The Fed On Your Side

As September has someway somehow come around so soon again, with its football, hurricanes and hints of Halloween (thanks Starbucks), the Fed has given us a rare but eerily reliable stock market the downside.

From the Blue Line Premium Service August 31st Weekend Update:

Three times in the past 20 years a prolonged series of Fed Funds rate increases peaked and then were followed by a series of rate cuts. The first rate cut after a series of rate increases had the same prescient message for the market: Hard down. The arrows in the chart highlight the reversals in Fed Funds rate direction as well as simultaneous reversals in the S&P 500.The message from this chart is that the market is at just the beginning of a multi-month move lower. 

This reversal in interest rate trend is both a warning and an opportunity. It points to September and the 4th quarter of this year as not to be a good time to be fully invested, or to at least be hedged in an inverse ETF on one of the major stock indexes. SH is an unleveraged inverse ETF for the S&P 500. It will go up more or less the same percentage that the S&P goes down. Accordingly it will fully hedge a stock portfolio without generating any tax consequences via long term capital gains. The ramifications of this hedge are worst case, market keeps going up and the gain in the market is offset by the loss on the hedge. Best case: The market crashes and you come out unscathed. 

Along with SH there are several leveraged inverse ETF's that are more than basic  1:1 hedges, they are designed to go up 2X or 3X the amount that a market index declines.  During the 4th quarter of 2018 there was a mini-bear market in which the S&P 500 declined 20%, the Dow fell 18.5% and the Nasdaq 100 fell 22.7%. During that same time, the Russell 2000 fell 24% while TZA,  its 3X leveraged inverse ETF, rose from $41.50 to $93.45 for a gain of 125%. Based upon the Fed Funds chart above, buying TZA right here right now could be the trade of the year. 

But we are not looking out for a generic 20% bear market. The two sell signals generated by the Fed Funds' reversals in trend shown in the chart above resulted in declines of between -80% (Nasdaq 2000-2002) and -50% (S&P both in 2000-2002 and again in 2007-2009). A leveraged ETF like TZA has the potential to do much, much, better in this kind of environment, leaving a mere 125% gain in the dust. 

The Ultimate Change-Your-Life Play

Let's stop throwing snowballs are start launching cannons. A 50-80% decline over 6-18 months means precipitous drops in 80%+ or more of the stocks listed on the major market exchanges. Puts on those stocks and market indexes will soar triple digits in a matter of weeks, or days. They will be sold, gains realized, and the proceeds placed in the next trade. The process will be repeated, albeit incurring some wipe-outs along the way, but in the throes of the bear, there should be at least 3 triple digit gains for every one that goes bust. Whereas losses are limited to 100% (less with any decent trade management system) there is no upper limit on gains. During that mini bear market at the end of last year some of our options were up 400-600% before expiration. If the Fed Funds signal is on the mark for a third time in a row, those ridiculously high returns will be closer to the norm than the exception. 

Potential like this doesn't come around very often. In fact, only three times in the last 20 years. But that third time has just happened, on July 31, 2019. Has the market given us any hint about what is coming next? You decide:

S&P 500


Russell 2000


And last, but not least, our secret weapon:


Bottom line (literally): This is a good time to be trading options, however you decide is best.