Categories
Commentary

Weekly Brief For July 3, 2021

Market Commentary

Key Takeaways: U.S. equity index futures diverge in their attempt to discover fair prices for two-sided trade.

  • Economy is set for sustained boom.
  • Ahead is a light economic calendar.
  • SPX, NDX, DJI higher. RUT coiling.

Summary: Last week, U.S. stock index futures auctioned sideways to higher into Friday’s employment report. The release showed an addition of 850,000 jobs in June, the strongest employment gain since last summer. 

The S&P 500 and Nasdaq 100 led the week-long rally, while the Dow Jones Industrial Average followed closely behind. Though the Russell 2000 did end lower, it has been building energy for a break.

Considerations: It was the beginning of April JPMorgan Chase & Co’s (NYSE: JPM) Jamie Dimon wrote strong consumer savings, an increased pace in COVID-19 coronavirus vaccinations, and unprecedented efforts to spur economic activity could mean that a boom lasts as long as 2023.

Dimon’s comments remain valid. Months after, officials are hard at work in helping the U.S. reach herd immunity with vaccines that produce antibodies for the most well-known variants of COVID-19. Additionally, the economy is making progress toward meeting the Federal Reserve’s objectives for employment and inflation; just a couple of weeks ago the institution brought forward the time frame on when it will raise interest rates. 

In a statement, BlackRock strategists noted: “We believe the Fed’s new outlook will not translate into significantly higher policy rates any time soon. This, combined with the powerful restart, underpins our pro-risk stance.”

Alongside that news, the equity market sold violently, into Quadruple Witching, or the large expiry of futures and options. Thereafter, indexes staged a massive reversal, and the CBOE Volatility Index (INDEX: VIX), a measure of the stock market’s expectation of volatility, traded to its lowest level since February 2020.

According to SpotGamma models, up to 50% of the gamma in and across the S&P 500 complex was taken off the table that expiry.

This, as SpotGamma has said in the past, “creates volatility because, as large options positions expire[], are closed and/or rolled, dealers have large hedges they need to adjust.”

Put more simply, the initial action, into the expiry, may have been attributable to the sale of long stock that hedged expiring short exposure above the market (i.e., call side).

After that exposure was cleared, the prospects for a rally improved, boosted by the buying back of short put hedges as volatility imploded.

Last week, though, things became a tad frothy with the number of put options sold-to-open seeing heightened levels.

Graphic: SpotGamma’s analysis suggests equity put options were sold-to-open (red arrow). 

Put sales, which can be part of sophisticated volatility-based trading strategies, often suggest increased confidence as market participants look to options for income, and not insurance.

Historically, the returns after such developments are mixed; more often the appearance of strong initiative buying surfaces (e.g., August and January 2020) before a liquidation helps correct excess inventory, and bring sense back into the market. 

Kris Sidial – co-chief investment officer at The Ambrus Group, a volatility arbitrage fund – and I recently held a conversation regarding meme stock volatility, market structure, and regulation. He noted that ongoing risk-on dynamics can be traced back to factors like Federal Reserve stabilization efforts, and low rates, which incentivize risk-taking.

“The growth of structured products, passive investing, the regulatory standpoint that’s been implemented with Dodd-Frank and dealers needing to hedge off their risk more frequently, than not,” are all part of a regime change that’s affected the stability of markets, Sidial notes. “These dislocations happen quite frequently in small windows, and it offers the potential for large outlier events,” like the equity bust and boom during 2020. “Strength and fragility are two completely different components. The market could be strong, but fragile.”

That dynamic is playing out as Cem Karsan, founder at Kai Volatility, notes volatility is dramatically oversupplied. As a result, as implied volatility drops, options gamma – an option delta’s sensitivity to market price changes – rises. Associated hedging forces make it so there’s more liquidity and less movement. In other words, the market tends to pin.

Still, in line with Sidial’s comments, Karsan believes expected distributions are fat-tailed, given “fragility.” In other words, it’s hard for the market to unpin. Should it unpin, however, there’s “not enough liquidity” to absorb leverage on the tails.

Given this, Karsan finds it interesting to sell at-the-money option structures to fund out-of-the-money structures. Alternatively, knowing what forces – e.g., charm or the rate at which the delta of an option changes with respect to time – decay poses on so-called “dealer positioning,” going into the July option expirations (OPEX), one could look into long calendar put spreads on the S&P 500.

