Breaking News: Stock Market Sell-Off Raises Questions about Future Trajectory
In a sudden and unexpected move, global markets experienced a dramatic sell-off yesterday, leaving many traders and investors scrambling to understand the motivations behind this violent move. While some may attribute it to the natural ebb and flow of seasonal patterns, we delve deeper into the market dynamics, potential scenarios for September and October, and offer insights on why the top may not yet be in for 2024.
Seasonality or Something More?
At first glance, yesterday’s market sell-off may appear to be driven by typical end-of-quarter jitters and the approach of summer holidays. However, we argue that there are other underlying factors at play, which warrant a closer examination. As the market grapples with ongoing global concerns, from inflation and interest rates to the specter of a recession, a more nuanced analysis is needed to unravel the intricacies of the situation.
The Current Market Environment: A Delicate Balance
The recent performance of major indices, such as the S&P 500, has been characterized by an uneasy coexistence between strong economic data and nagging concerns about the impact of monetary policy tightening on the broader economy. Yesterday’s sell-off served as a stark reminder of the inherent volatility of financial markets and the risks involved with over- or under-allocating assets.
Scenario Analysis for September and October
Based on historical trends and current market sentiment, we are considering three possible scenarios for the next two months:
- Consolidation: Following yesterday’s dramatic correction, the market may be poised for a period of consolidation, with traders re-entering positions after digesting the sell-off and recalibrating their portfolios for the potential implications of an impending rate hike.
- Mean Reversion: In the aftermath of the correction, there may be an opportunity for markets to bounce back and correct the extreme levels of recent weeks. This would be driven by a resumption of positive fundamentals and an increase in investor risk tolerance.
- Extended Correction: A deeper examination of technical and fundamental factors suggests the possibility of a more significant and potentially long-term correction, which would be influenced by an increased likelihood of recession and reduced investor appetite for risk assets.
Why the Top May Not Yet be in for 2024
While it is challenging to predict with certainty the exact trajectory of markets over the coming months, several key factors may suggest that the top has not yet been reached for 2024:
- Valuation: Many major indices still trade at historically elevated valuations, providing an initial buffer against a full-scale correction.
- Earnings: Upbeat earnings growth has thus far helped prop up investor sentiment, even in the face of declining GDP estimates and inflationary pressures.
- Monetary Policy: While interest rates have risen significantly, they still remain historically low, allowing for a potential increase in borrowing costs and continued monetary accommodation.
- Geopolitical Uncertainties: Global political and economic concerns continue to simmer, posing risks to markets and fostering uncertainty that can drive sentiment.
As markets navigate these complexities, investors would do well to stay informed, adaptable, and vigilant. Yesterday’s sudden sell-off serves as a poignant reminder of the inherent risks involved with market participation and the importance of prudent risk management strategies.
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Keyword Tags: Breaking news, stock market, sell-off, September, October, 2024, financial markets, economic concerns, interest rates, recession, inflation, market volatility, risk management, monetary policy, earnings growth, valuations, geopolitics.
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Befvore i get into it, I realise I have 15k people following my profile. And for my subreddit, r/tradingedge there is 23k. I post every day without fail to the subreddit, but not so much to my profile of late. So if the 15k people who follow my profile are not seeing my posts and want to, please make sure you join my subreddit r/tradingedge. That's where all the actions been happening of late.
Now, we went into the weekend with positioning looking quite rosy in markets.
It was more sketchy in tech, that much is true, but I noted that in the sub. Nonetheless, SPY, DIA, and even IWM were looking very strong, particularly so for DIA.
Skew was pulling back, which in hindsight may have been a signal, but its been pulling back for some time, whilst price was flat or moving higher, as we see below, so this was a hard signal in hindsight to call.
QQQ had just put in a hammer candlestick, holding the trendline on Friday. This is a bullihs technical set up.
VIX shwoed that we had vol sellers on the positioning, which was likely to keep VIX surpressed.
So all of this tells us that traders were basically caught out by yesterdays sell off.
There is some seasonal risks that traders can point to as causing teh sell off, but we see here that the seasonal risk generally comes from 18th onwards. Before then, we are pretty neutral. Now it is possible that traders were front running this seasonality, but that isnt really the whole picture.
So then, What caused it?
Well, the first worrying sign came in overnight ASian session, with the following news. "BOJ Governor Ueda
submits document to a government panel suggesting that the central bank will continue to raise interest rates if the economy and prices perform as expected by the BOJ."
