Short covering rally is over, now waiting for Powell

Mid-week market update: According to Goldman Sachs, systematic hedge fund positioning has reversed from a crowded short to a crowded long. Readings are similar to the levels seen at the market top in late March. 


The S&P 500 stalled at 200 dma resistance. In light of this analysis of HF positioning, the bulls are unlikely to regain control of the tape in the near term. The key question for traders is, “How will the Powell speech Friday move the markets?”



A change in tone

The tone of the market has definitely changed. The bears have begun to seize control of the tape after a goal-line stand at the 200 dma. The relative performance of defensive sectors tells the story. Healthcare and consumer staples tested relative support and bounced. The other two defensive sectors never deteriorated to relative support levels.



Equity risk appetite factors are flashing negative divergences. In particular, the relative performance of speculative growth stocks, as measured by ARKK, was rejected at relative resistance.




A possible pause?

Subscribers received an alert on August 12, 2022 that my inner trader had shorted the S&P 500 when the correlative between the S&P 500 and VVIX, which is the volatility of the VIX, had spiked. The signal was slightly early by two days. The trade’s drawdown wasn’t overly onerous, but it has turned out to be a good decision so far.



The slower moving but usually reliable S&P 500 Intermediate-Term Breadth Momentum Oscillator flashed a sell signal this week. The signal was unusual inasmuch as it occurred when the NYSE McClellan Oscillator was already in oversold territory, which is a cautionary sign that downside potential may be limited.



I interpret these conditions as downside momentum is in need of a pause. Fed Chair Jerome Powell is scheduled to speak at the Fed’s Jackson Hole symposium on Friday at 10 ET. However, market positioning is already tilted towards a hawkish tone. Fed Funds futures are now discounting a 75 bps hike in September, instead of an expected 50 bps last week. The terminal rate is now 375-400 bps, which is 25 bps more than last week. 



Jon Turek at Cheap Convexity rhethorically asked

The most important theme for this week and really going into the September FOMC is how does the Fed dropdown from 75 to 50bps without it being perceived as an ease on financial conditions (FCIs)? Jackson Hole is the start of this journey, the beginning of, “we want to go to 50bps, but we are not done in this fight.”

The answer can be found in the level of interest rates and not the rapidity of the increases.

The Fed wants to transition to a world where the hawkishness comes from the level of the funds rate not the size of the interest rate hike.

While Powell will probably push back against a dovish pivot, the risk is his speech may be less hawkish than market expectations, which would spark a relief rally.



Sell the rips

While I continue to believe that the market is likely to work its way lower and test Fibonacci support at about 4050 and 3970, the S&P 500 is short-term oversold and it’s due for a pause in the manner of the mid-April consolidation. Powell’s Jackson Hole speech Friday could be the catalyst for a brief bullish reversal.



If this downdraft does weaken further to test the June lows, keep an eye on insider activity. In the past, insider buying (blue line) exceeded selling (red line) when the stock prices fell to key support levels. Should that occur, it would be an intermediate-term buy signal for stocks.




Disclosure: Long SPXU


6 thoughts on “Short covering rally is over, now waiting for Powell

  1. Great intraday fake-out moves by the market today. You really can’t day trade this stuff – you’re either in or you’re out.

    The greatest fake-out this week may be a rip higher on a commitment by the Fed to higher rates. The market loves to fade rational arguments.

    1. RSI(5) recovered to midpoint (~50) – it rarely turns around right there, but at least tries to go a little higher, maybe we are going back to overbought. China seems to be back in panic mode, trying to stimulate the economy, but this may also add to inflationary pressures. In hindsight, we might have seen the usual volatility late last week before the Flash PMIs, but the market shrugged off that data. Eventually this market is going to give us another good short opportunity. The world is again trying to solve all problems with spending. 10-year still above 3% – in order to be bullish on bonds maybe one has to believe that Powell completely rules out going above “neutral” – unlikely.

  2. Bostic says “restrictive is 3.5 – 3.75%” – that is way more specific than what most people would have guessed.

  3. Not a great day for me. Whereas my latest trade was slightly in the green at Thursday’s close, I’m down -1.2% today (thanks to moderate position sizing and assistance from a position in TLT). No change in plans – still a swing trade.

  4. It is not clear to me how they will combat inflation in the liquidity and fiscal deficit areas. Interest rates cannot be the only tool IMHO

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