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This Is Not a Drill

The intent of this post is not to make any additional panic. I’ve been on the defense since the first half of February, and I hope you were too after posts Bonds, buy Bonds and Bumpy road ahead were published.

But things are getting serious, the virus is affecting the economy and the markets greatly as you have probably already noticed. I’m not an expert on viruses, but the markets are telling us this situation is not to be taken lightly. As I tweeted a few times in the past couple of weeks I prefer to “panic” sooner rather than later. Majority does the opposite, rather than prevent they’re forced to deal with the consequences.

As of writing the S&P 500 stock index is down more than 8% just today, or down more than 25% from the peak. This is on record the fastest 20% correction measured from the peak, including the 1929 meltdown.

We might be due for a snap back, a face ripper, rally. This may also be a historic buying opportunity, but as things stand, I wouldn’t exclude more downside further down the road, or, in best case scenario, a period of very high volatility with a range bound trading. There’s just an overwhelming supply waiting at higher prices.

I’ve been seeing so many “buy the dip” calls during this selloff. Everybody is so eager to buy the bottom because they’re sure the market will be higher a few weeks, months or years from now. But what if we don’t see a repeat of 2019? What if the EU and the US get into a complete lockdown? What if the selling is not over yet? What if the exchanges are forced to shut down for a prolonged period of time? Could you handle that?

However you might want to turn this around, this is a period when cash is king.

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Crash of 2020

What a historic times! After relentless selling and the fastest correction on record according to Deutsche Bank, we’re seeing some crazy after-weekend moves in the over-night session. S&P 500 index futures are limit down (meaning, after a quick -5% move trading has been halted until the US opens), bond prices are surging and that oil… man, crude oil was down -30% from Friday’s close in just a matter of minutes!

Brent oil’s move at the moment stands as the 2nd largest one day move ever. On Jan 17th, 1991 Brent closed down -34.8% in a day. Let’s see where it closes at today, but the next largest move is -13.5%, so today’s move will be either the largest or second largest on record. Here’s a chart of WTI oil.

I don’t know how the stock market will react once the US session starts. Will we see a bounce, or a continuation of selling is anyone’s guess at this point. However, I hope you took precautionary measures in February when I posted Bumpy road ahead and Bonds, buy Bonds. Hope you’re safe and were able to limit you losses.

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Bonds, buy Bonds

Earlier this month I wrote a post Bumpy road ahead. Short term traders probably think what a foolish call that was, because the stock market went nowhere but up since then. While the intention of the post was not to call the top, it was to warn you that volatility could pick up. Riding up trends in low volatility environment is nice, and while calling tops is not sensible, we must ensure we not become complacent. Easy times can last longer than most anticipate, but they can be escorted by volatile moments too.

You might want to try to play heightened volatility by buying puts or by executing some other options strategy, shorting stocks, or by doing something else. However, I think the best risk reward opportunity right now is to be long bonds.

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Bumpy road ahead

Markets fluctuate, they go up and they go down too. Our job is to make the most out of these fluctuations by going with, and not fighting, the tape.

Even though you could have pointed out many reasons why one should have been expecting a correction, or even a crash, we’ve been bullish for the most part of last year up until now. Looking back, that was the only right decision to be made.

However, we think now could be the time for becoming cautious going forward. We’re not becoming ‘the end of the world’ bearish yet, but the ride could become bumpier.

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Banks are rolling lower!

Since early October I’ve given so many warnings about the stocks market it’s almost making me sick already. No, not because the market might correct or even crash, but because I must be starting to get annoying to all of you. The intention of my warnings is to make you aware that there are risks and that you do everything that’s in your power of protecting your wealth (see Do NOT underestimate the risk). This is why we’re here, aren’t we? Making money is important, but protecting it, this is an even more important task in my opinion. 

Let’s take a look at a banking sector. I wrote a post about financial sector a few weeks ago and that we are looking to short it under the right conditions (see Sectors on the watch to short). I was also going on about yields falling or bond prices rising in the intermediate term (see From yield curve inversion to bond squeeze?). 

What if the FED hikes for the last time this December and pauses with rate hikes next year? What if the natural consequence is that the banks suffer in the same period? And when banks are trading lower it is never a good sign for the stock market in general!

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From yield curve inversion to bond squeeze?

Yesterday we got the first US yield curve (3 and 5 year) inversion since 2007. Usually a recession follows within two years but I don’t want to scare you with that. Firstly, it doesn’t have to happen immediately and secondly, if you read any of my posts lately you know that getting defensive is not something we should fight against and in that case you’re well prepared for a case of a downturn.

The point of this post is to point out that we could see a flight to safety, that is into treasury bonds. A lot of people are expecting inflation and interest rates to rise over time, meaning bond prices to fall, including me (see Bond breakdown?). But it looks too many got ahead of themselves so it would be irresponsible to ignore the intermediate term risks in the market. Let me present what I think could happen.

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Generational shift

In the beginning of 1980s interest rates and inflation started to trend lower. They have trended lower ever since and they got to levels never seen before in the history of mankind. It feels that we have forgotten they could ever rise again. Inversely the same is true for bonds. But I think we are witnessing one of the greatest generational shifts that are happening right in front of our eyes.

What if interest rates and inflation are about to rise for the next 3 decades while treasury bond bubble is about to burst with bond prices trending lower in the same period?

Most media don’t even cover this topic. They’re too focused on clickbait stories. I covered this topic last September in But aren’t bonds supposed to only go up? and three weeks ago in Bond breakdown? posts. But it’s so important I need to give you another update.

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Bond breakdown?

… and inflation is coming.

I could end the post with this. For some this could be the news, for others maybe not so much. I wrote a post last year But aren’t bonds supposed to only go up? Like then also now I was chatting to a friend recently and he was very surprised when I said I’m expecting inflation to pick up.

Most people think we’ll stay in this disinflationary and low rates environment forever. But we’re getting inflation signs everywhere. For example, the housing market is strong in most cities (in Europe) and it seems it could stay that way for a while. There are some other big infrastructure projects under way. Food prices are slowly but steadily rising. Huge pressures on salaries starting to emerge. And I believe oil prices could rise to $100 in the near future too (see here)!

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Macro overview

I would like to present you my current macro views. The markets are at very interesting points and offer very good opportunities at the moment.

The format of this post will be slightly different than usual, I will post my tweets because I think that the combination offers a better reading experience.

I would like to start with the major stock market indices. There is so much interest in this market thus everyone has an opinion on it. I’ve been seeing so many bearish calls lately, such an increase in the negative sentiment,.. Sure, they might be right and as stated many times before, I don’t mind if the markets doubles or goes to zero from here. All I care is to participate from the right side. Read More

But aren’t bonds supposed to only go up?

I would like to start with my tweet from earlier today.

Are they? Or is just the cycle long enough so that the people forgot that bonds might also fall and interest rates rise over time?

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