This all points to a stronger JPY, as was a hawkish message. This initially sent USDJPY down by 1% overnight, and sent VIX higher.
We must remember that USDJPY has a direct relationship with technology comapnies in US. We saw this relationship come to the fore at the peak fo that carry trade stuff last month.
Here we see it again.
We saw the relationship break down a bit after 12th f August, and that is because most of the carry trades which causes this correlation had been liquidated.
But we see from this bloomberg article, that whilst a lot of carry trades got wiped out from August 5th, traders are back putting the carry trade on again.
This means that the relationship becomes more into focus. This news overnight set Tech off to a bad start and was a contributing factor.
Then the ISM data we got at 10am really was the killer for creating the sell off.
We saw that on the headline number, manufacturing ISM missed expectations, in a deeper decline than expected, whilst ISM prices rose.
This on the surface, points to a weaker economy, with higher prices. Pretty bad.
Traders for some time now have been trying to work out whether the economy will be entering into a recession or not. As scuh, reactions to waht can be cosnidered MEDIUM weight data, like ISM, PMI, Initial jobless claims, has been exaggerated.
Why do traders care so much about whtehr we have a recession or not? Well, mostly becuase rate cuts are coming. Whether rate cuts are bullish or bearish for the market as we look out 3m, 6m and 12m depends a lot on whether we are in a recession or not.
We see evidence of that here:
In a recession = bad, not in a recession = v good.
The difference is so stark. Its not small, which means that traders are v keen to get ahead of this. So when we get data that points us more towards one side, the market reaciton is highly exaxggerated.
This is what initially caused a strong market reaction.
Then things got exaccerbated basically, because not long after market open, with the combination of both points above, we saw the amrket drop below 5595. That is the level that separates positive gamma and negative gamma. As such, we moved into negative gamma. With that, volatility basically increases. In both directions, but generally it is to the downside. This is because MMs begin to hedge in the direciton of price action, basically exaccerbating it. This created the added volatility.
Then we also saw VIX rise as a result of the data, which had MMs further hedging short on equities in order to balance their exposure. Additionally, vol control funds sold as a result, which also put pressure on equtiies.
The result? This big sell off yday.
So what's the deal going forward?
Now I was always of the camp that we see a push to ATH in early september, as I mentioned for some time in this sub. I then saw that we see seasonal correction from September to October (which is furhter pressured by the fact that immediate reaction to rate cuts tends to be negative for teh first month), before end of year rally.
Why do I see this seasnal effect? Well, even outside of election years, we see that back end of september tends to be tough. You can search this in the sub and see many posts Ive made on it.
Then pair that with an election year, we see that that september correction is evne more obvious.
Then furthermore we must rememebr we have rate cuts coming on September 18th. We see from the above image, that the forward return after 1 month, regardless of what economic scenario we cut into, tends to often be negative.
This again aligns with the fact that we see markets pressured into mid October.
My suggestion was that that comes from mid september as is usaully the case, as data suggested that market continued bullish push until OPEX, which is also in mid spetmeber, which is also the time of the rate cuts. The timeline seemed to align for that to be the case.
But i also noted in premarket yesterday that it would not be totally surprising to see some front running of this seasonal effect if we see loss of momentum in the market from the data.
This is ebcause this week is a major data packed week. And as I mentioned above, traders are sensitive rn to data releases. So if data does not support, we can see some sell off in early september, then we get the usualc orrection from mid september, and the result is a correction throughout all of september.
This is data dependent, that's the thing, so i cannot really call it with certainty. It's my base case that we see a correction in september through to Ocotber. It was my base case that we see that from Mid September. Yesterday's sell off has worsened positioning in the market though, and has increased the chance that traders try to front run the september correction.
Here we see QQQ positioning:
A lot of ITM puts that will have MMs curbing upside, whilst OTM puts grow as traders bet on more downside.
Similar picture in SPY.
Now as I mentioned, thingsd are data dependent this week. With the right data release, for instance from NFP, we can see a squeeze of this bearish positioning, to send us back to 5650, but since we cannot predict the data, we must say that the base case is that markets remain pressured throughout september.
As such, traders should exercise caution in Sptember. My downside target for SPX is below 5360 by october. WE can see as low as 5200. As such, traders should buy slowly IMO, and should not jump the gun to buy on the first day. The probabilities are overwehelmingly in the favour of the fact that evne if we see small bouncs ehre and there, markets WILL remain pressured through october.
