"Just one more thing."
- Lt. Columbo

I have to head out of town for a meeting tonite and tomorrow morning.
My posts tomorrow will be short and on point.
Thanks for reading my Diary today, I hope it provided value.
Enjoy your evening.

* Trading opportunistically and, again, fading the machines and algos

With some additional purchases I am now small net long in exposure.

"Investment wisdom/vision is always 20/20 when seen in the rear view mirror."
- Warren Buffett
The business media has this continuing predilection to focus on the obvious (and the inconsequential). They tend to simplify the investment mosaic - which is, in fact, increasingly more complex.
Case in point the ubiquitous discussion of the inversion of the 2/10 curve.
Since most other curves have already inverted - this was almost a foregone conclusion and is not likely the reason why the markets are getting schmeissed today.
So, Dougie, where should the media's discussion be now? Give me some forward and second level questions!
Here are a few:
* Watch for a sustained inversion - which has more consequence than a momentary inversion ("a false positive")
* Watch high yield spreads - While lower today they are generally stable over the last week and not yet indicating a credit default cycle of any meaning. (Let's focus on the (HYG) is the time ahead)* Watch equity risk premiums - (the difference between the inverse of the P/E and the risk free rate of return). The premia is wide, suggesting some "margin of safety" to the downside and why my downside is projected at only 2700-50 on the S&P Index.
* Watch forward LIBOR and other spread relationships (especially in Europe) - I will be updating you all on this.
* Watch the stock market - more weakness can quickly seep into the real economy - Since market capitalization as a percentage of GDP is near an all time high and individual equity ownership is elevated, lower stock prices will likely have a disproportionately adverse impact on the U.S. economy.

Moved to large Kraft Heinz (KHC) and Canopy Growth Corp (CGC) this afternoon. 

* My calculator and contrarian view positions me neutral now

With today's trades, I am back to market neutral in exposure. Phew!

My expected range for the SPDR S&P 500 exchange-traded fund trust  (SPY)  over the balance of the year is $270-$275 to $290-$295.

Spyders are currently $285 - implying 125 downside and 75 upside.

Given the volatility and standard error that is basically placing reward and risk in equilibrium after today's 80 handle drop in the S&P.

As posted, I have no index shorts on now.

I am getting ready to buy Citigroup (C) and Bank of America (BAC) personally.

My pal Tony is preparing to get more aggressive in the markets:

Nearing point to get more offensive

The market spiked yesterday on the back of a tweet from President Donald Trump that suggested a relaxing of some tariffs scheduled to go into effect on September 1. That enthusiasm has been tempered this morning by poor economic data coming out of China and Germany. Add to that, for the first time this cycle, the 10-year US Treasury (UST) yield dropped below the 2-year UST yield (intraday), suggesting the multi-year countdown clock for recession in the US should begin with a weekly close in inversion territory. In our view, the market is still in the corrective process that should set the stage for the next intermediate-term leg higher as the Fed gets more aggressive in cutting rates and the positive economic effect of lower UST yields takes hold.

Looking to get more offensive despite news backdrop. The recent weaker global economic data coupled with the intraday inversion of the 2-/10-yr UST yield curve has heightened fear of an imminent recession, but we want to emphasize:

•  A curve inversion is an intermediate-term "buy" signal. The UST yield curve inversion leads a recession by nearly two years, and the S&P 500 (SPX) sees median gain of 21% to "the" peak prior to recession (Figure 1). If you look at the last three levered cycles most similar to the current environment, there was a median 34% SPX gain to peak, with a median 25 months before recession. Figure 1: The initial inversion of the 2-/10-year UST yield curve works with a lag and is "buy" signal

• Still expect economic rebound from lower rates. The drop in global interest rates that has come with the weaker global data should cause a rebound in economic activity as we head toward year end, similar to how the rise in rates in 2017-18 has generated slower economic growth thus far in 2019. Large changes in interest rates work with a lag, and there is no sign in our credit metrics (highlighted in the August Strategy Picture Book) that indicates a shutdown in money availability that would make the lower rates less impactful for forward growth expectations.

