I am sitting on the Johns Hopkins campus right now. And I’ve pulled open my computer to assess the markets. Just like last time I traveled, momentum for the S&P 500 went negative. In fact, it’s gone negative at the fastest pace since October 2020. There has been a massive selloff in commodities. Gold prices are off 4.6%. Oil prices have slumped about 2.7%. The U.S. dollar is on the rise as investors race to cash.
This is a classic shakeout. Speculators are dumping positions. Investors who have been buying on margin are being caught in the crosshairs. This is what happens when the market is so centered around what the Federal Reserve will do. It’s less about fundamentals. Technical numbers aren’t that critical right now. It’s all about the Fed’s coming efforts to take the training wheels off the economy. My expectation here is simple. The pain will last a little while longer. But it will create new buying opportunities.
As I’ve noted, institutional buyers were moving heavily toward cash in recent months. There’s a reason for this. They are expecting to see a 3% to 5% downturn in equity prices. This will gladly buy into strong companies from retail investors. The latter category of investors have been net buyers during the recent run up. I move to cash when my momentum indicators go negative. I know that sounds downright insane to some people, but that’s what has worked.
Leverage For When Momentum Goes Negative
In addition, I like to look at other ways to leverage the rest of the market’s race to cash. That’s found in the Invesco DB US Dollar Index Bullish Fund (NYSE:UUP). This fund is a simple way to play the U.S. dollar against a basket of different currencies around the globe.
It’s bounced back over the last week as questions around the Fed’s policies heat up. But there are two advantages to this fund that a lot of people overlook. First, this fund has moved at an inverse relationship to the S&P 500 over the last year. So, when market momentum is negative, I’m buying into the U.S. dollar through this fund. And when market momentum goes higher and investors move cash off the sidelines, I’ll look to short UUP.
The second benefit of this fund is the leverage potential in its options chain. Currency funds don’t experience a significant amount of volatility. That keeps the implied volatility relatively low. Right now, you can pay $24.75 for a single share of UUP or $2,475 for 100 shares. Or, you can go out to September 17, 2021, and purchase a $24.00 call option for $0.81. You would have control of the same 100 shares for just $81.
This contract would give you the right, but not the obligation, to purchase 100 shares of the stock on or before September 17. You’re effectively paying just $6 for 92 days until expiration. You’ll effectively replicate the returns of the underlying asset at a fraction of the price.