Enormous Downside Risk for Stocks

The S&P 500 ETF (SPY) chart shows three major resistances:

a. long-term downtrend line extending from May of 200
b. horizontal resistance/June highs
c. underside of channel support defining current bear rally off March lows.

On top of that, we have a parabolic move with tremendously overbought conditions. I will be in awe if we can break out of this pattern; at that point, technicals would be completely broken, I'd be going long on margin until 1010 and essentially betting on a crash from that level.

The VIX is right on its long-term uptrend line support as it approaches the apex of its enormous falling wedge. This should resolve with an explosion in volatility. I would not be surprised to see the VIX get back above the 50 level this fall/winter.

Apple (AAPL) reported earnings yesterday, met with a gap up and sell off. It is sitting right at a long term resistance trendline and is showing one of the most bearish technical signals of all: the evening star candle. I see a massive reversal in AAPL coming. But in this broken market, anything is possible.

Gold is still performing well. If it can breakout of its triangle it should make a powerful move through $1000 soon.

The stock market looks ready for a very, very powerful down move. At the very least, downside risk is enormous and buying at these levels and these resistance points is a difficult activity to justify. I have seen first-hand the power of HFTs and liquidity "providers" and how they can move markets (and seen it after-the-fact through study, such as in 1987), but at these strong levels of offered supply, I am betting big against stocks. With very tight stops of course.

The NYSE's margin debt/credit balances tables provide context for this bear market rally. Instead of increasing equity (from rising stock prices) lowering debt and increasing credit balances, during this rally, margin debt has increased from $182B to $189B while credit balances have shrunk from $137B to $117B. This means the demand driving this rally has been increasing not only its exposure, but its leverage. This is highly unsustainable, makes very much sense in the context of highly levered HFTs, and indicates a drastic lack of liquidity in the market.

Another crash this fall is looking increasingly likely with the lack of liquidity in this market and the bearish technicals and divergences all over. Not to mention the economic fundamentals and balance sheets of the largest financial institutions.

Disclaimer: Short SPY, AAPL; Long GLD

Comments

[Larry House:]

I am prepared for the type of fall/winter action you describe. Now if it just happens!

Jul 23 10:38 AM

[Mad Hedge F...:]

For sure. Let me tell you that I, and the rest of the hedge fund industry, are highly suspicious of the global stock market rally that has ensued over the past week. Companies lowered earnings expectations so far they were easy to beat, and could be achieved by laying off a few more workers. The question this raises is how the economy moves forward with skyrocketing unemployment. Now that we have double topped in the S&P 500 at 956, even the bulls are saying we only have another 4% to go. This on a day when we are all wondering if commercial real estate loans will be the stick that breaks the back of the banking industry. Mike Mayo, a banking analyst with Clayon Securities, says that the industry may have to write off a quarter of its $7 trillion loan book over the next three years, levels greater than seen during the Great Depression. While banks are making a lot of money trading, they are losing it even faster in loan losses. It’s like trying to fill a barrel with water that has been perforated with a shotgun blast. If you are playing from the long side here, keep one foot in the exit, and a finger right on your mouse.

Jul 23 10:40 AM

[Shimmers:]

Thanks Nauful, I like your articles.

Jul 23 11:27 AM

[thiazole:]

Exactly - I have a pretty bad thumbs ratio, but I've been right on about the economy and market since I started posting. I'm kind of thinking that SA posters are very good contrarian indicators. There is one guy (won't mention his name) who I went back and read most of his historical posts, and he has been a perfect contrarian indicator. I think his first post was something along the lines of "GE is going to zero". He also has a very high thumbs up ratio. I pay close attention to what he posts because I can depend on reality being the polar opposite. I fear that he will get frustrated at being wrong 100% of the time and stop posting, though.


On Jul 23 07:56 AM Maxe Paul wrote:

> (note to self, mega thunbs down = right)

Jul 23 12:03 PM

[zenfarmer:]

From actual forecasts I'm seeing in the Silicon Valley, I am sure we will be retesting the March lows. Who knows when but 4Q 09 seems likely. The green shoots sentiment and fictitious bank balance sheets do not form a basis for a true economic turnaround. The Fed's policies are unsustainable. Able companies will follow the path of Halliburton. The paramount outcome of this past year has been the creation of an improved and seemingly unstoppable GS at the expense of the taxpaying citizens of this country. That will have ramifications that are yet unfathomable.

