The year 2016 turned conventional wisdom on its head. It wasn’t just the predictions but the reactions, on everything from politics (Brexit and Trump) to figuring out the direction of interest rates (turning negative early in the year.)
To even stocks (rallying to all-time highs even as economic indicators slowed down) that pundits and investors got wrong.
Indeed, some of the best performing investments came from the least likely candidates such as energy, steel and Russia to name a few.
And some of the biggest losers were the supposedly next big growth areas like cybersecurity and biotech.
This shouldn’t come as too much of surprise as Warren Buffet has famously stated, “be fearful when others are greedy and greedy when others are fearful” and to “buy when there is blood in the streets.
Looking out to 2017 I thought it would be fun to do it in the format that Zerohedge.com http://www.zerohedge.com/ a truly contrarian (some would say conspiracy) website, called “Costanza Trades” for the upcoming year.
For those unfamiliar, George Constanza was the lovable loser on Seinfeld who so distrusted his own instincts and lack of success he realized every decision that he has ever made has been wrong.
So he is decided to try doing exactly the opposite of his initial instincts and usual actions. And much to his pleasant surprise his life, everything from dating to work, starts meeting with success.
And believe it or not this approach has real and constructive applications to the markets and trading. Not only a fun exercise for exploring both sides of an issue, from a market opinions, to chart reading to sentiment readings being aware of the counterclaim is good way to test the validity of your own thesis.
That is by doing the opposite of what is the prevailing view. So, without any further ado I give the “Constanza Trades” for 2017.
- Short the SPY
This is about as anti-consensus as you can get. I saw a list of 17 sell side firms’ 2017 year-end targets and all 17 of them had bullish objectives. The average target was 2500 with a 2450 median which would be roughly 6% higher than here. Not a massive move but still uniformly bullish. More to the point is the bullish sentiment which is hitting an extreme.
And the Fear and Greed Index is starting to peg into the right.
Instinct: Trump will reflate the economy via tax cuts and fiscal stimulus; repatriated Dollars will go to share buybacks; there is still a high amount of cash on the sidelines and real money still is underinvested in equities.
Costanza: there is no guarantee Trump will follow through and/or be able to institute any of his campaign plans. His pro-business billionaire cabinet will run into much flak in the opponent process.
Bonds are getting more attractive especially to pension funds that are closing their funding gap; geopolitical risks are rising. Perma bears have capitulated bullish recently and their throwing in the white flag is a great contrarian indicator.
Estimated probability of Costanza being right: 25% in 1H, 40% by year end. This is so consensus that I am worried about being long. That said; it is true that large asset managers who rotate their book about as quickly as the Titanic could turn have still not fully bought into this rally.
Therefore, if Costanza does prove right, it will probably be later in year once the rotation is complete. We expect dips to be get bought very quickly in the beginning of the year.
It is hard to argue with this bull trend in SPX…
- Long GoldGold has been declining since Brexit risks faded over the summer and the depreciation really gained momentum once Trump won the election. It is moving because real yields and the US Dollar have been rising which makes its 0% yield useless in this environment.
Instinct: US Dollar and real yields will continue to appreciate taking Gold lower.
Costanza: Geopolitical risks are rising with US/China; inflation is picking up. The market has priced in a more aggressive Fed so there is a lot of downside if the Fed proves to be more dovish than expected.
Gold recently broke at a very important support level but then gave bullish candle.
From false moves come fast moves!
Estimated probability of Costanza being right: 35%. I’m essentially long term bearish on gold but find the Costanza reasons to be resonantly strong. Not only are there increasing geopolitical concerns but they could become hairy via trade war.
While Gold has not been a good inflation hedge, a slow to move Fed would remove one bearish concern. And note, Trump is filling his cabinet with proponents such as Mick Mulvaney for Budget Secretary, of alt-currencies such as gold and bitcoin.
- Short Oil The OPEC and non- OPEC production cuts really changed sentiment. It went from a global supply glut story to one of more balance if not slightly imbalanced if demand picks up as expected. Specs have gotten very long, and now it is a matter of will OPEC member stick to the deal and will US Shale increase production at these more attractive levels?
Look at the increase in rig count in just the past few months as oil has crossed back above $50 a barrel.
Instinct: OPEC and non-OPEC members will cut production as agreed to keep the market balanced; demand picking up
Costanza: OPEC deal will not live up to the agreed upon production cuts; US Shale production increasing; producers happy to hedge above $50; Dollar strength will put pressure on oil.
Estimated probability of Costanza being right: 60%. I can see Costanza getting this one right. While I think OPEC will more than likely keep the cuts as they said they would, this trade could work simply because US supply comes back online. In fact, it is already happening. The switch has been flipped on. Additionally, this could be a very good sneaky Dollar long proxy. How can oil keep rising if the Dollar is going to appreciate?
- Long U.S 10 Year Notes (TLT)
All three are essentially the same idea so let’s just combine it. The fixed income market slowly started to sell off in the summer as Brexit risks faded and global growth improved.
Trump was the big kicker that got the reflation theme running on his pro-growth policies that will also lead to more supply. That got rates, curves (2s10s), and breakevens all moving higher in tandem.
The market is now very positive on forward growth and inflation prospects, and remains positioned for a more aggressive Fed as specs are still at or near record shorts in Eurodollars, Fed Funds, and 5yrs.
Instinct: Trump will reflate the economy via tax cuts and fiscal stimulus; Fed to be more aggressive in 2017; foreign central bank selling; increasing long end issuance; potential for ECB and BOJ to taper
Costanza: there is no guarantee Trump will follow through and/or be able to institute any of his campaign plans; bonds are getting more attractive especially to pension funds that are closing their funding gap; geopolitical risks are rising; composition of the Fed shifting to more dovish; still yield seekers around; long-term demographics .
This chart shows another case of testing important support which made lead to a reactionary rally.
Estimated probability of Costanza being right: 45%. I could actually see this potentially working out later next year. If you look at the long-term chart of US 10yrs, there is the potential for a move up to 2.90% and still be in its long-term down trend that is probably largely due to the aging demographics of the US.
I have been arguing that we have witnessed a regime shift and all the reasons for the short trade instinctively make sense; improving growth/inflation even before the election, Trump stimulus plans, etc., but the sheer crowdedness of the trade should concern us all.
However, much like equities, there are still many large Real Money types that have long standing UST positions that need to be sold. This makes it a coin flip but I could see a move higher in rates first and then back into the long-term trend lower.
And with that, I wish you all a very terrible and miserable 2017!
Steve Smith is an expert options trader with 25 years experience in the markets. Steve was a seat-holder of the Chicago Board of Trade (CBOT) and the Chicago Board Option Exchange (CBOE) from 1989 – 1997. Steve is currently the editor of The Option Specialist and runs the 20K Portfolio Program which provides all types of options trades for all types of traders.
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