Missing Opportunities

Last week was a classic example of the downside of waiting for the exquisite opportunity.  The opportunity can just pass you by.  The bus can leave the station before you expected.  There are no guarantees in the market, unexpected things happen, which is what keeps people coming back to the biggest casino in the world.  If the casino always won, the players would never come back.  But the players sometimes win, which is what keeps them coming back.  Unexpected things happening in the market = players winning in the casino.  They happen much less than 50% of the time, but they happen often enough that the gamblers and speculators keep coming back to play.   In the long run, the casino wins.  But in the short run, the players sometimes have their moment in the sun, basking in their wins.  

Its not often that you see a feared event, the nonfarm payrolls report last Friday, in a bull market, actually deliver on the fear and scare investors enough to force them to sell heavily both before and after the event.  That's what you saw last week, and its not common.  Quite a few unusual things have happened in the past few weeks, which makes the market trickier than usual.  

You first had a V bottom off the August 5th low, even though the market was in a seasonally weak time of year, and was super overextended in July before dropping into early August.  Usually such overextended positioning and excessive bullishness gets worked off by the market trading in a choppy, lower range, not a V bottom off a mini panic low, that takes it quickly towards the previous highs.  The market managed to both squeeze the early short sellers and also crush the late long buyers in the past 3 weeks.  Its been an uncomfortable market for both the bulls and the bears.  

You are hearing a lot of talk about September being a seasonally weak time of year for the stock market, while its selling off.  While I agree with the crowd about September likely to be weak, you have a late quarterly options expiration this month, with opex on September 20.  So there are still 2 weeks left till the big expiration.  Still plenty of time to reverse the current down move.   In bull markets, stocks usually don't sell off hard before triple witching opex (quarterly opex).  The pattern is one of strength up to middle of quarterly opex week, and then weakness starting from opex day extending to post opex week.  The reason for this pattern is because many of the longer term options hedging is done in the quarterly expirations, which have the most liqudity and biggest open interest.  Thus, you get a build up of a lot of put hedges that provide downside protection for investors until opex, at which point investors are again more lightly hedged and more likely to sell stocks/buy puts instead of just holding on to their positions.  

The downside put protection is still there, and there are still almost 2 weeks till expiration, so there is definitely room for stocks to bounce in the pre-opex window.  But as you get closer to that quarterly opex, the less support there will be.  The FOMC meeting is on September 18, so I don't expect a huge down move before that event, especially with opex still to come after the Fed.  So there is a window of about a week where we can see a countertrend bounce, which would be a good opportunity to short SPX.  

Bigger picture, beyond September, the positioning is looking unfavorable for longs.  The COT data as of September 4, which covers the period when SPX went down approximately 100 points, the asset managers went nowhere, and held their heavily net long exposure.  On the other hand, leveraged funds covered a big chunk of their short position.  While asset managers are the best fades in the COT data, the leveraged funds are also a bit of a fade, as they are usually the least short before a long downtrend begins (e.g. Dec. 2021).  Dealers also added to shorts into a down tape, which is a bearish signal.  Overall, its looking grim for the bulls for the next few weeks. 

The options data was mixed last week, you did see a pick up in put buying and the put/call ratio, but the levels are not extreme, and nothing that would signal a significant bottom.  This supports the view that any bounce should be minor, and that there is further to go in the selloff that started last Tuesday.  By the time we reach a low for this selloff, probably sometime in late September/early October, the bearishness will likely exceed that of early August, and it will likely be a sloppy bottom, more like a U than a V.  

The continued underperformance of the Nasdaq 100 vs the SPX is an ominous sign for the long term prospects for this bull market.  Bull markets feed off of an increase in risk appetite, a desire for high beta equities, not a search for low beta equity exposure.  Since the October 2022 bottom, up until the July 2024 top, the Nasdaq 100 was the leader, outperforming the SPX throughout.  Due to both superior earnings growth and AI hype.  That has changed dramatically over the past 2 months.  The current Nasdaq 100 underperformance is similar to what you witnessed in the latter parts of 2021 and first half of 2022.  That was a bad time to be long equities.  

While the economic situation is quite different now than in late 2021, one thing is similar.  The sky high household asset allocation to equities vs other asset classes.  That is one of the single best predictors of long term equity returns.  Compared to 2021, the earnings outlook is poorer now due to the lack of money supply growth vs 3 years ago, as well as the nearing maturity wall of corporate debt coming due in 2025 and 2026.  The average yield on corporate debt outstanding is much higher now than in 2021, while the money supply growth is slower.  Fiscal deficits are also lower as a percentage of GDP now than vs 3 years ago.  This is mainly due to the absense of some of the Covid stimulus, which is the gift that keeps giving, but at a slower rate now than before. 

Overall, this is a more bearish long term set up than late 2021.  Not only will earnings growth be slower over the next 3 years than from 2022 to 2024, the baby boomer population will be shrinking leading to net selling of stocks from that demographic.  2025 will be quite the contrast from 2023 and 2024.  It may be a bit of a shock to those with short memories and a permabull mentality.  

We are getting a big gap up off the "scary" selloff on Friday, that gave investors flashbacks to August 2, and the possibility of a manic panic Monday post NFP.  Alas, that selling was front run by risk management teams at the funds and it appears that the first wave of this selloff is finished.  I expect more waves of selling to continue in the weeks ahead but the pre quarterly opex forces should be supportive this week.  Any bounces above 5500 up to 5550 will be good spots to put on short positions.  Waiting for the opportunity.