In such a case, traders are short puts in July and long puts on forward. This way, you’re collecting decay as a result of realized pinning. Here’s Karsan’s full take, from the source.

Graphic: The risk profile of a long put calendar spread, via Fidelity.

After mid-July, though, the window for fundamental dynamics (e.g., a shift in preferences from saving and investing to spending, monetary tightening, seasonality, or a COVID-19 resurgence) to take over is opened. 

In a note on COVID resurgence, to not venture too far off into the abyss, I cite strategists led by JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic who last year correctly suggested equities would continue rallying on the basis of low rates, improved fundamentals, buybacks, as well as systematic and hedge fund strategies. 

“The delta variant should not have significant repercussions for the pandemic situation in developed markets (e.g. Europe and North America, which have [made] strong progress in vaccinations) due to the level of population immunity.”

What To Expect: In the coming sessions, participants will want to focus their attention on where the S&P 500 trades in relation to Friday’s $4,323.00 untested Point of Control (POC).

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

That said, participants can trade from the following frameworks.

In the best case, the index trades sideways or higher; activity above the $4,323.00 POC puts in play the $4,347.00 excess high. Initiative trade beyond the excess high could reach as high as the $4,357.50 Fibonacci-derived price target.

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

In the worst case, the index trades lower; activity below the $4,323.00 POC puts in play the untested POC at $4,299.00, as well as the POC and micro-composite HVNode at $4,285.00. Thereafter, if lower, participants may look for responses at the $4,263.25 LVNode, $4,247.75 LVNode, as well as the $4239.25 HVNode and $4,229.00 POC.

Volume Areas: A structurally sound market will build on past areas of high volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low volume area which denotes directional conviction and ought to offer support on any test). 

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

For a full list of important levels, see the 65-minute profile and candlestick chart, below.

Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Graphic: Weekly candlestick charts of the S&P 500 (top left), Nasdaq 100 (top right), Russell 2000 (bottom left), and Dow Jones Industrial Average (bottom right).
Graphic: SHIFT search suggests participants were committing the most capital to call strikes at and below current prices in the cash-settled S&P 500 Index (INDEX: SPX) and Nasdaq 100 (INDEX: NDX), last week. This activity denotes (1) stock replacement, (2) hedges for underlying short positions, or (3) speculation on the upside. Also, there was a meaningful bid in September puts on the S&P 500 and Nasdaq 100. This dynamic suggests participants, despite their commitment to higher prices, are hedging against near-term risks, like the Jackson Hole Economic Symposium.

News And Analysis

Markets | The premium Elon Musk adds to Tesla, other ventures. (Kyla)

Markets | Forward-looking indicators point to improving credit trends. (S&P)

Travel | TSA screenings surpassed 2019 levels in a pandemic first. (CNBC)

Energy | WH is worried about high oil prices, sees enough supply. (REU)

Energy | An overview of data from IEA’s Energy prices database. (IEA)

Energy | OPEC ends Friday’s meeting without a deal for agreement. (CNBC)

Agriculture | Dry weather damage spells trouble for U.S. spring crops. (S&P)

Economy | States ending jobless benefits early hit labor milestones. (REU)

Markets | Spotlight turning to mergers, acquisition for fintech SPACs. (S&P)

Economy | Jobs gain largest in 10 months; employers up wages. (REU)

Energy | Cal-ISO, utilities ask consumers to conserve amid heatwave. (S&P)

Economy | Economic growth hiccup to derail credit spread stability. (BBG)

Markets | Record S&P 500 masks fear trade gripping stock market. (BBG)

Innovation And Emerging Trends

FinTech | BTC mining now easier, more profitable after crackdowns. (CNBC)

FinTech | ‘Flight to quality’ as private insurtechs draw big investments. (S&P)

FinTech | Bank customers cement relationships with digital channels. (S&P)

Markets | Money-losing companies sell record stock, flashing signal. (CNBC)

Markets | Wall Street rebels warning of ‘disastrous’ $11T index boom. (BBG)

Mobility | When do electric vehicles become cleaner than gas cars? (REU)

About

Renato founded Physik Invest after going through years of self-education, strategy development, and trial-and-error. His work reporting in the finance and technology space, interviewing leaders such as John Chambers, founder, and CEO, JC2 Ventures, Kevin O’Leary, businessman and Shark Tank host, Catherine Wood, CEO and CIO, ARK Invest, among others, afforded him the perspective and know-how very few come by.

