Archives February 2021

Founder's Trading Journal

Waiting for the Last Dance

AF Thornton 0 Comment

The chart above is a good visual reference of our current market state. The top half shows the S&P 500 index’s current distance from the 200-day Simple Moving Average. The bottom chart shows the CBOE Put/Call ratio and its distance from where the market typically ends an intermediate correction. The two graphs move in opposition to each other.

Since my strategy and algorithms are based on mean regression, consider the 200-day line to be the “intermediate” mean. We are a dangerous distance from that line. At a 26% distance, this is more than we have experienced in a long, long time. Mean regression is like a rubber band. Stretched too far, price snaps back with a sting. The sting is proportional to the leverage involved. Suffice it to say, the leverage right now is unprecedented, and the rubber band is due to snap back soon.

Confirming that possibility, the bottom half of the chart is the CBOE Put/Call ratio. The indicator measures the sentiment of retail traders – the crowd that tends to arrive near market peaks. The lower the ratio, the higher the complacency. The ratio has reached the lowest level in my 34-year career. In short, the indicator shows too much bullishness – close to a long-term record.

In other words, excessive optimism is pervasive among retail (not to mention institutional) investors. We only see this near market tops. There is little to no fear in the market, and yet it keeps falling to record lows. As Ben Franklin once said, you want to buy on the canons and sell on the trumpets. The trumpets are blaring – but the question is for how much longer? That is not an easy question to answer.

There are titans in this business. One of those titans, Jeremy Grantham, is In the same league as Warren Buffet or Sir John Templeton. Mr. Grantham is an understated but legendary investor. Born in 1938, he will turn 83 this year. I will be lucky to live that long, much less have his perspective. 

Mr. Grantham is a British investor. He is co-founder and chief investment strategist of Grantham, Mayo, & Van Otterloo (GMO), a Boston-based asset management firm. GMO had more than US $64 billion in assets under management as of October 2020. Mr. Grantham is regarded as a highly knowledgeable investor in various stock, bond, and commodity markets and is particularly noted for predicting various bubbles. He has been a vocal critic of different governmental responses to the Global Financial Crisis from 2007 to 2010. Mr. Grantham started one of the world’s first index funds in the early 1970s. In 2011 he was included in the 50 Most Influential ranking of Bloomberg Markets magazine.

Every once in a while, I will read something that crystallizes my thinking. There is no point in rewriting or paraphrasing. I could not improve it. Tonight, I would like to share just such an article. “Waiting for the Last Dance,” written by Jeremy Grantham at the end of January. The report is a simple yet powerful presentation of the dilemma before us. Enjoy the read. It is not long.

I will put out the outlook in the morning, as I don’t want to dilute Mr. Grantham’s impact.

A.F. Thornton

Founder's Trading Journal

Diamonds are Forever

AF Thornton 0 Comment

As proof positive that I am here in my office playing computer games and enjoying my coloring books, my latest rendering above is a diamond formation using half-day candles (195-minute) on the S&P 500 index. As the wife says, “if the shoe fits.”

But honestly, there is such a formation in the markets, and it typically occurs at a top. The “diamond formation” words above are linked to the Investopedia technical definition for those interested in the details. For now, realize that the breakdown of the formation leads to a measured move down from the corner of the formation equal to the distance from the top to the bottom of the middle of the diamond. We would look for evidence to reenter around that measured distance.

In our current case, the distance is 50 points. Since we are cornered around 3900, we would look for bottoming action around 3850. The market still must confirm it is grounding there for us to reenter, because the 50 point move is the minimum to be expected.

So why do these patterns develop, giving us such predictable consequences? I am not sure we will ever know the precise answer to that question. I suspect it is because we are all playing the same computer game. Perhaps it then becomes a self-fulfilling prophecy.

Given the pattern and its connotation that the market is balanced between bull and bear forces until the design breaks, I view the key references today as go/no-go triggers. Use the 3928.50 all-time high as the upper reference point to negate the pattern entirely. 

