Was Witching Week Putting A Bid Under Equities?
Markets sometimes move in mysterious ways. Shorter term gyrations lasting months can have less to do with fundamentals and more to do with market mechanics. I've written before about this recent rally and what the likely causes were. Some people choose to label it as a rally by some secretive Plunge Protection Team, some as a manipulative rally, some say it is fueled by Fed liquidity injections. I tend to believe what is most obvious is that people who are calling a rally conspiratorial were likely positioned for the market to go down and didn't get their wish. It's easier to explain away your faulty market calls if you blame some unknown forces. Having clients sitting on the sidelines while the indices are screaming higher is surely a very unpleasant situation. So, what does one do? Blame it on conspiracy. I guess a little of "the devil made me do it" from the Church of What's Happening Now! Unfortunately, Flip Wilson was a hell of a lot more funny.
What money managers, caught on the wrong side of the trade, should have said was that risks did not warrant an aggressive market stance. Ben Graham, Warren Buffett, David Dreman, Julian Robertson, Richard Russell and John Templeton would all likely feel extremely uneasy being long and hard right now. In fact, I know a few of these names are sitting with inordinate amounts of cash because there is nothing to buy. That includes Warren Buffett who is sitting on a monster mound of cash and has commented that there is little value out there. These are the people who will (or did) win the investment race over the long haul. And so will you if you learn to think like them. Part of that philosophy is not chasing nor feeling some great desire to be in the markets all of the time. There are simply times when one needs to stay true to their discipline knowing they will ultimately be rewarded with better opportunities. That compares to the frantic "return chasers" who are gambling in the market today.
Historically, it's not that difficult to find a rally into weakening fundamentals. For that, all you need to do is look at the second half of 1998 and 1999. In addition, the data has not been so bad that every major market participant would run for the door. ie, The soft landing crowd still has an argument although it is a weakening argument.
I've shared my disdain for all of the conspiratorial theories as to why the markets have rallied and chalk much of this rally to short covering with a dash of defensive movement, money moving out of real estate, merger mania and money moving out of commodities. The dump in May was telegraphed quite clearly. The particular day it started was a mystery but not the months leading up to the sell off. Once the ashes had cleared in August, there was a dearth of sellers. So, the market basically did nothing for quite some time until participants got their bearings. As we all waited for the next move, there was a selling vacuum and the big money had all they needed to see. Everyone was short or in cash and someone was going to have some fun jamming all of those short positions. Most of us know when shorts have to cover, that act over covering is actually called a "buy to cover" for those who are neophytes. When the pain is too great, the shorts cover, buy their stocks back and actually fuel the buying momentum upwards. It's not rocket science. It also explains the almost step-like approach to the rally. The same action was common intraday where many daily moves were finished in an hour with the rest of the day basically treading water. That was likely cash/futures arbitrageurs as a relatively easy explanation for that type of intraday activity. Buy the futures premarket and the cash market rams higher immediately at the open. Ultimately when there are no more shorts, the market easily slides higher with no resistance above. That is, until there are no more buyers. Then, what is left below? An area of no support because normal action of backing and filling never occurred. Look at the Major Market or OEX and you'll see what I mean. There is no support below until you get to the May top. To me, that potentially means any sell off could be brisk and steep until we drop back to the May highs.
To the uninitiated the market action appears as though Wall Street is speaking and the global fundamentals are fantastic. Maybe they are but there's too much fundamental data to the contrary so I tend to believe this is a temporary phenomenon. That said, we just have to wait and see. Wall Street's insanity can be long lasting. The market was wildly overvalued in 1998 but that didn't keep the machine from grinding higher for another eighteen months. Why would this bubble be anything other than irrational like the last one?
I don't expect the averages to implode on Monday but underlying strength in the markets is weakening. On the chart below is the NDX with two plots against it. These plots are the normalized buying pressure of two groups of Nasdaq equities. The blue-green line is the cumulative buying pressure of a set of underlying Nasdaq stocks I would classify as value oriented. The red-gold line is the cumulative buying pressure of a set of underlying Nasdaq stocks I would classify as speculative. In other words, the buying pressure for each individual stock is normalized and added to a total for the set of equities included in the calculation. Buying pressure is my definition of an algorithm, whose primary input is volume, which I have developed. They are not oscillators hence theoretically, they should remain in the direction of the trend for as long as it lasts. Of course, markets never trend forever without some type of pause to refresh. So, maybe we are just pausing here. But, it's rather abnormal to see the data points turn negative without the averages showing any weakness. It will be interesting to see if there was a bid put under the markets that might be gone now that we are out of witching week.