Having worked in engineering and majored in economics, Renato is very detailed and analytical. His approach to the markets isn’t built on hope or guessing. Instead, he leverages the unique dynamics of time and volatility to efficiently act on opportunity.

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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

Weekly Brief For May 2, 2021

Happy Sunday! Markets were choppy, ending the week flat-to-down. This came after President Joe Biden’s joint session of Congress, Fed Chair Jerome Powell’s assessment of the economy, and blowout earnings by heavily weighted index constituents.

The following commentary on U.S. broad market equity indices will discuss what happened, why it matters, what to expect, and how participants can position themselves for the coming week.

Market Commentary

What Happened: U.S. broad market indices closed the week out flat-to-down after a failed attempt to break higher on Thursday, April 29. Last week’s action suggests participants are looking for information to initiate a directional move.

  • Policy leaders, creators: Inflation pockets transitory.
  • Ahead: Data on labor, manufacturing, and earnings.
  • Markets balancing, positions for directional resolve.
Updated: 10:00 AM EST Sunday.

Why It Matters: The sideways action during last week’s trade came after a lengthy run, higher. 

The S&P 500, in particular, from its March 2020 low, is up over 90%.

That said, as investors enter into a new month, popular news outlets are beating the drum of an old adage: “Sell in May and go away.”

Is there any truth to this statement? It depends on perspective.

Historically speaking, the period spanning May to October is generally weak. On average, the S&P 500 is up as high as +2% during this six-month period.

“Stocks are up more than 87% from the March lows, suggesting a well-deserved pullback during these troublesome months is quite possible,” LPL Financial Chief Market Strategist Ryan Detrick said in a recent blog post. “But with an accommodative Fed, fiscal and monetary policy, along with an economy that is opening faster than nearly anyone expected, we’d use any weakness as an opportunity to add to positions.”

Adding, trends are changing, though; stocks have been higher during these so-called weak months 8 out of the past 10 years, according to LPL Research. 

Graphic by LPL Research. Data from FactSet. 

So, with that, in maintaining objectivity, we zoom out and ask a few questions.

  1. Where are we in relation to the prior week’s range? Overlapping.
  2. Is the market’s attempt to go in a certain direction supported? No. After a failed balance-area breakout, participants rotated and accepted prices back in the prior range, as evidenced by unchanged value-area placement, the area where 70% of prior trade (i.e., 1 standard deviation) is conducted.
  3. Is the technical and fundamental narrative supportive of current prices? Technically, the market is in an extended uptrend. However, despite value-area placement suggesting a validation of higher prices, market liquidity metrics point to distribution, the opposite of accumulation.

Now, we analyze other factors in play.

  • Real Yields: Alongside April’s FOMC — at which the Federal Reserve left rates unchanged and asset purchases steady — 10-year real yields are on track for their biggest drop since last summer. Low real rates may catalyze risk assets as the present value of their future earnings become more attractive
  • Capital Gains Tax (CGT): The White House expressed its desire to raise the federal CGT rate to 43.4% for wealthy individuals. However, as Goldman Sachs Group (NYSE: GS) sees it, Congress is likely to settle on a more modest increase. Adding, weak S&P 500 returns, historically, going into CGT hikes are short-lived.
  • Low Rates, Debt Expansion: Such dynamics incent market participants to take risks, causing destabilizing factors to brew. As Ambrus Group’s Kris Sidial says, “The growth of structured products, passive investing, the regulatory standpoint that’s been implemented with Dodd-Frank and dealers needing to hedge off their risk more frequently than not” are all part of a regime change that’s affected the stability of markets.
  • Positioning: According to Nomura data presented by The Market Ear, CTAs have taken their positions too far on the long side, reaching levels last seen prior to the 2018 Volmageddon. Additionally, the (1) SPDR S&P 500 ETF Trust (NYSE: SPY) and the (2) Invesco QQQ Trust Series 1 (NASDAQ: QQQ) funds saw some of their biggest outflows. At the same time, certain breadth metrics are diverging from current prices while the SPDR S&P 500 ETF, cash-settled S&P 500 Index, and Invesco QQQ saw sizable call-side bets trade, Friday. 
  • Earnings Reaction: Last week, heavily weighted index constituents reported blowout earnings. The reaction was muted, leaving broad market indices flat-to-down. One explanation is that the expectations, going into the events, were too high. Another is that the equity market is priced to perfection, at this stage of the recovery, and further advances will be supported by the rotation into cyclical parts of the market — financials, energy, and value. 
  • Option Expiration (OPEX): Option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire worthless) and the reduction dealer gamma exposure. According to SpotGamma, a provider of actionable options insights, on Friday, up to 30% of the S&P 500 and Nasdaq 100’s gamma rolled off which may allow the indices an opportunity to directionally resolve.