Our positive core thesis remains in place - don't fight the Fed (and market rates). The volatility in the trade war with China, the prospect of a hard Brexit, Hong Kong protests, and the intraday inversion of our favored yield curve measure provide solid excuses for continued market volatility as investors hunt for the correction low. Although we continue to believe more time is needed to complete the current correction, our still-positive core fundamental thesis continues to suggest any weakness should prove limited and temporary and provide a more attractive entry point for a move toward our 2020 target of 3,350. A generational change in Fed thinking coupled with declining inflation expectations should allow the Fed to catch up to market expectations by more aggressively cutting rates. In addition, lower market rates and solid money availability despite the flatness of the UST yield curve point to an intermediate-term reacceleration in growth as we approach 2020. In our view, this sets the stage for a move toward our 2020 S&P 500 (SPX) target of 3,350 based on SPX Operating EPS of $176 and a 19x multiple, which assumes an expansion back to the level of 3Q/16-3Q/18.

I have reduced my gold position from medium to small-sized. For the second time in several months, we have made out quite well on the GLD long.

I do not worship at the altar of price momentum.

Higher share prices are my enemy, so I am reducing because of the diminished upside reward vs. downside risk

GLD was placed on my "Best Ideas List" in mid-April at $120.12. It's currently trading at $143.34.

My favorite short sector investment managers (Franklin Templeton Investments  (BEN) and 

T. Rowe Price Group Inc  (TROW) ) are rolling over, again.

My short thesis. 

Back to program selling (today) and buying (yesterday).
The rubber band is getting stretched daily in a market without memory from day to day.
Trade opportunistically, don't be self confident in view and size positions according to your risk profile, time frame and the new regime of volatility.
I am.

CBS (CBS) has been a nice winner over the last several years.

I sold my position at $51-$52 earlier in the year (the stock was on my Best Ideas List for several years) and I would not bottom fish with the stock -$2.70.

From my perch the combined entity (Viacom (VIAB) /CBS) does not have the scale to compete against Disney (DIS) , Netflix (NFLX) , et al.

Moreover, the costs associated with their competitive efforts in streaming are likely to surpass and offset the synergies and cost saves of the merger announced this morning.

From the news services: *NAVARRO SAYS U.S. CAN'T MEET CHINA `HALF WAY' IN TRADE TALKS

I just added to (AMZN) $1777, (GOOGL) $1177 and FB $184.

Helene's column today has a lot of bonafide reasons to be technically sour on yesterday's market rally.
It is worth a reread!

Peter Boockvar on sentiment, trade and other stuff:

It was good to see some economic sense reverse the really bad idea of taxing incoming consumer goods just a few months before the holiday shopping season. If only everything can now be reversed because I've seen estimates that about $110b of consumer goods will still be subject to the 10% tariff rate. Hopefully the administration is finally realizing the limits of this tariff fight and the damage done to one self. It can't come soon enough right now and you don't need me to tell you that, just look at the world's yield curves.

The US 10 yr yield of 1.62% is now below the 2 yr yield of 1.63% for the first time since 2007. The 3 month yield is now 37 bps below the 10 yr. The 30 yr yield is at a record low amazingly and scarily. We also now have inversion in the UK where the 10 yr gilt yield of .46% is 1 bp below the 2 yr gilt yield of .47%. The German 10 yr gets further negative by 3 bps to -.64% and the Euro STOXX bank stock index is down another 2.4%.

US 30 yr yield

Helping the inversion in the UK was the higher than expected inflation figures. Headline CPI for July rose 2.1% y/o/y, two tenths more than expected and the core rate was up 1.9% y/o/y, one tenth above the estimate. PPI was also just above expectations. So, just as in the US yesterday, the short end follows the inflation stat while the long end worries about the growth numbers.

