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Nirvana for Stocks?


This action is presumably due to the market embracing a 'Goldilocks' scenario, where the economy is not too cold and not too hot...


Historically speaking bonds tend to outperform stocks after the Fed is through raising rates. Usually, and I stress usually, stocks tend to fall after the Fed is finished and begin to rise after the second rate cut. The decline usually approximates 8 to 10%.

Bonds actually performed well alongside stocks in the 3rd quarter, but lately, stocks as measured by the DJIA have begun to trade better than bonds with the Dow reaching record territory. This action is presumably due to the market embracing a 'Goldilocks' scenario, where the economy is not too cold and not too hot - or nirvana for stocks.

While my firm has recently initiated a long position in the 10 year note, it is more of a long-term call on economic weakness than a near-term trade. We continue on the defensive as it relates to stocks as we have been selling into recent strength. The popular trade which is getting more crowded by the day is for higher prices still. While certainly possible, the stock market seems risky to us and the most painful, and unexpected move could be lower.

I have to be honest that I have my doubts. Real estate, I fear, will eventually have a larger, more negative impact on the economy and therefore stocks. There is most certainly the possibility that I am wrong. That possibility always exists in this profession.

Now to the hedgers

When you open a commodities account, you are asked if you are a 'speculator' or a 'hedger.' Speculators are broken down into small and large (retail and large accounts like macro hedge funds) and hedgers are 'commercial accounts' like large money managers, banks and the like. Historically, the large speculators tend to be trend following, or momentum players, while hedgers will take 'the other side of the trade.' Generally speaking, my firm does not fight the hedgers as they are considered 'smart money,' and explains why our 10 year position is a modest 10 to 20 percent of portfolios, not something larger.

How large is the hedgers' position? They are short a record 468,706 contracts that are worth approximately $107,625 each or a nominal value of $50,444,483,250. That's a lot of dough, no matter how you slice it. According to CFTC data, released Friday as of Tuesday's data, suggests that they are now short about 20% of the 2,241,109 contracts outstanding.

See the chart here showing the number of 10 year contracts they are short on an absolute basis.

Now see how the hedgers have done in the past relative to the price of the 10 year contract. Note that we are now at a critical support level, and my firm doesn't know what they did last Wednesday through Friday as we bought into market weakness. There is also a downtrend line that was respected on this latest rally. We expected the market to fail on the first trip up there and expected a pullback to support. We got the decline and bought a partial position into the weakness. We also bought a decent size position in 'off the run' 2 year notes around 4.8% after having taken profits in the 4.5% area a few weeks ago. See the chart here.

My firm also took some profits in Mortgage backed Securities as the bid side for our seasoned paper is VERY strong right now and we are happy to sell into strength. Buying low and selling high has never hurt me before and I don't think it will hurt now.

What about the hedgers' position in the long bond? They bought weakness in the spring but have since gone to a much more neutral position. See the chart here.

What about the hedgers' position in the S&P? They are short here, but this chart underestimates their true short position. While they are short 32,000 or so 'big contracts,' they are also short a net 245,000 'E-Mini' S&P contracts so, their total net short position is growing to levels that are associated with previous market tops. See the chart here of their position in S&P's.

In summation, my firm sees and respects the position of the hedgers. We don't like to fight them that hard and hence, are treading lightly in 10's. If we see them cover, we will accelerate our positioning.

In stocks, they are starting to lean bearish, a position we agree with as the pain trade now seems lower after the latest divergent, short covering rally.

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Position in 2 year and 10 year Treasuries

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