Written 2/25/2022
A doctor friend is skeptical of the thesis I laid out in my previous piece 2022 — Here now, what next?. So this and subsequent monthly updates will chronicle how the equity market unfolds in 2022. We’ll see how closely it tracks my thesis.
January 2022 would have closed with the biggest loss in a January ever, — had it not been for the manic rally in the last two days, prompted by an oversold situation. That low was subsequently dubbed the “Omicron Bottom”. The manic rally from that low was mostly fueled by “Buy the Dip”-ers. While some of these are professionals keying off sophisticated exhaustion signals (e.g. the DeMark Indicator), a lot of these are amateurs conditioned by their financial advisors to believe “in the long run, the equity market always goes up”. They see every dip as a bargain (a proven strategy in a 40 year-long bubble). As a group, “Buy the Dip”-ers created a powerful market surge for four straight days from the “Omicron Bottom”.
By Feb 2, the market had become overbought. After close of market that day, Facebook (now rebranded as Meta) announced disappointing Q1 earnings. The next day, it crashed a stunning 26%, dragging a whole bunch of richly valued tech stocks with it. The Nasdaq shed 4% and S&P500 shed 2.5%. Half of the gains from the previous 4-day manic rally was given back.
Understandably, this much of a drop in just one day once again created an oversold situation, which invited profit-taking (i.e. buying to cover) by short-sellers. Profit taking generates a counter-trend, thus a pause in the prevailing trend. This is often misinterpreted by amateurs to be a trend reversal. Thus, more “Buy the Dip”-ers stepped in. The market spent the next 5 trading days swinging wildly within a wide band, — showing a tug-of-war between “Buy the Dip”-ers and “Sell the Rip”-ers. “Sell the Rip”-ers are typically professional portfolio managers who see every vicious short covering rally in a down trend as an opportunity to pare positions and raise cash. Unlike amateur “Buy the Dip”-ers who typically take action at open of market, professional “Sell the Rip”-ers only take action in the closing 15 minutes. That is why these 5 volatile trading days opened high, and closed low.
On the 9th trading day in February, another far-reaching event happened: CPI printed an elevated 7.5% (from 7%). Institutional investors started selling in earnest. They understood the implication: The Fed’s threatened rate hikes are now all but certain and may even be more aggressive than planned. The Fed’s new priority now is to give the unequivocal impression of fighting inflation (knowing full well their paltry rate hikes actually still leave real interest rates deeply negative and do absolutely nothing to fight inflation!) rather than protecting the equity market (which they have been doing since 2008). The range-bound indecisiveness of the previous 5 trading days instantly resolved itself on the downside, breaking below range and continuing the next day in the direction of the “Omicron Bottom”. (Side point: As much as CPI is worsening, PPI is worsening at a steeper rate. This portends profit recession and further downward adjustment of equity prices.)
Worsening CPI print, added to Facebook’s earnings miss, amounted to the Roadrunner’s startling “beep beep”. Wyle E Coyote (“smart money” in the market) suddenly rediscovered gravity. High inflation means higher cost of capital in the future, and lower forward cash flow projections (which factor into Net Present Value calculation of equity prices). Professional investors are waking up to how high above solid ground current valuations are!
Then, just like in the same time frame of 2020, an exogenous event — Russian troops entering eastern Ukraine, — came along on Feb 21. The market declined further, with all major indices breaking below the “Omicron Bottom” in just two days.
Feb 24 (yesterday) was the “spiciest” day of an already doozy of a volatile month. It opened down a whopping 3% on further Ukraine angst but suddenly reversed course, wiped out the entire 3% loss within the first hour, turned green for the rest of the day, and actually closed UP 3%. This highly irregular 6% about-face smacks of a severe gamma squeeze on dealers, resulting in amplified surges in the indices from the leverage effect of options (i.e. dealer call-buying when squeezed producing an outsized upward reflexive move in underlying stock prices, therefore the major indices). This is symptomatic of a much less liquid and much more volatile market because with the Fed hawkish pivot, trading strategies pivoted from short volatility/long gamma to short gamma/long volatility, — which resulted in dealers now trading on the same side as traders, thus exacerbating both upward and downward moves. Here is an explanation of the mechanics (fast forward to 46:00).
Today, the second last day of the month, has been a slo-mo melt-up day (read: shorts are being thwarted rather than squeezed). Will the market now return to “perpetual melt-up” characteristic of 2009 to 2021 (with just a short “Covid intermission”)? Or is this a bear market rally? Time will tell.
With just one trading day left in the month, February is pretty much a wrap. January was a month of swift downdraft. February has been a bipolar month. It was manic in the first half, recovering 61.8% (a Fibonacci number) of January’s loss. Then it was depressive in the second half (with the exception of yesterday’s dramatic 6% turnaround and today’s slo-mo melt-up), resuming January’s downtrend and breaking below the “Omicron Bottom”. True to Bipolar form, February’s price movement was choppy (some may even say “nail biting”) all month, often with one day undoing the previous day (or with market-close undoing market-open). When all’s said and done, the major indices are down roughly 3% for the month at today’s close. That means depression overwhelmed mania. Unless and until the market rises above the February manic top, interestingly made on Tuesday, 02/02/2022, — for those into numerology, — the January downtrend is still intact.
So what lies ahead? I have a sneaky suspicion I’ll be writing about Otis in March. Stay tuned.