So, in summarizing this section, technically, the market is bullish, supported by the prospects of a healthy rotation. In the coming week, given increased clarity on policy and a sizable derivatives expiry, participants may see directional resolve.

What To Expect: An increased potential to resolve directionally.

In addition, metrics, like price movement, market liquidity, and speculative derivatives activity, confirm participants’ bullishness and opportunistic hedging in light of an acceleration in the global restart and a turn in flows, the result of an apparent shift in consumer preferences, from saving and investing to spending.

Graphic: Physik Invest maps out the purchase of call and put options in the SPDR S&P 500 ETF Trust (NYSE: SPY), for the week ending April 30. Activity in the options market was primarily concentrated in short-dated tenors, in strikes as low as $400.000, which corresponds with $4,000.00 in the cash-settled S&P 500 Index (INDEX: SPX).

What To Do: In the coming sessions, participants will want to pay attention to where the S&P 500 trades in relation to its $4,186.75-$4,110.50 balance area. 

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend).

Any activity above (below) the balance-area high suggests participants are interested in discovering higher (lower) prices. Any activity within the balance area suggests participants are looking for more information to base their next move; in such case, responsive buying and selling is the course of action. 

Responsive Buying (Selling): Buying (selling) in response to prices below (above) area of recent price acceptance.

Initiative trade below the balance-area low suggests an inclination by participants to revert to the mean and repair some of the poor structure left behind prior discovery. Initiative trade above the balance area puts in play the $4,210.75 minimal excess rally-high, and the cluster of price extensions at and above $4,200.00, typical price targets based on Fibonacci principles.

Initiative Buying (Selling): Buying (selling) within or above (below) previous price acceptance.

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

So, in the best case, the S&P 500 makes an attempt to balance or discover prices as high as $4,300.00. In the worst case, participants look to auction the S&P 500 into prior poor structures and low-volume areas (LVNodes) that ought to offer little-to-no support.

More On Volume Areas: A structurally sound market will build on past areas of high-volume (HVNode). Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area (LVNode) which denotes directional conviction and ought to offer support on any test). 

If participants were to auction and find acceptance into areas of prior low-volume, then future discovery ought to be volatile and quick as participants look to areas of high volume for favorable entry or exit.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

News And Analysis

Markets | U.S. builders produced record share of homes with hot market. (BBG)

Economy | Consumer spending, labor cost data suggests inflation warming up. (REU

Trade | Baltic Dry Index breaks 3,000 points in more than a decade on prices. (TW)

Wealth | Rich Americans fleeing tax hikes may turbocharge the shift to ETFs. (BBG)

Markets | Fed’s Robert Kaplan warns on ‘imbalances,’ wants to talk taper. (REU)

Markets | A volatility quant nets $540 million as momentum trades boom. (BBG)

Lending | States are investigating predatory subprime auto lenders. (Jalopnik)

Markets | Record metals prices catapulted mining profits beyond big oil. (BBG)

Medicine | Biden’s ARPA-H agency to ‘end cancer’ modeled after Darpa. (TC)

Markets | Bond market’s inflation bulls get Powell’s go-ahead to double down. (BBG)

Markets | Bridgewater Co-CIO sees ‘fair amount’ of stock market in bubble. (BBG)

Markets | Retail investors could counter the much-anticipated correction. (SA)

Economy | Warren Buffett denounces SPACs and Robinhood at meeting. (Axios)

Markets | Crypto’s shadow currency surges past deposits of most U.S. banks. (BBG)

