Discussion
Of course, just as soon as I say I’m “in the zone” this weekend my feel for the market goes away this week. I was surprised by the sustained nature of today’s move down given the supportive OPEX flows that are in place, and as a result I spent far too much unproductive time today staring at the screen questioning myself. Part of the problem is this morning I entered the first leg of a multi-part trade structure, and I spent the better part of the day questioning myself. Anyway…
Once I was able to get away after the market close and think passively while doing other things, the picture became clearer: today was a bear trap.
HY CDX failed to break above its August 8 high despite SPX making a decisive correction low.
The UST curve bull/bear steepened, which should have nuked NDX, but NDX held in and as confirmation I saw a fair amount of bullish Tech chatter on Xwitter through the day.
In a decisive risk-off tape defensive sectors will sharply outperform if not stay green. But today XLU got slammed and XLP provided hardly any advantage (XLV did outperform, but was red on the day). I have been noting that defensive sector lagging in the short term has been a rates signal, but the relative strength in Tech today nullified that signal today.
The head of options at Piper Sandler today xweeted out that implied volatility has fallen over the course of this correction. This prompted me to check in on the October SPY $400 put I had traded around awhile back. Despite a high and sticky VVIX and a -3% correction, the price of the put was lower today than it was 1-2 weeks ago with VVIX at a similar level. Odious performance from a bearish perspective.
Against the backdrop of points 1-4, and especially #4, the fact VVIX lagged the move in VIX today is a bullish signal.
Adding it all up, today looked an awful lot like a bear trap. If this -3% correction was the start a major move lower, defensive sectors would be really busting a move to the relative upside, HY CDX on fire, 80-90% downside days accumulating, and implied VOL pricing blowing out. Perhaps like the COVID crash window opened the day of February 2020 OPEX, the window to a 15-20% correction will open Friday and those key major correction conditions will fall into line. Who knows. But right here and now, with all possible objectivity, this market is set up for one more bull trap.
Based on what I’m seeing from the Fed, Powell wants to be hawkish on 8/25. I’m wondering if he’ll want the rates market to consolidate here ahead of his speech so that he’s not forced to be dovish to head off a market accident. With 5y5y BEs coming in sharply, it wouldn’t surprise me if Powell feels like he now has room to do his thing behind the scenes to calm markets ahead of the speech. I know this runs contra to my commentary in the “Buy It” update today, but I’m just thinking out loud in the context of what appears to be a bear trap today and what could catalyze a move higher - because right now it’s tough to see what could lead to another rally attempt.
Exhibits
Sharply risk-off day on the surface, but NDX outperformed and VVIX lagged VIX.
Defensive sector performance smelled an awful lot like an end of a correction move lower.
HY CDX failed to make a correction high. This should be blowing out right now if this correction is the real deal.
Tech appears to be bottoming out here.
TIPS 30s above 200, yet defensive sectors are underperforming, HY CDX meh, and Tech bottoming out. Like 1987, it’s going to take an even larger move higher in rates to crack equities.
Lastly, 5y5y BEs have moved sharply lower, perhaps giving Powell room to work it out behind the scenes so that financial markets can consolidate into Jackson Hole and allow him to deliver a “higher until highly confident” hawkish message.