Weekly Preview / July 18
Notable Events on our Weekly Watchlist:
Monday: NA
Earnings: BAC, SCHW, GS,
Tuesday: Building Permits;
Earnings: NFLX, JNJ, HAL, IBKR, LMT
Wednesday: Existing Home Sales
Earnings: ABT, ASML, CSX, KMI, UAL
Thursday: ECB Intrest Rate Decision;
Earnings: ABB, AAL, AN, ISRG, NUE, PM, SAP,
Friday: NA
Earnings: TWTR
ETFs to watch: XLF, XLE, XTN
Inflation came in hot last week, above economist’s estimates, at 9.1%, marking the largest gain since the end of 1981. Initially, risk assets fell sharply on the news and a 100bps July rate hike became 80% implied by the Fed Fund futures market. FOMC voting members Waller and Bullard poured cold water on the notion that the Fed would hike by a full percentage point, and instead suggested 75bps back to back hikes are the optimal approach. This gave the markets reason to rally, with the S&P500 closing up by 3.69% from Thursday’s lows to Friday’s close. On the week, the overall market made little progress, declining by 0.30%. Yet the fact that minor support held, gave bulls some impetus coming into this earnings heavy week. Also helping the bullish narrative is the extreme short positioning of professional investors. The ECB is also widely expected to raise rates by 25bps, but focus will fall on forward guidance, rather than the decision itself. On the earnings front, we are watching Netflix and ASML as far as market reaction is concerned.
With the setup coming into this week covered, let’s take a look at major markets and internals in order to understand where the optimal positioning lies.
SPY Analysis
As noted in the intro, SPY held minor support. The absence of bad news is good news, and the S&P500 finds itself on a short term buy-signal, not overbought, and ripe for a short-squeeze. Algos will start to chase on a breach of 3900 and bid the market further. The potential upside move can take the index up to 4100, where heavy resistance will come into play. As stated at the start of the week, that is the region where we will initiate net-short positioning. For now, this looks like a sellable rally, for reasons outlined below.
Market Dollar Volume Analysis
Transaction Dollar Volume remains unusually weak at the moment. A sustained advance needs conviction from buyers, which gets translated into higher than average volumes on our instrument. This is not the case now. Lower volatility is welcomed, but we view it as an opportunity to get long vol at this stage.
Market Breadth Analysis
We are focusing on the Market Internals > Overbought/Oversold instrument as it has been the best at calling out significant pivot points in the market. On this front, we observe a relatively high reading, within an established negative trend. This technique indicates that fading the rally is the best positioning medium term. After all, the Fed is desperately trying to raise rates in order to “gather ammo” for when more accommodative policy is required. This effectively creates an environment where the Fed is selling calls on the market, thus limiting any potential advance. Counter-trend trading, as suggested by our instrument makes sense from this perspective.
Aggregate US Equity futures positioning, Asset Managers + Levered Funds
Extreme bearish positioning could add fuel to a short term rally in equities.
XLE Analysis
We are continuing to focus on XLE in our Weekly Preview article because it is one of the only two sectors of the equity market with positive 6 month returns. XLE has broken our designated support level and we are looking for a potential retest before making any adjustments to positioning. The market is digesting the impact from higher energy prices and to what extent commodity values are sustainable long term. We like energy companies at these levels, but must honor technical levels in the interim.
Takeaway:
Equities have the “wind in the sails” at the moment. The market doesn’t crash when everybody expects it to. Several factors are favoring short term bullish price action, but we think this will be short lived. The overall environment is challenging, we are expecting downside revisions to earnings, and the Fed is still on a hawkish track in the fight against inflation. The US Dollar’s blistering rally is overextended at the moment, but we still expect it to be the top asset class chosen by our systems. TLT is offering a much better risk-reward ratio at current levels, and we will continue to add to this position instead, using any weakness that does not violate support.
Andrei Sota