A Little Panic in Short term Bonds

There has been a global rout in the short end of the yield curve.  Australia, Canada, Korea, Brazil, US, etc.  I imagine a lot of it is leveraged curve steepeners that are getting liquidated, as that was the favored trade for the 1st half of this year, and some people are really slow to cut losses or are just too late in closing out long term positions that were the favored trade a few months ago.  This is happening the week before the FOMC meeting, where Powell will tell us about the taper.  

Market participants often remember what happened the last time, especially when it was a big move.  And they usually want to avoid that situation, so I am sure a lot of discretionary managers are very underallocated in bonds at the moment.  After the last FOMC meeting, bonds were absolutely crushed for the next few days.  Bond investors don't want to make the same mistake again.  With yields much higher than back in September (especially the short end), and with a lot of panic liquidation already behind us, its actually probably a good time to look for a long on any dips ahead of next Wednesday for a swing trade.  

The RBA is a perfect example of the lagged reaction function of the central banker, and going overboard reacting to the Rona.  They have been looking in the rear view mirror almost all year long and stuck with their hamfisted yield curve control policy which is like a man in his 20s seeing a man in his 90s walking with a cane and following the old man (Japan) by using the same exact cane.  When the Australians finally got the nerve to test the RBA by pushing 3 year yields higher, the RBA did nothing, and folded like a cheap lawn chair.  Even with their stubborness, they probably realized that the market was right and that they were wrong to stay so easy for so long.   Although they would never admit it.  

The market worry is that inflation will cause the central banks to overreact, pushing up short term interest rates and pushing down long term rates as growth slows, which is being forecast by leading indicators.  While I agree that inflation will be a problem for a while, I disagree that the central banks will aggressively tighten in reaction to that.  If we've learned anything since 2008, it is that central banks, especially the Fed will find any excuse or small sign of economic growth slowdown to delay tightening.  In a stagflationary environment, its much more likely that the Fed would ease than tighten.  People forget that inflation was quite high from 2006 to 2008, yet the Fed aggressively tightened from fall of 2007 to the spring of 2008.  This was before the stock market crashed in fall of 2008.  While oil was surging higher, the Fed was reacting to a weakening stock market and slowing growth and cutting aggressively.  

In fact, this aggressive pricing of rate hikes for 2022 and 2023 sets up the Eurodollars market for a big rally if the economy weakens, like leading indicators are showing, and/or the SPX has a big correction, which looks likely as both monetary and fiscal policy will be substantially tighter in 2022.  I am watching for now, but at these price levels, the short end of the yield curve is looking like an attractive place to park money and collect positive carry, which is getting fatter and fatter as more and more rate hikes get priced in. 

Recently seeing a surge of speculation in TSLA and cryptos, a sign that speculative fervor is alive and well.  Put/call ratios have dropped a lot this week.  Its not a good sign for 2022, or even December of this year, but its not something that I'm worried about at the moment.  There seems to be some hedging trades in index futures and options ahead of the FOMC meeting next week, and VIX has caught a bid.  With the steep contango at the front end of the VIX curve, there still seems to be some demand there for put protection as the effects of the long Sep/Oct pullback have not totally faded away.  

I would start worrying if we continued to maintain very low put/call ratios while the VIX futures curve flattened out, a sign of low demand for puts.  When the 1 month out VIX futures are trading 16-17, then I would be concerned about too much complacency, but right now its around 20, the mid point value between the Nov 17 and Dec 22 VIX futures contract.  

The steep rally off the October lows is starting to slow down, as we are in new high territory.  A parabolic blast higher is the exception, not the rule when the SPX hits a new high.  In most cases, the SPX just grinds up when its at an all time high, which it hit earlier this week.  And with the poor earnings reports from AMZN and AAPL, there is a perfect excuse to sell them down today, and consolidate the gains.  If we get towards 4540-4550, the area of the Sept highs, I may buy on that dip. 

