Markets are pressing higher again on Tuesday.
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Don’t Forget: The Long-term performance of the S&P 500, some longer-term setups, and 5 red flags that showed up before the 2022 bear market.
Our View
@RealTraderDave is both a friend and a fellow trader. Since we met over 7 years ago — yes Dave, 7 years ago already! — I have learned a lot about his methodology.
TD, as I call him, told me when we met, “I only trade a few times a year, I wait until my work points to a high percentage entry. That’s what he did during Brexit and many times since, including when he called last Thursday’s CPI low, (in addition to calling that low he was pushing people in the MTS chat telling people to get long when the ES was under 3520). I asked TD if he would help out with today’s Opening Print with a short interview:
We have seen a lot of big ups and downs since we met, but 2022 has been highly volatile. Do you think this is going to continue into the end of the year and into 2023?
Sure the volatility is likely going to continue, but it will likely be in both directions. The Fed is draining liquidity and thus the bid/ask spreads in most asset classes are wider than normal and moves to get a large order filled has expanded dramatically. If we do have a recession, the median bear-market correction is near -37%. If that does happen, volatility will stick around.
As you know it’s been a rough year for a lot of people that day trade futures. When we first met, you were trading the ES but now you only trade options. What pushed you to make the change?
Several things inspired me to move toward trading options. When I looked at my trades, all my big losses were related to the ES and my largest gains were trading options. But also the CBOE made some large changes this year. First, they added 8:15 PM to 9:30 AM eastern trading hours for SPX options. Now SPX options players can get in or out overnight! Then they added every Tuesday and Thursday option expirations which help “Lotto” traders who like to play on the expiration days.
You have been pushing the long side since last week, can you tell us what your work is saying and how high can the ES go?
I can’t say with certainty how high we may go, but I will say we are close to an important low if we have not already seen it. Sentiment data is showing most players have large negative bets on and are heavily invested in cash. This does not mean we are at the exact bottom, but it’s a precursor of large rallies. I have found that many important lows of historic bear markets occurred near the monthly options expiration, which occurs this Friday.
While we are on the topic, I do believe any rally that does occur will be a bear market rally. We would need to take out the August highs above 4300 to consider it anything more than that. Bear market rallies can vary from 10% to 30%, so that is a wide range. My best estimate would be a 10% to 20% rally off the lows given the current volatility reading below $40 (VIX). In the 2008 financial crisis, the VIX traded above $80 and as a result, we were able to rally 30% in the October 2008 bear market rally.
Dave, I know a lot of your work with analogs dates back to your days when you were managing $250 million for Morgan Stanley, would you mind showing us the chart you used to make the decision to go long last week?
We were down 6 days in a row heading into Thursday’s data, which was very different from the rally heading into the September 13th CPI release. Then after reviewing several important bear markets on Wednesday night, I concluded that the setup that would hurt the most players would be a sell-stop run below the previous lows at 3571 to take out the weak longs, while at the same time exhaust most sellers and short sellers if the CPI news was very bad.
I had a similar analog set up into June 26th, 2002 that showed a multi-day down run that ended on a bad news gap lower about MCI Worldcom accounting fraud news and I posted it in the MTS chat room. I was unsure if the move would be the start of a multi-day rally or a new uptrend, but it was a perfect example of how the market likes to trap and hurt the most traders.
You have been around for a lot of crashes and market declines, what do you think makes this selloff different?
There are several things that make this one different. Normally interest rates rise and initially markets rally because the economy is very strong and earnings are improving. You all know the “three steps and a stumble” saying and usually when the Fed starts raising rates the market does fine one year out.
In 2022 we started selling off three months before the first rate hike and continued lower all year. The main difference was the out-of-control inflation and a Fed that waited too long to begin raising rates.
Once they realized they were behind the inflation curve, they went on the most aggressive tightening cycle in history — and included Quantitative Tightening as well. Their stated goal was to create tighter monetary conditions, which included a lower stock market and removing the froth in the housing market. We haven’t seen this type of market since at least the early 1990s and most would even say the 1970s, so you needed to adjust your trading accordingly.
Knowing what happened in past inflation fights helped us navigate 2022 a little better. It has also been a great year for cash equivalents versus stocks and bonds. One other major difference from the 2000 and 2007 stock market bubble pops, is that the Fed had plenty of room to cushion the blow of a slowing economy via interest rate cuts and QE. They were much more concerned about deflation and thus used the “Fed Put” and “Plunge Protection Team” to defend the market.
This time around, the Fed is NOT your friend — it’s the enemy.
Our Lean — Dave’s Take
Dave:
Looking at the current market, today is a pivotal day. My work shows that the direction of today’s close could dictate the next several days of trading. If it is up, we likely keep rallying late into the week.
However, if we sell off on Tuesday, another test of the lows may be in store. We are kind of in no man’s land in terms of price and time, so I will let the market tell me its direction.
Technical Edge
- NYSE Breadth: 92.5% Upside Volume
- Advance/Decline: 83% Advance
- VIX: ~$31
Game Plan: S&P 500
Traders are starting to wonder about the validity of a low being in. That’s after Thursday’s bullish reversal, (and despite Friday’s setback), Monday’s big rally on strong breadth, and now (potentially) Tuesday’s follow-through with the S&P futures up almost 2% at 8:00 a.m. ET.
The markets are climbing notably this morning, but bonds and the dollar are not really moving.
I am keeping today’s portion quite short.
S&P 500 — ES
The ES cleared short-term resistance and got to our 3710 to 3725 target. Now trading 3750+ bulls need to see 3685 hold as support. On the upside, 3800 to 3820 is in play if bulls maintain momentum.
The problem though? We’re coming into the day up 80 handles. That’s tough to navigate from a trader’s perspective.
That 3800 to 3820 was resistance earlier this month, but it’s also where the 10-week moving average comes into play:
Above the 10-week could open the door toward 3915 — which is the 50% retracement of the current down leg, the 21-week moving average, and a prior support level. (It stands out on the daily chart as well).
The weekly setup looks rather constructive if I’m being honest. A 5-wave move down to the 200-week moving average, 50% retracement, and the prior breakout area. As you know, I have wanted a test of this area for some time. I wasn’t sure what the reaction to this area would be, but so far, I like it.
S&P 500 — SPY
Intermediate-term bulls need to see the SPY build above $370. On the upside, $374 to $378 is a key area. It’s where the SPY stalled earlier this month and it’s where the declining 10-month moving average comes into play.
One can see how ~$390 could be on the table if it resolves through this area.
Assuming we open notably higher this morning, be leery of a test of the 10-week, near $376.50 to $377. The first test could be a reactionary sell.
Go-To Watchlist
*Feel free to build your own trades off these relative strength leaders*
- Numbered are the ones I’m watching most closely.
- Bold are the trades with recent updates.
- Italics show means the trade is closed.
Notes:
- FSLR — Not great price action yesterday, but closed well. We’ve got one trim already. If you’re still in (or just got in), Thursday’s low (~$120.50) is a good stop (unless you are still going with a B/E stop, then that’s fine too.
- XLE — Down to ⅓ to ½. $87 to $87.50 could be next up as we go monthly-up. B/E stop now.
Relative strength leaders →
Top:
- LNG — nearing the breakout near $150
- MCK — Stopped earlier but still holding the breakout near $340
- CAH
- LPLA
- CCRN
- FSLR
- REGN
- ALB
- VRTX
- CYTK
Economic Calendar
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