By Tomi Kilgore
Tom McClellan sees liquidity concerns resulting in some choppy weakness for 6 to 7 weeks, before the next big rally
The technical indicator that helped push long-term bull Tom McClellan to bet that stocks would fall for the next six to seven weeks actually sent the sell signal more than a year ago.
McClellan, editor of The McClellan Market Report, turned bearish on the S&P 500 index SPX for short- and intermediate-term trading styles after the market closed on Tuesday, as he expects a “meaningful but not permanent decline” to a low due in mid-April.
He maintained his long-term bullish stance, however, as he sees a recovery and “probably new highs” after the April dip.
“The reason for the expectation is my monitoring of banks’ positioning in the interest-rate futures markets, and how that leads to ripples later on in the liquidity stream,” McClellan told MarketWatch.
As excess money in the financial system starts drying up it’s believed that the stock market tends to suffer, as riskier assets like equities are sold to raise funds.
And his model, which tracks banks’ positioning in the futures market for the Secured Overnight Financing Rate (SOFR), through the Commitment of Traders (COT) report, has been calling for a top, ideally due this week.
The sharp selloff on Tuesday, with the S&P 500 dropping 1%, coupled with signs of negative divergence in some underlying technical momentum indicators-the indicators have been declining while the index has been rising-gave McClellan reason to believe the top was actually reached with Friday’s record close of 5,137.08.
The SOFR COT model showed that big-bank commercial traders, considered the “smart” money, were net short – there were more bets that overnight rates would rise – at a level not seen in years.
That’s not a bet that the Federal Reserve will raise its target for the fed-funds rate; it’s a bet that there will be a drain in market liquidity that will put upside pressure on the SOFR.
Read live updates on Fed Chairman Jerome Powell’s testimony to Congress on Wednesday.
That “signal” flashed 278 trading days ago – or a little over 12 months.
“For reasons that I still have not figured out, the changes in [the commercial traders’] net positions tend to get echoed about 13 months later in the movements of the S&P 500, which is a pretty fun trick,” McClellan wrote in a daily market report.
He believes the liquidity impact will get amplified as the tax-deadline day approaches. Investors who had a great year in 2023 will have to pay higher-than-normal taxes on April 15.
“And so when they mail those checks to the [Internal Revenue Service], and it cashes those checks, that will create a drain on liquidity that has not been a feature up until now,” McClellan said.
Basically, the big banks have known about this for a while, and may have already started hoarding cash in the weeks leading up to deadline day.
The decline McClellan is expecting is likely to be a bit choppy, with a minor bottom due March 14 to 15, a minor top due March 18 to 20 and a minor bottom due March 25 to 27, before the final decline to mid-April.
The S&P 500 was up 0.5% in afternoon trading on Wednesday, but was up as much as 1% earlier in the session.
When asked how far he thinks the S&P 500 will fall during the decline, he said that rather than a point or percentage-decline target, he has a “time” target.
“We can never get more out of a move than what it offers us, and so trying to count those chickens in advance is not something I have found a reliable way to do,” McClellan said.
-Tomi Kilgore
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03-06-24 1413ET
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