VTI - The Bull Market Rodeo Is Over

2023-04-26 12:30:00 ET

Summary

• The very systematic funds that drove stocks higher in the middle of March have now turned sellers.
• Additionally, liquidity is now leaving the market.
• Stocks remain very expensive relative to earnings growth.

This data has been presented previously to the subscribers of Reading The Markets , an SA Investing Group.

Yep, the bulls were trapped , all right, and now they have big trouble potentially coming their way as the systematic funds that helped to drive stocks higher will once again flip and become sellers, and reserve balances sink.

Yes, the systematic funds, such as commodity trader advisers ("CTAs"), that helped to push the market up from Mid-March, and got stuffed heading into options expiration because of market maker hedging, are very close to turning sellers. Based on an article in Bloomberg , these systematic funds have loaded up on around $170 billion in global equities, reaching their highest levels since early 2022.

The trouble is that these funds are now likely to turn sellers following the big selloff on April 25 and, at some point, will likely start to short the market. The S&P 500 (SP500) fell by 1.6% on April 25, as worries over the debt limit, more bank troubles, and a slowdown in global growth sent stocks lower. The article from Bloomberg noted that a breach of 4,130 on the S&P 500 Futures (SPX) would start this selling process and could result in the funds having as much as $276 billion to sell over the next month if the index continues to head lower. Additionally, at some point, they will likely start to short the market as well. For that to happen, it would probably take the S&P 500 20-day moving average turning lower.

Unfortunately, these funds are momentum driven, and they don't care about things like fundamentals or earnings. They only trade based on their models and market signals. So the only thing that turns them around again is a shift in market momentum.

It isn't only the systematic funds; implied volatility is likely to start creeping higher as realized volatility increases. With the VIX falling to around 16 over the past week and its lowest level in more than a year, there is plenty of room for the VIX to rise should realize volatility continues to climb.

Liquidity Is Leaving

Additionally, reserve balances are again shrinking, as noted in last week's update on the Federal Reserve balance sheet. Reserve balances are the amount of money depository institutions hold at the Fed. My model shows that reserves have continued to shrink as the Treasury General Account rises as it received tax receipts. Also, the reverse repo facility usage remains high heading into April month end. Both act as liabilities on the Fed balance sheet, and when they rise, they reduce reserves. Changes in reserve balances over time tend to impact the liquidity conditions in the financial market.

Technicals Are Weak

This has left the equity market in a precarious position because the S&P 500 is showing it may still have further to fall here, as the index is trading around a level of technical support at 4,080. With that level now in play and multiple gaps that need to be filled down to 3,970, a further decline could result in the index giving back all of its gains since mid-March.

18 Is Too High

To make matters worse, the index isn't even fairly valued at this point. It is trading for almost 18 times its following 12-month blended earnings estimates, as earnings are expected to fall by around 4%. Additionally, since the start of this still-bear market, the index has topped multiple times now, around 18 times earnings.

So, options expiration managed to do the job of sucking the last of the bulls into the market trapped them, and now the forces have turned against them.

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