Coiled Spring Capital Macro Report March 26th, 2023

The stock market is anything but simple. It’s complicated enough without throwing confusing messaging from the Fed and the Treasury. Last week we saw conflicting statements come out of Powell and Yellen that sent the market spiraling.

As we alluded to in our mid-week report, the notion of not backstopping the banks seemed misplaced. Low and behold, Yellen walked back those comments the next day and the market found footing. Trading in this sort of newsy environment is extremely difficult as traders get whipsawed daily with every new headline. We wrote about this in our last weekend report and why we would prefer to tread lightly in the current environment. Traders like trends, and we are in a trendless market dynamic. The good news is that these regime shifts are always temporary and will eventually resolve in a more identifiable pattern. The bad news is that we are just not there yet.

The macro continues to deteriorate but the market won’t comply with the bears. Last week was a good example, as the Fed raised rates, threw out some confusing messaging and another large bank (DB) was facing market scrutiny. Yet, the SPX still closed up on Friday and for the week. The Russell continues to lag as it is most exposed to small banks. The Nasdaq closed up a whopping +6%.

The ST dynamics for the SPX have been well defined. Friday we tested the 50% retracement level from the March 13th low and have been confined to this bear flag pattern. The low on Friday was also the lower band of this bear flag.

Friday, the SPX broke the 200 day (yellow) but clawed its way back to close above. Clearly there is a battleground brewing and we are still carving out this bull flag pattern on the daily.

This week will mark the end of the quarter, which usually produces some wild swings, as portfolios window dress and balance their books. Here is an early look at the SPX quarterly chart.

Bullish or bearish?

The Quarterly MACD crossed bearishly for the first time since the GFC in Sept ‘22. Interestingly enough, the GFC saw the quarterly MACD cross down in Sept ‘08 and the market bottomed 6 months after in March ‘09. We are now 6 months into the current bearish cross. We are not making any conclusion, but something to think about as the market is certainly trying to price in a recovery after peaking 15 months ago.

The bank crisis continues to loom over the stock market, but the Fed insists it has it under control. But does it? The junk bond market now has the % of distressed issues jumping almost 300 bps since before the SVB debacle. Stress building in the riskiest parts of the bond market is usually a precursor to a downturn. Banking issues lead to credit contraction, which means borrowing becomes harder and more expensive. Indebted companies that have issuance coming due are most at risk because refinancing may not be possible. If you cannot pay off your debts and cannot refinance, you go into default. Our fear is that this is the next shoe to drop - corporate defaults. This is likely contributing to the lagging Russell performance and the Nasdaq outperformance, as large tech companies are typically cash rich and debtless.

There is simply no shortage of things to worry about. But maybe that’s the issue and why the market won’t collapse. Everyone is bearish and positioned for a collapse and rarely does the herd get rewarded.

The Skew Index is essentially crash protection. This spiked to the highest level in almost a year last week.

And money market deposits are now at the highest on record.

With institutional money managers being the most overweight in cash.

CTA (quants) are currently the most short for this cycle.

And now the Fed Balance sheet is expanding again. Interestingly enough, when overlaid with DeMark signals, the last 9 buy marked the inflection, and now with a flip up (green 1 on top of the line). The SPX is highly correlated to increased liquidity and despite the wranglings over whether this is really increasing liquidity, it’s hard to argue against the trajectory of the market when this is trending upwards.

And sentiment per the AAII bear/bull ratio remains quite depressed.

What does this all mean? What should we expect for the stock market given sentiment seems so stretched to the downside?

To read the balance of our analysis, please consider subscribing below for $24.95/month.

Subscribe to Premium to read the rest.