It was no surprise that the NASDAQ rise at the open yesterday immediately fizzled and went nowhere for the rest of the day. The amount of the opening pop was just too tiny to incite any major enthusiasm. The good news is that even without significant upwards pressure, there was also a distinct lack of interest in a resumption of the sell-off. Instead we had a basic staring contest, with the bullish camp and the bearish camp each waiting for the other to make the next major move. I think the bears may be getting tapped out and may have exhausted this downward switch in the trading range, while the bulls are waiting for confirmation that that is the case before venturing further. In short, yesterday was a stalemate. I consider that a positive sign - it could have been much worse, with a steeper sell-off.
Hedge funds remain the key - if more of them switch to a risk-off position or deepen the capital they are willing to deploy on shorts, the sell-off will resume, but if just a small fraction of them switch from risk-off to risk-on, we could see a dramatic short-covering rally. The only problem is that short-covering rallies are not sustainable by themselves, with the bears simply waiting a day or two and then re-opening their short positions with only increased fury. The bull theory is that once a few hedge funds switch their bias, more of them will incrementally follow suit over the coming days once the rally shows some sustainability and we can then trade back upwards in the full trading range.
The Fed? Mostly that is simply noise at this stage. Sure, the Fed will most likely remove the patient language in their statement next Wednesday, but that is now old news, and most of the Fed officials and fed funds futures consistently point to the fall and September in particular for liftoff of interest rates, so there is zero short-term impact of anything the Fed might do next week. The odds of liftoff in June are down to only 19%, and 40% in July. Even September is down to 58%, which is better than a coin flip, but not a slam dunk. The fed funds target rate will most likely be only 0.75% at the end of the year, and only a coin flip 50% chance of rates being 1.00% in January and up to a year from now.
Ditto for a strong dollar - it is mostly noise and will be a net wash for most companies and stocks.
NASDAQ futures are up moderately (again), indicating a moderate rise at the open, but it is still worth noting that futures and the opening move are not reliable indicators of the trajectory of trading for the rest of the day. I'm optimistic that we could see a much larger bounce than futures suggest, but of course that is no slam dunk. And if futures and the opening move are too weak, that will only embolden the bearish hedge funds to double down. The flip side is that doubling down by the bearish hedge funds at this late stage puts them at greater risk if their bullish brethren sense that too many people are leaning too far in one direction and decide to jump on the other side with enough conviction to kick off that short-covering rally I was talking about. Either way, volatility will reassert itself.
Hedge funds like to trade on volatility, so if volatility runs low as it did yesterday, the path of least resistance - and maximum volatility and profit - is to switch the direction of the market and trade in the opposite direction, and keep switching whenever volatility runs out. That's why we see trading ranges so frequently in major advances, as we did last year.
-- Jack Krupansky