Further GME Momentum Makes Russell Outperform, But Now On Lookout For A Major Market Peak

Summary

• GME momentum higher will probably continue for some more days, even weeks. The Russell 2000 will continue to outperform in that case. Tech earnings season should see NDX100 do well.
• This GME saga is unlikely to morph into a Lehman style of market dislocation. More likely, some type of LCTM rescue/bail-out will be engineered by the Federal Reserve.
• Some of the short-selling hedge funds will disappear -- bankrupted or bought out (likely pennies on the dollar). When that happens, the GME rally/momentum will break.
• If a GME resolution happens within the next two weeks, it will coincide with the peak in global and domestic liquidity flows, and the subsequent, seasonal liquidity drought will weaken equities and long bond yields until late March at least, maybe even until June (we will reappraise as more liquidity data comes in).
• Global liquidity, especially that coming from China, is set to go sideways to lower until late 2021 at least. That will crimp the evolution of cryptos/bitcoin, which will probably end the year lower from the highs we have seen several weeks ago.

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This is the latest performance of PAM's One-Contract Portfolio, with a margin capital of $100,000, making the same trades as the flagship Swing Fund, but doing consistent, one contract-trades.

---------------------------------------------------------------------------------------- Here is the current status of the PAM flagship Swing Fund, which includes open and closed trades.

During the twelve months of 2020, PAM delivered phenomenal real-dollar Hedge Fund trading performance, the best at Seeking Alpha:

PAM's flagship Swing Portfolio, year-to-date (December 31, 2020) delivered $100, 181,522.77 net profit on $11,172,813 margin capital.

Year-to-date performance: 754.20%, on 888-98 win-loss trades.

December 2020 spreadsheet here:

Year to date 2020 spreadsheet here.

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WEEKEND MUSINGS:

JANUARY 30, 2021

robert.p.balanModeratorLeaderOwnerJan 30, 2021 3:39 PM

Regression of the Covariance of 10 Yr Yield, Russell 2000, GME, PLUG

With Yields rising, the Russell 2000 is the best choice to go long equities, if GME and PLUG resume their rise.

We believe the reason why yields are rising is because GME, PLUG (now composing the largest weightings in the Russell 2000) will likely continue to rise for a little longer, following the sharp rise in yields on Friday.

On the (much larger) rest of the equity universe, tech earnings season winds down February 2, and Amazon (NASDAQ:AMZN) should have very good/excellent numbers, and those bits and pieces could buoy equities as well -- more reason for yields to rise further.

The other ramifications of the GME saga may not be optimal for other indices (which may be sold to meet margin calls), but will provide an opportunity for Russell 2000 outperformance. The whippy end of the tech earnings season should also see Nasdaq 100 performing well. The Russell 2000 and Nasdaq 100 March 2021 futures contracts (RTYH1 and NQH1) are what we are buying Monday.

The "Masters of the Universe" not signaling immediate systemic risk

Also, I believe that yields are rising (see chart above) because the bond market and Primary Dealers are not seeing any Lehman Bros. event, but probably a Long-Term Capital Management (LTCM) style bail-out, but with no immediate systemic risks.

@RM13 observed that " the delta neutral positioning shows little stress, but once this month's inflows are in by about Feb 4-5th, the market is left to its own universe of seasonality. IRA inflows come in at the beginning of the month, are placed into the equity market . . . but all the big earnings are over; AMZN is done on Feb 2nd. We are left with seasonality, new administration jitters, COVID variants, and uncertainty of SEC oversight over GME and related shorts."

That is not to say that everything is in the clear. There are still good odds of the situation deteriorating if the Federal Reserve does not step in quickly. The prospects of that happening soon got a little murky when Fed Chair Jerome demurred when asked about the GME situation. But the Fed will be at the front and center of this titanic battle between David and Goliath before long.

The "revolution" will eat many of its children

And in the end, both the short sellers and the meme traders will be damaged by the time this amazing take down of the hedge funds get final resolution. Some of the short-sellers will disappear -- become bankrupt, or will be bought out. Sadly, many of the meme trader late-comers will be wiped out too. Many of the "WSB warriors" will make money (even life-changing minor fortunes), but the "revolution" will eat many of its children. That's how zero-sum games work.

