Headlines
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Small traders keep pressing their bets...both ways:
The smallest of traders increased their speculative behavior in the options market again last week, spending a near-record amount on call options. But they're also holding a large net short position in index futures. A similar disconnect happened in 2007 and 2017.
Consumers are feeling increasingly positive about the future:
The latest figures on consumer confidence for May show that they're feeling increasingly pessimistic about their current situations, but also increasingly positive about their futures. That has had a mixed influence on future stock returns.
Rejected at the 200-day: The S&P 500 traded above its widely-watched 200-day average for the first time in months but wasn't able to hold above it. Since 1962, there have been 11 times it exceeded its average on an intraday basis for the first time in at least a month but wasn't able to close above it. A week later, the S&P showed a gain only 3 times and two weeks later 5 times. The dates were 1966-12-13, 1968-04-01, 1969-03-27, 1969-10-22, 1970-09-04, 1973-09-27, 1975-01-28, 1977-06-24, 1980-05-06, 1982-05-07, and 2008-05-19.
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Smart / Dumb Money Confidence
Smart Money Confidence: 57%
Dumb Money Confidence: 61%
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Risk Levels
Stocks Short-Term
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Stocks Medium-Term
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Bonds
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Crude Oil
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Gold
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Agriculture
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Research
BOTTOM LINE
The smallest of traders increased their speculative behavior in the options market again last week, spending a near-record amount on call options. But they're also holding a large net short position in index futures. A similar disconnect happened in 2007 and 2017.
FORECAST / TIMEFRAME
None
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During the week ended May 15, we saw that the smallest of options traders opened a new record of net bullish positions.
The positive market further encouraged them. For the week ended May 22, they used more than 45% of their total volume on buying speculative call options, on par with the highest levels of aggressive betting in 15 years. Prior to that, it only happened in the year 2000.
It has not worked out well for them. According to the Backtest Engine, the S&P 500 declined every time small traders got this bullish.
They're not the only ones placing heavy bets on a continued rally. Call buying and put selling was so popular across all traders that it pushed the Options Speculation Index above 1.3, meaning that traders opened 30% more bullish contracts than bearish ones. Again, the Engine shows this has not worked out well when traders across the spectrum were betting so heavily on a rally.
The curious thing is that at the same time they're aggressively buying speculative call options, they're shorting the major equity index futures. Their net position hasn't changed much in recent weeks, and they're still net short about $15 billion worth of contracts.
In the past 30 years, as a percentage of stocks' market capitalization, it has really only been exceeded by 1994-95, which was a very good sign for stocks.
Small traders' position in the futures markets isn't a particularly good contrary indicator since they have less of a correlation (positive or negative) with prices.
If we look at both sets of data together, then we can see that this kind of behavior has happened twice before.
The chart below shows each data set relative to its range over the past 3 years. Small trader call buying is in red, and small speculator positions in index futures is in blue. When the red line is high, it means they're buying a lot of speculative call options. When the blue line is high, it means they're buying a lot of futures.
Right now, the red line is high and the blue line is low. Usually, the two move together, so this is unusual. It's only happened twice before to this degree, in July 2007 and November 2017.
In 2007, it was clearly negative as stocks declined almost immediately. In 2017, stocks rocketed higher for a few months then ultimately collapsed. There isn't a lot to go on there.
There are several possible explanations for why this is happening - maybe they're long a lot of stock, and using the futures to hedge against that, while others are buying calls as a cheap flier in case stocks take off (like they have been). Or maybe they're really betting against stocks by speculating on their short futures positions and using calls as a form of stock replacement. Nobody knows.
All we can go off of is how they've behaved in the past. The contrary record of their call buying activity is much better than their futures positioning, and we'd give that a lot more weight. Even the couple of times they were buying a lot of calls that weren't confirmed by their futures positions led (at some point) to a decline. Overall, it's not a clear warning sign like it would be if their options and futures positions were more in alignment, but we'd still consider it a negative.
