Front Running, Shorting, Macro

The financial markets don't exist to fit traders' cookie cutter assumptions.  Front running is the rule, not the exception.  The weakness in stocks from Jun 20 to Jun 27 was as much a massively overbought market mean reverting as it was hedge funds front running the pension fund rebalance, which was hyped up even on Bloomberg on Jun 16, as being as much as $150B out of stocks into bonds.  That was your warning sign that the rebalance effect would be pulled forward.  Despite this, bonds weren't able to go higher, even with stocks being weaker and with no significant econ. data.  That set up the unwind trade later this week, as the hedge funds bailed out of bonds ahead of the end of the quarter, and stocks were pre-sold ahead of time by funds to cover into the anticipated pension fund selling.  It appears the pension funds pulled forward their rebalance to avoid being target practice for the hedgies. 

This week once again proves that its hard being a short seller, even in such an overbought, overvalued market.  To survive as a short seller, you either have to focus on 1) small cap retail traded stocks or 2) be like a cockroach when shorting large caps/index.  

For 1) The dumbest hands in this business is fast money retail.  The most edge is from shorting whatever stock they are playing that day.  Since most retail traders are longs, when they buy and drive a small cap stock higher on either no news or meaningless news, shorting into the strength from their irrational buys is a big edge.  Then you cover when they eventually sell at the end of the day or the following days.  Pure edge.  But scales poorly, due to small floats, but that's irrelevant for most retail investors. 

For 2) Shorting big caps stocks and the index is hard.  In most cases, you have to be on the sidelines waiting for perfect setups.  The only times you can be aggressive is in bear markets, but bear markets don't last long, and end with the bears getting their face ripped off.  So not a forgiving game.  If you want to have a chance, have to be super selective in short entries and take profits when the market corrects.  Being too greedy trying to perfectly time the bottom for covers is asking for trouble, and setting yourself up for missing the graceful exit, and being stuck short on the other side of the V bottom.  You can't short in the hole, you have to set up the short ahead of time, anticipating future weakness.  Once the weakness arrives, its usually too late to get a good short, as the first half of the selloff is where the best risk/reward happens.  You have to be a cockroach.  A survivor.  Resilient, be able to take hits, be unaffected, and go on to the next shorting opportunity. 

Lastly on trading/investing based on macro.  Its a very tough game.  It's not a long term alpha generator for most.  Its the most crowded space out there in the financial markets, so the edges are small AND long term, a bad combination.  Usually when you have to play long term, you want edges that are big, due to the extra volatility involved in long term positions.  That's not the case with macro investing.  FX is the toughest market out there.  Most of the time, especially over short to intermediate term horizons, stock indices and bond yields are hard to predict. 

Seeing a big squeeze higher today, catching the "rebalance" believers off guard.  Today is the JP Morgan fund collar trade expiration and reset day.  Those sold calls are deep in the money, they are 1 deltas and the put spreads 0 deltas.  Dealers have to replace their 1 delta short stocks position with something like a 0.40-0.45 delta combined short stocks positions as they get long calls and short put spreads.  So that leaves them with a net 0.55-0.60 delta of SPX buying they have to do by the close today, with a fund that's over $15B last time I checked.  So close to $10B of buying pressure they are adding on the SPX today. 

I am not in a rush to short, but SPX above 4450 will start to catch my attention.  From a timing perspective, probably need to get closer to mid July before I am really interested in putting on a big short.  Early to mid July is usually a bullish time period for SPX, especially coming off of a post triple witching opex selloff. 

Waiting for Bulls to Overplay It

Stocks often enter a bear market during recessions not only due to earnings going down, its because valuations are usually high going into one.  They say valuations aren’t a good timing tool.  I would disagree.  If you are timing an entry point for weekly options, yes they are a bad timing tool.  If you are trying to set up a long term allocation for stocks, they are a great timing tool.  And most investors would care much more about the latter than the former.  Its unusual to see such strength here when valuations are this high with competing assets like corporate bonds providing a higher yield than the free cash flow yield on the SPX. 

The forward P/E for the S&P 500 is now higher than all periods over the past 25 years except the bubble period of late 90s/early 00s and late 2020 to early 2022.  Those periods were a bubble for a reason:  earnings were growing at a high rate, unlike now.  

