Hopefuls are piling back into the markets, on the words that bottom has been reached. After notching above 2% 2 sessions in a row, rumours spread of a month of October that would finally buck the trend of the bear market, the myth of Uptober was reborn.
We believe it is a tad too early to celebrate this much. Since Dec21, the pattern has been invariably the same, risk-on at the beginning of the month, risk-off at the end. The market has notched down gradually. It is not unusual that traders take their profits at month-end, and close down their position. In a bear market, the overwhelming position is short, and closing shorts make the markets artificially rally. As it rallies, further shorts are taken out, creating a short squeeze.
Short squeeze gives the illusion of a sudden and very bullish momentum, and for a moment followers stack up to this idea and push the velocity of the rally a bit further. As evidenced by the activity this week, the rally was a big fat nothing burger. Such short squeeze took place in US treasuries, in Gold, and in equities.
In a nutshell, we are not there yet, but we are getting close. As reiterated last week, we see some value in short-duration investment grade bonds and money market instruments, as decent yields are reinstated. Cash is no longer trash, as Ray Dalio would put it.
Fundamentals have been a mixed blessing. The job market is cooling down, lending is tightening, but unemployment rate is still low at 3.5% in the US, and consumer morale has been on an upswing last month. Therefore, the Fed is still bent on further cooling down the economy by rising rates. The current expectation is that they will peak at ~4.6% in Mar23, which means only 30bps to go on the US 2-year.
Before the market stabilizes, volatility will rule supreme. We are monitoring cracks that appeared in the banking system, with a recent run on Credit Suisse bank after their capital was eroded by huge losses on the investment banking debacle on Greensill (up to $10bn at risk) and Archegos funds ($5.5bn lost). Trust is still broadly there in the financial system (as measured by the TED spread), but disappears at times, such as when bids for UK Gilt vanished as pension funds entered into fire sale last week.
These breaking points will most certainly call the end of monetary tightening policies. The more they multiply, the closer we are to the bottom. Hard call for a green Uptober, but I’d advocate for a more constructive early 2023.
360 Advisory LLC is a Boston-based RIA managing investments, including crypto