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The S&P500 is in a very precarious position and looks set to drop over
the coming months. After the Brexit risk rally, where it appeared that
central banks would once again step in with yet more stimulus and QE, the
S&P500 broke out to new highs, but since then it has dropped back to the
top of its year long range and is acting in a manner that would suggest it is
going to fall back through this support.
Technically if we break below 2100 on the SPX, we should at least
test 2000, and more than likely the bottom of this large range at 1800 over
the following months. The recent price action is that of a tired
market, a market with no impetus to rise and in addition, sentiment isn’t
bearish at these levels for a change, hedge funds in particular are Net
Long…and everyone is expecting the same yearly cycle of a year-end rally
after the election.
 
Trump Card
Fundamentally and politically there are also quite a few factors which
could cause a risk off period in the markets. We are coming up to an election
where the two candidates are possibly the most disliked potential presidents
in American History. It looks very likely that Hillary is going to win,
however as we have seen with Brexit anything can happen. There are a lot of
voters out there who are not comfortable revealing that they would vote for
Donald Trump, but in the privacy of a Polling booth it’s a different story. A
Donald Trump win would be a shock and quite a large risk event in the
markets. The initial uncertainty combined with his hostility towards the
Federal Reserve would cause a sell off, as this market rally has been on the
back of low rates and QE from the Fed. I personally don’t think that a Donald
Trump presidency would be bad economically for the US, the stage has been set
for that already by years of borrowing for consumption and the misallocation
of capital and resources. However the market could tend to over react
initially, similar to Brexit.
Expect the media to cover this in their usual way, headlines will be
“Flash Crash 2.0”, or “The Trump Crash” etc. If Clinton wins the market may
hold up a little longer before selling off, this Sell off will probably be
blamed on nervousness around the Fed raising rates, headlines such as, “Fed
Fears” or “The Equity Tantrum” will abound.
Hawkish Central Banks and European Divergence
As well as the election, we have in addition, a much more hawkish tone
coming from central banks globally, it would appear that they are starting to
realise that QE doesn’t actually provide economic growth or stimulus to the
real economy. The Fed is set to raise rates in December, the ECB is slightly
more hawkish in tone than normal and are unlikely to increase QE to the
extent to which the market had initially expected, although it appears they
will continue their bond buying programme past March.
Already we are starting to see the rotation and shift between European and
US Equity markets for the first time in seven years. Over the past month the
EuroStoxx and DAX have rallied, while the SPX has gone sideways. We have not
seen European outperformance for a long time. This is due in part to the
change in Central Bank policy in the two regions. However, this rotation can
also be indicative of a top in US markets, and hence equities globally.
Expect Europe to catch up fast on the downside and overtake the US markets
should this S&P500 rollover
Strong Dollar
We also see the US Dollar starting to strengthen considerably over the
past month. Moreover, it looks like it is on its way to making new highs this
year. This could potentially signal the beginnings of a flight to
safety and of stresses in the financial markets globally.
The Real World
The average person is not better off since the crisis of 2008…nothing has
changed. All that happen was interest rates were dropped to zero, banks where
bailed out, and QE was initiated. All of this was enough to stop the system
coming to a halt. It papered over the cracks, allowed governments and
businesses to get into even more debt, meaning that when the next down turn
comes it will be larger in dire magnitude than in 2008. This will create lots
more opportunities for the prepared investor. It’s FAR from ideal that our
economies are run this way, but we know they are. Therefore what’s in our
control is to adapt and be positive in looking for the opportunities as they
appear.
The Big Put
My preferred method of capitalising on this potential equity sell-off
would be an options play, buying March 1800 S&P Puts. I think that this
market will start to come off gradually…and then there will be a large
volatile drop, similar to what we saw in August 2015. However, this time
there would be the added selling of those who bought the new highs, now
trying to liquidate as the market drops back to the bottom of the range it
had just broken out of. This final sharp drop could be 5% Plus - and this is
where holding the options pays off as this sharp drop will increase the value
of the options exponentially…providing you are quick enough to cover once
this drop comes. Buying a Put also has limited downside, which means you can
only lose the amount which you purchased. Prudence demands I would only
ever make a trade where I already know my maximum downside risk.
Gold
Now is a good time to lighten up on equities in order to rotate into
precious metals and precious metals miners. Don’t expect the miners to get
dragged down with the overall market this time like they did in 2008, I hear
this line regurgitated all the time as if history exactly repeats. It
doesn’t. Although it does occasionally rhyme (I’m aware of the Ironic
Regurgitation).
Peter Hegarty
Peter.P.Hegarty@gmail.com
Disclaimer: This is not financial advice or a recommendation to Buy or
Sell. This is my own personal opinion based on my analysis of the markets
over the last 15 years.
Always consult your financial adviser before changing or making any
financial investments.
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