Perception vs Reality
Posted on Sunday, February 24th, 2019
When we last left you the S&P 500 was running into resistance at its 200 DMA. We thought that the bears might try and hold their ground. The 200 DMA has come and gone – having fallen victim to the bulls. This rally has gone much further than anticipated and may have broken the bears. The short interest on the S&P 500 has fallen to levels we have not seen since before the Great Financial Crisis in 2007. The bears are almost extinct – and that is not good news. The market is in better condition when there is a fair amount of skepticism and, therefore, short interest. Short interest indicates the amount of traders betting the market will go lower. Short sellers eventually have to buy that stock and, perhaps even, chase prices higher giving the market an undercurrent of support. That support is not in play today.
Markets are overbought and extended far above their 50 day moving average – a sign that buyers could become exhausted and allow for a market pullback. While the selloff in December was exaggerated due to year end funding issues this rally may be just as extended. Perhaps, that is a function of how oversold the market was but the bulls might be playing with fire here. There seems to be no stopping this market. Usually, that is where it stops. We know our mistakes and ours is to sell too soon. There are three symbolic animals on Wall Street. Bulls make money. Bears make money and pigs get slaughtered. Not one to be pigs we felt that by taking some profits and reducing risk where we did we risked 5% upside. That 5% is here. 2800 is a strong area of resistance and markets could use a rest.
The FOMC minutes were released last week and there was one particularly interesting insight. The main takeaway (and impetus for higher stock prices) was that the FOMC was looking at ending the tightening of the balance sheet in late 2019. As you know we have made a case that the expansion of the balance sheet directly led to the rise in asset prices in the post 2009 GFC Period. We also made the connection that a contraction of that same balance sheet would have a counter effect and act as a weight on asset prices. The FOMC may have been intimidated by the December sharp selloff and are now looking to end the contraction of the balance sheet sooner than previously planned.
“the staff presented options for substantially slowing the decline in reserves by ending the reduction in asset holdings at some point over the latter half of this year and thereafter holding the size of the SOMA portfolio roughly constant for a time so that the average level of reserves would fall at a very gradual pace reflecting the trend growth in other Federal Reserve liabilities.”
–Fed minutes released 2/20/29 Jan 30th 2019 meeting
The Fed is still tightening no matter what it says it is doing. We may finally resolve the inside baseball discussion of whether stock or flow was more important. It is a question of Perception vs. Reality. Does the market follow along with the perception that the Fed is about to stop tightening and head higher or does it go along with the reality that the Fed is still tightening and begin to move lower?
Wall Street is currently favoring perception. Since early January we have been in the grips of the “Everything Rally”. Gold, bonds and stocks are acting in concert and moving higher and lower together. That is historically odd. That indicates Wall Street is playing the QE Trade. Let’s see if that can continue.
March is a quiet month on the Federal Reserve calendar for balance sheet tightening. While April is also quiet May is a very big month. The FOMC has used the word patient extensively of late. That usually means that they do not intend to make any changes for 2-3 months. That takes us until the end of April. 
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
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