What a week we just had! The NASDAQ 100 rallied 8.69%, with several commodities showing similar performance as palladium was up 11.28%, cocoa added 9.38%, platinum charged 8.66% higher, and copper surged 6.28%. Even gold shined, as the yellow metal returned 5.82% on the week.
We saw the CBOE equity put call ratio hit 1.3 before collapsing down to 0.55. That reading of 1.3 was the highest since 2008 during the Great Financial Crisis. Meanwhile the peak to trough drop was both dramatic and rapid, one of the largest I've ever seen in such a short period of time. Does this mean we have an all clear signal?
Not so fast! While the signal of panic is behind us, we're now venturing back into an extreme of optimism which often coincides with some level of de-risking to follow.
In the above chart we can see that when there's greed in the (inverted) CBOE equity put/call ratio, the market tends to have more downside risk from recent highs, whereas when there is fear it is likely that we see a reversal higher. The dramatic shift from fear to greed is worth noting as it may suggest that the recent move may be short lived.
We've also seen single stock skew toward puts, which is a phenomenon that backs up what some of the dramatic charts showing record equity put buying were illustrating: a dramatic shift from retail and institutions piling into puts instead of calls in stocks. Even with the dramatic shift toward call buying of late that phenomenon remains intact. It will be curious to see what happens after the monthly options expiration coming this Friday, though.
We've seen index put skew collapsing as hedges at the index level have not been sought for as much for over a year now, helping to lead us toward a more volatile market.
We can see the downward trend in the CBOE index put/call ratio with the SKEW index following it lower. While we do remain in a market with a volatility smirk toward index puts, and have since the 1987 crash, it is not as defined as it was this time last year.
Meaning we're likely in a relatively poorly hedged market. Protection hasn't been sought because it hasn't worked, but this is a bit paradoxical because at times when protection isn't sought it can and often does begin to work again.
The lack of efficacy when utilizing S&P 500 puts and VIX calls during this bear market has discouraged their purchase to hedge against downside risk, which is one of the reasons we see changes in index options flows and the S&P 500's skew dropping as a result.
It's almost a damned if you do and damned if you don't scenario. Whereas with these hedges not working, one can't reasonably rely on them, but without them VAR models are going to be a bit problematic during times of stress, encouraging hedging when it may not be affordable or effective.
The biggest risk, however, is hedged or not, if the hedges are not working or not sought then portfolios with any degree of leverage are more at risk of disorderly deleveraging during times of intense market stress.
A slightly cooler than expected CPI report, in part made possible by a periodic adjustment in health insurance, used cars, apparel, and from falling natural gas prices as provided from utilities, helped to juice animal spirits as the headline number came in at 7.7% vs the expectation of 7.9%. That report also helped to drive the US dollar down 4.08%.
Energy was up 17.6% year-over-year, and food was up 10.9% year-over-year. Both of these expenses have risen at a rate that has caused some stress for American families as we see spending in these categories rise at the cost of spending in other categories, such as discretionary spending on merchandise, travel, and also deferring of purchases such as buying a new home, car, appliance, or even mobile phone.
The month-over month reading of 0.4% was given about a 16 bps relief (or, in other words, would have been 0.56%) if the periodic adjustment of health insurance costs did not occur. This came in below the expectation of 0.6%, which was seen as cause for celebration without a deeper look as to why some of that deceleration happened and why it may not be sustainable.
Within the report we see a few other trends that are also somewhat concerning, including a rise of fuel oil by 68.5% year-over-year, and 19.8% in the last month alone. Natural gas was also up 20% year-over-year despite falling 4.6% in October. These rises in price make for a potentially more expensive winter than some may be prepared to pay for as two thirds of American families are living paycheck-to-paycheck.
Sizable flows came in to QQQ, HYG, IWM, and even the TQQQ leveraged NASDAQ 100 ETF, all of which risk-on. During the same time period we saw large flows out of SPY, IVV, VTV, TLT, and VTIP. While SPY and IVV are risk-on, they are lower beta, and VTV, TLT, and VTIP are seen by many as relatively defensive.
On Friday we also saw a $4.2B inflow into SPY, $2.19B flow into HYG and JNK, and $991M into IWM. At the same time $1.6B came out of the SHV short-term Treasury ETF, and $574M out of the IEF 3-7 year Treasury ETF according to FactSet. More evidence of a pretty strong risk-on mentality, but assuming risk in some of the lowest quality components of the market while selling down defensive positioning.
