- High doses of stimulus yet to be fully felt.
- Hedge funds add to long, short exposure.
- Economies eye growth, uneven recovery.
- Powell kept stressing inflation downsides.
- Traders price in a quarter-point rate hike.
- 10-yr yield, S&P 500 dividend yield cross.
- Bond, equity market volatility separations.
- JPMorgan does not see a market bubble.
What Happened: U.S. stock index futures auctioned lower.
This came alongside (1) a material divergence in bond and equity market volatility, as well as (2) a convergence in the 10-year Treasury rate and S&P 500 dividend yield.
What Does It Mean: Equity traders began pricing in the risk of a rapid move up in rates, due to concerns over bond values, as a result of rising debt levels and inflation.
Additionally, the yield on a 10-year Treasury, a risk-free asset, which was — per Axios — “artificially depressed by the flight-to-quality trade during the coronavirus pandemic, as well as by large-scale purchases by the Federal Reserve,” converged with S&P 500’s dividend yield.
Typically, the S&P 500’s dividend yield is less than the risk-free rate because investors expect to earn less in dividends than they would holding the same amount in bonds, absent rising stock prices.
Values are derived using the discounted cash flow calculation; as interest and discount rates go up, the present value of future earnings goes down, which will drag stock prices, especially in growth categories, as seen.
Still, despite the pricing in of rising debt levels and inflation, a divergence in bond and equity market volatility persists. In such a case, market participants ought to widen their outlook; there is some potential for risk asset capitulation in the present down cycle.
Moving on, it’s important to take note of the market’s unpinning, after February’s monthly options expiration (i.e., OPEX), as well as the long-term trend.
More On OPEX: Option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire worthless) and the reduction dealer gamma exposure.
Aside from OPEX, last week’s volatility did not disrupt the S&P 500’s long-term uptrend (Graphic 2), and a skewness toward put options — evidenced by Graphic 3 and market gamma — suggests the potential for a near-term turn-around.
What To Expect: Directional resolve, given the S&P 500’s rotation near a prominent high-volume area, or HVNode (Graphic 4), and an overnight rally-high at $3,959.25.
More On Overnight Rally Highs: Typically, there is a low historical probability associated with overnight rally-highs ending the upside discovery process. More On Volume Areas: A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test). If participants were to auction and find acceptance into areas of prior low-volume, then future discovery ought to be volatile and quick as participants look to areas of high-volume for favorable entry or exit.
What To Do: In coming sessions, participants will want to pay attention to the VWAP anchored from the $3,959.25 peak and $3,657.00 low, as well as the $3,840.00 HVNode.
Volume-Weighted Average Prices (VWAPs): Metrics highly regarded by chief investment officers, among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.
In the best case, the S&P 500 opens and remains above the $3,840.00 volume area.
Additionally, auctioning above the $3,875.75 VWAP would suggest buyers, on average, are in control and winning, since the February 15 rally high.
Auctioning beneath $3,785.00 would (1) leave the $3,840.00 HVNode as an area of supply — offering initiative sellers favorable entry and responsive buyers favorable exit — and (2) portend repair of poor structures (e.g, the $3,785.00-$3,777.00 gap) left in the wake of a prior advance.
In such a case, participants should look to the next area of high-volume (i.e., $3,794.75 and $3,727.75) for favorable entry and exit.
Conclusions: The go/no-go level for next week’s trade is $3,840.00.
Any activity at this level suggests market participants are looking for more information to base their next move. Anything above (below) this level increases the potential for higher (lower).
Levels Of Interest: $3,840.00 HVNode.