Red Flags and "Rip Your Face Off" Bounces

While I have been constantly talking about red flags and warning signs in the past few weeks, the market has been making new highs again and again. This fits into what is described below by Summers about the "rip your face off" bounces that follow each tiny dip. It seems nothing can stop the wildly bullish trend that is simply shooting up regardless. 

To be clear, while I'm generally bearish about the overall market for now, it doesn't mean I'm not doing bullish trades these days. Actually we closed a good profitable bullish trade for SPX today in our Family that we placed a few days ago when SPX was trending down. Another bullish trade I'm still holding is for AMZN. You know I was bearish about AMZN for a few weeks till recently when it crashed down towards its 200 DMA. I think there is a good chance that AMZN will bounce back strongly in the next few weeks. The easiest option trade is to sell its naked puts but you need a lot of money to do so, since one contract means over $300K worth of the stock value for 100 shares. Even with a margin, it easily means $50K to $100K cash required depending on the broker's margin requirement. I have a much better way to play with it as I have shared with my Family (for each contract):

It means we can potentially make a profit of about 70% in the next few weeks as long as AMZN is not trading below 3280ish by its expiry (AMZN is trading around $3350ish).  I think the odds are quite good in our favor, given how oversold AMZN is right now!

 

This is just an example about my swing trading in either direction, regardless of how I feel about the overall market state.  

Red Flags and "Rip Your Face Off" Bounces   Stocks are relatively sleepy due to low summer volume. The primary dynamic since the summer started is that rallies are lethargic and occur after days of chop (see red rectangles in the chart below). The problem is that whenever stocks start to roll over, "someone" steps in and manipulates them higher. We get at most a day or two of selling, followed by a "rip your face off" bounce. I've marked this in the above charts with blue ovals. In this environment, large institutions are not buying, but they're also afraid to sell for fear the Fed (or whoever is manipulating stocks higher) will instigate a major bounce. In this environment you get a slow grind higher. Underneath the surface, things are looking weak. High-yield credit, which usually leads stocks, is rolling over. Similarly, breadth, which also usually leads stocks, is breaking down. The ratio between stocks and long-term Treasuries has a rounded top. The long-term chart for this ratio shows that it has broken out of its long-term upwards channel. This suggests a "reversion to the mean" move is coming, which will see TLT dramatically outperform SPY. We see a similar over-extension in the ratio between stocks and the $USD. This, too, suggests a "reversion to the mean." Both of those charts tell us that stocks are severely overbought. Does this mean a collapse is just around the corner? Not necessarily, but it DOES suggest that the primary focus for investors in this environment should be risk management, NOT loading up on stocks. What could trigger a serious risk-off move? It's difficult to tell. Certainly if the U.S. started another round of lockdowns or even partial lockdowns, things could get messy. There's also pronounced economic weakness showing up in the hard data. Take a look at the below chart from Societe Generale and you'll see what I mean. The economy is surprising to the DOWNSIDE in a big way, I'm watching this situation closely and will issue updates as needed. But red flags are starting to crop up in the markets. Best Regards, Graham Summers