One Trader’s Opinion on the Market Pullback
Feb 10, 2018 Trading Blog
This past week was one of the most interesting weeks that I can remember in a long time. It is exactly why I chose to become a trader and a participant in the most fascinating game ever created. I can’t even imagine the boredom and misery of a regular job where everything is the same day after day after day. But honestly, over the last year or so, the market has felt like a miserable regular job. There has been no volatility, only a single direction and ever decreasing opportunity for daytrading. What a blessing this week was. This past week was a reminder from the market that we never have this game mastered, and we NEVER know what is going to happen next. The boredom that has slowly infiltrated my trading may be gone for awhile, as something in this market has changed. And for that, I’m thankful.
However, that blessing did come with a cost. As it stands, I’m down about 2.3% for February. I’ve got three positions right now in PE, JAG and ECR. The PE and JAG positions will be liquidated this week on the first significant bounce in the market. Both positions are about 10% of my account, with one down about 13% and the other down about 6%. I would imagine that both are due for very large bounces, so most of the losses should be recovered this week to get back to even for the month. I will be keeping the ECR position, and maybe even add to it, as I had planned for this to be a longer term play. After a couple adds, my average price is still 1.83, which is down about 5%. Another add or two would probably take that average price down near 1.75, which I think over the longer term is an absolutely great trade.
So the question is: Why liquidate these trades? Because I think something in the market has changed. When I entered these trades, it was strictly on a technical view expecting a regular pullback down to the 36-37 XOP area. Instead we got a 23% crash of the entire sector, with the XOP hitting 31. Simply put, I was wrong, and when you are wrong the only thing to do is stop being wrong, which means correcting the mistake by getting out.
Which leads to a better question: Why was I wrong and what did I miss? At this point, I’m really not sure, but I suspect that the true reason will become apparent in the coming weeks. I’ve been trading a long time and this week wasn’t normal market action. Something that we don’t yet see or recognize is happening under the surface. It could be the new FED leadership and a new direction for them, it could be inflation or rising rates, it could be an approaching recession, it could be some poorly structured products about to implode, it could be a change in demographics with 401k owners reaching the age to withdraw their stock money, it could simply be too many passive investors sitting on the same side of the boat all invested in the same stocks. It could be anything really, or a combination of things. But one thing is for sure, a 23% move in the energy sector in just a few days isn’t a common occurrence. Someone knows something, or expects something is coming. Do you want to close your eyes and trust that your long term money is safe in the market at these lofty levels?
There is a really good chance that the next narrative that takes effect in this environment could be one of people beginning to realize their ever increasing risks and taking action to bring that exposure down and move to safety. And if that happens, this market is toast. Almost everyone I know has taken almost 100% of their cash (both 401k and personal savings) and put it in the market. Why? Because you can’t make any money in cash and Ray Dalio says it is stupid to be in cash. I remember years ago holding all of my net worth in CD’s with 8-10% returns, which today seems like complete fantasy. I slept very well at night and would give anything to have that opportunity again. And maybe I will, soon.
The thing that has the market upset is the inflation issue. Maybe not the inflation itself, but rather the associated increase in interest rates that are needed to control inflation. The FED is preparing us and it seems that the market only began listening this past week. If rates increase, that means that opportunities to make money off of your cash are created. Maybe it is bonds, maybe it is a CD, maybe it is just the gift of getting 2% in your savings account. Whatever it is, and however small the reward, there will be money chasing the guaranteed interest. I will be one of them putting my cash back in anything that will return a rate of interest. And where is that cash going to come from? From the place where all the cash is now – the stock market. An aging demographic holding stocks will eventually want the safety of a riskless return, no matter how small. Preservation over growth. I am one of them. All this crazy risk we took on stocks produced the returns we wanted, now it is time to take those gambling winnings and be responsible adults and move to protection and preservation mode, and hopefully get paid for it.
Another angle is that we have been in a period of “growth” for years and no matter how much the FED does, a recession is a natural part of the cycle. The FED knows this. They also know that they are going to need ammunition to fight that recession. They need higher rates now (well ahead of the recession), which in turn gives them the ability to decrease rates again when needed. You can’t just raise interest rates for no reason, at least Yellen couldn’t. But maybe Powell can. It is certainly curious that inflation was nowhere in sight only months ago, but now is a huge pressing issue. How convenient. The FED needs higher rates, inflation makes a guest appearance. Whether inflation is really here is debatable. I personally don’t see it, but the FED is the promoter of the narrative, and sometimes perception is indeed reality. Bernanke proved this for years and years. Are commodities and commodity stocks looking like inflation is coming? Not really. It will be interesting to see what evidence the FED uses to prove this ‘inflation’ claim, if they even try to prove it at all. Inflation could turn out to be the WMD that never existed, only time will tell.
Or maybe the FED finally realizes their mistake of the last decade and the huge bubble they created in the stock market and have decided to take responsibility for it before it gets out of control and brings down the entire system. Maybe this is their way of bringing it in for a soft landing before a recession becomes a concern? It certainly is easier to deal with one crisis at a time, rather than having one cause the other and all hit at the same time. At this point, who knows what is reality and what is merely perception with them.
But I guess the most important issue is this: The rule for the last decade when the FED has been super lenient has been “don’t fight the FED, just buy”. Maybe now we are looking at the same rule, just in reverse as the FED becomes tighter, “don’t fight the FED, just sell.”
Will we have a bear market from here? I have no idea. Nobody knows. But what I do know, is that something (FED) may have changed and to ignore that possibility is simply irresponsible trading. I’ll still be in there going long and short every day, but my opinion of the overall market is now different.