Week of September 29

Correction is over?

Recap of last week

Very tricky week last week to trade. We took 3 ES trades and the results were +3 pts, -40 pts, +35 pts to end the week slightly red. Last Sunday night the market gapped down, which turned out to be a fake move as RTH saw the dip instantly bought and market closed at a new ATH. That move also turned out to be fake, as the next day the market gave up the entire gain after Powells comments on markets being “highly valued”. When the market is closing very bullishly/bearishly and then completely reversing the next day, it makes it quite hard to trade. We must always be wary that a move is a fakeout, or a look above/below and fail but at the same time most moves are real and are not that. So we can’t wait like 2-3 days for a move to confirm everytime because the result would be missing the majority of most trends. Sometimes you just have to accept not every week will be great for making money, and your job is to just get through it and protect your capital. There will be easier weeks to trade and harder weeks. This felt like the latter.

Lots of volatility last week, in the end the SPX opened at 6654 on Monday, and closed at 6644 on Friday. No real trend just stopping out everyone on both sides, with huge intraday volatility. We did make two big probes lower on Thursday, into the 6630s on ES1 to see a strong reaction from buyers. Is that a bottom for now?

Next move for markets

Up. I do believe the 6624 print on ES should hold as a nice low for the next week or two. The big event in markets this week is the looming government shutdown. Interestingly enough, the last shutdown was during Trumps first term, in late December 2018. It lasted about 35 days. It had no discernible market impact. However, that can be misleading as it occurred after the market already dropped almost 20% that 4Q as the market wrestled with a hawkish Fed at the time. In other words, positioning was already bombed out and the market was on the cusp of a bear market when it occurred, drastically different conditions than what we see today. So keep that in mind.

In very strong uptrends you will see assets find buyers at the 20DMA. That is what we are seeing right now.As you can see, since April, the market has consistently found buyers at this key support level. We touched that last Thursday. I know it barely feels like a pullback. Which is true. This is a market just punishing people for staying on the sidelines. Expecting that to continue. This is why we wasted no time entering the risk reversal last week. I think we need to hedge ourselves. As we approach the year end, you need to hedge the right tail, not the left.

Last week we broadly saw another de-risking from the professional investor community. Hedge funds took a big leg down in net exposure and L/S ratio. They are down in the 20th percentiles in both cases. HFs have done pretty well this year running lower nets, as this year has really awarded those adept at picking single stock names. For us focused on trading the index, this lower net exposure to the market is a bullish development. They are in already a defensive market positioning, and should they decide to performance chase into year end, they could help support equities as they run even higher.

Another week in the negative territory for the GS sentiment indicator. As mentioned previously, I much prefer this signal to more basic ones like CNN fear/greed. As you can see, we have spent the entire year post April in the negative territory. You might even think this measure is broken. Then you realize the market has rallied 35% since the April lows. The right way to measure euphoria, is by positioning, and not price. The price of SPX could be 10,000 right now, if people aren’t exposed to the rally, there is no euphoria. Right now people are not buying here. It’s a little puzzling to be honest. Maybe its valuations, maybe it’s TDS, I don’t know. Bottom line. It’s contrarian to be bullish stocks here.

Another way of looking at positioning is the NAAIM index. Rather than looking at absolute values, I wanted to view this value as a percentile in a one year look back. We are in a tepid low to mid 60th percentile in NAAIM exposure. That’s a really far cry from any sort of euphoria you expect to see at or near market tops. One recent market top that I like to look at as reference is November/December 2024. I don’t like to use the Liberation day top as a reference because it was largely event driven. As you can see in that period of time NAAIM exposure was in the high 90th percentile, and overall the mood was much more euphoric.

Another great perspective from GS here. Nothing new here for us experienced traders, but when you see a divergence between market sentiment and price, 99% of the time the price is right and the crowd is wrong. The sentiment indicator, along with ancillary market positioning, follows the price of the SPX — not the other way around. This was from earlier in the week, the current value of the indicator is -0.6. Put in very simple terms here, people will end up buying higher prices into year end because they have no other choice.

Here we have the sentiment indicator overlaid with GS vol panic index, which is an aggregated look at various measures of stress in the volatility markets. Despite a mind numbing rally the past 6 months, there still are no signs of euphoria, or the depressed costs of hedging often seen near market tops. Markets rarely top when people are afraid of the market topping. We will finally get that big selloff when no one is worried that it will happen.

In my post last week titled “Bubblicious” I alluded to the fact that market trends can go on much further than one might rationally expect. My recent benchmark for true euphoria and unbridled risk taking is the markets in 2021. That was when ARKK was going up every day, people paying millions for “NFTs”, Gamestop to $300, the SPAC craze, etc. A more quantitative metric we can use for gauging that is percentage of members making new 52 week highs in the SPX. As you can see we are currently at about 6% in that measure, in the days of 2020/2021, we saw that number in the 20%-40% range. Things can get crazier, more euphoric than they are now. I think they will.

Shifting to a more short term, technical view of markets here in the next week or so. Of course its the end of 3Q which means big rebalancing of books for all the big funds. GS estimates a rather large rebalance of about 19bn, which is 89th percentile going back 25 years. This will keep a lid on upside, or potentially cause a small wobble. Couple that with the government shutdown uncertainty we could see some weakness in the early week. This is however nothing structural that will compromise the year end strength I expect to see, and will 100% be an opportunity to buy more deltas if we do get some weakness.

Onto systematics, the overall story remains the same. This cohort is at/near max long. This is not a bearish factor in and of itself, it only really matters if the market can sustain a prolonged selloff below some key levels. That does not seem to be an issue as of now. However we will acknowledge this fattens any potential left tail scenario.

CTAs look like they are on strike, as they are buying almost nothing up here. They remain big sellers on any down move as well, something to make a note of. But again, sellers would need to take the S&P below 6500 for this sell flow to kick in, which is rather a long way away from current levels and realized volatility as of late.

The market had quite some trouble with the 6500 resistance back in August, and now that that’s cleared, it should provide a formidable support as well. Dealer gamma positioning echoes this as well. Dealer gamma rises significantly on a -2% to -2.5% move in spot here, which coincides with the 6500 level on the SPX, as well as the JPM short call strike. That would be very strong support here into the first week of October. I think low 6500s would be an absolute floor level here if we were to reach those levels due to any government shutdown/rebalancing flows.

To sum up, we finally got a mini correction last week down to the 20DMA. I think either the bottom is already in, or we might see another probe lower (depending on shutdown news, or NFP) but highly doubt on any additional downside below the low 6500s. The overall positioning board is rather light for a market making new all time highs. Dealer gamma positioning is very supportive on a move 2% lower from here, and short gamma on the upside. As is commensurate with an asset manager community underexposed to a rising stock market, I expect a year end chase and for dips to continue to be shallow. Any sort of wobble due to month end rebalancing or government shutdown news would be a strong buy for me.

Trade Ideas

1. Will alert in the chat