We live in extraordinary times.  It is not normal for stocks to rally so much and get so expensive when earnings are expected to show little to no growth, and as the Fed is tightening monetary policy.  These are the type of markets that make impatient investors give up on fundamental analysis and just become chart jockeys following price and momentum.  This market is making a mockery of stock market history.  The extreme divergence among the large and small cap stocks are luring the fundamentalists into buying the laggards because they look cheap relative to the market.  Only to likely see the laggards get crushed alongside the leaders when the correction arrives.  

If there is one thing I’ve learned from the new market dominated by passive index ETF flows, divergences last for a long, long time.  Big tech outperformance lasted for 13 years from 2008 to 2021.  Big tech was always more expensive relative to value stocks, and remained that way.  Only in 2022 did some mean reversion happen, and in 2023, that mean reversion has been completely reversed and then some. 

Its been a long term loser trying to be the wise guy who thinks he can just look at relative value, or play out their macro views to make money buying certain stocks and shorting others.  It gives hedge funds an excuse to collect 2 & 20 despite having no alpha, although it sounds great during a Power Point presentation to prospective clients.  The very fact that so much money is allocated to hedge funds is itself evidence that most asset allocators don’t understand the market and are overflowing with hubris despite underperforming a 60/40 portfolio almost every year since their existence.  Really, the most alpha seems to come from playing for unwinds of crowded hedge fund trades.  There is one thing that's a near certainty:  hedge funds have a low pain threshold.  When hedge funds are caught off sides and all on one side of the boat, it doesn’t take much for the market to go the other way and make them run for cover.  

The road to profitability lies in realizing that most of the time, there are no trading opportunities.  (This applies for trading big markets like equity index, bonds, commodities, FX, and big cap stocks)  The only consistent source of short term trading alpha is from fading retail traders, which means you have to play the short side of speculative small cap stocks that are flavors of the week/month.  And even that space is getting crowded as the number of retail short sellers has grown by huge amounts since 2020.  So you get occasional insane short squeezes that take away several months of profits in a day. 

Year to date, in a market that doesn’t really fit my style, I’m glad I haven’t gotten buried.  I would have never guessed such a strong rally would happen with the Fed just marching along with rate hikes beyond 5% with total oblivion.  Especially at these high valuations.  This market makes very little sense here.  It looks like an accident waiting to happen.  But instinct and intuition kept me from aggressively shorting the markets in May and early June.  I know from gut feel that its usually a bad time to short when you have investors worried about nothing burgers (debt ceiling, massive T-bill issuance to refill TGA).  And then it looked like a real possibility that there could be a call frenzy in the 2 weeks ahead of June triple witching opex, which felt like a perfect storm for early bears who were set up to get delta squeezed during opex week.

 

I feel no envy seeing longs making money in this strange market while I’m losing a bit here and there.  I don’t feel FOMO relative to others.  I feel FOMO relative to opportunities that I see.   My opportunity set will be a tiny subset of all the opportunities out there in the market.  The goal is to keep increasing my knowledge base and edge in the markets to be able to recognize more good opportunities than I did in the past.  So far this year, the opportunities have been few and far between.  But with the big rally and the optimistic mood change on the economy, I am starting to see setups that could arrive in July.  The potential energy is building, and while some of that was released over the past week, there is a lot left to get unleashed.  Coiled spring/ticking time bomb type of market here. 

Its been 6 trading days since the top on June 16, triple witching expiration.  Its been quite a low volatility move lower, and there's been no fear on this move down.  It means that if there is a bounce, it likely won't be a strong one that takes us back to the highs.  I covered the remaining shorts on Friday and Monday, and am looking to reload shorts at a later date.  Playing hit and run.  For singles and doubles.  

 

With these sharp moves higher, you usually get a consolidation for a few weeks to digest the move and for investors to get used to these higher prices.  There is a sticker shock element to stocks as well.  After a few weeks, that fades away and gives room for the market to make another push higher towards new highs.  Its at that point where I will be watching closely at the Russell 2000 and Eurostoxx to see how they perform relative to the SPX.  If we see a resumption of relative weakness for the Russell and for Eurostoxx, that's going to be a green light to load up for a more aggressive short trade for July and August.  Watching and waiting for the bulls to overplay their hand.  

