What the heck just happened in the stock market on Wednesday? It suddenly rose from the ashes and lifted itself toward the heavens, like a Phoenix rising from the dead.
The media suggested yesterday that the market rallied because Chairman Pow! walked back his thinking from October that interest rates were way below neutral. Supposedly those words triggered the October crash. The media said that traders thought that meant that the Fed would keep hiking rates through 2019.
But yesterday, the take on Powell’s speech was that he said that rates were now close to neutral, which CNBC characterized as a “change in tone.” That was ostensibly the reason for the 62 point rally in the S&P, which translated to a nice little attention grabbing 617 point gain in the Dow. That should get a few retail investors piling back on the train to oblivion.
But as economist Ian Sheppardson pointed out, Powell didn’t say that. The market overreacted, hearing what it wanted to hear. I think his analysis is spot on.
“Markets think Chair Powell said rates are now “just below” neutral. What he actually said was that rates are “just below the broad range of estimates of the level that would be neutral”. This is just a simple statement of fact…
…The “broad range” of FOMC estimates of neutral is 2.5-3.5%, as per the September forecasts. The target range for fed funds now is 2.0-2.25%, so the Fed is just one hike away from the top of the target range hitting the bottom of the neutral range. QED.
But they’re 3 hikes from the middle of the range, and 5 from the top. Powell said nothing to suggest that he or the majority of the FOMC think they’ll be able to stop at the bottom of the range, after just one more hike.
The US labor market, which is what they’re worried about, has not weakened appreciably in recent cycles with real rates less than 2%. Right now, they’re zero, and unemployment is at 49-year low, and falling. The Fed has a lot more to do.
More importantly, interest rates are a red herring. The real problem, as we know, is that the Fed is pulling $50 billion per month out of the banking system and the Treasury simultaneously sucking vast amounts of cash out of the market with $780 billion in new debt sales in the fourth quarter 2018 and first quarter 2019. That giant sucking action will soon suck the life out of this rally.
In the meantime, fellow Sure Moneyans, we have a market meltup. Now there’s a little something that I have noticed time and again in my 50+ years of charting stocks that suggests there was less rising from the ashes than met the eye yesterday.
And that sets up another profit opportunity for us.
That little something is that the more often a trading range is crossed, the thinner it becomes.
That’s because each crossing of the range takes a few more bids and offers off the books of dealers and investors. There are fewer and fewer offers to sell on the way up and fewer bids on the way down. We say that the market is thin.
The result is that as a range extends over time, prices race easily across the range. I call it “slot racing,” or “range racing.” Or as Shakespeare said,
“…it is a tale,
Told by an idiot (Wall Street and its media handmaidens), full of sound and fury,
Moves are becoming particularly acute and spreads are widening to begin with because the market is increasingly starved for liquidity. Ultimately, markets that are becoming illiquid must ultimately break down.
But in the meantime we get these vicious rallies. They are hallmarks of bear markets. Fast and furious. And quick to die too.
Over the past 12 months, the S&P 500 has traded between 2650 and 2800 on 175 of 250 trading days. And it traded in today’s trading range from 2684 to 2744 no fewer than 77 times. So the market traded in today’s range on more than 30% of trading days over the past year. As a result, there’s a significantly reduced inventory of stock for sale. And suddenly lots of buyers.
This happens again and again in bear markets when the Street convinces its customers, the mostly institutional herd, that the bottom is in.
So color me unimpressed.
That said, technically a 6 month cycle upturn was overdue, and this fits the bill. With the range being thin up to 2810-20, it wouldn’t be surprising for the market to race to that area, give or take a few points. I would be surprised if it got through that area, but I’ll cross that bridge if and when we get there.
I would view the first sign of a rollover after reaching, or attempting to reach, that level, as an opportunity to put on a trade of SPY puts with about a month to expiration. I like to buy options just in the money. If the market falls, they’ll move virtually point for point with the SPY. The ETF will move with the market at the ratio of 1 SPY point per 10 SPX points.
Conversely, if the market rallies further, these at the money options will tend to hold premium and won’t fall point for point if the SPY rises. I recommend entering a put trade near an obvious resistance level. In this case if the rally rolls over around 2800 or thereabouts, the obvious resistance level would be around 2820. Then I’d have a mental stop at 2830, or 283 on the SPY.
Trend channel resistance is suggested around 2740-50. The market should try to get through that. By the time this is published, it may already have done so. That would clear the way for a move to that 2800-2820 area.
But what if they break through 2750, can’t hold there, and reverse to close below 2740. That would suggest that the rally is in big trouble. I’d buy a few puts using 2750 or 275 on the SPY as my mental stop.
Because options can go to zero, I always recommend betting no more than you are willing to lose on a short term trade. The profit potential is great, but it’s critical to manage trades to limit losses.
Meanwhile, Tom Gentile’s ingenious Money Calendar research service doesn’t care what direction the market is headed. It has identified seasonal patterns that pinpoint profitable trade opportunities over and over. Click here for info on Tom’s service.