The July economic data from China was not good. China said industrial production slowed to a growth rate of just 4.8% y/o/y, less than the estimate of 6%, down from 6.3% in June and it's the slowest since 2002. Manufacturing and infrastructure investment led the weakness. Retail sales softened to a growth rate of 7.6% y/o/y from 9.8% in June and that was 100 bps below the forecast and driven by a slowdown in auto sales. Fixed asset investment ytd was 5.7%, about in line with expectations. Bottom line, the slowdown is picking up steam and the Chinese stimulus in place and lined up is just meant to cushion the moderation. Chinese markets instead focused on the trade news as the Shanghai comp rallied by .7% and the yuan is higher.

Japan had some good economic news but for June where so much has happened since. Core machinery orders, an always very volatile data point, jumped 13.9% m/o/m after a 7.8% decline in May. The estimate was for a decline of 1%. This was all led by orders from service companies as orders from manufacturers declined. For the 4th day, the 10 yr JGB yield is outside the 20 bps range around zero that the BoJ's yield curve control was intending. It's at -.22%.

German confirmed as expected that its economy contracted in Q2 by .1% q/o/q after a .4% increase in Q1. This brings the Eurozone Q2 GDP performance at up .2% q/o/q. Trade was the main drag not surprisingly. Fiscal stimulus is the tool that the German government has to respond but of course haven't used yet. The euro continues to hang in there around the $1.12 level.

After last week's 9.1 pt drop in the number of Bulls within the II data, bulls rose 1.4 pts to 49.5. Bears remain in small company amazingly with everything going on as they were up .2 pts to just 18.1. Those expecting a Correction fell slightly to 32.4 after jumping by 8.3 pts last week. Bottom line, while Bulls have fallen from the near 60 level over the past few weeks I'm still amazed how so little have become bearish in light of the new flow. You want a sustained rally in stocks, you better get some more bears, speaking strictly from a sentiment contrarian standpoint.

Not even a 30 yr mortgage rate with a 3 handle was enough to move the needle much for home purchases. The MBA said they rose just 1.9% w/o/w after falling for 4 straight weeks. Yes, they are up 12% y/o/y but it took an almost 100 bps decline in rates to get that. Affordable issues are still overwhelming the benefit of lower rates. Again, refi's are the main beneficiary as they spiked 20% w/o/w and 196% y/o/y and to a 3 year high.

REFI index

Why 2019 Feels Like 1929 from Knowledge@Wharton.

I am now out of my (SPY) and (QQQ) short rentals on the woosh lower this morning (SPY, $287.55 and QQQ, $184.85).
I am now market neutral in exposure reflecting my view that we have 150 points of downside risk and about 75 points of upside reward in the S&P.
This sounds asymmetric (from the standpoint of reward vs. risk) but given volatility it is within a standard of error of being neutral.
The only long today - was an add on to (KHC) .

There is no consistent trade policy out of the Administration.
Trade and other policy are hastily crafted (on the back of an envelope), conflated with politics, with little in depth analysis and delivered via tweet.
Indeed, in a perverse way, Tuesday's Trump tweet on China trade may lead to even more business indecision and shelving or postponing of capital spending plans.
As I warned earlier in the year, The Orange Swan is serving to Make Economic Uncertainty and Market Volatility Great Again #MUVGA
This development - the president's inconsistent policy tactics - is market unfriendly.

* Surprises aplenty look likely over the balance of the year

At the request of our managing editor, Jerry Kronenberg, back in late June I outlined my second half economic, monetary, political, market and other expectations (and surprises) - its a good time to recap them:

We all would love to have a crystal ball in predicting the course of the last half of this year - but mine, to be honest, is fairly cloudy.

