2023-07-11 03:45:00 ET
Summary
- The rally in 2023 is due to multiple expansion on the S&P 500 and is basically the reverse of 2022, when we had multiple contractions.
- But we also had a record short position in S&P 500 futures, where in early June we had 434,200 contracts of net short positions in S&P 500 futures by “non-commercial” (speculative) traders.
- Net S&P 500 short positions were cut by more than half in June and now stand at a more normal level of 207,200 contracts for the decline that began in January 2022.
I think we have started an intermediate-term correction, where a good target would be the area of the 50-day moving averages on the S&P 500 or the Nasdaq 100. The drawdown in the S&P could be around 5%. When we get there, the market will show us if there is more to go, or if it was the “pause that refreshes.”
The rally in 2023 is due to multiple expansion on the S&P 500 and is basically the reverse of 2022, when we had multiple contractions. But we also had a record short position in S&P 500 futures, where in early June we had 434,200 contracts of net short positions in S&P 500 futures by “non-commercial” (speculative) traders, as shown by the Commodity Futures Trading Commission’s weekly Commitments of Traders report (see chart below). Net S&P 500 short positions were cut by more than half in June and now stand at a more normal level of 207,200 contracts for the decline that began in January 2022.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
You can thank the short sellers for the sharp June rally. The problem with short-covering rallies is when the shorts cover, there is no support for the market - if short covering was the main driver of the rally.
We also have rising interest rates, which was a huge problem in 2022. AI has been ignoring rising yields, but I doubt AI will be a meaningful contributor to earnings in 2023, so rising yields need to be respected.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Treasury yields and stocks were inversely correlated up until April, but ever since then, they have been positively correlated as the Nasdaq 100 has pulled the S&P 500 higher, driven by the AI craze. A decline to 4200 would be normal, while one all the way to 4000 (the 200-day moving average) can’t be ruled out.
German DAX Volatility Explodes
Last Thursday, the German DAX Index suffered a 400-point decline, which was over -2.5%, closing more than two standard deviations away from its 20-day moving average. The German DAX index is usually relatively sleepy, but when it moves like that, it suggests the market is worried about something. In the process, the DAX violated a three-month range to the downside, and I believe more selling is coming.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It was not only Germany that reacted that way. Most European bourses saw similar moves last Thursday. Germany is in the middle of a technical recession - even though the Germans themselves try to belittle it - while the ECB is hiking rates. Since the Germans have not yet experienced the ECB monetary policy lags, it is likely the recession will get worse, suggesting more declines for the DAX. At a minimum, the DAX is headed for its 200-day moving average near 14,900, and it could be quite a bit more.
On most days the German DAX is heavily correlated to the S&P 500, although German futures open at 2 am Eastern Time and the German cash market opens at 3 am. Correlations can differ from day to day, but on most days it is quite strong for the first 3-4 hours of German regular trading hours. A German stock market in the middle of a correction is likely to pull down the U.S. market as long as the correction lasts.
All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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The Short Covering Rally Is About To Stall