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Commentary

Daily Brief For January 20, 2022

Daily commentary for U.S. broad market indices.

The Daily Brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 200+ that read this report daily, below!

What Happened

Overnight, equity index futures auctioned upward, into the prior day’s range, after some overnight exploration, lower. 

As explained better below, some positioning metrics suggest a bottom (at least near-term) may be in the making.

Ahead is data on jobless claims and manufacturing (8:30 AM ET), as well as home sales (10:00 AM ET).

Graphic updated 6:40 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: The prevailing narrative facing market participants in recent trade is centered around the prospects of contractionary monetary policy in the face of strong economic and earnings growth, as well as cooling inflation while “excess supply” of goods/services builds.

This, as Bloomberg puts it well, “threatens to inject more volatility across a range of assets.” 

As a result, the benefits afforded to holders of diversified portfolios are less.

“If current, priced in, inflation and growth expectations are exactly realized we predict that risk premiums on 30-year yields will increase by 15bp and equity risk premium by 30bp,” which would, according to Damped Spring Advisors, “generate a 2% headwind on long bond prices and a 10% headwind for equity prices.”

Participants are pricing in these expectations, selling heavy the rate-sensitive products, and pushing the Nasdaq into correction territory, yesterday.

Graphic: Per Bloomberg, “The rout pushed the Nasdaq Composite over the threshold into correction territory.”

“Right now you have people waiting before they go and buy back in,” said Jamie Cox, managing partner at Harris Financial Group.

“You have a Fed meeting coming up, so there’s not going to be a lot of movement anywhere until the Fed meeting is over with. You look around, there’s not a lot of problems in the economy, what you have is just the question of, ‘does all this add up to a faster rate hiking cycle that we anticipate?’ And I don’t think so. I think it’s not likely.”

Moreover, unlike the U.S., counterparts elsewhere, in China and Europe, for example, are not looking to tighten as quickly.

“If major economies slam on the brakes or take a U-turn in their monetary policies, there would be serious negative spillovers,” said Chinese President Xi Jinping. 

“They would present challenges to global economic and financial stability, and developing countries would bear the brunt of it.”

For context, China cut its benchmark interest rate to 3.70% (10 basis points), “cement[ing] the pivot to easing.”

Graphic: Per Topdown Charts, “China cuts benchmark interest rate -10bps to 3.70%. i.e. the 1-year LPR [Loan Prime Rate].  n.b. the PBOC also cut the 5-year loan prime rate by -5bps to 4.6%.”

Though this move away from tightening in China is good for assets in that country, emerging markets, and commodities, according to Callum Thomas, an economic slowdown there may foreshadow what is to come in other parts of the world.

Obviously, in saying that plainly, we’re discounting China’s clampdown on its housing and financial sector, but the data seems to suggest the “reopening [and] stimulus-driven global economic rebound may be losing steam headed into 2022.”

Graphic: Per Topdown Charts, OECD leading indicator down sharply from highs.

Stifel Financial Corporation’s (NYSE: SF) Barry Bannister provides us with the implications of tighter U.S. financial conditions: a correction down to $4,200.00 in the S&P 500, near-term.

And, with that, post-correction, equities risk the 3rd bubble in 100 years if the “Fed loses its nerve and cancels much of the tightening plan.”

Graphic: From The Market Ear.

As an aside, to temper some of the bearishness in the above section of the newsletter, here is a chart of S&P 500 returns during Federal Reserve hiking cycles.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS), from The Market Ear.

Positioning: Despite elevated measures of implied volatility like the Cboe Volatility Index (INDEX: VIX), the VIX term structure remains upward sloping, albeit less so than before.

Graphic: VIX term structure shifts higher. The flows associated with hedging protection in the S&P complex ought to pressure the market, should this term structure continue higher.

This is as the unwind of large long-delta positions in heavily weighted index constituents, pre-monthly options expiry (OPEX), alongside demand for downside (put) protection, is finally feeding into the large index products.

Graphic: SpotGamma’s (beta) Hedging Impact Of Real-Time Options (HIRO) indicator suggests Negative options delta trades likely had dealers selling the S&P 500 and Nasdaq 100 ETFs, yesterday.

Moreover, further flattening or inversion of the VIX term structure would clearly coincide with destabilizing demand for protection (as a result of the counterparty supplying protection selling underlying to hedge).

Thus, any expansion in volatility (which could be construed as demand for protection), likely coincides with further weakness.

Notwithstanding, though conditions could worsen, if we take into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics remain positively skewed, even more so than before. 

Some sort of bottom (at least near-term) may be in the making.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

Technical: As of 6:40 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Spike Scenario In Play: Spike’s mark the beginning of a break from value. Spikes higher (lower) are validated by trade at or above (below) the spike base (i.e., the origin of the spike).

The spike base is at $4,549.00. Above bullish. Below bearish.

In the best case, the S&P 500 trades higher; activity above the $4,565.00 untested point of control (VPOC) puts in play the $4,603.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,619.00 HVNode and $4,650.75 extended trade low (ETH Low), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,565.00 VPOC puts in play the $4,514.25 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,492.25 regular trade low (RTH Low) and $4,471.00 VPOC, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Definitions

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 areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test. 

If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.

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

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

Options Expiration (OPEX): Traditionally, 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) and the reduction dealer gamma exposure.

About

After years of self-education, strategy development, mentorship, 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.

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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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