Golden Age for Stocks is Over

Lies, damn lies, and statistics.  For the US stock market, since World War 2, it has been an amazing period of high returns that has shaped the current view on the equity market for institutional, retail, and foreign investors.  The assumptions for forward returns are often based on past history, most of it dating back to a period where the US was a emerging as the world superpower, obtaining reserve currency status, with both high growth rates and big productivity gains.  Those historical assumptions are projected out into the future, with most investors thinking its natural and common for stocks to return 10%/year, or 7-8%/year after inflation.  Those are bold assumptions likely to disappoint current investors.  

How did the stock market go up so much since World War 2?  There are 3 phases which contributed to this great bull run in stocks.  

Phase 1:  Demographic Growth

From 1947 to 1964, the US population grew at a 1.7% annual rate, laying the foundation for a much bigger labor force in the 1980s and 1990s.  The working age population surged higher.  The labor participation rate for women went from under 35% in the 1950s to 60% in the 1990s.  This resulted in a huge increase to the labor pool, especially during the 1960-1990 time period.  More labor = more production = more wealth.  That flowed through to more consumption which boosted revenues and profits.

Phase 2:  Technology Golden Age

Computers and Moore's law, making computers both faster and cheaper continuously from the 1970s to the 2000s.  Add in the network effects and efficiency gains from the internet and you had a golden age in technology.  EVs, AI, cloud computing, etc. don't even come close to what happened in the past.  EVs will have no effect on productivity or efficiency for the overall economy.  Cloud computing is just outsourcing servers.  AI is the hype monster at the moment, and I'm no expert, but its got to get a lot better to even have a marginal effect on the economy.  Improving search results and answers to questions doesn't do anything for productivity.  It could be a niche tool for certain tasks, but its doesn't have the mass game changer potential that computers and the internet have had in the past.  Not even close.  

Phase 3:  Profit Margin Expansion

Anti-trust legislation has been in the books for over 100 years, but the enforcement and interpretation of the law have gone extreme to the right side of the spectrum.  In the past, when companies got too powerful and too big, they were forcefully broken up.  Classic examples being Standard Oil and AT&T.  If the standards of the early 1900s, or even the 1970s or 1980s for anti-trust were enforced, Google wouldn't have been allowed to buy Youtube.  Facebook wouldn't have been allowed to buy Whatsapp or Instagram.  Cisco would be much smaller, and many of its acquisitions would have been blocked.  Microsoft and Amazon would have been forced to breakup their Cloud business.  A lot of modern day oligopolies wouldn't exist.  Mergers and acquisitions are basically rubber stamped, and collusion is the norm, not the exception for many industries.  While I don't expect a return to the past of more strict anti-trust enforcement, you've reached a point where corporate influence in politics is near a maximum, as populism keeps growing.  

The corporate tax rate going from 35% to 21%, and the addition of favorable tax rules and loopholes have gone straight to the bottom line of corporations, at the cost to the government having to issue more debt to fund those tax cuts.  Corporate welfare in the form of lobbying to get favorable treatment, as well as pressuring lawmakers to put in  regulations to prevent competition and build a moat around a business are now normal and expected in corporate America.  

The US budget deficit has been ballooning higher since 2008, and even during boom times in 2022, the deficit hit $1.4T, which is unheard of for such a high GDP growth year. For 2023, the CBO projects a $1.5T budget deficit, but that's already looking way too low, as the April tax receipts came in $250B less than expectations, mainly due to less capital gains collected due to the falling stock and bond markets in 2022.  So 2023 is looking like its going to be closer to $2.0T budget deficit.  That's a deficit of around 8% of GDP, which is a big boost to the economy.  No wonder the recession keeps getting delayed.  

You should have seen a big slowdown in the US economy in the 2010s with the excess credit being taken out of the system but the government came in to fill the hole with big budget deficits which continued even when the economy was fully recovered.  And it hasn't looked back.  Even before the Covid stimulus, you had big budget deficits even during an expansion in 2018 and 2019 because of unfunded tax cuts and the growing baby boomer population collecting Social Security and Medicare.  These public sector deficits become private sector surpluses.  That's kept the growth going even though natural demand from a growing working age population is just not there anymore. 