TSLA and Bitcoin

When we look back on this era, a lot of people will be shaking their heads.  Or will they just dismiss it as just a case of a bubble feeding on itself, pure greed with investors rationalizing the crazy valuations with explanations that were considered reasonable at the time, but in hindsight, are cringeworthy.  

TSLA hit a market cap of $1 trillion yesterday, reaching levels that would make CSCO in 2000 look like a value stock.  Bitcoin is over $60,000, giving it a market cap over $1 trillion.  These are the trillionaire twin towers of this era's bubble.  TSLA is the poster boy for the ESG movement.  Climate change is not something that's going to be solved with ESG investing and building electric cars, solar panels, and windmills.  But seeing their behavior, you would think that somehow renewable energy capacity would magically grow if they stopped investing in fossil fuel production.  Short sighted thinking on Wall Street, as always.  

 Bitcoin is the poster boy for the antiestablishment crowd who think its an inflation hedge, a deflation hedge, a hedge against dollar debasement, a hedge against a stock market crash, etc.  Basically your new age gold bug.  There is no way to value it so in essence, ridiculous price targets (remember those nonchalant calls for $5000 gold in 2010 and 2011? LOL) can't be disproved with fundmentals, because there are no fundamentals.  

Like the dotcom bubble, this bubble has turned into a two tier system of the fundamentally glued and the unglued.  The vast majority are in the glued group:  bonds, global equities ex US, commodities.  Then there is a very loud minority in the unglued group:  US big cap tech (MSFT, AAPL, AMZN, FB, GOOG, etc.), meme stocks (AMC, GME, etc.), speculative playthings (EV and "new" tech stocks (TSLA, NIO, etc), flavors of the day (DWAC, PHUN, etc.), cryptocurrencies, and NFTs.  

I am sure some of you will say that US big cap tech stocks are reasonably valued and deserve their big valuations based on their dominant positions in their industries, but the law of large numbers make continuous double digit growth impossible (unless the US turns into a Jumbo Zimbabwe, then all bets are off).  And bottom line, FB and GOOG are glorified advertisement sellers, AAPL is a glorified phone seller, AMZN is a glorified retail company, and MSFT is a glorified software company.  

During a bubble, the financial markets become an absurdity.  Since people always need a reason for these crazy moves, explanations and rationalizations are made to fit the situation.  For example, the go to rationalization for sky high valuations for such mature and large companies like AAPL, MSFT, GOOG, AMZN, etc. is low bond yields.  Even though bond yields are basically at the same levels as they were in the middle of 2016, when these big cap tech stocks were trading at much lower valuations with more growth potential.  

As for TSLA, bitcoin, and other speculative mania plays, they are just greater fool theory vehicles, and nothing more.  These plays present some great opportunities on the short side, as we get closer to the final top for the stock market, probably sometime in the spring/summer of 2022.  There will be some extremely attractive risk reward trades in put options strategies, or just outright shorts without the need to catch the top, you could wait for downside confirmation and still be shorting at good levels, as there is so much hot air in them.  

After seeing the way that bulls have remained sticky and complacent, even through an extended pullback in Sep/Oct, and seeing how quickly they get greedy and rush towards the most speculative names, its about that time to slowly prepare for how to play the top of the biggest bubble of all time.  Its going to be really choppy for the next few months as the smart money distributes their holdings to the crowd, and I would expect a gradual decline in speculative fervor as the SPX makes marginal new highs, while the likes of TSLA and bitcoin probably top out before the broader market.  Unlike this year, when TSLA and bitcoin weakness in the spring/summer signaled nothing to the SPX, in 2022, I expect TSLA and bitcoin will be canaries in the coalmine, foreshadowing a sharp SPX correction.  In the final stage of a bull market, speculative stocks top out first and lag the overall equity indices (Nasdaq lagged SPX from March 2000 to September 2000 at the top).  

