Updated June 13, 2023
Raymond Micaletti, Ph.D.
The broad U.S. equity market was up small last week, while the Nasdaq 100 took a breather (finishing flat) after having gained 9% in three weeks (and despite sporting a weekly gain of nearly 1% Friday morning before tumbling).
The dollar also had its first drop in four weeks, while gold treaded water and the 10-year yield rose slightly.
Despite the relatively tame market moves, much larger moves happened in sentiment and investor positioning.
Bulls surged and bears evaporated in the latest AAII sentiment survey (of retail investors). Bullish retail sentiment is now at its highest level since the late-2021 market peak.
On the relative sentiment front, institutions engineered the second biggest decrease in their aggregate equity positioning in the last 18 months last week.
That is, institutions sold the market hard–as retail investors and speculators were chasing it. This behavior is notable because up until last week institutions had been buying as the market moved higher.
Dollar positioning remains bearish, as does intermediate- and long-term bond positioning. This is a curious combination, as one might expect falling bonds (rising rates) to go hand-in-hand with a rising dollar–as was the case in 2022.
Instead, investors appear to be positioned for a reignition of inflation. Bearish bond and dollar positioning suggests a Fed with its hands tied–on hold or cutting rates (perhaps because of bank-crisis fallout)–while inflation remains elevated.
Long-duration bonds and the dollar would both likely fall in that scenario. While inflation appears to have taken a backseat to growth and AI recently, the aforementioned relative sentiment suggests it could come back to the fore soon….
And perhaps this week–as we will see lots of potential market-moving data, starting with the CPI on Tuesday, PPI and FOMC on Wednesday, retail sales on Thursday, and University of Michigan consumer sentiment on Friday.
With that full slate of data looming, which side has the edge?
The Bull Case
The bull case is well known and (now) widely accepted. The market is being carried by the cumulative effects of prior breadth thrusts, the continual achievement of new technical milestones, still marginally favorable relative sentiment, and a drastic improvement in retail sentiment–all coupled with a compelling AI narrative that can’t be debunked anytime soon.
Morgan Stanley noted this week that the Nasdaq 100 is 20% above its 200-day moving average–an event that’s occurred 15 times since 1983. In 14 of those 15 cases, the index was higher 12-months forward (by an average of 35%!); in 13 of 15 cases, the index was higher both 6- and 48-months forward (by an average of 17% and 48%, respectively).
That’s some fierce bullishness.
The Bear Case
The bear case is that the market (or at least tech stocks) has gotten way ahead of itself in pricing in the AI narrative.
The Nasdaq 100 has gone parabolic, and while that may continue for a bit, it will become increasingly harder to sustain such a trajectory. If tech stocks were to have a healthy correction, that would likely bring the entire market lower.
Notably, while institutions are still marginally bullish in their equity positioning in the aggregate, they are relatively bearish on the Nasdaq 100 (a big sea-change from their monstrously bullish positioning in the Nasdaq earlier this year).
This reversal by institutions suggests other equity indices may start to narrow the year-to-date performance gap versus mega-cap tech.
And while implied volatility keeps making new lows, the volatility of volatility has risen and intraday volatility appears to have increased, as the market alternately surges and plummets intraday. This whipsawing behavior suggests rising instability, which may be a prelude to a bigger pullback.
Given the dramatic selling by institutions last week, we expect one of two scenarios to play out:
The market keeps moving higher in the short-term with no major pullbacks as FOMO and euphoria rule the day. Institutions would likely continue to sell hard into any such rally and that selling would almost certainly foreshadow a substantive correction from higher levels in the not-too-distant future.
The market pulls back moderately from current levels, punishing late-to-the-game retail traders and speculators.
While we may be in only the middle innings of this market rally–indeed, lots of statistics suggest the recent bullishness presages more bullishness in the coming months–institutional selling implies the return prospects from here are lower than they were when institutions were backing up the truck in October through January. Other (mainly cross-asset) positioning corroborates that view.
Recall that institutions were buying when everyone thought the world was ending, and are now selling when the (bullish) AI narrative is gaining steam.
Over time, institutions tend to be on the right side of equities more often than not, so their behavior is worth monitoring.
While momentum and short-covering may carry us higher in the near-term, any further rise might not be sustained without a subsequent correction. And a correction could very well start from here given the stretched nature of the market.
The market’s reaction to the FOMC this week will likely dictate which of the above two paths the market takes.
Allio Portfolio Updates
No change to Allio’s strategic portfolio last week. Early this week, we will exit our tactical position in the Nasdaq 100, which we have held since mid-April when QQQ was in the high 310s (and begin looking for new tactical opportunities).
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