Jul 23 12:08 PM

[Roger Knights:]

The strength of the rally is explicable if Da Boyz have got wind of a plan to, in effect, devalue the dollar by year-end.

Jul 23 12:17 PM

[Teutonic Kn...:]

The present euphoria has to run its course, fueled by the power elites absolutely bent upon pumping up the market at ALL COST. They have the (printing) machine to gun down any doubters.

The institutional professionals are the key players, and the Fed is gladly pleased to go along.

However, stock price is based on fundamentals, and not on gambling fever. The blackjack gambler would tab on the velvet sheet to signal one more, even at 15 or 16 --- Greed Rules!

Jul 23 12:24 PM

[Graham and ...:]

As Ben "Graham" (Grossbaum) would say, "in the short run, the market is a voting machine, and in the long run, it is a weighing machine."


On Jul 23 12:24 PM Teutonic Knight wrote:

> The present euphoria has to run its course, fueled by the power elites
> absolutely bent upon pumping up the market at ALL COST. They have
> the (printing) machine to gun down any doubters.
>
> The institutional professionals are the key players, and the Fed
> is gladly pleased to go along.
>
> However, stock price is based on fundamentals, and not on gambling
> fever. The blackjack gambler would tab on the velvet sheet to signal
> one more, even at 15 or 16 --- Greed Rules!

Jul 23 12:32 PM

[Stephen Ros...:]

Nauful,
I think you underestimate the momentum we're seeing into stocks after the last correction.
Already, since this was written, we've broken through June resistance and moved above the long term down trend of May 2008 (I'm presuming you're speaking of 2008).
In addition, the earnings being presented are quite good which bring investors in. Apple deserves its rise. Investors are pleased with GAAP earnings of $1.35 but, I suspect, are not looking closely at the bigger story of nonGAAP $2.14.
You're previous predictions of a crash have been not fulfilled. I believe you will again be wrong in this prediction.

Jul 23 02:04 PM

[Swashbuckler:]

Naufal, I enjoy your posts. It is my opinion that you write beyond your years.

Jul 23 03:06 PM

[thiazole:]

The bears have their ears plugged to all that news - if it sounds like "green shoots" they call it weeds and walk away. All they can have to say is "what about unemployment". Seriously, we are beyond green shoots. Green shoots were those little hints in March and April that suggested the economy would stop contracting in a few months. It is pretty clear that the economy is no longer contracting. That is a sign of plants, not shoots. The fruit will come next and that will be a drop in unemployment. That is still probably months away, though.


On Jul 23 02:04 PM Stephen Rosenman wrote:

> In addition, the earnings being presented are quite good which bring
> investors in. Apple deserves its rise. Investors are pleased with
> GAAP earnings of $1.35 but, I suspect, are not looking closely at
> the bigger story of nonGAAP $2.14.
> You're previous predictions of a crash have been not fulfilled. I
> believe you will again be wrong in this prediction.

Jul 23 03:39 PM

[roflmfao:]

"I am betting big against stocks. With very tight stops of course."


This is the entire problem ... "with very tight stops"

Jul 23 04:17 PM

[Old Trader:]

thiazole,

I'd like to propose a "cyber-wager", *s*. I haven't been keeping actual count, but I'd be willing to make the following wager: for every company that has thus reported that beats on the top line (increased sales), I give you a dollar. For every company that's reported a drop in sales, you give me a dollar. Fair enough?

Once we get to the point where sales are at least flat....THEN we can start discussing "stop contracting".

Jul 23 05:22 PM

[thiazole:]

I wish there was a website that kept track of this. I was just thinking yesterday that if I ever get laid off, maybe I'll use my free time to start such a website. Basically only include companies in the 3 major indexes (to make it more reasonable to keep track). In any event, I'd like to make a wager like this, but who has the time to take the tally?


On Jul 23 05:22 PM Old Trader wrote:

> thiazole,
>
> I'd like to propose a "cyber-wager", *s*. I haven't been keeping
> actual count, but I'd be willing to make the following wager: for
> every company that has thus reported that beats on the top line (increased
> sales), I give you a dollar. For every company that's reported a
> drop in sales, you give me a dollar. Fair enough?
>
> Once we get to the point where sales are at least flat....THEN we
> can start discussing "stop contracting".

