Categories
Commentary

Daily Brief For March 16, 2022

Editor’s Note: 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

Stock index futures were higher after positive developments, abroad.

According to some reports, the talks between Russia and Ukraine are making progress. This is while China vows to stabilize markets with a promise “to ease a regulatory crackdown, support property, and technology companies and stimulate the economy.”

On the China news, the Hang Seng China Enterprises Index (INDEX: HSCEI) rose ~13% (in the context of a ~30% 1-month drawdown).

At home, in the U.S., the Federal Reserve is expected to increase rates by a quarter-point, the first since 2018. Markets are pricing up to seven hikes this year.

Ahead is data on retail sales and import prices (8:30 AM ET). The NAHB home builders index and business inventories (10:00 AM ET). As well as the Federal Open Market Committee (FOMC) announcement (2:00 PM ET) and press conference (2:30 PM ET).

Graphic updated 6:30 AM ET. Sentiment Risk-On if expected /ES open is above 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 60/40 portfolio is headed for its worst performance since the financial crisis of 2008 as assets are hurt by a mix of slowing economic growth and inflation.

Graphic: Via Morgan Stanley (NYSE: MS). Stocks and bond relationship upended. Adding, per a Bank of America Corporation (NYSE: BAC) survey, participants believe the markets would have to fall 24% (from peak to trough) – $3,636.00 SPX – to solicit a Fed pivot.

Further, this letter has talked about the “bonds down, equities down” phenomenon before. To borrow from letters published over the past two months, in short, over the past 40 or so years, monetary policy was used as a crutch to support the economy. 

Graphic: Via tastytrade. Asset correlations matrix.

This promoted deflation, innovation, and the subsequent rise in valuations.

With rates lifting, that’s a headwind; coupled with participants’ increased exposure to rate and equity market risk, which can play into cross-market hedging and de-leveraging cascades, 60/40 turns into somewhat of a poor hedge.

Why? Let’s back up for a moment.

For an investor to take on additional risk for return, they must receive in excess of the risk-free rate (as provided by the Treasury). This excess is the risk premium.

As Investopedia details well, therefore, “the total return on a stock is the sum of two parts: the risk-free rate and the risk premium.”

Moreover, higher rates and risk premiums increase the required rate of return.

Higher interest rates, basically, decrease the present value of future cash flows, making stocks, especially those that are high growth, less attractive.

So, at higher rates, shares should fall. At lower rates, shares should rise. Some strategists estimate that annual returns for 60/40 will be less than 5% over the next decade, as a result.

Graphic: Via Bloomberg. The FOMC is likely to signal more hikes.

This conversation has me bringing up a conversation I had with Karan Sood, the CEO and Managing Director, Head of Product Development at Cboe Vest Financial LLC.

“Bonds have been giving you really good returns because interest rates have been going down since the 1970s when they peaked at about 11%,” Sood explained to me. 

“That’s changing now; we’re at the zero bound, and it’s unlikely that will be as a strong of a tailwind. Worse, it could be a headwind if interest rates start to rise.”

Graphic: Via Bloomberg. Federal Reserve to raise rates for the first time in years.

In regards to the Federal Reserve’s balance sheet, Bloomberg explains that participants ought to receive updates on the pace of buying, as well as the sale of assets.

“That may include setting out caps on how many billions of dollars worth of Treasuries and mortgage-backed securities will be allowed to mature every month without reinvestment, something that Powell told Congress earlier this month would be discussed at this meeting.”

Graphic: Via Bloomberg. S&P 500 participants proactively price in the Federal Reserve’s intent to cut support. It is monetary frameworks and max liquidity that enabled markets to diverge from fundamentals.

Positioning: Based on a comparison of present options positioning and buying metrics, the returns distribution remains skewed positive.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

Pursuant to the buying support remark, JPMorgan Chase & Co (NYSE: JPM) strategists say pension and sovereign wealth funds, in rebuilding risk-on positions, may boost markets by as much as 10%. 

“It’s the biggest rebalancing since 2020 in terms of buying equities,” JPMorgan strategist Nikolaos Panigirtzoglou said. An inflow of at least $100 billion and as much as $230 billion could trigger gains of between 5% and 10% to global stocks, he said.

Graphic: Via Bloomberg. “[D]eclines have driven down the value of targeted allocations for the world’s biggest funds, many of which hew to a traditional mix of 60% stocks and 40% bonds. To address the shortfall, they have to buy equities.”

At the same time, expected is further compression of volatility (via the passage of FOMC), as well as the removal of customer puts (and associated hedging pressures) via OPEX (options expiration).

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). 

To note, there is the potential, according to SpotGamma, for some “path dependency,” as “the expiration and/or covering of a large swath of these put hedges may place the market back into an ‘underhedged’ position.” 

In such a case, new demand would add fuel to weakness.

Technical: As of 6:30 AM ET, Wednesday’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, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

Gap Scenarios: Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.

In the best case, the S&P 500 trades higher; activity above the $4,285.25 high volume area (HVNode) puts in play the $4,326.25 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,346.75 HVNode and $4,375.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,285.25 HVNode puts in play the $4,249.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,219.00 VPOC and $4,177.25 HVNode, or lower.

Considerations: Push-and-pull, as well as responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active. 

Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.

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.

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.

Categories
Commentary

Daily Brief For March 14, 2022

Editor’s Note: 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

A lot to unpack, today. Part of the newsletter may be cut off, as a result, in your inbox. Just click to view in another window.

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).

Graphic updated 6:11 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: 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.

Graphic: Via Bloomberg. As Treasury yields rise, participants price in Fed tightening.

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.

Graphic: Via CME Group Inc (NASDAQ: CME). Participants price in an increased probability of a shift in the target rate. Click here to access the FedWatch Tool.

“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.

Graphic: Via McClellan Financial Publications. “The Daily A-D Line for corporate high yield bonds continues to look quite ugly. That is a concern for the overall stock market because high yield bonds drink from the same liquidity pool as stocks do, and these bonds are arguably more sensitive than stocks are to liquidity problems.”

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.”

Graphic: Via DC’s Chartbook. Funding spreads “have stabilized over the past week, not making new highs after the gap-up open on March 7. These are encouraging signs that the stress in money markets is for now mostly contained and not an imminent risk to financial stability.”

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.”

Graphic: Via DC’s Chartbook. Cost of credit insurance for Citigroup Inc (NYSE: C). Hedging with CDS results in mechanical steepening which raises the curve. “This is in sharp contrast to the curve in March 2020 (yellow, orange, and red), when the short end of the CDS curve rose quickly and flattened the curve.”

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.”

Graphic: Via Andreas Steno Larsen. “Heatmap on quarterly inflation-adjusted returns across asset classes during stagflation periods (1973 – today).”

“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.”

Graphic: Via S&P Global.

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.

Graphic: Via Bloomberg. S&P 500 (INDEX: SPX) down, CBOE Volatility Index (INDEX: VIX) down.

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

Graphic: Via SpotGamma. “Netting call & put delta, you can see we’re near extremes in terms of put:call positions. Often large put positions are removed by expirations, which seems to coincide with market lows. Many of these are quarterly expirations which coincide w/FOMC meetings – such as next week.”

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. 

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “18-Mar has more expiring near-the-money SPX open interest than any expiration since 2019.”

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).”

Graphic: Via EquityClock. Taken from The Market Ear.

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.
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.

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.