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Planning For A Difficult Range Trade - Morning Market Squeeze

Key Tactical Takeaways:


> The recent rotation away risk averse sector leadership continued Tuesday, with XLP and XLRE now in the Weakening quadrant, and XLU not far behind. Conversely, XLK is growing closer to moving back into the Leading quadrant.


> The late-Sep through early-Oct window is typically a very choppy period of sideways-to-upward rotation in the S&P. However, bulls must generate a close > SPX 3351.60 to officially enter that upward rotation phase.


> Although profit taking on last week's dollar surge has boosted the metals complex this week, DXY is now entering the near-term backstop that should EVENTUALLY propel it toward the 95.50 area, leaving GLD vulnerable in the near-term.


> As we are anticipating a volatile transition into October trading, we're not adding to what's already working on our trade ideas page. 


Some Quick Thoughts:


As much as we'd love to leave politics out of the daily discussion, we're at the point where this will be impossible for the next several weeks, maybe even months. Why months? Because last night's debate seemed to lend credence to the idea that the November vote may be a contested one. While the post-debate weakness in equity futures supports this view and vindicates those who were positioning for an ugly contest, right now were are not seeing the kind of flight-to-quality bid in the VIX, yen or Treasuries that would cause us to think markets are panicking. Instead, we simply see recent price action as fitting well with the down-to-sideways seasonal pattern transition that tends to develop during the late-September through-early-October window.


Throughout the entire post-September corrective phase, it has been our view that the correction would ultimately bottom within healthy limits (healthy corrections typically do not draw down much > 10%). With a max drawdown of -9.64% so far, we're right in that sweet spot. So, what kind of price action might we see from here? While we don't claim to know the answer for sure, our base case is that a difficult, volatile range with a higher bias is setting up, based on the large TICK readings (the number of stocks that are rising to the number of stocks that are falling on the NYSE) that accompanied last week's selling, the favorable sector rotation and upside breadth readings that have occurred since, and the sideways-to-higher seasonal window that now exists through the 1st week-and-a-half of October.


How can a higher price bias develop over the near-term if history suggests the VIX should start trending higher over the next 4 weeks (see page 8)? Remember, a higher VIX does not automatically mean lower stock prices. Ultimately, we think that any transition to a higher trending VIX will represent protection against pre-election uncertainty, as well as the risk of another pre-election, 2nd half of October drawdown that the seasonals are warning of.


So how do we play the upcoming transition? Look to take profits on any tactical shorts that are highly correlated to the S&P 500, in the event of a sell-off these next couple of days. From there, pay close attention for a closing rally above SPX's bearish NT Trailing Stop (currently 3351.60), as such a development could spark a sharp early-October short-squeeze up to the next short entry area.


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