Jul 23 06:16 PM

[thiazole:]

You'd also need to define what a "drop in sales" means. If you are talking yoy revenues, the economy has contracted significantly since 1 year ago, so that isn't a fair comparison. If you are talking quarter over quarter profits, then I think it would be very close (on one hand, lower costs will contribute to profits, on the other, that was a period that spanned up to over 3 months ago - I'm not saying things were rosy 3 months ago).


On Jul 23 05:22 PM Old Trader wrote:

> thiazole,
>
> I'd like to propose a "cyber-wager", *s*. I haven't been keeping
> actual count, but I'd be willing to make the following wager: for
> every company that has thus reported that beats on the top line (increased
> sales), I give you a dollar. For every company that's reported a
> drop in sales, you give me a dollar. Fair enough?
>
> Once we get to the point where sales are at least flat....THEN we
> can start discussing "stop contracting".

Jul 23 06:19 PM

[Mad Hedge F...:]

It's even bigger a the end of today. There is no doubt that the next trade from here in stocks is a sell. Buying NASDAQ on a 12th consecutive up day, the S&P 500 on the back of a 110 point move, and the Dow on top of a 1,000 point pop is not what great fortunes are made of. After stopping out of my own shorts in the 880’s, I have been holding back, holding back, holding back. See my warning not to sell too soon at www.madhedgefundtrader.... I have never been one to fight the tape. The only trader who is always right is Mr. Market. The earnings to support a full fledged bull market are not just there. Deleveraging worlds don’t support expanding earnings multiples. It all works for me because the more it goes up now, the bigger the fall later. Even the raging bulls are warning about a “W” shaped recession and another market dive in 2010. How finely do you want to trade this thing? It’s clear the big core shorts at the major hedge funds haven’t budged, and that most of the recent low volume action has come from day traders, momentum players and CTA’s. All we need now is for mom and pop to come in and ring the bell at the top. Is 2009 going to be replay of 2008? Is a “Sell in May and go Away” at www.madhedgefundtrader... to be followed by another October crash? If your friends’ long positions make money from here, just revel in their good fortune, and let them pick up the dinner check.

Jul 23 06:42 PM

[H. T. Love:]

I was thinking exactly the sam as you O.T. I had noticed such a high % that reported top lines down 11, 15, 20, 30% and my first thought was it sure ain't over yet.

What *did* surprise me was how all the "stuff" took off when we all know the bar had been set so low on earnings. And then I wondered how folks could ignore the top line.

I've many more thoughts related, but I'll control myself here.

HardToLove

On Jul 23 05:22 PM Old Trader wrote:

> thiazole,
>
> I'd like to propose a "cyber-wager", *s*. I haven't been keeping
> actual count, but I'd be willing to make the following wager: for
> every company that has thus reported that beats on the top line (increased
> sales), I give you a dollar. For every company that's reported a
> drop in sales, you give me a dollar. Fair enough?
>
> Once we get to the point where sales are at least flat....THEN we
> can start discussing "stop contracting".

Jul 23 07:00 PM

[Spartacuss:]

I am surprised that no one comments on the negative earnings on treasuries and CD's. So, what then are you to do with your dollars, well, buy equities of course especially when the Chinese stimulus was used to buy commodities and we all know that commodities lead a recovery.

That there are humungous negative incentives to investing right now is all to obvious, however the big funds and well to do's have to invest, they have to do something and following the herd is always in vogue. We may see still more euphoria, but I am not the one to stick my neck out any more than I have to since I am playing with my own money and not somebody elses.

I agree with this young author, this fall is going to be interesting.

Jul 23 10:27 PM

[Market Spec...:]

Naufal...I see you are still negative on the market. AAPL is slightly extended here making a new high on light volume, but looking at the weekly chart it is nothing but bullish. BIDU GOOG all very bullish and are big stock leadership.

Looking back at periods were the NASDAQ has made double digit consecutive positive days you see the index pause then move another 3-5% then correct back to roughly the 7-9th day of the consecutive day move...then base, then a big move higher.

There are other big boy LFT TNDM are setting up and Chinese Gamers NTES PWRD are leading this market.

Best of luck to you

Jul 26 09:58 AM

[Stephen Ros...:]

It's fascinating to see someone gain so many followers after being so consistently wrong.

Aug 03 01:33 PM