The lunatics have taken over the asylum.
And by asylum, I mean Wall Street. Last week, over $900 billion in Tesla options contracts changed hands. More than every other option contract in the market… combined.
The unrelenting gamma squeeze boosted Tesla’s market cap by more than $300 billion in a single week (read more on gamma squeezes here). So, despite owning less than 2% of global market share, Tesla now commands a greater market value than every other automaker on the planet… combined. In the last year alone, Elon Musk gained more net worth than Warren Buffett accumulated over his entire life-time.
Meanwhile, the Shiba Inu meme coin is up 60,000,000% in 12 months.
For some background, the Shiba Inu coin was inspired by Dogecoin - which began as a joke to poke fun at the current crypto mania. Today, these two meme coins enjoy a combined $80 billion valuation, or about the same size as General Motors.
Perhaps the biggest winner of meme coin mania was the guy (or gal) who turned an $8k bet on Shiba into a $5.7 billion windfall.
If there was any previous question about the state of today’s market, the debate should now be settled.
Can any serious person argue that this isn’t the greatest mania of all time?
Future generations will look back upon this period in the same way that we study the Japanese real estate market in 1989, tech stocks in 2000 or real estate in 2006. You only see these extremes at the tail-end of historic asset bubbles.
Given the fever pitch of speculative fervor observed in the last few weeks, my working assumption is that we’ve officially entered the blow-off top stage of today’s rally.
For long-term investors, today’s price action is a giant red flag. This could all end at a moments notice. However, for traders who can manage their risk, blow-off tops should be embraced rather than feared. These events can be highly profitable, given the extreme moves possible in a short period of time - often while volatility remains cheap. With a VIX at just over 16, the options market currently offers high-return/low-risk exposure to a potential blow-off top scenario.
Depending on how market conditions evolve from here, premium subscribers will soon get access to an options trade designed to capture 5-to-1 or even 10-to-1 upside from a potential melt-up into year-end.
When looking at the sheer volume of money flowing into the market, it’s easy to understand today’s price action. Whether it’s the record flow of speculative options volumes, or the torrential downpour of cash flooding into the broader equity markets, we’ve simply never seen anything like this:
With the Nasdaq and S&P 500 closing at new all-time highs last week, and no signs of options volumes or money flows slowing, the path of least resistance appears higher for now… and the moves could grow even more extreme in the weeks ahead.
But make no mistake, the end is near for this economic expansion and market cycle. Under the surface of ebullient risk markets, the economic warning signs grow louder by the day.
Recent Data Indicates U.S. Economy Already in Recession
As I’ve written about previously, rising prices often provide the catalyst for a turning point in a late cycle economy. In particular, the last two recessions were preceded by spiking energy costs. So, it should come as no surprise that economic growth ground to a halt in the third quarter - just as energy prices broke out to new highs.
The Bureau of Economic Analysis released its initial estimate for third quarter U.S. GDP last week, posting a paltry 2.0% annualized rate. That’s a major deceleration from nearly 7% growth in the second quarter, and the slowest rate of economic expansion since the post-COVID recovery began.
The numbers were even worse under the hood. Let me explain…
You see, economists will often look through temporary inventory fluctuations when assessing the underlying health of GDP figures. Stock analysts do the same thing - adjusting corporate earnings for changes in working capital, which include adjustments for inventory changes. Why? Because these fluctuations revert to zero over time, such that a tail-wind in one quarter becomes a headwind in a future quarter, and vice versa. So, here’s the punchline…
If you adjust Q3 GDP for the 2.07% contribution from inventory builds, the U.S. economy contracted in the third quarter.
Of course, hope springs eternal on Wall Street. For the moment, the consensus assumes Q3 was an anomaly due to the “Delta variant” of the COVID-19 virus. But a growing body of evidence suggests Q3’s economic weakness is far from transitory, and that Wall Street remains way offsides in its expectations.
The following chart presents a stunning visual of the current disconnect between Wall Street and Main Street, in the case of the auto sector. Spiking car prices have crushed consumer sentiment and future buying expectations… and yet, the stocks in this sector have gone vertical:
We’re seeing a similar collapse in homebuyer sentiment, which has reversed from all-time highs in September 2020 to all-time lows in October 2021, thanks to record high home prices. Here again, homebuilder charts tell an entirely different story as they trade near all-time highs.
When you consider today’s high energy prices, which are feeding into higher consumer prices across the board, plus collapsing sentiment for the two major durable goods underpinning the economy - housing and autos - it paints a grim picture for future economic growth.
Last week’s GDP report should have delivered a wake up call. Instead, Wall Street economists expect an imminent growth rebound to over 5% in Q4, based on the latest consensus estimates compiled by the Atlanta Fed.
My bet is that we’re heading for a replay of the Q3 forecast trajectory - where the consensus remained optimistic versus the real-time Atlanta Fed model, only to be “surprised” by a “weaker-than-expected” official Q3 GDP figure:
Finally, my favorite economic forecaster - the bond market - continues telegraphing an imminent downturn in the economic and inflation cycle.
Smart Money Prices in Economic Slowdown
A lot of recent headline space has focused on rising interest rates at the front end of the yield curve, both in the U.S. and globally. Much less attention has been paid to yields on long-dated bonds moving in the opposite direction.
What’s going on here?
The bond market is pricing in the normal consequences of short-term inflation and monetary tightening: a slowing economy, and thus lower bond yields in the longer-term. The spread between 20 and 30-year Treasury yields has compressed for 12 months now, and just last week, the spread inverted. This provides the strongest warning signal yet that the U.S. economy is on the verge of contraction:
The yield curve has inverted roughly 6 - 18 months before every recession of the Post-WW2 era, providing one of the most reliable leading indicators you can find.
Long duration bond bulls should welcome, and not fear, the upcoming Fed taper and tighter monetary policy. A temporary sell-off in long bonds is a common head fake at the start of a tightening cycle, which often precedes the real move - a sustained rally in long bonds, as the economy and inflation slow.
We saw the same phenomenon in 2018, just before the Fed ramped up its monetary tightening campaign in October. Long duration bonds sold off for a few preceding weeks, before reversing course and heading much higher. I’m betting on a repeat of this familiar “Fakeout then Breakout” pattern in the bond market today:
Premium subscribers received a real-time alert for an option-selling trade that locked in a 15% yield on the long-term Treasury ETF (TLT), back on October 13th. This trade is still live and paying off nicely to date - check it out, here.
Looking ahead, as the data comes in for Q4, I’m expecting further economic weakness rather than the consensus growth rebound Wall Street is looking for. Stocks could continue ignoring the data, as they have for the last several months, with flows overwhelming fundamentals in the near-term.
Treasuries, on the other hand, have held up well even in the face of negative consensus opinion and positioning. In my view, further upside in equities remains a high-risk proposition, which requires advanced trade structuring for managing risk (i.e. options). Long duration Treasuries, on the other hand, offer less downside and substantial upside if the consensus view and positioning begin to shift:
As always, you can find isolated pockets of opportunity in certain sectors and individual stocks even in today’s manic stock market. Energy in particular provides a nice negatively correlated pair against Treasuries - where you can win if inflation or growth surprise to the upside. Plus, you get the added tailwind from the ESG crowd helping to artificially suppress supply, even as demand heads to new highs.
This brings us to the portfolio update section of today’s article.
Three companies in the Ross Report tracking portfolios delivered earnings last week, including a top tier Canadian energy company that reported big news on both the operational front and its shareholder return program, sending the stock 15% higher.
Here’s why I think the stock is still cheap, even after the recent run-up…