Haven't touched my SPX position, still holding long, been waiting to add on any dips but they've been so shallow and fleeting that I haven't had a chance.  Still a very strong market that effortlessly blasted through all time highs.  SPX flys on a feather, making new highs while Europe, and especially Asia lag behind.  Its only been 2 weeks since the blastoff higher started during opex week.  After extended pullbacks in a strong uptrend, the rallies off the bottom usually last at least 4 weeks, so 2 more weeks of a grind higher at a minimum if history repeats.  Not even thinking about 2022, just trying to milk this move for as much as I can while seasonality is positive and fund managers are still in accumulation mode. 

Less Trading Longer Time Frames

As a beginner, trading only stocks, I envisioned taking on long term investments and holding for several months to years.  That lasted about a month, as watching the market everyday and not trading is very hard to do.  I traded more and more until I basically became a daytrader. 

I didn't know what I was doing, but I had a sense that it was easier to catch one big move than to catch several small moves.  In trading, 5 > 1+1+1+1+1.  On the path to catch several small moves, you often get something like this:  1+1+1-10.  Unless you have great discipline, which many don't, the more you trade, the more you leave yourself room for making a big mistake.  We are fallible, emotional, and prone to be undisciplined. 

Unless you are super disciplined and great at taking losses, small wins will eventually kill you in this game.  The market is like a series of heat seeking missiles.  It eventually finds your weakness and keeps attacking until you either change or throw in the towel.   I got hit with enough of those missiles over the years and gave up on daytrading, which was getting harder as the algos took over from the humans and made intraday patterns much less reliable.  Thus, I have reduced my trading, reducing my exposure to short term market moves by trading smaller and holding longer.  You don't get hit with as many missiles when you are smaller and further away.  The closer you play to the present, and the bigger you are, the more you are exposed to heat seeking predatory algos.

Even with the reduced trading, still probably trade way more than I should.  I could probably get rid of almost all of my short term trading and it probably wouldn't hurt the P&L at all.  Its mainly because a lot of those short term trades that end up as losers would have been big winners if I just waited for a better entry.  When you wait for the really good entries, you will end up missing quite a few good, but not great opportunities.  But most of the time, those great opportunties were actually good opportunities that became great opportunities due to the market overshooting due to algos and liquidations.  

If you are selective about trades, you will miss moves, and feel FOMO, but that's the only way to reduce your exposure to adverse market moves.  Buying or selling in the middle of the range sets you up to get chopped up by the algos that test your pain threshold by going to the top and bottom of the range. 

Back to the current market, the current rally is a classic FOMO rush after a pullback from a very long up trend, similar to March 2007, October 2014, and August-September 2019.  Investors experienced almost a nonstop rally for several months and have memories of the market making V bottom after V bottom, with higher highs and higher lows along the way.  The greed factor is still deeply embedded in the psyche of today's investors, as I've mentioned before with the post about sticky bulls, and how tenacious they have been even in the face of a downtrend that went on for over a month.  In these environments, after a dip, there is almost a reflexive reaction to buy no matter what when they see any sign that the market has bottomed.  I should have done nothing this week, but I tried to micromanage my position, reducing my profits by selling some on Monday, looking to buy back lower.  Of course, that never happened.  

Still holding my core long in SPX, and letting it ride.  Learned my lesson from the last few years of selling too early after these flush out bottoms, once you have a good position, doing nothing and hanging on for the ride is the best choice.  

Treasuries are starting to get to interesting levels, as 10 yr yields get closer to the year's highs at 1.75%.  Still waiting for a bit more weakness before possibly taking a swing at the long side.  But I don't see much potential for an explosive up move in bonds until after the first rate hike, which is priced to happen on September 2022.  There are already 2 rate hikes priced in for 2022 in the Eurodollars futures curve, and that's quite aggressive, considering how firmly the Fed has stated that they wouldn't hike rates while tapering.  And I don't expect a fast taper, just because of how they operate with an abundance of caution, taking their time when removing accomodation, but rushing when easing.  

