Alex Cho
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Pitfalls to Following Soros Into The S&P 500 Short

So, if you didn’t already know this yet, it seems like George Soros is doubling down on his bet against the S&P 500. If I had to guess why he’s getting so aggressive it probably has to do with rising oil prices, which will trigger inflationary readings thus prompting the fed to raise rates in response to higher consumer pricing in some of the more cyclical sectors like transportation.

Since Soros makes a lot of money betting against the prevailing trend, it’s hard to ignore him. But then again he’s adding to his short position while he’s also long certain stocks as well. This means that he’s not exactly certain on the timing of when a major correction will hit, or whether economic data will deflate as rapidly as 2007.

Remember, 2007 was a special year and anyone following stocks will never really forget the year where weekly moves entailed 500 to 1,000 points off the Dow Index. Hoping for a repeat of a monumental financial collapse seems sort of cringe worthy, and quite frankly, I find a bubble in credit many years away. Without a fully sustained recovery, and balance sheets of consumers not fully-levered, we simply don’t have the necessary ingredients to witness another massive wave of insolvency and even longer lines at employment fairs. You get the drift, if things were going to shit, I would be hitting the panic button too.

I’m not exactly a Soros follower, but I’m not going to deny I have a deep respect for the guy after reading some of his books. It’s hard to bet against a guy who’s established such a great strategy for macro allocations across commodities, indexes, and currencies. But, with the absence of compelling data, it seems like the fund manager is timing his allocation away from net long to net short as we progress through the cycle. Since he manages such a large sum of capital, it’s hard to move allocations to net short, so he’s taking his time to gradually shift the allocation so that he can play both the cycle and generate net alpha across growth stocks. It’s a strategy that seems to work for him, and while I don’t have the tools to back test his strategy, I can deduce that he’s milking the current cycle as best as possible while shifting allocation slowly to a short position.

Quoted from the Wall Street Journal:

The 85-year-old’s fund disclosed a 2.1-million-share “put” option in an exchange-traded fund that tracks the S&P stock index. Meanwhile, Mr. Soros—who has been warning of a repeat of the 2008 financial crisis, this time with China at the center of the storm—bought a 19-million share stake in Barrick Gold Corp., the world’s largest gold producer, along with “call” options in about 1 million shares in a gold-backed ETF set up by the World Gold Council.

I’m not going to join him on the gold trade, or bet against the S&P 500 in such a compressed time frame. Not every cyclical decline in equity prices requires economic recession, but generally, I’d prefer timing an exit out of the market in 2018 to 2019 with anticipatory trading likely in response to an issue in consumer credit in the 2020 to 2022 timeframe. In the meantime, here’s the best reasons for getting bearish on stocks.

Bank of America mentions these key points in a recent report:

An increasing number of charts in our work depict levels that are only prior to a bear market. The distress ratio is at levels that led the last two bear markets. Corporate buybacks, in aggregate, tend to top-tick the market, and the proportion of companies buying back shares is near all-time highs, at the same levels as the ‘07 peak. And the number of companies for which analysts forecast losses is at levels never seen without a bear market.

So, with Soros betting against markets, let’s observe some of the better arguments for why you would now start betting against markets.

Source: Bank of America

For the most part, HY ratio is a bit of an early indicator. Meaning that it could be a couple years before markets pop, so it’s really not as reliable.

Source: Bank of America

Okay, maybe this is a bit worrisome. Maybe we should think about this a little more. Yes, more companies are buying back shares. In each subsequent cycle the proportion of S&P 500 companies buying back shares have increased, so maybe we need to reach 70% to 75% before we start getting worried? Reaching a new peak should be worrisome, and in some cases the figure consolidates into a range, which goes back to the narrative of let’s give it a couple more years.

Source: Bank of America

Oh, yes back to the negative earnings theme? Okay, well…. It’s hard to rationalize our way out of this one. But, basically it takes a couple years before this thing starts to build up, and we’re only in the initial stages of earnings revision. Furthermore, there are sector specific issues like energy, and technology struggled this quarter as well. So, growth might not be as robust, but there may be sector specific issues distorting results. Furthermore, if we were to exit stocks based on this indicator, it would also imply that we could miss out on two-years of market gains before the wave of revisions start to get really worrisome. In other words, negative earnings predictions do pick-up as we progress to the latter parts of the cycle, this is well-known, but it’s still a two-year story.

I’m obviously not going to follow Soros into the trade. When looking over the more compelling data points, it still seems we’re a couple years before economic data catches up to the reality of falling stock prices.