Use the 3909 settlement (close) as neutral. Incidentally, the S&P 500 futures have settled at that same 3909 close for four sessions in a row. I have never seen that before. The “settlement” at the futures pit in Chicago is considered the final “closing price.” The price can vary slightly from the print close you see on your quote service.

A violation of the balance area low at 3878.50 would indicate that the pattern is on its way to completing the top formation. That would leave the projected mark low at 3850 as a target. 

The volume point of control sits just above that at 3855.25. I will be using the 5-minute chart at those levels to look for bottoming evidence. Exploration below 3850 connotes more ominous behavior – so be careful. The cyclical pull here is not strong – so we should pass through this mid-month low without a bloodbath. That is my best guess.

If the diamond discussion is all for not because the music is still blasting at this party, the curfew sits around the upper channel line and Weekly Expected Move high at 3950. Given all of that, the trade I am looking for is likely to develop later rather than earlier in today’s session.

The intermediate, swing-trading Navigator model is 100% in cash. It may throw some buy signals at the 3850 targets. We shall see but stay alert.

A.F. Thornton

Founder's Trading Journal

Stalling the Plane

AF Thornton 0 Comment

As a young child, my father bought several airplanes to lease out to the flight school at the old Freeway Airport in Tucson, Arizona. When you are a kid, flying in your own small plane can be quite a thrill – except when a commercial jet is landing behind you.

Freeway Airport Circa 1966, Tucson, Arizona

Of all his planes, my favorite was a “V” tailed Beechcraft Bonanza. Again, when you are only 8-years-old, the “V” tail is cool – and different from the other planes. Always the curious cat, I wanted to know how this worked and why it was different. In fact, I wanted to know everything about the plane, flying, etc., and my father often gave me the steering wheel to fly. It was not as easy as it looked, and I had to learn to give it a light touch. Just like the markets, it is easy to oversteer.

Beechcraft Bonanza “V” Tail

I enjoyed flying but never pursued it as an adult. Let’s say I know myself too well. I am an absent-minded professor.  I spend too much time in my head. Indeed, I would be the one you read about in the papers who forgot to put the gear down before landing the plane.

Instrument Panel

I often say that flying an airplane on instruments is one of the best analogies I know to the skills necessary to successfully navigate the markets. You learn to trust your instruments. When flying In bad weather, you cannot always see the ground. Many a plane has been plowed into the side of a hill when a pilot trusted her “gut” instead of her instruments. We did not have GPS in those days.

When my father used to let me fly the plane, he often told me not to pull back too hard on the wheel. He would explain that if the plane went up too fast at too steep an angle, it would stall. After a stall. and absent the skills of an experienced pilot, the plane could end up spiraling straight down. 

I have applied this aerodynamics lesson many times to the markets – as the principle is much the same. As an example, take a look at the chart of the NASDAQ 100 below from the start of this bull market in 2009:

NASDAQ 100 Index – 2009 to Date

If that were the flight path of an airplane on a radar screen, guess what happens next? There are no guarantees in navigating the markets, but I consider myself a skilled pilot. And even if I landed the plane we find ourselves in now with the gear up, it would still be a lot better than trying to pull the plane out of a spiral after the stall.

So if I seem a bit cautious of late, hopefully, you can see that there is a method to my madness. There is nothing normal about the current situation – and we are living on borrowed time. At some point, we will have to pay the piper. Incidentally, the Piper Comanche was my second favorite plane. I wonder if the social justice warriors will require a name change?

Today's Plan

The liquidation break I had been expecting the last few days finally came and went yesterday. It was a 40-point air pocket in the S&P 500 futures – not a pleasant ride unless you are short. Interestingly, the market tested above Tuesday’s high and then below last Thursday and Friday’s lows – but landed smack dab in the middle by the close.

Chart Below is a Carve Out from First Chart Above (The dark blue candle is yesterday and the light blue candle that follows is the overnight action so far today):

As I have often communicated, liquidation breaks strengthen the market, as the poorly positioned longs and weak hands are eradicated, at least in the short-term. But the exploration above and below recent highs and lows typically gives us scant clues about what the market wants to do next.  This morning’s level is not a great position to establish longs either, unless you are willing to be super attentive.

Moreover, this particular leg of the rally rose on diminishing volume, except for yesterday.

Chart Below is a Carve out from First Chart Above (Note the diminishing volume on each daily candle until yesterday, when volume spiked):

So, as Joe Biden’s new press secretary often drones, “circling back” to my airplane analogy, the volume spike on the outside day yesterday is another sign of “stalling.” We often see this kind of candle behavior and volume spike near short-term peaks and troughs.

Having said that, the red line on the charts is the 5-day Exponential Moving Average, and it is providing support for now. That will be a key line in the sand if you are still in the markets. As has been the case recently, we handed the ball to the bears yesterday and overnight, but they keep fumbling. The bulls have the ball for now.

We grabbed some timely profits yesterday on half of our XLF and XLE positions. So we still have a small exposure to the markets (a leveraged 3% in calls).

The trigger for consternation yesterday may have been the inflation numbers. Both the consumer and wholesale inflation numbers were tame and less than consensus estimates. We will be tracking these numbers closely for the foreseeable future as the deflation/inflation debate is a key theme for our near-term sector allocations.

Consumer Price Index

The US’s annual inflation rate was steady at 1.4% in January, the same as in December, and slightly below market forecasts of 1.5%. From an annual perspective, central upward pressure came from food prices (3.8%), used cars and trucks (10%), utility gas service (4.3%), medical care services (2.9%), shelter (1.6%), electricity (1.5%) and new vehicles (1.4%). Meanwhile, apparel prices fell 2.5%, and energy costs went down 3.6%, mainly due to gasoline (-8.6%). 

On a monthly basis, consumer prices went up 0.3%, in line with forecasts and following a downwardly revised 0.2% rise in December driven by a 7.4% rise in gasoline cost. The indexes for electricity and natural gas declined, but the energy index rose 3.5%. Food prices rose slightly by 0.1% as an advance in the index for food away from home more than offset a decline in the index for food at home.

With deflation still a considerable risk in a potential collapse of the gargantuan debt bubble at hand, markets would like to see inflation pick up. Given the rise in oil and commodity prices of late, I don’t think the financial markets will be disappointed with the February numbers published in March.

As price value and the settlement on the S&P 500 futures contract have been virtually unchanged for the last three sessions, there is little impetus to react strongly one way or the other at the open. I will trade from the basic framework that while the market is still overbought in the short term, there has been some corrective activity (a liquidation break) that might strengthen it as it goes. I am cautiously bullish unless price finds acceptance in the lower single prints, paying close attention to where value develops.

My approach always is to follow the market as it tests the overnight highs and lows and yesterday’s highs and lows to see where it grips. References above are yesterday’s high (also the all-time high) of 3928.50, settlement over the last three sessions at 3908.75, the top of the single prints at 3889.75, and yesterday’s low (also the bottom of the single prints) at 3878.50. The references to untouched POC’s and the top of Gap in the previous two morning outlooks should also be carried forward.

The bulls still have the ball, and my best guess is that they have one more small push to the top channel line visible in the first chart above before the mid-month cycle low draws us down.

A.F. Thornton

Founder's Trading Journal

Cutting XLF and XLE Positions in Half

AF Thornton 0 Comment

The liquidation break I had been expecting has arrived, and while the XLF and XLE are bucking the trend, I want to take profits on half of each position as we approach the old swing highs here.

When approaching an old swing high, there is no guarantee we will punch through it. If we do, then we still have half the position. Always remember that calls involve considerable leverage, and the short-term enthusiasm in the market generally is overdone. The market can drag the XLF and XLE down with it in a correction, no matter how much we like the sectors.

A.F. Thornton

Founder's Trading Journal

Greater Fools

AF Thornton 0 Comment
Navigator Algorithms - 94% Cash, 3% XLF Calls and 3% XLE Calls

It is extraordinarily mundane, hard work to create and program investment algorithms. I spent two full years and roughly $50,000 in losses (running the programs) to create the Navigator Algorithms. And then there were the 30-years of investment and trading experience that preceded (but enhanced) the resulting computer programs. Life is much easier now, as the computers do most of the work.

