Market Disconnect

Where to from here?

Given the general state of the world, it feels wrong to have the markets at all time highs. Of course, when we say markets, we are referring to some index or another. What I should say is that the broad based US equity market indexes are just off all time highs.

But what does that mean right now?

In the case of the Nasdaq 100, the most high flying of the “markets”, it really means that the FIVE stocks that make up 40% of the index are up. Those exact same stocks make up about 20% of the S&P 500. When we talk about the “markets”, we are increasingly about a very small handful of stocks.

It makes sense that in an online world the big tech giants are doing great. But there are many things about the current markets that don’t make a lot of sense. For the average person out on “main street” the economy sucks. There are lots of people who aren’t sure how they are going to pay for the basic necessities or what work is even going to look like going forward. That is at the same time that the wealth gap is increasing and the 1% are increasing their wealth.

Then you have the market dynamics. Overall trading is way up since March. That is not the usual reaction to bad markets and a bad economy. Options trading especially has skyrocketed to record volumes. There are hordes of people out there trading that have very little knowledge or experience.

To me this all adds up to some potentially bad stuff. The “markets” are pricing in vaccines and a better economy and smooth sailing. It is entirely possible that the markets just shrug off any issues and climb higher. But as I have said, your models (or at least your thinking) need to include the possibility of a significant drop in markets in the reasonably near future. I hope that is not the case, but you better be ready for it.

There are a number of ways to play this. I am a volatility trader, and mostly a relative value volatility trader. But one way to approach this is to look to sell things that look overvalued given the current markets (some big tech names) and buy things that are undervalued and/or could do well if and when the other shoe drops. With options this could take the form of various long and short spreads to keep risk at a minimum. But how to structure is something we will cover in the near future.

I tend to ramble here, but my basis point here is that the “markets” feel disconnected from reality and you had better be ready if things aren’t quite as rosy as what is priced in.

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