Last week in “Crushed” we talked about a coming volatility spike and sure enough $VIX spiked to over 20 from the 15 handle in a matter of days only to be crushed again. Thursday’s one hour 1.7% dip on $SPX was once again ferociously bought and new highs have once again ensued, no matter what the internal picture of the market may be, which continues to rally irrespective of the lack of participation underneath the surface.
Just this morning we got a taste of this:
Cool trick.$SPX is green no matter whether internals are +2200 or -1100 on $NYAD. pic.twitter.com/OOgMUYEBn3
— Sven Henrich (@NorthmanTrader) July 12, 2021
But that’s neither here nor there and won’t matter until it does.
More impressive to me are the fingerprints left behind by each $VIX spike and how these spikes fit inside the larger volatility structures we’ve been watching build for months.
Many of you will be familiar with the larger $VIX structure I’ve been pointing to. It remains alive and well:
What’s fascinating is that this main structure can be found across many other volatility instruments.
Take the original $VIX formula, the $VXO:
Note where it stopped last week: Right at the top of the trend line. The message: This line matters big time and it has mattered since the March 2020 lows.
Technicians know that the more often a trend line gets tagged the weaker it becomes suggesting that one of these days volatility will burst through the confines of its prison.
Even more fascinating, the same trend line behavior was observed last week at the same time on small caps ($IWM):
Its underling volatility component, $RVX, also stopped dead in its tracks at the trend line sending the same message.
And lo and behold, tech, up 8 weeks in a row and going on 9 keeps showing a very similar structure which is extremely clean:
As subscribers know I haven’t touched or changed these trend lines in months, price keeps respecting these structures cleanly, hence they matter from my perspective and they keep building for a coming volatility event. Also of interest: All of these volatility structures are forming on top of the previous ones in the years before. Which is surprising considering the high price levels we’re seeing and the pronounced calm in markets.
Now, as I’ve said before, even at the beginning of the year, all this can take months to play out, but the message of all these patterns remains the same: A big volatility spike is coming and this ongoing one way market strength, ever so desperate to buy every single little dip, continues to disconnect markets ever further from historic trends.
If we’ve learned one thing over the past years it’s this: The extremes become ever more extreme, and when things are extremely stretched the reaction to the downside is often much greater than anyone can imagine. Nobody will give us a day and time as tops are processes, but the underlying picture keeps bubbling as it shows ever more weakening beneath the surface:
And as you can see from this chart history, $SPX continuing to make new highs on weakening internals and momentum, can end up being extremely deceiving.
The broader message: As the volatility structures keep tightening across the board the next big spike may not stop at the respective trend lines. How dramatic such a move (when it comes) will end up being will depend on a lot of factors, not only on technicals, but also positioning.
And it’s fair to say we’ve never seen such a one way positioned market:
They’ve really managed to get everyone long.
Rydex bull/bear ratio vs $SPX pic.twitter.com/YnRvsklhwU
— Sven Henrich (@NorthmanTrader) July 9, 2021
There are no bears, only bulls. Who’s gonna cover their shorts and buy stocks during the big volatility event if everybody is already in? An academic question at best at the moment as nobody can even imagine any downside in markets that now print record highs almost every day. I can’t give you a day and time, but I can give you the structures above and you can choose to ignore them of course. What they tell me is this: It’s coming, just a matter of time and perhaps the right trigger, and then downside, currently so elusive, may come faster and deeper than anyone expects.
I’ll leave you with one historical example, as a reference: 1998. It was relentless on the way up out of the gate in the early part of the year, consolidated for a few weeks and then ripped higher into the summer. Does that script sound familiar? It should, as it basically reflects the actions we’ve seen so far this year. What happened then?
It peaked ironically in July and then proceeded to correct by over 20% before setting up for a rip roaring rally into the end of that year:
History never repeat but sometimes it rhymes? We’ll find out. A 20%+ correction would feel like armageddon right now and this market may not correct 20% this year, but frankly, from my lone perch, it would be healthy in cleansing out the speculative excess and likely set up for a major buy. But for now markets can’t even manage a 2% pullback before the panic buyers show up (as we saw last week).
One day the character of this market will change, and when it does it will happen suddenly, and when it does participants may perhaps find themselves psychologically unprepared:
Everybody is so trained to cover shorts on any down move and instantly panic pile long into any dip that by the time this market really rolls over hardly anybody will be positioned for it and most will have covered way too early getting crushed trying to catch a falling knife.
— Sven Henrich (@NorthmanTrader) July 8, 2021
The trick will be to recognize when things have changed and these volatility structures above give us a clear guide as to when that moment has arrived: When the trend lines are no longer lines of resistance.
