Cannonball

The bulls have jumped back in the pool.  And it wasn't a smooth rip entry.  It was a cannonball dive, meant to create as much pain for those underwater as possible.  The shorts last week were swimming in the waters that the bulls cannonballed into, and got crushed.  After the bonanza for short sellers from mid July to August 5, there was going to be some payback.  Shorts didn't expect this much payback this quickly, but a combination of options expiration fuel burning puts and gaining momentum from calls above 5500 gave us that screaming move higher last week. 

Its still a bull market.  An aging bull market that's in the late stages, but still a bull.  Traders got a reminder of that this week, as you got a V bottom off the August 5 low, with VIX being crushed down to under 15.  The vol sellers won again, as the market just wasn't weak enough to keep VIX even in the high teens.  It was another triumph for the dip buyers, although they had to take more heat than last time, and I'm sure quite a few got hurt badly.  

The COT data for SPX futures showed asset managers reloading their longs back to near the highs for the year as of Tuesday, Aug 13.  This doesn't include the explosive move higher last Thursday, so this coming Friday will likely show even more asset manager net longs.  They are almost back to where they were before the pullback.   

 ISEE index also shows a strong rebound of call buying, as options speculators have regained their confidence that the market will go higher.  

Equity investors have mostly shrugged off the weakness from a few weeks ago and are back to their bullish bets.  Given the euphoria and high bullishness in the first half of July, I would be surprised to see the SPX go right back up to those levels.  The bulls have already used up a lot of their vol selling fuel, with VIX going below 15.  They also have been steadily buying calls last week so many options speculators have already reloaded.  Also you didn't see the ETF outflows for a true capitulation in early August, so conversely, I don't expect them to suddenly chase this market higher with big inflows in the coming 2 months ahead of the election.  

From browsing Twitter, most have gotten bullish again, with many more believing that this market will continue higher than those that think we’ll get another big selloff.  The bulls are quite sticky, and firm in their beliefs.  Its almost as if we’re back in the early July mentality again.  

I imagine it will be difficult to sustain this level of bullishness with the market coming up on the seasonally weakest time of the year over the next several weeks. The monthly opex last Friday had a big influence on pulling the market higher as all that gamma from out of the money calls got into the money, as well as the vanna effects from the IV plunging last week killing put deltas.  It was a lethal combo.  Some of that opex fuel should be given back early this week.  

Now we are in a fork in the road, with SPX 5550 as the pivot.  There are two paths.  The first path:  If the SPX stays below 5550 for most of the next 3 weeks.  If the SPX trades mostly below 5550 and stays choppy in a 5350 to 5550 range, then another leg down is likely.  Under that scenario, the SPX retests the 5200 level, and possibly undercuts the lows of August 5.   

The second path:  If the SPX stays above 5550 for most of the next 3 weeks. If intraday volatility dies down with no moves below 5450 for the next 3 weeks, then you are looking at a grind higher into the FOMC meeting and the first rate cut of this cycle, possibly making new all time highs, with a pullback post September opex and in October to be mild, with the SPX bottoming above 5350.  

Don't have a strong lean towards either the first or second scenario.  I don't think market will suddenly plunge, or rocket higher from here, so traders have time to wait to see how it unfolds.   I would lean towards putting on shorts in early September, perhaps after the nonfarm payrolls is behind us, and before the September FOMC meeting on September 18. 

Under the 1st scenario, I would short aggressively in early September, and go max short.  Under the 2nd scenario where the SPX lingers above 5550, I would play it safer and scale in more slowly into shorts and not put on a full sized position. 

I haven't talked about bonds much but its getting interesting again.  I think the trend lower for bond yields made a capitulation low on August 5, after the nonfarm payrolls report on August 2 and the panic calls for an intermeeting Fed cut from those with their hair on fire on August 5.  I expect higher lows and higher highs in bond yields from now till the end of the year.  Its not because of the economic data or Powell eager to get rate cuts started to get that soft landing.  Its because of politics.  The election is in November, and bond investors had a couple of traumatic post election experiences in 2016 and 2020.  Considering how likely it is that both Trump and Harris will pursue inflationary fiscal policies, bond investors will not be looking forward to the election results.

I see too many investors that are leaning towards the economic weakness view, looking at the rear view mirror, while the latest data has shown that the weakness is likely overstated.  Jobless claims, retail sales, and ISM services reports were stronger than expected.   The economy is definitely slowing, but not enough to meaningfully affect corporate earnings and credit spreads, which is what really matters for the market.  A reversal of some of that economic bearishness will lead to bond yields going higher.  It was interesting to see last week that the CPI came in weaker than expected and bonds weren't able to rally on that number.  It feels like the long side is saturated in the bond market. 

Got in way too early on the SPX shorts last week.  Deep underwater, but I see plenty of opportunities to make it back for the remaining 4 months of the year.  Will look to exit this week looking for a post opex pullback, but don't want to stay short beyond Tuesday.  Not willing to make a bad short term trade into a bad long term trade.  Probably should have just been hands off after closing shorts 2 weeks ago, but was trying to play for the little wiggles, and got burned. Another lesson that I should avoid short term trading and only look for intermediate term setups where I have more conviction and am willing to hold for a few weeks.  That is why I avoid daytrading as much as possible.