Bill Gates Meets the Butcher (MSFT,XLU/XLV)

Before we discuss today’s jackpot winning trade, we have one to close.

And it goes like this –

On the 16^th of December, we sent you a letter called Down to Your Last Nickel, in which we urged you to purchase the XLV June 19th 92 PUT for $1.98 and sell the XLU June 19th 63 PUT for $2.00.  Total debit on the affair was $0.02.

And today?

The long XLV trades for $1.17 and the short XLU for $0.91.

Sell the former, buy back the latter and you net $0.24 on two cents down.

That’s 1200% in six weeks, friend.

Mm, mm good…

Today’s trade arrives with the following backdrop –

First, sentiment.

As the weekly AAII Bullish Sentiment chart (below) shows, Main Street investors are now more bullish than they’ve been in the last two years.  But more significantly, bullish levels have also reached those that preceded the January 2018 leveling, when the S&P 500 dumped 12.5%.  They also exceed the calamitous decline of the winter of 2018, when the S&P dropped 20% and the NASDAQ 23%.

Have a look at the chart –

Current bullish levels have not reached historic highs, granted.  But a great number of risk factors are currently baked into the pie that make this an especially dangerous time to be a bull.

They include –

• The coronavirus, which threatens to restrain Chinese retail spending in a wholly disproportionate way (with all the ripple effects that would entail),
• An oil price spike emanating from the mushrooming conflict between the U.S. and Iran, and
• Weaker than expected global growth.

At the same time, we see markets dominated by fewer and fewer names as each new high is notched.

Dangerous Concentration

The following chart shows the percentage weight of the five biggest S&P 500 stocks.

And as you can see, the last time the big five swung a wurst of this heft was back in the year 2000, at the height of the dot.com bubble.

Have a look –

This year’s big five include Facebook, Microsoft, Apple, Google, and Amazon (F – MAGA).

Only Microsoft (NASDAQ:MSFT) made the list back in 2000, and for bearing that honor it fell 67% in the ensuing twelve months.

Will it happen again?

We think a decline is certainly in the cards, though the magnitude is far from clear.

Have a look at MSFT for the last six months –

Several items to point out here, starting with…

1. An exaggerated, three month 25% rise (in red) that culminated in
2. A bearish engulfing pattern (in blue), that’s very often indicative of a top.
3. Add to that, negative divergence from the RSI for the last month, a signal that buying momentum is weakening (in green), and
4. An imminent MACD rollover,

And you have all the makings of slushy sledding ahead.

The most damning evidence against the schemers from Redmond, however, issues from the weekly chart, which tells no lies, bars no witnesses and possesses unimpeachable bona fides.

Have a gander –

The technical picture from the weekly is plain bad.

Consider –

• Most ominous is the weekly overbought read (in green), from which one can expect – at best – a sideways drift, and more likely a meaningful pullback.
• We also see an eight month rising wedge (in red), whose front edge is narrowing rapidly – meaning a resolution to the formation is in the immediate offing.  Any decline below the bottom edge of the wedge would trigger a cascade of selling among technical traders.  A rising wedge is always a bearish formation.
• We note, too, that the last half year’s gains have occurred amid shrinking volumes (in black) and that the last touch of either of the long term moving averages was back in 2013.  Under normal, healthy circumstances this would occur every two or three years.

And it’s with that in mind that we’re selling a CALL spread and using the funds to purchase a PUT spread.

Like this –

A Jew and His Money recommends you consider selling the MSFT July 17^th 170 CALL for $7.30 and buying the MSFT July 17^th 180 CALL for $4.25 for a credit of $3.05.  Then, buy the MSFT July 17^th 155 PUT for $5.80 and sell the MSFT July 17^th 145 PUT for $2.93, for a debit of $2.87.  Total credit on the trade is $0.18.

Maximum profit on the venture is $10.18.

Maximum loss is $9.82.

With kind regards,

Hugh L. O’Haynew

Follow @HughLOHaynew