Market Update / Window Dressing

Being the last week of the quarter (Q4 starting Wednesday), we know that we are seeing some of the effects of Window Dressing at quarter's end, "The Art of Looking Smart" where funds drop underperforming assets and pick up the out-performers, typically the last week of the month, more so the quarter and end of year. Keep in mind the T+3 (Trade plus 3 days) settlement rule as well, which would have made yesterday one of the heaviest days for Window Dressing.

What is Window Dressing? It's how funds appear to look smart by selling the worst performing assets in their portfolios for the quarter and replace them with the best performing assets for the quarter, so when a new perspective client looks at their "last reported" holdings, they are amazed that the fund had all of the hot stocks for the quarter, even though they may have only owned then for the last few days of the quarter. Once the quarter ends (Tuesday September 30th, they can go back to whatever stocks they like which may include deeply oversold dogs that they may like for a short squeeze or an oversold bounce. It's pretty clear small caps and mid caps have been the under-performer so it's not surprising that they'd be dumped in to the last week of the quarter which shows up in breadth types as well as the relative underperformance of the Russell 2000.

Another reason they may window dress is for regulatory reasons. On April 30th, the end of the month (still window dress, usually not to the extent of quarter's end or year end), the F_E_D's 1-Day Reverse Repo facility saw the second highest usage ever as banks tried to shore up their collateral position for the end of the month reporting, making them look stronger to their regulators who happen to be the same people they borrowed the collateral from.

On June 30th, the end of Q2, the same 1-Day Reverse Repo facility saw the highest usage ever with 94 banks using nearly 1/3rd of a trillion, which of course is returned the very next day, it's just a shadow game, a farce and the F_E_D likely permits it as their regulator because the F_E_D has absorbed most quality collateral through Q/E purchases, leaving the banks with very little left over, which is one of the reasons I suspect the F_E_D changed its tune from "Holding assets until maturity" to "Shrinking the size of their balance sheet".

It's hard to look at the market and not consider all of this so I've taken a quick look based on Window Dressing and what I might see that seems out of place.  One of the first things I thought of, although this is just off the top of my head , is the T+3 rule which was yesterday, with the worst market performance in 8 weeks and the European hedge fund shutting down 4 of their portfolios in the US, it kind of makes me wonder about the timing and the reasoning for doing so.


From a breadth point of view, the market has been selling assets which we can see by the percentage of stocks above moving averages having fallen to new lows on the year, some of this is recent, a lot of it has been a trend since Q3 opened on July 1st, it is that clear,  you can see July 1st as a clear demarkation zone of severe deterioration. So I suspect there's a little of both going on, overall asset reduction and window dressing making some of the more recent indications really bad like last night's chart of the Percentage of NYSE Stocks ABOVE Their 200-day Moving Average, which hit a new low for the year while the percentage of stocks above their 40 day moving average is a mere 21.5%

The  Percentage of NYSE Stocks ABOVE Their 200-day Moving Average at less than half of all NYSE stocks and a lot of deterioration since July 1st (Q3), nearly at new low and with price (SPX in red) where it is, this is the worst breadth divergence since before 2007's top. Advance Decline lines are showing the same, the NASDAQ Composite being one of the worst, with a recent report that nearly 50% of the Composite's stocks are in a technical bear market, down OVER -20% with the Russell at 40% and probably much worse given the last week or so.

From a Leading Indicator point of view which I just finished looking at...

 My two newer custom indicators with the SPY on top, the SPX/RUT Ratio in the middle and the VIX Inversion at the bottom.

The VIX Inversion is "close" to a short term buy signal, I'll show you this in greater detail. The SPX/RUT ratio is showing near by positive confirmation as the market runs flat here which  is where we see the heaviest underlying activity whether it be distribution (usually after an up-trend) or accumulation (usually after a down-trend).

 On a longer term basis using the same indicators going back to mid July, the SPX/RUT calls the July decline in to early August and then gives a much larger positive signal during the week of stage 1 3C accumulation from 8/1 to 8/8. Also just before, the VIX Inversion gives a buy signal at the red bars, this is a pretty large one, you can see a smaller one to the left and the difference between the trends that came after the signals, they are proportional to the size of the signals given.

