The CASP: February 25, 2024

Executive Summary

• VOL: Bullish behavior, bearish structure

• CDX: Short-term bullish, medium-term bearish

• Breadth: Decisively bearish

• FICC: Neutral near-term, bearish medium-term

• Market Character: Bullish, full stop

• Flows Windows: Bullish

Analysis

VOL: Bullish behavior, bearish structure

The VOL market remains complicated. On the bullish side it cannot sustain a bid, getting sold hard within hours/days of a spike (post-Jan 31 FOMC and post-Feb CPI report are case in point). But on the bearish side the structure of the VOL market is behaving as if a topping process is underway.

CDX: Short-term bullish, medium-term bearish

I have flagged the major bearish divergence between SPX and IG CDX for weeks now, but that divergence broke down in the wake of the February CPI report with IG CDX barely reacting to post-CPI weakness. Via private Xwitter I said ahead of NVDA earnings that the market was ripe for a ripper based on this limp reaction from IG CDX, but I did not actively trade around it because when you zoom out IG CDX is still indicating a topping process is in the works.

Breadth: Decisively bearish

Big negative divergences between SPX and its 50dma breadth and the NYSE advance/decline line. And now defensive equities are beginning to put in a short-term base. Against the backdrop of bearish VOL market structure and medium-term bearish IG CDX behavior, it’s clear a tactical topping process remains intact.

FICC: Neutral near-term, bearish medium-term

The equity market’s relationship with the long end of the UST curve has clearly changed since the summer 2024 rates-driven sell-off, as a cursory look at where long rates are versus last summer suggests SPX should be below 4700. This change in character implies one of two things, or some combination of the two: money in search of AI is overwhelming standard market analysis and/or economic growth is reaccelerating and thus overwhelming the equity market’s sensitivity to a higher cost of capital. IMO, it is likely a combination but a combination dominated by the AI theme, especially given the likelihood foreign capital sees the US equity market as the most attractive vehicle for obtaining exposure to the AI revolution. I say this because small caps and equal weight underperformance relative to SPX is largely in line with what one would suspect with a rising cost of capital. However…

I believe the key macro pairs (Transports vs. Utilities, Banks vs. Utilities, Discretionary vs. Staples) I have discussed at length this year suggest the US economy is heating up, if even mostly on a nominal basis driven by rising inflation. Given the Fed’s hawkish reaction to the January CPI report, if my thesis is correct that nominal growth is heating up then inflation break-evens and swaps are likely to continue their steady march higher and ultimately force the Fed to shift to guiding to a resumption of rate hikes post-Election Day.

Market Character: Bullish, full stop

SPX refuses to breakdown below the 20dma, and after reversing almost as soon as the price/100dma hit the critical 110% level the market has since reversed right back up. This is bullish, full stop. The other pillars of The CASP discussed above suggest a tactical topping process is underway, but this bullish character suggests any pullback is likely to be limited to the SPX 4500-4700 level before SPX launches to 5500-6000 by Election Day.

Flows Windows: Bullish

As Cem Karsan said on February 16 and updated on February 22, if equities could make it through the week following Valentine’s Day they would move much higher. That has happened, and when looked at against the backdrop of short-term bullishness from CDX and VOL (as discussed above), it’s likely SPOOZ move higher into EOM, likely to around SPX 5200 before volatility comes back into the market in March.

Tactical Outlook: Bullish into EOM, bearish into May

Adding it all up, it’s clear a topping process is underway but in the very short-term equities are likely to continue higher to circa SPX 5200. 5200 by 4700 into May seems to be a decent path before the market launches to 5500-6000 by Election Day.