"Appear weak when you are strong, and strong when you are weak."
Higher interest rates triggered another bout of market volatility on Wednesday, but it wasn't nearly as dramatic as the last reaction. Three weeks ago a spike in bond yields triggered the unwinding of the "short-volatility" trade. The led to a massive swing but traders were regaining their confidence after a big V-shaped bounce.
That V-shaped bounce started to falter around the 50-day simple moving average but was holding quite well. That set the stage for a strong reaction to the Fed minutes yesterday.
There wasn't anything that surprising in the minutes, though. Economic growth is strong, signs of inflation are developing, and the Fed is likely to raise rates steady in the next year. That was already well anticipated.
What happened Wednesday was that our good friends, the computer algorithms, were programmed to use the minutes as a trigger point. The initial reaction was to buy, even though there was nothing market-friendly about the news. It was just automatic buying, which squeezed shorts and sucked in buyers that were afraid they were missing out once again.
The folks in the news media struggled to explain the initial positive reaction and that set the stage for a very sharp reversal and a surge in selling. The computer programs then viciously reversed course and it was straight down into the close. Bonds dropped and the dollar rallied.
That action yesterday is a clear technical negative. It produced a bearish candlestick right under key resistance at the 50-day moving average and suggests the bounce is ending. It is such an obvious negative pattern that you have to wonder if it is too obvious.
Overnight, futures traded quite a bit lower but they are bouncing back this morning and are now slightly in the green. The dollar is up slightly but bonds have bounced and that is the key.
At this point the dilemma of this market is that the argument for more downside is so obvious that it seems to be a contrary indicator. The technical pattern is bad, higher interest rates are a headwind and there are some indications that volatility is going to stay at higher levels now. There are plenty of good reasons why this market should roll over here. Many bears think that a retest of the lows is likely to occur but that is the textbook setup.
The problem for the bears is that these bulls don't seem to quit. The computers consistently turn strong when the big picture looks weak. The big selloff at the start of the month produced a massive bounce and cut through resistance with hardly any hesitation. This now looks like a classic opportunity for the bounce to fail but the risk that the overly confident bears will be squeezed is quite high if the buy programs go to work again.
All the normal indications are for more downside, but all the recent experience suggests that it won't be easy. The dip-buying support is still out there and they are already at work several hours before the open.
I am preparing for further downside at this point but I'm very aware of the possibility that it may not come quickly or easily. There is still good action in individual stocks but I'm raising my cash levels and have put on some index shorts. Such defensive measures have often failed to work but there isn't much choice given market conditions.