Summary

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This past week has seen the return of joy in risk assets, the global stock market has regained $3.3 trillion in market capitalization and the crypto ecosystem is back to $1 trillion in total capitalization. The market insists on continuing to discount an idyllic soft landing / mild recession economic scenario, characterized by cooling inflation, non-recessionary growth and reduced monetary tightening. However, as we will see in this newsletter, with inflation not letting up and US employment remaining strong, it does not look as if the Fed's forceful speech in December will be altered at the next FOMC on February 1. Is this the umpteenth attempt by the market to validate the pivot narrative and kick-start a bull market or is it yet another short squeeze led this time by low quality assets? This week again comes loaded with market-sensitive data, along with the start of the US earnings season and the Bank of Japan on Wednesday. The Bank of Japan is expected to be forceful in its actions, the yield curve seems out of control despite its extraordinary interventions. Severe changes in Japan's monetary policy may have major implications for the markets; a lot of carry and leverage to be unwound along with a cross asset spill over.

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Macro and news

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Relevant data for this week:

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Tuesday: GDP Q4 y/y China, inflation Germany, employment Uk, Zew Eurozone economic sentiment survey.

Wednesday: Central Bank of Japan; rate decision and monetary policy, Uk inflation, Eurozone inflation, PPI December and US retail sales.

Thursday: ECB monetary policy meeting accounts, construction permits USA

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Special attention to what the Bank of Japan has to say this Wednesday, it is very likely a change of trend after decades of infinite QE, it seems that the 20 year carry trade dream is coming to an end.

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Inflation in the US as we observed in the December data released last week does not slacken, in this case it is important to look at the underlying month on month, 0.3% increase over the previous month. Services and housing weighed heavily in the final data, leading the increases. Energy and used vehicles as the components with the largest declines.

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Even so, the market managed to consolidate the rises experienced in the previous days, the data was in line, in the short term mission accomplished, another thing is the background reading, which does not invite optimism in terms of a relaxation of the positions and policies of the FED.

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U.S. employment continues at full speed, unemployment rate at 3.5%, the lowest in 50 years, and lower than expected jobless claims and renewals.

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Sticky inflation and strong employment coupled with a severe easing of financial conditions is not exactly what the Fed needs to pivot urgently.

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The market has decided, once again, to try to lead a Fed pivot. Participants no longer believe what the Fed tells them, it seems to have lost its credibility and this is certainly a very dangerous thing. Inflation may have peaked in the near term but the threat it poses is far from over, especially if we go back to easy money. The Fed has the ability to raise the cost of capital and remove liquidity from the global financial system to destroy demand by eroding wealth, slowing the economy and making debt more expensive, but that doesn't work when the stock and bond market fights it to force the Fed's hand. Since one of the drivers of inflation is supply-side inelasticity, something the Fed can do nothing to address, the biggest risk is demand normalization. Because in that scenario, inflation may not only return significantly, but also from higher base prices. In such a scenario, because very little has been done to increase supply, we would see another increase in inflationary pressures that would be difficult to alleviate in the short term.

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Here China has a lot to say with its famous "re-opening", the Asian giant abandons the strict zero covid policies and begins to demand raw materials at its usual level, it is clear the impact it will have on the price of raw materials and therefore on inflationary pressures.  

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Thinking about a soft landing and mild recession with U.S. consumers completely out of cash certainly seems complicated. 70% of American GDP is consumption, and it seems that it is being fully financed as personal savings are at a record low.

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The percentage of income earmarked by families for the payment of their mortgage obligations seems to be reaching unsustainable levels as the following chart shows

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It should be remembered that this hiking cycle has been the most aggressive one undertaken by the Fed in terms of speed along with the biggest collapse in money supply growth in 40 years.

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The market insists on discounting recessionary deflation, which in the medium term would not be bullish for risk assets. It stands to reason that if the economy is doing well, there is no reason for the Fed to make emergency cuts and pivots. And if the economy is doing so badly that the lack of demand causes prices to fall sharply, forcing the Fed to lower rates quickly, recession will be fully assured. The markets, as we have said in a newsletter, are trapped in the Fed-recession cycle.