10 yr yields are probably range bound until the first hike, between 1.40% to 1.75%. The power flattening over the past month has made the belly of the curve very attractively priced and with the most positive carry.  In a range bound market, collecting carry makes the difference between breaking even and making a decent gain.  Long side in Treasuries is getting more and more favorable, not only from a potential price appreciation, but also from the more positive carry from the higher yields.  

The New Safe Haven: Commodities

Bonds and gold used to be the safe havens in a sane fiscal policy world, where deficits were still considered bad.  Now, deficits are ignored, and fiscal policy has been off the rails since Trump's tax cuts got passed 4 years ago.  At first, there doesn't seem to be any consequences from the massive fiscal spending, but these things work with a lag, and are cumulative.  The first couple of years of big budget deficit spending + tax cuts don't have  much of an effect on inflation, but then the economy gets saturated with dollars and everything goes up.  Both paper assets and hard assets.  

But paper assets have been receiving all the investment flows since 2008, and commodities markets have mostly been ignored and investment in new production for energy has been mostly absent since 2015.  Shale oil production looks to have peaked out and it was never going to be a long term solution for oil supply.  There just aren't enough shale oil reserves to make up for the decline in conventional oil supplies outside of OPEC.  And even OPEC doesn't seem to have much spare capacity seeing how sparingly they are increasing production, and several countries are actually unable to produce up to their increased quotas.  

If it wasn't the possibly worst seasonal time to be long oil, I would have already dumped my SPX long and gotten long oil, even chasing the strength.  Commodities are the only market where I can picture a big move higher in 2022.  I can't picture bitcoin or any stock market that could match that strength.  Its been years of underperformance for commodities and they have been overshadowed by the big gains in the big cap growth stocks and speculative playthings like bitcoin, meme stocks, NFTs, etc.  

But the last 2 months of massive outperformance by crude oil and natural gas have given us a preview of things to come in 2022 as economic normalization and increased air travel will increase demand at the same time that OPEC added production will likely be less than what's needed.  We forget how inelastic energy demand is until you see a natural gas spiking higher on low inventory levels.  Crude oil demand destruction is one of the most overhyped and misunderstood concepts, because too many assume that the price of gasoline has an effect on how much one drives.  Most people drive out of necessity, and less for leisure.  The first is very, very price inelastic.  The second, leisure, is relatively price inelastic because most of those that travel have plenty of excess savings, and an an extra dollar/gallon of gas is not going to change their plans.  

In 2008, when crude oil went up to $147/barrel, there was very little demand destruction.  In 2021 dollars, that's probably close to $250/barrel.  Its laughable when people talk about demand destruction at $100/barrel.  Which was were crude was trading at from 2010 to 2014.  There was no decrease in demand at those prices.  

In a world where money is increasingly used as an opiate for the masses, the side effects of excess money are naturally going to follow.  Governments printing money to solve short term economic problems leads to debasement of the currency and long term inflation problems.  Instead of shaving and reducing the size of silver coins, they will just print more money and try to brainwash the public into thinking inflation is transitory.  

The best way to play this environment is to be long commodities, in particular those with constrained supply growth like crude oil and natural gas.  The metals and grains should do ok, but the supply is more resilient in those markets than in energy.  In any case, I see a supercharged commodities markets for the next 3 to 5 years, similar to the 1999 to 2008 commodity supercycle.  When they look back at this period, they will say that the commodities supercycle started slowly at first in 2016 and was at its peak in 2022 to 2024.  I know how ridiculous some of these commodities targets sound, because people have heard so much nonsense, especially from gold investors who nonchalantly called for $5000 gold in 2010 and 2011.  But $200 oil seems ridiculous to most people, but its a reasonable target by 2024.  Even at $200 in 2024, on a true inflation adjusted level (not the CPI garbage that they spew out), it would be similar to $120 oil in 2011, which no one thought was outrageous at the time.  

