Why not, nothing is out of bounds now that investors have shown they are prepared to accept insane valuations for stocks. We're still skeptical and very well-hedged (and our hedges are getting crushed) but it's more than offset by the ridiculous gains in our long-term positions so party on Trumpmerica!
As you can see on the chart, we came off the 10,000 line in 2011 rose 75% to 17,500, pulled back to 15,000 (33% retrace) and now we're on the road to 20K in one mighty leap since the election, adding 1,000 points since election day – not even counting the 500-point sell-off that occurred right before the rally began (blow-off spike down).
The 5% line off 18,000 was, of course, 18,900 and you can see we had a brief pause there before shrugging off resistance and heading higher. The 7.5% line is 19,350 and not too much upside resistance there and then it's a hop, skip and a jump to 20,000 – no problem!
In fact, the Russell 2,000 is just under 1,350 and that's up 200 points since early November (not counting their spike down) and that is just shy of 15% so the Dow is MILES behind if the move in the Russell is real (we have bet it is not but those bets are killing us!). The Nasdaq is up 4.3% and the S&P is up 5.5% and the NYSE, the broadest index, is up 4.8% so it's really the Russell that's a huge outlier – and that's why we're shorting it.
HOWEVER, we could be (and have been) very wrong about the Russell and, if so and it heads higher still, then it's the other indexes that should be catching up so we can hedge our hedges with long positions on the Dow, S&P and Nasdaq. For example, the Dow ETF (DIA) is at $190 so a 5% move in the Dow would be $199.50 and we can make the following play to gain leverage:
- Buy 30 DIA March $188 calls at $6.70 ($20,100)
- Sell 30 DIA March $193 calls ar $3.75 ($11,250)
- Sell 5 AAPL 2019 $97.50 puts for $10 ($5,000)
This spread requires a net cash outlay of $3,750 and the spread pays $15,000 back if the Dow even squeaks higher into March expiration (17th) and you can use any stock for an offset but Apple (AAPL) is a major Dow component and makes a very desireable buy at $97.50 and the margin on 5 short puts is just $5,000 – so it's a very efficient trade that profits $16,250 (433%) if the Dow goes up 2.5% – good deal, right?
A trade like this is especially relevant for those of us short the Russell Futures because, for a very small amount of money, we can insure against further damage from a continuing rally – very cheap insurance – especially if you offset it with a stock you'd REALLY like to own anyway – any of these components would do:
The reason the Russell is outperforming the S&P and other indexes by about 4:1 is because money is indiscriminately flowing into equities and the average Russell component has a market capitalization of $1.8Bn while the average S&P component has a market capitalization of $40Bn so, if a person allocates anything more than 5% of their equity flows to small caps, they will rise disproportionately to large caps. I'll bet you can see from your own IRA of 401K that you allocate much more than 5% to small caps.
This, of course, also sets them up for a nasty fall if people change their minds and decide to pull money out, which is why we're focused on the Russell as our hedge position – but we never expected this much of a rally. As noted by the WSJ chart, a big move in biotechs, material and energy companies has also added fuel to the Russell fire.
OPEC has their big meeting on the 30th (next Wednesday) and, if they fail to come to an agreement, we could see a sharp correction in the energy sector. There's also still plenty of things to be concerned about (see this morning's news notes) but I don't want to be all doom and gloomy on a holiday weekend – I just want to stick with our hedges but also hedge our hedges for a mall cost – just in case this rally never comes back to Earth.
Spreaking of Earth, here's a really cool chart of how much debt we citizens are all in and keep in mind that's per person, not per family!
You can see how Japan is an island unto itself and there's Italy, where the possible collapse of the $169Bn Monte dei Paschi bank could severely damage Italy's $1.8Tn GDP. All of those red countries have very little room to move on policy while, on the bright side – our $20Tn National Debt (103% of GDP) doesn't seem bad at all compared to Japan's 250% so President Trump can spend $20Tn and we still wouldn't make it to the center of that map!
Have a great weekend,