Morning Notes – 5/26/2022

Good Morning:

• Overnight futures are trading positively, around 4000 at this writing.
• S&P 500 volatility estimates remain in line with the last several days, allowing for plus or minus 50 points from today’s regular session open.
• It would appear from the Option Contract Open Interest released overnight that call positions were added above 4000 yesterday, with 4100 and 4200 adding 10,000 and 15,000 contracts,  respectively. That is not huge, but it was enough to kink the gamma curve.
• The Volatility Trigger, one of the critical metrics we watch, moved down to 4000. That would typically indicate that volatility will contract above that level, and the market will return to “mean-reversion” behavior. Dealers will need to sell rallies and buy dips to hedge positions rather than sell into declines and buy into rallies – exacerbating the moves.
• Our next focus is the June 15th Fed Meeting (also VIX Expiration) and June 17th monthly options expiration. Quarterly expiration also arrives on June 30th. How much “risk-on” behavior will market participants seek ahead of the Fed meeting?
• Resistance is in the 4000-4015 (SPY400 equivalent) area, with support at 3960 (SPY 395) followed by 3900. More details about the 4000 resistance area appear below.
• The market survived the release of the April Fed minutes relatively unscathed yesterday.
• The S&P 500 index could be breaking the steep downtrend (depending on how you draw it), and perhaps it will even break the 7-week bear candle streak if the market stays above 3931 today and tomorrow (and it should).
• Note that there is a positive bias moving into month-end next week. Corporate buybacks are also on the table again.
• Overnight, the market is taking out yesterday’s high, but the price is also at the expected move high (WEM) for this week, roughly 4000 on the S&P 500 index. The vertical downtrend line also sits at 4000.
• So 4000, give or take a few points, will be resistance for the rest of the week, hence the 4000 – 4015 resistance levels mentioned above. The Volatility Trigger itself can provide initial resistance at 4000 until it breaks.
• There are positive divergences and improving market internals on the recent lows, making a rally somewhat more probable here, even if it is short-lived.
• Watch for a True Gap higher at the Open and apply Gap Rules as necessary. But focus more on what happens when the Gap fails.
• Remember that the WEM high is a formidable barrier to higher prices until next week when prices will have more headroom. Recall that dealers fight to maintain these levels, which have a 68% probability of holding.
• One only needs to look at last Friday for proof. The S&P 500 Index recovered nearly 60 points in the last hour. Dealers and Market Makers staved off billions in losses by staging the last-minute rally to close a few ticks above the WEM low at 3900.
• We have to go back to 1932 to find a similar 7-week bear candle streak as we just experienced, and I don’t need to remind you what an unpleasant period marked the Great Depression.
• But alas, nothing goes straight down, and in most bear markets, we get a relief rally just about this time. I have been expecting it and mentioning the possibility on these pages over the past week.
• And the mean (21-day line) is coming down to meet us. The market could break this line, but it could even rally back to the 50-day line if history is any guide.
• When the Founder’s Group issued the swing buy signal at 3955 yesterday, we set the ultimate target to 4125. If past bears are any guide, that should be an achievable goal. Some precedents could take the market back to 4300, so we will see how it goes.
• I also have less confidence in this signal than just about any signal we have issued recently. We are moving our stop to 3975 this morning to lock in some gains and may move it higher as the day wears on.
• If you are not a subscriber (and you should be), Look for pullbacks on the hourly charts to take a position. But my overall concern for this rally and where it could take us relates to the sloppy overlapping price action on the hourly charts. Even the daily chart has a rising wedge appearance to it. Wedges are not guaranteed to lead to a price reversal, but I prefer a cleaner look to the rally.
• This rally attempt posits a one-for-one relationship between the first and second down legs from the top. If it fails quickly, the index will likely need to complete a 1.618 retracement of the first down leg.
• That brings the price down to 3500, which could also relate timewise to the June 15th Fed meeting.
• So be careful here, do not get too aggressive, and do not be surprised if this rally fails. I view it as a bear market rally even in the best case.
• As mentioned yesterday morning, the Founder’s Group also maintains an unofficial position (meaning we are sharing what we are doing instead of calling out a trade) in September Monthly TLT calls (U.S. 20-Year treasury ETF).
• We expect longer-term treasury bonds to recover gains as short-term rates rise and long-term rates fall (yield-curve inversion).
• Also, longer-duration treasuries may experience a flight to safety from further global tensions and as the economy shows signs of sputtering.

Stay tuned,

A.F. Thornton