Get Short – I Don’t Like the Market Backdrop Here

May 20, 2022

Posted 9:30 AM ET – The big news overnight is that the PBOC cut interest rates and that sparked buying in Asia. The market is weak and the price action this morning is nothing more than a bounce. There is a negative market bias and the move lower is very choppy.

This was a timely rate cut by China. Overnight several brokerage firms cut their growth forecasts for 2022. Covid-19 has spread outside of quarantined areas and an estimated 2400 Chinese hedge funds have been hit with margin calls. Property developers are perilously close to default.

Wars, inflation, recessions and viruses can all be resolved in time. Credit is the one issue that can lead to sustained market declines. High yield bonds (junk) are retreating and that is an early sign that we need to tread cautiously and keep our eyes open.

After a 12-year market rally the market bid remains strong and investors are conditioned to “buy dips”. This battleship is hard to turn. As the selling pressure builds, that temptation to buy dips subsides. That means the market bounces are shorter in duration and shallower in amplitude. Buyers start to realize that they will have an opportunity to buy stocks at a lower price and sellers realize that they need to be more aggressive if they are going to reduce risk. Eventually, the bid crumbles and the market hits an “air pocket”. We need to see that deep low. I don’t know where that support level is, but I can tell you that it is lower than most people think. We have not had the interest rate hikes and we have not seen the economic impact they will have. That will take a few months to play out. When we do hit that low it will be a gut wrenching experience like we saw in 2020. The bounce will also be furious like we saw in 2020.

For the first time in years I am going to suggest that swing traders take a ½ short position in SPY on the open today. I plan to hold this position until the FOMC statement in June. I am not going to suggest a larger position because the market decline has been very choppy.

Day traders should watch for a possible gap reversal this morning. On the surface the news looks good, but the overnight news is not going to excite buyers. There is a reason China is cutting rates when the rest of the world is raising them. Consecutive stacked red candles with little to no overlap in the first 30 minutes would suggest that you have to be aggressive with shorts. I don’t believe we will see that level of urgency after a big market decline Wednesday. A more likely scenario is an early oversold bounce that runs out of steam an hour into trading. During the move higher, mixed overlapping candles will be a sign that the upward trend is weak and that the short side will be tested. This is our best case scenario because we will have time to look for relative weakness.

Resistance is at SPY $394 and $397. Support is at $388 and if that level is breached it will trigger sell stops.
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