Probability Map Preview May 4th 2020

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Meta Strategy Derivatives Portfolio – Probability Map Update

This table maps my current data-driven estimate of the probabilities for future returns of the S&P 500 over the short term (1 – 8 weeks), medium term (3 – 6 months) and long term (6 – 18 months). It is updated each Monday and whenever probability estimates change significantly. The main inputs leading to my current market scenarios and price targets are listed below the probability map.

For background information read this article – a quick guide on how to read this table and how to translate probabilities into a concrete portfolio exposure can be found here.

May 4th ProbabilitAssessment over the next 1-8 weeks: Short 30% : 70% (probability of positive : negative returns)
All index levels are S&P 500 (including overnight futures) unless stated otherwise.

Probability ≠ Certainty: everything I state here are my personal ideas and best guesses, that I use to make my own investment decisions (I may hold positions discussed here). It is not investment advice. Everyone is responsible for their own investment decisions and potential losses.

Key Insights 

  • Current Market Environment: Bear Market (until golden cross) & High Volatility Regime (adjust position sizes down)
  • Basic Premise: Market Environments are sticky – trading with the trend will be profitable over the long term
    • Every major current move (from February) was much larger than expected – this should continue until the regime quiets.
  • Uncertainty: High Volatility Regimes are hard to trade; the focus is on preserving capital for the next bull market; to stop trading altogether would be a sensible decision for the moment
  • Big Picture: two major scenarios – historical cases are skewed towards recovery by 10 : 5 (= basic economic growth trajectory) – especially after exogenous shocks
    • 1) Bear Case: The coronavirus shock speeds up the usually drawn out top of a long bull market and this crash cascades into a longer economic downturn & severe bear market of -40% to -60% (playbooks: 1929, 1937, 1973, 2000 Nasdaq, 2007)
    • 2) Bull Case: The coronavirus impact is strong, but temporary. Enormous stimulus acts like rocket fuel to propel economic growth to bounce back quickly (playbooks: 1970, 1980, 1987, 1990, 1998, 2001, 2010, 2011, 2015/16, 2018)
    • In both cases the short/medium term often plays out similar and is tradable: very volatile claw-back over several months; higher prices from low with severe pullbacks (low retest) along the way are most likely
  • Retest or partial retest of Low: has high probability of 70%; Lower Low 30% prob.; low range: 2200 – 2670  (until mid/end-May)
    • Momentum and breadth measures of recent rally decrease likelihood of complete low retest; main target is 50% pullback of recent rally; possible range for next bottom is very large
    • Significant Up- or Downside is likely to be limited to about 200-300 points beyond expected move: worst case on both sides: 3000 Up & 1960 Down

Current Thoughts

  • Recent rally: is very overstretched and has reached most extreme target area 2920 – 3000
  • Top consolidation: @ 2750 – 2920: price closed above, but retraced down into top range immediately
  • Decisive area: 275-day MA (2980) marks long term trend between bearish & bullish > return to neutral portfolio on close above 3000
  • Market focus: news flow is starting to switch from pandemic recovery to economic fundamentals = currently bearish, but watch for speed of economic recovery; April 30 initial claims causes first negative reaction to economic news, China tariff game is on again
  • Oil: trading below $0 at historic lows – weakness may pull stocks down again with time delay
  • VIX Term Structure: stays inverted during the entire rally = volatility regime change & reliable bearish indication 
  • 30.4. Gamma Exposure: @ 2880 = neutral; Zero Gamma = 2910; Volatility trigger = 2855; Call Wall/Top Gamma Strike = 2950; Put Wall 2500; Absolut Gamma 3000 (primer on gamma exposure)
  • Meta Strategy: reaches technical Stop Loss Level and indicates RED = Bear Market (Short entry: 60/275 day MA or contrarian Long entry -25% below 275MA @ 2250.)
  • Studies: Long term bullish, Short term bearish, Medium term unclear. 
    • All short term studies (9) indicate weakness (the recent rally is overstretched on any measure) and 90% of long term studies point to higher prices in one year.
    • Fundamental studies point to prolonged bear market, but may be late due to exogenous shock.
    • Most technical studies point to similarities to late stage bear markets (some time before bottoming, but after the main drawdown)
  • Most probable scenario: picture is unclear, volatile and noisy now: (historic precedents do not fit well)
    • Volatile sideways range: expected approx. 2200 – 2900
    • Playbook: lower low or low retest (may stop at partial low retest) 4-8 weeks after initial low (end-April to mid-May); worst case on both sides: 3000 Up & 1960 Down
    • W- vs V- bottom: in three different case studies: 15 : 3 (17% V); 37 : 2 (5% V) and 71 : 3 (4% V) – all other times (partial) low retest or lower low
  • Insider Buying is strong: historically very close to the bottom price wise but 3-4 months early on a timing basis. Based on that, we could put in a final bottom sometime in June before going higher.
  • Sentiment: Retail looks to buy bargains = uncommon for real bear market bottoms; Pessimism fades = short/medium term bearish; >> typical bear market cycle ends with capitulation and despair, but we only saw initial panic in March.
  • Seasonality: weakest period of the year is beginning – „Sell in May and go away”

