The stock market is in what we call a polarity zone - a price range with equal resistance above and below. The Nasdaq peaked in November and the S&P in February and since then both indices have been bouncing within a tight range. In that time, dividend paying stocks and traditional value stocks have demonstrated relative strength, and the energy sector has been on fire. But it remains to be seen which pole the broader market will gravitate towards. Will it be dragged lower and follow software and the like or will it break out higher following industrial and energy sectors? To find our answer (or at least make an educated guess) we have to look for clues in things like “advance decline” metrics, number of sectors above or below their 200-day moving average, earnings report reactions, and fund flows. We also want to see former leaders lead, and economically important sectors show strength (for example, technology and banks as discussed last month). Currently, semiconductors are at a make-or-break moment. The sector has bounced up or down from this level 5 times since last October. The longer a stock or sector gets stuck on a polarity zone, the greater the probability of a large move in one direction or the other, once the breakout occurs.
Market participants have been bracing for chaos and a breakdown in the markets for months now. In the fall when the major indices peaked and began moving sideways the talk was about the over-concentration by a few large companies in our stock market, and how AI was rapidly both making every industry more efficient and destroying them at the same time. And in truth investors were over positioned in a few companies so individuals and institutions started unwinding those trades. Headlines about the market crash in software, venture capital, and private equity lending have stoked fears but under the hood the story has been a little different. The number of stocks making new lows on the NYSE is shrinking not expanding even as indices drift lower. Much of the selling, especially among the larger companies, has already happened. They were overextended in a few sectors and have since reined that in. That’s what has been pulling the market lower. But if stocks were really breaking down then we would see broader participation to the downside. So, where are all the sellers if everything is falling apart and war and oil and AI are here to usher in the new bear market? It’s possible that they are already gone. Investors have spent the past 5 months preparing for a crash and already loaded up on cash and short positions. Contrary to our instincts, it’s not narratives that drive the market, it’s positioning. Narratives exist to give us a story to try to make sense of the unknowable.
Goldman Sachs is estimated to have sold roughly $190 billion in in equities in the past month and are now net short by about $50 billion. This means they are guaranteed buyers of roughly $50 billion worth of stock in the near future. They are not alone. Historically, when institutions are at a net short position in the market this is usually not indicative of the beginning of a downturn. It usually signals we are closer to the end of one. Before the monster move in equities today the major indices were down about 10% from their highs. So, a sizable move lower has already taken place and if major sellers have already sold this would be a logical place for momentum to flip in the other direction. The bounce we are seeing today (3/31) is right off that major polarity zone and a decisive thrust in favor of the bulls. This is exactly what we would expect to see when underneath the surface there are actually more stocks going up than down (even as indices fall) and the percentage of stocks above their 200-day moving average is rising. Yesterday, stocks got hammered but financial stocks were rising. You don’t get sustained rallies and bull markets without a healthy financial sector, so this was a very telling and positive sign.
If everyone is saying stocks are falling apart and the data is saying otherwise trust the data. After stocks break out of this polarity zone a new narrative will emerge but we will know it was always just about positioning the whole time.