Momentum is Red. With that said, I’ve moved to cash and taken a speculative long position on the SPY into Wednesday and stopped shorting the market. The market is so “net short” that it’s time to be contrarian. I’m currently speculating on a move north of $392 on the SPY by Wednesday afternoon. I think we’ll get there by tomorrow, assuming no significant impact to the markets by the earthquake in Mexico.
The squeeze is on. The S&P 500 rallied on low volume again Monday, coming off near-term lows from Quad Witching. These are tough markets to navigate. But if you look back to June for clues, you might find some opportunities ahead. Right now, the market is bearish. Too bearish. Recent data from Bloomberg shows that S&P 500 futures net positioning is the most bearish the market has been since… Four previous crises in the last 14 years.
The last times that the market was this net short were the 2008 Financial Crisis, the 2011 Debt Ceiling crisis, the Chinese Yuan crisis in 2015, and the COVID-19 crisis of 2020. What a perfect visual representation of financial stability by central banks during my critical earnings years as a millennial. So much strength in the global markets… no wonder millennials are the most aggressive movers to cash in this market right now.
Welcome to the Fed Drift
Between September 1994 and March 2011, an interesting phenomenon happened ahead of the Fed’s monetary policy announcements. It was called the pre-FOMC announcement “drift.” Economists David Lucca and Emanuel Moench explained it in 2012:
“For many years, economists have struggled to explain the “equity premium puzzle”—the fact that the average return on stocks is larger than what would be expected to compensate for their riskiness. In this post, which draws on our recent New York Fed staff report, we deepen the puzzle further. We show that since 1994, more than 80 percent of the equity premium on U.S. stocks has been earned over the twenty-four hours preceding scheduled Federal Open Market Committee (FOMC) announcements (which occur only eight times a year)—a phenomenon we call the pre-FOMC announcement “drift.”
The fascination with this anomaly has been quite profound over the last decade. Especially as the Fed kept cutting rates and pumping money into the system. Economists and analysts have noted the “disappearing” FOMC drift over the last few years. In a 2021 article in Finance Research Letters, three economists wrote:
“We extend the sample to December 2019. We find that after first appearing before FOMC announcements accompanied by the Fed Chair press conferences, the Pre-FOMC drift essentially disappeared after 2015 in both announcements accompanied by press conferences and announcements not accompanied by press conferences.”
Disappeared? For four years? It goes without saying that the market had benefited from lots of rate cuts and cheap money. But interestingly, it’s reemerged a little on the back of 2022 Fed meetings. There has been ample movement to the upside during meetings this year – largely as the Fed announces its intentions to raise rates. Perhaps it’s short covering… perhaps it’s a matter of speculators taking excess bets off the table for even higher rate hikes.
But we’ve also witnessed some interesting gains on Fed meeting days AFTER the announcement by the Fed. Call it the “Relief Drift.” The post-announcement rallies have been stunning. In March, as the Fed prepared for a 50-point hike, we saw a noticeable rally in the market in the period leading up to the announcement. (March 15-16)
We see another noticeable move from May 4 to May 5, as the Fed hiked rates by 75 basis points.
Then there was the dagger in June. We see a rally higher into the close on June 14, and the market peak out after the Fed announcement.
The next day it bombed. And in July? Another pop on the back of positive momentum. After the Fed announced 75 basis points and little concern about recession, it just kept rallying. This forced some short covering, and the rest is history.
This is a reminder that the market is not the economy, and the economy is not the market. But when the Fed offers just a glimmer of hope, markets will respond with a surprise. I anticipate that 75 basis points are coming.
With that said, there are still ample positions out there betting on a 100-point move higher. When that doesn’t happen, anyone who is shorting this market may have to cover – creating a very attractive short squeeze environment. I’ll discuss this Wednesday during our roundtable. You’ll receive an invitation soon.