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Opinion: Trouble for U.S. Stocks After Massive Change in Direction

Monday’s stock market movement in the United States was unlike any other in recent memory, with the S&P 500 plunging over 4% before finishing marginally higher.

While positive turnarounds are frequently regarded as a favourable indicator, this may not be the case here. According to Bespoke Investment Group’s estimates, Monday marked the sixth occasion since 1988 that the Nasdaq recovered from a four-percentage-point intraday loss to end the day higher. The tech-heavy index has previously experienced a median decrease of 5.5 percent one month later and a dip of 7.9 percent three months later.

Markets are getting more volatile as investors try to assess the impact of everything from Fed tightening to the impact of the pandemic and geopolitics such as Russia-Ukraine. The Cboe Volatility Index, or VIX, finished just under 30 points, compared to a historical average of roughly 19.5. The average projection for the S&P 500 by the end of the year, as reported by Bloomberg, is 4,982, compared to its Monday finish of 4,410.13 — but given the gauge just avoided a fall on Monday, many market observers are likely rethinking their forecasts.

Here are several perspectives on the situation:

 

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Will The “Fed Put” Come Into Effect Around the 3670 Level?

Examining the few ‘exercises’ of the Fed put, marked by extraordinary announcements or unexpected forceful actions – 1987, LTCM in 1998, 2001 Tech Bubble burst, 2008 GFC, 2019 ‘Powell Pivot,’ 2020 Pandemic Rescue – the average ‘exercise price’ is a -23.8 per cent peak to trough (equating currently to SPX 3,670; in proximity to our 2022 downside scenario extreme of 3,575.

“Despite the first signs of stock market stabilisation on Monday,” Julian Emanuel wrote, “Powell-speak should still be regarded with caution, as investors did throughout the Chair’s first uneasy year in office, before feeling more at ease after the execution of the ‘Powell Pivot Put’ in January 2019.” “Investors wishing to gain exposure to the S&P 500 while factoring in the potential for sustained elevated volatility could go long the June 30 4,740 call/3,670 put risk Reversal due to the steep skew (expensive downside puts, relatively inexpensive upside calls) could go long the June 30 4,740 call/3,670 put risk Reversal due to the steep skew (expensive downside puts, relatively inexpensive upside calls) (buy call, sell put). While 2022 is unlikely to be an ordinary year by most metrics, if the average -23.8 percent strike price comes into view, the Fed is likely to “exercise the Fed put.”

The value of ‘clown stocks’ is expected to plummet by 90%

“It appeared to be a near-term bottom.” According to Brian Barish, chief investment officer of Cambiar Investors LLC, “the Fed meeting this week is (probably) an upward trigger. Above and beyond this short-term trading setting, it’s evident that these stocks are in tremendous problems due to their extremely high multiples and ‘deliberate plan to lose money now since the future is vast’ business models. For the past two to three years, values for these types of assets have continued to rise, and a return to reality is required.”

“There’s another class of equities, more the small-cap speculative things,” he said, “that have no apparent valuation link with anything.” These are what I’ve been calling the RobinHood equities, and Jim Cramer refers to them as the ‘clown stocks.’ Well, it’s obvious that these stocks are now in a bear market. Like Nasdaq in 2000-2002, the clown stocks might lose 80% to 90% of their value. I don’t believe it’s odd to think like way.

Counter View: The Bottom Could Already Be Here

In a message Monday, Brian Rauscher, Fundstrat Global Advisors’ head of global portfolio strategy and asset allocation, stated, “My most aggressive tactical indicators have flashed a trade buy signal (HALO-2 & V-squared) to negative extremes and positively inflected intraday today. This is quite similar to the pattern we observed during the trading lows on 12/26/18 and 3/23/20, when the S&P 500 was crushed on a Friday options expiry only to find a trading bottom the next Monday before noon.”

“My research implies that a trade bottom is likely in,” he added, adding that he is less convinced that the first-half low has already been hit because the Fed’s pricing, inflation peaking, and COVID rolling over haven’t yet played out. “Aggressive traders and strategic investors may be able to take advantage of the projected recovery to hunt for higher-quality equities that have been oversold,” says the author.

Leverage Unwinding

“There’s no doubt that the recent ride has been crazy,” said Matt Maley, chief market strategist at Miller Tabak & Co. “Today’s bounce was spectacular, and we did see some surrender around the mid-day lows. The volume was high, the breadth was narrow, and there were indicators of ‘forced selling,’ such as margin calls. This should ensure that the bounce lasts longer than a few hours.”

“However, the level of debt that has accumulated over the last few years will take longer to unwind,” he warned. “As a result, I believe we’ve entered a phase when investors should sell rallies rather than purchase declines.”

A Head Fake?

“Monday’s intraday relief surge in the S&P 500 was a ruse.” Stifel strategist Barry Bannister stated, “The index executed a nearly flawless intraday inverted head-and-shoulders to conclude the day approximately flat.”

For a stock market bottom to occur and the bull market to continue, Bannister believes a number of factors must happen, “but none appear to be in the offing.” A dovish Fed turn reduces the 10-year TIPS real (after-inflation) yield, as well as a bottoming in the US Manufacturing PMI and a bottoming in S&P 500 quarterly EPS beats minus misses, which has declined since the third quarter.

But The Skew is Missing

“Even while we were selling off severely, S&P skew (and skew purchasing power in general) remained weak and low,” said Amy Wu Silverman, equity-derivatives strategist at RBC Capital Markets. “Part of the explanation — and this part is a little concerning — is that people aren’t as long and don’t have as much to hedge. Rather than requesting downside protection, investors are opting to take money off the table. Even when we recovered this afternoon, S&P normalised skew levels across all tenors remain close to one-year lows.”

Overdoing the pullback

In a report released Monday, JPMorgan Chase & Co. strategists led by Marko Kolanovic said, “Market fears about rates and corporate margins are overblown. The latest risk asset selloff feels excessive, and a combination of technical indicators entering oversold territory and pessimistic sentiment suggests we may be nearing the end of this correction. While the market tries to process the rate hikes’ forced rotation, we anticipate earnings season to reassure, and in the worst-case scenario, the ‘Fed put’ to resurface.”