S&P Looking Heavy

The S&P is trading like it wants to take another peek at last week's lows.  I don't think we can get that low, but I do think a pullback to 1900 is very possible this week.  ES 1990 acted like a lid for this bounce and the last two trading days has shown the lack of V bounce power that you saw in October 2014 and previous V bottoms over the years.  I can't overemphasize the extent of the carnage that we went through last week, it was 2011-esque, not 2014-esque.

You have VIX trading extremely strong here, much stronger than one would expect for just a 1% down day.  Add to the weakness in stocks is the weakness in bonds, a horrible situation for the market because a lot of fund managers use fixed income to hedge their equity exposure.  If both are weak, they have to sell a bit of both to reduce risk.

The Fed put is obviously lower than most market participants think, because Stanley Fischer sounded super hawkish despite the turbulence last week in the markets.  If the Fed put is much lower, then this market has to trade lower to reflect that reality.  Looking for lower prices for the rest of the week.

Another V Bottom?

It would be quite shocking to this trader if we got an October 2014 V bounce.  The market participants have seen so many of those V bottoms that many jump in at the first sign of a bounce.  That is why you got so many fake out V bottoms in the first 6 months of the year.  The market lacked buying power to extend the V bounces beyond the first few days.

The market will do what it wants to do, regardless of news.  Unless it is something central bank related, the news is meaningless.  And China's central bank is not going to cause a sustained bounce unless they do something totally unexpected like a QE and buy US Treasuries with it.  In fact, there are rumors that they are doing the opposite and selling Treasuries.

By the way, the VIX got as high as 31 in October 2014.  This past Monday, VIX hit a high of 53, and has sustained levels above 30 for the past 2 days despite rally attempts.  This is not the same market.  This selloff is much more insidious and something that will take time to resolve itself.  It doesn't help that all those corporate buybacks couldn't get this market higher.  The value buyers will not step in at these levels because we are still overvalued.  Low single digit corporate profit growth with P/E of 18 will not get value buyers excited.

The best thing this market has going for it is that there are a bunch of bears out there, but it would only be shocking if there weren't after such a fall over the past 5 days.  This is a counter trend trader's market.  Basic strategy is this:  Sell after stocks rally for 3 days.  And buy after they selloff for 2 days.

Hopeful Opens and Scary Closes

We are now in the looking for a bottom market.  You get an awful close like you had on Monday and Tuesday, and you get monster gap ups the following morning.  The bottom pickers eschew risk overnight, but are more than willing to take risk during the day, even with a 50 SPX point gap up open!

This is a fear based market now, you have crushed the market so that the fund managers are well into the red on the year.  And when fund managers are negative on the year, this far into 2015, they get nervous.  They fear for their jobs.  So they go into shell mode, and try to minimize losses at the risk of minimizing gains.  Even though the market is only down about 8% on the year, that is a big number in the land of relentless bull markets and short memories.  It is now the land of panicky irrationality.  How else do you explain a dump down to ES 1850 and a run up to ES 1914 in the overnight session?

This is a tough market, I didn't expect this big drop over the past few days but with it comes opportunities to trade the volatility.  You have to buy the fear and sell the hope.  It will be a choppy market over the next 2 months.  Do not expect a repeat of earlier selloffs in 2012, 2013, and 2014.  I see no V bottom here.  The technical damage has just been too great, similar to what happened in 2011.

Monday and Tuesday did a lot into forming the boundaries of the new trading range.  No, I don't think we will pull off a V bottom like October 2014, or even in July this year.  There is a real fundamental scapegoat here in China, not some scary Ebola headlines or Greece in July.  That being said, you have gotten to a level where you will get bottom picking and it is still a bull market, although it doesn't feel like it at the moment.  Hedge funds were underexposed to US equities, before the panic, so I don't expect that much unwinding.  I am looking to be a buyer on any dips today down to the lower end of the trading range, SPX 1860-1870.  The rips should be sold near SPX 1940-1950.  We may get a run higher to 1970-1980 by the end of the week/early next week, but that would be a selling spot, not a point to look for a continued V move higher.

P.S. - These are the markets that ES traders live for.  Take advantage of the opportunity while it is here.  Sell the hope and buy the fear.  That is the mantra to live by for the next two months.

Mix of Aug 2007, Aug 2011, and Oct 2014

This market has entered an altered state.  A higher volatility period that likely plays out in one of 3 different ways.  This is based on past history, market conditions, sentiment, and market positioning.

