A Sad State of Affairs – Morning Outlook 2/18/2022

A Sad State of Affairs – Morning Outlook 2/18/2022

Housekeeping

As a quick housekeeping item, I have to make a few changes for the remainder of the time I am on the left coast in the Pacific Time Zone. As you probably know, a lot of work goes into each morning outlook – several hours at the very least.

I have been getting up at 4 am and rushing to get this out at the last minute. It doesn’t give day traders much time to digest the information, and it is wearing me out. Then I have to correct typos after rushing out the commentary, and I am hardly ready to trade myself.

Needless to say, I got spoiled in Europe, where the U.S. stock market opens at 4:30 in the afternoon, and I have all day to prepare and write. I will be returning to Europe in late March or early April.

I wait to write the analysis until the morning to add the overnight futures data to the report. But I realize that micro-level information is not important to most of you. For our non-leveraged swing strategy and those interested in the big picture, I will now be writing the macro perspective in the evening after the close.

I will then publish the chart of important micro levels for day traders in the morning with a few relevant comments. This saves a lot of time and allows me to deliver the information more timely.

Day traders are a specialized, technical audience. This change also complements the new day trader subscription service, which adds the trading plan for the day, live comments/alerts, and the trading room. You will need our ProTrading App for the additional alerts. Drop me an email at info@BluPrintTrading.com if you are interested. There will be a formal announcement soon.

With housekeeping out of the way, let’s move on to the big picture analysis.

Current Market Analysis

As I have been communicating, the stock market is best described as regressing to its long-term mean from the top of its multi-timeframe channels, including the 100-year pathway:

I don’t mean to beat a proverbial dead horse, but this perspective is important to understand why the market is so volatile, and declines could exceed recent experience. The long-term channel is another way to look at valuation, which is historically and unsustainably high.

But nothing goes straight down – except maybe once in 1929. Our Navigator Swing Algorithm Strategy has recently been in cash, with positive year-to-date returns that have significantly outperformed the benchmark S&P 500 index. We are awaiting another tradable swing low to deploy cash, which we expect soon.

The market has been rising out of the 20-week cycle trough. The trough is due about now, but the first low came in a bit early in January. A full retest of the low is not unusual in such cases and might be underway. Perhaps the orthodox low is not in place yet and will happen in the next few sessions.

Alternatively, the cycle could have had an early peak associated with “left translation.” We could be heading to significant new lows in such circumstances – the most bearish outcome.

Today, the 4406 lower support boundary identified in this morning’s report failed to hold, triggering a break through the Put Wall and putting the market algos into a negative gamma spiral, as can be seen in the 5-minute S&P 500 Futures chart immediately below:

While there are always buyers and sellers in the market, options trading volume has grown so exponentially that it influences day-to-day price action considerably. I keep abreast of key levels where most put and call options congregate.

The big picture is that market makers/dealers have to sell futures on a break of the Put Wall to handle the negative gamma (movement). Selling futures to guard the volatility of dealer inventories exacerbates the decline. The Put Wall is the price location of the largest amount of put gamma where dealers are short. More often than not, the wall provides support as dealers unwind hedges and restructure trades.

When what should happen doesn’t (WWSHD), we need to pay attention. The failure to hold the Put Wall becomes a bearish signal in and of itself.

The cause of the accelerating bearishness is a combination of Fed Policy concern, uncertainty around Russia invading Ukraine, and unstable authoritarianism in Canada. Truly, I don’t know whether Russia will invade or not. What disappoints me is that I cannot believe or trust my own government.

This administration (and certainly many others that came before it) has done nothing but lie and distort everything from China Virus and vaccine information to monthly economic data. They seem to be in the “fear” business rather than running the government – which is in shambles. The fear-mongering is so bad that it is now called “fear porn.” It is a psychological strategy to keep the population off-kilter and dependent on the current rulers. Understandably, the market puked on President Biden’s assurances today that Russia will imminently invade Ukraine.

