In my last article on October 5, I discussed how the credit markets were precariously close to signaling another sharp leg down in the stock market. No sooner than that piece was published, stocks ripped higher, and within a day the credit markets (credit) followed, caught up, and ultimately even exceeded (at least by some measures) the upside performance of stocks.
As I began tweeting the very first day stocks zipped higher, in the context of the article that was the “low odds” outcome. For the last 6+ years credit has been driving the performance of equities and I can’t recall a time that stocks took the lead while credit lagged so badly.
Fast forward to Friday and it is deja-vu all over again, except this time credit is on the verge of fully supporting a powerful move higher. The Investment Grade CDX is toying with the 80bps area, which, when last crossed from below, cleared the way for the recent correction. The High Yield CDX has also tightened, as have High Yield and Investment Grade cash spreads. China sensitive CDS’ have retraced a good chunk of the widening suffered while various Chinese markets were in the grips of manic volatility. And lastly, the CDS’ of large US financial institutions suggest anything but a looming credit crisis.
On the cash side of credit (even more important than the derivatives market), corporate bond issuance, which revived as scheduled after Labor Day, continues in full swing. And the overwhelming majority of large deals sold since early September are showing some very nice profits for the buyers.
So it’s no surprise then that stocks are where they are. Last week I noted that the S&P 500 Pit Traded futures contract (SPA) had failed to complete a daily TD Sell Setup, a sign that buying momentum might have been waning. But none of that mattered. On Thursday the SPA qualified the break of a daily TD Line (the DeMark equivalent of a trend line) which targets SPA 2270. And on Friday, the Nasdaq 100 futures broke the daily TDTS Level Up on a “qualified basis”, suggesting that there is way more to go to the upside before this move tires out.
The fuel for equities to run higher is there in spades. The EMC/Dell and Bud/Mondelez deals alone are putting in the pockets of shareholders some $100B that will have to find new places to land. Meanwhile, albeit for many reasons stock purists would describe as “wrong”, new announcements of corporate stock buybacks are going through the roof, led by Walmart’s (WMT) $20B shopping spree, $11B by Goldman Sachs (GS), and $10B by Johnson & Johnson (JNJ).
As I have said before and will repeat ab nauseam, I will concede that stock buybacks – especially those heavily funded by debt – will prove a colossally asinine idea when the current credit cycle ends. But in the meantime I would urge readers to respect the stock buybacks for what they are: a tidal wave of money aimed at inflating stock prices. If one wants to fight this dynamic because in one’s mind that’s not the way “it is supposed to be”, all I can say is “good luck”.
Actually, I will say “good luck” and “but apparently you are not alone”. I have highlighted many times that, despite the mantras that “everyone is bullish” and “stocks are in a bubble”, short interest positions are through the roof. There has only been one month in history with higher short interest on the NYSE. And as percentage of shares outstanding, open shorts are actually at all time highs by a lot. Brian Reynolds, of New Albion Partners, estimates that about 5.5% of all NYSE shares have been borrowed and sold, and “half of all the shorts that were put on this summer, and 10% of the total, are now underwater.” If these folks run into the buyback peeps…, I will leave it to your imagination to figure out what it could do to prices.
In summary, just as a couple of weeks ago most “tells” pointed to lower prices for stocks, those “tells” are now on the verge of signaling the “all clear” for a strong (and I mean STRONG) run into year-end. Just like a couple of weeks ago, stocks could again choose to disregard the message of the credit markets, and to embark on the path of “low odds / highest resistance”, this time to the downside. As Minyanville’s Todd Harrison was fond of saying – that’s why they call our business “trading” rather than “winning”. But at risk of taking some lumps here and there, sticking with what has proven to be tried-and-true for the last 15 years seems the safer way to go.
Good luck and good trading!
Twitter: @FZucchi
Author has a position in the S&P 500 ETF (SPY) at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
