Last week, we reviewed Marko Kolanovic’s research showing the positioning of hedge funds and systematic traders. The bottom line here is the equity exposure of these managers continues to be at very low levels relative to history. But with the stock market indices a chip shot away from all-time highs, the question is why are these traders so underexposed to the big rebound in stocks?
Based on the relentless rise in the major stock market indices, another question worth pondering is why trading volume has become so thin lately. According to the WSJ, only 6.2 billion shares traded hands daily last week on the Nasdaq and NYSE, which is the lowest weekly average seen in more than seven months.
Some argue that investor anxiety is to blame on both fronts. Uncertainty about a tenuous economic backdrop, trade talks, earnings, mutual fund outflows, and the political landscape could be causing some angst – and keeping investors from chasing the current run for the roses.
A third reason that investors may be exhibiting some caution here is the current state of the charts. In short, after a very rare and very perfect “V” bottom, the major indices are now bumping into what technicians tell us will be an important (as in, very important) resistance zone. As such, we should expect, at the very least, a pause in the action as traders “test” this area of resistance.
S&P 500 – Weekly
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But hasn’t it been the “expectations” of what will come next in Ms. Market’s game that is really behind the hedgies being on the wrong side of the trade? Hasn’t it been “prudent” to be cautious since December 24th? And hasn’t the market made a mockery of both ideas for the past 4 months – and past 560 S&P points?
The “Retest” Was A Lock
Lest we forget, when markets fall 20% in short order there is usually a reason. In this case, it was the triumvirate of slowing global growth and fears of policy missteps by both the Fed (raising rates too far) and the administration (engaging in a prolonged trade war) that caused traders to hit the sell button early and often in the fourth quarter of last year.
It is also worth noting that the vast majority of the downside debacle occurred in rapid fashion between 12/3 and 12/24. Recall that the S&P 500 plunged -15.9% during that 13.5 day stretch. Thus, to those keeping track of such things, the move qualified as a “waterfall decline.”
Every manager who has been around awhile knows that when a market experiences a “waterfall decline,” the trading tends to follow a familiar pattern in the coming months. As the “crash playbook” tells us, first there is a bounce of the dead cat variety, then a retest of the lows (which can take many forms), a basing period (to make sure the worst is over), and finally, a resumption of the uptrend.
Therefore, just about everybody in the game has been looking for a retest phase since about mid-January. The reason that retests occur is rooted in psychology and human emotion. You see, usually, the initial reason for the big decline rears its ugly head again at least a time or two in the months following an emotional low. And when it does, the selling tends to resume – at least for a while. Sometimes, the lows are tested. Sometimes, they break. Oftentimes they don’t. But at the very least, stocks usually pull back as some fear returns for a spell.
Until It Wasn’t
But this time around, the crash playbook turned out to be useless. The market’s problems were cured tout suite as the Fed caved and the administration figured out that they’d best get a trade deal done – now. Thus, there has been no retest. There has been no resurrection of the reasons for the decline. No, now it’s all about future expectations and brighter days.
So, I get it. The correction has now been corrected and prices are back to where they were before the dance to the downside began. Yet at the same time, even the most ardent bulls will admit that the current pace of advance is unsustainable.
So, at some point, the current rally will pause (during the “Sell in May” period, perhaps?). At some point, stocks will pull back a bit (and perhaps test the seemingly all-important 200-day moving average?). And at some point, an entry point that so many have been looking for in 2019 will appear.
However, given the strength of the move and the readings seen on our Fundamental Factors board, I’m of the mind that any pause in the action, any pullback, or any “testing” will prove temporary as all the underinvested folks decide that new highs will be their “sign” to get back in the game.
Thought For The Day:
The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails. – William Arthur Ward
Wishing you green screens and all the best for a great day,
David D. Moenning