The 1960s-1980s were about demographic tailwinds, the 1990s-2000s were about technological tailwinds, and the 2010s-2020s were about corporate welfare and government deficit tailwinds.  

With the working age population stagnant and no breakthrough technologies to improve productivity, the stock market can only lean on corporate welfare and big government deficits to fuel future profit growth.  But welfare and deficit fueled growth is pure inflation.  Inflationary growth is growth of the lowest quality.  As it concentrates wealth into those with the most access to government largesse and money spew.  It doesn't add real growth.  Its a redistribution of wealth, not an addition of wealth.  Inflation is not wealth creation.  Even though it often feels like it for those who only look at nominal numbers.  Inflationary environments mask recessionary conditions because we live in a nominal world.  If you reduce volume but increase price, you can increase revenues with negative real growth.  That's what the weak commodity markets in an inflationary environment are telling you.  That's what greedflation is doing to the economy.  Corporate pricing power is very strong, and the CEOs are pushing prices up to maximize profits, not revenues or volume.  

US corporations have done a great job pushing up profit margins over the past 20 years.  They have been rewarded with higher and higher stock prices, so the incentives are there to keep pushing margins higher.  Only when consumers are no longer willing to pay up will corporations change strategies.  But with all the government money floating around and $2T added each year, prices have to go up to match supply and demand.  Wages have to go up as more money is chasing the same number of workers.  More money is chasing the same number of goods.  That's inflation.  

So I expect future stock market gains to be fueled mainly by higher inflation, which boosts nominal numbers.  The golden age of low inflation and high stock market returns are history.  

The irrational exuberance phase of this rally is frustrating bears and the underinvested.  You will need to see even more greed from investors to take this market higher.  Its not going to be fundamentals doing the heavy lifting.  This rally over the past few months has been all valuation expansion and soft landing/delayed landing optimism.  Valuations are quite rich for such a tight monetary policy environment.  Take a look at the SPX/M2 ratio as of April 1 (when SPX was ~4100), around 0.20. With the SPX around 4400, that ratio is above 0.21.  That is higher than almost all periods since the pre-Covid highs in early 2020 and mid 2021 to early 2022.  You had brief periods in 2000 and 2007 when the ratio was higher, but only marginally so.  You are in nosebleed territory here. 

 

We are finally getting that pullback after an extremely sharp up move in the first half of June.  Based on how slow this pullback is developing, and the shallow nature of the losses, its not going to be easy for the market to reach that 4300 level I was originally expecting later this month.  I will lighten up on shorts today into the weakness, with plans to add more shorts if we get a bounce next week.   Bond market is looking heavy so I don't expect a sharp rally from stocks anytime soon.  There are rhythms and patterns to how the stock market reacts to such sharp and fast up moves, and they are usually not immediate collapses (Jan 2018 being an exception).  You get a shallow pullback most of the time and some consolidation and narrow range trading with compressed vol.  That appears to be the case this time as well.  Yesterday, VIX went down even as the NDX sold off over 1%.  Not looking for any big moves right now, just trying to hit singles.

Tops Take Time

We got the hawkish pause, and a selloff in both stocks and bonds.  Another weak response to an FOMC rate decision, making it several in a row that has shown weakness. A recent phenomena, the total opposite of what you saw for most of the past 20 years.   I remember there being a study done about how a big percentage of the S&P 500's annual gains were achieved on FOMC days back in 2011 or 2012.  The markets are getting more and more efficient, and these obvious patterns tend to get either front run or just no longer work as they get gamed out by investors/traders.  

It looks like Powell has not completely fallen into the trap that the market rally setup, which was to induce the Fed to hike again this month. Although it did influence him enough that his default stance now is a hike in July.  Which means that if you don't get a stock market swoon (SPX below 4100) from now until the next FOMC meeting, even with weaker economic data, he's going to do another 25 bps at the July meeting.  This is not great for my bond position, but it works well for my short equities position.  I was skeptical that the Fed would get egged on by the market to overtighten, but that's what's happening.  And with the animal spirits back with a vengeance in the stock market, its testing the Fed's credibility on fighting inflation, which Powell seems obsessed about maintaining at the moment. 

