🗞 Committing to One View

WHILE YOU POUR THE JOE… ☕️
Indian Takeout?

When China was the center of overseas investment attention, everyone had doubts and fears about investing in any market other than the US.

Today, that trade has become a bit crowded. That doesn’t mean it’s too late to get in—just the opposite. But we’re already overweight China stocks (and oil), so we now need to look ahead to the next decade or two for the big swings.

It turns out that market is India, where not many people feel comfortable buying into that country’s market yet, except for bond traders across the world, who have floated the most money into India’s fixed-income assets since 2019.

To get a good enough and diversified exposure to this market, you can look into $INDA, the ETF that can meet all your Indian needs today.

Speaking of falling dominoes, let’s get on with today’s email 📧…

SENTIMENT READINGS
Join the Poker Table

There is one major report 👀 that comes out every week, and it measures the level of futures contracts inventory held by both institutional investors and commercial dealers.

Keeping track of this report and the levels of inventory is key, as you can pretty much gauge out who is actually committed to bringing the market higher, and more importantly who thinks the market could soon be about to turn.

This is why the report is called:

Commitment of Traders (S&P 500)

This is the commitment of traders report for the S&P 500 futures, where the green line represents institutional investors and the red line commercial dealers.

Notice two things here:

1. Institutional players (green) are trend followers, so the higher an instrument goes, the more they’ll buy, and vice versa.

2. Commercial dealers (red) trade their book’s needs, so they are actually the better gauge to look at and understand.

Think of it this way, when a car manufacturer in Japan like Toyota (commercial dealer) stops making more cars, it means they probably expect the vehicle market to take a hit 📉.

This way, if they control and tighten their inventory and production, they won’t be as negatively affected when the slowdown comes. The opposite is true if they suddenly ramp up production. It means that they expect a strong market ahead and want to be ready.

Now, a local dealership is like the institutional players (green). They will have lots and lots of inventory on hand as long as they see buyers coming in. But, just like today’s car market, when the tide changes, they are left holding the bag 📉 and running discounts.

This is what’s happening in the S&P 500. Commercials are really, really short the index, and institutional players are chasing the rally. However, today, they seem to be tapped out on the upside already.

What being “Tapped out” means is the level of inventory is as long as it’s been since the pre-COVID cycle, so finding new buyers will be hard moving forward. We all know what happens next. 👀 

Commitment of Traders (Bonds)

When it comes to bonds, we see a similar trend happening in the short-term bonds here.

Commercial dealers are buying a large number of contracts in short-term bonds (2-years), betting that the yields will come down. Now, if you follow us on Twitter, you’d know we have an inflation run thesis on our hands.

But inflation and liquidity issues would be nothing without the yield curve (10-year bonds minus 2-year bonds) going up, so here’s what we know.

For the ten-year bonds, commercial dealers have recently turned around to decrease their inventories and potentially going to turn short. This is a bet that ten-year yields will keep on going higher.

Again, we express this view in our last post, which calls for further declines in the $TLT long-term bonds ETF which could also bring the $IWM small-cap stocks ETF down. 📉 

This bet also means that the yield curve will increase as commercials sell 10-year bonds and buy 2-year bonds.

In other words, we have a confirmation of inflation in our hands…

One last check to confirm our view on the small-cap short trade, here’s what the commitment of traders looks like for the Russell 2000 index:

Notice the commercial dealers (red) switching their book to a net short now, which is right in line with our bearish view for the small-cap space as a result of spiking inflation coming up.

Can’t say we didn’t warn you 🫰.

TRADE OF THE WEEK
Michael Burry Moment

One of the main trades we are looking to make this week, in addition to the yield curve trade through some bond ETFs, is going short the $IWM small-cap ETF.

Our reasoning for being short small-cap stocks right now can be found in our last post, where we explain how the divergence between bonds and small caps signals a potential inflation warning.

Along with price action in commodities and other asset classes and the evidence of traders' commitment we saw today, we feel good about initiating a short position in the $IWM.

But there’s more:

Someone just made a very big bet against the $IWM, too. Up to 21,000 put option contracts were bought in the index.

This trader is betting that the $IWM will go to $180 or less by the end of the month, which is literally this week. 📉 

We don’t see many catalysts ahead to bring on such a steep decline, but a wild card from the Middle East could definitely get it done.

That doesn’t mean go short this at the market open; here’s where we see our ideal entries and potential exits:

Based on structure and volume profile, we think entering a short in $IWM at $221.75 would be an initial position.

Then we could add $225.5 🎯 if it gets there, or we can even wait for it to get there in the first place to start accumulating shorts.

On a market profile basis, we agree with these entries. When it comes to the exit points, we think the ideal would be the volume point of control for the year, which is that thick red line at the $203-$204 level.

Before then, we need to see bearish price action and order flow at the volume cutoffs at the $217.75, $216.5, and $214.75 levels.

We can’t just go in naked, though; that would be stupid on our part. So, how do we ensure we’re okay if our timing is wrong?

Here’s what we think the best hedge is:

That’s right. We want to go long on the growth ETF $IVW this time to hedge out our shorts in $IWM. 📈 

Why? Very simple, actually

On a fundamental basis, growth stocks in this ETF have a lot of international exposure, so they should be fine whether inflation ends up hitting the US or not.

On the other hand, the $IWM and its small caps will suffer due to the ETF's domestic-only exposure. This means that if costs go up and margins come down, small caps will suffer.

So, we’re going to put this hedge on logically.

Now for some technical points.

Correlations, rolling ones, that is. We now see a correlation breakdown, which makes sense and tends to be the case when inflationary environments are here.

Pretty much, these two assets diverge in price when domestic outlooks go on the negative, such as the ones we expect to see shortly, so we will be hedging our short $IWM with enough longs in $IVW, but how much of each?

To save you time on the math, we have a delta hedge ratio of 0.5185. This means that for every 1 share long in $IVW, we want to short 0.5185 of $IWM to be as neutral as possible.

That’s all for now, folks. Keep up with this trade live on our Twitter feed, as we’ll announce how and when we put it on. 👀 

NOW GO AND MAKE IT HAPPEN
Retirement Knowledge

Over 50 years of futures trading experience has been brought to you by one of the best out there. Larry Williams goes over some of the strategies and things to look out for when trading and gauging the market.

Today’s book recommendation 📖 helped me understand some of the intricacies of futures trading and indicators, which help me shape my strategies today.

To your success,

G. 🥃