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Did Wolf Street Just Short The Entire Stock Market?

Short Market
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EDITOR NOTE: This is a funny article from Wolf Street. It highlights the case for a short trade in the market, but takes an almost apologetic tone for its future failure. In short, it promotes a “thesis” on a future prospect by way of “retracting” that thesis. Interestingly, the announcement of the trade is “hedged”--negative payoff is already accounted for, while the positive payoff, should the forecast be correct, results in an “I told you so” moment. Hopefully, the trade itself is also hedged. If so, it reflects how traders typically think. Large ventures can be risky, but never unhedged. As you build or rebalance your portfolio, shouldn’t you be thinking in a similar manner?

I hate shorting. The risk-reward relationship is out of whack. It feels crappy. I lost a ton of money shorting the worst highfliers a little too early in late 1999. It’s just nuts to short this market that is even crazier than in late 1999. But this morning, I shared in a comment in our illustrious comment section that I’d just shorted the SPDR S&P 500 ETF [SPY]. My time frame is several months.

I’m sharing this trade so that everyone gets to ridicule me and hail me as a moron and have fun at my expense in the comments for weeks and months every time the market goes up. And I do not recommend shorting this market; it’s nuts. But here’s why I did.

The stock market had just gone through what was termed the “greatest 50-day rally in history.” The S&P 500 index had skyrocketed 47% from the intraday low on March 23 (2,192) to the close on June 8 (3,232). It was a blistering phenomenal rally. Since June 8, the market has gotten off track but not by much. It’s still a phenomenal rally. And it came during the worst economy in my lifetime.

There are now 29.2 million people on state and federal unemployment insurance. There are many more who’ve lost their work who are either ineligible for unemployment insurance or whose state hasn’t processed the claim yet, and when they’re all added up, they amount to over 20% of the labor force. This is horrible.

But stocks just kept surging even as millions of people lost their jobs each week. The more gut-wrenching the unemployment-insurance data, the more stocks soared.

Then there is the desperate plight many companies find themselves in, and not just the airlines – Delta warned of a host of existential issues including that revenues collapsed by 90% in the second quarter – or cruise lines – Carnival just reported a revenue collapse of 85% in Q2, generating a $4.4 billion loss, and it is selling some of its ships to shed the expense of keeping them.

These companies are in sheer survival mode, and they’re raising enormous amounts of money by selling junk bonds and shares so that they have enough cash to burn to get through this crisis.

This crisis hit manufacturers whose plants were shut down. It hit retailers and sent a number of them into bankruptcy court. It crushed clinics and hospitals that specialize in elective procedures. It shut down dental offices. It sent two rental car companies into bankruptcy court – Hertz and Advantage. It has wreaked untold havoc among hotels and restaurants, from large chains to small operations. And yet, stocks kept surging.

The situation has gotten so silly in the stock market that the shares of bankrupt Hertz [HTZ] – which will likely become worthless in the restructuring as creditors will end up getting the company – were skyrocketing from something like $0.40 a share on May 26 to $6.28 intraday on June 8, which may well go down in history as the craziest moment of the crazy rally.

There were stories of a new generation of stuck-at-home day-traders driving up the shares looking for their instant get-rich-quick scheme. And those that could get out at the top made a bundle (but HTZ closed at $1.73 today).

The smart folks at Hertz and their underwriters, Jefferies LLC, saw all these sitting ducks ripe for the taking, and they came up with a heroic plan to sell up to $1 billion in new shares into this crazy market, while informing investors that those new shares would likely become worthless in the bankruptcy proceedings.

The bankruptcy judge – likely shaking head in despair – approved it. As HTZ began plunging, the size of the offering was reduced to $500 million. This would have been like a donation to the company’s creditors, who now run the show.

Hertz would have likely been able to pull off this stunt in this crazy market, but then someone at the SEC woke up and asked some questions, which put the whole escapade on hold. But you can’t blame Hertz. They need money badly, and they’re just going where the easy money is.

Even during the crazy dotcom bubble in late 1999 and early 2000, the day-trader frenzy hadn’t reached these levels. But back in 1999, the economy was strong. Now this is the worst economy of my lifetime.

This kind of frenzy has been everywhere in recent weeks. They bid up nearly everything unless it filed for bankruptcy – and even then, they bid it up, as Hertz has shown. This would have been an inexplicable rally in normal times. But these are not normal times.

These are the times of record Federal Reserve money printing. Between March 11 and June 17, the Fed printed $2.8 trillion and threw them at the markets – frontloading the whole thing by printing $2.3 trillion in the first month.

And in this manner, the otherwise inexplicable frenzy became explicable: The Fed did it. And everyone was going along for the ride. Don’t fight the Fed. Spreading $2.3 trillion around in one month and $2.8 trillion in three months – in addition to whatever other central banks globally were spreading around – was an unprecedented event. And the fireworks probably surprised even the Fed.

Credit markets that had been freezing up for junk-rated companies suddenly turned red-hot, and speculators started chasing everything, including junk bonds sold by cruise lines and airlines though their revenues had plunged 80% or 90% and though they were burning cash at a stunning rate. The Fed’s newly created money went to work, driving up stock prices.

But over the past six weeks something new was developing: While the Fed was talking about all the asset purchase programs it would establish via its new alphabet-soup of SPVs, it actually curtailed the overall level of its purchases.

Then in the week ended June 10, the Fed’s total assets of $7.1 trillion increased by less than $4 billion. And in the week ended June 17, its total assets actually fell by $74 billion (you can read my analysis of the Fed’s balance sheet here). This chart of the week-over-week change in total assets shows how the Fed frontloaded its QE in March and April, and how it then systematically backed off:

And there is another big shift in how the Fed is now approaching the crisis. It’s shifting its lending and asset purchases away from propping up financial markets toward propping up consumption by states and businesses, and ultimately spending by workers/consumers via its municipal lending facility, its PPP loan facility, and its main-street lending facility. These funds are finally flowing into consumption and not asset prices.

So the superpower that created $2.8 trillion and threw it at this market, and that everyone was riding along with, has stopped propping up asset prices.

And now the market, immensely bloated and overweight after its greatest 50-day rally ever, has to stand on its own feet, during the worst economy in my lifetime, amid some of the worst corporate earnings approaching the light of the day, while over 30 million people lost their jobs. It’s a terrible gut-wrenching scenario all around.

And so I stuck my neck out, and I’m sharing this trade for your future entertainment when it goes awry, and you get to have fun at my expense and hail me as the obliterating moron that infamously shorted the greatest stock market rally of all times as it was floating weightlessly ever higher above the worst economic and corporate crisis imaginable.

Originally Posted on Wolf Street

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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