Market rally? Sorry to disappoint

My previous post painted a grim view of a market in retreat when faced with unaccommodating fiscal and monetary policy (Federal budget surplus and Fed tightening actions).

Then a rally happened and forced me to re-evaluate. There are always two questions I like to ask:

1. what changed since last time I looked at this?

2. how persistent is the change likely to be?

I am discounting the change in financial media narrative (“equities rise again” via Bloomberg) since they are price-driven and looking backwards.

But the month of January did end, and I can now project the full fiscal year deficit based on data and trends already visible. It comes out at $340B compared to over $3T last year. The last time we had a deficit that small, it was 2008 ($386B) and 2007 ($107B). This preceded the Great Financial Crisis and I am not drawing too much of a parallel since the debt burdens are significantly lower now. It’s just another reason to look closer. It’s just hard to find the market’s motivation for the last rally in it.

Another thing that changed recently is the put/call ratio.

Since both the 10-day and 20-day moving averages are above 1, I am tempted to attribute the rally to it. All these discussions about a rebound in the short term might have enticed investors to favor put options buying. That will help the market rally, added by some short squeezes triggered by it, but it’s only likely to last until theta runs out and the put buyers have to roll into the next expiration.

This is in general profitable for option sellers and market makers - they collect the premium and if the buyers show up again, do it repeatedly.

But the VIX (“fear indicator” in SP500 futures) and other trackers of implied volatility are still high, which makes the options rather expensive. So to answer the second question about persistence, I need first to theorize how long will the investors be willing to pay for expensive protection and when will they turn complacent, thinking the market has changed trend already.

I don’t really care who coined that, Niels Bohr or Yogi Berra - it still rings true yet funny regardless. What I care about is keeping an eye on VIX (cost of hedging) and options open interest around expiration dates for single stocks I am interested in shorting. So far, this is not the rally I am looking for.