Big news includes Netflix Inc (NASDAQ: NFLX) beating earnings estimates but having a weaker-than-expected forecast, Tesla Inc (NASDAQ: TSLA) cutting prices the sixth time this year, Meta Platforms Inc (NASDAQ: META) and Walt Disney Co (NYSE: DIS) commencing layoffs, and mortgage rates edging higher to ~6.4%.
Graphic: Retrieved from Bloomberg. “US mortgage rates increased last week by the most in two months to 6.43%, denting already sluggish demand.”
Equity markets are down, and equity implied volatility (IVOL) measures, including the Cboe Volatility Index or VIX, are climbing. Notwithstanding, the trend lower in IVOL is intact, and that’s good for traders biased short volatility.
Graphic: Retrieved from Bloomberg via Danny Kirsch of Piper Sandler Companies (NYSE: PIPR). Call option volatility for the $4,150.00 strike. May monthly expiration.
“With all the focus [on S&P 500 (INDEX: SPX)] 0 DTE lately, I look at how expensive these have been since 2022,” IPS Strategic Capital’s Pat Hennessy says, referencing a backtest he conducted selling a 1 DTE straddle and holding till maturity.
“Performance since the November CPI has been stellar, with a 63% win rate and an average gain of $20.00.”
Graphic: Retrieved from IPS Strategic Capital’s Pat Hennessy.
Volatility trader Darrin John agrees, noting volatility remains expensive, a detriment to those who may be biased long volatility.
“The VRP is so wide across all of the tenors I track,” John elaborates. “It’s going to be hard for gamma buyers to cover daily theta bills.”
Clouds are appearing on the horizon, however, and the trend higher (lower) in stocks (volatility) may not last. Bloomberg forecasts the largest fall in SPX earnings since the start of 2020. Notwithstanding, strength can continue for longer …
Graphic: Retrieved from Citigroup Inc Research (NYSE: C) via @tr8derz. “YTD rally stems from $1tn in CB liquidity. High-frequency indicators suggest this is already stalling, and coming weeks seem increasingly likely to bring a sharp reversal. Higher TGA and RRP, ECB QT and reduced China easing could easily see a net drain of some $6-800bn.”
… even with the SPX breadth reading poor. The SPX has rallied with multiples rising; strength came with positive earnings surprises, bond demand, and other things.
Graphic: Retrieved from Morgan Stanley (NYSE: MS) via Bloomberg.
Hence, at the risk of sounding like a broken record, the low-cost call structures we’ve talked about in the past remain attractive.
If markets move higher, you can monetize and roll profits into put spreads (i.e., buy put and sell another at a lower strike). This may work well if JPMorgan Chase & Co’s (NYSE: JPM) call that “even a mild recession would warrant retesting the previous lows” is realized.
Such structures work well as “a big pop in the market can result in a decent drop in the VIX…and vice versa, a market sell-off will result in a greater increase in the VIX now than it did in 2022,” says Alpha Exchange.
Alternatively, lean neutral and buy into cash or bonds yielding 4-5%. Some long box spreads yield 5.4% as of yesterday’s close.
In other news, Physik Invest’s first in-depth note is nearing completion and will be available for public viewing in short order. Take care and watch your risk!
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Consensus is a tightening cycle that climaxes on May3 with one final 25 basis point hike. Most traders price three cuts after—one in July, November, and December.
Note: After the release of strong bank earnings today, this analysis remains intact.
Graphic: Retrieved from CME Group Inc (NASDAQ: CME).
Though policymakers are successful in walking up traders’ interest rate expectations, the long end of the yield curve hasn’t budged much; despite the response to banking turmoil helping “calm conditions, … and lessen the near-term risks,” many believe the Fed will have to pivot, soon.
The Federal Reserve’s ranks expect a “mild recession,” too, validating people such as Bank of America Corporation’s (NYSE: BAC) Michael Hartnett, who said investors should steer clear of stocks. Hartnett added the expectations of a recession would solidify following the upcoming earnings season, a test of how companies have managed headwinds like the bank crisis and slowing demand.
Graphic: Retrieved from Bank of America Corporation (NYSE: BAC).
Despite billions in redemptions over the past week or so, the market’sstrengthcan continue for longer, though. Here’s why.
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via The Market Ear.
Contextually, positioning overwhelmingly supports the market at this juncture. That’s per the likes of Cem Karsan of Kai Volatility have explained.
Falling volatility has led to billions more in buying flows from volatility-controlled funds rebalancing their risk exposures, Tier1Alpha adds, noting “there is a chance realized volatility [or RVOL] will continue to decrease until the end of next week as long as the SPX returns stay muted. If volatility rises beyond the +/- 2% threshold, net equity sales could exceed $5 billion.”
“This is not expected due to favorable CPI data and dealer positioning,” however.
With markets likely to be contained in the short to medium term, and fundamental weaknesses, such as the Fed hiking long-end yields, likely to cause them to fail in the long run—play near- or medium-term strength via call spread structures, and use the profits to lower the cost of longer-dated bets on markets or rates falling.
In support of this view, per The Market Ear’s summary of some Goldman Sachs Group Inc (NYSE: GS) analyses, “the disconnect between Nasdaq 100 (INDEX: NDX) and bond yields has grown to statistically significant levels.” Thus, “owning downside asymmetry” is starting to look “more attractive.”
Graphic: Retrieved from VIX Central. The compression of implied volatility, or IVOL, is a booster for equities. Investors are mostly bullish with a +1 Put, +100 Stock, -1 Call position, while dealers hold the opposite with a -1 Put, -100 Stock, +1 Call position. As the volatility trends lower (e.g., S&P 500 realized volatility or RVOL is ~10), options lose value, and dealers must buy back their short stock to re-hedge. This supports the market.
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
We’re excited to announce that we will be publishing ultra-detailed notes with context on fundamentals, positioning, and specific trades. Notes will be nearly 3,000 words or more, and will not be in the traditional newsletter format. Though this newsletter will continue to be published, it will not maintain previously long lengths because of time constraints. Notwithstanding, there will be occasional longer issues, we promise! We aim for quality rather than quantity. Stay tuned for future money-making updates.
Market indicators suggest an interest rate hike in May is more likely. This is backed by inflation data and Federal Reserve meeting minutes.
To be more specific, the indicators show traders are betting on higher rates in the near-to-medium term, and lower rates in the longer term. Adding, while inflation has moderated and there have been recent turbulences in the banking sector, monetary policymakers think higher rates for just a bit more are valid. However, they are also aware that a reduction in lending could potentially lead to defaults, recession, and a credit crunch in the worst-case scenario.
Fed President John Williams agreed that bringing down inflation requires more work. Williams suggested that the Fed should consider one more interest-rate hike before pausing, but the actual trajectory of rates will be based on analysis of newer data.
Per Cem Karsan from Kai Volatility, the negative effects of policy decisions will take time to reflect in the market.
He said investors are mostly bullish with a +1 Put, +100 Stock, -1 Call position, while dealers hold the opposite with a -1 Put, -100 Stock, +1 Call position. As the volatility trends lower (e.g., S&P 500 realized volatility or RVOL is ~10), options lose value, and dealers must buy back their short stock to re-hedge. This supports the market.
Thus, Karsan said the markets will be contained in the short to medium term, but fundamental weaknesses, such as the Fed hiking long-end yields, may cause them to fail in the long run. We maintain medium-term strength is monetizable via call spread structures discussed in prior newsletters. Rotating profits into longer-dated bets on markets or rates falling is attractive as well.
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Short, low-alpha letter. We are working on an in-depth write-up detailing what trades to take and why they are optimal. Enjoy your day, and keep risk in check.
Goldman Sachs Group Inc (NYSE: GS) warns the S&P 500 (INDEX: SPX) could drop upwards of 2% if the consumer price index (CPI) comes in hot.
If year-over-year inflation exceeds the previous reading of 6.00%, stocks will likely fall ~2%; Tier1Alpha suggests “we could see between $4 to $7 billion of equities sold off, as … funds will have to de-risk their portfolio.”
If year-over-year inflation meets the consensus of 5.10%, stocks will likely rise; from an options positioning perspective, if fears are assuaged, and traders supply their bets on or hedges against the market direction (i.e., vol falls), this may indirectly add support.
Graphic: Retrieved from SqueezeMetrics. Dealer hedges with the underlying (i.e., stock or future).
CPI and Federal Reserve meeting minutes could clarify how much more policymakers have to go to rein inflation.
Based on the data and policy response, the consensus is that the economy is already entering a recession; GS warns that recession may manifest a spike in volatility during the rest of 2023, Bloomberg reports, noting they prefer hedging equity declines with put spreads (i.e., buy put, sell put below it) and collars (i.e., own stock and sell call to finance put spread). We wonder who has been saying the same thing for weeks.
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. You can learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view the content calendar at this link.
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Tomorrow’s Good Friday, and some markets, including the US’s equity market, will be closed. The Treasury market will remain open, albeit for less time, and may enable traders to price the impacts of coming releases, including non-farm payrolls (NFP). The consensus is that the US added 235,000 jobs in March, with the unemployment rate expected to remain steady at 3.50%. Higher for longer, then? We shall see.
Moreover, the big news is that the trend in mortgage rates, followed closely in the US, continues to be down. US 30-year fixed mortgage rates fell for a fourth-straight week, though applications to buy and refinance a home declined for the first time in a month. However, borrowing costs remain generally high and housing inventory low, keeping a cap on homebuying activity.
Notwithstanding, as explained by Akash Kanojia, for the housing market to “clear” on today’s affordability, home prices need to fall by about 20.00%.
To explain, typically, banks use a debt-to-income ratio to determine how much they will lend to a borrower to buy a house. Adding, they could enforce a limit of 80% on the purchase price of the house, and the remaining 20.00% is paid in cash by the borrower as a down payment.
Mortgage rates comprise the short-term risk-free rate, term premium, the Treasury-MBS spread, the primary-secondary spread, and a credit spread based on the borrower’s creditworthiness. Any of these numbers changing can influence a borrower’s final payment to the lender.
Graphic: Retrieved from Negative Convexity.
An analysis starting with a home price in 2021 of $575,000.00 and a borrower whose income was $92,000.00, and adjusting all for inflation and movements in rates, the decrease in home values to boost affordability is 21.00%.
Graphic: Retrieved from Negative Convexity. “To do this analysis, I started with a home price in April 2021[1]($575,000) and figured out how much annual income a borrower would have needed at that time to buy the house (~$92,000). I then adjusted the annual income up by 8% for 2023, extrapolating from this, resulting in a person that would have earned ~$92,000 earning $99,205 today. Then I calculated how much house a person earning $99,205 can afford today at a mortgage rate of 6.70% ($452,000). Divide the two, and you get a decrease of 21%.”
A worst-case scenario is that the fed funds rate rises further to quell inflation. If the fed funds rate were to rise to 6.00-6.25%, matching the latest annualized CPI print, and “the market realizes the Fed is not going to cut, and the curve (e.g., 3m-7y UST) steepens to historical norms (~150 basis points long-term average), barring changes in the MBS spread, primary-secondary spread, and credit charges, this produces a ~40.00% decline in home prices.
Graphic: Retrieved from Negative Convexity.
Consequently, as the economy slows and layoffs increase, as we’re starting to see, it will negatively affect housing demand and affordability due to income stability and growth. On the bright side, inflation destroys the nominal value of debt, Kanojia says. Assuming wages keep up, buyers in hot markets may be spared if they can withhold from selling at market-clearing prices, Kanojia ends.
On a note about the doom and gloom (i.e., economy slowing and layoffs increasing, as well as yield curve steepening), JPMorgan Chase & Co’s (NYSE: JPM) Jamie Dimon says the following:
Today’s inverted yield curve implies that we are going into a recession. As someone once said, an inverted yield curve like this is ‘eight for eight’ in predicting a recession in the next 12 months. However, it may not be true this time because of the enormous effect of QT. As previously stated, longer-term rates are not necessarily controlled by central banks, and it is possible that the inversion we see today is still driven by prior QE and not the dramatic change in supply and demand that is going to take place in the future.
Dimon, the CEO of JPM, says that a graph showing the yields on bonds of different maturities is inverted, meaning that the yields on shorter-term bonds are higher than the yields on longer-term bonds. An inverted yield curve has often been a reliable indicator of an upcoming recession; it reflects investor demands for higher returns on short-term investments and expectations that short-term rates will fall in the future, which happens when the central bank cuts rates in response to a weak economy.
In other words, the conditions around the yield curve inversion are different this time.
Graphic: Retrieved from the Federal Reserve Bank of St. Louis. A normal yield curve is upward-sloping, meaning long-term interest rates are higher than short-term rates; investors demand a higher return for tying up their money for a longer period; the spread between the 10-year and 3-month treasury yield is positive.
Further, a peek at the bond market shows cuts priced within six months.
Graphic: Retrieved from Bloomberg via @TheBondFreak.
Same thing with the Secured Overnight Financing Rate (SOFR) market, developed by the Federal Reserve to replace LIBOR, which was phased out due to manipulation concerns, among other things, as a benchmark interest rate.
Unlike LIBOR, which is based on unsecured lending transactions between banks, SOFR is based on actual transactions in the overnight repurchase agreement (repo) market, which makes it a more reliable benchmark. Consequently, the shift from the Eurodollar (FUTURE: /GE), used to intervene in support of the dollar and other currencies and allow lenders to lock in rates, to SOFR has accelerated, too.
As stated yesterday, options activity in the SOFR market was centered around the 95.00 strikes. To calculate the implied interest rate using the value of the 3-month SOFR future, we can use the following formula:
Implied interest rate = 100 – future price; the implied interest rate calculated using the 3-month SOFR future is an annualized rate.
For example, if the current value of the 3-month SOFR future is 95.00, the implied interest rate would be 100.00 – 95.00 = 5.00%.
Graphic: Via Charles Schwab Corporation’s (NYSE: SCHW) thinkorswim platform. The three-month SOFR (FUTURE: /SR3) curve implies a 4.86% terminal rate today, followed by easing into year-end.
The S&P 500 (INDEX: SPX) has not bottomed based on these conditions. 3Fourteen Research concludes that the SPX has never bottomed during a Fed hike cycle, which one is still ongoing; typically, forward earnings stabilize and turn higher 3-6 months after a market bottom, which hasn’t happened; the 2-10 yield curve has never remained inverted six months after a major bear market bottom.
Graphic: Retrieved from Bloomberg via @MichaelMOTTCM.
Notwithstanding all the doom and gloom, we explained in past letters that markets would likely remain strong through month-end March.
Graphic: Retrieved from Damped Spring Advisors’ Andy Constan. “6 of the last 6 quarters, the quarter end flow has resulted in a spike or dip and a subsequent 8%+ reversal.”
Accordingly, it made a lot of sense to own low- or no-cost call options structures in products like the Nasdaq 100 (INDEX: NDX), where many participants were caught offsides and bidding call volatility in response to the dramatic reversal; the reach for the right tail reduced the cost of ratio call spreads, making them the go-to structures.
It may make sense to re-load in similar call structures on pullbacks while using any proceeds or profits from those structures to reduce the cost of owning fixed-risk and less costly put structures (e.g., vertical) that may enable us to participate in equity market downside, as well as bet on lower rates in the future using call options structures on the /SR3 to express that opinion.
Graphic: Retrieved from TradingView via Physik Invest.
Disclaimer
Don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 7:00 AM ET. Sentiment Risk-On if expected /MES open is above the prior day’s range. /MES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Administrative
Not all doom and gloom. Make sure to read to the end!
Fundamental
In the Daily Brief for 3/20, we summarized the financial industry and policymaker responses that would turn asset fire sales into managed, orderly asset sales.
