Short Wave Craft, 1932
This week’s Reddit question:
“Is the bull market just starting?”
~ a 2023 Redditor ~
Arguments for yes
The market is moving higher and has cleared some key bear marks in the sand. There are many variations of this strength we could look at, but overall it is well demonstrated by this S&P chart:
SPY (top) with its 200 daily MA (blue line), with the Advance/Decline line underneath and NYSE New Highs/New Lows below that.
the daily ADL has broken to new highs
price bounced bang on the key vaccine breakout of 2020
price is comfortably above the daily 200 MA and it has turned up
new highs/ new lows show an increasing number of stocks making new highs (compare to what they were doing heading into the bear market top)
Arguments for no
The macro arguments are a mess, largely because the majority of macro commentators didn’t expect such a strong rally. I never ‘expect’ anything - I’m a human, too dumb to fortune tell - but my Risk Index was certainly throwing out warning signs (and in many ways it still is).
Now several commentators are looking to turn their reasoning for bearish price moves into reasoning for bullish price moves. Detailed analysis on how higher interest rates could be stimulatory, etc.
Our brains don’t have the capacity to pull all the variables together to make any such conclusions more than a 50/50 potshot (as much as we would like to think they can). At 50/50, they just muddy the water rather than adding any edge.
What we can conclude, and what should be fairly obvious, is that we have a Fed (plus many other central banks) that wants to find a way to tighten monetary conditions. Whether they have or haven’t managed that yet, and when they will manage it, is about timing. It’s why we don’t bet it all on one trade. But history tells us, they will find a way.
Timing for a short is indeed a problem and the bond market is a clear example of how no one has gotten it right this time around.
Dotted line is the current yield curve of US treasury yields. Blue line is the same data in May this year.
the structure is the same, the curve has just moved higher.
so, in May the bond market was pricing in an end to the Fed hiking cycle and a reduction in rates sooner than they are now. This has been the same rolling pattern for most of the year.
the bond market is effectively saying, ‘we expect rates to come down at some point, so we’ll keep pricing that in rather than considering that they may continue higher before they come down.’
note to self the next time someone says it: no, the bond market doesn’t always know best.
The Fed want to tighten monetary conditions. If you want to bet against them finding a way to do this, fine, ignore history and good luck to you. If you want to side with maths, ye olde adage is as apt now as it always has been: don’t fight the Fed.
But…the S&P is showing so much strength. Don’t fight price? This is a valid opinion and the reason I haven’t been stepping in front of this train so far. However, there are some creaks under the surface. The S&P is around 5% away from new highs. Of its top 16 stocks by market cap, which make up around 36% of the total index (and almost 50% of the Nasdaq!), a mere 5 have hit new highs. Most are significantly lower than their previous highs. If this was flipped and there were 10 or more hitting new highs and the underlying market wasn’t, it would be game on. Instead, it’s a signal not to get too frothy just as everyone else does.
What’s the trade?
Given that market internals have been improving, and commentary is becoming increasingly bullish, it is tempting to either join the crowd or at minimum lose conviction in a short trade idea.
The answer to the question is, as it often is with trading, ‘maybe a new bull market is just starting.’ The trouble is that in taking a trade, it feels like you’re making a choice - you’re being 100% bearish or 100% bullish. That’s not the case.
I want to put on a short trade where even if I’m wrong in the long run the trade has a chance of working out.
I think we are kicking around one of those spots.
Q3 is statistically the worst quarter. Since 1950, that loss has started in August and been fully realised in September.
Average % change per month in the S&P since 1950.
So, it’s seasonally a time to look for shorts. Furthermore, anyone who has been holding longs during this rally will be looking to take profits very soon.
One box ticked.
The second box that needs ticked is fragility of the market trend - how extended it is. The answer over the last few months has been, ‘not very at all,’ and coming to that conclusion would have saved many a failed short.
Fast-forward to today and although we are not at the all-out ‘this must fall’ stage, it’s certainly not a place I would want to get long.
Stocks above their 50-Day moving average (top) and the S&P (bottom)
As a straight-out ‘overbought’ trade, this indicator (as with many other similar ones) is still not quite at extremes- pretty close though.
However, this is an interesting spot to look for divergence. If this indicator can’t hit extremes, it shows a loss of strength just as the S&P grinds higher. This often results in a deeper pullback than a simple ‘overbought’ reading brings (as overbought simultaneously means ‘this rally needs to take a breather’ and ‘there are a lot of strong stocks out there that people will be buying once things have cooled off.’)
Has the market already priced in my conclusion?
So, taking this all into account, I like the idea of looking for short equity trades from now until mid-to-end September. Extremes, whether they make a new bull market more likely or not, set up a short trade when they are combined with strong seasonality.
If the market had priced in this conclusion, it would already be moving lower and it has not. So, there’s a trade here.
There’s also a clear place to express the trade. Nasdaq 7% or so from new highs, S&P around 5%. Many European indices at or near new highs. Russell 2k…..24% from new highs. It needs a mini bull market just to hit new highs!
Weekly of the Russell 2k. To sum up: a bunch of confluence where price is right now. If an initial short doesn’t work, opportunity to reload at the 50% retracement mark around 5% higher.
Will the 2k crumble at 2k? Worth a bet.
FX
Aside from indexes, if Q3 does turn into its usual crap show, USD will rally (and JPY too). There are a few areas in FX that this is lining up, though to be A-trades, USD needs to take one more dip.
If I were a betting man, I would say we could get this over the next few days (plus some fallout into next week) with the Fed and then ECB.
Several may line up, but for now, I’m looking at USDCAD and may be tempted to take an early shot if there is some volatility over the Fed.
USDCAD weekly. A pop down to that little target would be a good setup for a long. It’s already struggling to go lower as it kicks around the 50% range of last year’s price action. Always looking to get in on daily or weekly extremes (in price range), but this could be setting up nicely.
So, is the bull market just starting?
Of course, no one knows. No one ever has. But that hasn’t stopped traders and investors alike from making good money despite our ignorance.
I reckon there are some decent opportunities lining up on the short side. It’s been a quiet year for me so far, so I’m looking forward to taking advantage of them.
The wait is over; it's time to get to work.
Have a different opinion? Want to talk through a point some more? Pop in a comment below and let’s chat.
Be patient and trade well.