The only certainty I do have is that there will be more uncertainties and numerous more surprises:

* It's likely a good bet that higher (perhaps much higher) volatility will be a cornerstone of the next six months. The VIX, currently at comfortably low levels, may move to and establish a new and elevated trading range.
* I expect domestic and non U.S. economic growth (as well as corporate profits) to miss relative to expectations. That miss may be much larger than I fear.
* The current earnings recession may deepen in the third quarter. S&P earnings for 2019 may fall to below consensus to $160/share.
* The expansion in stock valuations could come to a halt and the price earnings multiple of the S&P Index may contract - perhaps, measurably.
* Stocks, which have decoupled from the real economy, could suffer a small double digit decline during the balance of 2019 - as we return to "reality."
* I anticipate not only additional cuts by the Fed but an announcement of another bout of QE to be implemented in early 2020. Despite further economic headwinds/weakness and further Fed rate cuts (and the announcement of QE4) the yield on both the 10 year U.S. note and long bond could move higher - something the consensus no longer expects.
* Reflecting a lower stock market and rising economic concerns, I expect the early 2020 presidential polls to tilt away from Trump and for the Administration's approval rating to fall - raising further market concerns (higher taxes for the wealthy and for corporations, more regulation, etc.). If I am correct and there is evidence that Trump's base weakens, another big surprise could be that Vice President Pence may be replaced on the 2020 Republican ticket.
* Another surprise (remember my 2019 Surprise that this year will be the year of women?) could be the emergence of Democrats Senator Warren and Harris as the leading contenders for the Democratic Presidential nomination. (they were the likely "winners" of the first two Dem debates this week.).

Politically, it is a reasonable bet that - as we move closer to the November election later next year - the partisan atmosphere in Washington, D.C. will deteriorate further. Moreover, there may be economic and stock market consequences of hastily crafted and/or misguided policy (especially of a trade kind) as well as out of control fiscal spending.

Bottom Line

The last half of the year, like the first half of 2019, may be another period in which consensus falls flat.

Look for the unexpected.

I have had a small long position in Macy's (M) for some time.
This morning the company spit the bit, as, not surprisingly guidance was lowered.
While I have not purchased more stock into this morning's decline I likely will later in the morning.
My analysis of the quarter should be out in the next day or so.

I just moved down to small-sized in my Index shorts.

* Using market volatility to my advantage
I covered half of my (SPY) $288.65 and (QQQ) $185.55 for some large gains from yesterday afternoon.
Now back down to medium-sized in my Index shorts.
My aggregate portfolio exposure is down to between small/medium-sized in light of the 50 handle drop in the S&P from Tuesday afternoon and the changing reward vs. risk.

* Yesterday I debated the most reverent Rev Shark on this subject
* Rev is of the view that machines can legitimately change "technical conditions" and that spikes can be sustained by algos longer than we think
* I don't believe so (as I have observed that machines algos can often create contra trend trading opportunities)
* As discussed yesterday, "Price is Not Truth"
* Machines know everything about price and nothing about value
* I aggressively shorted Tuesday's machine-induced sharp market ramp - yell and roar and sell some more

"Typically, computer algorithms are driven to keep the bounce going longer than many expect because it is easier to keep emotions running in a positive direction. This produces some squeeze action and fear of missing out and that makes for better shorts when it eventually comes to an end."
- Rev Shark (yesterday) How Computer Algorithms Game This Morning's Action


Yesterday Rev'Shark and I had a good discussion on Twitter on how to handle the increased role of machines and algos.

There is a limitation of debate on Twitter so, given my respect (and money making abilities) of Rev Shark I don't want to put words into his mouth - but here is my brief assessment of how our views towards the machines are different.

Rev has changed his trading strategies (and time frames) to accommodate the machines and so have I. But we reach different conclusions on how to capitalize on the volatility delivered by the quants.

As I understand it, Rev suggested (see quote above) that when the machines drive stocks up on a spike that we should consider that there is a tendency for the spike to be sustained and that we should trade accordingly. In the specific case of yesterday's move, Rev thought shorting such sharp rallies was first-level thinking.

I also think that is first-level thinking. But, by contrast I believe we have to use second-level thinking to analyze why the spike is occurring (let's call it the "quality" of the machine-induced advance) in an attempt to gauge the sustainability of the move - in other words, we should not treat every spike or schmeissing the same.

Yesterday I determined that the machine based rally was B.S. and I aggressively shorted the monster move higher in the afternoon.

