Cable Concerns Mount As Brexit Negotiations Begin Again

European diplomats began hashing out what they want from the next stage of Brexit talks this week, seeking a united stance they can present to the U.K. The envoys will start to discuss the ideal length of the transition phase, its scope, and whether the bloc would impose the EU’s “four freedoms,” including free movement of people. For now, cable has been relatively stable, but as Bloomberg’s Mark Cudmore warns, the pound’s resilience to negative news may not last much longer.

Via Bloomberg,

This week’s round of Brexit negotiations are absolutely crucial.

With the exception of the Bank of England’s Super Thursday, sterling has traded well in the past two weeks, shrugging off a host of domestic political turmoil.

That dynamic is persisting today. The market has shown little reaction to the FT story that major financial institutions are close to a Brexit “point of no return” after which they’ll start moving “thousands” of jobs out of London, or to reports that Theresa May is on the verge of losing a second top minister in a week.

When a market shows an asymmetrically positive reaction to news, it’s normally a bullish sign. But things may change soon.

Underlying positioning has played a particularly critical role in trading sterling this year.

March saw short positions reach the most extreme level in history, according to CFTC data. That was the catalyst for the Bloomberg Pound Index to rally by 6% in less than two months.

September then saw CFTC positioning turn positive for the pound for the first time in almost two years.

The market is now roughly neutral on sterling.

You can see this in the analyst notes from banks. Brexit bears have tired of aggressively playing that theme without reward. And since the main argument of sterling bulls was that people were overly pessimistic, that angle has also evaporated.

This leaves sterling fresh to trade on a new macro theme. All it needs is a catalyst.

The fundamental backdrop for the currency is very poor: extremely negative real yields, sluggish growth and a large current-account deficit. So, barring any solid arguments to the contrary, the path to a weaker pound is well marked.

There’s valid optimism that the U.K. is finally on the verge of making progress on a Brexit deal. But what is abundantly clear is that we are now past the time when any negotiations-disappointment will be ignored by currency traders.

Some clear positive must come from this week’s Brexit talks, otherwise it could be time for long-term structural sterling bears to come out of hibernation.

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Uh-Oh…Draghi’s Ammunition To Buy Italian Bonds Before The Election Is Less Than We Thought

Having successfully pulled off the announcement of the ECB’s “dovish taper” – where monthly bond purchases will be halved to Euro 30 billion from January 2018 – last month, a challenge for Mario Draghi in Q1 2018 has appeared on his radar. The ECB’s bond buying ammunition is slightly less than analysts thought and there is the small matter of the looming Italian election. The latter is likely to be held in March 2018, although it could take place as late as May. Veteran strategist, now Bloomberg columnist, Marcus Ashworth explains in “Italy’s Shrinking Safety Net”.

One of Mario Draghi’s hands is being tied behind his back just as bond markets may need his help the most. Data released by the European Central Bank this week show the ECB president will have reduced scope to buy Italian bonds if markets start convulsing ahead of the country’s general election in the spring. From January, the ECB’s Quantitative Easing program will pare its monthly bond purchases by 50 percent to 30 billion euros ($35 billion). Draghi has sought to soften this so-called tapering by emphasizing how the ECB can reinvest maturing bonds to pick up the shortfall.


There’s a hitch — the central bank said it intends only to reinvest proceeds from maturing bonds in debt of the same country. That leaves Draghi with only limited flexibility to use his buying power to the benefit of one country over another.

Monday’s release showed that proceeds from these maturing securities, which could then fund new purchases of Italian bonds is both less than expected and likely skewed until after the election. Ashworth provides us with the numbers.

Monday’s release showed that proceeds from these maturing securities which could then fund further purchases of government bonds, will only be about 8.5 billion euros, less than analyst expectations of as much as 12 billion euros. This means the pace of bond purchases under the QE program will fall by about a third from this year’s rate of 60 billion euros a month. The first quarter will be noticeably lighter in monthly redemptions compared with the rest of 2018. The big months for Italian redemptions won’t come until April and October.

This is inconvenient, especially as the ECB had already been “pushing the envelope” in terms of Italian purchases (and French), as Ashworth laments.

The ECB has already spent most of 2017 buying more Italian bonds than the capital key, a formula that determines how much of each nation’s debt the central bank can buy, would suggest. That variation is allowable – but it leaves little extra available slack to cut Italy.

Ashworth notes that the fragmented nature of Italian politics could lead to problems for the Italian bond market in the run up to the election. While the anti-Euro 5-Star is the largest party, its reluctance to form coalitions has significantly reduced its chances of forming the next government. While that’s a positive, Ashworth’s biggest concern is the reaction of the bond market if Silvio Berlusconi returns to, “or even near”, power. As we discussed in “Berlusconi: The Greatest Comeback Since Lazarus?” here, last Sunday’s Sicilian elections were seen as an important barometer for the upcoming national election and Silvio is on the comeback trail.

Nationally, the PD (center-left) is just behind 5-Star, which has 28% support. In the center-right bloc, Forza Italia and the anti-immigrant, Northern League, have 14% each, while the far-right Brothers of Italy have 5%. As media outlets emphasised, much of the Sicilian election campaign focused on the personalities of those involved, rather than the “big issues”, like the economy, jobs and immigration. Ironically, we suspect that Mr Berlusconi will revel in such a situation if it continues in the upcoming national election campaign. Besides cementing the alliance between his Forza Italia, Brothers of Italy and the Northern League, we will be watching as Berlusconi seeks to overturn the ban on his running for public office. Berlusconi, of course, denies any wrongdoing.

Super Mario (Draghi) has enjoyed a charmed existence as President of the ECB. There would be a comic irony if his legacy was tainted by his corrupt, octogenarian countryman so late in his tenure. As Ashworth concludes.

Draghi’s toolbox has been downsized. Investors can’t say they weren’t given fair warning. Their only consolation: his ability to pull a surprise at the very last moment.

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Hong Kong’s IPO Mania Goes White Hot, Drives Up Interbank Rates

IPO mania is gripping Hong Kong and if you’ve been looking for a warning sign that equity markets are close to a peak, just maybe this is it. It was a feature of the Hong Kong market in 2006-07, before the Great Financial Crisis, and in 2000, prior to the bursting of the bubble. No surprises, the current mania is also focused on the technology sector. The focal point today is the China Literature Ltd IPO which began trading this morning. The stock price rose as high as HK$110 per share compared with the HK$55 IPO price. No wonder the company’s executives were looking smug.

China Literature is an Amazon Kindle “look-alike”, being the Chinese mainland’s largest publisher of e-books. However, it is also growing its own network of contract writers and owns the rights to well-known Chinese online novels, such as the Grave Robbers’ Chronicles and Ghost Blows Out the Light series. The HK$8.3 billion IPO was more than 600 times oversubscribed with 5% of the city’s population applying for shares. According to Bloomberg.

Hong Kong demand for new share sales has hit fever pitch, with 417,000 people applying for lots in Tencent Holdings Ltd.’s online bookstore unit — more than 5 percent of the city’s population. China Literature Ltd.’s retail offering was 625 times oversubscribed, according to the company. That locked up at least HK$520 billion ($67 billion), or a third of the city’s monetary base, the South China Morning Post reported. It’s easy to see why the clamor: China Literature’s shares surged as much as 100 percent on their Wednesday debut…”You can tell Hong Kong investors like tech stocks,” said Daniel So, Hong Kong-based strategist with CMB International Securities Ltd. “If you’d managed to get the stock, you’d have made a lot of money.”

One signal of the scale of the current IPO mania is that the China Literature had a 200-basis point impact on Hong Kong’s interbank rate, as Bloomberg explains.

Interest in initial public offerings is so intense it’s affecting the city’s interbank rates. The overnight Hibor fixing jumped 2.1 percentage points on Oct. 31, the most in a decade, as investors placed orders for China Literature.

In contrast to some of the era’s IPOs, at least China Literature is profitable and has a coherent strategy. It uses “big data” to drive revenues and aims to cross-sell content into other media.  As Bloomberg reports.

China Literature had profit of 213.5 million yuan ($32 million) in the first half of this year, compared with a 2.4 million yuan loss for the same period in 2016, according to its prospectus. The company — created through the merger of Tencent’s online literature business with Carlyle Group LP-backed Cloudary Corp — had 9.6 million works and 6.4 million writers as of June 30. Customers can pay for an entire book or buy a few chapters at a time to see if they want to keep reading.


