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A Fool and his Money
Posted on Thu, 06 Nov 2014 @ 12:11:32 CST by Captain_Hook

Originally published as a subscriber article on 7 July 2014

Do you remember the indelible words ‘a fool and his money are lucky enough to get together in the first place’? Do you know where this famous quote comes from? The answer is the movie Wall Street – wisdom offered to Bud Fox by Gordon Gekko – an Oscar winning performance for Michael Douglas. And there could be no truer words for many in the stock market today, benefactors of the great reflation (monetization) quantitative easing (QE) has provided since the panic lows in 2009. Unfortunately however, most people have not benefited from this reflation. For the most part, it’s been a ‘rich man’s rally’.

What’s more, and in fact, not only has the rally in the stock market not benefited most, it has hurt people due to cost push inflation in the necessities of life far beyond any wage gains – if you are still employed. And correspondingly, because of this, in the end even the rich will not benefit from the games being played to boost stocks, because the economy, consumers, and potential investors have been hollowed out by these exercises in greed, leaving little truly productive capital to fall back on when needed. So many who think they are rich today may be proven fools too – not just the exploiters of a foolish public.

Because it’s not a zero sum game. There is not a winner for every loser, as Gordon Gekko would have you believe, because those who don’t actively trade would lose in a crash. But there does need to be a population of fools to sell to once prices go up, which are usually the retail trade in stocks. Either that or the top players will get stuck holding the bag, which is not how you stay rich. Based on participation rate measures of various dimensions (here, here, and here), they may have a problem this time. Maybe people are tired of Cramer (think Gekko) front running them – no? Don’t let the door hit you on the way out Jimmy.

But seriously, who do these fools (the asset rich) think they are going sell all this stock to – generations x and y? Maybe the Israeli’s, or Chinese, or Russians. Certainly not the baby boomers – they must be hoping their kids will be buying. Or do they even think in this regard? Something tells me not, which is why it will fall on the Fed, who will obviously fail due to the numbers and dynamics involved. Harry Dent is correct in his assessment of the situation in my opinion – demographics is the insurmountable obstacle that will matter at some point in the not too distant future. 

So make no mistake about it, whether overtly via a long overdue stock market swoon, or by accelerating subversive taxation, one way or the other, it’s going to be a lot harder for the average fool (apparently the powers that be think that’s you and me) up and down the line to keep their money moving forward, never mind make more. Because every time you turn around there’s some scoundrel with their hand in your pocket in one way or another. And again, at some point this is going to matter to the most overvalued stock market in history, where some surprise will be enough to tip the balance. 

And again, as pointed out last week, and witnessed on Thursday as stocks surged into light trading associated with the July 4th long weekend, the most important broad measure in the US, the S&P 500(SPX), hit extreme sinusoidal resistance when factored by the CBOE Volatility Index (VIX), with a ratio reading of 192. Again however, while this might be enough to stop stocks temporarily, in order to see a monthly close at this level (at monthly closing basis resistance), either stocks must first push higher and then fall back into month’s end, or visa versa. (See Figure 1)

Figure 1 – Click Chart For Sharper Image

It would not be surprising to see either scenario play out given there’s likely still enough short sellers in the market to sponsor more squeezing, however signals that stocks are extended enough to begin becoming concerned are appearing, so who knows – right? One thing is for sure however if the message in the chart below is to be taken seriously, where tech stocks are poised to surge up to another 5% on continued strength, be careful if you are short. If you are using double short funds, the market could hand you a 10% loss (this is probably exaggerating things) in just a few weeks, and then what do you do, hold for the longer term with the dollar($) looking increasingly vulnerable by the day. (See Figure 2)

Figure 2 – Click Chart For Sharper Image

Due to this risk, one might be better off to wait until month end in order to put a majority of one’s positions if you are inclined to participate in this lunacy. Why is shorting stocks a lunacy? While I may be proven wrong in such concerns, what has occurred up until this point, is at inflection points like this one, speculators pay close attention to all the information services (think Zerohedge) that promote such thinking, and indeed, short the market in one way or another, raising put / call ratios and short interest levels even higher – becoming food for the machines. (i.e. think short squeeze.) Again, this is why it may be better to wait until month’s end to put on any short positions (so they can get squeezed), even if we see a reaction lower in stocks this week. (See Figure 3)

Figure 3 – Click Chart For Sharper Image

But if you are alright with allowing a position to go up to 10% offside (which one should be if you believe the fundamentals warrant a hold) then this is likely as good a shorting opportunity you are ever going to come across from a longer-term perspective because corporate profits are collapsing due to debt, crony capitalism, hollowing out of the middle class, inflation, etc. which should all matter at some point. (i.e. when the short sellers become exhausted.) Of course one does not want to be a fool and just throw away money shorting stocks because these things have not mattered for quite some time – not to the machines. So again, caution, which has been our modus operendi all along, is still warranted in terms of position limits at this point, at least until month’s end when we hope the picture penned above falls into place.
Further to this, and in commenting on Figure 3 finally (didn’t forget), another thing we would like to see at month end is tech stocks to remain contained by the parameters denoted above, if not a reversal lower. Along this line of thinking, if we are to have a lasting reversal lower in the broads, in addition to being led by the financials, it will have to at least be accompanied by tech, or more strength could still be in the offing, believe it or not. In fact, if the patterning in the present sequence where to mirror that of the 07 / 08 topping process, a test of whatever highs in the SPX are witnessed within the next fortnight should in fact be anticipated next year. With technicals showing stretched conditions in the above however, and more negative divergences undoubtedly on the way, such an exercise would signal the coming of the apocalypse we are expecting afterwards. (i.e. think deflation scare taking the broads down 50% or more prior to a quasi-hyperinflationary event / response by central planners.)

So while this is all great fun hypothesizing on ‘what should be’ coming down the pike, if I can leave you with one sentiment today, again, it must be caution with respect to any aspirations you might have towards betting big on any downside in stocks moving forward. Because again, although stocks might pull back this week, with all the puts and shorts still in the market, things should tighten up again as options expiry approaches next week (on the 18th).

Again, it appears wise to wait until month's end to see if the scenario laid out above materializes.

And as for precious metals, which would suffer initially in a deflation scare (the $ would soar), with corrections in the SPX / SLV Ratio and Dow / Gold Ratio (DGR) now apparently underway, a long-term buy point is approaching for the metals, but again, if the broads are topping, one must be wary of precious metals shares until the margin clerks have finished, which historically takes roughly six-months from an equity top. And we are nowhere near this point.

Thus, while bullish trading opportunities may still exist in precious metals shares today, only a fool would not respect the risks involved at this point.

More on this later in the week.

Captain Hook
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