The market has enjoyed a furious run recently, but the bearish narrative is gaining traction at the same time that the market is dealing with overbought technical conditions. The market needs a rest, and there are plenty of good arguments to justify a pullback.
What has driven the market recently is belief in a Goldilocks economic scenario in which inflation is slowing but the economy remains strong and won't fall into a recession. Inflation is not too hot and growth is not too cold.
Many skeptics don't believe that the economic issues will resolve quickly or easily, but they end up fueling a vicious short squeeze. According to Goldman Sachs, this past Thursday, the day after the Fed announced its latest interest rate policy, produced the heaviest day of short-covering by its hedge fund clients in the last 10 years.
Not only have shorts been fueling the market rally, but bulls are underinvested and there is a near-record amount of cash on the sidelines. As the market has run away to the upside, many bulls have started adding exposure out of fear of being left behind.
The thing that really confounded the bears was that the market had such a positive response to the Fed decision. There was nothing very dovish about it, and it has little impact on expectations of future rate hikes.
On Friday, there was a huge upside surprise in the employment numbers. None of the forecasters were even close to predicting the number, and there even was a theory that there was some calculation error because it was so strong.
Despite the strength and the increase in the likelihood of more Fed interest rate hikes, the market held up fairly well but is seeing some pressure early here on Monday morning.
Earnings season continues this week, but most of the key names have already reported. What is particularly interesting about earnings is that they have been quite mediocre overall. According to Lisa Abramowicz of Bloomberg, "S&P companies are reporting earnings that are 0.6% above estimates, far below the five-year average of 8.6%. If that remains unchanged in the rest of the earnings season, it will mark the lowest level of profit outperformance since 2008."
The theory of some of the key bearish strategists was that these poor earnings would be the catalyst that caused the next leg down in the bear market, but it turned into a vicious bear trap instead.
The question now is whether the very compelling bearish arguments will kill the price momentum that has developed over the past month. Many bulls are celebrating improved technical conditions, but the bears are convinced that they are misreading the Fed and fail to appreciate the economic obstacles ahead.
There are at least four Fed members, including Chairman Jerome Powell, who will speak this week, so watch for headlines to impact the market action.
We are starting the week with red on the screen, but when a market is this strong there tends to be decent support for a while. If the bulls cannot bounce things quickly, the bears will ramp up the pressure.