Technology | Roku says it may lose YouTube app after Google’s demands. (Axios)

Economy | Ex-Treasury Secretary Summers on scarcity of workers, inflation. (BBG)

Markets | Parametric fund earns ‘Gamma Hammer’ moniker with its bets. (FT)

What People Are Saying

Innovation And Emerging Trends

FinTech | Apex Fintech has blow-out earnings ahead of NYSE listing. (BZ)

FinTech | How to attract large investors to your direct investing platform? (TC)

FinTech | New fintech groups form as industry scrutiny is ramping up. (S&P)

FinTech | Cryptocurrency bank wins OCC approval to form de novo. (S&P)

Markets | CME eyes wider customer base with micro bitcoin futures. (TB)

FinTech | Coinbase plans to acquire data and analytics platform Skew. (TB)

FinTech | How U.K.-based Lendable is powering fintechs across EMs. (TC)

FinTech | Amid the IPO gold rush, how should we value fintech startups? (TC)

FinTech | 10 fintech headhunters you need to know for recruiting to talent. (BI)

FinTech | U.K. banks speed up plans to ax branches, switch to digital focus. (S&P)

Medicine | Kevin O’Leary-backed MindMed has uplisted on the Nasdaq. (BZ)

Media | Creators are making lots of money selling Google spreadsheets. (Mashable)

Media | As newsletter advertising grows, advertisers opting for quality. (ADWK)

About

Renato founded Physik Invest after going through years of self-education, strategy development, and trial-and-error. His work reporting in the finance and technology space, interviewing leaders such as John Chambers, founder, and CEO, JC2 Ventures, Kevin O’Leary, Canadian businessman and Shark Tank host, Catherine Wood, CEO and CIO, ARK Invest, among others, afforded him the perspective and know-how very few come by.

Having worked in engineering and majored in economics, Renato is very detailed and analytical. His approach to the markets isn’t built on hope or guessing. Instead, he leverages the unique dynamics of time and volatility to efficiently act on opportunity.

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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

Weekly Brief For April 25, 2021

Happy Sunday! Markets were choppy, ending the week unchanged. This came alongside talk of central bank tapering and an evolution in fiscal policy.

The following commentary on U.S. broad market equity indices will discuss what happened, why it matters, what to expect, and how participants can position themselves for the coming week.

But first, here’s a quote from Adam Funds CEO, Mark E. Stoeckle:

“To try to guess that this is the right time to be out of the market, you may as well go to Las Vegas.”

Market Commentary

What Happened: The S&P 500, Nasdaq 100, Russell 2000, and Dow Jones Industrial Average closed the week out basing, pricing in new information for the next directional move.

  • All talk and no action from policy leaders, creators.
  • Ahead: Fed meeting, GDP and Sentiment, earnings.
  • Markets balancing, position for directional resolve.
Updated: 10:30 AM EST

Why It Matters: The sideways action during last week’s trade came after a lengthy run, higher.

The S&P 500, in particular, from its March 4 low, is up nearly 13%.

Moreover, just because something is high, doesn’t mean it must come crashing down. To put this into perspective, here’s a quote from Jeff deGraaf, co-founder at Renaissance Macro Research: “Overbought/oversold conditions are useless without first defining the underlying trend of the market.”

So, with that, in maintaining objectivity, we zoom out and ask a few questions: 

  1. Where are we in relation to the prior week’s range? Overlapping, but slightly higher. 
  2. Is the market’s attempt to go in a certain direction supported? Yes, value, defined by the area where 70% of prior trade (i.e., 1 standard deviation) is conducted, is following price.
  3. Is the technical and fundamental narrative supportive of current prices? Technically, the market is in an extended uptrend, but recent activity suggests a validation of higher prices. Fundamentally, the topics of monetary and fiscal tightening have investors worried.

Now, in determining whether to change equity market exposure, we zoom closer in and analyze the risks at hand. 

The Bank of Canada, ahead of other central banks, in light of increased growth and inflation forecasts, cut its bond-purchase target and suggested an increased potential to hike rates earlier than expected.

This is an interesting development. The Federal Reserve, too, last week announced the U.S. economy would see higher inflation, but Chair Jerome Powell expressed the institution’s commitment to limiting any overshoot.

