Executive Summary
VOL: Complicated, but bearish beneath the hood
CDX: Decisively bearish
Breadth: Decisively bearish
FICC: Bearish
Market Character: Bullish
Flows Windows: Bullish until Valentine’s Day
Analysis
VOL: Complicated, but bearish beneath the hood
The VOL market is a bit complicated here on a day-to-day basis. In short, it appears VOL sellers remain firmly in control of both the VOL complex and the equity market, as evidenced by the fact VVIX cannot seem to breakout as it typically does when the cross-asset market evidence turns this decisively bearish. However…
…When you zoom out and look at the structure and trend of the overall VOL complex - in particular the direction of travel for the VVIX/VIX ratio - beneath the hood the VOL complex is setting up for an equity market correction over the coming weeks.
CDX: Decisively bearish
The IG CDX index has carved out a decisive bearish divergence with SPX, pointing firmly to an eventual SPX level of at best 4700-4800. More likely than 4700-4800 is a scenario such as Feb-March 2023 or July-October 2023 where the IG CDX moves decisively higher alongside an equity market correction, pulling SPX/NDX down even further than currently implied by the bearish divergence.
But the CDX market needs to be monitored closely in a correction for signs the Yellen/Brainard “put” is being engaged with SPX down -5% in the 4700 range. If SPX corrects down to 4700 as implied by the bearish divergence, but IG CDX doesn’t budge in the process, then equities likely must be bought circa SPX 4700.
Breadth: Decisively bearish
Next to the CDX pillar of The CASP breadth is pointing decisively to much lower levels in equities. We need to be cognizant of the tendency for breadth to catch up to strong index levels in bull market environments, but with the Fed on the move it’s more than likely very weak breadth is pointing to a “catch down” scenario in equity indices.
NYSE 50dma breadth has diverged sharply with SPX, pointing to as low as 4500 on SPX.
Just today alone breadth is almost -10:1 to the downside despite indices down less than -50 bps. Given the broader weight of the evidence, it’s unlikely this divergence lasts long nor resolves in a bullish manner.
Defensive sector relative strength is weak both as the result of an economic reacceleration and now higher rates. I strongly suspect that this area of the market will quickly pick up relative strength once the rest of the market catches down, as it did during the rates-driven July-October correction.
FICC: Bearish
In short, the Fed has killed the bull market nirvana scenario of a reaccelerating economy + rate cuts. From the opening day of trading in 2024 the Fed has made it crystal clear it will not tolerate an economic reacceleration, especially one that results in an above-target TIPS break-evens curve configuration. This re-hawking was punctuated by Powell’s hawkish January 31 press conference; an exclamation point was put on it by Powell’s Feb 4 appearance on CBS 60 Minutes; and a second exclamation point was applied by FRB Minneapolis President Neel Kashkari this morning in an essay detailing the likelihood the neutral stance of monetary policy is higher than generally assumed.
Coupled with Friday’s hot NFP report and this morning’s blowout ISM Services prices paid data, the Fed’s re-hawking has made FICC (USD + rates) a problem for equities. Further, the TIPS break-evens curve is above-target, sticky, and trending higher.
Market Character: Bullish
No question headline SPX/NDX indices are displaying fabulously bullish character, powering higher through good and bad headlines and ignoring all bearish divergences. Obviously “price” is all that pays. But good market character always looks good until it doesn’t. The broader weight of the cross-asset market evidence points to a bull market move running on fumes.
S&P 500
NASDAQ 100
Flows Windows: Bullish until Valentine’s Day
Per usual, I’ll let Cem Karsan outline the pertinent flows windows. In short, equities have a window through Valentine’s Day to remain relatively well-supported.
Tactical Outlook (4-8 Weeks): Bearish
Given the combination of bullish market character in the short-term and rapidly deteriorating cross-asset market evidence everywhere else, it’s likely Cem’s path to Valentine’s Day plays out here. IMO, the Fed is being ultra aggressive here, so I do not want to get bullish for a last gasp 1-2 week move to SPX 5000/5100, but the last gasp move scenario must be kept in mind when trying to position for a correction here looking out over the next 4-8 weeks.