Tightening Theme

There is a new theme out there in the markets.  The bond guys have caught on to it, expecting tight monetary policy from the Fed and after last week's Draghi speech, the ECB.

Most of the time, you get news stories that try to fit into the price action.  When you see a sudden selloff in the bond market, which also coincides with a weaker selloff in stocks, the knee jerk reaction is to blame rising rates and hawkish central banks for the weakness.  But higher rates were mostly ignored by stocks post-election in November and December.

The key here is investor positioning.  Back on November 9, right after Trump won, investors were cautious on stocks.  Also, there is a big difference when SPX is at 2100 and at 2440.  At 2100, the market can absorb higher rates, but at 2440, higher rates will cause equity volatility.  That is what you saw last week, as what Draghi said didn't seem significant.  Draghi had to come out more hawkish because the equity markets are rising and as the ECB runs into mandated percentage limits for the purchase of bond issuance for Germany.  Unless they increase the percentage of issuance that the ECB can purchase, they have to taper, or start buying more corporate bonds or expand the program into stocks.  The natural thing for him to do at this point is to downplay lower inflation and talk up future inflation.

The bond market didn't take his words well, even though it wasn't anything news breaking.  When you have had a torrent of bond ETF inflows this year, and more aggressive long speculator positioning, the pain trade was for bonds to weaken in the short term.  And today, you get a stronger ISM number and with economic expectations back to being relatively low, you are going to get more economic upside surprises, which also reinforce the bond weakness theme.

In the long term, the central banks tightening despite mediocre economic data only makes stocks more vulnerable to a nasty drop.  We got the first signs of that last week.  But this macro background of tighter monetary policy works slowly, and in the short term, they can lead to bear traps.  It is something to keep in mind, but it's more important to see the SPX uptrend flatten out more, and to see day to day volatility increase.  That is your sign that the market is saturated with buyers and sellers are starting to meet demand more eagerly.

This is a US stock market holiday week, and the beginning of the month, both positive forces that can last a few days.  Perhaps by Friday, these positive factors will disappear and we'll see what the sellers can do.  I am expecting a drop to 2400 to be fairly easy work, but below that level, the dip buyers will get more aggressive and since they haven't had too many opportunities to buy deep dips over the past 2 months, they will be out there providing a bid between 2350 to 2400.  The game plan is to short strength  from Friday onwards, hopefully near all time highs around 2450.  My threshold to short is lower now.  No longer waiting for the perfect conditions.