I did so because of my calculus that the reward vs. risk on a short had markedly improved that ratio. Importantly, my decision to short aggressively was based on my assessment that the catalyst to the machine's euphoria (algos know every thing about price but nothing about value) - the Trump Chinese trade tweet - could produce more corporate confusion (and continued delay of cap ex spending plans) because of the inconsistency and the uncertainty of policy. (See my next post Trump Makes Economic Uncertainty and Market Volatility Great Again!) As well, as noted often, I don't believe a substantive trade agreement is even possible based on our cultures and other considerations.

This Morning's Weak Pre Market Action Confirms My Shorting of The Rally and My Skepticism That Tuesday's Market Spike May Not Be Sustained

S&P futures (at 6:10 am) are now -25 handles lower (and Nasdaq futures are -77) which means that the S&P has fallen by over 30 handles from yesterday's high. (I believe a 17 year low in factory output in China helping to push futures lower).

Of course one data point (and failure to hold the gains) doesn't prove either Rev's or mine views on how to deal with machines.

The Debate

Here is what I wrote on the debate late yesterday afternoon:

The S&P (now at 2928) has moved closer to the upper end of my expected trading range (which is 2950) - and I have reloaded on the short side.

The proximate cause of today's rally is the tweet delivered by the president regarding the delay of some tariffs with China.

Meanwhile, today the 2/10 has inverted, Trump seems not to have a real comprehensive trade strategy (it's ad hoc and not based in facts, for example who pays for the tariffs), stocks rally into the mouth of the Beast.

Despite the market rally what happened today should give investors even more pause because of the obvious uncertainty in policy. How does a corporation make long duration business fixed investments given that uncertainty?

I truly feel there are no adults left in the room anymore - just machines, algos and Pavlov's dogs.

To be frank, I no longer feel sorry for anyone who falls for the nonsensical and hastily crafted policy delivered by tweet.

I am sticking with my contrarian streak and my ursine fundamental views on economic growth and corporate profits.

James DePorre @RevShark

I appreciate your strategy for enlarging shorts here but I think from a technical standpoint there is a likelihood of more upside from this point. There is a change in conditions today. 

Douglas Kass

¿@DougKass

The difference in our approaches is that you see this as a change in technical conditions.
I see it as a "newsy" event which doesn't change my overall negative mkt case and makes the downside risk (from here) relative to the upside reward more appealing. Thus I short into it. https://twitter.com/RevShark/status/1161290087864446976 ...

I have had a Twitter dialogue with Rev Shark today (see above) - he thinks today's move has technical consequences and represents "a change in conditions". I respectfully disagreed with him.

I continue to support the notion that there is only limited natural price discovery (because of quants) and that stock charts have lost their legitimacy and/or "predictive ability".

Finally and most importantly, with today's sharp gains I continue to rely on my calculator which suggests upside reward is now dwarfed by downside risk.

Bottom Line

I don't believe that all machine and algo induced spikes or schmeisses should be treated equal.

We must analyze what produced the move and how it is impacting market reward vs. risk.

Danielle DiMartino Booth talks inflation gauges this morning:

• The market has more confidence in the Fed hitting its 2% inflation target relative to the same target for the ECB and the BoJ; as evidence, the U.S. inflation swap matches the Fed's 2% inflation target while that of the Euro Area is at 1.2% vs. Japan's 0.1%
• Over the last 20 years, non-discretionary inflation are highly correlated with the headline CPI while discretionary inflation is significantly less correlated; non-discretionary inflation is the more volatile of the two, while discretionary inflation holds to a range of 0-2%
• To honor its mandate, the Fed should dismiss its adopted core PCE inflation measure and adopt non-discretionary CPI inflation; inflation for required items that U.S. households can't avoid should align with what the Fed uses to set monetary policy

American artist Andy Warhol was a leading figure of the 1950s pop art scene, but it was his work during the following decade that would propel him to stardom. Through paint and canvas he explored the relationship between artistic expression, advertising and the celebrity culture that flourished in the 60s. He drew to his New York studio, The Factory, a mixture of distinguished intellectuals, drag queens, playwrights, bohemian street people, Hollywood celebrities and wealthy patrons. Those he chose to promote became known as Warhol's superstars. Amongst all this glitter, be coined the still widely used phrase"15 minutes of fame." Who knew?