The best inflation hedge is investing in a hard asset that hasn't been driven up excessively by speculation.  Real estate used to be a great inflation hedge but for most countries, low interest rates have made real estate historically expensive, especially in Asia.  Stocks also are a good inflation hedge but the valuations have gone up so high by speculation, that it makes it a much worse choice to protect against inflation than commodities.  It seems investors are finally catching up to the attractiveness of commodities over the past few weeks, although there is still a lot more love for stocks than commodities.  There is still plenty of room on the commodities bus, as most investors are still riding the equity bus which is overflowing with passengers.  

SPX making one its patented burst higher from oversold conditions over the past 4 trading days.  Still long most of my position, I did lighten up a bit on Monday, and that looks like it was a mistake.  I may have to bite the bullet and get back in anywhere close to SPX 4480.  It could chop here and pullback towards SPX 4450, or just keep powering higher to new all time highs.  I give both an equal chance of happening, so you gotta be long, especially before tech earnings next week, IMO.  After FOMC on Nov. 3, a lot of that wall of worry will be behind us and with it higher prices. 

Q3 Earnings and Return of Stock Buybacks

At the start of September, the stock market hardly thought about the supply chain, or the earnings for Q3, and really only worried about a Fed taper and a possible taper tantrum.  Debt ceiling wasn't really much of a thought and there was no talk about an energy crisis.  There was a little bit of talk about Evergrande, but nothing that investors thought would really matter for US companies.  After 45 days of a downtrending market with lots of volatility and choppiness, everything seems to be horrible.  

Most investors are worried about inflation, and what that will do to bond yields, and how it affects Fed policy.  They are worried about how the supply chain problems will lead to lower earnings estimates and higher inflation.  They are worried about the energy shortages in China, the rising price of commodities feeding into inflation.  The wall of worry is high.  But at the same time, investors have been conditioned by the numerous quick rebounds off dips since spring of 2020 and don't want to miss the bottom.  Thus there are two countervailing forces, the worries vs the greed of wanting to catch the bottom and riding the market higher like previous V bottoms.  That is what gives you the chop that we've seen between 4300 and 4430 since the end of September.  

As I write, it seems we've broken that chop range to the upside, but I have little confidence that it will be a straight shot higher to new all time highs.  But I am staying long, because while I don't think the path will be smooth to new all time highs, I do believe that is what will happen over the coming month.  We could see another move back down towards 4390-4400 next week after today's opex, and ahead of tech earnings, which now seems to be more feared than embraced.  But I will stay long, because I don't want to lose my position if the market just keeps going higher and doesn't chop back down.  That's a path that's very possible, even if its not the most likely one.  

You have to average out all the different paths that the market will take and make the right decision.  And even at these levels around SPX 4460, the missed profit of losing my position and missing the ride up to new all time highs is greater than the opportunity cost of not being able to buy a dip back down to 4400 because I am heavily long.  Maybe if I see more signs of a short term swing top, I may reduce 1/3 of my position, but I want to keep a core regardless.  The seasonality is too favorable and the earnings season now seems like a sell the rumor, buy the fact event, especially the tech heavy earnings week from Oct. 25 to 29.  I can picture a little dip next week, only to see another big rally the week after.  And into the FOMC meeting on November 3, which is an event that is considered a bear catalyst, but likely will serve as springboard for lower VIX due to the event passing and reduced uncertainty which should bring in the last of the sidelined equity investors coming back in to put money into this market.  

There is a seasonal tendency during earnings season to see the S&P 500 selloff a couple of weeks before bank earnings, and then make a big move higher right before most of the tech companies start reporting.  This month, that period would be from October 25 to October 29.  That also coincides with the end of the stock buyback blackout period.   As you can see below, November is historically the heaviest buyback month, which should support the SPX.  Also, it has seasonally been one of the strongest months of the year.  

