Needless to say, you probably shouldn’t trust Wednesday’s monumental rally in U.S. equities.
That’s not an attempt to throw cold water on the best session since 2009 as much as it is a realistic assessment of the current environment.
There’s nothing “normal” about what transpired on Wednesday and the fact that a 5% rally played out on a day when the Richmond Fed collapsed the most on record speaks volumes about the extent to which the market is marching to the beat of its own drum. It’s ironic, too, because the narrative over the last three or four weeks has revolved around the idea that the selloff is overshooting economic fundamentals and Wednesday was the exact opposite of that – the Dow surged 1,100 points while the shipping subcomponent in the Richmond survey plunged to its lowest in nearly a decade.
It’s also interesting to ponder the prospect that investors might have written off the “Fed put” at the exact moment it went into the money. We talked about that at length on Wednesday morning.
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Premature ‘Fed Put’ Obituaries And The Laughable Perils Of Q1 2019
Common sense dictates that trying to get a “clean” read on things during the trading days between Christmas and New Year’s is an exercise in futility. Additionally, it seems entirely likely that some folks were forced buyers into the close on Wednesday, supercharging the rally.
In any case, we wanted to highlight a couple of excerpts from the latest note by Goldman’s Rocky Fishman. Long story short, there’s good news and there’s bad news.
The bad news is that liquidity continues to be abysmal. “Although high volatility and the holiday season are contributing factors, SPX E-mini future top-of-book depth has continued to weaken”, Fishman writes, adding that on Goldman’s estimates, “the median bid/ask depth of the front-month E-mini SPX future was $1.7mm notional on Monday, 24-Dec, [just] around 1/4 of the $6.7mm on 23-Nov, the last holiday-season short session.”
He also observes that “Friday’s SPX futures/options settlement, had one of the larger gaps between the settlement value and front-month futures prices in recent years.” Here’s an updated visual from CME’s E-mini liquidity tool:
(CME)
The good news from Fishman is that a close historical parallel to the current environment suggests stocks could rally and volatility could come back in sharply.
“The contrast between Q3’s 6.5% realized vol and Q4’s sell-off is similar only to the contrast between 1962’s Q1 (7.4% RV) and Q2 (-21% return)”, he writes, on the way to noting that “although vol remained slightly elevated as the market rallied in the remainder of 1962, the SPX followed Q2 with eleven consecutive up-quarters, six of which remain the least volatile quarters in the index’s history.”
Anything’s possible, I guess. Although since the S&P technically skirted a bear market with Wednesday’s surge, a repeat of the 1962 experience that sees the index rally for another eleven quarters suggests that by the time this bull finally dies, some of the traders who started their careers just after the crisis will be pushing 40, a hilarious prospect that speaks to, well, it speaks to a lot of things.
Anyway, Goldman also notes that the S&P’s Q4 return is among the worst ever.” Specifically, it’s in the 3rd percentile since 1929.
(Goldman)
We’re gonna need more Wednesdays.
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You have to put “bad news bulls” on the table speculating that the FED must be done, based on their own numbers (look at crude also). Then you have the fact that bear market rallies are very strong…..
This market is crazy. Seems like folks (computers) were offsides on expiration, hedged into Friday and Monday and then got caught. Does anyone really think Powell is safe because Kevin said so? No one that has paid attention does. Did fundy guys chase today? Doubt it but with y/e never know. I think we try to make sense of the senseless too much, whether it is Trump or trading. Today is one of those days (like many this month) where one just says “ok, tomorrow is a new day and literally anything can happen”. The market looks more and more like it is uninvestable. A fed remark could cause it to rally hard or sell off hard (as things and people chase), a tweet, a “we’ll see”, a crazy comment, a policy out of left field, a firing, an impeachment, a return to normal order, a backing off a trade war, an escalation of a trade war and on and on. Anyone says they are confident in what is coming is either a liar or a fool. Excluding Trump who is both.
Friday’s SPX futures/options settlement large gap was likely due to the fact that on Thursday futures surged 1% in the last 20 minutes of trading. Only 5m with stocks trading, a mismatch of 0.8% between futures and stocks was created.
The settlement price of the index is not calculated using futures. A special opening quotation system is used. Instead of calculating the index from futures, the index is calculated using such special opening quotation for stocks.
I had noticed analogies between this 2018 correction and the 1962 bear market (also tweeted).
From a 50 pages report I had read in February after the sudden drop, concerning the 1962 bear market, I took note of this sentence: “Just as the break …was unusual and generally unexpected, the pace of the subsequent price recovery was equally unusual.”
This correction started when bond yields went to 3.25%, and some labour data were released. Initially it was an inflation concern. After a few weeks, likely taking cue mainly from oil prices dropping (due to a whole range of factors were fundamentals were only a part, see Kashoggi/Iran), it turned into an almost recession narrative. The market overshot higher in summer ignoring Chinese data and rest of the world, but later it also overshot down. Lack of liquidity, technical trading (levels broken and trend following), gamma, noise trading mistakenly taken as fundamental info snowballed all together and created this absurd quarter.
It could affect expectations, and turn into a real economy mess.
Maybe to see that consumers spent and weren’t hindered by the stock market fall was a trigger, who knows.
At 2600-50 spx may stabilize and range trade for a while. The right balance between expectations, China, macrodata, QT, and positive corporate earnings in a framework of slower growth.
All of the regional surveys have been slumping. There will be some serious gnashing of teeth if PMI goes south.
Franceska–thank you for your comments and insight. Makes sense what you are saying. I hope we get to 2600 as it seems like that will be strong resistance.
The market is grasping for air like a person drowning. There appears to be some gulps of air but the air is running tight. Absent a life saver, the last gulp of air is coming soon.