• Weekly Comment for July 17, 2017

    Yellen's comments combined to lower than expected inflation data nicely pushed markets to new highs, making them even less affordable in terms of valuation measures. However for now, liquidity and momentum are what matters.

    On the liquidity front, we can see that money continued moving out of Excess Reserves. My guess is that some of this liquidity found its way into equities.



    It is interesting to note that since about 2014, Excess Reserves have provided about 700B$ of liquidity. In the Figure below, we can see in Blue that Active funds have also lost about 700B$ since 2014. However, passive index investing has gained 1.1T$. Although I cannot prove it for sure, I have the feeling that most of the Excess Reserve funds have moved into passive investing.



    Last week, I pointed out the negative Effective Volume divergences for SPY and QQQ, the two most active ETFs.

    http://www.effectivevolume.com/conte...r-July-10-2017

    These divergences continued into the bounce. As a reminder, the Effective Volume calculation tends to detect imbalances between large and small players. This however does not show an underlying force that will move the market. It shows a common decision by large investors to take a directional trade, which eventually will weigh on prices.

    In the case of ETFs, what we are detecting is I believe a decision by a majority of investors to book profits maybe as a realisation that index investing is a crowded trade.





    Please note below that the market bounce is almost entirely due to the 10 largest stocks, while small caps have been under pressure.





    It is also interesting to see the continued divergence taking place inside of the S&P500 itself.



    However, the Cumulative Tick continues detecting a flow of positive Ticks. This is because ETFs must follow prices higher and purchase the underlying stocks, even though at the same time large index investors are selling them.



    You might also note that US Treasuries are attracting money again.



    Conclusions:

    There are several aspect related to today's market:

    1. Last week was all about stable rates expectations. In reality, Yellen needs rates to stay low if she wants to unwind QE starting in September. It is not good to sell in a down market: that would just increase the selling. I believe that as soon as earnings are out of the way, the market will focus on QE unwind.

    2. Earnings should be good for the largest tech stocks. At least, past earnings were good and what worked well will continue working well. Big caps are the easy buying targets for most funds. However the data shows that they need to balance their portfolio in order to stay risk neutral.

    3. Index investors are afraid of what is coming after earnings. They were taken by surprise when the QQQ slipped early in June and they clearly prefer to play it safe by selling strength.

    I have no way of predicting what force will gain the upper hand and when. However I still think that shorting small caps in spikes using options is the way to trade this market.