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US500USD

The market timer - how close are we to a tradeable bear market rally?

Chris Weston
Head of Research
May 10, 2022
Everyone is looking for a trading low or a V-shaped bottom in equity indices – it's arguably the most asked question in markets.

If we look at the NAS100 we’re not far off retracing 50% of the 152% rally seen since the March 2020 lows and right now there's a lot of fear, panic and disdain towards equities – while price action will always dictate, too many, buying when there's real anguish is the best policy – I prefer to wait for the market to at least show real evidence of a change in the flow.

We know the fundamental reasons for the drawdown – reserves (held as liabilities on the Fed’s balance sheet) have fallen 22% since December and the market sees the Fed as having lost control, and see them chasing inflation every single day – how can you price risk when the markets central price maker has no confidence in its ability to correctly set policy?

China is shut down and everyone is asking what's the correct probability of a recession? Then, of course you’ve got to ask what's the correct multiple to pay for expected earnings – this is incredibly hard when few have any confidence in their ability to price the correct level for the assumption’s money managers input to assess the ‘fair value’ model.

As mentioned in prior reports, so much of what we’ve seen has been flow driven – forced selling by hedge funds due to high realised volatility, options market makers shorting equity futures to hedge their delta exposure, and liquidations from concentrated tech holdings. Much of this is hard for retail to see and it's one of the advantages of having access to investment banks, as they can offer detail around the flow they’ve seen – that’s what they do, they manage flow and trade the possibilities.

The question is how much of this liquidation and flow-based activity flow has played out? That’s hard to gauge, but we’d be looking for signs that funds are starting to have a nibble again, as they see ‘value’ in valuation – if the VIX pulls back below 25% then that will manifest into higher equity prices, and volatility-targeting funds will look to put money back to work in equities. A lower US CPI print (tomorrow) will help and we’re seeing signs that bond and rates traders are starting to price out rate hikes, perhaps as a sign of growing recessionary risk. However, we’ll be watching for signs in upcoming communication that the Fed is seeing signs that tighter financial conditions are starting to have the correct effect.

Most can see for themselves that the technicals are grossly oversold and sentiment is shot to pieces – but this is a bear market and this is what one would expect – the idea of don’t fight the Fed still applies.

The probability of a tactical bear market rally is certainly elevated, but that's what it will be – a bear market rally and one where traders will sell in to – ‘buy the dip’ has morphed into ‘sell on rallies’. At this stage, we need to be open-minded and open to anything – the set-up on higher timeframes is obviously awful, however, if our job is to assess the distributions of outcomes then we can easily state the case either way – one thing is clear, with high vol and negative gamma (in the options market) we can expect big moves – up or down.

With price testing the neckline on the US500 of sizeable head and shoulders, it's clear we’re at a make-or-break time – I would argue that equity markets will be higher over a 2-month period. However, for traders we need to be far more accurate in our timing. For me take the timeframe in and buy strong, sell weak.

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