Want a Warhol of your own? You can have one through the convenience of modern technology otherwise known as an online "Warhol effect generator" that allows the recreation of Warhol's iconic four-square paintings. Your family photo instantly takes on the feel of Marilyn Monroe, Campbell's Soup or Brillo. Call today's Feather illustration the QI inflation quadra-pane. The four charts above play on the Warhol effect by presenting the series on the same axes.

Focus your discerning eyes on the top left pane. The first thing you notice is that household long-term inflation expectations are stable vis-à-vis that of the market-based variety. Both have gradually ground lower in recent years; the former edging down to 2.5% and the latter to 1.9% as of July. Yesterday's 2.2% core CPI inflation rate, which excludes food and energy, is bracketed by these two metrics. Having core inflation, even that not preferred by the Federal Reserve, run between Main Street's and Wall Street's expectations should help monetary policymakers sleep easy at night.

Shift to the top right. This is the 5-year, 5-year inflation swap rate. It's a common measure, used by central banks and dealers to discern the market's future inflation expectations. We've painted it three ways for Japan, the Euro Area and the U.S. The takeaway is straightforward: Investors believe the Fed is more credible at hitting its inflation target compared to the European Central Bank (ECB) and the Bank of Japan (BoJ). All three central banks aim for 2%, or close to it in the ECB's case. As of yesterday's close, the U.S. inflation swap was 2.0%, compared to 1.2% in the Euro Area and 0.1% in Japan.

Now move to the bottom left. Higher tariffs are outweighing a stronger U.S. dollar and helped raise core goods inflation to a modest 0.4% year-over-year rate in July. As tame as that may sound, the rate is running at a six-and-a-half-year high. Yesterday's Trump tariff punt on China imports until December 15 will just delay the inevitable until after the Christmas shopping season for retailers trying to survive the cannibalistic environment wherein online sales displace market share away from traditional brick and mortar shops.

And finally glance at the bottom right. QI innovation strikes again. The red line of non-discretionary inflation and blue line of discretionary inflation are juxtaposed against the yellow line of headline CPI inflation. We've Feathered about this before. To review, non-discretionary inflation includes prices for food and beverages, energy, clothing, household supplies, housing, utilities (including water and sewer), health care, health/home/auto insurance, phone, television/radio, internet, higher education (i.e., college tuition) and personal care services. Discretionary is everything else, a.k.a. wants.

The first thing you should notice is how non-discretionary inflation is a tight fit with the CPI, a 0.97 correlation over the last 20 years. Discretionary inflation, meanwhile, clocks in at a much lower 0.54. The second observation: non-discretionary inflation is the more volatile of the two. And finally, discretionary inflation is well-contained, trending in a range of 0-2%.

How relevant is headline non-discretionary income? Indulge a paraphrased excerpt from Fed Up to illustrate. At Stanley Fischer's first FOMC meeting, he asked why headline CPI was not the reference inflation rate used to devise Fed policy. After an uncomfortable silence, one brave Board staffer answered that the Fed's models would not break down if the core PCE was abandoned. To this, St. Louis Fed President Jim Bullard replied, "Let me get this straight. This is how we make monetary policy? Crap in, crap out?"

Three rhetorical questions jump out at us: A) Have you ever respected Bullard more? B) Do Bullard and Fischer have a point? C) Why on earth does the Fed still use the core PCE that imputes healthcare costs using Medicare and Medicaid reimbursement rates? (What's in your deductible?)

With that as a backdrop, QI humbly endorses a regime change in the Eccles Building. It's time to not only ditch core PCE but take one step farther than headline CPI. The time has come to adopt non-discretionary CPI inflation to gauge price pressures. Needs inflation cannot be avoided; minimizing it satisfies the Fed's key mandate. It is the public interest, after all, and not 15 minutes of fame, that monetary policy is intended to serve.