Recession Prediction: Is Call Buying a Warning?

Posted On June 21, 2018 1:51 pm

Going by the reaction in China, you would’ve thought global markets were in for a thrashing after President Donald Trump’s latest belligerence on trade. And while a few cracks widened, in the end it was another muffled reaction in U.S. stocks. Any immediate recession prediction has yet to bear fruit.

For the S&P 500 Index, declines that swelled past 1.5 percent in overnight futures trading shrunk to one-third of that by session’s end. The technology-heavy Nasdaq Composite Index was down just 0.3 percent. Only the Dow Jones Industrial Average suffered notable damage, falling 1.2 percent due to losses in high-priced stocks Caterpillar Inc. and Boeing Co.

The question of why American equities keep skating past a worsening trade conflagration has been baffling for strategists. One simple explanation is positioning. For all the drama landing at their doorstep, U.S. investors won’t stop plowing money into bullish trades.

“We’ve had more negative catalysts and more negative pull this year than we’ve had for a long time, but the positives continue to prevail in the investor’s mind,” Jeff Carbone, a managing partner at Cornerstone Wealth in North Carolina, said by phone. “They’re shrugging off the negativity and taking the positive to a greater extent that this is not the end.”

It’s visible in manager surveys, which last week showed equity funds only a trifle less long than at the height of January’s euphoria. It’s in markets for call options, where individual investors are engaged in a buying binge of historic dimensions. It’s in tech IPOs, stocks favored by short sellers, and ones with shaky balance sheets, all of which recently surged.

For traders so inclined, each trauma is just another test, even as their frequency quickens. In Tuesday’s version, the Dow Jones Industrial Average fell for a sixth day, the longest streak since March 2017, but the Russell 2000 Index reached an all-time high and the FANG block of tech giants rose to another record.

Contrast that with the situation in China, where benchmarks plummeted almost 5 percent, and one in four stocks fell the maximum 10 percent Tuesday amid concern that a trade war will stall the economy. U.S. stocks have beaten the rest of the world this year, as tax cuts boosted earnings, making the country a haven while turbulence erupts from emerging markets and Europe.

It’s not like people haven’t been warned. They have their memories of February and March, and strategists at banks like Morgan Stanley and Goldman Sachs Group Inc. have repeatedly urged investors to rein in optimism, citing everything from politics to peak earnings and monetary tightening. Earlier today, Citigroup Inc. flagged a potential bubble in growth stocks.

 Related: Are Markets in Denial About the Risk of Recession? 

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Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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