Market Commentary For The Week Ahead: ‘Should I Stay Or Should I Go’

Notice: Physik Invest’s daily market commentaries will be suspended for the next five regular trading sessions or February 22-26.

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Key Takeaways:

  • Debt, inflation threatening low-rate regime.
  • Markets most complacent in two decades.
  • Sentiment turns hot from hotter amid slide.
  • Global equity fund net inflows decelerated.
  • Markets fret about economic performance.
  • Retail sales and industrial production gain.

What Happened: U.S. stock index futures auctioned lower last week.

What Does It Mean: Market participants witnessed a rapid de-risking event, as a result of individual stock volatility, and a subsequent v-pattern recovery, that was later taken back as Friday’s large February monthly options expiration (OPEX) neared.

More On The V-Pattern: A pattern that forms after a market establishes a high, retests some support, and then breaks above said high. In most cases, this pattern portends continuation.

At the same time, bond and equity market volatility diverged, materially. 

In other words, a rapid move up in rates — as investors become increasingly concerned over the value of their bonds due to rising debt levels and inflation — has yet to be priced in as an equity market risk.

Graphic 1: The Market Ear unpacks divergence in volatility across different markets.

Adding, the risk of inflation comes alongside a potential for slowing in economic growth, which may have knock-on effects, such as savers protecting their capital by investing in non-productive assets, thus helping form speculative asset bubbles.

Risk Of Monetary Support: The increased moneyness of financial markets; investors look to exchange-traded products (e.g., S&P 500) as savings vehicles, thereby forcing participants, like the Federal Reserve, to backstop market liquidity, and promote market and economic stability in times of turmoil.
A great paper on the impact of central bank intervention, passive index investing, and asymmetric liquidity provisioning.

Still, as Bloomberg suggests, reasons to not panic include an overreaction by market participants, premature Fed tightening, and a risk asset rout (i.e., rising rates may eventually increase demand for safety assets).

“Typically it’s a good environment for risk assets. Neither the pace nor the extent of the move so far has been unusual relative to other historical moves coming out of a recession,” said Pimco’s Erin Browne. “It would take a significant move in real yields in order to disrupt risk markets broadly.”

Graphic 2: Benchmark 10-year real rate in solidly negative territory.

Moving on, given OPEX, participants have a clue as to why the market failed to resolve directionally over the past week: 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.

Aside from OPEX, we must talk more about the v-pattern recovery and a prior week’s spike exit from balance, as well as low broad market volatility.

In light of the v-pattern, balance, and spike, the S&P 500’s long-term uptrend remains intact. In support of this uptrend, systematic and hedge fund participants are increasing their long-exposure, given the economic recovery, and a drop in volatility.

Beyond that, speculative activity in the options market and measures of market liquidity fail in offering much information.

Graphic 3: 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 February 19, 2021. Activity in the options market was primarily concentrated in short- and long-dated tenors, near the $390, a strike that corresponds with $3,900.00 in the cash-settled S&P 500 Index (INDEX: SPX).

What To Expect: U.S. stock indexes are positioned for directional resolve.

This comes alongside the acceptance of higher prices (inside a prominent high-volume area, or HVNode) and an overnight rally-high at $3,959.25.

More On Overnight Rally Highs: Typically, there is a low historical probability associated with overnight rally-highs ending the upside discovery process.

More On 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.

What To Do: In the coming sessions, participants will want to pay attention to the VWAP anchored from the $3,959.25 peak and $3,909.25 HVNode.

Volume-Weighted Average Prices (VWAPs): Metrics 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.

In the best case, the S&P 500 opens and remains above the $3,909.25 volume area.

Additionally, auctioning above the $3,915.00 VWAP would suggest buyers, on average, are in control and winning, since the February 15 rally high.

Auctioning beneath $3,909.25 turns the HVNode, nearby, into an area of supply, offering initiative sellers favorable entry and responsive buyers favorable exit. 

The situation would drastically deteriorate with trade beneath the $3,880.00 HVNode, the last reference before participants find acceptance in an area of low-volume.

In such scenario, future discovery ought to be volatile and quick as participants repair some of the poor structures left in the wake of a prior advance, and look to the next area of high-volume (i.e., $3,830.75) for favorable entry and exit.

Graphic 4: Profile overlays on a 65-minute and 4-hour chart of the Micro E-mini S&P 500 Futures. See all decision levels of /ES and /NQ here, also.

Conclusions: The go/no-go level for next week’s trade is $3,909.25. 

Any activity at this level suggests market participants are looking for more information to base their next move. Anything above (below) this level increases the potential for higher (lower).

Levels Of Interest: $3,909.25 HVNode.

Photo by Charles Parker from Pexels.


Market Commentary For 1/14/2021

Notice: To view this week’s big picture outlook, click here.

What Happened: Market participants further digested higher prices, as evidenced by U.S. index futures balancing within prior range.

What Does It Mean: For ten sessions in a row, the S&P 500 has consolidated near the $3,800 high-open interest strike.

What To Expect: Thursday’s regular session (9:30 AM – 4:00 PM ET) will likely open in prior-balance and -range, suggesting no immediate directional opportunity, again.

Given the open inside of a developing balance area, participants can expect higher volatility. As a result, focus should be directed to price levels that, if broken, would denote a change in tone, as well as the following dynamics:

  1. The failure to resolve directionally points to the absence of larger, other time frame participants (i.e., institutions that don’t transact at technical levels). Still, all broad-market indices are in an uptrend, evidenced by higher prices and value. This recent pause is healthy; consolidation after trend allows prices to converge with value, forming high-volume areas. The prices in this area are valuable and offer favorable entry and exit.
  2. The minimal excess rally high at $3,824.25 remains intact. Excess forms after an auction has traveled too far in a particular direction and portends a sustained reversal. The absence of excess, in the case of a high, suggests not enough conviction; in such case participants will (1) liquidate (i.e., back off the high) and strengthen the market, before (2) following through. Participants have already accomplished the first reaction.
  3. The pinch and subsequent recovery of the volume-weighted average price, anchored from the Sunday evening open, suggests further upside resolve as the average participant, from the anchoring point, holds a profitable position.
  4. The week ending January 8 established a v-pattern recovery, a price sequence that ought to be followed by further price discovery, as high as the 100% price projection, which happens to be near the multi-month upside breakout target at $4,000.
  5. Unsupportive speculative flows and delta (e.g., commitment of buying or selling), as can be viewed by the order flow graphic below.
Pictured: Divergent delta in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500

Moreover, in light of the above dynamics, the normal course of action is responsive trade. However, any break that finds increased involvement (i.e., supportive flows and delta) above $3,824.25 or below $3,763.75, in the S&P 500, would favor continuation.

Noting: In most cases, a break-out from balance is usually the start of a short-term auction. Therefore, placing trades in the direction of the break is the normal course of action. Trading back into the consolidation, thereby invalidating the break-out, would portend a move to the other end of balance.

Levels Of Interest: $3,824.25 regular trade high and $3,763.75 balance low.