THE BIG OFF: When will the music stop?

If you’re a trader in the Bear camp like me then you are probably perplexed each day watching the strength of this current market rally and wondering what will it take for investors to see what you see in order to propagate a shift in market direction ending this rally.

Jeffrey Gundlach, CEO of DoubleLine and known as The Bond King “I’m certainly in the camp that we are not out of the woods. I think a retest of the low is very plausible,” Gundlach said on CNBC’s Halftime Report, “I think we’d take out the low.”

“People don’t understand the magnitude of … the social unease at least that’s going to happen when … 26 million-plus people have lost their job,” Gundlach said. “We’ve lost every single job that we created since the bottom in 2009.”

In the 17 years that I have been a derivatives expert I have learned that when people start talking about how this time it’s different, it’s time to get worried.

I laughed at the time, when back in March, Citi’s Head of Equity Trading Strategy Alexander Altmann had estimated that the S&P 500 (SPX) could get to 2700 in the current upward swing and we’re now knocking on the door of 2900.  This 2700 SPX value represented about 5500 for the ASX 200 (XJO). So, you can see from Wednesday’s XJO value of around 5350, we’ve not yet tested the limit as much as our US counterparts, but something has got to give.

To add to the ambiguous market direction, analysts from UBS, Citi, Bell Potter and RBC have been busy outputting Buy Hold Sell recommendations which I believe has misled a lot of investors into thinking it’s safe to go back in the water when in reality there’s a big shark still lurking out there. Most of these valuations are based on pre-existing valuation models with the addition of a best guess adjustment factor loosely based on GFC shocks.

On top of this, financial news platforms are peppered with articles alluding to the fact everything will return to normal once we are out of lockdown with plenty of talk about coming out “the other side”, whilst realistic analysis of the dire economic outlook is hard to find. As a trader I am seeing truckloads of sugar-coated articles from mainstream media through to financial news outlets such as CNBC, Bloomberg et al glossing over jobless rates and other key economic indicators opting to celebrate overnight market rallies in the USA.

Compounding this delayed market shift are irresponsible marketing terms such as “Economic Hibernation”, the concept of pushing out an economic timebomb, blaring the music louder in the hopes we don’t hear the tick-tick-boom.

This topic of media sentiment & its choice of words remains a key factor that is keeping the music playing within the 5000-5500 trading range for now. Investors are trading off headlines focused on reduced infection rates and reduced death rates whilst forgetting this only ends with the existence of a vaccine or with the majority of the national population being infected: herd immunity. Both of these scenarios will take a long time to play out beyond what popular opinion in the media is illustrating.

Going back to a catalyst for this current market rally to end as the big question we all ask; and while likely none of us will be able to answer, it is in fact often the search of this very question that triggers a domino-effect decline. History has proven ‘The Big Offs’ arise from seemingly nowhere and whilst most people will be looking to Unemployment, PMI and Commodity Prices as catalysts it is normally something obscure like a large scale shift out of an asset class that can’t be explained which is then construed as someone “knowing something” triggering an almighty shift.

Humankind has a long-time obsession in searching for the truth and absolutes with the numbers-driven world of economics being no exception. Unearthing catalysts for a shift in market direction in an attempt to get ahead of the game often prove fruitless and as historical downturns have proven, those who are agile and poised to attack are those who will triumph and importantly, endure this phase of the economic cycle.

What I am looking for is not so much a catalyst but being ready to get a jump on a direction change. As an Options trader for now it is important to avoid direction-based short strategies unless you are hedging. Watch out for unusual market activity that can’t be explained, this can often be an indicator of changing sentiment. Take advantage of volatility to position yourself for a potential change in direction. It is unlikely markets will trade sideways much longer so keep your strategies flexible thereby being positioned to capitalise on both sides of the market direction, and you’re ready for anything.

NATHAN GERMAINE
DIRECTOR, EQUITY FUNDS PTY LTD

Please note this is General Advice only and doesn’t take into consideration your personal circumstances, objectives, financial situation or needs.

This article is provided by Nathan Germaine, Director of Equity Funds Pty Ltd. The views and opinions expressed in this article are those of the author and do not necessarily reflect the views and opinions of Reach Markets.

Trading options is not suitable for everyone. There is a risk that you can lose more than the value of a trade or its underlying assets. You should only trade if you are confident that you fully understand what you are doing. If you are thinking about acquiring a financial product, you should consult our Financial Services Guide (FSG) at www.reachmarkets.com.au.

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