Observations

The tide is high but I’m holding on
-Blondie

It ain’t over ’til it’s over
-Yogi Berra

Since the March lows, the S&P 500 has rallied roughly 50%. There are two forces that determine market prices: buyers and sellers. In a healthy uptrend, buyers overwhelm sellers, demand far exceeds supply, and prices are propelled higher.

On the flip side, markets can be moved higher without a huge increase in demand. This happens when sellers retreat. In short, the market can be moved higher on weak demand so long as supply is even weaker.

Since the lows, buying has lacked vigor and sellers have all but vanished. These observations have been the primary thrust behind my risk aversion thesis.

In the last couple of weeks, I have observed small improvements in both volume and demand. This change is worth noting as it differs from the behavior seen since March. Notable as this change is, it is only one of many data points. The most important observation in reference to this improvement is follow through. Will volume and demand continue to improve? If the market begins to retrace, will heavy selling emerge? For the time being, traders are finding every reason to increase their risk. At some point, de-risking will replace re-risking, and sellers will overwhelm buyers.

There are a myriad of data points–both technical and fundamental–that lead me to believe the March low was not THE LOW. As mentioned, the rally from the march lows was not a function of vicious buying, rather the result of a retreat in selling.

In the shorter term, there are signs emerging that hint at trouble for equities. Credit spreads are widening and the credit markets have begun selling off. Premiums in default swaps are rising which hints that big players are putting on flight to safety trades. During a conversation with a well-known billionaire this week, he opined that credit markets (as opposed to equities) are beginning to better reflect the fundamentals. The disconnect between credit and equity will not persist indefinitely.

Given the overbought nature of equities off the July lows, it won’t be a surprise to see the market give back some of it’s recent gains. When the market does sell off, it may do so far more substantially than the majority are prepared for. Jesse always used to remind me:

“Stocks are manipulated to the highest point possible and then sold to the public on the way down.”

Where that highest point of manipulation is remains elusive. At some point the inevitable catalyst lower will emerge. Before it does, there will be plenty of clues.

This detective will remain on the case.