The S&P 500 has now recovered about 2/3rds of the losses that it saw from the February meltdown.
Let’s break down the psychology of two different market “themes.”
The first is the idea that a retest is coming. That the market will finally catch some weakness, rollover, and break 2600 with another panicky selloff.
Honestly, that seems to be the “easy” analysis. Let’s see if we can poke holes in that argument.
A market retest is never a guarantee. I can point out a few examples of the market having a big dip and never hitting those levels again. The Ebola crisis, Brexit panic, and US Election panic are all recent examples… the latter two you’ll need to look at futures charts to see.
These kinds of “one-off” pullbacks tend to have an event that is a binary risk event. Once the Ebola crisis was over, there was no reason to sell again. Same with Brexit.
Retests tend to happen when there is a larger macro overhang… China rates, Eurozone debt… things like that.
So what’s our overhang?
First, we have the spectre of inflation. That somehow 3% yields will make stocks seem like a bad idea. And I do think that was “part 1” of the market selloff.
Yet think about this: treasury yields broke to new relative highs this month, but stocks are ramping higher. The premise there is not very sound anymore.
I think the “rate scare” was just an overall psychological issue in the market. In case you don’t remember, right before we sold off the market was massively stretched. We were due for a pullback and just needed a reason.
The second phase of the selloff, and the bigger phase, had to do with the volatility markets breaking. Way too many investors had net short vol exposure, and XIV collapsed.
Well, those volatility shorts got blown out and they aren’t there anymore. If they can’t get runover again, then they can’t cause more selling in stocks, can they?
You can see how the retest argument can actually be a difficult one to make.
It’s possible, of course, but we’d need to see an introduction of a new catalyst, and more importantly, actual sellers to show up again.
The second theme is a little more nuanced. It’s the sideline FOMO trade.
Say you went through the last half of 2017 in cash because you thought the market was up too big. You’re waiting for a pullback.
All of a sudden, the pullback comes, but it’s more like a mini-crash.
The pullback you wanted to buy is here, but it looks scary so you hold off… and you wait for the retest.
But if the retest never comes, you get more impatient. You get FOMO, and start to buy some of your favorite stocks.
If you get enough of these “sideline players” with this psychological profile, then it will ignite the market higher. The momentum can feed on itself. Early shorts get blown out.
This is becoming a more likely scenario.
Let’s put this into some simpler concepts.
Last week’s low, right around 2700, is the key line of support. A loss of that and we can see an easy 100 handle push lower. The longer we hold above that, the higher the odds we squeeze.
My squeeze target is 2815. If we hit that quickly, that will be a “layup” short area.
Right now, my focus is on stocks that showed good relative strength. Stocks that didn’t really take out their 50 day moving average… no massive cracks when the market panicked.
Trade #1: BA
Breaking out, looking for a pullback to breakout pattern to get long.
Expected Price: 360
Sell to Open BA Apr 325/320 Put Spread
Tier 1: Enter at 0.70, Exit at 0.20
Tier 2: Enter at 1.00, Exit at 0.50
Tier 3: Enter at 1.30, Exit at 0.80
Trade #2: LULU
LULU is one of a few stocks that held a rising 50 day moving average– this tells us it has relative strength. Last quarter it had a huge gap up on earnings, so I expect the stock to start accelerating in anticipation of its next earnings event.
Expected Price: 80.77
Sell to Open LULU Apr 70/65 Put Spread
Tier 1: Enter at 0.67, Exit at 0.17
Tier 2: Enter at 0.97, Exit at 0.47
Tier 3: Enter at 1.27, Exit at 0.77