It only takes one enterprising early-comer (probably another hedge fund, the WallStreetBet veterans, or why not BlackRock?) to yell "fire" and take profit, and there will be stampede towards the exits. Many of the naive late comers (the "cannon fodder" of the more savvy WSB "autists") will not get to see their paper profits -- many will be wiped out too. These "cannon fodders" will very likely be part of the exit strategy of the WSB masterminds.

As of Thursday, short interest has not moved at all that much, so the battle continues. The short sellers look to be digging in -- but the WallStreetBets meme traders look just as resolute. However, that nominal short interest data shown above may not be as useful in gauging the true extent of the hedge funds short exposure (and pain threshold). These headline short interest numbers are likely net delta flat to the in-the-money GEM call holders, and therefore won't be squeezed in any way.

The short-sellers are still not hurting enough, more joining the fray

There is therefore a possibility that these headline numbers are overstated, especially after short-holders are said to have degrossed when GME prices fell on Thursday after RobinHood and other brokers curtailed new longs on GME and other shorted stocks. Short open interest have declined by just 5 million shares over the last week, falling by 8%. Put another way, the short-sellers bought some time, and may still have a lot of fight left in them. There were also stories from mainstream media (NASDAQ:CNBC) that new hedge funds have joined the fray and are willing to bet against GME stock. It's turning into a class-warfare.

Nonetheless, we wonder how the short sellers can keep on playing (and paying margin calls); maybe their options are now severely limited as the cost to borrow GME stock had exploded as high as 200% , virtual death sentence for any hedge fund who plans to keep the GME short on for a long period of time. However, cost to borrow GME stock has moderated to 30% after the raid on XRT GME stock holdings (see chart below), when $700 million worth of 300,00 GME shares were pulled from the ETFs assets. The bad news to the short-sellers is that there a no more GME shares to raid.

The GME squeeze and momentum will likely continue

For all of there reasons, the GME squeeze and upwards momentum will likely continue --- but looks like any uptick in equities and yields from here is heading towards a period when a seasonal liquidity event may conspire with the current market instability to produce a sort of Minsky Moment. Market instability further exacerbated by liquidity drought is a very toxic combination.

The inter-connectivity of market sectors often lends to non-linear effects on asset prices. The unpredictable impact on asset price can be mind-boggling and frightening. I personally have seen an example of this non-linear process during the October 1987 panic when so-called "program trades" wreaked havoc on asset prices which these "algos" were supposed to protect. I saw prices of futures prices going in the opposite direction of the underlying equity baskets (indices), back and forth, forth and back, and the process looped several times before futures and their underlying indices synchronized (I described it in my Elliott Wave book).

It also does not help to read from history that every asset price mania since 1918 has led to a major market cash. Nonetheless, even if push comes to shove in this GME saga, it will not be the Fed's first rodeo. Over the past 40 years, the central banks has developed significant expertise in dealing with narrow market perturbations.

And most crucial of all, if everything else fails, the Fed will just throw a billion tons of dollars on the problem. And maybe that is why the "Masters of the Universe" are not batting an eyelash.

The GME perturbation may coincide with onset of global, seasonal liquidity drought

The bond market is still hewing to this template (see chart below), so it might just be a case of rising yields for a few days. If the Treasury Cash Balance (purple line) continues to turn lower, we could see an inflection point of flows by next week. The actual inflection of the nominal values/prices may come a few days later. That should lead to significantly lower yields and lower equities over the next several weeks, if we got this one right.

If we are going to go long, it would be on RTY, but then we cannot overstay. To which recommendation, Mr. TK had a sharp riposte -- "why don't we just wait to SELL?"

Why not indeed? However, I was thinking of a sharp relief rally in RTY to follow, and if that lasts for a few days, it could produce some significant gains. That goes true too for the whippy end of the tech season for NQ. I have NO fear of cataclysmic, falling-of-the-bottom event this week -- the situation is not still acute or dire enough. And there are still good prospects of squeezing good market performance during the last days of the tech earning season.

My "canary in the mine" is the long bond yield and the position taken by the Primary Dealers (the MOTUs) in governments and long duration Treasuries. So far, they are SELLING Treasury paper to anyone who wants them. Trust me -- these are the people who will know first if the market has TECHNICAL or OPERATIONAL reasons to crash. When they start hoarding government paper, and if the change rate in the transaction volumes fall sharply -- then look out below.

