/ October 13 / Weekly Preview
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Monday:
N/A
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Tuesday:
Fed Chair Powell Speech
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Wednesday:
Various Fed Speakers
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Thursday:
Various Fed Speakers
Initial Jobless Claims (depending on Gov. Shutdown)
PPI (depending on Gov. Shutdown)
Retail Sales (depending on Gov. Shutdown)
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Friday:
Building Permits (depending on Gov. Shutdown)
Housing Starts (depending on Gov. Shutdown)
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Monday:
N/A
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Tuesday:J P Morgan Chase & Co
Johnson & Johnson
Wells Fargo & Company
Goldman Sachs Group, Inc. (The)
BlackRock, Inc.
Citigroup Inc.
Domino's Pizza Inc
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Wednesday:
ASML Holding N.V.
Bank of America Corporation
Morgan Stanley
Abbott Laboratories
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Thursday:
Taiwan Semiconductor Manufacturing Company Ltd.
The Charles Schwab Corporation
Intuitive Surgical, Inc.
Interactive Brokers Group, Inc.
The Bank Of New York Mellon Corporation
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Friday:
American Express Company
State Street Corporation
The Market Finally Cracks
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After trading relatively flat for most of last week, a sharp reversal in sentiment and positioning hit equities hard. On Friday, the S&P 500 fell -2.7% following comments from President Donald Trump who blasted China for imposing export controls. In response, the President escalated trade tensions by announcing additional 100% tariffs on all goods starting November 1’st and “critical software” export controls.
This aggressive statement shocked market participants who were on edge anyway due to valuation concerns, a lack of economic data to digest and a stretch of very low volatility accompanied by record highs. It was the perfect match to light a tinderbox filled with speculation and leverage.
While investors have heard this rhetoric before, prospects of renewed trade tensions with China immediately raised concerns about global supply chains, chip exports, and corporate margins. As a consequence, stocks and sectors which did best this year saw a heavy amount of profit-taking. Tech, growth and semiconductors were hit hardest. Though all Factors were in the red, the iShares Semiconductor ETF (SOXX) led losses with a -6.27% decline, followed by other risky areas of the market like Emerging Markets (EEM, -3.65%), the Nasdaq (QQQ, -3.47%) and Mega-Caps (MGK, -3.3%).
At the same time, the government shutdown enters its second week with no clear path to a resolution. For markets, the most important consequence is the suspension of several key economic data releases:
Several Weekly Jobless Claims Reports
CPI
PPI
Retails Sales
Housing Starts / Building Permits
The BLS did confirm that CPI will be published on October 24’th, just 2 days ahead of the Fed’s next interest rate decision. Until then, investors are in the dark regarding the path of inflation and the state of the job market.
Bond yields also reacted to the sharp decline of the stock market, as safe haven demand picked up in the face of uncertainty. The 10-year Treasury yield fell toward 4.05%, and close to achieving a technical breakdown. Of course, this translates into a blistering performance for TLT, the long-dated treasury bonds benchmark ETF. TLT crossed the R1 level at $90 and is headed to the top of its trading channel, now acting as resistance.
Given the enormous short position on US dated treasuries, as well as strong support in Dark Pools (which is also reflected in GEX), a further short-covering rally is becoming more likely.
This week’s price action hinges on buy-the-dip sentiment colliding with the President’s next move. Let’s cover the larger context of today’s market before diving in to historical precedent and the most likely outcomes.
First of all, we’re tracking the market’s response to the latest Fed rate cut. A positive close 1-Month later is associated with continued bull runs 1-Year after the cut. In contrast, a market that’s lower 1-Month after the cut signals a potential bear market next. Since the last Fed meeting occurred on September 17, the key date now becomes October 17 (the coming Friday). As of right now, the return is negative, at -0.65%.
Further muddying the waters is the activation of one of our most accurate medium term SELL signals, based on the number of key sectors registering Positive GEX-to-Volume metrics (if the number is above 10, this indicates too much greed). Across 48 events since 2020, the hit-rate is 60%, with an average return of -2.67%. This signal last triggered on June 12 and calls for prices lower than $600 by December 12.
