Inside Markets — Light Attendance

Attendance is light and volumes are low with yesterday’s late session rally (~35% of the advance came in the last 10 minutes of trading) likely due to systematic funds trying to take advantage of Market On Close (MOC) illiquidity.  The last two weeks of August are always characterized by light attendance, low volumes and illiquid conditions that tends to produce greater single stock volatility.  The lack of liquidity also tends to impair the signal quality market internals and cross-market relationships.   

The near-term setup for equities remains bullish as the aforementioned technical conditions and open buyback window generate the potential for an exploitable pain trade.  Another near-term bullish factor includes the biggest two-week VIX volatility decline in history (62% decline in 9 days) and associated equity demand from volatility targeting systematic funds. The buyback window will remain wide open until mid-September when season weakness usually kicks in.

The Fed is widely expected to cut rates by 25bp when it meets on September 18.  The current Fed funds rate of 5.30% remains well above the neutral rate, which the NY Fed recently estimated to be as low as 2.5%. To be conservative, we’ve been using a 4% neutral rate, which implies ~150bp of rate cuts in the future. The Fed tends to use predictable and gradual rate cuts unless there are signs of increased economic stress (2001/2007).  A predictable rate cutting cycle to achieve ‘neutral’ policy is currently being priced into markets.  A predictable and gradual cycle tends to be favorable for risk assets, while more aggressive cuts in response to economic stress usually have negative implications for risk assets.