We’ve been warning that the bull case is flawed…

The more we looked at it from different angles, the more we realized it was built on a soft foundation.

And as a result, we’ve been calling out the blatant hype that actually brought valuations back to peak bubble levels.

Returning valuations to those levels is like getting burned and then coming back to the fire with matches in hand.

On that basis alone, the market was due for a correction.

And one big catalyst behind this rally was retail and commodity trading advisor (CTA) capital that had bought a “breakaway momentum” narrative.

Retail traders have pumped $1.5 billion per day into this rally. And CTAs just follow momentum wherever it leads them – until momentum breaks.

These are two groups that have bad track records… and weak hands. Once prices reach their breakeven point, they will sell.

Take a look at this chart… It shows the daily capital inflow from the retail side overlaid on the S&P 500.

The unadulterated froth coming from retail was highest earlier this month when the Nasdaq was near 13,000.

And assumptions like the 200-day moving averages (MAs) being some magical level that “thou shall not cross” haven’t helped the prospects either… Because we’re looking at a lot of capital that can vanish quickly if those “magical” levels get breached.

Right now, the market is ominously sitting right atop the 200-day MA. And factoring all that in makes the potential downside ahead look much bigger.

But our max downside will ultimately be determined by the biggest player in the capital markets…

The Fed.

This Rally’s Catalyst

When trying to forecast the downside ahead, interest rates dominate all other market considerations. And the Fed controls interest rates.

Assets always rise and fall in relation to something else… whether it’s cash, bonds, or one sector versus another. And when rates are rising, the value proposition for stocks loses its luster.

Why would an investor hope for an average 9% yearly return on the market, which is inherently risky, when they could buy a 1-year risk-free Treasury note and lock in around a 5% yield?

It’s not worth the risk for a marginal 2% additional gain.

It’s really as simple as that… All assets rise and fall as a result of some version of this comparison. And the market bottomed out in October precisely for this reason.

Investors went hard into the beaten-up credit market in October, buying fixed-income products and knocking down rates. Those lower rates helped put a floor to stocks.

Then, the slowdown in inflationary indicators made it seem like a lot of bad news was priced in – a good clean bet for long-term buyers.

That was then followed by the January rally… which created momentum for the momentum hunters (CTAs). Finally, the narrative writers piled in, conjoined at the hip with the retail crowd.

But the main catalyst for the rally was that shift back into credit markets. It brought the spread between the junk bond rate and the 10-year Treasury yield down a big notch, which made stocks more attractive.

If that catalyst is now in question due to an aggressive Fed, however, then the low in October is now also in question.

But there’s something bigger to consider…

The entire COVID rally that brought the Nasdaq from its pre-COVID highs of 9,771 to 16,776 was driven by the Fed, by stimulus – in an environment where rates were at zero.

I wouldn’t be the least bit surprised if the market retests that low, which is about -20% away from here.

The market is one big, Rube Goldberg machine… investors need to cut through all the unnecessary movements and focus on one thing: Don’t fight the biggest trader in the room.

There’s Always Something to Buy

The Fed is going to bring rates to a level that the bull case hasn’t accounted for.

I predict 5.37% at a minimum by September… and if economic indicators continue to show job growth and sticky inflation, we’re going even higher than that.

This week’s FOMC meeting minutes showed us why. Not only did they brush off the “Fed Pivot” storyline, but some Fed officials were actually gunning for a 50 basis point (bps) rate hike.

The Fed Fund swaps have been pricing in higher rates for longer ever since the jobs report obliterated estimates a couple of weeks ago. That is when the selling began in earnest.

The Invesco QQQ Trust Series 1 (QQQ) has now dropped 6.5% from its peak that day. And it is precariously sitting atop the magical 200-day MA level.

But even when it seems there’s nothing to buy… there’s still always something. We can always find a sector or opportunity left behind by the recent fad in the market.

Investors can’t be fully directional to one side. That’s both a risk and an opportunity cost.

We had an example of that just recently…

One company had become so undervalued it was laughable. It presented an opportunity on Wednesday in the Opportunistic Trader advisory, and we bought calls on Cheniere Energy (LNG).

Earnings were a blowout. Our stock options more than doubled… and amid the weakness in the market recently, it’s up 9.25% today.

So in the meantime, what do you do when you’re so bearish it hurts?

You sell the bad, but don’t forget to buy the good.

Regards,

Eric Shamilov
Analyst, Trading With Larry Benedict

P.S. If you haven’t yet watched Larry’s Money Shock Calendar event from this past Wednesday… I recommend you do so soon. There’s a shock just around the corner that you want to be prepared for. Catch the replay here.

Reader Mailbag

In today’s mailbag, One Ticker Trader members share their success with Larry’s recent recommendations…

Larry! Another winner! Thanks.

– Paul S.

It seems that volume is lighter today. Such volatility should have higher volume showing more conviction. The market may turn up tomorrow. Another great trade, 65.9% in seven days.

– Frank U.

Hi Larry, I sold the three put options and made $575. I’m glad I signed up for One Ticker Trader.

– Steve K.

Thank you for your thoughtful comments. We look forward to reading them every day at feedback@opportunistictrader.com.