The Market: Volmageddon’s Hand is on the Door
On watch for SPX 4000 by September 29, opening the door to a Volmageddon event down to SPX 3500 by October 3. Bulls should pray for an addressable financial crisis to erupt ASAP.
Discussion
On July 1 in the post below, I outlined the path to a retest of the October 2022 SPX low of circa 3500, stating:
“A breakout in the 10y UST note to 425-450 would likely be the catalyst for a move down to 3500 sometime in the classic danger zone of September/October.”
The overwhelming weight of the market evidence, discussed below, points to this scenario as higher than average probability event in the next 7 trading days.
(1) The SPX Daily Sentiment Index is not even close to fully oversold, providing ample room for the sell-off to continue apace.
(2) Anecdotal sentiment data from market participants suggests little to no concern that a large-scale decline is underway. Comments below from Goldman’s Tony Pasquariello show passing concern about more downside and increasing focus on 2024, complacently assuming the 4Q23 bias is up.
(3) There is no “Fed Put” up here until an addressable financial crisis erupts. NONE. Mary Daly said Friday she is “completely unwilling” to entertain raising the 2% target; Nick Timiraos is now citing stronger economic data; and 5y5y TIPS break-evens are reaccelerating. After almost two years of the Fed surprising on the hawkish side, financial market participants continue to fight the Fed. We’re at a breaking point.
(4) Last but not least, the 1987 analog continues to point the way lower here. Is an 87 event likely? NO. Obviously it’s low probability. A -33% drop from the SPX high of 4607 would mean SPX 3087 by next Monday. Highly unlikely. The point of the analog is that 2023 is about to have its own “event”, and given the well-documented extreme levels of VOL selling, the 2023 “event” is likely to entail a far less extreme drop in SPX to at least 4000 by September 29, and then at worst 3500 by October 3, but with an explosion in volatility to VIX 50-100 as so many VOL experts have said is easily doable once something breaks.
As discussed in The WOTE Report last week, it’s not the chart comparison of 2023 SPX vs. 1987 SPX that’s alluring, it’s the fact 200dma breadth (breaking down hard) and UST 30s (breaking out hard) are tracking so similarly alongside the Index chart pattern.
SPX closed Friday decisively below its 100dma - at this point in the 1987 crash sequence it went back up and retested the 100dma before descending for good, and once it fell to its 200dma alongside new lows in 200dma breadth, the crash process accelerated. This took about a week.
September 29 is EOM and EOQ, the perfect window for a panic puke into the weekend, which then opens the door to Volmageddon into October 2/3. Here’s how I see the sequence playing out:
A. SPX moves up to retest its 4377 100dma Monday/Tuesday;
B. Falls to its 4191 200dma by Thursday;
C. Then closes the week and quarter no higher than 4000, down -7.4% on the week.
D. Weakness begets weakness and markets crash from oversold levels. With SPX -7.4% on the week, VIX probably closes the week over 30, swinging the door wide open to a classic “Black Monday” scenario of a big gap down on SPX and VIX moving above 50. A -12.5% gap down to 3500 seems unlikely, but a -5% move to 3800, where SPX traded in the wake of SVB, is easily doable.
E. The problem for SPX is the Fed is in a box until an addressable crisis erupts. If something in the banking system snaps by October 2, the Fed will deploy its balance sheet and the decline will be halted at 3800. But if nothing breaks, the selling likely continues into October 3 down to 3500.
But first things first. Let’s reassess the landscape at SPX 4000 on Friday.