Before we get into the markets, we need some context for what’s going on right now.
The Federal Reserve’s poor signaling has led to interest rate volatility, and that drove equity volatility as we headed into December.
Things… well… accelerated recently with the European conflict and the massive spike in commodity prices.
This is an instance where we have a “known risk,” but the outcome hasn’t been fully fleshed out. We have war, diplomacy, and all sorts of other hairy geopolitical risks that can spill over into stocks.
I don’t have the hubris to say our levels are 100% predictive in a news-driven market. If things accelerate, then you can easily see a liquidity crunch… and things get weird.
That’s why I highly recommend being very tactical and aggressive with your profit-taking in this market.
All that aside, our levels have been performing very nicely.
The week’s trading range was constrained within levels that we pointed out weeks ago, and we had a failed auction higher that brought us back into that range.
Our Trading Roadmap performs well when it comes to identifying pockets of liquidity with the highest odds of seeing movement away from them.
Now, onto the markets:
SPY Chart
A lot of traders think that price levels are no longer valid once they’re broken.
I disagree.
We’ve seen many instances where the market clears a key level, reverses back, and then that level holds again.
We’re seeing that play out with the 425-428 zone on SPY. The market blew right through it on a few occasions since liquidity simply wasn’t there, only for the market to regain that level.
This is currently the “must-hold” level for me.
We had a clean response off it on Friday, and that can lead to price stabilization. If we get that, alongside some realized volatility compression, and a drop in risk premiums, the stage is set for a sustained move higher.
That is a “prove it to me” kind of scenario. We still haven’t seen any kind of clean hold above the 435-437 range, which will soon coincide with the Anchored Volume Weighted Average Price (AVWAP) from the recent trading highs.
QQQ Chart
We have a very clear over/under level for the Nasdaq. 343 is a level where we’ve seen failed auctions lower on most of the days.
For instance, we didn’t see a sustained hold under that during January’s pullback,
The February crush absolutely did break under it, but once it recovered, we saw most of the action last week hold that area until Friday.
Our bull case is that we could call this a back-and-fill after a capitulatory low where the Nasdaq had a “close enough” retest of the March 2020 AVWAP.
Yet, I would be a lot more comfortable if the market could actually hold above 343 right now.
On the macro side, something I spent my weekend thinking about was energy risk with respect to the large-cap tech stocks.
Remember, you’ve got 6 stocks — MSFT, AAPL, AMZN, GOOGLE, FB, and TSLA — that make up about half of the weighting in stocks.
My question is:
How much energy risk does MSFT carry right now?
Sure, rising rates may change how investors allocate capital to tech…
But these mega-cap tech stocks have massive floats, solid cash flow, and probably more cushion against the risk in Eastern Europe.
This is why I think much of our price volatility is a function of changes in Fed policy. We have a Fed rate hike coming up in about a week, and if the Fed manages to hike and provide better clarity, you could see forced liquidation in large-cap tech stock.
That narrative is nice, but it has to be confirmed by the price action — which is why I’m focused on that 343 level.
If we hold that, 354-357 is next up. That will capture the AVWAP from the December swing highs.
IWM Chart
I’m still pointing out the relative strength in small caps.
While the other indices were getting wrecked in February…
We saw a clean double-bottom hold on the Russell.
Similar to our level in QQQ, the 197-199 area has led to some buying. If we get a hold here, we may finally see that push to 210-212, a huge level with many indicators lining up in the same area.
Other than that, we just need to assume high vol and reversion until proven to the contrary.
Some sectors that are very hot right now — small-cap energy is a good example.
Perhaps the index composition here could help provide some tailwinds to the index.
VIX Chart
I’d love to flesh this out more, but one of the reasons we haven’t seen a rip-your-face-off bear market rally is that we haven’t had the kinds of option dynamics that spurred previous rallies.
There’s something called a “vanna squeeze,” where a hard drop in the VIX leads to a forced buy-in in stocks — more participants are trading options, and overall market liquidity is trash.
VIX is sticking above 30, and justifiably so: There’s war in Eastern Europe and market liquidity has continued to drop.
Protection against risk will stay elevated until we get some newsflow that changes that fact.
It’s always possible you’ll see hints of it before the news comes out. If the VIX starts getting crushed out of nowhere, don’t be surprised if there’s some front-running by those “in the know.”
That’s all for this week’s Market Primer.
To learn more about the Roadmap I used in today’s analysis:
