The much talked about Quadruple Witching has just expired with the June S&P 500 contract rolling off. September is now the front. This quarterly event is significant in that all the futures, index and stock options expire altogether.
Why is this so important?
Because tons of liquidity from pension funds, institutions and hedge funds are linked to the quarterly roll-off and there is a lot of futures hedging that goes on that can distort the market's true picture.
The most important are the index options as market makers, who are generally short the options where the market is trading around, will do whatever they can to keep the market pinned. With just a slight headline bullish or bearish, they can either be massively long on the way down or short on the way up.
Such are the fun and games going into index expiration. Friday morning was a clear example, with the S&P 500 futures rallying all the way to 3140 and then rolling over down to below 3100.
The bulls and bears have been in a constant tug of war these past two weeks, shifting the cyclical-over-defensive narrative and aggressively taking the Energy, Financial and Industrial stocks on a roller coaster ride. Last week the index went all the way to 3250, rolled over down below 3000, before finding support from the gamma hedgers who drove it higher as they bought.
The bulls have to capture 3170 now to then target new highs, whereas bears need to break 3070, the key 200-day moving average, to then establish a downward momentum trend.
What has really been supporting this market?
Since the Federal Reserve announced its aggressive buying initiatives at the end of March and April, together with the endless QE that was done at a rate of $600 billion per week, the central bank's balance sheet has expanded to north of $7 trillion -- a $3.5 trillion increase in a space of three months! We are in unprecedented times when economic collapses are met with even more aggressive Fed policies to see risk assets bounce back up in a short period of time.
The weekly rate had moved down to about $50-60 billion until last week. Last week the Fed, for the first time, reduced its balance sheet by $74 billion! This is also the first time it dropped since May 2009!
It is interesting -- and perhaps no coincidence -- that the S&P 500 had its worst wobble ever last week, down 7% in a matter of days. Could it be that the Fed itself thinks that at 3200, the market is out of danger for now?
We can call this recovery whatever we want, but it is anything but V-shaped. Investors are blatantly ignoring the huge divergence between corporation's profit margins and their share prices and the sheer multiple expansion seen even on the index level for 2021.
Investing is all about risk vs. reward. The game has changed over the past decade and it has been all about the endless QE by Fed policy makers. Even when the Fed tries to stop or normalize its balance sheet, the market cannot sustain itself.
Fourth quarter 2018 is a clear example of what happened when the Fed did try to taper. Even smart money managers are now brushing aside their fundamental tools to just "trade the momentum." Right as that may be, today the Fed is not adding that much liquidity as we saw back in March. The macroeconomic headwinds that have been building up could now come to surface with the Fed's blind support.
The Fed is just buying time, with all this liquidity support, hoping that it will eventually lead to a growth rebound. But it cannot force companies to invest or consumers to spend.
Given the amount of companies now laying off people permanently, not just furloughing, and 20 million + Americans out of a job, this V-shaped recovery looks even more dubious. Anyone who says this market is up on "fundamentals" is lying to themselves.
As we start second-quarter earnings in earnest, the outlook and guidance will not be pretty. If QE has come to a pause, and stocks are back to year-to-date highs in some cases, the risk-reward is tilted to the downside.
It is best to lock in your gains, stay in cash and await a better entry point, as there will be one.