However, it's not all doom and gloom, and that much is definitely true. Data overwhemingly points to the fact that we have NOT SEEN THE TOP THIS YEAR.
Economic data is actually stronger than most think, under the hood. I pointed this out in a few macro posts this morning.
BUt the data does suggest that we have a strong last couple of months to the year.
We reach this conclusion from looking at a number of studies.
First, let's talk about the fact that rate cuts are coming in Sptember, and the fact that We are likely cutting into the soft landing scenario.
Well, a look at the true historical data, which is shwon below, shows that forward 6 months returns are ALWAYS higher in this scenario, with average of 9.5% higher. Now we cannot predict where we will be in mid September, but say we are at 5400, that puts us at 5900 by March next year.
Then we look at the next instance:
Last month we saw a massive and rapid incrfease in breadth in the market. THis is known as a breadth trhust. It also set off a breadth thrust bullish signal to the amrket ono 15th of august, as over the last 5 sessions, the % or SPX tech sectors stocks abvoe teh 10DMA went from 10% to 90%, which triggered this breadth thrust signal. And with this signal, Forward returns are strong. After 6 months, market tends to be trading up by 5% on average, up in 80% of cases.
In this instance, SPX should be trading at 5850 by March 2025.
Again, another sign that the top isn't in.
Here is one of the strongest signals IMO.
Well, this year, 7 of the first 8 months have been green. That is rare, and has happened 12 times since 1954. In only 1 of those cases, have we seen SPX finish the rest of the year down from the close of the 8th month. That means that we are talking about a 91% cahnce that we trade above 5650 by end of the year.
But it's better than that. The average return in these previous 12 instnces, as a gain of 5% from the close of August 2024. This has SPX trading at 5800 by YEAR END.
I gave you on the weekend a study on forward returns from strong global breadth as we are seeing now too.
So the result of this study was SPX trading at around 5875 by March 2025.
In all of these instnces then, we see that the probabilities are in our favour that we close the year STRONGLy.
Then furthermore, I refer you finally to the seasonality chart I showed you before for the election years. Do you see that massive run up to close the year 2% above the August close. That also suggests we havent reached the top this year.
SO THE CONCLUSION OF ALL OF THIS IS THAT WE LIKELY SEE SOME ROCKINESS IN SEPTEMBER AND INTO OCTOBER. THE EXACT TIMING OF THE START OF THIS ROCKINESS IS UNCLEAR AS DEPENDS ON DATA IN NEAR TERM. BUT THIS ROCKINESS WILL NOT MARK THAT THE TOP OF SPX IS IN, MOST LIKELY. INSTEAD, IT WILL BE A GOOD OPPORTUNITY TO BUY FOR STRENGTH INTO YEAR END. MY SUGGESTION WOULD BE TO BUY SPXL, TO AVOID THE RISK OF BUYING SECTORS WHICH LAG THE MARKET. BUY SLOWLY, BUT DO BUY THIS DIP IMO.
IF YOU ARE BUYING BEFORE MID SEPTEMBER, LOOK FOR SMALLER GAINS AND TAKE PROFITS FASTER. THAT WILL PROTECT U FROM GETTING CAUGHT UP IN SEASONAL SELL OFF THAT IS LIKELY TO COME LATER. E.g if you buy NVDa at 105, look to tke profit at 110, not just hold, unless ur strategy is long term. BEST ALSO TO PLAY CATALYSTS. EG IF YOU SEE NFP COME STRONG, AND POINT TO SOFT LANDING, WE CAN EXPECT A SMALL PUSH IN MARKETS. BUT IT WONT LAST. SO BUY THAT DAY, AND LOOK TO GET OUT BEFORE PRESSURE COTNINUES.
As mentioned, please make sure you join my subreddit r/tradingedge. That's where all the actions been happening of late.
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Great take as always!
It’s turning now, I’m in USO which is oil no way it doesn’t go back up in my opinion.
Legend
Day: 3
Planet: The Dip Moon
Captain’s note: We’ve touched down on the wrong moon, lads! I’m holding bags so heavy that my strength is waning… Once we locate our wayward rocket, we’ll stow our bags aboard and set our course anew. Onward, my brave comrades – we shall conquer this misstep and sail to our true destiny!
Hindsight is 20/20