This is going to be a novel, but bear with me as I want to put everything down that I’m thinking on this market right now.
The way I normally approach trading is price action first– and then I observe if any narratives are then attached to that price action. Narratives don’t lead price, it’s the other way around.
Today we’ll focus on the narratives and then distill it down to price action.
Right now there are 2 major narratives that are currently attached to price. We’ll take a look at each one in detail, but only after we look at price action.
The first narrative is the trade war with China. The Yuan currency rebalancing that happened last week was a distinct escalation, and the last time the Chinese did this was Aug 2015 and we saw how that went.
This particular narrative moves in cycles… determined by politics which are more unpredictable than stock price. You’ll get some kind of an event, an escalation, then after the Hang Seng drops enough it motivates both sides to initiate “talks” whatever that means.
I don’t think this is the big risk– this makes for good political headlines but it has been a “known unknown” for what… 2 years now?
The second narrative is the big one. It’s what brought all the stress into the market at the end of 2018 and it’s the “spooky” side of things that gets me worried when I go for my morning walk.
If you look at the major pivot highs on the S&P, they have all coincided with Federal Reserve decisions. Now that hasn’t always been the case, but it shifted aggressively back in 2018 when the Fed was hiking rates and not taking a look at the data.
And with the most recent rate cut and projections they will cut again, the market sold off… what gives?
It’s useful to think about other asset classes out there and how they have fared over the past few years.
EEM, an emerging market ETF, is nowhere near its highs from 2018. In fact, it’s well over 20% lower, what we would characterize as a bear market.
You also, over a two year span, have seen multiple currency dislocations from emerging market currencies. Just recently, the Argentinian Peso was massively devalued on the back of elections. Around this time last year we saw the Turkish Lira get absolutely spanked on news that Erdogan was appointing his brothier (I think) to their central bank.
Here’s the main macro risk. You have a TON of emerging market debt that is denominated in the US dollar. And even though the Fed cut rates, you have the dollar near its highs.
This is the spooky part– in spite of all the Central Bank accomidations across the board– not just the Fed but the ECB and the BOJ — it didn’t stop a global recession. This recession may never hit the US but you can feel it when you look at EM and their currencies.
If you want some history about this, the Asian crisis in 1997 — which was a series of currency devaluations. When you’re a reserve currency it doesn’t matter much, but if your debt is denominated in USD then you’re hosed.
And then this ties back into China, and even the protests in Hong Kong. There’s a very real possibility that if the trade war escalates in step with Hong Kong… and if HK loses part of their autonomy, then the US no longer treats them as a special case when it comes to trade.
This would force the Hong Kong Dollar to get de-pegged to the USD… and that would be a gnarly one.
Are you sufficiently spooked yet?
Well, consider my next statement…
This is what it comes down to. Everything I’ve talked about has been a known unknown in the markets for a while. And if a risk is known for long enough, then it gets priced in.
The last Chinese currency issue was Aug 2015, and if too many people are leaning into a retest of the lows, then we won’t retest.
There’s also one more dynamic going on, and it goes back to the end of 2018.
A LOT of people got smoked that quarter. There were massive liquidiations, and plenty of investors went to cash. Just a few months later, all those losses are erased, and you have (I think) cash on the sidelines that has been looking for a proper dip to get back in.
You could see it in the price action last week, where responsive buyers showed up into the dips. It’s a little different this week so far, but the “sideline cash” fingerprint was definitely there.
And now I’ve written out all the crosscurrents that I think are currently going on in the market, and it should be about clear as mud. Which is fine– my guess here is that reversion is the name of the game here.
So here’s my line in the sand… any sustained hold sub 2880 is bearish, and we’ll most likely retest the lows… not just the regular trading hours (RTH) lows but the overnight session lows that were printed in the futures market.
Yet the longer we hold above that level, the higher the odds we see a push into 2980.
The good news is, with the duration we trade, we only need to care about the next 20 trading days at a time. And if we’re getting good entries and picking the right stocks, then the macro case becomes less of an issue.
Today we’re focusing on two stocks where I think the macro doesn’t matter as much.
Trade #1: ROKU
ROKU is the strongest stock on my screeners. It’s overbought, and I want to see a gap fill and a test of the rising 5 day moving average.
Expected Price: 125.32
Sell to Open ROKU Sep 110/105 Put Spread
Tier 1: Enter at 1.05, Exit at 0.25
Tier 2: Enter at 1.35, Exit at 0.55
Tier 3: Enter at 1.65, Exit at 0.75
Trade #2: MA
This is a relative strength play. While the rest of the market regained 50% of the recent selloff, MA took out more than 70%. It’s still above its rising 50 day moving average, had a failed breakdown under 255, and filled the gap from August 7th.
Expected Price: 272.31
Sell to Open MA Sep 255/250 Put Spread
Tier 1: Enter at 0.85, Close at 0.25
Tier 2: Enter at 1.15, Close at 0.55
Tier 3: Enter at 1.45, Close at 0.85
Stop out if MA Closes under the swing low at 253.9