Surfing

Summary

• The first two weeks of July are supposed to the most profitable two-week period of the year, and the last two weeks of July did not disappoint either. This a step in the right direction for the bulls.
• Bulls and bears will be confused by this move higher in the market. Most of this move is from systematic strategies (computers) that are buying with corporate buybacks.
• Things could get very dynamic here, as liquidity is in short supply and systematic strategies can get price-agnostic.

Diego Thomazini

The market got back everything that it lost in June. The first two weeks of July are supposed to the most profitable two-week period of the year, and the last two weeks of July did not disappoint either. This a step in the right direction for the bulls. This could go on for a while. One of 2022’s more accurate Wall Street strategists - who called the selloff - now believes that we bounce back to 4200 on the S&P. I think we are headed, at least, to the 200-day moving average at 4344. Either way, corporate buybacks are out of their blackout period, sentiment is still low and systematic strategies are covering their shorts and getting long for the first time in months, sending the market higher. Things could get very dynamic here, as liquidity is in short supply and systematic strategies can get price-agnostic. Translation - Computers don’t care about price, and there will be no one around in August to sell. This could drive the market much higher. We expect Fed speakers to try and cool markets in the coming days.

Why didn’t the capitulation selloff come?

This is what we told you two weeks ago in our note:

Everyone is recognizing the looming recession. I see a recession looming but with a strong jobs market. What does that mean for markets? I see underweight investors and, most critically, systematic strategies positioned for a fall in equities. If that fall does not come, these computerized strategies will be forced to buy stocks and push the market higher. Most investors will be scratching their heads as the market rallies and the long-anticipated capitulation selloff does not arrive. Quite frankly, that selloff would make things too easy.

It’s the next phase of the market that is most important to this 18-month cycle. Bulls and bears will be confused by this move higher in the market. Most of this move is from systematic strategies (computers) that are buying with corporate buybacks. This brings in late-to-the-game bears who have bet against the market to cover their shorts. Underweight investors will also join the party.

There is a natural buffer to the market maintaining higher levels, and that is the Fed. For years, we have bet on the market while monetary and fiscal policy provided a tailwind. That tailwind is now a headwind as the world’s central bankers fight inflation. The Fed knows its history. The Fed cut back on its inflation-fighting policy in 1967, 1973 and 1980, which just let the wildfire of inflation rage again when the Fed thought it was under control.

As the S&P rises above 4000 (we closed Friday at 4130), it will induce the Fed to keep restricting policy - running down their balance sheet and raising rates. While it may get more difficult to raise rates, the Fed can restrict the market in other ways. The higher the market goes, the more excuses the Fed will have to raise rates. They will raise rates until something breaks. By then, systematic strategies will be long and the shorts will have covered. At some point, sentiment will change in favor of the bulls. This is precisely why the last move lower in a bear market is usually the quickest and steepest. When everyone thinks something is going to happen, something else will.

This is going to be a long process. This will be a boom/bust market for the next decade, and we will need to surf the waves.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.