The S&P 500 has been stuck in a 100-point range for the past month. It seems like it can't decide between breaking 2800 to the downside and 2900 to the upside.
There is a big tug of war between the bulls and the bears causing the index to be stuck in this triangle-wedge pattern. The bull's case rests solely on the fact that the Fed will never disappoint us and we need to buy every dip, because that is what has happened over the past 12 years; it's no fundamental or logical answer. The bear's case is one built up entirely of facts, figures, and rational conclusions. The bulls here have proven to be useless adversaries, from an intellectual point of view. But they have been proven right as the momentum has been in their favor.
Just to set the record straight, it is not the rally or bounce from March that is debated, but the extent of the rally and risk-reward looking dubious today. There will be a moment of reckoning. Both bears and bulls can be proven right, it just depends on their investment horizon. The debate is, do we add to equities today, now, at these levels?
When one looks at the S&P 500, about 22% of its market cap is made up of the Top 5 technology stocks, Apple (AAPL) , Microsoft (MSFT) , Amazon (AMZN) , Alphabet (GOOGL) , and Facebook (FB) . The more equal weighted index of the same S&P 500 constituents shows an entirely different picture of performance. Just looking at the index level can be misleading. Even filtering through to the sectors, the only sectors that are outperforming are technology, health care, and utilities. This sector leadership is not synonymous with a "healthy" market. If there was indeed a recovery, sectors such as energy, mining, financials, and industrials would be the ones holding the baton. Also looking across at what the bond market, rates market, and commodities in general are saying about the global economy speaks of deflation, not a recovery. So, who is wrong?
Looking across at what the bond market, rates market, and commodities in general are saying about the global economy speaks of deflation, not a recovery.
The problem is investors do not want to hold cash as they realize most central banks are deflating away all fiat currency by printing endless amounts of money. When you have a Fed that has veered away from the usual playbook, buying corporate bonds and junk bonds, even, it is easy to not give into that mentality. Technology companies have a lot of cash, and are borrowing even more, thanks to the Fed's zero interest rates, to then buy back their own stock, inflating earnings even more. It is a vicious cycle. It seems even the Swiss National bank, according to its latest filing, showed that it increased its weighting in these technology stocks. The leadership is very limited and momentum is losing strength here. There are some macro proprietary indicators screaming sell signals not seen in the last 20 years, that have predicted big declines to follow in equity markets.
The Fed has eased off on its treasury and mortgage-backed securities purchases in May from a run rate of about $600 billion a week to now only $20 billion a week. The Treasury is also issuing massive amounts of debt in May to pay for the coronavirus stimulus bill. The bond market has seen yields rise over the past week, this is a bear steeping as is not indicative of a "growth" or "recovery" trade. There is just too much supply, and bond yields are ticking higher as demand wanes at these levels. All this combined points to a lower, not higher market. So, what is holding it back.
The May S&P 500 options expiration is this Friday. There is about $1.32 billion in open interest on the 2900 strike, $1.48 billion on the 2950 strike, and $1.28 billion on the 2850 strike. But the 3000 strike has a sizable open interest of $2.25 billion. According to the famous Charlie McElligot of Nomura, the "net delta" position in the Nasdaq is extremely long at $11.5 billion, which is in the 97th percentile since 2014. Historically post expiration, that has been followed by negative price returns the following month and three months. This is ominous, as at time when every retail investor and trader is chasing the same basket of names higher, we may be coming to a technical point where the market loses its support.
This is ominous: At a time when every retail investor and trader is chasing the same basket of names higher, we may be coming to a technical point where the market loses its support.
Options expiration are vital to how the broader index trades. Most investors do not give it much credit, but it is a big part of the market especially when so many institutions, funds, and counter parties hold the S&P 500 as a hedge against their portfolio. The technical set up can delay the real picture of the market for quite a few weeks as the traders manage their risk going into the event. We have seen the worst of the lockdown impact as economies are slowly reopening. But we now need to deal with the economic damage, and there are limited signs of a "V"-shaped recovery. The risk-reward looks skewed to the downside. As they say, better to be flat and right, than be long and wrong.