What money managers, caught on the wrong side of the trade, should have said was that risks did not warrant an aggressive market stance. Ben Graham, Warren Buffett, David Dreman, Julian Robertson, Richard Russell and John Templeton would all likely feel extremely uneasy being long and hard right now. In fact, I know a few of these names are sitting with inordinate amounts of cash because there is nothing to buy. That includes Warren Buffett who is sitting on a monster mound of cash and has commented that there is little value out there. These are the people who will (or did) win the investment race over the long haul. And so will you if you learn to think like them. Part of that philosophy is not chasing nor feeling some great desire to be in the markets all of the time. There are simply times when one needs to stay true to their discipline knowing they will ultimately be rewarded with better opportunities. That compares to the frantic "return chasers" who are gambling in the market today.
Historically, it's not that difficult to find a rally into weakening fundamentals. For that, all you need to do is look at the second half of 1998 and 1999. In addition, the data has not been so bad that every major market participant would run for the door. ie, The soft landing crowd still has an argument although it is a weakening argument.
I've shared my disdain for all of the conspiratorial theories as to why the markets have rallied and chalk much of this rally to short covering with a dash of defensive movement, money moving out of real estate, merger mania and money moving out of commodities. The dump in May was telegraphed quite clearly. The particular day it started was a mystery but not the months leading up to the sell off. Once the ashes had cleared in August, there was a dearth of sellers. So, the market basically did nothing for quite some time until participants got their bearings. As we all waited for the next move, there was a selling vacuum and the big money had all they needed to see. Everyone was short or in cash and someone was going to have some fun jamming all of those short positions. Most of us know when shorts have to cover, that act over covering is actually called a "buy to cover" for those who are neophytes. When the pain is too great, the shorts cover, buy their stocks back and actually fuel the buying momentum upwards. It's not rocket science. It also explains the almost step-like approach to the rally. The same action was common intraday where many daily moves were finished in an hour with the rest of the day basically treading water. That was likely cash/futures arbitrageurs as a relatively easy explanation for that type of intraday activity. Buy the futures premarket and the cash market rams higher immediately at the open. Ultimately when there are no more shorts, the market easily slides higher with no resistance above. That is, until there are no more buyers. Then, what is left below? An area of no support because normal action of backing and filling never occurred. Look at the Major Market or OEX and you'll see what I mean. There is no support below until you get to the May top. To me, that potentially means any sell off could be brisk and steep until we drop back to the May highs.
To the uninitiated the market action appears as though Wall Street is speaking and the global fundamentals are fantastic. Maybe they are but there's too much fundamental data to the contrary so I tend to believe this is a temporary phenomenon. That said, we just have to wait and see. Wall Street's insanity can be long lasting. The market was wildly overvalued in 1998 but that didn't keep the machine from grinding higher for another eighteen months. Why would this bubble be anything other than irrational like the last one?
I don't expect the averages to implode on Monday but underlying strength in the markets is weakening. On the chart below is the NDX with two plots against it. These plots are the normalized buying pressure of two groups of Nasdaq equities. The blue-green line is the cumulative buying pressure of a set of underlying Nasdaq stocks I would classify as value oriented. The red-gold line is the cumulative buying pressure of a set of underlying Nasdaq stocks I would classify as speculative. In other words, the buying pressure for each individual stock is normalized and added to a total for the set of equities included in the calculation. Buying pressure is my definition of an algorithm, whose primary input is volume, which I have developed. They are not oscillators hence theoretically, they should remain in the direction of the trend for as long as it lasts. Of course, markets never trend forever without some type of pause to refresh. So, maybe we are just pausing here. But, it's rather abnormal to see the data points turn negative without the averages showing any weakness. It will be interesting to see if there was a bid put under the markets that might be gone now that we are out of witching week.
<< Home