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The U.S. stock market is in a strange place: President Trump is manipulating the Federal Reserve to lower interest rates — and the rest of us with his on-again, off-again trade deal with China. Investment managers are chasing performance as the year comes to a close. And momentum investors are inflating prices.
And now there is new information about the stock market that all prudent investors should heed. Let’s explore with the help of a chart.
Chart
Please click here for an annotated chart of ETF DIA, -0.23%, which tracks the Dow Jones Industrial Average DJIA, -0.24%. For the sake of transparency, this chart was previously published and no changes have been made. Similar conclusions can be drawn from charts of S&P 500 ETF SPY, +0.08% and Nasdaq 100 ETF QQQ, +0.22%.
Note the following:
• From the chart, the first target for the stock market is Dow Jones Industrial Average 30,000.
• From the chart, the second target for Dow Jones Industrial Average is over 32,000.
• When I gave a “buy” signal on Donald Trump’s election at a time when many were predicting a big stock market drop, it was at first met with incredulity. When shortly thereafter I called for a high-probability scenario of the Dow Jones Industrial Average hitting 30,000 points in Trump’s first term, I received a ton of hate mail. I have subsequently repeated that call in Trump’s first term several times. Please see “Here’s the case for Dow 30,000 in Trump’s first term.” Now, a few years later, Dow 30,000 calls are commonplace.
• Normally we put a lot of emphasis on the Fed. But now, at least temporarily, the Fed has surrendered to Trump and is likely to lie low as inflation remains under control. November’s core inflation (Consumer Price Index) month-over-month came in at 0.2% vs. 0.2% consensus. The headline number was 0.3% vs. 0.2% consensus. The headline number was a little bit hot but investors should focus on the core number. Also, keep in mind that although the stock market pays a lot of attention to CPI, the Fed watches many other indicators, and it is well-known that this is not the Fed’s favorite indicator.
• Performance chasing is on. In performance chasing, lagging money managers aggressively buy to catch up with their benchmarks. Please see “‘Performance chasing’ and Trump’s impeachment process could push the Dow to 30,000.”
• Smart money flows are rising in inverse ETFs. This indicates increased hedging.
• Option trading patterns are also showing increased hedging, especially in popular stocks such as Apple AAPL, +0.33%, Amazon AMZN, -0.10%, Facebook FB, +0.35% and Google GOOG, -0.06% GOOGL, +0.00%.
• There also appears to be increased hedging in semiconductor stocks such as AMD AMD, -0.95%, Qorvo QRVO, +3.01%, Micron Technology MU, +2.83% and Intel INTC, +0.60%.
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What does it all mean?
While complacency has seeped into the stock market, the smart money appears to be hedging more against potential tails risks. In plain English, tail risks mean risks that have a low probability of occurring, but if they do occur, they can move the stock market a lot. Prudent investors should heed this new information and guard against tail risks. Due to market complacency, hedging is now less expensive, especially if some of it is done with near-zero cost strategies. For those who want to keep it simple, holding more cash is the way to go.
Caution
To be clear, this is not a sell signal. We continue to hold good long-term positions and opportunistically undertake short-term trades with good setups. Not knowing how the trade situation ultimately comes out and due to the elevated levels of the stock market as well as vast expansion of debt across the globe, guarding against tail risks is simply prudent.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.
