Lay of the Land

Here are the things that I am looking for to time this market and predict when this monster will top out: 

1) Market positioning.  This is a combination of CFTC COT futures positioning data, asset allocation percentages vs historical averages, hedge fund positioning, and ETF flows.  

2) Duration and magnitude of the uptrend.  Intermediate term uptrends off of a significant bottom like last October usually last from 4 to 6 months.  That is not a guarantee, but a guideline.  The farther the SPX is above the 100 day moving average, the more potential energy builds up, setting up a possible big move lower.  

3) Investor psychology.  There are certain behaviors that are common as a move becomes mature and vulnerable to a correction:  more call options speculation/less put buying,  growing optimism about the economy, buying laggards and high beta names to bet on a catch up trade, etc.  

This is the current situation on the above 3 factors: 

1) Market positioning.  Here is a look at GS prime broker hedge fund equity exposure:

Net leverage is off the highs this year, and even below the highs in 2023, and still nowhere near the high levels seen in 2021.  Hedge funds are not fully invested here so there is room for a chase for performance among the hedgies.  Bullish sign for the market.

The latest COT data as of Tuesday Apr. 2 shows dealers adding to shorts, getting to net short levels that were seen from June 2021 to January 2022.  Dealers usually build big short positions after an uptrend is very mature and overbought.  They tend to be on the right side of the trade ahead of a big move, which is usually during a trend reversal.  This time, they are setting up for a big down move. But they are often early and can hold these large short positions for months as the market goes higher, like they did from mid 2021 to early 2022.  Overall, this is a bearish sign. 

2) Duration and magnitude of the uptrend.  Take a look at when you had corrections since 2018.  With the exception of 2021 (an exceptional year in many ways), you had meaningful pullbacks after 4 to 6 months of an uptrend.  

The up trend off the October 30 2023 bottom is now 5.5 months old.  This is well into the danger zone time frame of over 4 months for uptrends without a meaningful pullback.   The time bomb is ticking.  A bearish sign.  

3) Investor psychology.  No charts for this one, as this is one of the factors where screen time, watching CNBC/Bloomberg, reading Twitter and financial media are necessary to gauge investor behavior and sentiment.  The overriding sentiment now is a worry about inflation, especially after that hot CPI number yesterday.  But even before then, the primary worry was about sticky inflation preventing the Fed from cutting rates.  This has kept investors from becoming overly bullish.  The prevailing view I hear is that the market needs to pullback, it is short term overextended, but that the overall economy is strong so they expect higher prices later this year.  Despite the cautiously bullish stance I hear over and over again, the SPX refuses to really pullback here.  A bullish sign.  

A quick word on the macro situation.  The economy in 2024 is weaker than the one in 2023.  The labor market is less tight, retail sales are weaker, and GDP growth is lower.  Yet investors are much more optimistic about the economy now than they were in 2023.  The consensus view is that the US economy is strong, that we will either get a soft landing or a no landing situation, something you didn't hear much in 2023.  

The market is pricing in less than 50 bps of rate cuts for 2024, clearly running with the view that the US economy doesn't really need rate cuts and that the economy will remain strong enough/inflation will be sticky enough to keep Fed from cutting anytime soon.  The risk/reward now seems more skewed towards betting on a hard landing than at anytime since the hiking cycle started.  

Considering how much the SPX has run up this year, I would favor shorting SPX over getting long SOFR or short term Treasuries.  Also, shorting the SPX is positive carry (for futures traders) while going long SOFR or 2 yr Treasury futures is negative carry.  Those little things add up every day and make a big difference over the long run.  This is of course a more long term view, so I am still waiting for the right timing to short this market.  In the meantime, I will just make smaller tactical trades as I await for that exquisite opportunity to put on a larger SPX short position. 

Given the strong uptrend and cautious optimism that I hear and the bullish seasonal factors coming up (mid April to early May is historically bullish, and corporate buybacks comeback), I am leaning bullish for the next couple of weeks.  I am talking my book, because I did get long late last week, and will look to add more on a further dip this week around SPX 5100-5120.  This is picking up dimes in front of a steam roller, so not recommended for long term traders/investors.  

Higher bond yields could definitely be a problem if things get unhinged again like last October.  But unlike last fall, the front end is leading the selloff, or a bear flattening.  Bear flatteners are more benign selloffs as the market is signaling to the Fed that it is about to make a hawkish mistake, and can't continue to stay tight.  Last October was a bear steepener, which is the most bearish selloff you can get in bonds, as the the long duration bonds are the most interest rate sensitive.  That's when the market is signaling that Treasury supply is overwhelming demand.  Neutral to slightly bullish on bonds here, but the trend is firmly lower, and there are lots of feared events coming up (Fed, NFP, inflation data, and Fed).  Its a fear and loathing market so I would rather let the dust settle than try to pick the bottom.