Post from MktContext: 🍔The Most Hated Rally Midweek market review and key charts to know

Midweek market review and key charts to know

“Readers should dive into this analysis because it offers timely insights into market dynamics following the VIX-plosion and the ongoing rally in SPX, helping them navigate potential FOMO and strategic entry points. Understanding how options expiries and Powell's upcoming Jackson Hole speech could impact market movements is crucial for making informed investment decisions. With actionable advice and a clear strategy, this report ensures you're prepared for whatever the markets throw your way.”

AAO

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FOMO rally

August has been all about VIX (the volatility index). After the VIX-plosion, volatility calmed down at the fastest rate ever seen. As traders stepped back in to short volatility, stocks have been systematically dragged upwards. We are now seeing the most hated rally as the SPX is up 8 consecutive days. When markets rise this fast, investors feel FOMO and rush to buy, reinforcing the cycle.

Our paid subscribers will know we bought a tranche last week (great timing near the bottom, might I add) and are waiting for another entry to spend our remaining cash. If SPX continues running, we will force ourselves to buy; in a bull market, we want to be fully invested as much of the time as possible and not get locked out. I’ll discuss this phenomenon more in next Sunday’s letter.

A lot of investors switched to cash and bonds expecting a recession. They are feeling the heat now that SPX has rallied 10% in just two weeks with no pullback (!). We’ve been hammering on the point that there is no recession. The good news is, a dip might come as soon as today (Wednesday) because VIX futures and options are expiring at 9:00 AM (ET). While the reasons are beyond the scope of this article, there is often a trend reversal after major option expiries. Watch to see how SPX reacts at today’s market open.

Jackson Hole and interest rates

There is also Powell’s Jackson Hole speech on Friday. Some charts have been making their rounds on the internet suggesting Jackson Hole usually results in a nothing-burger for stocks and bonds. I’m not so sure of that, as the Fed may push back the market’s expectation of deep cuts. Our Sunday report called out that this could be bearish for markets.

This week, several Fed members publicly announced their support for a September cut. A cut is pretty much a given at this point; the real debate is whether it’s a 25bp or 50bp cut. We think Powell will lean toward gradualism and the market could perceive that as hawkish.

Fed members want gradual cuts, and soon

Chart below shows how stocks historically reacted to the first rate cut. Doesn’t look great; but that’s because the Fed usually cuts in response to a recession. This time around, we may see one of the more positive scenarios.

SPX usually bearish after first rate cut

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Week in review

Earnings season for S&P500 companies is pretty much wrapped up. Overall, sales grew 5.2% while earnings grew 10.8%, both handily beating estimates. This proves the bull market is sustainable and companies are growing. Remember, earnings are the engine of the stock market.

On top of that, companies that beat their earnings estimates are seeing their stock prices go up more than usual. And misses are being punished less than usual. That usually happens when CEOs are offering positive outlooks.

Stocks reacting very positively to earnings beats; and not as badly on misses

A couple companies to highlight: Walmart and Costco gained market share as upper-class consumers traded down to “value” stores because they are feeling the pinch from inflation. This highlights the dichotomy of the consumer: hurting, but still resilient. Walmart’s management said, “so far we aren’t experiencing a weaker consumer overall.” Other commentary from banks and credit card companies point to a resilient consumer too.

As long as consumers are spending, the economy can continue to chug along. Speaking of which, the University of Michigan consumer sentiment survey came in positive. People are feeling good. Stocks do well when people feel good.

Stocks do well when consumers feel good and are spending

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Key charts this week

Retail traders have been buying ETFs EVERY WEEK since May. That’s a sign of bullish sentiment.

ETF flows were positive every week since May

Defensive sectors (Real Estate, Healthcare, Utilities, Consumer Staples) have outperformed the market over the last three months. This implies the market is in “risk off” mode, guarding against a possible recession. We don’t think this trend will last, as the recession is still a ways away.

Defensive sectors have outperformed the market in the last 3 months

Gold finally broke out to new highs after the 4th test of resistance. We follow gold because its price movements are driven by real interest rates, global liquidity, and debasement risk - all of which apply to equities as well. (H/T to Callum Thomas at Topdown Charts.)

Gold finally broke out after four tests of the highs

That’s it for today!

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Disclaimer: This publication is for educational purposes only. The authors are not investment advisors and nothing here is investment advice. Always do your own due diligence.

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