For everyone else who wants to make money, there is always the “Greater Fool Theory.” The theory relies on a bigger fool to pay an even higher price for the position I am ready to sell. The idea works remarkably well in the real world, at least until it doesn’t.

One measure of the number of greater fools in the Dot.Com era was the record public offerings of any company with “.com” in its name. These were nothing more than shell companies auctioned off at record prices to the public, most of which failed. Promoters were gaming the system.

The modern-day equivalent of the “.com” company is called a “SPAC” or Special Purpose Acquisition Company. I kid you not; this is a public offering of a “trust me” company. You give your money to the company, and the person running it says, “trust me to find a good company or investment to acquire.” This is the opposite of a typical public offering, where you invest in a company that you know what it is, does, and how successful it has been so far. The record number of these “dry powder” companies going public is surely a sign of too many fools still in the market.  Half of all public offerings in 2020 were SPACs.  

But it gets better. In the penultimate marriage of 2021 wokeness and greater fools, Colin Kapernick announced yesterday that he too is forming one of these “blank check” SPAC companies, hoping to raise $250 million in an IPO.

Think about the grift potential here. First, what investment bank would have the guts to turn him down? And when the bank contacts their best clients to invest, what client would have the guts to turn the bank down?

Now, I know absolutely nothing about Mr. Kapernick’s investment prowess. In fact, he might be quite astute and find his calling on Wall Street. One thing is for sure; I admire his moxie. But the rampant speculation in this market, as reflected by the record number of these “blank check” offerings, signifies that the short-term risks remain high, especially if all the fools are running out of money. And let’s face it, it does not matter who we elect as President; we still get Goldman Sachs in charge.

Today's Plan

There is not a lot of change from yesterday. Focusing on the S&P 500 futures, our primary model instrument, the overnight low held yesterday, and we punched on through to new highs. All of that continues to add to the piling on effect of unfilled gaps and untouched points of control below us with minimal overnight correction. Two of the last three overnight sessions have been 100% net long or close to it.

On the upside, there continues to be a lack of reference as we trade at new highs. The overnight high at 3925 is the main line in the sand above us, though we are approaching channel top boundaries. The Weekly Expected Move high is up around 3950. But overnight longs do not look well-positioned, contributing to the likelihood of a liquidation break soon.

Momentum divergences on the daily chart, combined with diminishing daily volume, continue to drive the algorithm trend strength into yellow or caution territory, as can be seen from the algorithm labels on the first chart above.

Be careful.

A.F. Thornton

Founder's Trading Journal

Reflation

AF Thornton 0 Comment
Navigator Algorithms - 94% Cash / 3% XLF Calls / 3% XLE Calls

S&P 500 Index Futures (half-day candles)
with Navigator System Status Labels

In the 2021 outlook video, I emphasized the inflationary consequences of the deluge of money-supply ripping through the Federal Reserve System. Nearly 40% of all U.S. dollars in circulation were printed in the last 12 months.

I will skip discussing my seething anger anticipating the bubble that will eventually burst. Suffice it to say that when we finally pay the piper, the Pandemic will seem like a walk in the park.

For now, inflation and growth expectations drive interest rates, which are now responding to the call of their inflation masters. Hence, the 30-year treasury yield is bumping 2%, while the 10-year seemingly has conquered the 1% level.

As oil continues its climb and higher rates reward the financial sector (mainly banks), I am looking to add to our XLE and XLF positions on dips. Because the market still has considerable influence on the sectors, I don’t mind exiting to cash on expected market turbulence. Make no mistake; managing market risk is paramount at these levels. A 10% correction is just around the corner, and waning market momentum is flashing yellow at this writing.

Crude Oil

Markets can tolerate rising rates (at these low levels), as long as Federal Reserve policy doesn’t change significantly. Rising rates and the steepening yield curve (long rates – short rates) also indicate growth ahead – which is good for earnings. Open borders will tame the inflation beast as wages, once again, will be hammered by global migration serving our glorious elites and the demonic Great Reset. So I am not concerned about the negative aspects of inflation yet, just how to benefit from the immediate turn.