I will admit, I've been wrong about the US economy and stock market since the middle of 2022, when the big rate hikes were happening.  Like many, I was expecting recessionary conditions to show up around this time period, and they have not.  I definitely underestimated the staying power and potency of what a huge fiscal stimulus does to an economy.  Also, the obvious boost to the house owner's balance sheet from having a 3% mortgage, has also been a source of resilience in consumption, as less of the monthly budget needs to be allocated to making mortgage payments.  Lastly, with how quickly the Fed went from 0 to 500 bps, the gradual nature of bonds maturing mean that the net average of the interest payments that corporations and individuals pay is still not that high, but is gradually rising.  While floating rates reset quickly to reflect market rates, the fixed rate market is much bigger and most of it is still low coupon, meaning most borrowers are not feeling stress from debt on their balance sheet, yet.  It will come eventually as all are resets to much higher rates for those that do need to reissue debt.  

That being said, the equity market is very overvalued on a relative basis to fixed income, and assume that what happened in the last 30 years will repeat over the next 30 years.  That seems like a bold assumption to make.  With the rally this year, equities as a percentage of household assets is now greater than 38%, which is higher than all periods except during bubbles in 2000 and 2021.  On a long term time frame, equities as a percentage of household financial assets is a great indicator.  It is the single best predictor of future returns.  

Bears got spoiled in 2022 when all rallies faded quickly, with the market giving very little time for bulls to sell the rally highs, and plenty of time to sell the lows.  That's the exact opposite of what had happened from 2009 to 2021, when bulls had all the time in the world to sell the highs and very little time to sell the lows.  The kind of pointy, quick top that you saw in August 2022, the last time the SPX was above 4300, is not common.  Most tops are a process, not an event.  Most of the time, the index trades near the highs for a few weeks before having a correction.  

But with a 200 point SPX rally in 2 weeks, near 4400, you are getting a good entry level to put on a short for a quick trade.  These type of sharp moves towards 52 week highs usually end up retracing at least half of the rally within the next 1-2 weeks.  Not likely that it gets back down to 4200 this month, but 4280-4300 is very doable.  With the stock market entering triple witching expiry, you have a potential classic top on expiry week, followed by a selloff post opex, into the seasonally weak late June time period.  Also, the weakness in the bond market is another good sign for those looking for a short term top.  

Given the speculative nature of this market with traders aggressively buying up stocks like NVDA, TSLA, and even the mega cap tech names, you have a nice short setup.  I entered a short position in SPX and some of the speculative tech names yesterday with plans on adding more today and tomorrow if the market stays up.  Not looking for any home runs here, just a single or a double.  The time to set up to try to hit the home run will be in July, if the market chops around these levels for a few weeks. 

Cruising for a Bruising

The stock market is doing its own thing, and fundamentals don't matter.  They say that the stock market is valued on the future discounted cash flows of all the public companies combined, but more often than not, its values fluctuate on short term positioning changes based on economic data, volatility, and recent earnings announcements.  There is no rhyme or reason for the price action from a purely fundamental view point.  Earnings haven't kept up with the rise in the SPX, so this rally seems based on renewed hopes for strong earnings for the 2nd half and a soft landing, or a delayed landing.  Or maybe its just investors chasing the market to keep up with the averages and not fall further behind.  

Its not easy to predict irrational confidence coming from stock investors, although there were signs in April and much of May before the debt ceiling deal that there was some hesitancy and leftover bearishness from the regional banking "crisis" in March. Overcoming those hurdles = higher prices.  With the removal of the wall of worry (banks, debt ceiling, etc.), you have discretionary and systematic hedge fund positioning back to Q1 2022 levels. 

Now that bulls no longer fear a banking crisis, and most do not fear the Fed (although short term bond investors seem to), they have been adding net exposure to levels that are the highest since early 2022.   Still lower than the bubble times from late 2020 into early 2022, which was an exceptional period of unfettered speculation by both retail and institutions, but no longer can you say asset managers are underweight.  In particular, they are longer NDX futures than even the bubble times in 2021.

SPX Futures Asset Manager Net Position

NDX Futures Asset Manager Net Position

With hedge funds and asset managers back to above average levels of net equity exposure, it will require continued resiliency in the economy and a delay of the recession as well as low volatility to meaningfully increase buy flows from here.  That is a high bar to jump over as all the data seems to be turning weaker (except jobs).  And the labor market is usually the last domino to fall before a recession is recognized by the public.  And jobless claims came in higher than expectations last week, as well as Canada surprising the market with job losses in their employment report.  So job losses don't seem to be too far behind here.  

