I've had a ST cautious tone on the market in general since mid July. Back then I warned that the market was showing signs of froth and advised against chasing. Symptoms of the froth were a string of very low daily put/call ratios, fear/greed index at 80+, NAAIM exposure 102 and AAII sentiment showing 2:1 bulls to bears. I mentioned how the market needed to shake out the Johnny come lately bulls such as the trend following CTA types who went from low market exposure at the beginning of the year to high exposure. As the market rolled over I mentioned that signs to look for at a correction low would be Fear/greed index at sub 25, NAAIM at sub 40, AAII bears 2:1 - essentially the opposite of July conditions. Well, these things all happened at the late Oct low. We've also seen CTAs running for the exists at the fastest pace since the COVID crash of 2020 to the point where they were short the market on par with the 2016, 2018 and 2020 lows. We have also seen the put/call ratio average about 1.05 for the past 3 months which is quite excessive. Even during this latest rebound, the put/call ratio has been constantly above which usually results in further ST upside.
The other thing I had mentioned a few months back was that the signs of froth we were seeing had implications for the ST, not medium/longer term as there were still plenty of fundamentalist type investors who were still skeptical and underinvested. I referenced B of A bull/bear indicator which is effective in gauging sentiment from a medium term perspective(1-2years). It had only reached a high of 4.5 in the summer which is only in the neutral range. Historically, you didn't have to worry about an immanent bull market peak until there's reading close to or above 8, which implied that any subsequent market decline from 4.5 would only be correction. At the recent market low the bull/bear indicator fell all the way back to 1.4, back into the buy zone, lower than it was to start the year. To sum up, the 10% decline in the market has resulted in a complete sentiment reset,which clears the way for the market to resume its bullish advance which began a little over a year ago.
Since the October 27th low we've seen quite a rebound in the market. It was sparked by the notion that the Fed has given hints that it done hiking...or at least that was the impression given by a softer than expected tone by Powel at the last Fed meeting. Jay tired to pour some cold water on that notion yesterday at the IMF meeting by stating there's still the possibility more rate hikes would be needed and is wary of disinflation head fakes. He also told somebody to shut the fucking door. The market seems to have disregarded his comments for now at least. It's incredible and quite silly how much of a Fed obsession there is out there, as if they are the masters of the market universe; as if is monetary policy is by far the single most important variable of the stock market. As if the disinflation we’ve been seeing since June 2022 was largely due to monetary policy. Go back to my Inspector Gadget post from last year…it’s playing out just like I said it would.
There are some things that I don't like about this latest rebound. First of all, it was initially driven by the "Fed is done" narrative, which runs the risk of being premature which would not the be first time this happens. The horribly lagging inflation data that the Fed tracks is still not sufficiently suggesting its a slam dunk by any means, however, next week's CPI report will show the impact of significantly lower month over month gas prices and lower used car prices as well. Perhaps the market has front ran this already. Speaking of inflation, the 5 year breakeven spread is currently at 2.3% and has been more or less around this level for 8-9 months. The day to day readings can get jumpy at times such as when it had a little spike to 2.53 in October. Fintwit was sure to point this out, implying that inflation was about to flare up again. Funny how fintwit is either quiet or in disbelief when the break-even spread had been hovering in the low 2's for several months. To me, it's not hard to see why this is so. Shelter is the largest component of CPI comprising 30% and 42% of headline and core figures respectively and it is baked in the cake for it to decline rapidly in the coming months. Data used to calculate shelter is horribly lagged by about 12 months. The yoy inflation of market rents/leases have been steadily declining, hitting pre-COVID levels in June and in the past few months are now tracking BELOW pre-COVID levels. So, it would appear that shelter CPI will be "normalized" by mid 2024 and onwards thereby putting downward pressure in the CPI for the next several months. It's probably likely that used car prices will also roll over significantly from here as well.
I digress. The ST concerns I have at this point is that we are quite ST overbought now with some indicators of sentiment having rebounded very sharply in short period of time. AAII sentiment went from 2:1 bears to bulls (sufficient to mark a correction bottom) last week to 1.5 bulls to bears this week. That's probably the biggests reversal I have ever seen. NAAIM sentiment also went from 29 last week (another marker to suggest correction bottom) to 62. 62 is not an extreme number but the huge jump is what's notable. This rally has also created 2 notable gaps in the charts. I fucking hate gaps like that as they tend to get filled, but not all do. The ones that don't, tend to happen at major inflection points Some people I bet are still waiting for the March 10, 2009 gap that kick started the bull market to get filled. The correction which started Aug 1 began with a gap down that did not get filled...at least not yet, but even if does eventually, you can see how it had staying power. I would expect the current gap from 4300-4330 will get filled at least. The one below that would require SPX 4220 to get filled. That one I am less sure of..
When the market hit a low on Oct 3, most of the aforementioned indicators were signalling bottom ( AAII was the exception at 1.5 bears to bulls, not quite 2:1). Then we got a rally and a lot of folks flipped bullish quite easily as calls for a year end rally became prevalent. The rally turned out to be a nasty headfake to which sentiment became extremely bearish again at the Oct 27 low, more so than on Oct 3 . Now we are seeing similar bullish flipping happening with this rally. I see evidence of people too eagerly turning bullish for a year end rally again, however, the persistently elevated put/call ratio suggests the opposite. In fact, it suggests more upside.
On August 21, after the market had declined 5% I wrote that the market was ST oversold and due for a bounce but not to expect that such a bounce would lead to a new leg higher. That turned out to be exactly what happened. I think we are in a similar situation but in reverse. The market is now ST overbought after having rebounded 7%.in a short period of time. It was achieved via 2 large unfilled gaps with bullish sentiment reversing very sharply, both of which are not constructive action. On the other hand, the put/call ratio had been stubbornly high all week which is contrary to the bullish sentiment and supportive for the market..That could turn on a dime but until it does it’s bullish and is arguably a more important indicator than sentiment surveys as it shows what people are actually doing with their money vs just feelings. So, It would not surprise me if the market goes higher still before peaking at some point mid or late next week and turns down but it shouldn't result in a lower low as medium term sentiment indicators have been fully reset. As usual I reserve the right to change this view as things unfold.
This post was mainly a tactical discussion. In the next post I will discuss more about fundamentals and consensus views/expectations for 2024. .
