Nasdaq and NYSE short interest just hit a new high. With stocks showing strong momentum, short squeeze is always possible, but the major equity indices are also giving out signs of fatigue. Having had difficulty converting potentially bearish candles into opportunities on several occasions in the prior 11 weeks, bears now have another opportunity.
 

The major US equity indices are at new highs, as is short interest on both the NYSE and Nasdaq. After a bumper 2024 and 2023, these indices are having another good year this year – thus far. These persistent gains have also given the bears an excuse to get active. And, boy, have they!

Mid-September, NYSE short interest increased 3.3 percent period-over-period to 19.2 billion; over on the Nasdaq, short interest grew 1.1 percent p/p to 17.1 billion. Both set fresh records (Chart 1).
 

If the current bullish momentum persists, it may not take long before equity bears throw up their hands, and a short squeeze follows. But they do have one advantage right here, which is that they have had several opportunities in the last couple of months. It is just that they have been unable to convert those. One such opportunity is staring them in the face currently.

The Russell 2000 has had a phenomenal time since April’s lows and finds itself at a crucial juncture. Last November, the index retreated after ticking 2466, which just edged past the prior high of 2459 from November 2021. On the 18^th, those highs were surpassed, tagging 2470 intraday. This momentum continued last week as by Tuesday a fresh high of 2489 was reached, but the bulls were unable to hang on to those gains. By the end of the week, the small cap index finished 0.6 percent lower to 2434, ending with a weekly spinning top – third weekly spinning top in the last five weeks. In fact, the day the index hit a new high, the session reversed hard to end with a red shooting star.

On 9 April, the Russell 2000 bottomed at 1733, surging 44 percent in five and a half months. A lot of buying power has been expended, even as the index has reached a crucial technical spot. This is an opportunity for small-cap bears to force a triple top (Chart 2).
 

In the most recent weeks, the Russell 2000 rallied on the back of heightened market odds of lower interest rates. Small-caps tend to be leveraged and by nature have higher exposure to the domestic economy versus their large-cap peers which are also exposed internationally.

On the 17^th, the Federal Reserve delivered a cut in the short-term rates, with the fed funds rate lowered by 25 basis points to a range of 400 basis points to 425 basis points. The FOMC dot plot expects two more cuts this year and one next year. The futures market, on the other hand, is pricing in four 25-basis-point cuts by December next year.

Market participants are hoping that the Fed will continue to put more focus on the stagnant jobs market than inflation which has doggedly stayed near three percent than the central bank’s desired two percent.

Core CPI (consumer price index) and PCE (personal consumption expenditures) have meaningfully dropped from their four-decade highs of 2022 but at the same have trended higher in recent months. In the 12 months to August, they respectively came in at 2.9 percent and 3.1 percent, up from April’s four-year lows of 2.6 percent and 2.8 percent (Chart 3). This trend cannot persist forever, and, if it does, the Fed cannot continue to ignore it.
 

Like the Russell 2000, bears have an opportunity to press their case on also the Nasdaq 100, which rallied 50 percent from 7 April when it bottomed at 16542. On Monday, the tech-heavy index tagged a fresh high of 24782 before coming under pressure a tad, ending the week lower 0.5 percent to 24504.

The back-and-forth action resulted in a weekly spinning top last week (Chart 4). This was the first down week in four. In the prior 11 weeks, several such indecision candles ranging from a weekly doji to a bearish engulfing candle to a spinning top to a hanging man to a gravestone doji appeared but were never confirmed. Unfortunately for the bears, they were unable to capitalize on those opportunities. If they succeed this time, then, to begin with, there is decent support at 23600s, which is in line with the 50-day at 23659.
 

There is a similar setup in play on the S&P 500, which has rallied over 38 percent over five and a half months, since the April 7^th low, that is. Last week, the large cap index dropped 0.3 percent to 6644, with a fresh intraday high of 6700 on Tuesday. This was the first down week in four – and 2^nd in eight. A spinning top formed on the weekly. In the prior 12 weeks, there have been several other indecision candles – from a couple of dojis to a hanging man to a bearish engulfing candle – but, as was the case with the Nasdaq 100, none of them were confirmed.

If the bears prevail in the sessions/weeks ahead, nearest support lies at 6530s, followed by 6480s (Chart 5).
 

Incidentally, both VIX and the S&P 500 fell last week, with the volatility index giving back 0.16 points to 15.29, having rallied as high as 17.74 on Thursday. In normal circumstances, VIX and the S&P 500 tend to go in opposite directions.

Once again, the daily Bollinger bands are narrowing on VIX; this tends to precede a sharp move. Since early this year, volatility bulls have defended 14.50s-14.70s, so the risk of a drop toward 13 or 12 is low as things stand.

Concurrently, the ratio of VIX to VXV has remained stuck in oversold territory for the last several weeks. VIX measures market’s expectation of 30-day volatility on the S&P 500. VXV does the same, except it goes out to three months. During a risk-on investing environment, as has been the case in recent months, demand for VIX-derived securities is lower than VXV. The opposite is true when sentiment turns to risk-off.

Last week, the ratio stood at 0.831. This was the eighth week in a row of readings of low- to mid-0.80s – and 13^th in the last 14 (Chart 6). Things are stretched a bit. When this gets unwound, VIX heads higher.

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