10-Year U.S. Treasury Yields (Rates)

Additionally, I am focusing some attention on international ETFs for the first time in a long, long time. The weakened dollar has put the emerging market economies back on a firm footing (their debt is denominated in U.S. currency). This time, the emerging markets do not have to worry about China pegging to the U.S. Dollar, as China would just as soon see the U.S. topple under its own largesse and political strife. Of course, they could change their mind now that China has installed their own regime to run the U.S. government.

Perhaps the most perplexing issue on my radar is Gold. I am showing a long-term peak in the metal based on Hurst’s Nominal 9-year cycle:

Gold

Of late, Gold has been correlating with U.S. Treasury prices, so perhaps the peak is related to the “Risk-On” nature of the current investing climate. Also, there is a clear division in outcome expectations of the financial bubble busting. Some experts expect runaway inflation, while others expect another deflationary spiral. Perhaps Gold is picking deflation as the winner, or maybe my forecast is just plain wrong. Time will tell.

If Gold is peaking, I look forward to building my coin collection in the decline. The more, the better given worst-case forecasts regarding the mounting Global Debt Crisis and the severe economic decline that may surely follow.

Today's Plan

The Navigator Market Algorithms are in short mode on the 195-minute (half-day candle) chart, as can be seen above. Moreover, momentum has declined on each rally loop of the chart. In attempting to conquer and hold 3900, it is not unusual to see some sputtering, but I still see high probability of a liquidation break soon.

Looking specifically at today’s session, the overnight low looks weak, leaving the potential for a sustained move back below 3900. Should a more significant liquidation break get underway, signposts start sequentially with yesterday’s low around 3887.25, on to the untouched points of control starting with 3880, 3850, 3827, and the top of the gap at 3799. Obviously, I would not expect traveling much below the ’50 handle in a single day on a liquidation break.

Should prices firm, note the spike that is at the upper end of yesterday’s distribution. Acceptance within the spike, especially after holding the overnight low and failing to break, would confirm still higher prices ahead and signal that the market is not ready to break.

As always, stay tuned.

A.F. Thornton

Founder's Trading Journal

Bubble Up

AF Thornton 0 Comment

More and more, the period we are in reminds me of late 1999. I will have a 30-minute video out this afternoon showing the comparisons and other important relationships.

What I can say for sure is to buckle up. While the secular trend is intact and bullish, the short-term trend continues in a blow-off, bubble-like state. Accordingly, this market is not for the faint of heart though the dip a week ago now looks like a one-off event related to the GameStop/Reddit phenomenon. Volatility will remain high, and downside risks are elevated to code red.

We should gap higher again this morning to a new all-time high in the S&P 500 index. The Nasdaq 100 is even a bit stronger and is also set to open at a new record high. Overnight inventory is 100% net long and we are currently trading close to the middle of the overnight range.

As there is no upside reference for trade today other than the overnight high at 3900.50, my early focus will be on whether or not there is a gap fill. Then, if so and how much. 

Friday’s time-based point of control was relatively prominent at 3880.25 and could also be tested on any weakness. Beyond that, we have untested points of control starting to stack up with two just in the last three day sessions at 3855.25 and 3827. Any of those can be targets on any corrective activity.

A.F. Thornton

Founder's Trading Journal

S&P 500 Exit at 3883.50

AF Thornton 0 Comment

We stopped out at 3883.50 on the S&P 500 Emini position in the core Navigator Model portfolio. That leaves us with a 94% cash position, 3% position in the XLE 40 calls expiring March 19, 2021 (paid $286 per call), and a 3% position in the XLF 30 calls expiring on March 19, 2021 (paid $125 per call). The chart below summarizes the year-to-date trades so far in our $10,000 account started on January 1st: 

Of course, the year is young, and there will be much to navigate before this year is over, comrades. And, as our regulators caution, past performance does not in any way ensure future results. Which begs the question – why does it matter at all then? Perhaps a quick statement about past performance as meaningless will get me a discount on my next tax return?

A.F. Thornton

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