Why the change in tone? Here’s Janus Henderson’s portfolio manager Jay Sivapalan’s take.

“We’ve got inflated asset prices in equities, house prices, and infrastructure, how do you normalize that? You need revenue growth and you need inflation … [b]ut at some point in the future, growth may need to be traded off for financial stability.”

In simpler terms, with prolonged periods of low interest rates and debt expansion, market participants are incentivized to take risks. This is how destabilizing factors begin to brew.

“The growth of structured products, passive investing, the regulatory standpoint that’s been implemented with Dodd-Frank and dealers needing to hedge off their risk more frequently than not” are all part of a regime change that’s affected the stability of markets, said Sidial Kris Sidial, a former institutional trader and the co-chief investment officer of The Ambrus Group, a volatility arbitrage fund that looks to exploit changing market structure dynamics.

Here’s an image to help visualize some of what Sidial is referring to.

Pictured: Newfound Research unpacks market drivers, implications of liquidity.

Also, this week, the White House expressed its desire to raise the federal capital gains tax (CGT) rate to 43.4% for wealthy individuals. Despite the market selling on the news, all losses were recouped prior to the end of the week. Why? As Goldman Sachs Group (NYSE: GS) sees it, Congress is likely to settle on a more modest increase, less than 30%.

Adding, as Bloomberg’s John Authers notes: “The way the market handled the last major CGT increase, at the end of 2012, is instructive. As it grew clear that higher capital gains taxes were coming, the S&P 500 languished and went sideways for the last few months of the year, closing roughly where it had been in March. Then 2013 turned out to be a great year; stocks started their rally at the beginning of January and never really stopped.”

So, if a CGT hike is already being discounted by the market, given Friday’s rapid recovery — which also has something to do with how participants are positioned, but that conversation is beyond the scope of this commentary — then why are some of the largest exchange-traded funds seeing outflows?

In particular, the Invesco QQQ Trust Series 1 (NASDAQ: QQQ) bled nearly $6 billion over the last week, the worst exodus since the dot-com era of 2000.

Graphic: The advance/decline line (A/D), an indicator of breadth, is diverging from Nasdaq-100 prices, via MarketInOut. This dynamic has not presented itself in other broad market indices this commentary covers. 

One explanation: “With earning season starting to heat up, especially for the tech sector next week, it is likely that the expectations for technology companies may be too high,” said James Pillow, managing director at Moors & Cabot Inc. “It’s early still, but just look where the earnings surprises are coming from: materials, energy, and financials, all about 80% or higher. Money will follow performance — and the performance is coming from those sectors.”

So, in summarizing this section, technically, the market is bullish, supported by a healthy rotation.

Fundamentally, though, clouds are forming. Participants are adding shifts in tone, by policymakers, into their narrative. Should fundamental conditions change markedly, odds of a technical breakdown in momentum increase substantially.

Till then, the market is flashing green lights. Any correction may offer participants favorable entry.

What To Expect: An increased potential to correct in time, rather than price.

In addition, metrics, like market liquidity and speculative derivatives activity, confirm participants’ bullishness and opportunistic hedging ahead of an acceleration in the global restart and a turn in flows, the result of an increasingly apparent shift in consumer preferences, from saving and investing to spending.

Graphic: SHIFT search suggests participants are still not as inclined to add call-side exposure, through the month of May, in the cash-settled S&P 500 Index (INDEX: SPX).

What To Do: In the coming sessions, participants will want to pay attention to where the S&P 500 trades in relation to its $4,186.75-$4,110.50 balance area. 

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend).

Any activity above (below) the balance-area high suggests participants are interested in discovering higher (lower) prices. Any activity within the balance area suggests participants are looking for more information to base their next move; in such case, responsive buying and selling is the course of action. 

Responsive Buying (Selling): Buying (selling) in response to prices below (above) area of recent price acceptance.

Initiative trade below the balance-area low suggests an inclination by participants to revert to the mean and repair some of the poor structure left behind prior discovery. Initiative trade above the balance area puts in play the cluster of price extensions at and above $4,200.00, typical price targets based on Fibonacci principles.

Initiative Buying (Selling): Buying (selling) within or above (below) previous price acceptance.

So, in the best case, the S&P 500 makes an attempt to balance or discover prices as high as $4,300.00. In the worst case, participants look to auction the S&P 500 into prior poor structures and low-volume areas (LVNodes) that ought to offer little-to-no support.