BOTTOM LINE
The latest figures on consumer confidence for May show that they're feeling increasingly pessimistic about their current situations, but also increasingly positive about their futures. That has had a mixed influence on future stock returns.
FORECAST / TIMEFRAME
None
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The latest release on consumer confidence from the Conference Board shows further evidence that Americans are feeling much better about the future than they are about the here-and-now.
Responses for May show that consumers' attitudes about their present conditions dropped again and are the lowest since 2013. Meanwhile, their expectations about the future rose from where they were in April.
There is always a tendency to think that this has to be a contrary indicator, and stocks can't form a true bottom unless consumers totally give up about the future. We've seen repeatedly in the past that this isn't the case.
Below, we can see every time since 1967 when confidence about present conditions was below 75 while confidence about the future was above 95.
These are consumers, not necessarily investors, so it didn't always follow the stock market. A couple of times (1970, 2003), we saw this as stocks were emerging from bear markets and consumers were just starting to feel optimistic about their futures again. A few times, it triggered after stocks had already rallied, and future returns were flat or negative.
The overall risk/reward was good, even if average returns were in line with random. Out of the 7 precedents, 5 of them saw flat or negative returns in the S&P 500 over the medium-term, with only 1970 and 1983 taking off to the upside and enjoying double-digit gains over the next 2-3 months.
Because of that tendency to see iffy returns over the medium-term, it's not a strong buy signal. The risk/reward is good even up to a year later, though, so it's certainly not a reason to sell. Opinions will vary on whether the confidence figures favor bulls or bears; the evidence suggests it's a very slight tailwind for the former.
Active Studies
Time Frame | Bullish | Bearish | Short-Term | 0 | 1 | Medium-Term | 7 | 4 | Long-Term | 33 | 1 |
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Indicators at Extremes
Portfolio
Position | Weight % | Added / Reduced | Date | Stocks | 38.9 | Reduced 10% | 2020-05-13 | Bonds | 0.0 | Reduced 6.7% | 2020-02-28 | Commodities | 5.1 | Added 2.4%
| 2020-02-28 | Precious Metals | 0.0 | Reduced 3.6% | 2020-02-28 | Special Situations | 0.0 | Reduced 31.9% | 2020-03-17 | Cash | 56.0 | | |
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Updates (Changes made today are underlined)
In the first months of the year, we saw manic trading activity. From big jumps in specific stocks to historic highs in retail trading activity to record highs in household confidence to almost unbelievable confidence among options traders. All of that came amid a market where the average stock couldn't keep up with their indexes. There were signs of waning momentum in stocks underlying the major averages, which started triggering technical warning signs in late January. The kinds of extremes we saw in December and January typically take months to wear away, but the type of selling in March went a long way toward getting there. When we place the kind of moves we saw into March 23 into the context of coming off an all-time high, there has been a high probability of a multi-month rebound. After stocks bottomed on the 23rd, they enjoyed a historic buying thrust and retraced a larger amount of the decline than "just a bear market rally" tends to. While other signs are mixed that panic is subsiding, those thrusts are the most encouraging sign we've seen in years. Shorter-term, there have been some warning signs popping up and our studies have stopped showing as positively skewed returns. I reduced my exposure some in late April and was looking for a pattern of lower highs and lower lows to reduce it further. With weakness on May 12, our studies turned even more negative over the short- to medium-term so I reduced a bit more. Some short-term indicators are already nearing oversold so we may get a quick rebound but it is what it is. If we see a clear pattern of lower lows, I may reduce even further in the week(s) ahead. Long-term prospects look decent because of the thrusts we saw off the low, but I'm more comfortable in cash in the interim. I'd consider adding back if we see our indicators and studies start to skew to the upside again, or if price action turns clearly better, indicating my caution is wrong.
RETURN YTD: -7.3% 2019: 12.6%, 2018: 0.6%, 2017: 3.8%, 2016: 17.1%, 2015: 9.2%, 2014: 14.5%, 2013: 2.2%, 2012: 10.8%, 2011: 16.5%, 2010: 15.3%, 2009: 23.9%, 2008: 16.2%, 2007: 7.8%
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