Violent Swings

The S&P 500 is lingering close to all time highs but the intraday swings have gotten more violent.  Technical analysis 102:  Volatilty at the top of the range is bearish.  Volatility at the bottom of the range is bullish.  We are seeing the former at the moment.  

Even with the strong bullish seasonal forces that are going to be at work in the final 2 weeks of the year, the underlying tape is one of distribution by the big hands.  Yes, you will get your typical snapback rallies off a short term flush out, like you did after the Friday December 3 low, or Tuesday Dec. 14 low, but they don't last for long because the buyers aren't eager to chase this tape.  

Sentiment is a contrarian signal at the extremes, but with a lag when at a bullish sentiment.  In other words, the best times to buy are when sentiment is at the most bearish, but the best times to sell is not when bullish sentiment hits a optimistic peak, but when it is trending down while the market grinds higher after a sentiment peak.  

You are not going to get an accurate read on the health of this market in the last 2 weeks of the year.  The seasonal bullish forces are especially strong at the end of the year after a big up year, due to delayed capital gains motivations and portfolio window dressing.  Also, those that are the most eager to sell and reduce risk have already done so, taking out most of the urgent sellers for the last 2 weeks of the year.  

Already, you can see the eager beaver end of year rally players who bought at yesterday's close or in the overnight market getting tested as the exuberant overnight highs in SPX and NDX are a distant memory as the top Nasdaq names get smashed ahead of the Friday opex.  There is a lot of motivation for dealers to sell their long stock inventory as a lot of their short call inventory in AAPL, MSFT, etc. will expire at tomorrow's close (huge options expiration).  They will have to sell those stocks anyway, might as well crush the long call holders in the popular individual names in the process of flattening their books.  

The options volumes have gotten so big, that they are the tail wagging the dog.  Especially around the big triple witching options expirations happening every quarter.  Delta hedging from dealers is a huge driver of index flows these days, as shifts in IV and the effects of time decay play a major factor in changing the index put deltas outstanding.  In general, as the put deltas decline as the market either rallies and/or IVs drop as the monthly opex gets closer, the dealers have to reduce their short index position to stay delta neutral.  That is the primary force driving the market when the hedge funds are not splashing around in the market.  And often times, the hedge funds often are doing the same thing the dealers are doing as a market rallies, which is when you get explosive moves to the upside (i.e. yesterday after FOMC announcement).  

We've seen quite a shake out in gross positioning for hedge funds based on prime broker data over the last 3 weeks.  That should be enough to clear the way for a year end rally.  But remember, this year end rally is more about hedge funds having already done most of their year end selling, leaving the year end rally players, window dressers, and options dealers to dominate the price action in that vacuum.   I would not be surprised to see new all time highs being hit next week in that environment.  But it is a mirage.  The real action will return in January, and that should bring back the volatility that we've seen the last 3 weeks.  

Not much to say about the FOMC meeting and the Powell press conference.  The Fed will always do too little, too late, and they're just catching up to what they should have been doing 9 months ago.  They say 3 hikes for 2022, but those hikes, especially the 2nd and 3rd one, are conditional on the stock market staying calm.  Somehow I doubt the SPX will be so cooperative after having rallied 110% over the past 21 months based mainly on a super dovish Powell doing what the market wants.  If Powell tries to hike 3 times and/or talk tough while the SPX is trending down, you can almost be guaranteed of a long overdue and unanticipated waterfall decline.