In an abrupt reversal from the recent buoyancy, stocks closed sharply lower during the latest session without much fundamental justification behind the sudden souring in sentiment. The market had traded firmly higher in early deals before the gains vanished after midday, with indexes finishing near session lows.
For regular market observers, the dramatic intraday swing likely carried hints of an expiration phenomenon rather than signals of any major change in the macro landscape. Specifically, the monthly options expiry on the VIX volatility index is likely the culprit behind the odd volatility.
In the lead-up to such VIX expiries, there tends to be a concerted effort from institutions and sophisticated traders to suppress volatility and complacency actively through the options market. Strategies involving the selling of downside puts on the VIX spurs forced index buying. As these products expire, that technical support fades. Consequently, short-term spikes in volatility often follow expiry dates when this activity rolls off.
By artificially dampening volatility in preceding weeks, bigger players can sell richer volatility premiums to unsuspecting counterparts, which are then pocketed as enhanced profits. This cycle tends to spur a stretch of low volatility that then corrects post-expiry. Keen observers would note volatility futures curves inversion ahead of the event, too.
With the expiration of December options now passed along with the monthly VIX expiry, two major technical forces propping up stocks have officially faded. Sophisticated options activity driving the markets in recent months expires, removing a pillar of support.
Specifically, heavy call option buying and volatility selling into December expiry spurred systematic dealer hedging flows that boosted stocks. The embedded buying to hedge dealer gamma exposure unwound as these derivative positions expired.
Similarly, the depression of VIX through its expiry date supported complacency. With both these major options expiries now elapsed, the positive gamma flows and volatility selling keeping markets buoyant evaporated. This leaves stocks more exposed to fundamental drivers rather than mainly technical, derivative-related flows.
In light of the expiring technical dynamics that supported this recent frenzied rally off bear market lows, positive momentum’s sustainability needs to be a more credible fundamental justification to drive stocks higher from here. Powerful options hedging flows tied to expiries provided loose sand for building gains, which washes out.
With that ephemeral technical foundation fading quickly, the risk of returning to the original liftoff level near 4,100 over subsequent weeks looks more probable. So far, the surge from deeply oversold conditions lacks enough evidence of an improving earnings or macro growth outlook to fuel further upside. The precarious rally stands prone to crumbling with flimsy supports removed post-expiry.
From a technical perspective, the recent surge in equities from the October lows has followed a clear 5-wave pattern that now appears fully complete rather than the start of a new bull run. Yesterday’s market peak reached almost 100% of the third wave on the Fibonacci retracements – an ominous signal that the exhaustive rally ended with a normal correction.
With the textbook impulsive structure capped out, the risk reversals, and heavy put selling expiring, all indications point to the rally losing last support.
While the latest sudden intraday reversal and technical setup indicates a potential market top is forming, some caution is still prudent before calling outright peak euphoria. Previous sessions in this rally have seen similar sharp downside dislocations that failed to follow through.
However, this time, certain markers look better aligned to suggest upside exhaustion over temporary setbacks. The five-wave count signals a completed impulsive structure; volatility shows signs of normalising from suppressed levels while stocks linger at peak oscillator overbought readings.
So the weight of evidence tilts more convincingly towards cresting sentiment finally but still merits observing if bulls manage to recover footing. If the pullback persists over the coming days, this relief bounce would reinforce the thesis since October has fully climaxed.
Nasdaq 100 Pulls Back from Recent Peak Levels
Yesterday’s intriguing development came on the NASDAQ 100 index, which momentarily eclipsed its November 2021 record intraday and closing peaks during the session. However, after initially crossing above those key technical markers, the index failed to hold gains and closed back below those recent tops.
Oscillating around pivotal historic levels before retreating likely carries some signalling value, but definitive interpretation remains tricky without further price action confirmation. Sharp failures from all-time highs can sometimes indicate bull market exhaustion and pending bearish reversals as buyers vanish at resistance levels. However, more data is necessitated.
On the one hand, if bulls had conviction on the economic and profit outlook, one would expect indexes to decisively close above the old peaks given the amount of time since. Struggling above the levels hints at tentativeness creeping in and sends a worrying signal of waning momentum. This could speak to investors’ pricing in peak conditions for growth, rates and the business cycle amid the grey clouds forming.
