Welcome back. Hope you guys and gals are doing ok. Let’s move on to the market analysis for the past week, and an outlook on the weeks to come.
The bottom is here!
… except it’s not.
In case you haven’t noticed, last week the CPI number came out. I invite you to break them down; they contain no indication of peak inflation being near. None whatsoever. But due to a technical adjustment superimposed to the cost of used cars going down, the overall figure of inflation increase was a little less than anticipated, especially month-over-month.
And boy oh boy the market shot up higher from that point…
And look, I’m not here to rub in anyone’s face that I did anticipate this happening. Being spot-on doesn’t pleasure me in particular. As a matter of fact, I also ate gravel on a number of short positions I had been holding.
At the time I’m writing, the market is discounting the terminal rate for the FED rises as lower than before. Which is exactly the opposite of what JPow cautioned about. In other words the market is once again fighting the FED.
Look, if there is something we have learnt for sure, and that keeps being true, is that one does never, ever, fight the FED. The inflation fight isn’t over, this is a fluke, and every time the market rallies, bond yields and US Dollar go down, which are both strong tailwinds for inflation.
And then the FED must come out, and hit investors on their little heads with a stick.
A 100 basis point stick.
Options
Volumes are not encouraging, but the put/call ratio is good. The structure is weak, but so far the rocket is still intact and headed for the moon baby.
Heatmap
The rebound is algorithmical in nature, but we can see a lot of profit-taking at the expense of the winners of the year, toward the high-growth stocks. Also, Energy continues to perform.
It is interesting to note that so far this year:
| When US Dollar… | then Commodities and Crude oil… | while Energy stocks… |
| goes down | go up | go up |
| goes up | go down | don’t go down |
There you go, that’s just you trading.
Interesting to also see Defense down, a big winner this year due to the ongoing war. Defense is down because of peace agreements rumors. I repeat: rumors. *wink*wink*
The fact that we still don’t know how much this rally will last (more on this later) makes up for a situation where it’s literally impossible to assume long or short swing positions with a reasonable degree of certainty. Anything you do, my recommendation is: close it quickly.
However,
it must be noted that the ongoing insanity is being done at the expense of a number of names that are going down big, but still retain a number of market tailwinds to reach higher valuations. Companies that despite the US Dollar strength or weakness, still retain their full pricing power.
I’m talking about
- Energy, of course
- but also about Healthcare, down BIG for the week
- Defense contractors, which have a lot of stockpile to produce in the next years
- Consumer stables and Non-durables
A rally without fundamentals
By this point I reckon no one in the audience is going to be astonished by the markets acting in a non-rational way. But why this strong rally? And why now?
There are a number of technicalities at play here. This has been a very bad year, a trend-down year. Now, if you happen to hold short positions and your fund did well, the last thing you want is to see 15-25% of those gain dematerialize right before the year ends. What you are going to do is cover, or hedge your shorts. That creates short gamma in the options market, and adds buyer’s pressure.
On the other side of the spectrum, if your fund has underperformed because you are holding a massive bag, and/or your is a long-only fund, the Santa Rally, the bottom narrative, the whatever seasonality is the perfect chance to double-down and make up for some of those losses before the year ends.
Both visions compounded with overreaching algorithmic price delivery make up for an upward-only market. Up we go!
How long will the rally last?
16th of December. That’s the deadline to rake in profits that then turn into fat bonuses.
It can’t realistically go past that. There are just too many headwinds pushing the market down. December’s contracts closure is when the market wraps up for the year, and performance counters reset for the funds.
Any reason keeping the market afloat expires with this calendar date.
So we know that the market wally has an expiration date, ok, but is there anything that can stop it in its tracks sooner than that?
Of course. A number of things. For example, the FED could come out and say something truly nasty about the next rate increase. In absence of that, the PCE numbers can also bring in bad news. Any of these events has a chance of reversing the rally right away, or being ignored altogether. The higher the market goes, the more the risk becomes to the downside.
All market participants are aware that there is a rug pull at the end. All of them.
But in order to gauge the sentiment of the participant it’s best to list the phases that any bear market rally goes through:
- Short covering
- Gamma squeeze, where market makers reduce directional risk by covering for in-the-money option contracts
- Then the quant funds start to trade based on technicalities (support-resistance, security bias and so on)
- And at the end the dumb money joins the party.
Step (1) got out of the way immediately. Step (2) seems to be over. Right now it’s all algos.
But wait: everyone in the market is in purely for the money. The market as it is right now isn’t generating any money! The FED isn’t providing the coke, and earnings from the companies are decreasing rapidly.
So if there is any value to be taken out of the market, then that money has to come out from the only faucet that ultimately pumps liquidity into the market. The Dumb Money.
And here comes the problem:
Retail investors are in contact with the real economy. They pay for their groceries. They get gas at the pump. They know the economy is going down and, differently than it was for the Summer Rally, this time retail investors see the writing on the wall.
Retail investors aren’t joining the pump scheme. Instead:
- They are dumping positions that are in the red, as an opportunity to get out with smaller losses.
- They are betting against the market via put options, or via inverse index ETF (which has basically the same effect)
You see this is a problem, because the market will ultimately, always, always take over the dumb money. And if the dumb money’s bets are for a market decline, then the only way the market makers have to take their money is run into all of their stops, pushing the market higher.
Save for any news factor hindering it, this is going to be the Mother of All Bear Market Rallies.