Morning Notes – 5/3/2022

Good Morning:

• The stock market kindly followed yesterday’s forecast, finding support at 4050 and rallying into the close.
• The short-covering rally recovered all of the morning losses.
• The recovery was impressive, and the case for 4000 or so to serve as the lower boundary of a new trading range grew stronger.
• Futures are at 4150 this morning after overnight highs of 4175. Our volatility estimates align with the last several sessions at 1.2%, or about 52 points plus or minus the open.
• Today, resistance will come in at 4200 to 4210 (SPY 420 equivalent), then 4250 if that level doesn’t hold.
• Support should start at 4110 (SPY 410 equivalent). If that level doesn’t hold, the next critical support is yesterday’s low at 4051 and our previously identified 4000 lower boundary.
• Remember that 4000 is the option strike with the most open interest. Typically, the market will encounter significant support at any such strike price when coming from above it.
• I would give a slight edge to a rally out of tomorrow’s Fed announcement, but probably not more than 5%.
• The same fuel as February is not present – but there is some fuel in the larger “short-covering” sense.
• We still need to get past the monthly options expiration on May 20th to have an all-clear signal.
• A sharp 5% rally could place prices back above 4400 and into positive Gamma territory.
• And if investors are willing to start taking on risk again, perhaps one could say that with a lot of jawboning and a few measly rate hikes, the market already did the Fed’s job for them.
• In that vein, the Fed is catching up to the market, not leading it.
• For example, mortgage and 10-year treasury rates have doubled to 5% and 3%, respectively, in a very short period.
• And to this point, the Fed has only raised short-term rates by one-quarter of 1%.
• And I have NEVER seen the Fed tighten after a calendar quarter of negative growth, a bear market, and an ensuing recession.
• The Fed will tighten tomorrow for credibility purposes and catch up to the bond market. But they will not need to do much more from here.
• And if the Fed chooses to continue persistent tightening after this meeting (at least to the extent they previously indicated) it could lead to an all-out economic disaster.
• One hopes that the Fed will respond flexibly to conditions as they develop, rather than stick to a rote or deterministic schedule.
• In the meantime, the stock market likely moves into a holding pattern until tomorrow’s announcement.
• It is too early to predict anything beyond a 5% rally on the bullish side. And it is never a good idea to marry any prediction up or down. Successful traders always keep an open mind.
• But should this bear be comparable to 2000 or even 2008, the market did not start the most significant decline in the series until late summer.
• In those challenging bears, the market was choppy and volatile between now and then – with 10% to 15% swings in asymmetrical trading ranges.
• But the 50% decline that ultimately took out the analogous lower boundary (4000) did not end until the following March, at least in the 2008-2009 case. (See chart above).
• So you can see why, from the first day of this bear back in early January, I have persistently argued to be on alert for a trading range, and perhaps one that will last a long time.
• As they say, those who do not study history are doomed to repeat it.
• I study history to the proverbial tick.
• So the bottom line is – I give a slight edge to a 5% short-covering rally from tomorrow afternoon’s Fed announcement. Otherwise, the price will continue to work down to about 3500, which is the 1.618% extension of the current range.
• Either way, we will be ready.

A.F. Thornton