M2K1! trade ideas
MICRO E-MINI RUSSELL 2000 INDEX FUTURES (CONTINUOUS: CURRENT CONVery strong landing and with the break of a very excellent support area and there is a great likelihood that he will continue landing
The Great Wall Street RepricingEquity Indexes: CME Micro S&P 500 ( CME_MINI:MES1! ), Micro Russell 2000 ( CME_MINI:M2K1! )
On August 26th, Fed Chairman Jerome Powell declared to forcefully fight the worst inflation in 40 years. He warned that the Fed would continue raising interest rates, even if it would cause "some pain" to the U.S. economy.
In an eight-minute speech at the Jackson Hole Economic Symposium, Chairman Powell said that higher rates could persist "for some time." "While higher interest rates, slower growth and weak labor market conditions will lower inflation, they will also cause some pain to households and businesses," he said. "These are the unfortunate costs of reducing inflation. But failure to restore price stability will mean even greater suffering.”
"Price stability is the responsibility of the Fed and the cornerstone of our economy," he said. "Without price stability, the economy doesn't work for anyone."
Stock market fell immediately in response to the Fed’s hawkish tone. By the end of the day, the Dow plunged over 1000 points, or 3.03%. S&P 500 and Nasdaq 100 tumbled 4% and 4.4%, respectively. Russell 2000 closed below the 1900 mark, down by 3.3%.
A New Game in Town
In the past decade, US capital market operated under the assumptions of low interest rate and low inflation rate. They have been effectively overturned. In addition, we also face heightened geopolitical risks in Europe and supply chain bottleneck in the aftermath of a global pandemic.
In a new investment regime, all financial assets would go through market repricing.
To navigate this new paradigm with rising interest rates and high inflation, we will launch a series on the repricing across major asset classes in this new regime. This week, we deep dive into the repricing of US equity index. Upcoming stories will follow up on interest rates, foreign exchange, energy, metal, agricultural commodities among others. We will also re-visit our previous trade ideas whenever appropriate in this series.
Equity Indexes Will Decline Due to Higher Cost of Capital
The discounted cash flow (DCF) pricing theory states that stock price is the present value (PV) of expected future cash flows discounted by the weighted average cost of capital (WACC).
Let me illustrate this concept using a $1 million payment, to be received in five years.
• For a company with excellent credit score, we could use Moody's Aaa Corporate Bond Yield as our WACC.
• Moody’s Aaa bond yield is quoted at 4.18% today, up from 2.52% a year ago.
• PV discounted by a 2.52% WACC is $883K. PV with a 4.18% WACC is $815K.
• When the cost of capital goes up, present value drops by 7.7%.
Fed rate hikes would raise borrowing cost for all US corporations. Therefore, stock prices across the market should decline due to a higher cost of capital, other things equal.
Last Thursday, in an interview with CNBC, St. Louis Fed President James Bullard claimed that his year-end target Fed Funds rate is 3.75%-4.00%. After Powell’s hawkish statement, I have good reasons to believe that Fed Funds rate would reach 4.50%-5.00% by the end of 2023 and stay at that level for at least a year.
Triple-A corporate bond yield is usually 200 basis points higher than the risk-free Fed Funds rate. Going back to our $1 million example, A 7% WACC would yield a PV of $713K. This represents a 12.5% discount from the current PV of $815K.
Of the 500 companies in the S&P index, only two have Triple-A rating. Nineteen are rated from AA- to AA+. And 119 are rated from A- to A+. This indicates that the borrowing costs for S&P component companies are higher than the Aaa bond yield. They could face a bigger hit in a stock market repricing.
Based on this logic, I expressed my view by shorting US stock index futures on June 22nd, as in my story titled Bear Market is Far from Over .
What about smaller companies, such as those in the Russell 2000? They usually have lower credit ratings and higher borrowing costs. Moody’s Baa Corporate Bond Yield is 5.13%, nearly 100 basis points higher than the Aaa yield. One year ago, it was 3.31%.
If we assume an 8% WACC for Russell 2000 and go through the same exercise, the $1 million future cash flow will have a PV of $681K, down 13% from current level.
Up to this point, we focus on just one factor, a higher borrowing cost. In an economic downturn, companies would incur lower revenue and lower cash flow. Smaller companies could be impacted more significantly.
Let’s further assume that our $1 million in five years will be down by 10%, to $900K. With an 8% WACC, the PV is now $613K, down 25% from current level.
With double hit from higher borrowing cost and lower expected cash flow, Russell 2000 is more vulnerable to a repricing risk compared to S&P 500.
In addition, Russell 2000 is overpriced with a trailing price earnings ratio (P/E) of 66.78, compared to a 22.84 P/E for S&P 500.
I further expressed this view by shorting CME Micro Russell 2000 (M2KZ2), as in my story “A Tale of Two Americas” on August 7th. Friday, Russell fell 65 points (-3.3%) and closed below 1900 points.
With three more possible rate hikes before the December contract expires, there might be some room for the Small-Cap index to fall. My view on shorting Russell stands.
Financial market is extremely volatile this year. Getting an information edge increases your odds of success in managing risk. I suggest leveraging real-time market data for a better gauge of market situation. Tradingview users already have access to delayed data. A Pro user could upgrade to real-time CME market data for only $4 a month, a huge discount at the time of high inflation.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
RTY1! - Weekly Market Update, 8/29Russell 2000 approaching support @ 1889
Followed by its 50 day SMA, below which several structures could catch price as well.
Should price fall past our prior lows set, the next leg down of a bear market will be what we're looking at
RTY UpdateRTY MFI is already overbought.
I don't recommend shorting anything but be cautious on small caps. NQ is heading to overbought rather quickly too. We could see some whipsaw to end the week.