The current positioning is not extreme, but you only get extreme bullish positioning when fundamentals are positive from both a forward-looking earnings basis and from a monetary policy perspective.  You have neither right now.  And you have high valuations, which matters, no matter how little the markets seems to care.  It is lot to ask to expect even dumber money to come in and pay up more than current prices without a significant change higher to earnings expectations, or a sudden shift to a Fed looking to cut before a lot of economic weakness.  Those buying now are looking to sell to greater fools or expecting a sudden change in the Fed reaction function.  Those are low probability bets. 

To add to the bearish mix, the central banks are still hiking as if the economy is fine and inflation is still a big problem.  Australia and Canada "surprised" markets with 25 bps hikes, and that has spooked the front end of the yield curve.  It almost feels like an echo of the early March period when the economy was resilient and the central banks were hawkish beyond belief, and the yield curve was bear flattening expecting a lot of future hikes. 

But unlike early March, the real economy is now weaker, more time has passed since credit really got tight, and the equity positioning is now much more bullish.  Add to that the low VIX, and you have a good setup to buy puts for the first time since early 2020.  I usually don't recommend put options for making a bearish bet, due to time decay, but with the bombed out VIX and recent SPX rally, they are cheap.  The VIX is totally mispriced here.  They are being priced off the recent low realized vol, not on the potential vol that could happen when the economy enters a recession and earnings forecasts get revised lower.  As most forward looking indicators point to.

Stocks are priced for earnings to be steady to higher, with very rich valuations for such an adverse monetary policy environment.  You have an economy that is slowing even before the lagged effects of rate hikes and credit tightening have fully been absorbed into the system.  SPX components have a big chunk of their earnings coming from overseas.  And the economies in Europe and Asia are doing worse than the US, and are also dealing with higher rates and tighter credit.  This is a synchronized global slowdown happening, with stubbornly hawkish central banks, yet the stock markets are looking beyond the leading indicators, focusing on the strong labor market.  

This week, the final bit of the wall worry should be climbed after the FOMC meeting this Wednesday, where many are expecting a hawkish pause.  I doubt you get anything from this week's meeting that will scare any bulls.  A hawkish pause is like jumbo shrimp.  Its an oxymoron.  I guess Powell could outright say that he's going to hike again, but that's not his style.  He'll usually be mealy mouth, and say the same crap such as data dependent, inflation is still above target, etc.  Cookie cutter comments that he uses at every meeting.  And I expect the market to have a small rally on that.  The positioning is no longer conducive anymore to big rallies, unless you've had a big dip.  So from here, I could see a bit more of a grind higher this week, before you start seeing some volatility and more 2 way trade later this month. 

The central bankers are like misguided cruise ships that keep going in one direction, and only after they hit an iceberg, and after doing a lot of damage, they realize they went too far, and then turn around and go in the opposite direction until they hit an iceberg again a few years later.  I have a feeling that they are approaching an iceberg at high speed and are irrationally confident that they can cruise along with only "mild" bumps along the way.  

With some ridiculous moves in stocks like TSLA, I am dusting off the bear suit to put on this week.  The rise in speculation in the market recently is setting off alarm bells.  The call volume has been quite elevated.  The put/call ratios have stayed low.  All while the fundamentals are getting worse.  Its been a while since I've seen such a bearish setup.  This is giving off some summer 2007 vibes.  I don't expect any fireworks for the next few weeks, but do expect a dip down towards 4150-4200 later this month that will likely be bought.  But that dip will be an omen for future high volatility later in the summer.  Tops are a process, so I would not be surprised to see SPX trade mostly between 4150 to 4350 for June and July, lulling the bulls into complacency.  Then you could see a  waterfall decline in August or September, as jobs numbers finally start to weaken amidst tight monetary conditions and recession worries come back with vengeance.  Remember, the only way Powell will react with what the market wants, rate cuts, is if the stock market goes down hard.  That is the irony of the current environment, as the longer the SPX stays above 4000, the more likely money stays tight and the more likely you get a bad outcome.  

