Regression to the Mean – But Which One? Morning Outlook – 2/14/2022

Regression to the Mean – But Which One? Morning Outlook – 2/14/2022

Happy Valentines Day. The market was down again this morning but has recovered on news that Putin is still willing to talk solutions to the Ukraine problem. I had some technical issues with the video last night, so it will be out later today. But let’s face it – you already know the issues.

Our 7.5% inflation rate is now the same as Mexico’s. Under the old formula, it is nearly 14%. So interest rates have risen, and the Fed will begin to catch up with them in their March meeting. The bond market has already set them. Whether rates continue to rise depends on future economic data and geopolitical risks – e.g., Russia invading Ukraine. Anybody who says they know what will happen is a fool. All of this will be data (and news) driven.

A large inflation component, Oil prices are approaching $100 per barrel. In part, higher prices are due to the Biden administration’s ill-conceived policies. But there is also a component of geopolitical risk in the price. How do I know that? Contango.

No, contango is not a new kind of dance. It means I can buy oil futures for year-end in the $80 per barrel range even though the price is close to $100 now. Normally, future prices are higher than current prices. So the market sees a short-term rather than long-term oil price risk.

The stock market is coming off a multi-timeframe channel top, including the 100-year channel. It overshot the mean to the upside with the friendliest Fed policy fuel ever conceived. The market has been waiting for a catalyst to start the ball rolling in the other direction. Now the market needs to snap back like a rubber band.

The market is likely beginning its journey to the middle of the 100-year channel, and we hope it doesn’t overshoot it like 1929. Certainly, the market could crash into the middle of the channel (unlikely). It can move sideways over several years (likely). Price could ride the top of the channel for longer (unlikely). In rare cases, the market can form an even higher channel (very unlikely).

Today, the middle of the 100-year channel is roughly 2200 on the S&P 500. The middle of the 2009 bull market channel is 3500. These numbers will rise over time, but the market will eventually work its way somewhere in between those levels. This is all normal.

I will continue to post the chart below as examples of the different ways the stock market has resolved this rubber band snap back concept in the past:

And here is the current picture on close-up:

That’s it. You have everything you need except a travel guide if you understand the analysis above. I will be your travel guide with the help of the algorithms I have developed over the past 35 years.

Already this morning, Putin has agreed to more talks, and the stock market has snapped back from overnight losses (see heatmap chart below). But short-term interest rates jumped on the news that war might not be available to tamp down interest rates. Get used to the volatility.

We are 100% cash for now in our intermediate and long-term strategies. We will continue to look for a new entry point if the strategies can endure the current volatility. I prefer to keep the round trips minimal in those strategies, if possible in the current environment.

Day Traders

Always mark the previous week and month’s open, high, and low on your screens. Mark the overnight high and low as well. These are inflection points. Price is not always near these levels, but they are important when nearby. For example, Friday saw the price drop below the weekly and monthly open to turn both candles red.

Overnight inventory is net short which may boost the open. I see major resistance today at 4397, 4410, and then 4500. Major support lies at 4344 and 4300.

Monitor geopolitical events carefully and use stops. Remember that Bad-Cop Fed Governor Bullard is already out with more hawkish comments on Fed tightening pre-market. European Central Bank President Lagarde speaks starting at 11:15 am EST. Also, the monthly options expiration is Friday, which has generally resulted in a dip over the last year. I will have more analysis on expiration as we get closer.

There are a lot of puts in the market, and the put/call ratio ended Friday’s session elevated. At current implied volatility (IV) levels, incrementally large moves are required for puts to payoff. This may deter put buyers and may incentivize put sellers to step up. Long puts closed could lead to positive delta hedging, which would support the market.

Current high IV is linked with large IV swings (vol of vol), which in turn can lead to rapid, amplified hedge adjustments (IV down = buy hedges, IV up = sell hedge). In other words, we do not need a change in large put positions but just a repricing of put positions to initiate large hedging flows.

If IV declines and the market does start to rally, use a break of the overnight high at 4428 as your first hurdle, then the 200-day line at 4450, then the 21-day line at 4500. As always, monitor for acceptance. If the puts run for cover, the move could be quick and decisive. The S&P 500 would require a few closes above the 21-day line and Friday’s high at 4520 to start a new leg higher.

Moving south, taking out the overnight spike low at 4354 gets the ball rolling for a test of the rising trendlines, Weekly Expected Move low, and January lows, as pointed out last night. For now, my best judgment is that it would take something the market does not know to drive below the January low today. This morning, Putin’s agreement to further talks could easily reverse, and all bets would be off. Here is the updated daily chart:

Here are my key levels. Everything I monitor is on the chart, but I emphasize following the roadmap and numbers outlined in the paragraphs above.

Good luck today!

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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