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.
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