Another chart which supports the bullish case is the Squeeze Metrics Dark Pools Index (DIX), which is a smart money indicator, measuring short sales in dark pools.  The higher the short sales, the more bullish it is for the market going forward.  Its been trading high for the past several days, and especially this week, despite a strong rally, which is unusual.  The last time DIX was high as the market rallied was in mid July, which resulted in the market grinding higher to new all time highs almost every day for the next 40 days. 

As for the bond market, its a tough trade right now.  Ahead of the Fed taper announcement in November, investors will be reluctant to buy bonds, so I am hesitant to get long.  At the same time, most are leaning short, so I don't want to get involved in that negative carry crowded trade. 

Everyone Has a Plan

 "Everyone has a plan until they get punched in the face" (or bit in the ear.) - Munchin' Mike Tyson

The moves in recent weeks are uncommon in a bull market.  In strong uptrending environments, it is not common to see such an extended pullback.  Its been over a month since the market was at all time highs, and for most of that time, in a downtrending channel. They are common in bearish environments, but not bullish ones. 

So does it mean the uptrend has now turned into a downtrend?  Its possible, but considering the fairly small SPX drawdown from all time highs, and its relative strength vs. other global equity indices, I am leaning to a bull market until proven otherwise for longer.

Its been a tough environment for mean reversion traders, and those that follow historical patterns.  Looking on the bright side, if the market always followed historical patterns and statistics, then all the patterns would change as systems traders front run trades and that itself would change the patterns, making them harder to time.  

The unpredictability and luck factor are what keeps everyone on their toes, it keeps any one group of traders or investors from totally taking over the whole market.  But I'm sure that will change with the advance of technology and AI.  The days of discretionary trading big macro moves becoming so tough that its not worth it are not too far ahead in the future.  Already, FX is almost untradeable.  I could definitely picture a day when equity index futures and Treasuries follow suit, and become just as untradeable.

Everyone can trade well when things go as one predicts, while making money.  Most of the alpha is generated in dealing with the drawdowns and when the market makes unexpected moves.  Knowing when to hang tight and when to reduce risk is what separates the winners from the losers.  Its the toughest part of trading, making the right decisions when losing money.

This market is not scaring them out, but wearing them out.  Its jab after jab after jab.  Not many knockout punches, but stiff jabs over and over again.  Yesterday was another one.  It feels like endless chop and the market can't sustain a rally.  It feels heavy, and its slowly turning overconfident bulls into reluctant bulls and even into reluctant bears.  

I remain long, but don't have any plans to add any more.  The SPX has worn me out.  The probabilities still favor the long side, but they are going down with each passing day of more chop between 4300 and 4400.  The wall of worry is quite high: inflation, supply chain worries, China, central bank tightening, bond yields, etc.  It appears that fund managers are taking down risk ahead of this earnings season and the upcoming Fed taper.  Hedge fund equity long exposure is still above average levels, but its come down over the past 2 weeks.  The put/call ratios have remained near the upper end of the 2021 range.  Slowly, the positioning is coming down to levels where we can sustain an extended rally phase again, perhaps for the next 2 months. 

With October almost halfway done, the seasonally weak period is almost over and the buybacks can't come back fast enough for the bulls.  Its just grin and bear it time for the longs here, waiting for the storm to pass.  Looking at charts doesn't help anymore.  Reading the news is repetitive and talking about the same things over and over again.  Its just discipline, risk management, and following the game plan now.

Debt Ceiling Worries

Did the market really selloff yesterday because of the debt ceiling uncertainty, and recover because McConnell caved in and agreed to a short term deal?  Worrying about the debt ceiling is the epitome of very short sighted thinking.  They have never failed to raise the debt ceiling.  Its about as near a certainty as the sun rising in the east.  The US government, with a spending problem, will not shoot themselves in the foot and take away their own credit card.  They don't need to mint a trillion dollar coin.  They can just do whatever they did in the past, and if not, there is always reconciliation, the easy way out of doing what you want without having any bipartisan support.   Not raising the debt ceiling is like a gambling addict going to the casino and putting himself on the voluntary no entry list.  Eventually the guy will find a way to gamble, if not at that casino, online or at another casino.  Or maybe the guy just binge buys a bunch of lottery tickets.  

