SPY: Squeezing The Shorts To Capitulate

Summary

• The COVID-19 pandemic took the SPY down to Depression levels.
• Monetary and fiscal stimulus changed the market calculus from Depression to only Recession.
• That resulted in a more than 62% retracement from the bottom.
• Now the SPY is above the 200-day, bear/bull line in the sand and it's reaching for a complete reversal of the pandemic selloff.
• Will the stimulus eliminate the unemployment and the recession that the pandemic promises to create?
• This idea was discussed in more depth with members of my private investing community, Daily Index Beaters. Get started today »

Is the SPY (NYSEARCA:SPY) in a bear or bull market? The bull market thesis is that money is pouring into equities because of monetary and fiscal stimulus, marching under the banner of “Don’t fight the Fed.” Trillions of dollars have helped pull the market back up from the bottom, with an enormous bounce that promises a “V” bottom, and a return to the previous market high. The shorts are being squeezed to capitulate and add to the move up, as they are forced to buy, in order to cover their short positions. Money is rotating into equities because of low interest rates in bonds. The market is ignoring fundamentals and moving ever higher on technical, Fed-created liquidity. The traders, using technical analysis, are coining money all the way up. The epidemic appears to be over in NY and the country is re-opening and returning to normal. Everyone will soon return to work. Shortly there will be a vaccine.

The bear market thesis is that eventually, the fundamentals determine price. Short term, the technical tsunami of money flooding the market and taking it higher will end. The recession, created by long-term unemployment and the global trade disruption created by the pandemic, will eventually determine lower prices. The SPY will not reach a new high, but rather form a classic, bear market, double top that will retest the low, as the recession rolls on well into the future. There will be no, quick-fix vaccine. The stimulus will prevent a Depression but not a Recession.

Which thesis is correct? Right now, the bull thesis is correct. The SPY keeps moving higher and it is now bullishly above the 200-day moving average. New York has stopped the virus spread and is slowly opening up. The summer has arrived and people are going to the beaches. Masks seem to be working in reducing the spread of the virus. As long as there is no second wave with the virus, then the opening up optimism will continue and the bullish thesis will remain intact. There are real problems in returning to office buildings, churches, sports events, etc., but these crowd centers are adjusting just like the beaches. The bull thesis needs a quick vaccine, no second wave of the virus and a big drop in unemployment.

The bears don’t think this perfect scenario will evolve. They don’t see any vaccine within 12 months. They don’t see a return to full employment. The possibility of a second wave in the fall is high without a successful vaccine. The epidemic is a rolling one, going from state to state in the US and country to country around the world. Short term, the bulls are winning, but long term, unemployment and poor earnings for many companies will keep the economy in recession and take the market down again. The pandemic has disrupted the way we live, work, and spend. There is no going back to the old high in the market until we have a vaccine. Meanwhile, as the market continues higher, the shorts are squeezed and are forced to buy at the top.

What is the small investor, using fundamentals, to do? Short term, he can tear a few pages from the trader’s handbook. “Don’t fight the Fed.” “Don’t fight the tape.” “Buy the bottoms and sell the tops.” “Timing is everything.” Meanwhile, every day we identify stocks with fundamental and technical buy signals in a pandemic market.

The bears, based on fundamentals, have the timing wrong. Short term, they are dead wrong. Long term, they may be right, but broke because their timing was off. Most professional bears are hedged with long positions and it is unlikely they will have to fold. Instead, they will just wait it out.

We can see the battle of the bulls and bears taking place in the chart below. Hindsight being 20/20, we can now see the bottom that needed to be bought. We cannot yet see the top that needs to be sold. You can see the signals turning up to be bought. We will see the signals turning down to be sold. The final lesson in the traders' handbook: “Wait for the signal.” The SPY is overbought, but it can stay overbought for weeks to come.

For the bulls to be right, we need to see a green spike in money flow, a golden cross, where the 10-week moving average crosses above the 40-week, and a crossover in the signal at the bottom of the chart. Volume is not showing a buy signal that could do that. However, a vaccine might do the trick.

Analyst’s Disclosure: I am/we are long SDS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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