More On Volume Areas: A structurally sound market will build on past areas of high-volume (HVNode). Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area (LVNode) which denotes directional conviction and ought to offer support on any test). 

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

Graphic: 1-day candlestick chart of the cash-settled S&P 500 Index (INDEX: SPX). See Micro E-mini S&P 500 Futures profile chart here.

News And Analysis

Politics | Joe Biden will deliver a ‘joint session of Congress’ this week. (ABC)

Market | The Rise of Carry returns; stock buybacks are kicking into gear. (Axios)

Recovery | The end of U.S. mass vaccination coming sooner than later. (BBG)

Commodities | OPEC says NOPEC bill could put U.S. overseas assets at risk. (REU)

Markets | SPAC deals are far below peaks but are still generously valued. (CB)

Economy | The MBA is forecasting record purchase volume this year. (MND)

Banking | Goldman, JPM talk with the U.K. over business travel corridor. (FN)

Climate | Leaking landfill contributes to world’s mystery methane hotspot. (BBG)

Trade | Beijing hopes U.S. companies will push to scrap China tariffs. (BBG)

Economy | Existing home sales suffer second straight monthly decline. (CNBC)

Markets | Taxes and inflation key themes for markets in the week ahead. (CNBC)

What People Are Saying

Innovation And Emerging Trends

FinTech | On blockchain- and smart contract-based financial markets. (FED)

FinTech | U.K. banks speed plans to ax branches, switch to digital focus. (S&P)

Health | What are all those constant video calls doing to your brain? (TC)

FinTech | Participants identify key operational areas for improvement. (TM)

FinTech | Alpaca intros Broker API that lets you build own Robinhood. (BZ)

FinTech | Public.com app connects users with public company leaders. (BZ)

About

Renato founded Physik Invest after going through years of self-education, strategy development, and trial-and-error. His work reporting in the finance and technology space, interviewing leaders such as John Chambers, founder, and CEO, JC2 Ventures, Kevin O’Leary, Canadian businessman and Shark Tank host, Catherine Wood, CEO and CIO, ARK Invest, among others, afforded him the perspective and know-how very few come by.

Having worked in engineering and majored in economics, Renato is very detailed and analytical. His approach to the markets isn’t built on hope or guessing. Instead, he leverages the unique dynamics of time and volatility to efficiently act on opportunity.

 Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

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Categories
Commentary

Market Commentary For The Week Ahead: ‘The Flow Won’

Key Takeaways:

What Happened: Amid a volatile, news-heavy week, after a slew of earnings reports by heavily weighted index constituents, and an FOMC meeting that made no change to existing monetary policy, financial markets experienced a rapid de-risking, similar to what transpired prior to the sell-off in February 2020.

What Does It Mean: After extending the S&P 500’s rally, as well as establishing acceptance near the $3,850.00 price extension, an upside target, and excess (i.e., a proper end to price discovery), participants auctioned back into range, repairing poor structures left in the wake of initiative buying.

The action found acceptance below the $3,824.00 – $3,763.75 balance-area, invalidating the prior week’s break-out to new highs.

Since then, market participants were witness to violent two-sided trade, a result of the market transitioning into a short-gamma environment (Graphic 1).

In such case dealers hedge derivatives exposure by buying into strength and selling into weakness. This, will exacerbate volatility.

Graphic 1: SpotGamma data suggests S&P 500 has entered short-gamma environment

In a conversation for a Benzinga article to be released this coming week, I spoke with Kris Sidial, co-chief investment officer at The Ambrus Group, a volatility arbitrage fund, regarding GameStop Corporation (NYSE: GME) share price volatility, market microstructure, and regulation.

According to Sidial, the dynamics that transpired in GameStop can be traced back to factors like Federal Reserve stabilization efforts, and low rates, which incentivize risk taking (see Graphic 2).

“The growth of structured products, passive investing, the regulatory standpoint that’s been implemented with Dodd-Frank and dealers needing to hedge off their risk more frequently, than not,” are all part of a regime change that’s affected the stability of markets, Sidial notes. 

“These dislocations happen quite frequently in small windows, and it offers the potential for large outlier events,” like the equity bust and boom during 2020. “Strength and fragility are two completely different components. The market could be strong, but fragile.”

