Is it a trap? Or is it just part of a pattern? Over the last five months, markets have bottomed out each month right around the third Friday of each month. What gives? Why would it bottom out on May 19, June 19, July 18, August 18, and September 20?
The Third Friday is a critical expirations date for monthly options. That’s why. As you can see, there’s been a steady uptick in the SPDR S&P 500 ETF (SPY) dating back to mid-May.
The key reason why this time is a bit different is because of three major catalysts that are keeping some would-be buyers off the sideline.
- The Chinese Evergrande situation remains unresolved. We have some experts saying that the property developer’s insolvency won’t spread contagion across the global markets. But I’ve learned not to take anyone at their word when it comes to China’s markets. This could quickly create a crisis that spreads across Asian markets… and Australia, which is a massive exporter to the Chinese market. Big questions ahead.
- The Fed Open Market Committee will conclude a two-day meeting. While no one expects an interest rate increase this month (or even by the end of the year), the question now centers around when the Fed will start to taper its massive balance sheet. As I’ve shown you, there is a direct relationship between the size of the Federal Reserve’s balance sheet and the performance of the S&P 500.
And, when there was a split when the Fed started cutting its balance sheet starting in 2016, keep in mind that the markets received a massive jolt thanks to the Tax Cuts and Jobs Act passed by the Trump Administration and Congress in 2017.
- Finally, we had quadruple witching last Friday. That is historically one of the most volatile days of the year for the market. Combine this swell of volatility with macroeconomic woes and you have a recipe for stocks to break below support.
As I’ve noted, market momentum is negative again, and has been so for a few days. The fact that the SPY is trading below its 50-day moving average will spook many technical traders.
This is why we’ve kept trailing stops tight and not made too many quick moves. Tomorrow, following the Fed’s decision will be a time to take action with calls and shorts. Until then, let’s enjoy the day and start to think about how to be more active tomorrow.