Market Journal: Embrace the Chop

4Q23 is likely to be extremely volatile with an upward bias.

Discussion

Per usual, Le Shrub perfectly captures the sentiment and positioning backdrop heading into Q4:

Based on my read of the evidence through the lens of my own process, and updated thoughts from other market participants I highly respect, I think the best way to sum up what’s ahead for 4Q23 is extreme volatility with an upward bias.

(1) Despite the exact acceleration in UST 30s I was looking for coming into last week, the 1987 scenario appears to be off the table as a result of options flows “pinning” SPX. The tick higher in the % of stocks over their 200dma confirms an 87-like meltdown is likely off the table.

(2) HOWEVER - I am very, very aware of the fact the market likes to fake you out just enough before going on to confirm your exact thesis. As Bob Elliott outlined on CNBC, stocks are now more expensive than they were at the July peak as a result of the move in rates. If the weight of the evidence resumes its close tracking of the 1987 analog, I will need to reconsider the 87 thesis. But given the power of options flows, EOY flows in a positive YTD market, and the sheer force of will by a consensus buying every downtick in SPX, it’s more likely that what Bob outlined will keep a firm lid on the market in Q4.

(3) Three market participants I greatly respect - Cem Karsan, Imran Lakha, and Ben Calusinski (see below) - are looking for upside in 4Q23 after continued chop in the first week or so of October. These three have processes that complement my own very well - Cem and Imran are options specialists, while Ben is technically oriented. With all three lined up in one direction, I have to factor their analysis into my thinking and process no matter how much it might conflict with my structural (1-2 years) outlook and the back half of my cyclical (1-12 months) outlook.

(4) Given the sharp reversal in VOL and CDXs on Thursday, I was pretty surprised at how sticky they stayed on Friday with VOL aggressively sold early in the day and only reversing modestly into EOD alongside the SPX reversal. CDXs are a always a big tell, but they can be poor short term timing tools. Adding up all of the above, my hunch is 4Q23 trades similarly to 4Q15 when SPX chopped higher alongside a sharply rising HY CDX before the bottom fell out of SPX in 1Q16. I think that’s the playbook here, except I would keep top of mind the more precarious macro backdrop when thinking about where the SPX bottom might come in 1H24.

(5) Lastly, as far as trading this upcoming week, my “friend” ancient warrior sums things up well.