Diamond Hands

They are impervious to weakness.  They believe.  In SPX We Trust.  Like those Reddit meme investors.  They have diamond hands.  They don’t get shaken out easily, and are willing to ride it out, come hell or high water.  

Last week, we hit the short term pain threshold for some index put options sellers and VIX call sellers, as well as some asset managers.  But overall, you didn't get a true purge that you need for a V bottom.  Which makes it likely that we'll repeat what happened in February to April of 2018 where you bottomed off the initial volatility spike higher and rallied hard, but then sold off a few weeks later to retest the lows.  You probably don't get as much of a rally this time, as Feb. 2018 had a bigger selloff and was during a more seasonally favorable period of the calendar.

Compared to 2018, the price action is much more subdued this time, and you had less capitulation.  You didn't even get a retest of the panic like Feb. 2018 after a few days because the dip buyers and vol sellers were so active.  Which is unusual because the economic conditions are worse now than in early 2018.  In early 2018, the economy was actually strengthening globally, with commodities prices rising along with bond yields.  Now, global growth is clearly slowing as shown by the weakness in commodities and the recent strength in bonds.  

The VIX closed at 23.39 on Friday, Aug. 2, and the SPX closed at 5346.  After last week's panic, VIX closed at 20.37 on Friday, Aug. 2, while the SPX closed 5344.  So you had the SPX lower on the week, with volatile intraday moves, yet the VIX sold off 3 points.  That is the power of active vol sellers in this market.  They suppress the IV of options, reducing the delta hedging and gamma forces in the market,  supporting the indices.  As of Tuesday August 6, leveraged funds (in blue) added to their VIX short positions, basically doubling down on their bets shorting volatility.  Dealers (in red) remain very long volatility, as they take the other side of the leveraged funds positioning. 

 On the other hand, you finally got capitulation in the yen carry trade.  The huge net short position held in JPY by trend followers and carry traders has been purged over the past couple weeks.  You are unlikely to see much yen strength from here in the short term, which is a positive for risk assets.  

For the SPX, you saw asset managers significantly reduce their net long positions from July 30 to August 6, as they usually do during big selloffs.  But asset managers are not completely dumb.  They have a tendency to reduce their net positioning from max long as the SPX enters the final stage of a bull market.  Examples include early 2015, early 2018, mid 2021, and now mid 2024. 

SPX COT Asset Manager Net Positions

Asset manager net positioning is a reflection of Wall Street sentiment.  Bullish sentiment on the market usually tops out before the SPX does.  So the best time to make bets for a big sustained down move is after the bullish sentiment has been decreasing for a few months while the SPX grinds higher.  For example, the bullish sentiment peaked in January 2018, but the SPX made a higher high in October 2018, right before a big sustained drop lower. Same thing happened in November 2014, where bullish sentiment peaked in late November, but the SPX made a higher high in the spring/summer of 2015 before a waterfall decline in August 2015.  It also happened in 2021, where bullish sentiment peaked in the summer, and the SPX grinded higher all year before the bear market started in January 2022. 

It appears now that we've reached peak euphoria for this bull market in July, with the mix of the AI bubble, Trump election hopes, sudden embrace of small caps as the Russell 2000 squeezed higher, and with bonds rallying on Fed rate cut hopes.  I don't think we'll be able to top that level of bullishness for this cycle.  I expect bullish sentiment to slowly drop over the next few months, while at the same time, complacency remain as the SPX stays in an uptrend.  Then like a lion escaping its cage, you can expect a sudden start to a raging bear market.  Best guess is that bear market starts in the first quarter of 2025.  

The ETF flows over the past month are more evidence that investors got really excited about the stock market.  Comparing 1M to 1Y flows, you see how much has suddenly flooded into equity ETFs.  You also had big inflows into short VIX ETFs.  Net inflows for SVIX for the year have all happened in the past week.  You don't see that when investors are scared.  And there was very little selling by equity index ETF investors during this selloff.  This is a short term bullish sign, as it shows that US stock investors are acting like meme stock investors, having diamond hands.  But its a long term bearish sign as investors remain heavily long equities and stay complacent despite the volatility.

OCC opening put/call transactions showed some more put buying than the previous week, but still below the levels that you saw in mid April.  You only got a partial capitulation, and many are still hanging on to their positions, or even adding to them, which means you still have plenty of underwater longs in this  market.  It makes the next few weeks harder to trade as you didn’t get a full capitulation which can be the springboard for a strong rally.  Now its more likely to be a choppy bounce that will lack the buying power that you saw after past bottoms.  But you have gone down quite a bit over the past 3 weeks, so its not a great spot to put on shorts either.

After last week's bottom, we're in a short term bullish relief phase in the market.  You will likely see the more "conservative" bottom pickers come in this week to buy stocks as the charts look better and it looks less scary.  In fact, during this phase, which can last up to 3-4 weeks after a bottom, its better to look for spots to get long than to get short.  

I would be careful trying to short a rally too early before its matured because the SPX can grind higher from here for several days.  At the same time, you can have sudden sharp 1-2 day selloffs that shake out the late coming, weaker hands.  Timing a good short will be harder than timing a good long during this relief rally phase.  Its a different strategy now than the one used from mid July to August 5.  For the next couple weeks, you have to be quicker to exit shorts in profit and be more willing to buy dips.  

Bottom line, its a mixed picture.  You had capitulation in the yen among CTAs and carry traders, and among some asset managers, but not in equity ETF buyers or vol traders.  For the rest of August, it should grind higher, with brief, but sharp dips that will likely be bought up quickly.  Beyond that, looking out into September and October, expect another wave lower back towards SPX 5200, or a slight undercut of last week's lows, in the seasonally weakest time of year, ahead of the election in November.