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Updated November 22, 2022

Consolidation As Expected, Now Perhaps a Pullback

Consolidation As Expected, Now Perhaps a Pullback

Consolidation As Expected, Now Perhaps a Pullback

Raymond Micaletti, Ph.D.

Raymond Micaletti, Ph.D.


The S&P 500 traced out a ‘spinning top’ candlestick last week, suggesting a high level of indecision among investors. It closed near where it opened, but in between, it had excursions both well above and well below its weekly opening price.

Of course, last week was also options expiration week and such weeks are often fraught with hedging flows that distort normal cross-asset behavior. Thus, it’s hard to say with confidence what last week’s action might have told us.

It does appear, however, that upward momentum has stalled (at least temporarily), as the market seems to be consolidating in the vicinity of its post-CPI high. 

Is the market just taking a breather before its next leg higher or is it gearing up for a reversal? 

Given the recent moves in the dollar and yields (big selloffs) and equities and gold (big rallies), it would be natural in the near term if the former were to bounce and the latter were to pull back.

The dollar came within half a percentage point of hitting its 200-day moving average early last week before slowly moving higher over the balance of the week. It’s unlikely that any asset would break through and sustain below its 200-day moving average on first touch (absent some exogenous shock). Thus, a further dollar bounce seems likely.

Similarly, both the 10-year and 30-year U.S. Treasury yields, which have also had sharp selloffs recently, are sitting at interesting technical junctures. The 30-year stopped going down right at September’s 3.85% high and sits just above that level at 3.93%. The 10-year seems to be tracing out a downward sloping channel from the October highs—a channel that may have the makings of a bull flag (which would portend higher 10-year rates relatively soon).

 If the dollar and yields bounce, it’s a decent bet that equities and gold fall. The S&P 500 futures contract came within 1% of its 200-day moving average after the PPI number came in significantly cooler than expected Tuesday morning. But that level was its high water market on the week. Meanwhile, gold got tripped up by rising real rates from Thursday onward. 

As recent asset moves have been sizable and the reversals, so far, have been minimal, it wouldn’t surprise us to see the reversals continue:

  • The dollar could backtest the lower trendline of the channel it recently fell out of (1.5%-2% higher).

  • Rates could retrace more of their recent drop.

  • The S&P 500, up 13% from its October lows, could easily experience a run-of-the-mill 3%-4% pullback.

  • Gold, at minimum, seems destined to backtest its recent breakout level (about 1% lower),

But beyond technical resistance, asset classes also have fundamentals weighing on them:

  • Growth is slowing (private economists are forecasting -1.9% GDP growth for Q4, which is wildly disparate from the Atlanta Fed, which is forecasting 4.2%).

  • Leading economic indicators fell for the 8th month  in a row, something that in the past has only preceded recessions.

  • The entire yield curve from 1Y onward  has inverted, with many points on the curve having inverted to a large degree.

  • Earnings will almost certainly not be moving higher—if they move at all, it will presumably be lower.

  • Equity valuations are already overly generous and haven’t fully deflated to sensible levels despite the year-long drawdown.

  • At current prices, the Fed is actively trying to jawbone equities lower.

With respect to the last point, on Thursday morning Governor Bullard suggested a restrictive policy rate may be upwards of 7%. Equities, which had been up about 1% in the premarket hours, fell nearly 2% high-to-low, but recovered later in the day to finish flat. 

On Friday, Governor Collins suggested that a 75 bps hike—which had largely been written out of the conversation since the last Fed meeting—might be the appropriate increase at December’s meeting. 

Thus, we should expect even more of that hawkish jawboning (and/or hawkish policy maneuvering), if equities were to continue higher. 

The big-picture view, then, suggests the path of least resistance for equities is likely lower.

Indeed, it seems almost inevitable that equities will have to fall much further at some point. The bursting sovereign debt and entitlement bubbles will see to that (120% debt-to-GDP, with $100 trillion in off-balance-sheet liabilities in the form of entitlements that will come online at approximately $3 trillion per year and grow at a 6%-8% annualized rate [data courtesy of Luke Gromen]).  

How will the U.S. meet its obligations in a slowing economy, with lower tax receipts and a fiscal deficit already 10% of GDP, without increased issuance monetized by the Fed (into already high inflation)?

The U.S. Treasury market would almost certainly break if the Fed continues QT into increased Treasury issuance alongside sovereigns selling U.S. Treasuries to buy energy. And if the U.S. Treasury market breaks, all other risk assets likely suffer as well.

Thus, the question is not will the U.S. equity market move lower, the question is when? Now or later? 

We hear a lot about the macro developments (inflation, terminal Fed funds rate, economic growth, the housing market, consumer confidence, etc.), but we don’t often hear as much about how investors are positioned—which we believe is one of the more (if not most) powerful forces that drives markets. 

While a short-term technical pullback would be natural, all the negatives conditions listed earlier are well known by the market. Yet, despite those negatives:

  • Speculators continue to remain bearish the dollar relative to retail traders—historically a good sign for risk assets.

  • Institutions are bullish on equities relative to retail traders—also historically a good sign for risk assets.

  • In a new development, institutions are about to turn relatively bearish on the euro, which also has been a good sign for risk assets historically (see our update on euro relative sentiment).Institutions reliably get currency direction wrong (speculators get currency direction right)—thus, if institutions are about to turn bearish on the euro, that generally means the euro is likely to appreciate, which would be supportive of risk assets.Why do institutions routinely get currency direction wrong? We hypothesize that institutions use currency futures and options to hedge non-U.S. equity exposure and thus their positions are not indicative of fundamental beliefs about the currency markets.

  • And lastly this Twitter thread appears to show that retail traders have never been more bearish in their option-market positioning or have had lower exposure to equities, while institutional traders have loaded up on calls at levels never seen before

In other words, ‘smart money’ is hedging themselves to the upside, while ‘dumb money’ is hedging themselves to the downside. 

While retail might end up being right (after all, slot machines do pay out every once in a while to keep the customers coming back), betting on retail being right has been a losing proposition since the dawn of markets. 

Thus, we think it’s likely that the odds still favor higher equity prices than the recent post-CPI high before prices once again make new lows. This view would allow for a reasonably shallow pullback in equities and gold (and a bounce in the dollar and rates) and then a resurgence after. 

The view would jibe with Sentix’s view from last week (which they have tepidly carried over to this week with qualifiers), namely, that equities would consolidate for two weeks before resuming their uptrend. It would also coincide with euro relative sentiment turning bearish, which has historically been good for risk assets. 

If such a scenario does play out, how high might the S&P 500 go? There are several points of interest on the chart (from a technical perspective). We have the 200-day moving average, which is currently at 4067, which also largely coincides with a gap-fill at 4087. There is also the Jackson Hole “scene-of-the-crime” at 4200 and another gap fill at 4230-ish. 

That many expect the rally to reverse here (e.g., big sell-side banks) or at worst at the 200-day moving average, leads us to lean towards a scenario in which the market surpasses those levels and continues higher—driven solely by flows and positioning, without any fundamental or macro justification. 

The one thing that gives us pause, however, is this:

“You’ve got to adjust your mindset to a world where the bears are finally in retreat, because I’m betting the next four weeks will be much better than what we’ve come to be used to.” ~Jim Cramer

There’s a reason there’s an inverse Cramer ETF in the works…


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