That said, going long equities from here (and selling Treasuries) of course requires a very nimble strategy in those trades. So, do we still want to go long equities, given the near-term outlook of sharply lower yields and equities?

We will do small scalpers, with long RTY, but with tightly controlled risk limits -- to mollify Mr. TK. That holds true for short Treasuries too.

Another thought -- the MOTUs could be very ingenious here and are setting up everyone, and pumping (the yield) up and then do the dump. More reason to be very careful.

Will be back tonight.

robert.p.balanModeratorLeaderOwnerJan 30, 2021 10:41 PM

There will be no contagion

What are the chances of an LCTM style bail-out of the GME short-sellers?

Market Insider reported that data provider Ortex suggested that short-sellers are sitting on on circa $19 billion plus losses as of Friday. In comparison, the Federal Reserve Bank of New York organized a bailout of $3.625 billion of LCTM by the major creditors to avoid a wider collapse in the financial markets.

It might be slightly different in the case of GME short sellers as there are only a few primary Hedge Fund actors, compared to the case of LCTM when practically all the large investment banks had exposures with LCTM.

Bond yields fell significantly during the days that negotiations were conducted for a possible buy out of LCTM by Goldman and Berkshire Hathaway for $250 million (LCTM was valued at $3.75 billion that January). The offer (given only one hour for accept-reject) lapsed. But yields have risen sharply after the bail-out became fait accompli.

That's why maybe yields have risen sharply Friday, even as equity indices were falling sharply because the bond market had already internalized the likely outcome of this (still) on-going) saga. There will be no contagion.

The S&P 500 also fell the days prior to the LTCM bailout, but recovered smartly, along with rising bond yields, in the weeks thereafter.

We are making distinctions here between the GME stuff, and the liquidity seasonality data which has underpinned PAM's good performance for January 2021, so far.

Despite the visible history of market players' blow-ups due to overleverage -- which seems to be the case with GME as well, shorting 113% of the company's total outstanding shares (aside from probably being illegal) -- the general markets seemed to have responded well to prescriptions of the Federal Reserve to solve similar situations before.

The primary actors, in this case the Hedge Funds which shorted the GME stock, will likely be damaged. But if history is prologue, this could just be a minor hiccup, and the market resumes its cadence thereafter.

What the GME revolution started, a liquidity drought may finish

Systemic liquidity seasonality is a different story altogether. The 2020 liquidity seasonality pattern has diverged greatly from historical, although after July last year, liquidity seasonality has started to hew again to the old historical cadence.

That's why the rise in yields on Friday was so significant to us. The bond Primary Dealers (which we call "Master of the Universe" -- MOTUs) seem to signal that the likely prescriptions to prevent market contagion, will succeed in doing so. If that is the case, then we can go back to dealing with the market vs liquidity relationship -- something that we understand very well.

One sign that the MOTUs (and the bond market as a whole) are/were not concerned is manifested in this chart which I have shown earlier.

Transactions in government paper/long duration declined, even as PD Treasury positioning fell last week.

JANUARY 31, 2021

Rising yields due to TCB seasonality has a counterpart in the equity universe. We have noted a few times at PAM reports that TCB seasonality has a great influence on the changes in long-term bond yields. Equities movements are more complex, as changes in this universe are impacted by the changes in all three major sources of systemic liquidity: SOMA Transactions (the Fed's Balance Sheet, Bank Reserves (BRS), and the Treasury Cash Balance (TCB).

The individual seasonality of these three liquidity sources do not sync, so the analytical challenge is to find the commonality of their flows signatures. We do that "nesting" process to look for the optimal (averaged) liquidity inflection point, assuming that the corresponding inflection points of changes in equities will match. These optimized liquidity points do not always coincide with the inflection points of equities, but coincidence happens often enough to make this analytical approach very viable.

For instance, juxtaposition of the the (adjusted) seasonality of SOMA Transactions, Bank Reserves, and the TCB vs the seasonality of the S&P 500 Index provides several actionable information:

The liquidity flows have bottomed several days ago, and the SPX change rate and nominal value are catching up, on a lagged basis. Note the behavior of the SPX change rate, as it is the link of the nominal SPX share price to the liquidity flows, e.g., flows to flows, making comparison mathematically viable.

