Resistance and Support

Bucket-list seeing Colorado aspens in autumn. It will remind you that the planet is a living canvas and that everything is going to be okay.

Colorado aspens at Muddy Pass summit. Karen Quast

Now, what about the stock market?  I said last week in the Market Structure Map:

“Predictions? I bet we rebound next week. BUT if Monday is bad, the bottom could fall out of stocks.  And you should always know what’s coming, companies, investors and traders. It’s just data.”

Well son of a gun.

New options traded Monday and the market took a vicious thwap to the noggin. Why? No, not Chinese real estate.  Or this thing, or that thing.  There was a buffet of options spread out for consumption and the crowd that showed up to feast was sparse like a pandemic trade show.

That’s weak implied demand. So stocks fell. Again, read last week’s blog. About 20% of market capitalization ties to rights to buy or sell that reset monthly.  If demand drops even a half-percent it can rock equities.

Who’s using those?  Hedge funds.  Traders.  Funds substituting derivatives for equities (permissible up to about 10% of assets).

Shouldn’t we wonder WHY fewer guests came to the options banquet? Yes, but in advance! If you’re casting about AFTER it happens, you’re making it up, like resistance and support. We talked for three weeks about the big risk into Monday.

The point isn’t being right. The point is correct data.  

What’s more, investors didn’t sell. Active Investment was down about 17% marketwide Monday. And the last-hour recovery that clawed back 30% from the lows came on quant money and machines.

I was talking with the investor-relations officer for a Nasdaq-traded Consumer Discretionary company.  I said, “What do you do for answers about why your stock moves differently from your peers?”

She said, “I call the Nasdaq.  The guy there tells me what our levels of resistance and support are.”

There are over $63 trillion in worldwide regulated (following standardized government guidelines like the Investment Company Act of 1940) investment funds, says the Investment Company Institute in its 2021 Factbook.

None of that money makes decisions using levels of support or resistance. So why would that be the explanation, if the job of the investor-relations officer is to help the board and executive team understand what drives shareholder value and how to succeed in the public equity markets?

Just askin’.

To be fair, this IR officer is now a client. It’s telling though, isn’t it, that for many in the investor-relations profession a telephone is the chief source of data. And the data provider says, “You broke through your support levels.”

Uh huh.

It’s true machines will calculate how to price bids and offers by sifting the surrounding data.  From that data come levels of support and resistance. The trouble is those machines don’t want to own anything.

Our friend in Consumer Discretionary saw shareholder value plummet 23% from the end of August to September options-expirations. Principal cause, Derivatives.  Active and Passive Investment patterns shrank over that time.

It had nothing to do with story.  In fact, that company’s Engagement score – quantitative measure of influence from Active stock-pickers – is 91%. Superb.  At this moment, the stock is exactly in line with what stock-pickers are willing to pay. That’s measurable.

And it wasn’t levels of support or resistance. Yes, over that time the machines manufacturing most prices averaged 55% of the stock’s volume and owned no shares at day’s end (and 60% of volume was short to boot – borrowed or manufactured).

To me, support and resistance are like the daytime temperature. Today’s high and low temperatures reflect seasons and weather-fronts, not support and resistance.  The seasons and weather-fronts of the stock market are patterns of changing behavior.

Last week, the S&P 500 saw a 1% drop in demand for derivatives – we call that a 1% decline in Risk Mgmt – when options-expirations should have driven an increase in demand.

Against falling demand (Sentiment) and rising supply (Short Volume) marketwide, we thought, “The market could take a Mike Tyson to the chin.”

Indexes reweighted too, and Passive investment was down 5% in the S&P 500.  Suggests weaker flows to Tech since that’s where all the market cap is.

What now? The Fed meets at 2p ET today.  Our 10-point index of short-term supply and demand called Broad Sentiment is 4.4, and 4.0 is a bottom. Probably stocks recover.

If the bottom turns to mush, people will be saying, “The market’s next level of support is…”

And that won’t be it. The data say we’ve been in a long slowdown from momentum since April. The consequences can show up all at once.  I doubt it’s right here, right now. But it’s possible.