1. The August 2007 scenario where you are in the heart of the topping phase of a long bull market, with weakening credit conditions, overvaluation, and a potential bear catalyst for a big drop.  Even in the worst of the 3 likely scenarios, you get a market that makes a flush out bottom, and rallies over the next 2 months towards the previous all time highs.  The current market is definitely much more bullish than August 2007, even if you can state without much doubt that the market is more overvalued now than back then.  But market positioning is more conservative now among fast money fund managers and there are much larger corporate buybacks now with fewer secondaries and IPOs.

The current market is definitely not like 2007, or even anything similar to 1998, which many seem to point out on CNBC.  In 1998 you had immense enthusiasm among the general public for stocks, with massive inflows into mutual funds at the time, not outflows as you have now.  Also with stock buybacks a much smaller part of the demand picture than it is in 2015.

2.  The August 2011 scenario when you have a financial panic.  It was building for several months, and it exploded into a final panic over European sovereign credit.  August 2011 was much scarier than August 2007, just by the magnitude of the drop, and the persistence of the weakness which lasted for a few months.  You didn't make the final bottom until October, and the coast wasn't clear until January.

This is the least like the current market situation from a fundamental standpoint.  In 2011, you didn't have the corporate buyback train at full steam, the market wasn't overvalued, but there was a risk of a financial crisis if the ECB didn't bring out the LTROs, and Europe is a much bigger part of the global financial system than China.   This is the short term worst case scenario, but the long term best case scenario.

3.  The October 2014 scenario where the market just got too bullish and complacent over the endless uptrend, you had a meaningless Ebola scare, and oil prices started its big drop.  This is the most bullish short term scenario but not bullish for the long term as the market is still overvalued and you never truly flush out the hard core bulls.  Since the cause of the drop is not fundamentally driven (oil was still around $80 in October 2014), but fear driven (Ebola), you a V bottom and the selloff ends as quickly as it starts.

Based on the amount of time (over 6 months) you spent building overhead resistance at higher levels (SPX 2040 to 2120), and the fact that you are now 80 points below those levels, the technical damage is much greater than October 2014, a bit greater than August 2007, but less than August 2011.

China is a convenient excuse for the selling, but the US stock market historically only enters a bear market when the US economy enters a recession (1981-1982, 1990, 2001, 2008), not when a foreign economy enters a recession (1997-1998, 2011).

Three scenarios is a small sample size, but it does give you a general guideline into how to trade the next couple of months.  I expect a flush out low this week that forms the initial bottom, upon which we should rally back up about 80-100 points over the next few weeks into the Fed meeting in September, where they will likely be more dovish than the market expects.  That should form a short term top, which will lead to renewed selling as investors fearing October and a shutdown of the corporate buyback window gives us a retest of the August low.  After that retest, I expect the market to bottom and rally into year end.  While the market is overvalued, the drivers for a continued rise are still there:  massive corporate buybacks, hedge funds still underweight US equity exposure, and a Fed that will be extremely slow in raising rates.

What a Week!

That came out of the blue.  The opex forces when market makers are massively short puts is tremendous.  You saw that all today from overnight dumping, to pre-market dumping to the close dumping.  The crowd is bearish but contrarian plays get easily trumped by forced selling, panic, and margin calls.

Will this continue?  Well the charts are completely wrecked, but we got a monster VIX spike, like that you saw in October 2014.   VIX was at 13 earlier this week, and hit 28 today!  That is ridiculous.  Those kind of massive VIX spikes usually occurred within days of a bottom.  Not always a V bottom, but usually a bottom.  Also like December 2014.  Can this market just keep dumping like August 2011?  I don't think so, because you need a financial crisis, and China's debt is mostly internal, and they have shown a willingness to paper over any holes in the TBTF banks.

What this looks like here is an old fashioned panic, based on lower prices causing forced selling and fear.  Since all the support levels have been blasted through this year, there is no guess as to where this market could drop to if we see more panic, perhaps SPX 1900.  Not likely, but definitely possible.

Opex Long Squeeze

What you saw in the last 30 minutes of equity trading was an opex delta hedge, fear of overnight gap down panic selling.  We have finally reached what I would call a clean flush out, with the previous attempts aborted by dip buyers and nervous shorts.   The China fears and the crushing of oil is making investors nervous, but it has been Europe that has been notably weak.