All these issues are causing a great disparity of opinions and a palpable nervousness in all markets. The big question to be assessed in the short term is the quality of this recent rally: is it a real change in sentiment or just markets without direction dominated by derivative flows and an excess of optimism with little macro support? We have certainly experienced a week that feels like a flashback to 2021. Markets since the second half of 2022 have been driven by singular events. We went from CPI reports to Fed meetings and back again. The time between these events is spent speculating on what will happen at the next one. Healthy markets don't work this way.

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The market is now more overbought than it has been since May 2022, when SPX was trading around 4176 and then plunging to 3666.

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The percentage of SPX stocks above their 50 average in an overbought situation again.

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Most shorted stocks up 16% in last 5 days

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Many of the major stocks have remained weak during last week's rally and have failed to make new highs after a 150 point upward move in the SPX, the "meme" stocks have led this rally. Generally bear market rallies are led by low quality components, and this week we have again seen that characteristic 2021 "fomo".

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But above all, we cannot forget about QT (quantitative tightening). The liquidity present in the system has a lot to say about the future of risk assets, as 2022 has shown.

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Certainly this week has again demonstrated the markets' addiction to liquidity. A slight uptick in liquidity over the past week (within an underlying trend of severe liquidity reduction) and meme stocks/most shorted stocks explode 50-200% in a few sessions. This is usually a bad sign of market health with participants again chasing riskier assets and using the options market as a venue for intraday leveraged bets.

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Almost 50% of the options traded have expirations of less than 24 hours, a trend that has been accelerating in 2022, causing major distortions in the flows derived from the trading of these options and even of the underlying on which they are referenced.

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Price is always a big attraction, and the fear of missing out (fomo) is still very present in the collective investment mind, and especially in the retail public. Last week we have seen a massive inflow of US retail flows. It is interesting to note how google searches for "bull market" are at the highest levels in the last year.

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And last but not least, we are entering the earnings season in the US, pertaining to the last quarter of 2022. What is the sentiment going into this important event? Nothing new, total optimism.

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However, it seems that reality is changing and downside surprises in earnings are becoming the norm. Surely the market is too hung up on inflation data and Powell's speeches to pay attention to this major issue.

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From Turing Capital we will be insisting on paying special attention to these three key issues: liquidity, earnings and possible escalation of the conflict in Ukraine, as they will mark the future of all risk assets and seem very little discounted by the market.

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Several countries, including Poland, Ukraine, France and Germany, have already decided to provide Ukraine with heavy weapons by supplying tanks such as the Leopard 2. Regardless of one's opinion on the conflict, the development of events on the military front may provoke international tensions such as we have not seen for 30 years, even putting at stake the redefinition of borders in the Eastern European states. We have reached a point of repositioning of all the positions in the conflict, so that the scenario we are going to face has nothing to do with what it was 6 months ago.

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Cryptos: spot, derivatives and on Chain metrics

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The crypto market has caught the joy in risk assets over the past two weeks. That's not to say that fundamentally BTC can't show strength, but current market conditions and the speed of the rise across the ecosystem compel us to be cautious and prudent.

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Bitcoin has managed to touch $21,000, but apparently institutional interest remains on the sidelines.

Looking at the fund volume index, the level of trading volume is negligible and there is nothing unusual.

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Looking at the Fund index Holdings, bitcoin holdings by institutions are falling even with this remarkable rebound in price.

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At the same time, no unusual transactions have been detected in OTC trading desks. Generally these OTC desks are used by institutional investors to place their monstrous positions in a stealthy and discreet manner.

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These three readings indicate that institutional investors have remained calm and on the sidelines of this bull run for the time being, from this perspective it seems that we have a long way to go before we are faced with a real change in trend.

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Digital asset investment products saw smaller inflows totaling $9.2 million last week, while trading volumes remained low at $866 million, suggesting that the recent rally in digital assets was not driven by investment products.

