Week of October 20
-3% from ATH and the correction is over?
Recap of last week
Great week for us last week. We took 3 ES trades, all 3 of them were winners.
We went long on the Sunday open for ~40 pts.
Long again on Thursday for about ~30 pts.
And a short on Wednesday, I personally cut too early, but was good for ~100pts for some of my followers.
Ultimately, we ended the week last week with an inside week. Every single lot traded in the ES last week was within the previous Fridays range. Is it safe to buy the dip? Or do we need to worry more about regionals and US/China?
Next move for markets
Up. I think time is running out for bears. When corrections like this occur, there usually is a window for bears to push price lower when vols are elevated and during seasonally weak periods. If they fail to do so, typically you see bulls take the wheel and push price back to the highs. To put it very simply, I think bears have this week to break the 6550 low in ES set last week or we go back to new highs in the first week of November.
I also believe that it most likely has to be a weakening of the credit market to break those lows, as in a US/China trade war tweet wouldn’t be enough of a bearish event. There are multiple ways to gauge whats happening now in the credit markets, you can look at HY spreads, or PE/PC, or any of the other alternative asset managers. KRE I think is a good proxy at the moment, as it is very fresh in the markets mind due to the 2023 SVB bank crisis, and a highly liquid ETF. On Thursday we had the biggest volume day since 2023 and SVB collapsed. You could argue that KRE is already trading something catastrophic in the regional bank system, all based off the 50m bad loan and the First Brands bankruptcy. Question is, has fear gotten ahead of itself?
I would say yes. GS has the redemptions from KRE at over a half a billion. This was more than in March 2023, when multiple banks full on collapsed, and were insolvent. This screams of recency bias. KRE is already trading the worst case scenario, and what if that doesn’t even happen. I was actively trading in March 2023, and actively buying the dip. SPX was 3800. Now it’s 6700. There is nothing to fear from a regional bank crisis, because the Fed will save the day. Or, the 50m bad loan could just be a 50m bad loan. Not every bad loan is the start of a GFC or SVB systemic crisis.
If I had to describe the last week, its fear has gotten ahead of itself. The banking system and reserves changed dramatically after the GFC. Then again in 2023 post SVB, as banks tightened up their lending standards. There will always be bad apples, but overall the system remains quite strong, liquidity plentiful, and if all else fails the Fed will backstop the system when needed. One measure of panic hedging I will look at is ETFs as % of tape. This shows how outsized in percentage terms ETF trading is compared to single stocks. An elevated number means elevated fear. This is because long investors in single stocks, will hedge by shorting macro products (SPY or QQQ ETF for example) to manage their delta, instead of having to outright sell their single stocks. Currently, we are at levels quite similar to April during the Liberation day crisis. Oh, and what happened after Liberation day? Massive rally.
Another measure of fear we can use here is in the vol market of course. This is however different than just a look at the absolute value of VIX or VX1. This is the delta adjust move of VX1. In other words, comparing how much VX1 moved in relation to the move of SPX, to how much it should have moved. GS found the “overperformance” of volatility compared to the relatively tame realized moves was quite significant, on par with two events in recent past. August 2024, and April 2025. What happened after both those events? Massive rallies.
Here is the actual data when backtested. This is very simply explained. Massive fear has permeated through markets due to X event (yen carry, tariffs, US/China, regional bank crisis), people put crash puts and put on massive amounts of hedges, when then ultimately have to be unwound. Or alternatively the actual event needs to be worse than everyone feared, which is pretty rare. This is a pretty classic, investors fear the worst case scenario, and reality is simply not as pessimistic, and we rally.
Hedge funds de-grossed quite a lot in recent weeks. Contrary to popular belief, the risk in entering long after a pullback is actually less than you might think. If people already sold their longs, they can’t sell again, basically. Hedge funds are getting quite low in L/S ratio and net long exposure again. Barring a huge systemic credit event, this probably means they cover their shorts and relever long in the coming months.
I am seeing alot of “biggest selling event since April”. People are playing ultra defensive and going max hedges into what is likely a minor bearish occurrence. Not every bad loan is the next financial crisis. On the US/China trade war, this has been going on since Trump’s first term. When SPX was below 2000. In the end US needs China and China needs US, there is no incentive for a true decoupling from either side.
The latest systematic footprint is mildly bearish. Some of these flows have already worked their way through the system last week. This has led to some of that extreme intraday realized volatility we have seen. However bulls are in the clear here as long as they remain above the 6550 ES low. This is a very bearish seasonal window due to no buyback support and some mutual fund year end dynamics. Bulls don’t need to rally here, just need to not collapse, and that will be a huge win. Come November the flows shift dramatically to the bullish side.
Positioning, still nothing to write home about. We are nowhere near euphoria. Last year around this time we were regularly printing scores of over 1.0.
Last but not least, let the perma bears worry over JEF and regional banks and the latest Truth Social. This is the most important thing. Earnings. Estimates are for 6% YoY growth, and last 3 quarters market has posted double digits. Banks passed with flying colours, if regionals make it through this week without total calamity Mag 7 earnings is probably lift off time and takes us to new highs once again.
To sum up, I believe that fear is way overdone right now measured through many different metrics. Market participants are way over hedged for something catastrophic to occur in credit markets or between Trump/Xi. I believe the bears have one week or so to break the 6550 lows in ES or we head to new highs. I will be keenly looking for larger longer timeframe swing long entries this week.
Trade Ideas
Will alert in the chat.