This aggregated approach provide the same information provided by the TCB versus 10yr yield construct --- further equity and yield rallies for the next 5 to 10 trading days, and then a larger decline in both equities, and long-term, bond yields. The bottom of this projected large decline is 37 to 42 trading days from Monday, February 1, 2020.

Will the market perform per liquidity seasonality this time? This is a question that needed to be asked because there was a period between the COVID-19 Quantitative Easing in March and until late September, when 2020 liquidity flows totally de-linked from their respective historical seasonality.

Here is an illustration, using the difference between historical TCB seasonal patterns and that which prevailed from January 2020 until today.

However, if we re-scale the current 2020-2021 TCB to the Y-axis of historical TCB, this is what we get --- changes in TCB and hewing once again to historical seasonality changes.

We have removed from the yield the front run of the "Master of the Universe" (MOTUs) which happens when the bond market's Primary Dealers (who understand the impact of liquidity on bond yields) try to get ahead of other market participants when close to historical seasonality inflection points.

The information from this purely TCB-based simple model conforms to the same information which we get from an aggregated analysis of the impact of the Fed's Balance Sheet, Bank Reserves, and the 2020-2021 TCB flows changes -- yield rallies for the next 5 to 10 trading days, and then a larger decline in long-term, bond yields. The bottom of this projected large yield decline is 37 to 42 trading days from Monday, February 1, 2020.

Will complete the Musings tonight. See u then.

robert.p.balanModeratorLeaderOwnerJan 31, 2021 10:05 PM

Other constructs also show that the markets are very vulnerable, short-term

There is another model which we have shown, on and off in PAM reports -- and that is the convergence of the changes in cryptos, metals, and equities during certain critical liquidity inflections points.

This is the model which we have been showing for a number of years now (I believe I first showed it to PAM members in July 2018). The chart above shows an aggregate global liquidity model. But earlier this year, I realized that liquidity from China is driving the model shown above.

And if we are to juxtapose the liquidity being produced by China shadow banking -- the Quasi Money Supply -- then we could see its interesting parallels with crypo/bitcoin price development. Quasi Money Supply stems from the country's Total Social Financing program.

This is where it gets more interesting. Total Social Financing is the real-time funding of the Five-Year Government (Budgeted) Expenditures approved/reaffirmed by the Communist Party plenum in December every year. This to me is looking like the Big Kahuna of cryptos/bitcoin funding source, or at least, the template.

(Sorry, this chart is for PAM members only)

In which case then, a consolidation period in crypto/bitcoin could last at least until May, this year.

Finally, global liquidity flows from the balance sheet of G5 central banks (Federal Reserve, ECB, BoJ, PBoC and SNB) have been severely cut nine months ago -- and the lagged impact of that liquidity outflow will soon manifest in the financial markets (see chart below).

If the implications of the liquidity outflows on asset prices will manifest again, risk asset prices should be on a downtrend until May, under this construct. And the magnitude of the pullback could be quite large (see chart above).

*SUMMARY:*

1. The GME momentum higher will probably continue for some more days, even weeks. The Russell 2000 will continue to outperform in that case.

2. I don't believe this GME story will morph into a Lehman style of market dislocation. Maybe some type of LCTM rescue/bail-out will be engineered by the Federal Reserve,

3. Some of the short-selling hedge funds will disappear -- bankrupted or bought out (likely pennies on the dollar). When that happens, the GME rally/momentum will break.

4. It is inevitable -- there will be a stampede to get out of long GME trades when that happens (or even before, once the Fed has laid out a viable rescue plan). Many of the naive, late comers to the GME party will be wiped out as well.

5. If that resolution happens within the next two weeks, it will coincide with the peak in liquidity flows, and the subsequent, seasonal liquidity drought will weaken equities and long bond yields until late March (we will reappraise as more liquidity data comes in).

6. Global liquidity, especially that coming from China, is set to go sideways to lower until late 2021 at least. That will crimp the evolution of cryptos/bitcoin, which will probably end the year lower from the highs we have seen several weeks ago.

Thanks for your patience. It has been the first sunny weekend for some weeks, so can't help go and bask in the sun.

I will see you in Asian open Monday.