The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!
What Happened
Overnight, equity index futures rotated higher, along with commodities. Implied volatility was bid. Bonds were lower.
In the news were some changes to China’s COVID policies, the European Central Bank’s (ECB) intent to follow its peers and raise interest rates in July by 25 basis points, and the Group of Seven (G-7) leaders are talking about geopolitics and placing limitations on Russia.
At home, mortgage lenders are turning “desperate” as soaring rates roil their industry. Some are bracing for a 20% reduction in business as 30-year mortgage rates level out below 5.75%.
Pursuant to some of our analyses last week, Scion Asset Management founder Michael Burry suggested a “supply gut at retail is the bullwhip effect.” More on this, later.
Ahead is data on trade in goods (8:30 AM ET), S&P Case-Shiller U.S. home price index (9:00 AM ET), consumer confidence index (10:00 AM ET), as well as updates by Federal Reserve (Fed) members (8:00 AM ET and 12:30 PM ET).
What To Expect
Fundamental: Though badly timed, last year ARK Invest’s Cathie Wood said inflation would be on its way out due in part to inventory build-ups and their impact on commodity prices.
At the time, she asked whether the velocity of money was depressed given pent-up savings and demand for assets, putting forth disappointing GDP updates (which grew, mostly, on the back of inventories) and slightly negative retail final sales as support for her broader thesis.
Recall happenings in real estate – the iBuying debacle – late last year. Wood said this:
“This is unsustainable, … and I’m wondering if even the housing market inflation is going to give way, here.”
Participants were extending moneyness to nonmonetary assets, given monetary policies and an environment of debt and leverage that ultimately cuts into asset price volatility. Ultimately, these trends bolster the risks of carry when volatility does rise and the demand for money pushes deflation, particularly in asset prices.
Read: Daily brief for May 18, 2022.
With bank deposits to drain about $1 trillion or so by year-end, that volatility is happening, now, as investors “continue to lower their selling prices to compete for the cash they want.”
Scion Asset Management’s Michael Burry nods at the “supply gut” in retail. Like Wood, he thinks that it is a deflationary pulse that manifests disinflation in consumer prices, prompting the Fed to reverse itself on rates and quantitative tightening (QT).
Read: DC’s Chartbook #16 on the “fundamental evolution in the global money markets.”
That’s as Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, who gained much attention this year on his bold market commentary, said the Fed is likely to change course as it “can only deal with nominal [and] not real chokepoints.” This is as “nominal balance sheet and liquidity trends will, at some point, clash with the realities of a garden variety of supply chain issues.”
Positioning: Incredible is the still-depressed volatility skew we’ve talked about ad nauseam on.
It’s the strong supply of volatility. Participants are hedging, buying into volatility that is closer to current prices, and selling (skew) that which is farther out.
The counterparts are long that volatility further out, which they may sell into declines, and all of this, together, “results in vol underperformance on market declines,” per Sergei Perfiliev.
For that reason, the volatility that the markets are realizing (RVOL) is heightened and, at times, in excess of that implied.
As said, yesterday, given these dynamics, it makes sense to lean toward owning volatility, rather than selling it. A “higher starting point” in IVOL, and a still-present right-tail (from the positioning for a bear market rally), make it so we may position, for less cost, in short-dated structures with asymmetric payouts (call and put side), precisely as we’ve been talking about for half-a-year.
In the near term, from a positioning perspective, the front-running of quarter-end repositioning flow is (and is expected), in part, to add to the equity market upside.
Technical: As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the mid-to-upper part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,909.25 MCPOC puts in play the $3,943.25 HVNode. Initiative trade beyond the HVNode could reach as high as the $3,982.75 LVNode and $4,016.25 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,909.25 MCPOC puts in play the $3,885.75 ONL. Initiative trade beyond the ONL could reach as low as the $3,821.50 LVNode and $3,793.25 Ledge, 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.
Balanced (Two-Timeframe Or Bracket) Trade The Status Quo: Rotational trade that denotes current prices offer favorable entry and exit.
Balance areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend).
Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).
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.
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.
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 also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.
Disclaimer
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.
