Morning Notes — Pain Trade

Calm: The CBOE Volatility Index (VIX) has now decelerated to neutral levels near 20. Elevated realized volatility usually serves as a strong headwind for sustained equity rallies.  The biggest driver of equity market volatility is bond market volatility (MOVE Index).  Increased bond market volatility this year has mostly followed Fed meetings and CPI prints. With the August CPI report nearly four weeks away and the September Fed meeting nearly five weeks away, it seems less likely that volatility will be a near-term headwind.

SPX: Last Friday, the S&P 500 (SPX) cleared technical resistance at ~4200 after the July CPI report added support for the peak inflation narrative. Daily momentum divergences in the two sessions prior to the June 16 low, signaled a likely reflex rally that tend to last 4-5 weeks with returns in the mid-teens. The two days prior to the June 16 low also included weekly momentum divergence, which occurs less frequently and preceded every major upside inflection since 2009.  Note that weekly momentum divergence was a less reliable indicator before the GFC with a success rate of ~70%. Nonetheless, the current rally is probably outside the definition of a reflex rally, lasting eight weeks and returning ~17.7%. But the path of least resistance may still be higher given reduced volatility, ongoing bearish sentiment and current positioning dynamics. The pain trade may also be higher as fundamental buyers remain unconvinced given a bleak economic outlook, while a popular CTA buy trigger (200-day moving average) lies just ahead at ~4330.