Weekly newsletter of Danny Merkel - Issue #90
Market Review:
Whether you’re long or short, it was likely a challenging week for you, as it was for me.
With my portfolio heavily skewed towards the short side, I wasn’t exactly thrilled with Monday’s sharp bounce, although I was expecting a short-term bounce at major gap support as shown below:
DJIA daily chart (2019 - present)
As I discussed in issue #88, the DJIA had the potential to find support at a major gap zone, but I’d like to expand on that now.
My view is that the COVID crash was ushered in by a gap down in late February 2020. Later on, in November 2020, a major gap up was produced, which created a sort of island and paved the way for higher prices going into 2021.
And it was this double-gap support zone that held up and provided support for this Monday’s bounce. But before we get too excited about this new bounce, bear in mind that the long-term trend remains down.
The trouble with bear-market bounces is that they’re like castles made of sand; they may look impressive to amateur traders, but they inevitably crumble away.
For example, the QQQ’s rally completely crumbled on Friday and even formed a new gap down.
In my opinion, gaps are extremely important and need to be studied carefully. The only thing that is more important than gaps is the long-term trend so, logically, gap downs in a bear market warrant serious caution.
As the chart below shows, most gap downs within this ongoing long-term downtrend have been major red flags:
QQQ with long-term trend (100 & 150ema)
With almost all gap downs (red circles), price either proceeds directly lower, or stalls out for a while and then proceeds lower. Either way, bear markets and gaps are a dangerous mix, which is why Friday’s gap down looks especially toxic.
As a side note, this Monday’s gap-up created a lot of bullish chatter on social media, but gap ups in bear markets can largely be ignored (asterisks in chart above). There are a million reasons one can think of to fight the trend, but trading is easier if you don’t.
Individual Stocks:
In bear markets, surprises tend to be unpleasant and each week brings new unpleasant surprises to those who choose to fight the trend.
One of this week’s unpleasant surprises involved a 16% decline in TSLA. Because the stock had such an extraordinary run in the past, it remains a crowd favourite today. In the chart below, notice how past rallies occurred when price broke out of a tight base to new all-time-highs:
For example, TSLA surged in early 2013 to a new ATH on volume that was about 10X the average. This magnificent rally was later digested as price consolidated throughout 2015 and 2016 and broke out again on even higher volume in December 2019.
These historical buy-points illustrate exactly what I’m looking for in terms of the idle stock to buy and is something to keep in mind for future bull markets.
But in order to take advantage of future bull markets, one needs to preserve capital in today’s bear market, and that is what the typical amateur trader fails to understand.
Today, TSLA’s chart is forming the opposite of what I’m looking for in a stock. First of all, all of the indices are in bear markets, which is the opposite of the previous idle buy points in 2013 and 2019.
Secondly, price is starting to break down from a large base on the monthly chart and a dip below support (red arrow) would be quite bearish.
To be more specific, if TSLA breaks below its base, there is a huge “air pocket” meaning there’s no logical support until price collapses back down to its previous December 2019 high.
All of this bearishness might be a turn off for some traders, especially for those who are 100% long-only. In fact, I recently had lunch with a former member in Dubai and I had the opportunity to ask him in person why he canceled his subscription and it was precisely for the reason I thought: I’m permanently bearish.
While it is true that I’m bearish at this moment, it’s not really the case that I’m permanently bearish. It’s just unfortunate timing that I started this newsletter at the very top of a massive speculative bubble, but had I started it earlier, it would have been a different story.
For instance, this is how my portfolio looked like in August 2019:
Notice how I’m long the Grayscale Bitcoin Trust. That is because at the time, GBTC was in an uptrend, making new highs and so I was bullish and long.
But if you just read my newsletter - such as Issue #68 when I called Bitcoin a liability akin to a ‘bag of garbage’ - you might think I would have never touched Bitcoin.
That’s the essence of Trend Following though- going long or short any asset class in the direction of the trend. And today the trend for almost all stocks is down, so I have no choice but to be bearish.
As of right now, Tesla along with literally every major tech stock is careening to new lows as shown by this FANG Index ETF:
FNGU weekly (2018 - present)
If something is making a new 52-week-low and you remain bullish, then you are simply fighting the market. This particular ETF is down 88% from its high, so why be bullish all the way down?
However, there is no question that new, fantastic bull markets will emerge in the future and I will turn optimistic again eventually.
The only question is how much of your account capital did you preserve during this difficult time so that you can take advantage of the next bull market?
Real-Estate:
Back in Issue #74, I made the observation that real-estate in places such as Canada and other countries were in a bubble.
But I also mentioned that you never want to short a bubble until you have solid confirmation that the trend has changed, and there is now plenty of evidence of that.
Even though one cannot sell an actual house short, the next best thing would be the iShares Residential Real Estate ETF:
Trading under the symbol REZ, the price action of the chart above looks horrendous.
From a purely technical perspective, I wouldn’t want to be long real-estate with this ETF hitting new 52-week-lows. I’m also bearish on real-estate based on fundamentals, but given that I’m not that smart when it comes to fundamentals, I’ll let somewhen who is much smarter than me - Nassim Taleb - do the talking for me: