FREE ACCESS, Trade Ideas February 19, 2020

Pride Goeth Before the Fall – SPY

by Dan

The S&P 500 (SPX) is trading at new all-time highs as I write, up 5% on the year and up 5.5% from the late January panic about the potential adverse effects of the coronavirus then just in China. Since breaking out to new all-time highs in late October, the SPX is up 12% in what feels like a straight line:

 

It is worth noting that the Equal-Weight S&P 500 index (SPW) is actually down 34 bps today on a day that the SPX is up 60 bps and is only up 2% on the year. We know why, MAGA, not that one but the nearly $5 trillion in market cap in just four stocks, or 17% of the SPX…  MSFT up 19% ytd, AAPL p 10% ytd, GOOGL up 14% ytd and AMZN up 18% ytd.

There is no fear in this market, with little to no new information about the spread of coronavirus investors feel emboldened that there will be some sort of V reversal in demand when the quarantines in China end and the world’s factory is back open for business.

ICYMI, In between pardoning the swamp, president trump is doing a victory lap about the U.S. stock market’s performance:

While it is hard not to be excited about a strong stock market at new highs, I guess I would feel a bit more comfortable if I wasn’t seeing (to quote another President) “some weird shit” out there.

First things first, Tesla (TSLA). Last spring, the word on the stock was that the company’s liquidity was poor and getting poorer and that the CEO’s tweeting habit had him in a tight spot with the Feds. Less than a year later, the stock is up 400% from its 2019 lows, up 118% on the year and sporting a market cap near $170 billion that is more than 2x that of General Motors (GM) and Ford (F):

 

I have seen this movie, I know how it ends, this will be a widow-maker. Good-Luck! (Taken Guy voice).

The complacency by investors in U.S. stocks is clearly a function of a flight to quality, low-interest rates, an accommodative Fed and corporate America that has, for the most part, behaved of late (balance sheets are in good order despite a predisposition to buy back their own stock as opposed to pursuing capex).

But there are no shortage of warning signs in my opinion in financial markets. First and foremost, long-term interest rates are once again in a race to zero, with the 10-yr U.S. Treasury Yield flirting with the supposed “generational lows of 2012 and 2016” I suspect alarm bells will go off when we see it break 1.32% on its way to sub 1%:

And what’s informing this opinion, long term interest rates on their way to zero is not exactly a great endorsement to own stocks at all-time highs, when the last year’s nearly 30% gain was almost entirely the result of multiple expansion, because its not just lower rates that are screaming of the coming growth scare… but its also, gold (making new 7 year highs), bitcoin (up 42% ytd) and freaking utility stocks which have gone parabolic this year, up 10%, the same as the Nasdaq Composite!

 

The U.S. Dollar, you know old king dollar, the thing that our central banks say they want strong, but they really don’t. The thing they hope that falls when they have an accommodative interest rate policy, but won’t say it out loud. Well its making new 52-week highs today, and that is not exactly what the Dr. ordered for this level of accommodation at this stage of the game… another flight to quality, but why?

It is also noteworthy that the VIX, the CBOE S&P 500 Volatility Index, plotted vs the SPX over the last year has usually seen 12% when SPX is making new highs, this time around, it’s being a tad stubborn at 14.55% at a new high… is the smart money worried??

 

As you would expect, this is reflected in the prices of short-dated SPY options, the etf that tracks the SPX, with 30-day at the money implied volatility (blue line below) at 11.5%, well above the 52-week low made in Nov just below 9%. But its worth noting that the white line below, realized volatility, how much the SPY has been moving is actually slightly above implieds, making SPY options look fairly priced for those looking to express directional views:

 

SO what’s the trade? If you look at the Twitter feed of the POTUS he appears to display a great deal of pride about many bad things… It reminds me a bit of what I deem to be some downright nasty things going on in risk assets and the pride that our politicians, central bankers, and market cheerleaders revel in as a result. If you subscribe to the really old saying Pride Goeth Before the Fall, then you might want to consider portfolio protection in the SPY.

 

Bearish Trade Idea: SPY ($338.50) Buy March 31st quarterly 332 put for $3.50

Break-even on March 31st:

Profits below 328.50

Losses of up to 3.50 between 328.50 and 332 with max loss of 3.50 above 332

Rationale: this trade idea breaks-even down 3% and only risks 1% of the ETF price for nearly a month and a half.