The Market: Thinking Fast and Slow
Discussion
With the equity market now in a “window of weakness” post-OPEX, the Fed confirming “higher for longer at the long-end”, the weight of the “oversold” evidence not yet oversold enough to overcome the decisively negative fundamental backdrop, and the historically precarious September/October period looming, in my opinion it is mission critical to zoom out and not get distracted by day-to-day cross-asset market movements. This is a difficult position to take for me because I’m a market junkie who stares at cross-asset market relationships all day every day. As such, it can be tough for me to ignore what might be a micro time frame set-up while focusing on the high probability medium-term outlook.
As they say in the counseling community, “if you mention it, you can manage it.” I see some very, very short-term bullish signals that I need to mention (thinking fast) in order to manage (thinking slow) the decisively bearish 3+ month outlook.
Purely a gut feel, but the way SPX traded yesterday and now this morning says it wants to continue higher. It was up pre-market before selling off a bit on higher rates; rates rose through the day, but it powered higher; and now this morning, despite another very hawkish Jackson Hole preview piece from Nick Timiraos (which I’ll write about later today) and a “higher for longer” piece from Bill Dudley, SPX is higher pre-market.
The HY CDX vs. SPX relationship on a micro time frame basis is behaving as it did in late February ahead of a small pop in SPX ahead of Powell’s March 7/8 Congressional testimony. This is a super specific analog, but aligns with the fact Powell speaks on Friday.
A key medium-term sentiment measure has fallen quite quickly, and the pre-COVID correction analog bothers me, as it would suggest the market could go on to make a new rally high before commencing with the ultimate correction.
Defensive equity sectors have not outperformed SPX to the degree I would have expected ahead of a sharp downturn in the equity market. I think the move up in rates explains this, but it still bothers me from the bearish point of view.
Lastly, Cem Karsan was quite clear in his interview Friday that VOL has not yet become unpinned enough to allow a big move down to occur.
But there are critical offsets to these micro time frame bullish factors.
Breadth was sharply negative yesterday, not even remotely confirming the bullish behavior from SPX.
More broadly, breadth has melted beneath the surface of this market over the course of this correction, suggesting SPX has a lot of “catching down” to do before this correction is over.
Short-term sentiment has already picked back up to the point it did ahead of Powell’s March 7/8 testimony, suggesting this bounce back is already on fumes.
Lastly, Cem Karsan’s commentary about VOL suggests the “unpinning” can actually come via a move to the downside - in other words it doesn’t necessarily need to come from a squeeze higher.
The bottom line: It’s critical to zoom out and focus on the 3-month outlook for stocks, which is sharply lower. Once oversold signals become dramatically oversold, I will focus on being more tactical. The point of walking through the micro time frame cross-asset market signals is to process the day-to-day in order to free the brain up to focus on the longer-term picture. If I know ahead of time there is the possibility of further short-term rallying, I can do a better job of keeping it in the back of my mind while it’s happening instead of trying to process it in real time.
Exhibits
HY CDX is behaving as if it has topped out and wants to move sharply lower, if not for a very brief period of time as it did just ahead of Powell’s March 7/8 testimony.
And MT OPTIX has fallen sharply. Ahead of the COVID correction this fell sharply and SPX responded by moving to a new rally high, but alongside decisive lower highs in sentiment and breadth.
Defensive sectors, XLU and XLP in particular, have not outperformed as decisively as I would have expected heading into what I believe to be a very bearish few months for the equity market. I think rates explains this, but it still bothers me.
But there are short-term negatives potentially offsetting the short-term bullish factors. First, breadth yesterday was decisively negative.
More broadly, breadth has melted in this correction, weakening the foundation of the market just as it heads into a seasonally precarious period.
And lastly, short-term sentiment has already picked up to the point it did back in March ahead of a fall to new correction lows.