The above prediction would imply a -10% change in the quarter which would not exactly be historically unprecedented. With Q3 reporting just getting started, valuations still stretched and heavy concentration risk in the main indices, downside risk has increased as of this Friday.
At the moment, and disappointment related to corporate earnings has the potential to further pressure the markets, this time from a fundamental perspective.
Friday’s sell-off was tied to multiple catalysts colliding. No economic data to parse, as well as very limited volatility during the previous period created a vacuum that breeds fragility. A single-day drop exceeding -2.5% has never been recorded while the S&P 500 was within 0.5% of its all-time-high in the previous session. As a result, a cascade of stop-loss orders was triggered.
In similar technical conditions (coming from a previous 6-Month positive trend) single-day losses of -2.5% were recorded during market-topping formations. While only 6 such cases were identified (all relatively recent), the track record in the following 2-Weeks and up to 1-Month is negative, with results turning positive after 6-Months.
The crypto market — a useful proxy for speculative risk taking — was also slammed, with Bitcoin down more than -10% at one point on Friday before eventually recovering during the weekend. In the Study below, we mapped days when Bitcoin was in a positive 6-Month trend and experienced an extreme down day, like Friday (worse than -6%).
We find these events happening within an ongoing bull market trend, most of the time. They do indicate selling pressure mounting at the 1-Week to 1-Month intervals, but they also signal overwhelmingly positive outcomes 6-Months afterwards (100% wins).
While the shorter term implications of our analysis above are definitely not bullish, we must also keep in mind who the buyers were on Friday: the “usual suspects” of dip buying, Dark Pools traders of course.
When we plot the daily Dark Pools Index average for the top 1000 stocks in the market, the jump is evident, though not on par with the magnitude of the market’s decline.
Longer term, plotting the 1-Week Dark Pools index for the same subset of stocks, we still get a clear distribution pattern. Temporary tops in accumulation occurred when SPY was trading at $600and $650 respectively (we’ll keep these levels in mind for our final Technical Analysis).
Ironically, Dark Pools distribution during an uptrend creates the situation where professional investors lag the market (June - October period). As such, the very same class of investors needs to buy-the-dip in order to “catch up” in terms of performance.
Sentiment has now crashed to heavily oversold levels, near the lowest recorded in all of the series. The good news is that most stocks are now oversold enough so as to elicit a reflexive bounce.
The not so good news is that the first time our indicator hits oversold levels (vertical bars) we get significant selling pressure in the short-medium term. The +/- range of outcomes varies from +9% / -15% at the 2 Week interval, up to +11% / -23% at the 1-Month interval. Risks are definitely skewed to the downside for the next period.
However, with oversold conditions being set up, the next BUY signal should be particularly profitable. In the chart below, the lightly shaded area represents the “set-up” part, with the bright green bars representing the actual dip-buying signal. For now, the market needs to digest the recent news and determine the path of least resistance.
Our Trading Strategy
Several stop-loss signals have triggered on our portfolio as well. While we have not yet acted in accordance, we need to be aware of which levels prove to be more problematic, to the downside.
Support should be just below the last close, as indicated by the 50-DMA and the accumulation level in Dark Pools. If the market closes below $650, then a more onerous correction is being set up, and we are far from re-allocating to risk. Below $650, the next support lies at the $600-$610 price interval. It all depends on how the market will digest news in the short term.
Critically, even a -10% correction to $600 would not mean the bull market is over. It would simply let some air out of “the bubble”, which is not a bad thing for the longevity of the overall advance.
If we get a breakdown, then we will act on our stops and add treasuries to the portfolio.
If we get a BUY signal in accordance to our Study above (and taking the input of our Enterprise model), then we will re-balance risks to the upside, picking up shares which have been hard hit. At the moment, there is no particular course of action to take absent one of the two outcomes above.
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