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What Happened
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Overnight, equity index futures auctioned sideways-to-higher, masking turmoil in products listed abroad, as well as commodities and fixed income.
In regards to bonds, they slumped (globally) in light of participants’ pricing in monetary action given heightened inflation. The Federal Reserve, Bank of England, and Bank of Japan are to issue policy updates this week.
Commodity markets are still roiling after a price spike in some products “created a systemic risk” that prompted exchanges to cancel trades, while equity markets in Asia saw their worst-selling in years.
The Hang Seng China Enterprises Index (INDEX: HSCEI) closed down 7.2%, the biggest drop since 2008. This was after Russia asked for China’s assistance in Ukraine (which could result, later, in sanctions from the U.S.), thus compounding uncertainties with respect to an ongoing regulatory crackdown.
Ahead is data on 1- and 3-year inflation expectations (11:00 AM ET).
What To Expect
Fundamental: We may attribute participants’ uncertainty to how far monetary policymakers want to tighten, slower economic growth, the implications of geopolitical tensions, imminent Russian defaults, a resurgence in COVID-19 abroad, and more.
As revealed by metrics like CME Group Inc’s (NASDAQ: CME) FedWatch Tool, for instance, participants are pricing a high certainty of an increase in rates.
“Yields are reflecting a surprise higher shift upward in inflation expectations,” said Morgan Stanley’s (NYSE: MS) Jim Caron. “Many thought inflation would peak in the first quarter and fall. Now, with oil prices, inflation may stay high.”
At the same time, there are some indications of market stresses.
As explained in DC’s Chartbook discussion, however, “stress in money markets is for now mostly contained and not an imminent risk to financial sustainability.”
In regards to credit default swap spreads, though they are wider than in recent history, “they are still far below where they were during times of material solvency risk such as March of 2020, and the term structure of CDS spreads suggests this is more due to mechanical de-risking.”
Okay. So, the “financial system is functioning smoothly.” How do you trade slowing growth in the face of heightened inflation?
As Andreas Steno Larsen of Heimstaden explains, the “best way to assess this question is via a historical study of empirical returns during times of actual stagflation dating back to the early 1970s.”
“Assets that tend to keep the value intact or even increase in real terms through stagflation are typically negatively correlated to low or negative real rates, which is why gold and real estate (REITs) are some of the best places to hide during stagflation,” Steno Larsen says.
“Equities overall struggle to perform in real terms and so do bonds, which might be even worse this time around due to the outset of bond yields into this potential stagflationary environment.”
To note, pursuant to the idea that participants have “priced in” the aforementioned, S&P Global Inc (NYSE: SPGI) data suggests “the initial stages of a monetary tightening cycle have not been disastrous for the U.S. stock market historically.”
Positioning: Based on a comparison of present options positioning and buying metrics, the returns distribution is skewed positive.
This is in the face of an S&P 500 (INDEX: SPX) and Cboe Volatility Index (INDEX: VIX) down environment.
In part, this has to do with the supply and demand of protection; mainly, the market is “well hedged and well-positioned,” Amy Wu Silverman of Royal Bank of Canada’s (NYSE: RY) says.
Given this, as JPMorgan Chase & Co (NYSE: JPM) analysts explain, “we could be closer to the end” of discretionary de-risking, and the compression of volatility (via passage of FOMC), as well as the removal of counterparty negative exposure (via OPEX) may serve to alleviate pressure.
As SpotGamma, explains, “As it stands, without further geopolitical events causing, even more, fear, the markets are due for a relief rally,” on improving seasonality, among other things.
“Following the FOMC meeting, as well as the reduction in put-heavy exposures post-OPEX (options expiration), the need for put ownership (protection) and relative short positions is reduced (less positive delta = less selling to hedge = less pressure).”
Technical: As of 6:30 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed 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 $4,227.75 high volume area (HVNode) puts in play the $4,249.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,285.25 and $4,314.75 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,227.75 HVNode puts in play the $4,189.00 regular trade low (RTH Low). Initiative trade beyond the RTH Low could reach as low as the $4,138.75 and $4,101.25 overnight low (ONL), or lower.
Considerations: Participants resolve a pinch of two anchored volume-weighted average price indicators (VWAPs). A VWAP is 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.
We look to buy above a flat/rising VWAP pinch. We look to sell below a flat/declining VWAP pinch.
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.
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.
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.
Physik Invest 