Bullish on China though, only because HSI is oversold.
Will we bounce off the POC from this recent consolidationwatching for a bounce today at this most recent consolidations POC
RTY1! - Weekly Market Update, 8/22Russell 2000 Futures have found resistance at the 200 day SMA.
Price penetrated but failed to settle above which is concerning.
We await failure and the next leg down from here or a rally through and settlement above.
RTY UpdateUnlike ES and NQ, RTY already hit oversold, and small caps tend to fill gaps. I'm looking at a bunch of crap stocks like W that seem to be acting like they want to fill the gap tomorrow or Monday.
IWM is probably your best bang for the buck if you're bullish on indices.
I would stay away from meme stocks, though it could be an up day for those as well.
RTY Almost oversoldI still don't think that was the top, looks to me like we get another pump when RTY MFI gets oversold.
Was busy timing my AMC play, lol. Dumped on the gap fill overshoot and just re-entered, figured it wasn't gonna go down more than a buck. Might wind up being a day trade, planning on bailing if teh market doesn;t kick up after the Euro markets close.
Seems to me like small caps went a little overboard on sell, but the Euros finally dumped so there could be another gap down tomorrow.
RTY UpdateThe melt up and short squeeze continues. I have it continuing until next Tuesday when RTY hits the resistance zone.
I don't normally play melt ups but bought some AMC calls for kicks and giggles on the dips this morning. If the market is acting stupid, then you need to be stupid too, lol. The only way to make money is to go with the flow.
Prediction is up tomorrow, a dip Thu and Friday open, then full pumptardedness until Tuesday.
RTYIs the melt up over? Seems like RTY rolled over, and the squeeze appears to be over except meme stocks like AMC
RTY not much to add since my last updateWe are at the first maj resistance - 110MA Weekly magnet.
RTY hit 200MA on daily, while others are lagging behind.
- 2032-85 is where I think this move will be capped, if we actually extend above 110MA.
It can still extend up to 2084-2108
I expect tomorrow red close
Russell2000 Trading The Bullish SequenceIn this update we review the recent price action in the Russell2000 futures contract and identify the next high probability trading opportunity and price objectives to target
RTY1!8.14.22 Yesterday I gave you my overview of the Russell and the es mini from a longer timeframe perspective. I went back and took a shorter timeframe perspective on the Russell, and compare it to the longer time frame thinking. I tried to discuss the advantages and disadvantages. I tried to describe a psychological aspect from my point of view, and I'm very much aware in my own trade decisions what the triggers are for my stress. Most of the time I would say that you should look at the Behavior of the market in an "objective "way...based on your observations of market behavior...which can definitely be done, but not all the time. The example I pointed to in this video found the reversal point, but the market came back close to it without making a new low 4 weeks, and from my point of view that's going to be a tough trade for me... and explain why. It doesn't matter if the market never goes below my entry, It doesn't really appeal to me to stay long in a market that doesn't move any significant range off the bottom and for three or four weeks it keeps on coming down to my entry. That is not my concept of Joyful Trading index futures. That's a function of me, not the market. Take a look at it and see what you think as it pertains to you.
RTY is overextending on the upside and downsideI haven't look at RTY for a while now, till the Fri close where I shorted it at 2015.50, willing to add if we stretch into the maj resistance zone right where the upper Bollinger is, that is also a 2.618 extension off the lows
RTY is overextending on the upside and downside compare to SPX .
We hit 50% retracement off 2020 lows in June and I see the whole way as 5 down and 3 up here.
We hit 110MA on Weekly as well as 200MA on Daily. If it's acting as it was on the way lower, SPX might not even reach 200MA in this case.
We are at the very top for this bear market rally, it can still extend up to 2084-2108
We are also at/near 61.8 off Mar high and Jun low as well as near 50% off the ATH and Jun low retraement
I will update the target for the Oct low after I see confirmations of the top.
For all the urban (RTY) traders in this market in the coming dayFor all the urban (RTY) traders in this market in the coming days, due to the formed reversal candle, equal to the number of buyers in the last 1h, which is shown in the drawn circles
Rty1! ES8.13.22 The Russell and the ES have foolish Swings, but the bigger pattern suggests that these markets will move lower and possibly make new lows. The bigger picture is that we are probably in a significant bear market....And I would be waiting for my trigger too short....As well as taking profits on the swing higher.
RTY1! - Weekly Market Update, 8/15Russell 2000 Futures post new BUY signal.
We'll need to overcome the 200 day sma to approach our projected target
Elliott Wave View: Russell 2000 (RTY) Likely See Further UpsideShort Term Elliott Wave View in Russell 2000 suggests the rally from 6.17.2022 low is unfolding as an impulse Elliott Wave structure. Up from 6.17.2022 low, wave 1 ended at 1795.1 and pullback in wave 2 ended at 1680.6. Wave 3 higher is in progress as a 5 waves impulse structure. Up from wave 2, wave ((i)) ended at 1783.6 and pullback in wave ((ii)) ended at 1682.3. Index then resumes higher in wave ((iii)) towards 1920.7, and dips in wave ((iv)) ended at 1884.7.
Wave ((v)) is currently in progress as 5 waves in lesser degree. Up from wave ((iv)), wave (i) ended at 1959.8 and dips in wave (ii) ended at 1904.1. Index then resumes higher in wave (iii) towards 2008.7. While wave (iv) dips stay above 1884.7, Index can see 1 more leg higher to end wave (v) of ((v)). This should complete wave 3 in the higher degree. Afterwards, Index should pullback in 3 , 7, or 11 swing within wave 4 before it resumes higher again in wave 5. This should complete the cycle from 6.17.2022 low before a larger pullback happens to correct that cycle.
