Rotation Trade Underway. Looming Liquidity Crunch Risk Exists

One of our favorite trading rules is in play

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Our View

When will the stock market sell off again? Well there are a few major events coming up that could change the tide.

This Fry-day’s option expiration is one, but next week is a quadruple header. Now that President Biden has secured his budget funding, the Administration has ordered the US Treasury to offer up to $1 trillion in new bonds to quickly refill its coffers. This in itself will cause a liquidity problem. I think at least part of the recent weakness is tied to this.

Next week, Tuesday is the dreaded CPI number and the first day of the Fed’s two-day meeting. Wednesday is the PPI number and the Fed’s rate decision and FRY-day is the all important June Triple Witching.

In a nutshell, there is an overload of economic and headline activity coming next week.

Our Lean

I can’t describe the feeling I have when I look at the ES and NQ. I know they are caught in a big slow grind higher, but both indexes are “stretched out.” We are not here to fight city hall, but next week could see a big uptick volatility.

As for today, I remain a pessimistic bull. The markets have fallen into the pattern of small pullbacks followed by a pop. Yesterday’s weakness in the NQ clearly weighed on the ES as part of a rotation trade. Is that trade over yet? I don’t know.

What I do know is that today is the Thursday before next week’s monthly options expiration. One of the PitBull’s rules is marking the Thursday/Friday low the week before the monthly opex. It doesn’t work every time — and we could see more pressure today before a potential bounce this afternoon or tomorrow — but keep that in the back of your head today.

Our lean is to sell the rallies and buy the pullback, keeping in mind my overall lean.

MiM and Daily Recap

The ES traded up to 4296.25 on Globex and opened Wednesday’s regular session at 4292.75. The ES traded 4191.75 and then like it does most days, it ripped up to 4304.75 and pulled back down to the 4278 level at 10:53. The ES short-covered up to the VWAP at 4290.50 at 11:46 and then did a low step down to 4269.25 at 1:44. After the low, the ES rallied up to 4282.25 at 2:25 and pulled back down to a higher low at 4271 and traded back up to the 4281 level at 3:23 as the early imbalance showed $537 million to buy.

The ES traded 4274 on as the 3:50 cash imbalance showed $577 million to buy and traded 4274.50 at 4:00. After 4:00, the ES traded in a 5-point range and settled at 4273.25 on the 5:00 futures close, down 15.50 points or 0.35% on the day.

In the end, the NQ weakness dominated the ES. In terms of the ES’s overall tone, it was weak but it also held better. In terms of the ES’s overall trade, volume was and has been tracking on the high side at 1.848 million contracts traded.

Technical Edge

The Nasdaq fell 1.3% on Wednesday, as mega-cap tech and semiconductors finally took a breather. The S&P dipped 0.4%, but the Dow gained and Russell 2000 ripped, climbing 0.3% and 1.8%, respectively.

There is clear rotation going on — at the sector and at the index level.

Put another way, there is money rotating out of tech (specifically big-cap tech) and into small caps, but also biotech, financials, industrials and materials. The question is — as it always is with rotations — how long will it last?

If tech can avoid puking lower and the rotation remains strong, then this is very bullish price action. But if the rotation lacks follow-through, it can quickly turn into chop and we’ll have to again rely on mega-cap tech to prop up the indices.

We have a lot to cover.

S&P 500 — ES

SPY

Gap-fill and 10-day ema tag this week? Three-day low is ~$426. Needs to hold this level for bulls to bounce. Otherwise lower is in store.

All week we watched and waited for that 78.6% retrace + 10-ema combo on the 4-hour chart as a potential support area. Maybe we get it today?

The setup:

**For the SPX, the 78.6% retrace is at ~4253.50.

SPX

NQ

Holding last week’s low (so far). Watch today’s Globex low. If the NQ can get back above (and stay above) yesterday’s low of 14,305, it could push 14,353, then potentially 14,400+

A break of last week’s low near 14,250 and failure to regain it could create more weakness.

QQQ

Right into the 10-day ema and near last week’s low. The 10-day ema is my preferred moving average, but as you all know, it’s not a holy grail.

Still, the Q’s have been in an incredible trend and taking a small “lotto” shot here doesn’t seem crazy to me. Ideally we hold last week’s low of $346.50 and at least get back to the “halfback” (the 50% retrace) near $352.50 – $353

IWM / RUT / RTY

A big burst over the $180 level and the 200-day moving average.

The IWM / RUT / RTY is now into the 61.8% and moving explosively. If it can continue higher, $192-$193 is next, followed by $196 and ~$200.

On the downside, you want to see it hold $180 and the 10-ema.

TLT

The TLT bottomed at $100 on the nose and bounced. Now rolling back over (and gapping lower this morning), I’m keeping a close eye on the gap-fill level down at $99.65.

With solid support in the $99s and a potential undercut of last month’s low in play, this is one to watch on the long side.

Open Positions

Down to Runners in GE, CAH, LLY, ABBV, AAPL, MCD & BRK.B. Now Add META, AVGO, UBER, CRM and AMZN.

Go-To Watchlist

Feel free to build your own trades off these relative strength leaders

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Economic Calendar

Disclaimer: Charts and analysis are for discussion and education purposes only. I am not a financial advisor, do not give financial advice and am not recommending the buying or selling of any security.

Remember: Not all setups will trigger. Not all setups will be profitable. Not all setups should be taken. These are simply the setups that I have put together for years on my own and what I watch as part of my own “game plan” coming into each day. Good luck!