Is This Market Rally Legit, or Nothing But a Head-Fake?

Is This Market Rally Legit, or Nothing But a Head-Fake?

Posted On May 27, 2022 4:09 pm

Stocks broke their 7-week losing streak with the major indices now up some 7.5% from last Friday’s low. The question again is if this is a bear market rally, or have we put in the low?  Quick answer, we have certainly put in “a” low, whether it’s the low remains to be seen. 

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Last week, I noted that Options360 started to shift into some bullish positions as I thought a bounce could occur.  However, I believe the SPDR S&P 500 (SPY) will run into resistance around the $417-$420 level. So, with the SPY hitting $312 today. I’m moving to a more neutral stance such as establishing an iron condor in Walmart (WMT) and may begin looking for new bearish positions. I still think Apple (AAPL) could be a good short, above $150, so I’m keeping a close eye on the price action. 

One thing I and others keep harping on — in terms of finding “the” low — is the capitulation panic of indiscriminate selling, accompanied by a big VIX spike above the 40% level. I’m starting to think we might not get such a day; at least not anytime soon. I think we’ve already had a series of mini-capitulations across various pockets. Remember, for most of 2021, big-cap tech masked the total destruction of the speculative money-losing ‘disruptor’ companies. Hence, a large market swath has already seen a capitulatory crash. It’s just not showing up in cap-weighted measures that would normally show a capitulation “whoosh”.

SPX volume momentum

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It could be that this level of selling pressure can remain elevated without hitting an extreme and can last for another few months as the SPY eventually works its way down to my $340 target.  This seems to be the scenario that the VIX is expecting. Looking at the term structure, one can see it’s fairly flat with nearly all futures contracts trading around the 28 level, suggesting expectations of volatility remaining elevated for the next 4-5 months.

vix futures term structure

Another area showing signs of waving the white flag is the steep drop-off in individual speculative trading, especially via the use of options. Call option volume by retail during 2020-2021 dropped back to near pre-pandemic levels.

average options trading value

To my mind, this all adds up. This rally is welcome, but temporary relief.  We still need to wring some excess from the market.  It just won’t happen in one day.

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.