“We can study our users’ social network and understand their preference and recommend to them what their friends like to read,” Co-Chief Executive Officer Wu Wenhui said in an interview. “We already have compiled a great amount of user data, which will enable us to study what they like.” The company also wants to leverage its content into other forms of entertainment, such as movies, TV series and anime, as Tencent aspires to create a Marvel-like empire. Shenzhen-based Tencent became China’s second-biggest technology company on the strength of its WeChat messaging app, which since has morphed into a portal for shopping, banking, gaming and consuming entertainment.

China Literature will select some content, and co-invest or co-produce movies or anime series, co-CEO Liang Xiaodong said. He added that his company is closely working with Tencent’s film and video units. “User demand for content is getting very strong, especially original material,” Liang said in an interview with Bloomberg Television. “Our content can easily be converted into movies and games to maximize coverage.”

The China Literature IPO came on the heels of HK’s largest ever fintech IPO, ZhongAn Online Property & Casualty Insurance. ZhongAn raised $1.5 billion and priced at the top end of its valuation range. As Bloomberg notes, there are more tech IPO’s in the pipeline with the focus now shifting to the gaming accessories sub-sector.

China Literature’s IPO follows ZhongAn Online P&C Insurance Co., which went public in September. The first major fintech listing in Hong Kong, and backed by Ant Financial, the owner of Alipay, the retail portion was almost 400 times oversubscribed. Focus will now shift to Razer Inc., a manufacturer of high-spec gaming accessories, which will begin trading in Hong Kong on Monday after raising $529 million.

The Razer Inc. IPO will make co-founder and CEO, Tan Min-Liang, a dollar billionaire. The global gaming market is “hot”, with growth expected to increase by 52% to $160 billion by 2021. Buyers of Razer shares will include Singapore’s sovereign wealth fund, GIC.

If we were to be strictly precise, the ZhongAn IPO was 391 times over-subscribed, while China Literature was 625 times over-subscribed. Consequently, the latter beat out ZhongAn to hold the record for a Hong Kong IPO. We look forward to seeing the metrics for Razer, but Hong Kong IPOs are obviously white hot.

Shouting on deaf ears no doubt, the FT reports that one analyst urged caution.

In recent years, a doubling in the share price on the first day of trading for a Hong Kong listing has been rare. The strong appetite for China Literature stock on Wednesday was driven by retail investors trying to get a piece of what many perceived could be the next Tencent, said Kevin Tam, an analyst at Core Pacific-Yamaichi in Hong Kong.“ They expect this to be Tencent number two,” he added. “Many retail investors missed out on the first Tencent IPO and the 10-times growth.” But Mr Tam cautioned that such expectations for China Literature were misguided. Much of Tencent’s value is locked in its userbase but China Literature has “just a very small slice of that”, he said.

Wu Wenhui. co-chief executive of China Literature, stated that he wants to bring original Chinese literature to a global audience. He might eventually be successful in this but, right now, he’s bringing the melt-up stage in the Chinese bubble to a global audience.

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Kremlin Says Trump-Putin Meeting “Highly Likely” In Vietnam This Week

In what is sure to stir up a media storm of over analysis, the Kremlin has commented that there is a strong possibility that Donald Trump and Vladimir Putin will meet on the sidelines of the upcoming international summit in Vietnam.

Both Putin and Trump have extensive plans for bilateral meetings, which have been agreed upon long beforehand. There is also the APEC summit program, so the relevant offices are trying to choose an appropriate timing and format,” he said, adding that the likeliness of a Trump-Putin meeting was high.

As Strategic Culture Foundation’s Andrei Akulov notes, President Donald Trump told Fox News last week that he may meet with Russian President Vladimir Putin. He said it was very important to meet the Russian leader. The US president expressed hope that Russia would help solve the North Korea problem. “It’s hard to overestimate the importance and significance for all international matters of any contact between the presidents of Russia and the United States,” said Putin’s spokesman Dmitry Peskov.

