Bad Santa Rally

12/19/24 Prospero.Ai Investing (179th) Edition (Midweek)

Before we get into our letter, we are working on an exciting new project! We will train an AI to answer questions as close to how our CEO, George Kailas would as posslible. We’d love your help. Ask us anything here - it will not only make our AI smarter but he will personally answer all the questions we get.

If you're like a lot of people yesterday, you got home and looked at your portfolio, or maybe glanced at it when I was supposed to be paying attention during a meeting, and realized that the stock market took a massive nosedive. And when I say "massive", the market lost over $1.8 TRILLION dollars in market capitalization yesterday. No, not a Billion. Almost 2 Trillion dollars. What in the world happened? Well, in their meeting yesterday, the Fed came out with some hawkish comments that inflation might be returning slightly, and hedged on their dovish outlook for 2025. But when you look behind the curtain, you realize the reasons for the drop are a little more nuanced than some slightly negative words from Chairman Powell. So, what was the REAL reason for the drop yesterday? It can be boiled down to one word: LEVERAGE. (Read full letter from our reader James Baker to dive deeper down the leverage rabbit hole) Bottom line is that hedge funds and retail are ALL IN with this market. A recent study by Bank of America showed that Cash positions are at their lowest point since 2001! (Dot Com Bubble). Folks are betting BIG on this market. Why? The two primary answers are 1) Crypto is hitting the mainstream. 2) There are headlines from the media just about every day, reminding us that the S&P and Nasdaq hit another all time high. Everyone is emptying their cash reserves and buying stock. Then using margin and buying more stock. Whenever there is THAT much money bet on one side of the market, then it presents an opportunity for a lot of money to be made. Our CEO has one unversal piece of advice for retail. “Don’t use the same playbook, Wall St. always has a new play.” Just as Wall St. can Stop Hunt, leverage hunting is even easier. With the right catalyst moving down they know they can buy Puts, short to add more downward pressure and the market will cave as margin is called. Retail typically does not have much leeway with their leverage, and pushing retail out in both the Crypto and regular markets is what caused such a big fall in George’s opinion. This also explains the rebound this morning. Whether it was intentional by some Wizard of Oz Market Maker on Wall Street, or just some algorithm realizing that retail was leveraged to the hilt, Powell's words presented an opportunity to make a lot of money with a quick and violent correction. And make no mistake, if you were short the market yesterday, money was made.

Now, let's take a step back and look at Prospero's signals over the last couple of weeks. We saw this coming. The first sign of trouble was when SPY Net Options sentiment made a huge bearish divergence with QQQ a couple of weeks ago. Even though QQQ was still in the 40's (bullish), SPY dropped down into the 10's. If you've been following us for awhile, you know that whenever SPY drops to major lows, that means that institutions are very short on SPY and are expecting (or preparing) for something. That drop in SPY had us pretty concerned. But, QQQ was still really bullish…until it wasn't.

Yesterday just after market open QQQ Net Options Sentiment went below the Bull line. That decline accelerated into the biggest Bearish pattern we have seen in months. About 30 minutes before Chairman Powell began to speak, I got concerned. I literally said out loud "OH CRAP!". I got rid of all my calls on NVDA and COIN and bought Puts on SPY. Sure enough, the Fed Minutes were released and they weren't great. When the Chairman gave his press conference it got worse. The VIX spiked to 28 and the market fell off a $1.8 Trillion Dollar cliff. I reached out to George (our CEO) to make sure he knew about the spike in VIX and decline in QQQ, and he replied: "I know. Shit just got weird!". I laughed out loud. Weird is one way to put it.

So what's next? As of the writing of this letter (pre-market), the dip is slightly being bought. But we urge caution. It's important to remain VERY defensive in this market until a clear direction emerges. At market open, if Net Options Sentiment is still well below our bullish line, then we could have more downside left to go.

A WORD FROM OUR CEO

This was an interesting week. If we have a regret it was that we went into yesterday with 9 longs and 6 shorts with SPY Net Options Sentiment at 7 the 17th and QQQ closing at 52 the 16th and 43 the 17th. We would have liked to be positioned closer to even long/short in retrospect. Nonetheless we were pretty well hedged and have a higher SPY beat than we did Sunday! We are currently beating the S&P 500 by 81% annualized, with a win rate of 59% against SPY benchmarks.

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Bad Santa Rally

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