As You Were

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Includes: DIA, IWM, QQQ, SPY
by: Orange Peel Investments

Summary

Markets are set to rally on Brexit on Thursday.

But after Brexit, where will the market head?

We think shorting this rally is the correct approach.

By Parke Shall

We do not doubt that the results of today's referendum in Britain will see Britain staying within the European Union. While oddsmakers have seen their odds for a "remain" vote scorch as high as 85% overnight, voting polls have only tipped in favor of "remain" by a slight margin. Apparently, this is enough to send equity futures into a frenzy.

(source: CNBC)

Much of the narrative yesterday was situated around the fact that once Britons got into the voting booth, like many other voters, they would become conservative and stick with the status quo. This is generally the case in most elections. Depending on voter turnout and sentiment, most voters are expected to take the "conservative" route once they get into the actual voting booth.

It is for these reasons that it looks like equity futures have decided to rally and the US indices look like they will open up in very positive territory.

We will have a good grasp on the results tonight at around 10PM, heading into about midnight eastern time. Heck, we think the market may even have another big rally day in it tomorrow on the very same news.

But we're also skeptical and think today's rally should be sold. We think that this rally, like many in days past, can easily peter out and deflate by the end of the day. 8 hours is a long trading session and more than enough time for sentiment to change.

Assuming that the vote count doesn't offer us any surprises, which we don't think it will, what is the next play for US equity portfolios after this week? Is it time to press all bets and bet on another bull market as a result of this news, or is it time to go out and short this pop like many have been doing with pops of recent?

Those that have been reading this for a while probably find it no surprise that we believe it is pertinent to go out and short this pop.

We believe there is going to be euphoria for a couple days surrounding the vote, but then as the dust settles and people start to look around, investors are going to start to ask themselves "what do we do now?

The answer, we think, is to continue with the same line of thinking that we have had leading into this mode. The markets have really only been volatile regarding this vote for a couple of weeks now. When the results of this vote are over, everything will be basically exactly the same as it was prior to this becoming a news event.

The Markets Prior to Brexit Panic/Euphoria

Let us reminder you where we were three weeks ago before everybody was panicking over this boat. We told investors to short to US consumer.

In this recent article we came out and made the following arguments,

  • It is a frightening time to be just long the markets, we would not be buying if we were a long only fund here. Because we are a long/short fund, we are making sure our short book is exposed to consumer credit in the form of companies like SYF and Bank of Internet (BOFI).
  • We have long been writing that we believe the market is reaching a top. We believe that a seven or eight year debt cycle is about to turn over and we have warned against being in any type of high-yield corporate paper or any ETFs or stocks that could be affected by the same. Today we want to zoom in our focus slightly and reiterate that we believe it is a great time to go out and short the US consumer.
  • If you do not want to go out and short the consumer via these methods, you can also just simply go out and take a couple of retail names that you think will be negatively affected by a credit bubble burst, short them, and look to add to any of your core long positions that you were holding over the course of the long term at the same time.

For those that have been reading us over the last six months, you know that we still expect a 10% to 15% correction in all of our indices over the course of the next 6 to 12 months. We have-based that on several factors.

First, we are starting to see bubbles in areas like high-yield corporate bonds and the auto financing market. We have suggested that these bubbles, which are relatively tiny compared to 2008, do you need to burst a little bit and "let the air out of the tire".

Mohamed El-Erian nailed it last week,

"The collateral damage and unintended consequences of this prolonged experiment with very low interest rates [and] very big balance sheets are starting to have a meaningful [negative] effect on the economy," El-Erian told CNBC's "Squawk Box."

Without a clear idea for the future of growth, the Fed has become "overly data-dependent," El-Erian said, arguing that such an approach has been sending "conflicting signals over time."

As we stated earlier this week, "We also noted that the Federal Reserve's indecisiveness could be cause for a much bigger correction, as the Fed has clearly dropped the ball on its responsibility to maintain interest rates in conjunction with the health of the overall market. Instead of being clinical and raising rates according to their schedule, the Fed remains spineless and unable to put even the slightest bit of pressure on equity markets for fear of backlash from the public and their constituency."

The Federal Reserve and its horrendous policy making should be the main concern of U.S. investors the second the Brexit vote results are announced.

We think it will obviously be a "sell the news" event.

In previous articles, we have argued that this inaction may turn out to be gross negligence when we look at it years in the future. We believe that failing to raise rates when it was appropriate to do so is going to lead to a much larger bubble that the Federal Reserve is going to be wholly responsible for. We have often asked the question of what would happen when quantitative eating simply doesn't work and the public loses confidence in the entire game.

As You Were

So what comes after the Brexit vote?

We think life returns to "normal", where the only real problems on the lap of U.S. investors remain the Fed and the run up of high yield debt. Again, we think today's push in the futures will once again help the market tap its all time highs, but that there's far more room to head lower than there is to head higher at this point.

^SPX Chart

^SPX data by YCharts

With the rest of the globe embracing negative interest rates, we don't think that we are that far off from a situation like this happening. What we predict will happen is that we will see a bunch of smaller bubbles burst here in the US first, we will see volatility from the upcoming election, we will see employment macroeconomic data not get better from here, and we continue to see all the recipes for a 10% to 15% correction in the overall markets.

So, post-Brexit vote, "as you were".

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.