Update To Short (Bearish) Outlook

Includes: QQQ, SPY, VXX
by: Market Scholar

Price has been inarguably bullish lately, and those taking any sort of bearish position, as I have, have certainly taken some pain. Personally, I am still holding puts on the S&P 500 (NYSEARCA:SPY), other US indices and individual equities. I have added to my puts on this most recent move up, but won't be doing too much further (I need to focus on a final exam, and I am not comfortable with any further risk). Despite the recent bullishness in price action, I still think there are very important reasons to remain cautious.


The first cycle is the seasonal one. Yes it is widely acknowledged, but it has proven to be true for over a century, and notably so in recent years. I will also add that QE was in place over the recent summers as well, and QE failed to overcome seasonality then. There's a reason why travel is cheaper to the tropics during hurricane season. That reason is: it is hurricane season (yes this is obvious, but needs to be stated). There are no guarantees - September in the Caribbean could be great - but I definitely would not be paying full price to go then.

Second is the presidential cycle. Year one is historically not a strong one, and that is where we currently find ourselves. Again, this is not just a recent phenomena, but one that has been well documented over the last century.

Third and finally, is the fact that we are still in a secular bear market (or winter in the Kondratieff cycle). Some have argued that we are now in a secular bull market; I do not understand how that can be the case. Real (inflation-adjusted) prices are still well off the highs set in 2000. Further, nominal prices in the Nasdaq (NASDAQ:QQQ) are also well off the highs. These two facts inexplicably suggest that were are still in a secular bear market.

None of these cycles are precise, but seldom do the three all line up at once. (Please see my previous article for more info on these). Most literature regarding cycles suggest that when multiple cycles line up, the resulting effect is compounded.

Macro Economic (Charts)

The first chart presented shows that the S&P is beginning to appear parabolic in my opinion. Just about everything and everyone seems to be bullish, and rightfully so; price action has been strong. One is likely better served waiting for a sign for a correction prior to getting short, and that may indeed prove to be my biggest mistake. But I think the parabolic nature of price action lately is worth noting. It seems like complacency is setting in. But as we all know, complacency can continue for some time: a consideration at the least. I will note that the chart could still get much more parabolic, and accordingly I could be very early. That being said, parabolic moves never end well, and those who bought Apple (NASDAQ:AAPL), Gold (GLD) or Silver (NYSEARCA:SLV) in the last few years can attest to that.

Second is the Ted-Spread. Crosses above the 150 day moving average from below have been rather precise in indicating corrections in the past. For those unfamiliar, the Ted-Spread is a measure of risk, and typically only receives attention after some sort of crises or correction is taking place. Like anything else, it is not perfect, but every cross above the 150 day SMA has led to near term sideways price action at best in the last 5 years (crosses are joined by vertical blue lines to the S&P 500 below).

Third is the VIX (NYSEARCA:VXX). It still appears that volatility is trending up lately despite the most recent market rally. Rising volatility and rising prices historically is not a good combination. Some have recently argued that this is actually a bullish development, which arguably has been so over the last 6 months. Longer term however this is not the case, but like many things, it is not definite. At this point I believe the longer term relationship will hold.

Fourth is margin. Margin debt has reached extreme levels again. There is a plethora of sentiment indicators to gauge, and none are accurate on their own. Margin debt has proven to be reliable however, so it should be worthy of a consideration. The current levels have previously corresponded with major market tops.

Source: here

The final chart is on bond volatility. The main bullish argument to date has been that you cannot fight the Fed. This is a strong argument, and one that has held to date. But again I remind readers that it is the same argument made in the late 90s, and that it works until it doesn't. Things could end in a similar manner to then, could be less extreme, or as history would suggest, potentially could even be more extreme.

Below is the MOVE index. It is an indicator of US bond volatility. Record low readings, the same of which were experienced in 1998 and 2006-2007, suggest that investors may be overly confident in the Fed's ability to prop up the market. Basically, investors are putting the same kind of faith in Bernanke as they did in Greenspan (QE versus the Greenspan put).

Source: here

One may note that the lows have preceded major market tops by some time, and accordingly I am early to be purchasing puts. This is an important consideration. However, the July 1998 extreme low in the MOVE index was followed by a 15% single month correction in the S&P - this following a six month rally that saw a gain of 17%. Six months gains were almost wiped out in one month. Prices recovered after this correction, but corrected down to this level again in 2001, and even lower from 2002 - 2003. Again, like many other economic relationships, it alone does not suggest any action. But in combination with other mentioned factors, I think it suggest buying puts may be a better idea than further long equity positions at this juncture.


Many of my initial reasons for getting bearish have been erased. Further, 4/5 things that I noted would challenge my shorter term bearish outlook occurred. As of writing this article, I have been proven wrong.

Perhaps I am betting on some sort of black swan event occurring, but I think there is still a lot of systemic risk in the world, and it wouldn't take much to derail the recent price action. Systemic risk has re-emerged every summer in spectacular fashion lately, and I don't see any reason for this summer to be different. I could easily write a 10,000 word essay about potential catalysts and still not cover them all. Accordingly, I still believe buying puts (September) to be a worthy consideration. One seldom buys insurance before they need it, and insurance is typically much more expensive after the storm than before it. I don't know what the black swan will be, or if one will indeed emerge, but everything I read seems to suggest one is likely.

On my previous articles many were quick to dismiss my arguments, and even more have done so recently. My initial reasoning for being short proved to be quite accurate, but also quite short lived. I am unequivocally wrong on my current position, but this position is for the summer. I have the ability to take short term profits (and losses), and this is not the case for everyone.

Consider what these cycles mean and what these charts actually represent. You don't have to agree with my outlook. I suspect most won't. But all of these cycles and charts are not obscure or irrelevant, they have proven to be reliable in the past, and at the least should be considered. They all illustrate very important economic relationships and have very real implications

Trading and investing is inherently difficult. I am sure many are familiar with the low success rates. I am not suggesting I have any unique abilities. This is simply the product of my research and studies to date.

Also I suggest readers consider that I am not an expert, but a student of the markets, and still have much to learn. Please seek further financial advice prior to making any investment decisions.

Brennan Basnicki

Disclosure: I am short SPY, FXA. 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.

Additional disclosure: I am short other US indices and individual equities. I also have a select few long positions in individual equities. My time frame is often short and my positions change frequently.