The net result of the intervention would be a reduction in credit creation, a tightening of financial conditions, as well as a slowing of the economy and inflation while, potentially, setting “a dangerous precedent that simply encourage[s] future irresponsible behavior” (e.g., risky lending/borrowing), the House Freedom Caucus put eloquently. Basically, the fear is in policymakers underwriting the losses of prevailing carry-type strategies and setting the stage for an even bigger unwind or so-called “Minsky moment,” the “sudden crash of markets and economies that are hooked on debt,” Bloomberg reports.
"Regional banks relied on a business model that relied on uninsured deposits," says @Lazard's @porszag. "The government needs to make explicit what a lot of people are assuming: that for the foreseeable future, uninsured deposits don't exist. Everything is insured." pic.twitter.com/GgZ9ZF2f7r
A systemic credit event is among strategists’ biggest fear, indeed. A Bank of America Corporation (NYSE: BAC) survey shows a credit event happening on the heels of a US shadow banking, corporate debt, and developed-market real-estate collapse. Recall this letter writer’s conversation with Simplify Asset Management’s Michael Green who said he sees “cracks in bubbles like commercial real estate” already appearing, too.
Bloomberg adds that JPMorgan Chase & Co (NYSE: JPM) strategists think the inverted yield curve signals recession and the stocks are likely nearing their high point.
Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm.
JPM adds that market lows won’t occur until interest rate cuts ensue.
Graphic: Retrieved from BNP Paribas ADR (OTC: BNPQY).
Recall 3/20’s letter citing BAC research that finds selling markets on the last Fed rate hike is a good strategy. The “Minsky moment” comment/fear has others at JPM adding that investors should sell into relief bounces.
Graphic: Retrieved from Bank of American Corporation (NYSE: BAC) via The Market Ear.
Most participants foresee rates continuing to rise by at least 25 basis points, per the CME Group Inc’s (NASDAQ: CME) FedWatch Tool. Following Wednesday’s (expected) hike, the path forward appears uncertain. Yesterday, the terminal/peak rate was at 4.75-5.00%. Today, the peak has shifted higher to 5.00-5.25%.
Graphic: Retrieved from CME Group Inc (NASDAQ: CME).
Financials look ready to fall off a cliff, to add. If they do, the whole market likely goes.
Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm.
Positioning
We keep referring back to our Daily Briefs published last week (e.g., 3/13 and 3/14). In those letters, we talked about the growing concern about markets enduring some exogenous shocks.
We opted to take the less extreme side since policymakers’ response was likely to stem (or push into the future) turmoil. Additionally, with participants easing up on their long-equity exposure, equity markets were likely to stay contained, relative to bond markets where the lack of liquidity is an issue, some believe. Anyways, following important events including inflation updates (i.e., CPI) and derivatives expiries, short bursts of strength (particularly in some of the previously depressed products such as the Nasdaq 100 or NDX, as explained 3/17) were likely to ensue heading into the end of this month and next month. Additionally, certain rates trades via options we set forth on 3/14 were ripe for monetization, too.
Rotating into a money market or T-bill fund or box spreads, while allocating some remaining cash to leverage potential by way of some call options structures, appeared attractive. While the T-bill or box spread exposures did not budge much, call options structures as proposed on 3/14 worked (and are likely to continue to work) rather well. The monetization of the rate structures discussed on 3/14 was timely, also.
The potential for coming events including the Federal Reserve’s (Fed) interest rate decision on Wednesday 3/22 to assuage participants’ fears of slowing may, accordingly, prompt fears of missing out on the upside, Bloomberg reports. A response may be FOMO-type demand for call options exposures, coupled with CTAs further “raising their equity exposure” on trend signals and lower volatility, boosting markets into a “more combustible” state as explained on 2/17. This fear of missing out is visible in options volatility skew; traders are hedging those tail outcomes.
Technical
As of 7:00 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, outside of the prior day’s range, suggesting a potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,004.75.
Key levels to the upside include $4,026.75, $4,037.00, and $4,045.25.
Key levels to the downside include $3,994.25, $3,977.00, and $3,959.25.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: 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.
Options Expiration (OPEX): Reduction in dealer Gamma exposure. There may be an increase in volatility after the removal of large options positions and associated hedging.
Volume-Weighted Average Prices (VWAPs): A metric 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.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 6:15 AM ET. Sentiment Risk-Off if expected /MES open is below the prior day’s range. /MES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Administrative
As indicated yesterday, through the end-of-this week, newsletters may be shorter due to the letter writer’s commitments. Therefore, please read the Daily Brief for March 14, if you haven’t already, for a big discussion on bond and equity market volatility, as well as the odds of the market falling apart or rising, and positioning contexts that support that movement. If there are any incomplete statements below, we shall complete them in the coming letters. We’re laying it all out for awareness. Take care!
Fundamental
Headline inflation via CPI (Consumer Price Index) fell most on energy and core goods while shelter, food, and services inflation continues to be sticky. Core prices continue to be high, risking “inflationary psychology [] becoming ingrained,” Bloomberg’s John Authers explains.
“There’s nothing in this report to suggest that inflation is defeated already,” explained Authers. “Not to raise the fed funds rate next week, with median inflation above 7%, would be a sign of panic,” and an acknowledgment of uncertainties with regard to the banking system, as talked about in the Daily Brief on March 14.
To note, however, contagion appears contained, despite Moody’s Corporation (NYSE: MCO) cutting its outlook for the banking system to negative from stable, and placing lenders including First Republic Bank (NYSE: FRC) on a downgrade review.
JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic did cut his equity allocation warning that not all carry trades, something this letter has talked about numerous times before (i.e., borrow at a low rate and invest in something that provides higher return), can be bailed out. Kolanovic appears worried about commercial real estate, which Simplify Asset Management’s Michael Green just told your letter writer is in a bubble that “we’re seeing crack,” finally.
Graphic: Retrieved from Bloomberg. The Federal Reserve’s new Bank Term Funding Program or BTFP is “QE in another name – assets will grow on the Fed balance sheet which will increase reserves.” Recall that QE is the flow of capital into capital markets while QT is the opposite. Q is for quantitative while E is for easing and T is for tightening.
Anyways, following yesterday’s CPI, traders price higher odds of a 25 basis point hike which puts the terminal or peak fed funds rate at 4.75-5.00%. Following this spring, factoring potential inflation plateau and financial system uncertainties, traders foresee the Fed easing. By year-end, traders expect rates to fall down to 3.75-4.00%. Recall that at the beginning of last week, there were no expectations of easing in 2023. Also, traders thought the Fed would raise as high as 5.50-5.75%.
Mortgage rates, determined by changes in the price of mortgage-backed securities or MBSs, fell too.
ARK Invest’s Cathie Wood, who your letter writer had the honor of interviewing in person for Benzinga articles, thinks we’re on the cusp of the “roaring twenties” as inflation “is likely to surprise on the low side of expectations” with the banking crisis also leading to “bad deflation.”
“Today, five major innovation platforms are evolving at the same time – multiomics sequencing, robotics, energy storage, artificial intelligence, and blockchain technology, all of which are converging,” she elaborates.
“Once the Fed stops looking backward at CPI inflation and starts addressing the deflationary banking crisis that a 19-fold increase in short rates and an inverted yield have caused, we would not be surprised to see a return to the Roaring Twenties.”
Graphic: Retrieved from Bloomberg.
On the backward-looking measures quote in the above paragraph, former Fed trader Joseph Wang notes that the Fed and central banks, in general, are aware segments of the market may break, but that won’t discourage them from tightening further.
“As the BOE saved the gilt market through purchases and kept tightening, so the Fed can save banks and keep tightening.”
Positioning
Tuesday’s letter said that following important events like CPI, the compression of wound implied volatility or IVOL, coupled with the nearing large options expirations (OpEx), sets the market up for potential short bursts of strength into the end of the month and next month.
That’s along the lines of what is happening. The S&P 500 rose mechanically after the release of CPI yesterday. Later, though the index succumbed, internally speaking the market remained strong through end-of-day, hence some short bursts boosted by some short-dated options activities, also.
As explained, yesterday, the recent re-grossing theme appears intact. Any further compression of wound IVOL and the passage of options expirations (OpEx) could support equities as month-end approaches. Though it may be too early to position for strength, one may consider it the way it was explained in the Daily Brief on March 14.
Technical
As of 6:15 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a negatively skewed overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,904.25.
Key levels to the upside include $3,921.75, $3,945.00, and $3,970.75.
Key levels to the downside include $3,884.75, $3,868.25, and $3,847.25.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: 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.
Volume-Weighted Average Prices (VWAPs): A metric 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.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 6:30 AM ET. Sentiment Neutral if expected /MES open is inside of the prior day’s range. /MES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Administrative
A long(er) letter, today. Through the end-of-this week, newsletters may be shorter due to the letter writer’s commitments. Take care!
Fundamental
Yesterday’s letter focused on the SVB Financial Group (NASDAQ: SIVB) failure, albeit with an optimistic tone. In short, the bank could not make good on fast accelerating withdrawals. Read more here.
According to one TechCrunch article, the likes of Founders Fund “reportedly advised their portfolio companies … to withdraw their money, … [and], if everybody is telling each other that SVB is in trouble, that will be a challenge,” as it was.
Graphic: Retrieved from @Citrini7. In the worst-case scenario, it was likely that uninsured depositors at SIVB would have received $0.80 on each dollar barring a bailout.
Authorities later put forth emergency measures guaranteeing all deposits. The effort shored up confidence in the banking system and markets strengthened, though some regional names such as First Republic Bank (NYSE: FRC) continued trading weak. In FRC’s case, the Federal Reserve’s (Fed) new bailout facility does not help. As former Fed trader Joseph Wang explains, “you need Treasuries and Agency MBS to tap the facility, and [FRC] barely owns any.”
Anyways, as yesterday’s letter briefly mentioned, expectations on the path of Fed Funds shifted. Traders put the terminal/peak rate at 5.00-5.25%, down from 5.50-5.75%, while pricing cuts after spring. Previously, no cuts were expected in 2023.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) FedWatch Tool.
Measures of US Treasury yield volatility implied by options (i.e., bets or hedges on or against market movement) adjusted higher, accordingly. This is often a harbinger of equity market volatility.
Graphic: Merrill Lynch Option Volatility Estimate retrieved from TradingView
Call options on the three-month Secured Overnight Financing Rate (FUTURE: SOFR) future (i.e., bets on interest rates falling in the future) paid handsomely.
For instance, bull call spreads that expire in December 2023 (e.g., BUY +1 VERTICAL /SR3Z23:XCME 1/2500 DEC 23 /SR3Z23:XCME 96/97 CALL @.0375) increased in value by about 650.00% to $0.33 (i.e., $750.00 per contract).
