It’s Friday morning just minutes before the 7:30 CT release of the September jobs report. The S&P futures (ESZ15:CME) traded all the way up to 1928.50 on Globex (pre-release) and is trading 1917.00 just as the number was released, and would trade down to 1883.00 early in the cash session, but it’s not where the futures were that mattered, it’s where they were going that shocked most traders.
When the non-farm payroll number came out showing a sharp drop in US job growth, analysts were expecting 200,000 jobs, while only 142,000 jobs were created, thrusting the S&P into an immediate tailspin. I am going to start this out again by saying that in my 38+ years on the floor, and being in the S&P since 1985, I have never seen the futures do what they are doing today. That said, please let me explain what I think happened and I guarantee that you will not read any of this in the Wall Street Journal or TheStreet.com.
ESZ Futures Rally 80+ Handles in 4 Days
While my reasons for why the S&P dropped and rallied so much may not fit the mainstream, that’s really not all that important me. What is important is to understand how the markets functioned after the jobs report. I am not going to talk about the effects of the weaker than expected jobs report, but the overall mechanics of the big drop, and the even bigger rally in the S&P futures.
It has always been my thought process that the S&P rallies and sells off on overbought and oversold conditions, but it’s much more than that. After the S&P sold off early last week, going back down to the 1861 level (a level I put out over 2 weeks ago), the tide had already ‘swung’ to the sell side. When the futures sold off Monday and started going back down on Tuesday, traders had shifted from long into the rally, to short into the decline. As the ESZ15 poured lower on Tuesday, those sellers not only added to their positions, but they added (shorts) at lower prices. After the algorithmic and HFT trading programs pushed through the sell stops under 1873 down to the 1861 low, the very same programs that pushed the (ESZ15:CME) lower started searching for upside buy stops. With $3bil to buy on Monday’s close, and while making a low early Tuesday, the futures began to short cover. Now I will explain how the algorithmic, HFT and S&P Program Arbitrage all work together.
ROBOTS WORKING IN UNISON
While my explanation may not be perfect, it’s what I call ‘plug and play’. The futures plunged early and started to short cover. We already know there was buying at the end of the quarter and buying on the first trading day of the new quarter. Meaning that despite the sell off, money was being put to work, as the futures started to short cover and ‘natural cash’ buyers started to enter, the result is that it widens out the premium levels between the S&P cash (GSPC.SNP) and the S&P futures (ESZ15:CME) that make up an index arbitrage buy program (offer the ESZ15 and buy S&P cash). As soon as this happens the HFT and Algorithmic trading programs that were searching for the downside sell stops see the shift and immediately start searching for upside buy stops. When the big investment firms and hedge funds start buying (covering shorts or lifting hedges) that’s when all 3 programs mentioned above start to work in unison and race and squeeze the buyers out. This type of price action is impossible to fight, and predicting tops becomes a very dangerous play, like we saw on Friday.
That is the exact price action we saw during last Fridays jobs report. The futures are trading higher before the open. After the big rally, most traders had been going from short to long into the rally, but as the futures dropped, the buyers that are trying to get out are being raced by the “new” sells from the HFT and algorithmic programs. These programs tend to stretch the S&P futures further than it should go. After the 8:30 CT open, the futures start to retrace the Globex low, but here is the catch; most traders already sold before the 8:30 open leaving the futures oversold. What do the traders do? They can’t hold the futures over the weekend so what do the traders do? They put in buy stops above the market, and that’s when the robots start working in unison, and the exact scenario I pointed out above starts to formulate. The programs do not care if the markets are going up or down, they have no preference other than going in the direction of where the most stops are built up, and clearly that was to the upside, and the early drop only added to the upside.
In Asia, 11 out of 11 markets closed higher (Hang Seng +1.62% ), and in Europe 11 out of 12 markets are trading higher (DAX +2.15%) this morning. This week we have a total of 15 economic release, 10 T-bill or T-bond Auctions or Announcements, 4 Federal Reserve Bank presidents speaking and the September FOMC Minutes. Today’s economic calendar starts with the Gallup US Consumer Spending Measure, PMI Services Index, ISM Non-Mfg Index, 3 and 6-Month T-bill Auctions.
NO KIDS ALLOWED
Our View: Sometimes the S&P leaves people speechless, and Fridays 60+ handle reversal was one of those days. I have continued to say that things are going to be volatile, and I will say it again. If you get on the wrong side of this bus; you get run over. If you’re slow, you get run over. If you make a bad decision, you get run over. This morning starts with the Gallup US Consumer Spending Measure, PMI Services Index, ISM Non-Mfg Index. Our view is that when you see the S&P up sharply, along with Asia and Europe closing up across the board, that the S&P just looks too good to be true. We lean to sell the early rallies. One of MrTopSteps trading rules is that after a big up day like Friday the S&P tends to trade sideways to lower. Right now the S&P looks the best it has in weeks, that usually means it’s close to a high.
See all of the October expiration stats here…
As always; please use protective buy and sell stops when trading futures and options.
- In Asia 11 out of 11 markets closed higher : Shanghai Comp. +0.48%, Hang Seng +1.62%, Nikkei +1.58%
- In Europe 11 out of 12 markets are trading higher : CAC +3.15%%, DAX +2.15%%, FTSE +2.13% at 6:00 am CT
- Fair Value: S&P -9.55 , NASDAQ -12.37 , Dow -107.76
- Total Volume: 2.46mil ESZ and 5.2k SPZ
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