Market- Quadruple Witching Expirations Cycle.
The quadruple expiration cycle is going keep markets pegged to levels between 1450 and 1460 heading into tomorrow, and we should see real volatility pick up a bit into next week as we get past this cycle. We should get a better idea next week whether or not real money is ready to come into this market following the QE3 announcement or if the extended nature of the rally will force weak hands to back away and bring markets out of this very overbought near term condition. My take is for this to resolve in favor of a moderate move lower before an eventual reversal.
There are several indicators/studies out that strongly suggest bullish sentiment, particularly retail level sentiment, is at extremely “giddy” levels which historically suggests a move lower is eminent. Some indices are more overbought than others such as the Russell 2000 Small Caps index (RUT/IWM) and sectors such as the homebuilders (XLH) and broad industrials (XLI). In contrast, the transports which should be accompanying the rally have diverged in a major way over this past week. The rails in particular have been very weak following major downward revisions and lower guidance from several of the big players. The energy complex has also reversed course this week and is leading the move to the downside. Crude oil in particular has been wacked this week in a very strange tape.
So lots of mixed signals! What usually accompanies these times of conflicting messages is volatility which has been missing in action. The reasons for this lack of volatility in my opinion is that current market participants are confident that markets are out of the woods because of the Fed QE announcements as well as the ECBs Open Market Transactions (OMT) plan. Like I said the other day, I think the bulk of the Initial reaction to these announcements has already been priced into the market and this last gasp higher is part of a blow off move which needs to be digested. As always is the case, these last few “stragglers to the party” get caught behind and left to clean up the mess!
With that being said, the price action of late has to be respected and the consequences of what the Fed has proposed to do need to be properly digested by investors. Make no mistake about it, the Fed is going to do whatever they can to deflate the dollar versus the major currencies and that will in turn boost the precious metals, materials and commodities in general. Housing related stocks will do better in this environment which in theory should stimulate overall economic activity. We have to keep in mind that this plan of action has not worked so far, (the Fed themselves will agree on this point) after several attempts over the past 4 years and it is very likely that this will not have the desired effect as well. Perhaps the Fed knows this as well and is just buying time till after the elections for lawmakers to try (key word) and get fiscal policy right. If you read my updates regularly, you know what I think about those odds… Nonetheless, considering the time of year, when we clear the elections cycle, there could be a huge “Beta Chase” move higher into year-end as money managers and portfolio/hedge fund managers try to catch up to their benchmarks. The major pit fall to this scenario is the so called “Fiscal Cliff” and how that battle shapes up into year end.
So to recap, my favorite sectors here are the mega caps versus small caps and in particular the large cap material plays and the global commodity related plays in general. I also like the home builders on the Fed’s focus on buying MBS (mortgage backed securities). Not liking the action in the rails, energy, financials and emerging markets in general. The weaker dollar could have very detrimental effects on emerging markets as the Fed attempts to export inflation.