Market Commentary: Get Ready For Market Climax Top

Have you got your seatbelts on as this market thrusts higher like a rocket attempting to escape orbit?

Extraordinarily, the market is up 23% for the year, yet the vast majority of that gain has come in the space of just 6 weeks.

Back in early November, the chatter around where the S&P 500 would end up centered around bearish targets. That seemed to make sense with the Ukraine war headlines dominating, inflation concerns running riot, and interest on national debt hitting $1 trillion per quarter.

Fast forward 6 weeks and the mood has changed dramatically to exuberance following an almost unprecedented rally with the S&P 500 up by almost 15%, corresponding to over 2% per week. Of course, that kind of rally is unsustainable for any meaningful period, so the question arises when will it end?

Key Points

• Bullish seasonal flows are likely to persist for the remainder of December and into early January.
• By mid-January expect bearish macroeconomic concerns to re-surface, particularly related to bond issuance.
• As February approaches, the high likelihood is that markets will struggle and the risk to the downside will be elevated.

Will a Blow Off Top Happen?

Not many investors have survived blow-off tops so they are not always easy to spot. Each time you log in to your brokerage account and see the market higher, you can get lulled into a sense complacency that the present will last long into the future. But underpinning the powerful price surge we’re in now is heightened volume, and that’s the first clue that a blow-off top might be in the offing.

Those who lived through the 1999-2000 technology bubble and bust are familiar with just how far and fast markets can move to the upside before furiously correcting. The second attribute of a climax top is high volume accompanying sharp price action to the downside as happened to the NASDAQ back then.

Right now, the movement is to the upside, sharp, fast and furious supported by volume that stems from re-collateralization, short squeezes and investors attempting to front-run January inflows. But what happens when they dissipated? Most likely a steep, fast and powerful correction to the downside, but when will it happen?

When Will The Market Top?

According to one analyst, the market top will mid-January. Cem Karsan, who was one of the largest market makers on the CBOE during the 2007-08 Great Recession period has a keen eye for bullish and bearish flows. In his view, the flows are largely bullish heading into the end of the year and early January but by the middle of the month they will subside.

When they do, underlying weakness will start to dominate. For example, the Treasury is going to have to issue paper to support the trillion dollars in interest due, which in turn means a flow of capital out of the equity market to fixed-income Treasury bills and bonds.

With temporary seasonal flows in the past, February promises to be a higher volatility environment, in his view, as macro flows dominate and narrative in media publications likely does a U-turn from Santa Claus rally exuberance to worrisome economic factors.

For investors, that translates to bullish positioning into year-end and early into the new year followed by a more cautious and defensive portfolio heading into the final two weeks of January and February, in particular.