Graphic: Retrieved via TradingView. Three-month SOFR Future (December 2023). When SOFR is at a lower (higher) number, the market is pricing an increase (decrease) in interest rates. Participants put the December 2023 SOFR rate at 100-96.145 = 3.855%.
In the equity space, some readers may have caught some commentary on spot-vol beta in the VIX complex strengthening like we have not seen in a while, a nod to the harbinger of equity market volatility remark a few paragraphs higher.
Recommended Readings:
Read: The Ambrus Group’s Kris Sidial on two major risks investors should watch out for in 2023. In short, volatility’s sensitivity to underlying prices (spot-vol beta) was low, and Sidial cast blame, in part, on commodity trading advisors and strong volatility supply.
Read: Simplify Asset Management’s Michael Green on using option and bond overlays to hedge big uncertainties facing markets. Following 2022, investors swapped poor-performing long-dated volatility exposures for ones with bounded risk and less time to expiry, hence the increase in 0 DTE trading.
Graphic: Retrieved from Piper Sandler’s (NYSE: PIPR) Danny Kirsch.
This spot-vol beta remark suggests that (at least some of) the volatility in rates, as well as certain small pockets of the equity and crypto market, manifested demand for crash protection in the S&P 500, “which feeds back into VIX,” one explanation put well.
Graphic: Retrieved from Piper Sandler’s (NYSE: PIPR) Danny Kirsch. “[Last] week finally got a bit of explosiveness in VIX as fixed strike volatility got bid. This is VIX generic front month future and move in SPX. Last time it really “paid” to have VIX upside was Jan of 2022 (point in upper left corner).”
Notwithstanding, for these options to keep their value and continue to perform well, realized volatility (RVOL) must pick up substantially, which is not likely.
Unlimited’s Bob Elliott comments: “the bond market is pricing a broad-based credit crunch, … [and though] it’s not crazy for the Fed to slow down here given the current uncertainty,” odds are financial problems are contained and the Fed moves forward with its mission to get (and keep) inflation down.
Graphic: Retrieved from Fabian Wintersberger. Just as the “monetary expansion supported the rise in equity and bond prices in January.”
Consequently, “the pricing of Dec23s and 5yr BEIs makes no sense,” Elliott adds. This means the example SOFR trade above is/was ripe for some monetization, and equity volatility must be dealt with carefully (i.e., price movements must be higher than they are now which would be difficult given that authorities/Fed do not want liquidations).
In support of siding with the less extreme take, we paraphrase Kai Volatility’s Cem Karsan who says that for years prior to the 2007-2008 turmoil, macro tourists were calling for a crash.
For markets to crumble, there would have to be an exogenous event far greater in implications than what just transpired with SIVB over the weekend. With odds that such turmoil doesn’t happen soon, coupled with participants easing up on their long-equity exposure (i.e., selling stock and not needing to hedge, hence the statement that owning equity volatility must be dealt with carefully), RVOL is likely to stay contained. That’s not to say that this volatility observed in the rates market can’t persist. It’s also not to say that markets can’t continue to trade lower (in fact, with interest rates rising and processes like quantitative tightening challenging bank liquidity, there is less incentive for investors to reside in lower-yielding equities). It just means that, barring some exogenous event, the market remains intact.
Graphic: Retrieved from Jack Farley. “Silicon Valley Bank owns >$80 Billion of Mortgage-Backed Securities (MBS), a market that is ‘more prone to bouts of volatility’ because ‘small investors & leveraged funds have become the main buyers’ as the Fed & banks step away from market, according to Dec 2022 BIS report.”
Positioning
Following important events like the release of the Consumer Price Index (CPI) today, the compression of implied volatility or IVOL, coupled with the nearing of big options expirations (OpEx), sets the market up for potential short bursts of strength heading into the end of the month and next month.
Graphic: Retrieved from Bloomberg. Inflation has been well within forecasts.
A quick comparison of the Russell 2000 (INDEX: RUT) and Nasdaq 100 (INDEX: NDX) suggests this options-induced strength may help keep the recent re-grossing theme intact. The compression of wound IVOL and passage of OpEx, coupled with the still-live re-grossing theme, may put a floor under equities.
Graphic: Retrieved from TradingView. Orange = RUT. Candles = NDX. Note the weakness in RUT. Note the strength of the Nasdaq relative to the Russell.
To play, one could place a portion of their cash in money market funds or T-bill ETFs or box spreads, for instance, while allocating another portion to leverage potential by way of some call options structures that use one or more short options to help bring down the cost of a long option that is closer to current market prices (e.g., a bull call spread or short ratio call spread). To note, based on options prices as of this writing, it may be too early to enter call structures (i.e., too expensive given the context).
DEFINED OUTCOME INVESTING
-Worried about the prospects of the 60/40 portfolio? -Looking for a strategy that takes advantage of higher interest rates? -Tired of market timing?
A 🧵on how to use exchange-traded options + U.S. Treasurys to define your risk today, for tomorrow.
As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,904.25.
Key levels to the upside include $3,921.75, $3,945.00, and $3,970.75.
Key levels to the downside include $3,884.75, $3,868.25, and $3,847.25.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: 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.
Volume-Weighted Average Prices (VWAPs): A metric 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.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 6:15 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 this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS price via MND. Click here for the calendar.
Positioning
In the news is quite a bit of noise surrounding ultra-short-dated options with little time to expiry. To quote Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott, the trading of these options is adding noise; “US equities are such an untradable mess right now.”
