Week of December 22

Santa didn't come last two years. 3rd times the charm?

Recap of last week

Mixed week for us last week. We got stopped on some longs mid week. But we also had conviction BoJ would be a fade and buy the news scenario which played out exactly as expected. Past month has been extremely volatile, as we are still trading within the Thanksgiving week range but with huge moves both ways that go nowhere. Every AI earnings report is now a macro event on par with FOMC.

One thing is clear. We are entering into a more volatile phase of the market, rather than a slow motion vertical meltup like we saw most of the year post April, its clear bears are making more headway and as we go higher more and more are turning sellers.

Next move for markets

Up. I am sticking with my original thesis of a late EOY meltup to new all time highs to around 6950 - 7000 SPX. This has been a difficult view to hold, as things changed rapidly only about 6 weeks ago when the market made its high in October 29. As of now, the ORCL earnings report which saw it gap up 35%, was a moment when the AI bubble popped. I don’t think this is the ultimate top, but it was definitely a major inflection point and new beginning or new phase in the AI trade. One where AI Capex went from being funded with cold hard cash, to one where Capex was funded with debt. Market obviously hates the latter as the ROIC story is largely in the air, to be generous. Many think all this money will barely amount to anything, akin to the metaverse phase the market went through a couple years ago. I disagree (AI is for real) but thats besides the point. The market trades on narratives and anyone with money to express a view gets a vote.

However, I also want to stress that in the medium term, say January to March of 2026, I expect turbulence and probably another significant correction. In the neighborhood of 5%-10%. This is primarily due to positioning. This has dramatically changed. The market has been notoriously underexposed delta/beta for most of the year. That is no longer the case. Things have changed.

I always like to start with the most simplest explanations that are often the most powerful. This looks, feels, smells like classic distribution. This 6900 SPX area has been big resistance since late October. Everytime we get to this area, we see huge dumps and volatility. It is clear there are alot of sellers and trapper buyers up here. This echoes the 6100 SPX resistance we saw most of the last year. The similarities are very uncanny. In the bigger picture of 2026, I expect the 6100 area to be retested and for that to be a major buy point and I will be planning for that months in advance.

Technicals provide the framework, and I think alot of this 6900 supply resistance is confirmed by what we are seeing in positioning data as well.

Investors are max long or very close to it. The newly revamped BofA bull/bear indicator is flashing red literally. A sell signal has been triggered and this is a very high quality one that has marked major tops and bottoms.

This is echoed by the BofA FMS, where cash levels dropped off a cliff, to a record low 3.3%. This sell signal notable triggered last year in Dec 2024 as well, which marked the top at 6100, before we crashed to 4800. Although to be fair, obviously Liberation Day was the main culprit. Still the point stands, positioning is no longer a tailwind, but a HEADWIND.

Run it hot, the Trump put, the Fed put, the Trump Fed chair. I don’t dispute it. But its consensus, Therefore its priced in.

For those who havent seen, my NAAIM exposure chart. This is NOT NAAIM absolute values, this is exposure plotted as a percentile in a 2-year lookback. Meaning positioning right now is in the 98th percentile of all readings in the past 2 years. For those following, that is 2 years of really strong bull markets (24 and 25) so we are in pretty high altitude of bullish readings here.

We circle back to hedge fund positioning here, as long time readers know they were heavy laggards in getting nets and L/S ratio back up after Liberation day. That is no longer the case.

Hedge fund are broadly close to max long as well now too. Gross leverage is in the 99th percentile, and nets are in the 81st percentile on a one year lookback. Everybody is in the pool.

The GS sentiment indicator is not far behind. Printing a rare positive number in 2025. It is not yet stretched. Maybe a little Santa rally can get us there?

So right now we are seeing classic signs of distribution. Positioning is max long are maybe just a hair below that. 6900-6950 is clearly a fortress of long term sellers. Bulls need to comfortably clear these levels and close like multiple days/weeks above it in January (not December, insufficient volume) or else we may see markets retest the lows made in November of around 6500.

Anyways, that is more of medium term view. Time frame is everything. In the immediate future (the next 5 trading days or so), I am bullish.

First off, the number one bull case for an end of year rally is the fact that volatility remains trading extremely heavy. Equities vol, and rates vol is has been heavily offered at every turn this whole month. I trust that more than equities price action solely as it can be a bid noisy and more micro focused (random AI headlines). GS flags that VX has underperformed price movements in the SPX for 9 days now. In laymans terms, VX is not going up as much as it “should” when SPX is selling off. This is often an early sign of an upside reversal.

The hardest thing to adjust to the past month, which has caused many a haircut in P/L (including me), is that every AI ER report is now a macro event. ORCL has the power to dump the market after a dovish FOMC, AVGO had the power to dump it again. Then MU earnings put the bottom in I believe on Wednesday. Sprinkle in a little rigged CPI report on top of that. Mcelligot flags that put sellers rushed in on the AI factor post MU earnings which may have put a stop to the bloodletting and reinvigorated the AI trade, which then pulls up the NDX, and therefore the SPX.

My view here for weeks is that once these major vol events roll off, we could see implied really drop off and Christmas week see a small meltup of maybe 1%-2%.

We are officially past all these events, including the BoJ which I flagged as a bear trap early. With MU providing a temporary bottom to the AI trade, zero vol events on the horizon, and a 6800 SPX support reclaim made on Friday. Seems to me markets wants to retest 6900 again.

To sum up, I am bullish to the end of the calendar month. Beyond that I am bearish and expecting most likely a test of the 6500 bottom made in November, unless positioning drastically changes or bulls can comfortably hurdle the previous all time highs. The Christmas holidays often sees volatility crater and that brings in more releveraging. The year end and month end often sees some window dressing and performance chasing as well which can squeeze prices higher. As always its important to know when volume and liquidity dries up, this favours bullish outcomes as sellers require volume to sell into, whereas without their participation is is very easy to make the market float up on low volume.

Trade ideas

1. Holding the long ES from friday, may switch to options instead at some point, will see.