the sell off. The fact is that the market was well overdue a correction.
Moving on, we wish to make a brief comment on Gold, which we have not discussed in a very long time. In the very big picture, with central banks pursuing extreme policies in recent years nearly a decade after the last global crisis, we can only wonder what they will do in the next crisis. In short, they will debase currencies like we have never seen before, and we have to believe that Gold will be a great asset to hold as this debasement occurs, hence we have held a small core allocation to Gold for a long time. As well as this small core holding, we have from time to time traded Gold from the bullish side of the ledger when we have thought that short term price trends support such a stance. And so it is that we bought some more Gold last week, and have decided to add this to our “trade ideas notional portfolio”.
We think that the recent decline in US real interest rates may have further to go, and if so, may be enough for the market to push the price of Gold up through obvious resistance around $1300 an ounce. We went long the December Gold contract traded in the US last Wednesday at $1274.40 per ounce, with an initial stop on the trade at $1245. With price moving quickly into the obvious resistance zone, we do not wish to see a reversal and for this trade to become unprofitable, and so we have moved the stop up to our entry price.
Having said that we are more concerned with analysing fundamentals and market pricing that we are with fitting the day’s news to explain price action. We would be foolish not to think that any escalation on the Korean peninsula would likely be bullish for Gold. However, any de-escalation would presumably be bearish, which is another reason for running a very tight stop on the trade. All that said, we are fundamentally bullishly disposed to Gold both in the near term, and as described above, in the big picture, and are happy to add the trade to our trade ideas section.
Chart 4 – Gold along with US real interest rates
So to wrap things up for this week, we very much view the price action in equity markets last week as adding weight to our topping process and bearish thesis. Even if we are right, this is very early days (the S&P 500 is only down 1.6% from its all-time high after all) and we need more downside price action to confirm our thesis. There is no doubt that markets feel a lot more fragile this week compared to a few weeks ago, but we also have to admit that bullish investor sentiment has been stronger in recent months than we would have thought likely. So long as last week’s highs remain intact, we will continue with our bearish thesis.
Summary of trade ideas highlighted in our weekly commentaries
As noted above, we went long Gold futures last week, initially risking about 60 basis points of capital. We do not like to see winning trades turn into losers, and have increased the stop on this trade to our entry price. We have done the same with the S&P 500 Put option we bought the previous week.
As the number of trades has increased, we have changed the format of the table below to try and make it easier to read. We show current open trades first, with entry prices, stop loss levels and the amount of capital risked on each trade. Then we show closed trades with realised profit/(loss). We also show cumulative realised profit/(loss), which is at the end of the day, what we are most interested in.
| RMG Trade Idea Summary – Initial Notional Portfolio of US$5 million | |||||||||||
| OPEN TRADES | |||||||||||
| Trade Date | Trade | Entry Price | Stop Loss Level | Loss to stop Local Curr | Loss to Stop US Dollar | Last Price | Open P/(L)% | Open P/(L) Local Curr | Open P/(L) (USD) | ||
| 26/07/17 | Short 100 Contracts Sept Schatz | 112.03 | 112.3 | -27000 | -31860 | 112.185 | -0.14% | -15500 | -18290 | ||
| 02/08/17 | Long 40 SPX Sept 2400 Puts | 12.7 | 12.7 | 0 | 0 | 24 | 88.98% | 45200 | 45200 | ||
| 09/08/17 | Long 10 Contracts December Gold | 1274.4 | 1274.4 | 0
|
0 | 1294 | 1.54% | 19600 | 19600 | ||
| Unrealised Totals | -$31,860 | $46,510 | |||||||||
| CLOSED TRADES | |||||||||||
| Trade Date | Trade | Entry Price | Stop Loss Level | Trade Closed | Close Price | Realised P/L | US Dollar P/(L) | Last Price | Open P/(L) | ||
| 14/07/17 | Long 10 Contracts Sept Cocoa | 1892 | 04/08/17 | 2047.7 | 8.2% | 15570.00 | |||||
| 14/07/17 | Long 10 Contracts Sept Cocoa | 1892 | 01/08/17 | 2068 | 9.3% | 17600.00 | |||||
| 14/07/17 | Long 20 Contracts Oct Sugar | 14.099 | 04/08/17 | 14.174 | 0.5% | 1680.00 | |||||
| 14/07/17 | Long 10 Contracts Sept Coffee | 132.10 | 04/08/17 | 139.4 | 5.5% | 27375.00 | |||||
| 19/07/17 | Long 20 Contracts Sept Cocoa | 1943.10 | 28/07/17 | 2035 | 4.7% | 18380 | |||||
| 19/07/17 | Long 20 Contracts Oct Sugar | 14.42 | 01/08/17 | 15.0245 | 4.2% | 13540.80 | |||||
| 20/07/17 | Long 10 Contracts Sept Coffee | 136.175 | 01/08/17 | 138.65 | 1.8% | 9281.25 | |||||
| Cumulative Closed Profit/(Loss) | $103,427.05 | ||||||||||
This is not meant to be a model portfolio and it is not meant to constitute any investment advice. This is purely a way of keeping track of specific trade ideas that we highlight in our weekly investment commentaries. These ideas will consist of the more important or higher conviction ideas that we implement in our multi asset macro fund. We have chosen to have a notional starting portfolio value of US$5 million; the reason being that we can also illustrate how much risk we are taking on each trade as well as keeping a cumulative track of how our main trade ideas are performing. This is a notional portfolio only and does not represent any portfolios that we manage. However, for the sake of clarity and consistency, we do put these trades into our multi-asset macro portfolio alongside other trades that we do not make apparent here. The prices we show in the table above are the prices we transact at for our macro fund, not including any trading expenses.
Stewart Richardson
RMG Wealth Management