What we saw from last Thursday to this Wednesday was a U bottom.  Its rare these days, and something people rarely talk about, because with all of the liquidity and predatory front running HFTs, you usually get huge flush outs from front runners forcing liquidations and running stops, taking markets too far down, so there is a slingshot effect.  Since there is always so much liquidity, the market roars back higher, just as fast as it went down.  Some examples of U bottoms are August 2010, June 2011, July 2015, August 2017, April 2018, August 2019, and if the market keeps rallying, Sep/Oct 2021 will be added to that list.  

U bottoms are characterized by markets that have support at lower levels, and lack the forced selling and liquidations which result in V bottoms.  Shaking the tree through time and choppy, volatile price action rather than capitulation. 

The first sign that a U bottom was possible was the sharp rebound on Friday unexpectedly (in my view) after a nasty overnight purge lower towards ES 4260 after the weak Thursday Sep 30 close.  I am sure some of that post-close weakness Thursday was delta hedging by dealers and those that were front running that because a big JPM fund put on a huge put spread paid by selling OTM calls on Sep. 30.  It was a chunky delta negative position, which was hedged for 1 day when the fund bought a in the money same day expiration SPX call to delta hedge their options position, basically kicking the can on the hedging from intraday Sep. 30 to the close and the overnight market.   So dealers had to hedge on a huge SPX short put spread position right at the close. 

Usually this quarterly trade isn't a market mover when markets are in an uptrend, but when markets are nervous, and their call that they sold the previous quarter finishes out of the money, then the position tends to cause a big short term ripple in the market.  

If Friday and Tuesday showed you that there was underlying demand for stocks below 4300, Monday and Wednesday showed you that there were still too many bulls looking for a quick rebound (as did that @hmeisler investor poll), and they were punished chasing strength on Friday and Tuesday.  But usually after 3 of these up and down cycles after an extended selloff, you have usually worn out all but the hardiest of bulls, and that provides the base for a strong rebound.  

Plus, despite a month long selloff, the SPX only sold off 5.3% from the peak on a closing basis.  That's just not going to do that much technical damage considering how strong the uptrend has been this year.  This month long selloff couldn't even get down to the July lows on a closing basis.  

But what I did learn about this market is that stock investors are quick to be bullish, and reluctant  to get bearish for long, even in the face of a lot of bearish news.  They have learned their lesson from the brief selloffs and strong V bounces since March 2020, and now conditioned to not fear down days, but look at them as buying opportunities rather than as a sign of weakness.  That might not mean much now, but its not a good sign for the longer term prospects for the US stock market. 

We got a big rally supposedly because of the debt ceiling "deal", but I think the market was looking for any catalyst to make a bottom and start the recovery from the month long pullback.  I was a bit worried that I missed my opportunity to add more longs by not buying on Monday, after seeing that strong Tuesday rally, but was relieved to see the gap down on Wednesday and was able to add long exposure at decent levels.  I plan on holding these longs for a longer term swing trade, maybe until mid November. 

Sticky Bulls

That's what a 20% rally from the start of the year does to investor psychology.  Remember, most investors use the rear view mirror when they trade.  That 20% rally which was relentless with every small dip being voraciously bought left a searing memory into the psyche of most investors.  They now don't think the market can stay down, and that even big dips are not a sign of a change in the market, but just a buying opportunity, a bump in the road to higher prices.  The Twitter poll run by @hmeisler had a repeat from the week prior, with bulls much higher than bears.  

I was a bit shocked, just because last week, the SPX traded much lower and only was able to put in a last minute rally on Friday afternoon, which obviously got investors bullish.  It tells me that investors are still very quick to get bullish in this market.  

