What Financial Markets Are Telling Us: Meretricious Enthusiasm Portends More Boring Consolidation Ahead

The rounding top made in the S&P 500 earlier in September excites old-school chartists since historically this pattern forecasts a harrowing bear market rather than a period of dull but unnerving consolidation. Yet fundamentals don’t suggest a bear market since the major causes of uncertainty are light and increasingly predictable. COVID variants are likely here to stay, but as the world approaches majority vaccination it’s unlikely COVID will mutate into a perennially deadly virus worse than the flu. And Chinese Communist paternalism is unlikely to persist in its current brute form since the Party cannot afford to kill the golden goose of business confidence. That leaves the erraticism of Kim Jong Un as the major bearish factor that could destroy global confidence; to date the signs from the DPRK are ambiguous and par for the course. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is neutral. Yesterday’s action saw several negative factors across global asset classes: copper is pointing to declining global GDP expectations, largely because the action in currencies signifies $US strength against the majors and EM, with the notable exception of the Chinese Yuan. Taken together, I expect the S&P 500 to be range-bound over the next few days.

This morning has the flavor of a new leg in the bull market as the prospect of higher lows since the September 20 downturn tantalizes the bulls. The derivatives markets support the bulls as they show declining hedges against a downturn, meaning bullish sentiment remains stable despite low volumes in the cash equity markets. As measured by the SKEW index of tail risk pricing, hedges have declined rather than picked up on downturns in the S&P 500, while the VVIX index of the volatility of volatility only once rose into bearish territory during this month’s correction. But the combination of persistently low volume and volume spikes on down days (both for the indices and for key stocks) logically means the bulls are stable but unenthusiastic, portending more consolidation. Bond market volatility as measured by TYVIX remains muted as the recent rise in yields simply retraces the fall in yields made over the summer. Since the fundamentals are only mildly uncertain, further consolidation within this summer’s trading range is more likely than a bearish completion of the rounding top.

My current market positions are in Activision (ATVI), Amgen (AMGN), Apple (AAPL), Gibraltar Industries (ROCK), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE) and a hedged position in the S&P 500 (UPRO and SPXU).