But what will the administration do about it? I hear many threats to Russia, but what will they do to help our Country and citizens? As one example, what will the administration do to ease oil prices? Will they allow our domestic oil industry to gear up? Will they allow the Keystone Pipeline? Any such move would take some wind out of President Putin’s sails.

This administration caused almost all of the exigent circumstances we are currently experiencing. Their attacks on our own energy industry have enriched Russia with near $100 per barrel oil prices. Russia’s debt to GDP is 17%. Ours is a record 135%.

Presidential administrations encounter economic cycles and forces beyond their control in the usual situation. A President’s success or failure can frequently be the luck of timing in the credit and economic cycles. But that is not the case now. The situation at hand can directly trace back to this administration’s decisions and policies over the past year.

Both Russia and Ukraine dispute the Biden Administration’s invasion analysis. Supporting that view, oil prices fell significantly yesterday and today (-7%), as you can see in the crude oil futures chart below:

One would not expect oil prices to be falling if Russia was about to invade. But gold just hit 7-month highs, and treasuries are rallying. Upward bias in these safe-haven investments might indicate a fear trade to “risk-off” assets. I am also following the Russian Stock Market ETF (RSX). Like our stock market, the RSX ETF was weak today. Accordingly, the money flow signals are mixed.

Is it inflation? Fed Policy? Russia? What is truly influencing the price of risk and riskless assets? To me, the best proxy to follow for an invasion is the price of oil – which is declining for now.

In the final analysis, I give more credence to institutional money flows than dubious government rhetoric. I will continue to observe oil prices, the RSX, and other objective measures to help us make good decisions in the days ahead. I know for sure what Ben Franklin deftly observed so many years ago. As difficult as it is, you have to “buy on the canons and sell on the trumpets.”

The various support levels below the market are marked with green lines in the S&P 500 Futures 5-minute chart above. Below is a macro view of the lines on the S&P 500 futures daily chart with labels:

The market could find support at any one of these levels or violate all of them. The most important level to test is 4211, the recent January low (also the October 2021 low). If the market gets to that level in the next few sessions (it may even briefly dip below it and run the stops), I would be very interested in redeploying some cash.

The weight of the evidence suggests that there will be lower prices from today’s low. But there are always countervailing forces, levels, and short-covering rallies. Most of the monthly options expire tomorrow at 4500. That could put some light tailwinds on price, though it did not seem to help today. And even if it does, the lift might only be a one or two-day wonder.

The 4211 low is a good target and will hold in the short term, in my best judgment. It should give us another good rally leg to work that lasts more than a few days, like the first rally from the January low. But I won’t know until we get there. We need to look for the usual positive divergences in momentum, breadth, volatility, etc., compared to the January low. It is one of those “I know it when I see it” moments.

Further irresponsible political rhetoric or a real Ukraine invasion could cause a crash. But that is the lowest probability outcome – with the volatility index (VIX) already trading near 30. I wish I could brush aside crash concerns, but I have to keep the slight possibility on our radar.

With monthly and weekly options expiration tomorrow, it is not a good session to day trade, as there can be price movement distortions associated with expirations.

Summarizing then, we believe that a tradable swing low is close at hand. The most likely level to target is a retest of the January low at 4211. But we need to keep an open mind and watch how the market reacts to the trendlines slightly above the target. Government fear-mongering will keep volatility high. A full-on crash is unlikely unless a serious conflict between Russia and Ukraine breaks out.

Don’t confuse a waterfall decline and spike low to test the 4211 level with a crash. Both are unpleasant, but one is a correction, and the other telegraphs economic calamity and a serious bear market.

Anything is possible, but now you know what is probable.

A.F. Thornton

AF Thornton

Website: https://tradingarchimedes.com

A.F. "Arthur" Thornton is an expert in logic, risk/reward quantification, market fractals, pattern recognition and asset class behavioral analysis with 34 years devoted to developing algorithmic and quantitative trading systems. In addition to trading his own capital, Mr. Thornton designs custom algorithmic and quantitative trading systems for a small and exclusive group of exceptionally qualified traders.

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