We do not have a current VIX Inversion buy signal right now, but we do have the highest VIX inversion since mid-August.

Looking at the Short term VIX Futures, VXX with the SPX's price inverted (over the last day or so), there's weakness in VIX futures relative to their normal correlation with the SPX.

The same is true of Spot VIX.

HYG (High Yield Corporate Credit) was forecasted to lead the market to lower lows and it has done so this week which is going to be a problem for the market, but I'm looking at the very near future rather than the big picture which is already pretty much set in stone, it's hard to make a stronger case than what we already have,  that being said, nothing goes straight up or straight down. After the initial break in 1929 of the market from approximately October 14th to November 14th,  few realize that the 1929 crash saw a 5-month rally for a 50% gain just after the first break of the market and then 5 more significant counter trend rallies until the 1932 lows.
 

 The longer term HYG/SPX relationship shows the July decline being called by HYG and it has led the entire August cycle by 4-7 days on average, doing everything before the market with the market flowing. The negative HYG divergences in red, the slight support for last week's head fake move (Chimney) in white, although it failed as HYG's position would suggest and now HYG leading at a new negative low below the August market lows, all in all a very dangerous situation for the market, but still in between here and there, we have some interesting signals.

 HY Credit has been flat, earlier in the week this was a leading negative signal, now it's a neutral signal, although there was a little negative reaction today which I suspect is connected to Bill Gross/PIMCO. While this is not a positive signal, it is neutral and considering market tone, that's somewhat positive, yet also a very short term indication.

 The pro-sentiment indicators didn't say much beyond yesterday's signal of a higher market this morning / today, I'll check them later again.

TLT however has been on a tear to the upside since we called the reversal in the August pullback, this also fits with equities moving down. While I think a lot of this is safe haven flow from one asset class to another, we can't forget the shortage of collateral at US banks so buying up treasuries before the end of the quarter, judging by past utilization and a new record high for the F_E_D's 1-day reverse repo facility specifically on April 30th and the last day of June (Q2), this would make some sense, however I suspect it's a blend of both.

Although this could mean as the quarter ends and the new quarter starts Wednesday, there "could" be a flow out of treasuries and back in to stocks having "fooled" (wink wink) the regulators and investors.


 Short term yield action is also somewhat neutral here after leading the market...

 On a longer term basis the dislocation would suggest the SPX move to approx. the $2000 area "if " it reverts to yields as we have seen so many times in the past (which is why we include this as a leading indicator).

 The Intraday TICK is wild, but about even between about +1000 and -1000, no trend except flat.

When I looked at this, I immediately jumped to the SPY chart thinking I'd see a Doji star on the daily...

  and there it is, it's also a Harami or inside day, which is a short term upside reversal signal. We'll see how it holds in to the close as well as volume.

 My Custom TICK chart shows the same, a kind of pinching neutrality in breadth.

Finally the Most Shorted Stocks which have been getting pounded are now moving lateral all of the sudden, an interesting change of character when taken with everything else above.

I didn't include 3C charts because I knew this post would take some time and they wouldn't look the same by the time it was posted, but I will take a look and post anything of significance that I can confirm.

What I'm essentially saying is that there's something going on around window dressing and I suspect there could be a change in character as of the 1st of October on a short term basis as small caps and mid caps have been dumped, they may be bought back on an oversold bounce or short squeeze attempt. I don't have much more evidence at present than what's above, but it is a start and the start of the Week Ahead analysis.

I don't want to short in to this weakness which is why I have been waiting for a bounce. So far this week, the dominant theme forecasted was down, although we forecasted an early week bit of weakness and a short term bounce which we saw Wednesday and then this week we had charts Wednesday afternoon saying weakness Thursday, but there were still 5 min positives that looked like we might see some more upside attempts. Those are largely gone, but who knows what will develop in the next day or so or even today. Right now, the best I have toward this line of thought is this 3 min SPY chart...

This is very strong, very accurate confirmation of distribution of last week's head fake move higher as we expected to see for at least 3 weeks and now shows a decent positive divergence still in effect, not a huge signal, but perhaps enough to shake things up as Q3 starts. We need a higher low at bare minimum in the current stage 4 downtrend so that alone suggests some bounce, which is important for the same reasons as this week, tactical entries.