Warning signs ahead
Whether you are in equities or crypto, there have been plenty of reasons to doubt the sustainability of this year’s rally in risk assets. Bear porn is everywhere - I see charts pointing to how overbought the market is, or how narrow the breadth is in equities, or how hedge funds are positioned max long, or how multiple measures of investor sentiment are flashing max bullish. I’m not going to bring out these charts in my post, because you’ve probably seen them already, and if you had acted on these bearish warnings too early, you would have missed out on a lot of the strength in equities and crypto this year.
That said, something has changed in market behavior this week that has triggered my spidey senses to be on the lookout for a correction over the coming week. The catalyst for a market correction would be the recent hot inflation data (both CPI and PPI), which is stirring speculation that the Fed will shift their dots from three hikes in 2024 to only two. The Fed’s projections for cuts in 2025 may also get dialed back. Yields have been rallying all week, and risk assets are finally starting to notice. Danny Kirsch from Piper Sandler has a nice chart showing how increases in 10 yr yields of 30 bp or more over 4 days or less tend to coincide with negative returns in the Russell 2000.
Fortunately I caught the move in yields, having sold 2 yr Treasuries at a yield of 4.54% (paid subscribers get real time updates on when I enter and exit positions). The position is in the profit by 18 bp of yield, and there is scope for more downside in bonds as we approach next week’s meeting. In anticipation of a hawkish Fed, I can see the market moving towards pricing in only 2 and a half 25 bp cuts this year - a move of 11 bp from current levels.
This morning I took profit on a few positions in the Fidenza Macro portfolio - the most notable one being the tactical long in Bitcoin that I put on at 53350 and exited at 69000. I’m still long-term bullish, but have turned short-term cautious.
The warning sign in Bitcoin was when we saw a record day of inflows into ETFs that propelled price above 73k but failed to hold those record highs.
Price then pulled back to support at 69k, attempted to rally, and then broke even lower.
Meanwhile, the Nasdaq is showing signs of distribution and is testing support on today’s open.
Super Micro Computer has been a bellwether of the AI rally, and is getting added to the S&P 500 today. No doubt the addition has been a contributor to its recent performance, but often this can lead to underperformance after the addition happens.
Today is also monthly expiration day, which often leads to market volatility as a lot of gamma expires, removing the need for market-dampening delta hedging by market-makers.
What would cause me to change my cautious view? If the pullback does not materialize and instead we see new highs in the Nasdaq and Bitcoin, I would have to turn bullish again. If we see a further tightening in yields of 10-20 bp but risk assets don’t sell off, I would also turn bullish as that would be a signal of resilience in risk assets. Finally, if the Fed turns out to be less hawkish than the market fears, that would provide a green light for the market to continue running higher.
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