Week of March 6

Powell testifies and Non-farm Payrolls on deck

Recap of last weeks action:

Last weeks analysis was pretty much spot on. I thought we had one more plunge lower before a meaningful relief rally. I predicted most of the down leg was complete, and that the last few points were not even worth going for and it was wiser to start positioning for the bounce back. My one long swing trade that I gave was to long the top of the NFP breakout. The market made its ultimate swing low less than 5 points above my level, before a 125 point bounce. That trade should have made your entire week.

Now you’ll notice I recommend longing QQQ 0.00%↑ and the reason for that is, if I am targeting a swing trade (which I would define as say 100+ pts move in $SPX) I am naturally willing to take more MAE. So knowing the right tool to trade with here is important. ES 0.00%↑ futures I mainly use in situations where I can really define my risk to maximum of 3-6 points. In this particular trade idea I gave a 30 pt range, in which case futures have too much leverage as that much excursion on my trade would potentially lead to enormous losses. Which is why I recommend QQQ 0.00%↑ as if I am proven wrong I am taking a 1.5-2% loss on my position max. Now everyones account size and trading goals are different. So when I say long $QQQ. You can long $QQQ, $NQ, $TQQQ, QQQ 0.00%↑ calls, whatever instrument you prefer.

In cases where you see a major level being tested in overnight trading, what I usually recommend is a starter position with futures, but with a fraction of your normal sizing. That is to say, if you normally trade say 5-10 lots of ES, I would be longing with just MES or a couple lots maximum. Mainly to have a position “anchor” before you can start to put on your real position in pre-market which opens at 4AM EST.

The other trade I gave was a ES futures long off my key level 3950. It ran for about 20 points or $1000/contract. I only gave 2 trades and they should have both been massive winners. I always preach this and i’ll say it again here. Trading is about waiting patiently for the right setup and swinging big at the fat pitches. A typical week for me I am taking 5 trades on average, and hitting 3-4 of those. And my winners are much larger than my losers. I know way too many traders taking hundreds of trades a week only to end up the week red or with small gains. Preserve your financial capital and preserve your mental capital.

Next move for markets?

Up. On a bigger picture, medium term time frame here, we have broken out of the 200DMA and then this past week we backtested it. We are even over the 50DMA. In the short term, I want to buy dips around 3950-4000 to test 4100/4200 levels again. In todays age of readily accessible, seemingly-limitless information, you often need to simplify things.

Image A: $SPX technical picture.

Now is that a bullish chart? Yes. Look I am not immune to reading and being influenced by the news, and every bone in my body wants to be bearish. But looking at the price action, I simply cannot be. The market is a discounting mechanism. It is much smarter than you or I. Whatever you know, it also knows too. And it’s likely been discounted already. That doesn’t mean I am calling for all time highs either. I think we are currently in a 3800-4200 range trade where you want to fade the extremes.

From an options/gamma perspective here, we are getting closer to the March OPEX. Again this is a really complicated topic but i’ll try and do a quick rundown of the broad strokes and how it affects the market. The majority of market participants are long. To protect longs they often hedge using put options. Most people prefer shares to calls for obvious reasons. So you have a natural imbalance of more puts being bought than calls. So the market maker (Citadel, Susquehanna) is short the put that the average market participant is long. When they short a put, they are not taking a directional bet, so they will then hedge their short exposure by selling the index, often through futures. As these put options decay over time, the amount of notional they then need to hedge decreases. So as these put hedges decay over time, the market makers who are then short the put are able to buy back their short exposure over time as the nominal value of the options they have short sold are decreasing. So over time as we approach options expiration in any given month the vanna/charm effects of these decaying options lead to a supportive bid from the market makers buying back their short futures/exposure. Generally this provides a soft bid to markets in this window which leads to a muted downside. In weeks and timeframes such as this I tend to favour the long side. It is not the only consideration I have of course, but it is one I always tend to make a note of as part of my analysis.

Seasonality here is also very supportive for bulls. We usually trough around the mid/back end of March and that lines up with the rest of my thesis as well.

I am a very avid reader, and my favourite topic is the markets and macro. The past two years going back to the QE bonanza of 2021 I have heard people waiting, hoping to buy the 3380 pre-covid high $SPX backtest. The $SPX has probably traversed a 5000pt range within the 4800 ATH and 3500 October lows in that timeframe. So you had many many people miss out on thousands of points to buy this “major low” that would have netted them a small fraction of that. Don’t get caught up into the noise of defining this market as bear or bull. Or longing some generational low. We are in an environment now, currently, where you can make tons of money trading the ranges.

