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Commentary

Weekly Brief For August 22, 2021

Weekly commentary for U.S. broad market indices.

Market Commentary

Equity index futures recover after last week’s liquidation.

  • Unpacking the inclination to taper.
  • Ahead: Busy week. Jackson Hole.

What Happened: The S&P 500, Nasdaq 100, and Dow Jones Industrial Average recovered more than 50% of last week’s liquidation. The Russell 2000 remains a laggard, trading weak below the halfway point of a multi-month consolidation.

Ahead is data on the Markit manufacturing and services PMI (Monday), existing-home sales (Monday), new home sales (Tuesday), durable goods orders (Wednesday), nondefense capital goods orders (Wednesday), jobless claims (Thursday), GDP revision (Thursday), personal income (Friday), consumer spending (Friday), core PCE price index (Friday), trade in goods (Friday), as well University of Michigan consumer sentiment (Friday). 

Also, the Jackson Hole Economic Policy Symposium starts Thursday.

Graphic updated 12:30 PM ET Sunday. Sentiment Neutral if expected /ES open is inside of the prior day’s range. See here for more on the Dark Pool Index (DPI) and Gamma (GEX). A higher DPI approximation is bullish. At the same time, the lower the GEX approximation, the more volatility. SHIFT data used for options activity approximation. Note that options flow is sorted by the call premium spent; if green and more positive then more was spent on call options. Breadth reflects a reading of the prior day’s Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index from 0-100.

What To Expect: During the prior week’s trade, on weak intraday breadth and market liquidity metrics, the worst-case outcome occurred, evidenced by a liquidation that repaired poor profile structures as low as the S&P 500’s $4,353.00 point of control (POC).

POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent. Participants will respond to future tests of value as they offer favorable entry and exit.

Then, during Friday’s session, a p-shaped profile structure (which denotes short covering) took back the spike base a few ticks below the $4,422.75 balance area high (BAH) – a prior break from value – negating the post-Federal Open Market Committee (FOMC) minutes liquidation.

Further, the aforementioned trade is happening in the context of moderating growth, peak long equity positioning, breadth divergences, a resurgence in COVID-19, geopolitical tensions, and an inclination to taper stimulus.

The implications of these themes on price are contradictory; to elaborate, as measures of macro expectations rolled over, in line with companies’ profit expectations, Treasury yields declined, triggering a rotation back into high growth equities.

Graphic: As created by Bank of America Corporation (NYSE: BAC) and shared by Bloomberg, the proportion of fund managers expecting a stronger economy tumbles while the number who are overweight in equities has barely moved.

This comes at the same time a strong July jobs report helped the Federal Reserve (Fed) move toward a consensus on tapering. Given the Fed’s enormous share of the Treasury market, fear of downside equity volatility is apparent; a shift higher in the VIX futures terms structure denotes demand for protection into and through the Jackson Hole Economic Policy Symposium August 26-28, 2021.

“The Fed has fostered a broad range of bubbles because their massive liquidity injections have been trapped in the financial economy,” Rich Bernstein of Richard Bernstein Associates said in a summary quoted by Bloomberg. “As with any cornered market, there are limited buyers and prices fall as the “cornerer” sells. Accordingly, bond prices seem likely to fall (interest rates rise) [as the] Fed reduces its cornered positions. Rising interest rates could be the kryptonite to the bubble in long-duration assets (long-term bonds, technology, innovation, disruption, bitcoin, etc.).”

Obviously, tapering may have major repercussions. However, to balance our expectations, looking back to 2014, when the Fed was scaling back bond purchases, the S&P 500 rose over 10% and rates fell after spiking initially. 

Graphic: Ally Financial Inc-owned (NYSE: ALLY) Ally Invest unpacks 2014 taper of Federal Reserve bond buying.

Ally Invest’s chief investment strategist Lindsey Bell concludes: “Conditions may not be perfect, but they could be strong enough to move from a wheelchair to some heavy-duty crutches, especially if it means keeping overheating symptoms like inflation at bay.”

Regardless, major risks remain given the growth of derivatives and the potential for offsides positioning. Even the slightest reduction in the Federal Reserve’s balance sheet – the removal of liquidity – may prompt a cascading reaction that exacerbates underlying price movements.

As Kai Volatility’s Cem Karsan once told me for a Benzinga article: “It’s not a coincidence that the mid-February to mid-March 2020 downturn literally started the day after February expiration and ended the day of March quarterly expiration. These derivatives are incredibly embedded in how the tail reacts and there’s not enough liquidity, given the leverage, if the Fed were to taper.”

Moreover, for next week, given expectations of heightened volatility, participants may make use of the following frameworks.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,437.75 high volume area (HVNode) pivot puts in play the $4,463.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,476.50 overnight high (ONH) and $4,511.50 Fibonacci extension, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,437.75 HVNode puts in play the $4,415.75 LVNode. Initiative trade beyond the LVNode could reach as low as $4,393.75 micro composite point of control (MCPOC) and $4,365.25 LVNode, or lower. 

Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.

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.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures updated 12:30 PM ET Sunday.

News And Analysis

Moody’s discusses taper – maybe this year, maybe not.

Single-family home construction the highest since 2007.

Fannie Mae says COVID-19 surge won’t impact growth. 

Goldman Sachs cut its U.S. growth forecast on the virus.

APAC corporate rating recovery may stall as cases rise.

Wall Street is just as baffled about markets as last year.

Canadian inflation has risen to 3.7%, troubling Trudeau. 

Powell second term approval boosted by Yellen backing.

A gaping 10-year bond call reveals growth uncertainties.

Michael Burry of ‘Big Short’ bet against ARK Invest ETF.

Outcry rises after White House looks to quell gas prices.

Big risks and trends facing banks globally and regionally.

Could a Western U.S. drought threaten municipal credit.

What People Are Saying

About

After years of self-education, strategy development, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets. 

Additionally, Capelj is a finance and technology reporter. Some of his biggest works include interviews with leaders such as John Chambers, founder and CEO, JC2 Ventures, Kevin O’Leary, businessman and Shark Tank host, Catherine Wood, CEO and CIO, ARK Invest, among others.

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

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