Notable Events on our Weekly Watchlist:

Monday: N/A

Earnings: N/A

Tuesday: JOLTS Job Openings

Earnings: BBY, HPQ, BIDU, CHWY

Wednesday: EU Inflation

Earnings: PLAN, MDB, OKTA, VEEV

Thursday: Jobless Claims, ISM Manufacturing

Earnings: LULU, AVGO, SIG

Friday: Non-Farm Payrolls, Unemployment Rate

Earnings: N/A

ETFs to watch: SPY, TLT, XLK, XLY

Is the Bear Market back? Also, have you checked out our new Technical Analysis Instrument (beta)?

What goes up, must come down. It’s a simple rule of physics, one that applies to the stock market when certain deviations are extended. In the month of August we have witnessed the extremes and subsequent reversal of 2 important deviations. First, the market (SPY) got extremely deviated to the downside, below its 200-day Moving Average and saw almost a full reversal complete on August 17’th. The reversion to the 200-day Moving Average is a common technical move.

SPY then got rejected at this key level, and started another common retracement, this time to the 50-day Moving Average. From our vantage point, it is really no surprise, as just last week I penned the following:

Of course, a decline of over 6% leads financial commentators and the media in a speculation frenzy, that only adds to fuel to the selling pressure. A culprit was immediately found - Jerome Powell, at Jackson Hole, delivered a speech that was decidedly hawkish:

The market was aggressively betting on a “pivot”, and the absence of that language in Powell’s speech sparked a sharp selloff. That leads us to where we currently stand:

SPY Analysis

With an Overbought/Oversold score of 56/100 (right scale) SPY is priced in a rather neutral manner. It is currently trading below the key Lower Channel Trendline (Z-Score -1), so our algorithms will exclude equities from future allocations. Horizon will even be forced to stop-out equity risk altogether. It’s safe to say that other trend-following models are broadly acting in the same way.

Knowing this will provide us with an edge. It is the reason our real-life investments (the Sigma Portfolio) will complete equity allocations to 33% weight IF support holds at the 387 - 400 level. Even in such a case, cash will still be the top asset class by far. As I advocate, this is a juncture where being patient and following a process is key. The market will let us know which direction it’s headed, and our job is to tune out emotions and execute an investment thesis.

Of course, if support levels are breached to the downside, we will have to re-adjust to a more bearish scenario. That is why we are only setting an equity-risk target of 33% and "not “betting the farm” on any particular outcome. There are significant risks to the downside, first and foremost being liquidity.

Volume Analysis

As financial conditions tighten, there is a clear link between liquidity and volatility. As dollars leave the financial system, volatility remains on an upward path. Less liquidity in the system = higher volatility that leads to lower prices. QT kicks into high gear starting September, when the Fed will be cutting $95 billion a month from its holdings. The full impact of tightening financial conditions is yet to be felt, from a dollar volume perspective.

Yet parts of the market are doing remarkably well. Due to the market cap weighting rule and other factors, the S&P500 has become a very biased index. Mega-cap companies make up 31% of its holdings and a similar weight is dedicated to Technology names (28%). If we compare the performance of SPY with more balanced ETFs (MDY + SLY) we get a more complete comparison of the benchmark S&P500 index vs the market. And the wider market is leading this time.

Market Internals / Z-Score Comparison

On our Market Fundamentals Instrument we can easily compare the average Z-Score of the top 1000 stocks (a.k.a. “The Market”) with SPY’s Z-Score. Using the difference between the two figures, we can tease out a breadth metric. The average stock is trading in a normal regime, with a -0.6 deviation from its regression line. SPY is trading “out of bounds” with a Z-Score of -1.16; this is bullish, as the difference is positive and tells us that certain pockets of the equity universe are performing well.

Takeaway:

We will continue to give the market the benefit of doubt for now. We are aiming to complete the equity allocation in the Sigma Portfolio to 33% risk exposure. We are mindful of the fact that proper stock selection needs to be considered, as the path for equities might be VERY divergent according to their particular sector and factor. Our position sizing is conservative, as this is not the time to take any outsized bets. Stay tuned for tomorrow’s portfolio rebalance, as we shed more light on the process.

Andrei Sota