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Again, there are too many bears

Similar to the markets position in June, we are again reaching a point where this sell off may have gotten a bit long in the tooth, with multiple market indicators suggesting another one bear market rally may be ahead. Namely, bearish sentiment and market positioning have again reached levels where further downside seems unlikely in the near term despite the fundamental and macro arguments for such an outcome.

From a technical standpoint, since the outright rejection of the 200-day moving average that ended stocks’ summer rally, the new bear market has seen stocks trade back to June lows. , with this zone around 3,650 for the S&P 500. Encouragingly, this support zone has held up so far and has been accompanied by a DeMark 9 sequential buy signal and perhaps a slight positive momentum divergence from the RSI.

Chart: 200-Day Moving Average - The renewed bear market has seen stocks trade back to June lows, with that area around 3,650 for the S&P 500.

The same can be said of the Nasdaq. This test of horizontal support seems like a great starting point for a much-needed countertrend rally into an oversold stock market.

Chart: Nasdaq horizontal support looks like a great starting point for a much-needed countertrend rally into an oversold stock market

While the technical picture is nothing out of the ordinary, from a risk appetite, positioning and sentiment perspective, a countertrend move seems warranted. Indeed, several measures of investors’ risk appetite are perhaps the most strongly of this view.

More noticeably than what happened during the June lows, this recent decline in equities has now resulted in significant positive divergences in bond markets’ risk appetite, the ratio of high beta equities to equities at low beta and that of cyclical stocks on defensive values. Generally, when measurements of internal market elements such as these diverge in such a way that the price action of the overall index, it does a good job of predicting what may happen.

chart: counter-trend movements

Likewise, when we compare the price action of the S&P 500 to junk bonds (via HYG), the latter does a decent job of leading the former in the short term to local highs and lows. This week’s price action has seen junk bonds diverge positively from equities in a way that suggests selling can be done for now.

Chart: This week's price action has seen junk bonds diverge positively from equities in a way that suggests selling can be done for now.

In the same way that risk appetites are sending a seemingly bullish signal, positive divergences are also starting to appear in several of the measures of market breadth that I watch. Notably, the percentage of stocks trading above their 50-day moving averages again hit single-digit levels, suggesting that a near-term bottom may be near.

Chart: The percentage of stocks trading above their 50-day moving averages has once again hit single-digit levels

Additionally, the VIX futures structure and the VIX itself appear to deviate positively from price, another indicator with a reliable ability to predict future price action.

graphic: the term structure of the VIX and the VIX itself seem to deviate positively from the price

From a sentiment and positioning perspective, in almost every way investors are bearish and shorting the market (which I’m sure is not news to you, dear reader). Indeed, the combined speculative positioning on the various equity futures markets is max-short. While this has been the case for much of 2022, at least some level of short position coverage appears to be a requirement before we see stocks continue to decline, as fundamentals and macro conditions tell.

Chart: By almost any metric, investors are bearish and shorting the market

One asset class that would lend credence to the idea of ​​another short-hedging rally is a pullback in yields. The new highs across the Treasury curve are due to poor liquidity in the rates market as well as structural issues caused by Fed tightening, dollar strength and persistent inflation.

Such dynamics may be causing rates to not act as they should, or at least not as they have lately given the macro outlook. However, it should be noted that the new 10-year highs were not confirmed by new momentum highs (measured here via price against the 50-day moving average).

Similar to stocks, bond selling looks oversold (overbought yields) and deserves a break. A pullback in yields looks plausible from here, if only temporarily.

chart: new 10-year highs have not been confirmed by new highs in momentum

Indeed, returns can only deviate from fundamentals for so long.

Chart: Returns can only deviate from fundamentals for so long.

Another would be the dollar. Like yields, the dollar also appears to need a pullback or at the very least a consolidation of recent gains.

Chart: Like yields, the dollar also appears to need a pullback

While I expect the strength to continue and any correction to be short-lived for now, given the negative correlation of nearly all asset classes to the dollar in recent months, a correction would certainly provide some relief not only to equities, but also to precious metals and commodities.

Chart: A correction would certainly bring some relief not only to equities, but also to precious metals and commodities.

However, it is important to consider a few non-fundamental headwinds that stocks will face in the coming weeks that run counter to what I have expressed here. First, the next 10 trading days tend to be one of the worst times for stocks on a seasonal basis, as we can see below. Although seasonality should only be a small part of a person’s business decisions, it Is question and is a noteworthy consideration.

graph: seasonality of the S&P 500

And second, the rollover of JP Morgan’s equity hedge is expected to take place at the end of the month, which Tier1 Alpha predicts should see a $12 billion equity futures sell-off on Friday. Thus, we may go lower before we go higher (if at all).



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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.