Donald Trump’s trip comes at a time the Asia-Pacific policy goals require clarification against the background of the US withdrawing from the Trans-Pacific Partnership (TPP) agreement. President Trump is pushing bilateral trade deals to replace the TPP, but Asian countries are reluctant to open negotiations, while South Korea is balking at his demand to renegotiate the existing trade accord. The relations with China and the problem of North Korea top the agenda. In Vietnam, the US president will articulate a new policy for Asia built on the concept of a “free and open Indo-Pacific” region. The idea presupposes bringing together Japan, Australia, and India to contain a rising China.

Putin and Trump first met at the G20 summit in Hamburg in July when they discussed allegations of Russian meddling in the US presidential election. Back then, the leaders agreed to focus on better ties. However, the relations have soured further since that time as the diplomatic scandal broke out. In August, the president signed new sanctions against Russia. During the election campaign, Donald Trump pitched himself as a leader who would normalize the relationship. The American voters backed this stance. But the promised improvement has not materialized.

Today, the relations between Russia and the US are on a downward spiral of sanctions and accusations. It’s true that the Russian-American relations are struggling through their most difficult period since the end of the ?old War. The domestic context makes it virtually impossible for the US president to attempt any kind of fundamental reset.

No breakthroughs are expected but there is a range of burning issues to be urgently addressed despite the divisions. What the leaders could do is implement a “ceasefire” on the diplomatic blows of the past few months. The hole is deep enough; it’s time to stop digging.

With Syrian conflict entering endgame and de-escalation zones in place, Russia and the US face responsibility for ending the conflict and launching the nation-building process. Syria should not divide but rather unite the two powers. Ukraine and North Korea will be included in the agenda. It’s also logical and imperative for Russia and the US to pursue cooperation on Libya and Afghanistan.

With arms control eroding, the time is right to launch discussions on the future of New START and the divisions over the Intermediate-Range Nuclear Forces Treaty (INF) Treaty. Moscow has declared readiness to negotiate an extension of the New START, but the US position remains unclear. If nothing replaces the New START, there will be a new situation when strategic offensive forces are beyond any control for the first time since SALT-I was signed in 1972. The fate of the INF Treaty is uncertain with both sides accusing each other of violating the agreement. It would be right if the presidents gave orders to launch meaningful discussions to smooth away the existing problems.

A lot of issues of mutual concern could be addressed if the US reversed its decision to shut down most channels of cooperation including the Presidential Commission (21 working groups). Regional security and arms control will probably dominate the official bilateral agenda but strong interaction between academics, media, businesses and public diplomacy could help manage existing problems and make the relationship much more fluid.

Much has been said about what causes the current deterioration, while almost nothing is said in the mainstream media about the fact that the dialogue is still alive despite all the snags on the way. Contacts are maintained.

This was in focus of the talks held in Helsinki between Russian Deputy Foreign Minister Sergei Ryabkov and US Undersecretary of State Thomas Shannon on September 11-12. US Secretary of State Rex Tillerson, has maintained dialogue with Russia over the conflict in Syria, and raised the possibility of joint stability operations, including de-escalation zones and ceasefire observers. In June, numerous US companies took active part in the St. Petersburg International Economic Forum (SPIEF).

The divisions were deep when the “Helsinki process” was launched in the 1970s. The Helsinki Final Act dealt with a variety of issues divided into four “baskets.” The same thing can be done today.

It is quite possible to put the differences into a basket to be addressed separately, while concentrating on achieving progress in the areas where it can be done. The fact that the initiative to arrange a meeting comes from the US proves the fact that Russia is an important world actor that no international security problems can be solved without. The APEC summit in Vietnam provides an opportunity to revive dialogue on the issues of common interest. It should not be missed at a time when the bilateral relationship has tumbled to a nadir.

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Three Easy Pieces

Authored by 720Global’s Michael Liebowitz via,

If someone told you that the President of the United States in 2028 would be a Democrat and a woman from the state of New York, could you guess who it might be? We highly doubt it. In 1998, ten years before being elected president, Barack Obama had just been re-elected to the Illinois State Senate and was on no one’s radar as a Presidential candidate. In fact, had you been told at that time an African-American Democrat from Illinois would be president in 2008, it’s likely you would have assumed that two-time democratic presidential nominee Jesse Jackson would be the 44th President. In 1990, George W. Bush had just bought the Texas Rangers baseball club and was still four years from becoming Governor of Texas. In 1983, Bill Clinton was ten years out of law school and serving his second term as Governor of Arkansas. We could keep going down the line of presidents, and you would realize that even armed with some key details about the future, it would be extremely difficult to predict who a future president might be.

Stock investing is a little different. If you know the future level of three simple data points, you can calculate to the penny the price of any stock or index in the future and the exact holding period return. This precise prediction will hold up regardless of wars, economic activity, natural disasters, UFO landings or any other event you can dream up.

Unfortunately, those three data points are not readily available but can be inferred using historical trends, future expectations and logic to project them. With projections in hand, we can develop a range of price and return expectations for an index or an individual stock. In this paper, we provide an array of projections based on those factors and provide return expectations for the S&P 500 for the next ten years.

Factor 1: Dividends

Dividends are an important and often overlooked component of stock returns. To emphasize this point, an investor guaranteed a 3% dividend yield based on the current price, receives a 30% gain (non-compounded) in ten years. In other words, the investor has at least a 30% cushion to guard against price declines over a ten-year period.  That is what Warren Buffett refers to as a “moat,” and it is a wonderful benefit of investing in dividend-paying stocks.

The scatter plot graphed below compares the S&P 500 dividend yield to the Ten-year U.S. Treasury Note yield since 1980.  This historic backdrop helps project the S&P 500 dividend yield for the next ten years.

Data Courtesy: St. Louis Federal Reserve (FRED)

From 1980-1999, Treasury yields and dividend yields behaved alike. The trend line above, covering these years, has a statistically significant R-squared of 0.84 (84% of the move in dividend yields can be explained by moves in the 10-year yield). Since the year 2000, that relationship has all but disappeared. The R-squared for the post-financial crisis era is a meaningless .02.

Around the year 2000, dividend yields appear to have hit a floor ranging from 1-2%, despite a continued decline in Treasury yields. The reason for this is that many companies want to entice investors with higher dividend yields. As such, they raised dividends to keep the dividend yield relatively attractive. Had the regression of the 1980-1999 era held, dividend yields would be below 1% given current Treasury yields.

The graph above makes forecasting the future dividend yield relatively easy. As long as Ten-year U.S. Treasury yields stay below 5-6%, we expect dividend yields will range from 1-2%. Accordingly, we simplify this analysis and assume an optimistic 2% dividend yield for the next ten years.

Dividend Yield – Base/Optimistic/Pessimistic = 2%

Factor 2: Earnings

Over the long-term, earnings are well correlated to economic growth. Our ten-year analysis easily qualifies as long-term. Over shorter periods, there can be sharp variations due to a variety of influences such as regulatory policies and tax policies all of which influence profit margins. To arrive at reasonable expectations for earnings growth, we first consider economic growth. The following chart plots the declining trend in GDP growth since 1980.  Given the burden of debt, weak productivity growth and the obvious headwinds from demographics, we think it is likely the trend lower continues.

Data Courtesy: St. Louis Federal Reserve (FRED)

Next, we consider S&P 500 earnings growth rates. Earnings growth over the last three years, ten years and since 1980 are as follows: 3.18%, 4.38%, and 5.93% respectively. Given the economic and earnings trends, we believe a 3% future earnings growth rate for the next ten years is fair, 5% is optimistic, and 1% is pessimistic.

Earnings Growth – Base/Optimistic/Pessimistic = 3.00%/5.00%/1.00%

Factor 3: Valuations

Robert Shiller’s Cyclically Adjusted Price-to-Earnings ratio (CAPE) is our preferred method of valuation as it averages earnings over ten year periods. In doing so, it avoids short-term volatility of earnings and provides a more consistent baseline reflective of a company’s or indexes true earnings potential.  Currently, the CAPE of the S&P 500 sits in rare territory, as shown below. In fact, outside of the late 1990’s tech boom, there were only two months since 1881 when the Shiller CAPE was higher than today’s level – August and September of 1929.

CAPE has a history of extending well above and below its mean. Importantly, it also reverts to its mean after these long stretches of time. It does not seem unreasonable to expect that, over the next ten years, it will again revert to its mean since 1920 of 17.29. An optimistic scenario for 2028 is a CAPE reading of one standard deviation above the mean at 24.77. The pessimistic case is, likewise, one standard deviation below the mean at 9.70. Further, as shown below, we also present an outlook assuming CAPE stays at its current level of 31.21.