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Categories: Market Analysis
It’s coming Sven. Never in history has the S1P been so stretched. Never. When the crash comes…it will be epic. I know this sounds crazy right now….but SPX below 1500 is a true possibility in the coming year…
If the SPX drops below 1500 and recovers 50% to 2250, someone will calculate the annual price appreciation since 1990. It will be 6%. The money supply is growing at 6%, government debt is growing at 6%, almost everything grows at 6% per year, so this is just logically consistent with how the system has been working all along: expect 6% returns forever and ever. Back when the SPX was at 1000 in 2009, the Fed could have announced a 6% annual price appreciation target for the stock market. Then we’d be at 2000 today and everything would be very sustainable.
Down 90% from here.
It will come. We crash 1 to 3 weeks and than this shit is a buy again. At the DMA-200 the Fed will stick to the old rule: “If you are in trouble, double!”
For me the central banks are now the black swan. They can push the markets to the moon. Faster than some billionaires will head there. Or they crash everything, because they MUST react to the inflation that maybe go out of hands. There is nothing in between.
Not so sure on the 1998 analogy, I think a 10% correction would not stop at around -20% – it would indicate a significant sentiment shift and lack of confidence in central banks with a more likely target of -40%. Anything more than -5% within a week or so timeframe will be very scary for markets. I think Carsten (above) is correct: there is nothing in between. When it goes, it plummets. However, I think Jay will sit on his hands even if inflation screams.
So if the Fed is not going to do anything and the market is playing a game of chicken, what can possibly crack it? When does fear overcome greed and FOMO because markets can remain irrational much longer than anyone of us can remain liquid if on the wrong side of the trade. The concept that you are going to jump short on a market that opens down 3% is hard to believe, especially when volatility at that open-down-3% is going to be priced much, much higher, making the conviction on a much broader move down even bigger.
Market historians: Am I correct in thinking that the only analogous market manipulated by its central bank in modern history would be Japan? Japanese equities went to the moon in the 1980s and Japan was held in high esteem – tech wizards buying up the US – Ginza noodle shops (60 sq ft) priced at a million bucks, and then PFFFT! it went up in smoke. BOJ has been pushing yen and dollars forever since then – printing and printing and printing and…markets have not recovered to anywhere near their former glory. Are the US financial markets and our economy similar to Japan of the early 1980s? And if so, do we have their post decline experience in our future?
The first leg down can be a technical rollover. Wave 3 comes on news out of Maricopa County and a full-blown Constitutional crisis.
News out of maricopa county? You think anybody cares what that fraudulent audit comes up with other than Trump and his zero integrity cronies? I doubt it.
Hi Sven, I really respect your views, but I think you are two years ahead… I am right?
Are we there yet?
I think we might be, though I’ve been wrong before and will be again. Maybe not this time. Note the appalling bredth in the major indices, the jitters whenever Fed speakers slightly hint at not refilling the punchbowl quite so fast, the increasing evidence of not so transitory inflation, the very mixed data on US economic rebound, the probable impending blip in US covid cases due to the delta variant – enough already.
So I would say there is a very good chance (>75%) of a 10%+ correction sometime in the next month. If so, the question becomes where does it stop and why? What do you think is fair value for the S&P500?
Answering my above question, I expect the first real pause around SPX 3950 before the end of August. Sometime before yearend we should see 3600. Where then depends on how we get there and what’s going on at the time, it could be the intermediate low (though I think 3300 is more likely) with a bounce back to 3900 sometime next year or credible possibilities exist down to 1800. Below that the financial system as a functioning entity becomes questionable.
With each passing day 3950 gets farther and farther away, with averages raising that number and either making it more expensive or just less likely. As I suggested beforehand, no one is going to ring the bell and at this juncture one either scales in a short or just stays out altogether in cash if biased to the downside. The only real value out there I see is in consumable hard assets — energy, materials, etc. as their revenue is dollar-denominated and the currency ain’t gonna go up, but down at this rate IMO.
MrMarket: You know what ya doing Jay, right?
JayPowell: Of course, M, everything’s fine.
M: I need some convincing J.
J: Why so, M?
M: Well you’re setting up a housing bust, that didn’t turn out well in 2008.
J: I don’t think so M.
M: …then a bond bust
J: Don’t worry on that score, we can just buy ’em, M
M: …then an interest rate spike
J: That could prove troublesome
M: …then a debt crisis
J: Like I said, could be troublesome
M: …and somewhere along that line I’m gonna have a big tantrum.
J: There’s no need for that M, really no need.
M: Well J, time to admit it: you ain’t got a clue, have ya?