With the mind blowing 165 handle rally in the S&P 500 over the past two weeks, we have now hit a point of absurd smugness from the equity bulls.
I have been waiting for the opportunity to add to my short equity position, and yesterday I pulled the trigger at the close.
I have been more interested in waiting for a specific point in time as opposed to a certain price. I believe that a good portion of the rally over the past week has been the result of a massive portfolio program. Yes, of course there has been short covering and other buying, but the relentless constant bid has convinced me that there has been a massive program (or multiple programs) at work.
In my old lifetime, I worked at Canada’s largest bank as the equity index trader. I was the one executing many of these types of programs, so I know first hand how much they can affect the market. These purchases are often long term asset allocation decisions made by portfolio managers at pension funds. Regular traders would often mistakenly think that a specific economic release would change the order or send the portfolio manager back to his desk to reevaluate. But these types of orders are not affected by the day to day developments as their time frame is often measured in years.
Why then do I think that the buy order is coming to an end? This is how I think this month’s trading has played out. In the midst of the sell off at the beginning of October, much of the long term money stepped back from the market and walked away from catching the falling knife. That is partly why the decline was so scary. Once it stabilized in the middle of the month, the long term money had to play catch up. They had all the buying that they had held back at the beginning of the month, plus these pension funds often will buy more when an asset declines (and also sell it as it rises). I know that seems absurd in this momentum chasing environment, but these sorts of stabilizers are often automatic for pension funds. They rebalance their portfolio as it moves around, keeping their percentages of each asset class somewhat constant.
For the last two weeks these long term funds had some serious buying to do. That is why the rally has been so ferocious.
But let’s step back and look at the calendar. If you were the portfolio manager at a big pension fund, how would you execute your buy order? You need to be done by the end of the month, but often you aren’t allowed to trade on the last day (too much opportunity for traders to mark their positions). Plus even if you are allowed to trade, October 31st is year end for many financial companies, so it is especially dicey day to trade. Maybe you will save some for Thursday, but there is a big problem on Wednesday. Today the Federal Reserve is meeting. In my years of executing program orders, I can’t remember a single day when I got a big order on a Fed meeting day. Liquidity stinks and you never know what is going to happen. So if you were given the mandate of getting invested a couple of weeks ago and your order was really big, you would probably aim for Tuesday for the order to be complete. I think that the program buying will have finished yesterday.
From a market sentiment perspective, I have also said that too many fast money types were still looking for the decline to continue, so there was likely to be another another push higher. Here is a great chart by Yardeni that measures the amount of market participants who believe we are in a correction.
Given the crowded nature of the correction camp, the point of maximum pain was higher.
My comment from a few days ago was to wait for a move higher and then, when things looked at their absolute best – that was the time to give it to them.
Even though it feels like nothing can stop this monster bull move, I am going to follow through with my plan. I added to my equity index shorts yesterday at the close.
Now you might be saying today is Fed day and these have traditionally been up affairs. That is correct, but one of the great services that I subscribe to called Quantifiable Edges has noticed that if the stock market closes in the upper 10% of its range on the day going into the Fed meeting, there is no upward bias on the actual Fed day. The upward edge for Fed day is also muted if the stock market closes at a relative high.
When you add it all up, it seems to me that it is time to pull out the pink tickets again.
I would like to see some real weakness for the rest of the week. If that doesn’t materialize, then I will unwind the extra unit going into Friday’s close.