Main market drivers

  • Political / central bank vs recession = extraordinarily strong stimulus & biggest, sharpest GDP decline in history: This is the irresistible force meeting the immovable object.
  • Coronavirus: stopped the real world economy
    • how much irreparable harm will be caused, how much is temporary slowdown in solid economic environment that can be saved by stimulus?
    • Flattening curves now visible worldwide and economies reopen slowly = reason for initial relief rally, but all good news now priced in?
    • Key question: economic slowdown vs. fiscal stimulus > what will be stronger?
    • Current Corona data

Further Outlook

  • Uncertainty & lack of historic precedents makes forecasts extremely difficult: Follow systematic Meta Strategy = Bear Market environment
  • Exogenous Shock Bear Markets are short (avg 15 months) and shallow (avg 30% decline) historically 
  • Bear Market may morph into longer recessionary bear market – pandemic may trigger overdue economic decline
  • Current Mid-Recession projection: (extreme GDP drop and fast recovery) > end of May = bottom area for typical bear market, but recession may last longer if corona effects cascade through economy
  • Bottom range: analogous to strong to severe historical bear markets: 1600 – 2000; extreme cases: 600 (Great Depression) – 1460 (GFC); economic V-recovery may lead to shallow bear market (no new lows)
  • Long-term projection: (1 year +) is necessarily very bullish (from lows) as only the Great Depression had long term downside after a -35% fall in stock prices (even a bottom at -50%+ is likely to see higher prices within 1 year)

Target Areas 

Long Targetstarget reached  commenttarget probabilityexposure change
2550xminimum retracement 38% (of 3130 to 2180)
2650xnormal retracement = 38% of entire drop / 50% of last down legmain targetneutral/short
2715xmajor consolidation low
2770 – 2800x62% retracement / 50% of entire dropmax targetshort
2900xlikely target, but more probable for summer rally
2920 – 3000x60MA to 275MA resistance cluster; retracement = 62% of entire dropextreme targetexit shorts on close above = max. risk
Short Targetstarget reached  commenttarget probabilityexposure change
2730lower boundary of top consolidation; additional short trigger on close belowreduce / add shorts for optimal exposure
2640 – 267038% of rallymin. targetreduce short, BE SL for rest
2500 – 2570put wall & 50% of rally
2440 – 2480minor Low = partial low retest @ 62%main targetneutral/short
2200 – 2350March Lowmax. targettbd / add long
1690 – 2000Lower Lowextreme targetlong

Disclaimer

This report is a description of my own investment approach and ideas and I personally invest in the Meta Strategy Derivatives Portfolio. The content of this letter is for entertainment purposes only and not meant to be investment advice to others.

I am not an investment advisor and I do not provide individual investment advice. None of the ideas in this letter are meant to be construed as professional financial advice.

Your investment decisions are solely your own responsibility and I am not legally or financially responsible for any losses you may incur from reading or using the content on this letter.

© 2020 David Steets, all rights reserved – be fair and do not distribute without my permission