The 'Dumb Money' Is Making a Frightening New Bet

The market's biggest extreme grows bigger... The 'dumb money' is a making a frightening new bet... Signs of a bottom in China... The 'National Team' is back... LAST CALL: How to make money no matter where the stock market goes next...

Regular Digest readers know Steve Sjuggerud has been tracking an historic sentiment extreme in the U.S. Treasury market...

Speculators – as tracked by the U.S. Commodity Futures Trading Commission's weekly Commitments of Traders ("COT") report – have become incredibly bearish on bonds.

In recent months, these folks have racked up an all-time-record short position on 10-year Treasury notes. And because bond prices and yields (interest rates) trade inversely, this means these folks are also making a record bet that long-term interest rates will move higher.

Why is this important? Because these traders are also known as the "dumb money." They're essentially trend followers, and when they're all crowded on the same side of a trade, it's often a big warning sign that the trend is due for a reversal.

Again, these folks have recently been making a massive bet that bonds will fall, and interest rates will rise...

When we checked in on this situation earlier this month, we saw that speculators were short nearly 600,000 contracts in 10-year Treasury futures.

That was the largest short position in history. But no longer... According to the latest COT data released last week, these folks are now holding a net short position of more than 700,000 contracts.

What's more, this extreme has continued to grow even as interest rates have been falling. The yield on the 10-year has fallen from 3% early this month to less than 2.89% today. Typically, we'd expect to see these traders reduce their short positions as rates fall. But that hasn't been the case this time. Instead, they've been adding to them.

In short, the latest data continue to suggest Steve's prediction will be proven correct: Long-term interest rates are likely to move significantly lower in the months ahead.

But this isn't the only record bet speculators are making in the bond market right now...

They're also making a massive bet on the yield curve, too. As news service Reuters reported on Tuesday...

[Speculative traders] are doubling down on their bets that the U.S. yield curve will steepen... The latest [Commodity Futures Trading Commission] figures show hedge funds and speculators now hold a record net short position of 700,514 contracts in 10-year Treasury futures, and a short position of 97,333 contracts in two-year futures.

That's the second week in a row the difference between the two has been more than 600,000 contracts, an unprecedented gap since the tracking of CFTC positioning data started in 1995.

In other words, these folks aren't just betting 10-year yields will rise. They're also betting that they'll rise faster than two-year yields, causing the difference or "spread" between the two to widen.

As we've discussed, this "2-10 spread" is the most widely followed measure of the yield curve. Whenever this spread has narrowed and "inverted" – or fallen below zero – bear markets and recessions have predictably followed several months later.

Today, the "dumb money" is confident the yield curve will avoid inversion in the months ahead. History suggests they'll be wrong... But we may not have to wait long to find out.

The 2-10 spread has fallen from a high of 0.33% on August 1 to a fresh 11-year low of just 0.18% on Monday. At this rate, we could see inversion by October.

Speaking of Steve's big predictions...

Regular readers know he has been incredibly bullish on Chinese stocks for the past couple of years.

Despite the recent sell-off in these stocks, that remains the case today. In fact, as we noted earlier this month, Steve says nothing about his long-term bullish thesis has changed.

Still, he has been cautious in the near term. He has recommended readers follow their trailing stops, if necessary, and wait for the uptrend to resume before getting back in to any closed positions.

Fortunately, history suggests this might not be far off. As Steve explained in the latest issue of True Wealth Opportunities: China, published last Thursday...

Just this week, the Chinese government stepped in... It "intervened" in the stock market. It started buying stocks.

This is likely to create a floor for Chinese stock prices.

Now, we're not proponents of government intervention in the markets...

We believe markets generally work best without interference. But as Steve explained, there is no denying that several countries – including China itself – have successfully used similar measures as a temporary "Band-Aid" in the past. More from the issue...

Chinese stocks crashed by more than 40% from their June 2015 highs to their August 2015 lows... Specifically, China's Shanghai Stock Exchange Composite Index peaked near 5,200 in June 2015, and then crashed to near 2,900 by late August.

The speed of the fall was crazy... For comparison, in the U.S. dot-com crash, the Nasdaq Composite Index peaked above 5,000 in March 2000. It didn't close below 3,000 until November – more than eight months later. (And we called that a crash!)

China's government saw what was happening... And it didn't want to sit idly by as the market went into free fall.

As Steve noted, the government tried other measures first. It cut interest rates. It even granted government pension funds the right to invest up to 30% of their assets in the Chinese stock market.

But these moves weren't enough, so it then began directly intervening in the stock market itself...

The "plunge-protection team" kicked in... The government actually started buying stocks. It lent money to brokerage firms so they could buy stocks. It also banned short selling. And it prevented big holders of stocks from selling shares.