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Crypto Quant's Ceo posted this tweet a few days ago.

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Everything seems to indicate that this upward movement has been led by futures and not by organic spot demand.

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Funding rates have reached a 14-month high. It is evident that traders are betting on higher prices, however, an analysis of the funding rates chart suggests a market climax, just as it occurred in previous situations.

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Following this price increase, we note that miners have taken the opportunity to unload their reserves.

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Rallies with this speed have unfortunately not been a prelude to sustainable bull runs, but to market traps led by speculative movements in the futures markets.

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We don't like to see tokens like the one belonging to the bankrupt FTX rising by almost 80% in the last week.

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A convincing break above 1.0 for the realized PnL ratio and the aSOPR has historically signaled a cycle change. We are now just testing this zone as we can see in the following two charts.

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For the first time since June, Bitcoin has seen a higher volume of gains realized on chain than losses. During bear cycles, this tends to act as a psychological level where investors sell at breakeven, creating resistance.

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We will soon find out if this is a genuine show of strength or a bull trap orchestrated with derivatives. For us, the battles that buyers have to win are clear: consolidate above the Vpoc of the volume composite and the Vwap and do not lose $19200. A consolidation would imply acceptance of this relevant zone and a clear path to test the upper part of the range.

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As we can see in the following chart, every time the price has tested the zone between the vwap and its first standard deviation, it has been rejected.

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As we always recommend from Turing Capital, it is important not to omit the existing correlation between crypto assets and the rest of risk assets such as SPY and QQQ. The recent rally does not seem to meet the characteristics of a quality rally, optimism has returned to the market but unfortunately it looks like a flashback of what we experienced at the end of 2021.

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The skew, which measures the difference between the IV (implied volatility) of OTM puts and the IV of OTM calls, has reached buying climax zones.

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skew 09/01/23

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skew 16/01/23

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Absolutely impressive is the behavior of implied volatility of at-the-money options, which has gone from dead to exploding due to high demand for calls following the recent upward move.

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ATM IV 09/01/23

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ATM IV 16/01/23

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The time structure of the volatility curve at the money again shows a severe tightening in the short end belonging to the nearest maturities. The market is discounting volatility for Wednesday, most likely related to the Fed's Beige book and the Bank of Japan's monetary policy decision.

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ATM IV 16/01/23

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Classic markets

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SP500 Futures 09/01/23

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SP500 Futures 01/16/23

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The market is trying to regain the important control level of 3960, it is the great battle to be won by buyers to overturn the selling control of the distributive structure marked on the chart in red.

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These are the scenarios that we marked last week, and both revolved around this important level of 3960, coinciding in turn with the zero gamma level of the SPX. The market has run before the release of the inflation data, once the data was released, in consensus with expectations, the market has remained in range, throwing away the movements expected by many analysts. This front run of news led by overnight moves and gains in low quality assets reminds us again of past times of irrationality of 2021.

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The gamma profile of the market two weeks ago showed a large bearish positioning, with a lot of interest in the 3800, 3750 and 3700 puts, which were increasing their gamma notional in a remarkable way after the last Opex. A short squeeze like the one two Fridays ago, causes these puts to burn and market makers have to unwind their short hedges, buying back the underlying, further boosting the asset. A change of bias and an overpositioning in options strongly biased to one side are always the main ingredients of this type of explosive moves.  

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The market has been showing us for some time now that 4000 is an area of interest, being a clear magnet during the past week. However, a gamma call wall of this relevance, with a market in a positive gamma regime, with the markets makers buying the dips and selling the tops, has acted as a clear resistance and has established itself as a clear area to be conquered by the bulls.

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Gamma profile 09/01/23

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Gamma profile 16/01/23

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The gamma profile at the beginning of this week, already marks the 4100 level, although as we have already pointed out, the 4000 level must be broken and consolidated.

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There is much talk of the beginning of a new bull market, which would undoubtedly be the most expensive in history in terms of valuations. The Schiller PE ratio is 29.24, with a mean of 17 and median of 15.91.

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