If Treasury exposure isn't particularly exciting here, does that mean rates have further to rise? Particularly of concern considering that the US government upsized it's fourth quarter debt issuance from $550B to $700B. While some of the recent auctions have been well bid, there is some cause for concern as the Fed continues down the path of quantitative tightening with a Treasury that is issuing ever more debt quarter-over-quarter.
After a dramatic move higher, the dollar has fallen rather dramatically. But is the move higher over?
The 10-year note yield, which has enjoyed a positive correlation with the dollar for much of the last year, suggests it may be a bit early to celebrate the demise of the strong dollar. Unless yields catch down, I would be surprised if the dollar doesn't firm up based on this relationship, but there's more to it than that. Given what I discussed above, I don't suspect that yields have much farther to fall.
We also saw the weakest global currencies perform the most against the dollar, particularly the Japanese Yen and Swiss Franc, where Japan's interest rate is -0.10% and Switzerland's interest rate is 0.50%.
The Yen has surged 5.69% higher and the Swiss Franc joined in with a 5.59% rally in a week's time. Something that in and of itself is extraordinary, especially within the context of much of it occurring post-CPI as a reaction. Some weakness in the dollar was to be expected given the bid in bonds, but this much may be overdone considering where some of the strength is emerging vs the dollar.
Even the GBP and Euro showed strength that was a bit extraordinary. Though after the year all of these currencies have had, a sigh of relief in the form of a bear market rally against the dollar was to be expected at some point. If the dollar does find its footing again it is likely to be a headwind for many stocks.
The Goldman Sachs unprofitable tech index rallied 15% on Thursday and over 8% on Friday. A phenomenon that we've experienced during prior bear market rallies this year was a theme of low quality leading, and the last two trading days were no different.
For traders that are taking advantage of the short-term pop and able to exit in time, this isn't of too much concern. But for swing traders and investors, these head fakes can be destructive as many fear missing out on the next bull market, buying into stocks after they've experienced strong gains, only to see them fall to new lows as the bear market makes a new leg down.
Fed Funds Futures continue to price in that a 50 bps hike is likely in December, which has been the most probable scenario for the last month. Even the Fed has suggested that they would slow down the pace of hiking and be relatively insensitive to near-term inflation data. So this isn't new. In fact the odds only changed from 61.5% (and 38.5% of 75 bps) to 80.6% after Thursday's CPI data.
But what's rather curious is that just a month ago on October 12th a 9.5% probability was assigned to a 25 bps hike. That probability is zero now and has been since the October 13th CPI print that followed the next day.
The expected trajectory of Fed hiking also only changed slightly, with the terminal rate being revised down from as high as 5.25% to 5%, with the first cut pulled forward from December 2023 to November of the same year at 25 bps, with another 25 bps cut to follow.
This change doesn't suggest a Fed pivot, or even pause, are imminent. Much like Chair Powell said at the latest FOMC press conference.
Speaking of tech stocks, TLT and QQQ have enjoyed a positive correlation in 2022, with TLT often leading NASDAQ 100 QQQ ETF lower. When QQQ (black) diverges too much from TLT (red) there's usually a corrective move lower by QQQ to 'catch down' to TLT.
Are we heading towards a catch down moment? It's quite possible seeing as a lot of the NASDAQ components benefited from the dual elixir of falling rates and a dollar that weakened meaningfully.
The latter of which is important for companies which have a lot of overseas revenue exposure, as "foreign exchange headwinds" have been a frequent reason for lamenting about missing revenue goals in earnings calls.
We had what can only be described as a week for the history books, where the NASDAQ had the biggest two-day rally since the depths of the Great Financial Crisis.
In fact, performance like that which we saw on Thursday for the tech-heavy index has only occurred four out of twenty times within the context of a bull market, the other 16 were bear market rallies, as Liz Ann Sonders of Charles Schwab points out in the above tweet.
Is this time going to be different? We'll have to see what happens next, but given that the last six bear markets only ended when the Fed began to cut rates, and often bear markets bottom during recessions after we see US households selling down equity holdings, we probably have more pain to come in terms of where stocks are likely to head over the next year. I wouldn't be particularly surprised to see the S&P well under 3,000 before all is said and done.