We have a very big week upcoming with Powell testifying before Congress on Tuesday/Wednesday. Now this is not FOMC, but anytime the big man speaks the market listens. So no major policy decisions, but likely some key words/phrases that algorithms will trigger your stops with. As always, Powell speaking is a giant risk, and an unknown you can’t really plan for. On days in which he is speaking I am extra cautious and don’t partake in any leveraged trades (futures/options). I am looking to fade around 4100 as that is the first big resistance. Ultimately this is not FOMC, there are no rate decisions or detailed looks into monetary policy so I favour a bit of a range this week between 3950 and 4100. Looking a bit forward to the back half of March, we have CPI and FOMC. Those are big market moving events which lends to my thesis that this may be a bit of a consolidation week within the 2023 range we have traded in so far.

On Friday, we have the non-farm payrolls report for February. Now I have gotten a couple DMs regarding why this event is so closely watched by market participants so ill try and do a quick crash course here.

Inflation simply is an excess of demand and not enough supply to meet that demand. The demand is enabled by the purchasing power of the people, which they acquire through their wages, which is a byproduct of the balance of the labour market. So you have a high number in payrolls, which means the job market is tight, which means employers need to offer more attractive packages (read: $$$) to attract the best talent, which means higher wage growth, more demand, and therefore more inflation. Which then is an impetus for a more hawkish Fed, who will then tighten more and lean towards a more restrictive monetary policy, reducing liquidity and ultimately hurting asset prices. So in theory, a higher number is bad for stocks.

But, a secularly tight labor market, as we are experiencing now, isn’t any news to the market. NFP has been beating estimates pretty much every month.

Image B: NFP trend since late 2021 has been solid beats pretty much every single month.

A hot jobs market is nothing new to the market, so barring a huge surprise to the upside or downside will not affect the market trend materially. Mainly expecting a short term whiplash for bulls/bears but am not seeing this as a significant market event. This market has been desensitized to bad news by now, as the news cycle and media has been overwhelming bearish the past year and a half. So we are at a point now where something bad has to actually happen (not predicted to happen!) before any significant downside is back on the table again. I reiterate a 3800-4200 range trade here seems most likely as we await for more data, and any changes that data has on the Feds future monetary policy.

So I have delved a bit into what’s capping the downside here in the medium term, what’s stopping the market from breaching 4200 to the upside? From a valuation perspective 4200, is a very generous 19-20 P/E in an era of 5.5% rates. So at that price you do have longer term sellers stepping in. You also have, in todays environment, alternatives to equities that weren’t really present in the last decade post-GFC. You have money market funds paying you 4.5% to sit in cash, and treasuries across all maturities where you can earn a risk-free 4%+. I will do a more detailed post on long-term investing in the upcoming decade separately, but there is very good reason to believe the past decade of equities outperformance will not repeat in the 2020s. Longer term secular headwinds such as rising rates, rising inflation, slowing growth cap the upside of equities around this price.

Lastly, this bear market will have to end the way it began. By way of the bond market. The historical, fastest fed tightening cycle in history caused trillions of value to be erased from the bond market. As rates across the entire curve were violently repriced, long-duration assets (such as technology) were most heavily affected. Technology is the cornerstone of the Nasdaq and the S&P 500 as well. $SPX is a bit more diversified but ultimately can not make any major moves to the upside without the big tech companies cooperating.

I think we are entering a decade of sticky, secular inflation. Which means the Fed has much more to do, and a longer path ahead of them. I don’t think we have seen the highs in rates yet. As long as inflation remains untamed, the pressure on bonds remains, and the upward trend of the terminal Fed Funds rate remains. I am watching MOVE 0.00%↑ here as a proxy for bond volatility and as long as this remains elevated bond bulls (and therefore equity bulls) are not out of the woods yet. As long as the downwards pressure on earnings remains, and the volatility and pressure on the bond market stays elevated, the market will have trouble trading about that 4200 level on the $SPX.

Image C: MOVE 0.00%↑ index showing no signs of relief.

Trade ideas:

With Powell early in the week and NFP later, I want to avoid leveraged plays such as options and futures. I am bullish biased in this week, favouring to buy dips.

1. I want to long QQQ 0.00%↑ in that 3950/4000 area in $SPX. When I give a range like that I generally start scaling into the trade at the closer target (4000) and am full sized at 3950. Stop would be a close below the 200DMA. I am targeting the 4100 are for these longs.

2. I would fade the 4150 area if we get here. As mentioned previously that is the 50% retracement of the Jan2022/Oct2022 high/low and major resistance. Also market is awaiting pivotal data towards the end of the month in the CPI, as well as FOMC policy decision and will be hesitant to break out before then.

Until next time, hope you have an amazing week!