I found a recent Wall Street Journal headline interesting …

Wall Street Bets the Fed Is Bluffing in High-Stakes Inflation Game

The article stated that the recent rally reflects a belief that inflation has peaked and that the Fed will shift from raising rates to lowering them sometime next year.

I agree with that assessment 100%, but what investors are missing is this: The old storyline of inflation peaks and then always falls back to trend does not apply today. 

Just look at the inflation reported in the UK (over 10% CPI) and Germany (37% PPI).

I think that was the wake up call the market needed and this week we will get another dose from Powell who wants to prove he can be Volker-esque …

Today, we’ll look at the signs that flashed a turn around in the market and where are headed in the weeks ahead. 

Junk Bonds ETF (JNK) Flagged Downturn

Notice the Bear Traps chart below clearly showing how JNK led the stocks down as they have many times in the past.

There JNK and the iShares High Yield Bond ETF (HYG) are two bond ETFs to pay attention to …

Once corporate credit starts to diverge from stocks, it is a signpost that stocks will soon follow.

That was the first signal that the rally was over …

The second one was Friday’s option expiration (OPEX), which included 25% of all SPY options expiring. A large majority were calls that built up during the rally.

Now, once the options roll off, dealer counterparts to the customer call buyers need to sell stock that was hedging their short call positions. 

In a bull market many of the expiring calls would be rolled to higher strikes …. We will not see that during this bear market and we could be in for a fast and furious ride back down. 

Notice the S&P 500 chart below. Last week’s top was ideal, the way it failed right at the 200 dma and the .618 fibonacci retracement. 

The key level for this week is the 4,195 … This area is where dealers are net neutral gamma, so hedging activity doesn’t impact the market. 

However, as put buying picks up heading into a historically volatile September, dealers will be short puts and need to sell stock to delta hedge the positions.

Then, as prices drop further, dealers will need to sell more stock as higher volatility creeps in as the market drops.

I think we could test the 50 dma (blue line above), which comes in below 4000 by the middle of September. This would take us into the Sept. 21 Fed meeting when the central bank will deliver a .50% (possibly .75%) rate hike.

Bring It Home

It will be a wild finish to the third quarter. The market got itself all pumped up for a continuation of new Fed money printing that could fuel a new bull market.

The narrative will now shift back to the energy crisis that offers amazing trading opportunities.

If you haven’t already, I encourage you to subscribe to my Power Income Trader (PIT) program. 

Not only do I send out a watchlist of stocks to lookout for each week, every Monday I present live to the subscribers to take a deep dive into critical data and trades.

Call 1-888-872-3301 and the Option Pit Customer Care team will provide all the details. 

As a trader, you want to trade inflation because inflation levels the playing field.

The Fed and the banks get crushed during inflation …

My PIT system will give you the advantage so you can beat the banks at their own game.

Live and Trade With Passion My Friend,

Griff