I say "it." But it wasn't one entity... It was a team effort – across government-owned financial institutions. The press calls it the "National Team." And in 2015, its biggest task was to step in and save the stock market.

Again, if you're like most folks, this kind of government intervention likely sounds extreme and even unprecedented...

But it worked... and it has been used successfully even in "free market" economies, too. One of the best examples is Hong Kong, during the 1998 Asian financial crisis.

As Steve explained, currency devaluations were spreading across Asia that summer, and even relatively strong markets like Hong Kong were not spared from the fallout. The entire Hong Kong market plunged by 25% in a single month as the crisis spread and short-sellers piled on.

But then the government stepped in. It bought $15 billion worth of blue-chips stocks over just 10 days to help temporarily support the market. And again, it worked...

Hong Kong stocks rallied nearly 20% during that time as many other Asian markets were crashing, and they never looked back. In fact, despite other bear markets since – including a severe decline during the global financial crisis in 2008 – the broad Hong Kong market has never come close to revisiting its August 1998 lows.

Of course, not every government intervention has been as successful...

Perhaps the most notorious example is Japan. Its government has been aggressively buying stocks – through exchange-traded funds ("ETFs") for nearly a decade. While this has certainly has helped push Japanese stocks higher, there is little evidence it has spurred any kind of lasting recovery.

To Steve, the reason is simple. As he explained, "successful" government interventions require two specific things...

1. Investors and speculators need to believe that the government is absolutely serious about carrying out its mission... In short, speculators need to believe that it would be stupid to bet against the government at this moment.
2. The timing has to be good. The market needs to be near a turning point already... And then – with a massive nudge from the government – it can make that turn.

Steve believes this is the case in China today...

The Chinese government certainly proved in 2015 that it isn't afraid to act to support the stock market. And he believes the market is already near a turning point... Chinese stocks are dirt-cheap and more hated than they've been in years.

Yet he also noted that even successful interventions don't always work immediately...

China's National Team intervened in the summer of 2015. It slowed the bleeding... But it did not stop the bleeding completely. It took about five months before the Shanghai Composite ultimately bottomed in January 2016 – at around 2,650.

This number is important actually... because just this week – here in August 2018 – the Shanghai Composite was about to touch those 2016 lows. The rally stopped that from happening. You can see it on the following chart...

In my opinion, someone important in China decided that Chinese stocks were not going to fall below the levels of the 2016 crash. I don't have proof of that, of course. However, I suspect that the National Team could defend the 2016 low... and that the National Team won't let the Shanghai Composite fall much below current levels – if at all.

In short, Steve believes the government's actions are likely to provide a 'floor' for Chinese stocks...

But as usual, he is waiting for confirmation before getting too bullish again. As he explained...

My opinion is that we are close to a low. The National Team is here. However, I can't in good conscience pound the table and scream "BUY CHINESE A-SHARES!" when the downtrend is still in place.

For now, we will continue to play it safe, and follow our trailing stops. I hope that – with the help of the plunge-protection team – the bottom is near and we can get back to making money again. But we need to be smart.

I strongly believe that – sometime in the next five years – Chinese stocks will soar more than 100% within 18 months. That time is not here yet.

Finally, a quick reminder before we sign off tonight...

Earlier this week, we mentioned our colleagues Ben Morris and Drew McConnell have introduced a brand-new strategy to their DailyWealth Trader service. As we noted, this strategy – known as "pairs trading" – is ideally suited for today's market environment.

But if you're interested in learning more about how you can put pairs trading to work in your own portfolio, you're almost out of time. Ben's detailed presentation – and his special offer to try DailyWealth Trader at a big discount – will be taken offline at midnight Eastern time tonight. Click here to read it now. (This link does not lead to a video.)

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In today's mailbag, a new Stansberry Alliance member shares a remarkable success story. What's on your mind? Let us know at feedback@stansberryresearch.com.

"Hey Porter, I want to update you on my progress. Back in 2015, I set out to earn the CFA Charter, largely due to that old valuation video you did [on your old podcast], among other things. I have no college degree, I tried that 2 separate times and made it a whole quarter both times. It just wasn't for me.

"I failed the Level I exam in June of 2015, but finished in the top 10% of those who failed. I took it again on December that year and passed. Then, I tried to pass Level II the following June (2016), but failed, finishing in the top 40% of failures. I sat for the Level II exam again in June of 2017 and failed again – top 10% this time... Finally, I sat for the Level II exam a 3rd time this June, 2018, and I'm pleased to report that I passed. I'm officially registered for Level III in June 2019.

"Guess what I've not had the entire way? A TEACHER. Just you. Funny how that works. I can't thank you enough... for all you do... for your candor, honesty, integrity, rigor, time... THANK YOU.

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Regards,

Justin Brill
Baltimore, Maryland
August 29, 2018