CPI is Tuesday, and based on how the bond market is positioned, its more likely to be a bull catalyst than a bear catalyst.  Same goes for the FOMC meeting.  So its probably best to wait till after the CPI and FOMC results come out before initiating any new short positions.  This is triple witching opex week, so odds are high that you get a climax top before a tradable down move. 

Longs Pushing Their Luck

The stock indices are moved by institutions, not retail.  Institutions and retail operate under vastly different conditions.  Retail investors are not competing with others to keep their jobs. Institutional investors are.  In particular, the subset of institutional investors which trade the most, and have the most outsized influence in the short to medium term are hedge funds.  They've been underinvested relative to their benchmarks since early 2022, and while it worked great in 2022, its been a disaster in 2023.  They've been underweight tech stocks for a while now, and they have been scrambling since the debt ceiling deal to increase their overall beta to keep from falling further behind.  

Sure, there is a bit of fundamental basis for their added long exposure, mainly earnings holding up better than expectations so far, and the labor market still appearing strong.  That's caused the crowd to be more confident that the economy won't be as weak in the 2nd half as many feared.  The stock market is no longer afraid of the Fed.  The market is seeing right through their hawkish rhetoric for what it really is:  a bunch of bluster.  You can't talk hawkish on the one hand, and then say you want to see how the economy reacts to the lagged effect of rate hikes by pausing.  The whole skip talk is another way of trying to manage market expectations, trying to keep the market from pricing in rate cuts. 

Some of the worries going into 2023:   

1) Sticky inflation forcing the Fed to aggressively hike rates

2) An imminent recession in 2023 due to the rapid rate increases and the above mentioned sticky inflation keeping the Fed hiking in big chunks.  

3) Earnings coming in weak because of the factors mentioned above.  

All 3 have not come to fruition so far, which is main reason that the SPX has gone from the 3800s to the 4200s in less than 6 months.  But there is a difference between not and not yet.  A recession has not come yet.  Earnings have not gone down yet.  With the lagged effect of rate hikes and bank credit tightening showing up more and more as the year goes on, 2 of the 3 worries mentioned above have merely been delayed, not eliminated.  Those worries should resurface in Q3 as tighter credit slows down the economy, along with the restart of student loan payments in September.  Also, a lot of those severance packages that white collar workers received late last year, early this year will be running out and that will force some in the upper middle class to reduce spending to match their reduced income.  

High frequency transaction data from credit/debit cards and ACH transfers show a notable slowdown over the past 2 months.  Recent earnings conference calls at retailers and consumer facing businesses have noted the spending slowdown.  It appears the excess savings are mostly used up for the bottom 80%.  The stock market is telling you a similar story, as the SPX and the NDX are masking the weak performance of economically sensitive sectors heavily represented in the Russell 2000.  

In the past 2 months, the stock market has climbed the wall of worry about a regional banking crisis, the debt ceiling, and now the huge T-bill issuance that is supposed to be a liquidity drainer that will torpedo this stock market.  I'm skeptical about T-bills doing anything bad for the stock market.  Replacing RRP funds with T-bills is replacing one cash equivalent with another.  No one was buying stocks because there weren't enough T-bills to buy.  There isn't a shortage of cash in the financial system.  There is a growing shortage of dumb money leaving large cash balances at the banks collecting near zero interest.  That's a much bigger worry than a bunch of T-bills flooding the market.  

Once the worries over the TGA being refilled and the T-bills being issued die down, hopefully the bears will capitulate, and the last wave of chicken little bulls come in to put in one last rally into the market to provide a selling opportunity.  The exceedingly low put call ratios and the heavy volume in megacap tech calls are clear signs that the animal spirits are back, and they aren't backed by fundamentals, just AI hype and soft landing hopes.  

I have refrained from putting on index short positions for several months, mainly to avoid these grind higher rallies that we've seen.  But the risk/reward has changed drastically not only because of higher prices, but also because of the deteriorating economic conditions that are not getting much attention.  As for options flows, June triple witching opex is coming up on June 16.  There is huge futures and options open interest on that expiration.  As we get closer to that date, negative deltas will melt away and expire (puts),, and lots of call deltas will get closer to 1, forcing more dealer buying of hedges.  Most of the dealer position squaring should be complete by early next week, right ahead of the FOMC meeting on June 14.  Its almost time to put on those SPX and NDX shorts.