The aforementioned regime change is one in which dealer exposure to direction and volatility promotes crash up and down dynamics. Last February, the market was heavily one-sided with participants, like target date funds (e.g., mutual funds), selling far out-of-the-money puts on the S&P 500 for passive yield, and investors buying-to-open put options in an increasing amount for downside exposure, thus exacerbating volatility. 

Graphic 2: Newfound Research unpacks market drivers, implications of liquidity.
Graphic 3: SqueezeMetrics highlights implications of volatility, direction, and moneyness.

Last week, per Graphic 4, the SPDR S&P 500 ETF Trust, the largest ETF that tracks the S&P 500, saw a rise in purchases of downside protection with time, which will likely lead to an increase in implied volatility and sensitivity of options to changes in underlying price.

These risks will be hedged off by dealers selling into weakness (see Graphic 3), thereby exacerbating downside volatility.

Graphic 4: Physik Invest maps out the purchase of call and put options in the SPDR S&P 500 ETF Trust, for the week ending January 30, 2021.

The activity was most concentrated in put options with a strike price of $361, corresponding with $3,610 in the cash-settled S&P 500 Index (INDEX: SPX). This, alongside the market’s entry into short gamma, and an inversion of the VIX futures term structure (see Graphic 5), in which longer-dated VIX expiries are less expensive, is a warning of elevated near-term risks for equity market stability.

Graphic 5: VIX Futures Term Structure per vixcentral.com.

What’s more? Aside from breaking technical trend (Graphic 6) is DIX, a proxy for buying derived from short sales (i.e., liquidity provision on the market making side) declining, and the presence of divergent speculative flows and delta (e.g., non-committed buying as measured by volume delta).

Graphic 6: Cash-settled S&P 500 Index experiences technical breakdown.
Graphic 7: DIX by SqueezeMetrics suggests large divergence between price and buying on January 27.
Graphic 8: Divergent Delta in the SPDR S&P 500 ETF (NYSE: SPY), the largest ETF that tracks the S&P 500.

What To Expect: In light of the technical breakdown U.S. stock indexes are best positioned for downside discovery.

As a result, participants ought to zoom out, and look for valuable areas to transact.

Graphic 9: 4-hour profile chart of the Micro E-mini S&P 500 Futures.

In Graphic 9, the highlighted zones denote high-volume areas (HVNodes), which can be thought of as building blocks.

A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test). 

If participants were to auction and find acceptance into areas of prior low-volume, as they have in the week prior, then future discovery ought to be volatile and quick as participants look to areas of value for favorable entry or exit.

Additionally, it’s important to remember what the market’s long-term trajectory is: up.

Late last year, JPMorgan Chase & Co. (NYSE: JPM) strategist Marko Kolanovic suggested equities would rally short-term with the S&P 500 auctioning as high as $4,000 on the basis of low rates, improved fundamentals, buybacks, as well as systematic and hedge fund strategies. Since then, Kolanovic has downgraded growth and suggested the limited potential for further upside despite odds of a sustained economic recovery.

Note, Kolanovic has not called for an implosion in equity markets. Instead, the market is due for some downside discovery given a moderation in the recovery.

Given the above dynamics, the following frameworks apply for next week’s trade.

In the best case, the S&P 500 takes back Friday’s liquidation and auctions above the $3,727.75 HVNode. Expectations thereafter include continued balance.

In the worst case, any break that finds increased involvement (i.e., supportive flows and delta) below the $3,689.50 HVNode, would favor continuation as low as the $3,611.50 and $3,556.00 HVNodes. Note that the second to last HVNode corresponds with the $361 SPY put concentration, which may serve as a near-term target, or bottom, for this sell-off, given last week’s activity at that strike.

Graphic 10: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures.

Conclusions: Participants ought to look for favorable areas to transact, such as those highlighted areas in the S&P 500, featured in Graphic 9.

Big picture, the sell-off ought to be bought, just not yet. Per Graphic 11, euphoria is still too high.

Graphic 11: Bank of America Corporation (NYSE: BAC) sentiment indicators.

Levels Of Interest: $3,727.75, $3,689.50, $3,611.50 and $3,556.00 HVNodes.

Cover photo by Pixabay from Pexels.