Spent

Markets often tell you when they are exhausted. Last week the market spoke loud and clear. Just like a cross-country skier at the finish line, It was done. Finished. Spent.

It made what I'm calling a classic "Taylor" non-con. Just what I was waiting for.

This technical concept (and many others) was taught to me by a great student of the market, Pat Taylor, who has since passed away. His work helped over many years and I miss his friendship and guidance every day.

The two charts below demonstrate the concept of 'non-confirmation'. The S&P 500 made its price low on Friday of last week. The VIX for the same time frame is shown below and notice it failed to confirm by not making a new high. Failing to make a higher high on Friday morning as the market was tanking is the essence of the non confirmation.

And, yes, the VIX really did put in its high around Tuesday at 11. Really.

S&P 500

VIX

This indicator along is not necessarily the 'all clear' for the market, but its a strong clue that the bottoming process is beginning.

We now know the point of maximum uncertainty was reached on Tuesday, followed by a Wednesday's dead cat bounce. Then the markets made a secondary, 'Non-Confirmation' low on Friday morning. That pattern is a dead give-away that showed that the market was spent on the downside.

Other technical indicators, such as accumulation/distribution and breadth, also failed to confirm the Friday plunge. It is a typical set-up that technical analysts use to determine if the market correction has run its course.

Although the low looks to be in, the risk model will need time to kick back into gear. The market's oversold position needs to be 'worked off'. Yesterday's bounce was 'too far, too fast'.

Patience is needed here. The psychological framework of complacency that was in place for all of last year has been shattered.

There should be a choppy testing phase that will help determine if a leadership change is underway.

Rotation to New Leadership?

As yet, there has been no sign of the momentum/growth sectors ceding their grip on the market. The lack of rotation into value groups was severely hampered by the coincident plunge in oil prices. Many value strategies have a high weighting in energy stocks.

Energy's underperformance, while seemingly unrelated to the VXY ETF panic, was notable. I have been wary of the crowded 'long oil' trade for weeks now and was looking for some unwinding during this seasonally weak period. The WTI oil contract is a victim to the same unwinding as other risk assets. Financial players often use oil as a risk-on asset play. I'm now looking to accumulate oils for the first time in six months but I'm not in a rush.

M2 Velocity- Bottoming?

Commodities are in focus now that inflationary fears have been reawakened. Non-energy commodities have held up well during the financial purge of the last 10 days. The velocity of money (above) looks like it could be bottoming - a cyclical positive. The steepening of the Treasury curve last week supports the view that the Fed is reluctant to get ahead of the market and over-tighten causing an early end to the cycle.

The CPI due tomorrow has taken on heightened importance after the recent wage inflation scare. This month's reading could be the last tame one before we start 'lapping' the Q2 weak patch and start printing readings above 3%. We could even get a surprise downtick in CPI given the strong data from last year. Bonds could rally, given how much of a consensus the 'short duration' positioning has become . But I'd still sell any rally in the long bond.

An impressive recovery in the cryptocurrency space reflects regulatory fears have been overblown and not likely to have immediate effect. I don't find it a coincidence that this asset class also bottomed last Tuesday. The resumption of the crypto-craze is a now a reliable short term sentiment gauge similar to the VIX.

The Chinese holiday season starts this week and the positive seasonality effects usually means a cessation of selling pressure. Copper seasonality kicks into high gear in mid-February and lasts until May. Gasoline usually peaks in late May as well. Lots of catalysts on the horizon.

Lastly, volatility is back with a vengeance. Another mentor of mine, Horst Mueller, used to say that this phase of the market is characterized by a "struggle" between conflicting leadership. Only the most nimble of traders will outperform. It also portends a topping phase, which is congruent with my long-standing view of a Q2 peak.

This week's shot across the bow was definitely a sign that the year ahead will be nothing like last year's complacent buy and hold melt-up.

Goldilocks is spent.

Who's up for a bit of trading?

Risk Model: 2/5 - Risk Off

The notable change from last week came on Thursday when the AAII survey results which showed an abrupt reversal of the massive surge in exuberance shown in January (see below). This is understandable given the sharp price swings but the measure did not take out previous lows - an encouraging feature given the massive media coverage of the sell-off.

Similarly, the Vix will take take time to work off the huge selling pressure that followed the VIX ETF product collapse.

On the positive side, the Copper/Gold is still bullish and the market remains within the comfort bands by the 200 day moving average. The RSI is deeply oversold but we must wait a bit longer before the all clear is blown.

AAII BULL/BEAR Ratio