The graph below shows CAPE and the three forecasts along with the current level.

Data Courtesy: Robert Shiller

CAPE – Base/Optimistic/Pessimistic = 17.29/24.80/9.70

What does 2028 hold in store?

The following graph and table explore the range of outcomes that are possible given the scenarios outlined above. To help put context around the wide range of expected returns, we calculated an equity-equivalent price of the 10-year U.S. Treasury Note and added it to the graph as a black dotted line. Investors can use the line to weigh the risk and rewards of the S&P 500 versus the option to purchase a relatively risk-free U.S. Treasury Note. The table below the graph serves as a legend and reveals more information about the forecasts. The color shading on the table affords a sense of whether the respective scenario will produce a positive or negative return as compared to the U.S. Treasury Note. The far right column on the table indicates the percentage of observations since 1881 that CAPE has been higher than the respective scenarios.

Data Courtesy: Robert Shiller and 720Global/Real Investment Advice

As shown in the graph and table above, only scenarios 8 through 12 have a higher return than the ten year U.S. Treasury Note. Of those, three of the five assume that CAPE stays at current levels. Scenario 8, shaded yellow, has a negligible positive return differential.


The bottom line is that, unless one has a very optimistic view on earnings growth and expects valuations to remain elevated beyond what historical precedent argues is reasonable, the upside is limited, and the downside is troubling. The odds favor that a risk-free investment in a 10-year Treasury note will provide a better return through 2028 with less volatility. With current 10-year note yields at roughly 2.25%, that should emphasize the use of the term “troubling.”

The lines in the graph above are smooth, giving the appearance of identical returns each period. Markets do not work that way. These projections do not consider the path taken to achieve the expected total return and they most certainly will not be smooth. The best case scenario, and the one least likely to occur is for volatility to remain low. This would generate the most orderly path. Given that the post-crisis VIX (equity market volatility index) has averaged 17.7, current single-digit levels are an aberration and it does not seem unreasonable to expect more volatility in the future.

Even if one of the scenarios plays out exactly as we describe, the path to that outcome would be very choppy. For instance, if the worst case scenario played out, an investor may lose 60-80% of value in a matter of one or two years. However they would most likely have better than expected annual returns in the years following.

In a follow up to this article we will take this thought a step further and discuss the so-called path of returns. We show you the expected and actual path of returns from 2005 to 2015 and argue that an investor armed with the three factors, and a little discipline, may have generated much better returns than those earned by investors using a buy and hold approach.

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‘Take That OPEC’ – WTI Slides As US Crude Production Jumps To Record High

WTI/RBOB extended losses post-API data overnight, but DOE data sparked some algo chaos as a surprise crude build (+2.24mm vs -2.45mm exp) was offset by a bigger than expected gasoline draw (exactly opposite what API reported). In addition, US crude production jumped to a new all-time high – take that OPEC!



  • Crude -1.562mm (-2.45mm exp)
  • Cushing +812k
  • Gasoline +520k (-1.85mm exp)
  • Distilates-3.133mm


  • Crude +2.24mm (-2.45mm exp)
  • Cushing +720k
  • Gasoline -3.31mm (-1.85mm exp)
  • Distilates -3.359mm

Last night’s API data showed smaller crude draw and a surprise gasoline build, but DOE surprised with a big crude build and biugger gasoline draw (and a notable build in Cushing stocks)…


Production has normalized back at cycle highs as storm effects fade, surging to new cycle highs in the last week


And total US Crude output just hit a new record high…


The trend is not OPEC’s friend…


WTI was back below $57 and RBOB below $1.80 ahead of the DOE data, sinking after last night’s surprise gasoline build

“If the EIA data disappoints then it could take further steam off the market,” says Jan Edelmann, analyst at HSH Nordbank.

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Gartman: “We’ll Not Hesitate Even For A Moment To Return To The Short Side”

Gartman does it again.
Yesterday we reproted that with futures spiking, and the S&P set to open just shy of 2,600, Gartman panicked, and closed out his shorts, instead predicting a “violent, parabolic” move higher.:

We have been wrong… badly…

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