The equity volume on the exchanges was mediocre, and it didn't seem like too many were anxious to make trades yesterday.  It appears that the bulls are mostly satiated with their dip buys, not really willing to put more money in at this time, but not willing to cut losses on recent purchases.  Also, it doesn't seem like too many are worried during this selloff, you aren't seeing the elevated put volume that you normally see after 4 weeks of a down market.  That worries me a bit as a dip buyer, it doesn't change my view that there will be a strong rebound once the bottom is hit, but it does make me wary of more selling in the coming days as there seems to be limited stop loss selling or capitulation.  

The explosive move higher in crude oil despite stock market weakness is a definite burden for the bond market, and thus, a negative for stocks, by collateral damage.  Anything that reinforces the notion that inflation will be high for longer will hurt stocks.  Reinflation is no longer welcome.  

More and more, this market is reminding me of October 2014, when after over 3 years of a steady uptrend, you finally got investors into a very complacent mindset leading to a sharp drop and an equally sharp rebound, which presaged an extended topping phase in 2015. 

Treasuries continue to be a tough trade, with FOMC meeting in November and higher energy prices as negative factors.  I don't expect a 2018 style bond market rout mainly because I doubt that the Fed will be able to go on an extended hiking cycle with how fragile the stock market will be from 2022.  And let's not confuse the current Fed with those from anytime pre 2008, and even pre 2020.  Inflation is just not a big factor in their decision making, no matter how much everyone talks about it.  The Fed's priorities in order are:  1) Stock market 2) Employment 3) US growth 4) Bond market 5) Inflation  

And the Fed wants all of them higher, except inflation, but they are willing to tolerate high inflation, but not a weak stock market, labor market, or growth.  So higher energy prices will not be a factor in Fed policy.  Just like the Fed ignored higher energy prices when cutting rates in 2007 and 2008.  

Being patient on adding more equity exposure, I am underwater on last week's purchases so would like to see some more fear out there before I add more.  We've had a lot of gap up and fade moves and that speaks to investor optimism.  Usually when investors are pessimistic, you see many more gap downs.  A big gap down that scares the crowd would go a long way towards making a bottom.  Thought that would happen last Friday but they brought it all the way back up. 

Going Down the Hole

It is looking bleak out there.  Futures gapping down after breaking last week's lows and below the key SPX 4300 support level.  Next psychological support level is 4250, and there is a open gap at 4258.  With the September selloff, we've backtested some significant trading levels (4420, 4350, 4300).  If you get some real panic selling, 4200 could be tested, but that is where the market lingered for quite sometime in April and May, so there is strong support at that level.

For the positives, you are finally getting some heavy put buying, as the ISEE call/put index shows.  Not just one reading under 80, but 3 times over the past week:

 Despite Thursday's selling, VIX didn't break out to a new high, and it closed lower than Tuesday, when SPX was 50 points higher.  SPX has made a lower low and VIX has made a lower high. 

For the negatives, the hedge fund CTAs are still very long this market, as regression data from the HFR CTA Index with the SPX is highly correlated.  Also, you still have negative seasonal effects at this time of the year, with stock buyback blackout in effect for the next few weeks, and volatile October seasonal patterns.  Don't forget that going into this week, according to that popular Twitter poll I mentioned on Monday, the dip buyers were still too bullish.  This week has gone a long way towards changing that, so we'll have to see how the FinTwit crowd reacts after this week's selling. 

I am still long, and early, but have dry powder to scale in more longs at these levels.  This will be for a longer term swing trade.  The uptrend is intact, but this selloff gives me more confidence that 2022 will be the year the SPX goes into a topping phase. If we do recover to new all time highs later in the year, don't forget about the price action this September.  Like February 2007, March 2011, and August/October 2014, a sudden, and deep sharp drop from a well established uptrend is a warning sign that the uptrend phase of the market is getting closer to the end.