Pullback Reveals a Lot

There is a lot of information that can be gathered from the reaction of market participants to a pullback.  Just from looking at the reaction on CNBC and on Twitter, you would think we were in correction territory, with carnage across the board.  But the SPX is 1% below all time highs!  This is unbelievable.  Turkey really did scare a lot of investors, even if they won't admit it.  The high put/call ratios also confirm what I am seeing and hearing on financial media. 

I thought this market would be topping out around this time period and entering a downtrend heading into the fall, but based on the near panic levels of put buying and excessive bearish mood relative to the small decline, I am rethinking my projections.  The probabilities now favor a breakout to all time highs and towards SPX 3000, which likely coincides with a US/China trade deal and a rebound in the hated emerging markets. 

China is aggressively priming the pump again, and that should be good enough for a reprieve from the selling for the next few months.  The long dollar trade seems extremely crowded now, and it will be difficult to get more dollar strength with the ECB and BOJ intent on normalizing policy in the coming months. 

Counterintuitively, with trade war worries still hovering over this market, there is a big potential positive catalyst.  Even though a trade deal won't solve the long term problems of overvaluation, late cycle dynamics, and monetary tightening, it will change sentiment and encourage risk taking behavior, which should be good for a few percent rally in the SPX. 

As for the rest of this month, I still see a range trade with the SPX ranging from 2790 to 2850.  We are closer to the top of the range, so its probably better to be short than long at current levels (2843).   But I have lost my confidence on the short side after seeing the panicky market reaction to such a small pullback. 

August is usually a bullish month for Treasuries, and that should keep bonds bid for the rest of this month, perhaps taking it to 10 yr 2.80% later this month, but that should change in September, if my medium term view on equities is correct.  Expecting 10 year to get back to 3.00% in September.