Looking at this market, it seems like everyone has been on the extended Easter holiday since the beginning of the last week! Quietness, lack of volume, indecision in the broad risk assets, and a shaky surge in stocks are the current market environment’s character.
Yes, the dollar has been under pressure. Yes, the most liquid western indices grew nicely. But is it a sustainable bullish market that we can confidently bet on now? In the long-term – probably, but in the near-term – I’d be extremely cautious. More about it later.
Narrative mind games – the recovery
We live in times of divergence. IMF calls it a divergence in economic outlooks, stimulus measures, and vaccine rollouts.
Fed’s opinion diverges from that of the market. We’ve seen it in the bond yields surge recently, pointing to the economic recovery optimism, while the Fed’s stance is still conservative. Fed looks at the data and remains cautious about hiking the rates as the employment and inflation are still far from the regulator’s objectives.
The market opinion diverges (outpaces?) from the economic realities as we see four major indices still closing the week positive.
Risk-takers get inspired by Joe Biden’s infrastructure plan, the relief bill, and vaccine eligibility ambitions in the US but get nervous about possible global corporate tax increases and a rise in COVID-19 cases worldwide.
The uncertainty around Iranian talks and Credit Suisse’s problem may add to volatility in the market.
Look for clues in the US 10-year bonds
After a sharp surge, it’s time for bonds to digest losses. Bonds are often the first to tell what investors believe about the economy and reveal underlying market tendencies.
If the yields are below 1.6% support, we can expect a deeper correction down. The RSI shows bearish divergence, hinting at the slowing momentum, as the indicator is making lower highs while yields were climbing to the new highs.
When yields were growing, the value sectors such as financials, materials, or industrials tended to outperform growth sectors like Technology. Therefore, we could see less tech-weighted Dows and DAX outperforming Nasdaq100. When yields started to pull back, Nasdaq100 showed a relative strength again.
When rates go up, it makes sense to focus more on value indices like US30 or DAX. When yields go down, investors shift focus to currently lower-yielding sectors like Technology, thus pushing Nasdaq100 higher.
If yields are range-bound, the market is indecisive. The next US CPI data on Tuesday can bring more clarity of further market sentiment.
The dangers of a “thin” market
You probably noticed that the markets were still climbing up and closed strong last week. What is so indecisive about it, you may ask?
Look how the volume is getting lower while the market is growing. Nasdaq100 broke local resistance 13300 and continued growth on the decreasing volume.
The same case is with the Dow.
Who is buying this market? Probably not big guys. This is when the market is vulnerable to sudden fluctuations as there is no big money to restrain volatility.
Short-term traders would be fine buying the overextended move if they got their exit plans in place. Another case is with the position traders and long-term investors. If you’re not ready to actively manage your positions, considering selling right away if the market goes south, it’s not the best market for you.
Finally, VIX broke its five-year low around 20, signaling that the market is stalling.
If we go to 12, it wouldn’t be a big deal. However, looking at the history, after the dip in volatility, VIX is likely to take off and at least double.
Now the market has grown decently lately. I wonder how the subsequent spike in volatility will manifest itself in equities – up or down?
The market’s opinion diverges from the regulator’s stance. The next hard data release and the response in yields may help to define the market’s direction. Thin volume and new lows in volatility may be the calm before the storm.