However, your letter writer, who mainly trades complex spreads on the cash-settled indexes, thinks there has never been a better time to trade. Ultra-short-dated options enable you to express your opinion in more efficient ways. Additionally, the trade of these options, in the aggregate, can influence market movements, and this is added opportunity if you understand it.
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via Bloomberg.
Darrin Johnson, a volatility trader, recently discussed sharp ways to use these options.
Heading into some big events this week, John noted S&P 500 (INDEX: SPX) implied volatility (IVOL) was trading at ~25% on a five-day straddle. Traders could buy this structure while, in the interim, selling other structures like it “against CPI, Retail Sales, and PPI” where IVOL was higher. This would enable you to lower the cost of having positive exposure to movement or positive gamma via the five-day straddle, though this is operating on the premise “that Friday’s volatility will hold mostly steady, while the other 3 deflate.”
Moreover, the ultra-short-dated options are palatable if we will, and other traders, potentially much bigger in size, are observant of this too. The growing interest in these products (e.g., in the second half of last year, ultra-short-dated options made up more than 40% of the S&P 500’s trading volume) is growing in impact on underlying products like the SPX.
In fact, JPMorgan Chase & Co’s (NYSE: JPM) Peng Cheng found these options have an impact that “can vary from a drag of as much as 0.6% to a boost of up to 1.1%.”
To explain, though as of late options counterparties may be playing a smaller role as “customers have taken equal and opposite sides” of positions, per SqueezeMetrics, we can naively look at there being a pool of liquidity to absorb the demand for these ultra-short-dated options which are very sensitive to time, price, and volatility. These increased sensitivities are hedged in a way that impacts this available pool of liquidity. If the trade or impact is large enough, it is transmitted onto underlying market prices.
For instance, consider so-called meme mania and stocks like GameStop Corporation (NYSE: GME) that rocketed as traders’ interest in short-dated options demands rose. To hedge increased demand in call options, for instance, counterparties must buy the underlying stock. This demand boosts the stock.
Likewise, if traders’ consensus is that markets won’t move much until some large macroeconomic events, then their bets against market movement (i.e., sell ultra-short-dated options) will result in counterparties having more exposure to bets on market movement (i.e., positive gamma) which they will hedge in a way that reduces market movement (i.e., buy weakness or sell strength in the underlying stock). So, if traders bet against the movement, resulting in more counterparty positive gamma, then market movement is reduced due to the reaction to this positioning.
On the other hand, if traders’ consensus is that markets may move a lot, particularly to the downside, their bets on market movement (e.g., buy ultra-short-dated put) will result in counterparties having more exposure to bets against market movement (i.e., negative gamma). This demand for protection will bid options prices, particularly at the front-end of the IVOL term structure as counterparties price this demand in, and the counterparty will sell underlying to hedge. If fears are assuaged and traders no longer demand these bets on market movements, the counterparty can unwind their hedge which, in the put buying example provided, may provide a market boost, such as that which we saw immediately following the release of consumer price updates (CPI) this week; to quote Bloomberg, “[w]hen the worst didn’t happen, these hedges were unwound, helping propel a recovery in futures. It’s partly why the Cboe Volatility Index, or VIX, dropped 7% in a seemingly outsize reaction in a market when the S&P 500 ended the session basically flat.”
Additionally, the re-hedging-inspired recovery was short-lived as well; the impact of ultra-short-dated options, as this letter has stated before, is short-dated. It, too, does much less to influence measures like the Cboe Volatility Index (INDEX: VIX), a floating measure of ~30 day-to-expiry SPX options trading at a fixed-strike IVOL, though it does have an impact. Thus, the dis-interest to hedge stocks traders do not own (or hedge further stocks that may be hedged) out in time, does less to boost the VIX.
Anyways, in January, your letter writer interviewed The Ambrus Group’s co-CIO Kris Sidial about major risks to markets in 2023, as well as reasons why volatility could outperform in 2023 and beyond. Some of the information in that Benzinga interview made it into this newsletter in the days following its release.
Basically, the SPX and VIX complexes are growing and, on the other side, are a small concentrated group of market makers taking on far more exposure to risk.
Graphic: Retrieved from Ambrus’ publicly available research.
During moments of stress, as we’ve seen in the past with GME for example, options counterparties may be unable to keep up with the demands of investors, so you get a reflexive dynamic that helps push the stock higher. “That same dynamic can happen on the way down”; counterparties will mark up options prices during intense selling. As the options prices rise, options deltas (i.e., their exposure to direction) rise and this prompts so-called bearish vanna counterparty hedging flows in the underlying.
“Imagine a scenario where [some disaster happens] and everybody starts buying 0 DTE puts. That’s going to reflexively drive the S&P lower,” Sidial said. “Take, for example, the JPMorgan collar position that clearly has an effect on the market, and people are starting to understand that effect. That’s just one fund. Imagine the whole derivative ecosystem” leaning one way.
Graphic: Retrieved from Ambrus’ publicly available research.
Well, that’s what JPM’s Marko Kolanovic just said is a major risk and could exacerbate market volatility. “While history doesn’t repeat, it often rhymes,” he explained, noting that the trade of ultra-short-dated options portends a Volmageddon 2.0. If you recall, in 2018, Volmageddon 1.0 turned successful long-running short-volatility trades on their head when traders who were betting against big movements in the market saw their profits erode in days.
