Coiled Spring Capital Mid-week report 12/6/23

The bears were out in full force today calling for the end of the stock market rally. Funny how that works. They were bearish all the way up from the end of Oct and they are now claiming victory. How does that make any sense? They literally missed a +12% move in the SPX over the last 5 weeks. Now the SPX is -1% from the recent highs, and they feel vindicated? These people should really find another line or work, or maybe try to stop making bold calls on direction when their insights are worse than a coin flip. Sorry, we can’t help ourselves. Their perceived victory laps or incessant drubbing on Twitter are nauseatingly sensational and inconsistent with reality.

Wouldn’t you rather be right on the way up, get cautious near the top and possibly call the next move lower? That sure sounds like valuable analysis to us. Maybe they should subscribe?

It’s no secret that the first couple of weeks in Dec are notoriously choppy, as portfolios reposition and tax loss selling takes center stage. Couple that with some furious short covering into last week, and that sets up for some volatile action. We posted this last week for our members that literally talks about this seasonality and to expect choppy action.

So now we are seeing this play out but it’s the end of the bull run? Any hint of weakness and the notable vocal bears jump back on the same bandwagon that left runny eggs all over their face. We are not here to tell you that the top isn’t in for the year. It very well might be. We take the information that is given to us, and we analyze it, hopefully spitting out some thoughtful conclusions that can help our readers do what they came here to do, make money. We got aggressively long in late Oct/early Nov. We focused on SMID caps (IWM) since the middle of Nov as we believed the rally would broaden out. We removed a considerable amount of our long exposure last week and got noticeably cautious heading into this week. Remember, tops after strong trends are typically a process.

The SPX has now traded largely sideways to down since before Thanksgiving. Meanwhile, our SMID cap call (IWM as a proxy) made new swing highs this morning before succumbing to the rest of the market weakness, but still massively outperforming on a relative basis.

Making a call to be a bit cautious this week wasn’t solely based on seasonality, as most of our indicators we track were pointing to extremes. This implies the probabilities of making successful long ST bets are low. This doesn’t mean we can’t be opportunistic.

The chart below shows how stretched we were using RSI.

This chart from GS shows how much positioning from CTA’s (momentum traders) have grossed up their exposure to extreme levels.

Last weekend we showed how bullish sentiment had gotten per the AAII.

GS has an analysis that highlights returns when the AAII bear/bull ratio exceeds certain levels. Interesting to note that they have a higher probability of being positive, but returns are muted. This makes sense as bull markets need skepticism.

As we wrote in a recent report, “the easy money off the lows has already been made.” This is why it’s incredibly important to be able to identify when a trend is changing or close to shifting, because riding that trend for as long as possible is how you make outsized returns.

Today we got a soft ADP number that sent SMID cap stocks screaming in the morning before selling overcame them. Keep in mind that the Russell (IWM) had also reached overheated levels, so the selling into the strength should be somewhat expected.

While the ADP report is not that reliable a predictor of the government payroll number (released this Friday), it does set up expectations for a possible disappointment should the number come in a bit hotter. Maybe that’s why stocks gave up there gains today. A stronger Payroll could cause a lift in rates and inject some more volatility into an overheated equity market. Coincidentally, this what we cautioned about in our weekend report, and one of the many reasons we have grown tepid on the recent rally.

If we have some concerns on the ST trajectory of the indexes, what levels should be considered to counter trend trade, if at all?

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