It was a 2% down day but it felt like a plunge, with the controlled volatility lately.  It looks like we've broken the 2045 to 2125 trading range that we've been in since March.  But there are a lot of bears so I wouldn't be surprised if we get a strong bounce over the next few sessions.  Still think bulls have the advantage over the intermediate term looking out 2-3 months.

Short Term Bottom in Oil

Oil looks like it has found a level where buyers are willing to take a stand.  I don't expect a big bounce, but I think we will trade sideways by bouncing from here to consolidate this down move.  The yield curve is flattening which means the bond boys are expecting the Fed to raise rates in September.

Just as we've probably found a short term bottom in oil, I think we've found a short term top in Treasuries.  It looks like we had the fear based top in Treasuries on Wednesday as the S&P was dropping towards 2050.  You had crude oil weak all day yesterday and Treasuries kept going lower, not higher.

The S&P is resilient as always, staying in this trading range.  I am being repetitive, but you cannot listen to the Twitter paper tigers who expect a correction on these dips.  Look what happened on Wednesday, there are some big hands that are buying up the market on these 1% down days and rallying the market into the close.  Happened last Friday, and then this Wednesday.

Nearing Capitulation

The China yuan devaluation is starting to panic investors.  The hedge fund favorites, Japan and Europe, are taking the biggest hits.  It is not common to see these huge trench like drops overnight in a market with a VIX of 14, so it is curious why volatility is so low when you have these kind of overnight moves.  It seems as if options market makers are willing to sell put protection for much less than when we saw similar jerky movements in January, when the VIX was trading closer to 20.

With the overnight weakness and Chinese devaluation, you should expect a weak close today.  Intraday action is a toss up, but I don't expect any intraday strength to last into the close.  Levels of ES support are the overnight lows around 2055, which also is near the levels of the lows 2 weeks ago, and 2035, which would coincide with SPX 2040.  I would buy any capituation today or tomorrow.  This looks like a retest of the July bottom.

1999 Again?

I remember when David Tepper remarked at the end of 2014 that the market in 2015 could be like 1999.  While the market hasn't been as strong in 2015 like 1999, it has been up, in a choppy fashion, with poor breadth, like 1999.  The market is completely different now than it was back then, with ZIRP and a 10 year trading around 2.25%.  Back then, short term interest rates and the 10 year were both almost 6%.

Just based on monetary conditions, and the supply of money out there, you can say its a more bullish environment than in 1999.  It has been proven that monetary conditions are much more than economic conditions when it comes to short to intermediate term direction of equities.  If the Fed is as slow to raise interest rates as the market is pricing in, which I believe will be the case, then the S&P should go higher because supply and demand based on corporate buybacks and M&A are all tremendously bullish.  Add to that the low net positioning in US equities by hedge funds and tepid sentiment and you have recipe for a blowoff move higher into the end of the year and beginning of 2016.

Only if the Fed reacts to the blowoff move higher in equities by tightening faster than market expectations will you halt the rise.  Based on past history, the Fed is always late to the game when it comes to raising rates and they do not raise rates to respond to a bubble.  A bull market as long as the one we've had with the bullish supply and demand picture that we have is a combustible mix that can explode at any time into a parabolic rise.  Breadth doesn't matter as long as these corporate buybacks keep coming and you have loose monetary conditions.  Only the Fed can stop this growing monster, and I doubt that they will.

Crude Oil View

Not much to do in this type of market.  Best thing to do is just position trade this bore.  The bore will eat up daytraders trying to make their daily bread.  Looking at the big picture, the S&P looks like it is consolidating for a move higher.

Crude oil is in the last stages of a bear market, as you get hate and disgust at the incessant downtrend.  I am not a believer that crude oil will stay low for longer.  Shale oil supply will shrink noticeably if you keep WTI under $50.  Price is a magical element in commodities markets for reducing supply and increasing demand.  Of course, price works with a lag.  You will get the reduced crude oil supply next year, not this year.  By that time, the market will have realized this and price will have already bottomed and be heading towards an uptrend.

I am not saying that crude oil has bottomed.  I am just saying that if you have a long term horizon (over 1 year), you will make money buying crude oil at these levels.  It doesn't mean that there won't be a short term move lower to wash out the speculative longs.  But these prices are not long term sustainable in crude oil.  I am not long crude oil, but it is something that I am looking at as a potential long later this year.  Seasonally, crude oil is weak in November and December.  That would be the time to look for a value long.  Nothing actionable for now, just something that I am thinking of in the back of my mind.

Given the slow trading these days, I will be taking a blog break.  Back next week.