Further, to conclude this section since your letter writer is running short on time, as Sidial said, “if you’re trading volatility, let there be an underlying catalyst for doing so.” From a “risk-to-reward perspective, … it’s a better bet to be on the long volatility side,” given “that there are so many things that … keep popping up” from a macro perspective. Check out our letters from the past weeks where we talked about protecting profits (e.g., sell call vertical to finance and buy a put vertical with a lot of time to expiry).
For Ambrus’ publicly available research, click here. Also, follow Sidial on Twitter, here. Consider reading your letter writer’s past two conversations with Sidial, as well. Here is an article on 2021 and the meme stock debacle. Here is another article talking more about Ambrus’ processes.
Technical
As of 6:15 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a balanced overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,153.25.
Key levels to the upside include $4,168.75, $4,189.00, and $4,206.25.
Key levels to the downside include $4,136.25, $4,122.75, and $4,104.25.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: 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.
About
The author, Renato Leonard Capelj, works in finance and journalism.
Capelj spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market. Separately, Capelj is an options analyst at SpotGamma and an accredited journalist.
Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 8:30 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 this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS price via MND. Click here for the calendar.
Fundamental
Consumer price updates (CPI) have traders pricing (even) higher rates for longer.
Yesterday’s data showed goods deflation is underway while services inflation persists. Per Unlimited’s Bob Elliott, “the picture of inflation for the Fed today is considerably less sanguine than at the last meeting.”
Graphic: Retrieved from @VincentDeluard. “The most important indices are the prices of wage-intensive services: haircuts, childcare, dentists, lawyers. With the exception of garages (crazy inflation), they all converge towards 6.5 – 7% YoY and 0.4%-0.5% MoM. That is the true long-term inflation.”
This new data confirms the hawkishness expressed by the Federal Reserve’s (Fed) Jerome Powell last week. US Treasury interest rates shifted higher, accordingly.
CME Group Inc’s (NASDAQ: CME) FedWatch Tool places the terminal rate at 5.25-5.50%, up from 5.00-5.25% on Tuesday before the CPI release. Easing is set to happen this year still in the November-December timeframe.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) website.
Recall “a higher interest rate environment implies a more potent” monetary tightening and heavier flow of capital out of capital markets (i.e., quantitative tightening or QT), to quote former Fed trader Joseph Wang.
The pressure from the sale of assets (e.g., USTs, MBSs) will increase interest rates and move yield-seeking market participants out of risk, hence the expectation that pressure persists on equities in 2023.
Graphic: Retrieved from TS Lombard. “Without a recession, the disinflation from the 2021 slowdown ends sometime soon, setting up for a re-acceleration later this year. Not to 8%, but high enough for the Fed to rue its choice of slowing rate hikes when it did.”
In other words, processes like QT manifest themselves as less demand for assets. Per Fabian Wintersberger, central bankers must “recycle bonds into the markets on an unprecedented scale, which could easily lead tolower bond prices/higher yields” causing a “reflux of capital to safe-haven assets, like treasuries.”
Graphic: Retrieved from Fidelity Investments. “The recent rally in stocks deviated from liquidity conditions, which have held steady but have not improved. This is just one reason to question whether there is an adequate foundation to support a new bull market.”
You can produce the above chart yourself. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.
Moreover, the above chart which this letter has produced for you in the past and some would say is naive, shows so-called net liquidity.
But, according to Morgan Stanley (NYSE: MS), the correlation between net liquidity and the S&P 500 (INDEX: SPX), over the past ten years is about ~0.70 and explains more than half of the movement in price-earings multiples over the past decade.
After CPI, there was short-lived relief, as this letter expected. Following CPI, weakness surfaced and measures of traders’ activity in options markets showed a bearish tilt.
Big trades that fired off include the purchase of put options expiring in March on the S&P 500 and call options expiring in May on the Cboe Volatility Index (INDEX: VIX).
The net effect is pressure on the indexes that remain well-supported and compressed heading into big options expirations (OpEx) this week, after which the door may open to enable them to move freely and in sync with their constituents, some of which, like Alphabet Inc (NASDAQ: GOOGL) (NASDAQ: GOOG), are trading rather weak.
Graphic: Retrieved from Tier1Alpha. “With implied correlation having fallen back to levels not seen since 2021, it’s notable that realized comovement shows no such improvement and instead sits near record highs. Whether this presages a violent snapback is unknowable, but certainly the conditions are in place.”
To explain, after OpEx, counterparty exposure to positive gamma (i.e., positive exposure to movement hedged in a way that reduces movement) will decline and “leave markets more at the whim of macro-type repositioning”; counterparties will do less to disrupt and more to bolster (i.e., add to movement). For how to trade (or how these events impact trades), see this case study by Physik Invest.
Should there be a large break lower, then “convexity could become an issue,” The Market Ear explained in a statement quoting Goldman Sachs Group Inc (NYSE: GS). “Inflecting CTA flow could translate to an approximately 20% sell-off in US equities over a month in a down-tape scenario.”
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS).
Technical
As of 7:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,136.25.
Key levels to the upside include $4,147.00, $4,159.00, and $4,168.75.
Key levels to the downside include $4,122.75, $4,104.25, and $4,083.75.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: 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.
About
The author, Renato Leonard Capelj, works in finance and journalism.
Capelj spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market. Separately, Capelj is an options analyst at SpotGamma and an accredited journalist.
