By the end of last week with the major equity indexes at or new highs along with most indicators at or near bullish extremes, it seems like there is something more than good news and earnings reporting involved. Due to Covid-19, some fear economic growth may slow again, but equities keep marching higher pushing market sentiment indicators to extremes while amplifying "Bubble" assertions. The Market Review touches on just a few concerns while including an overdue look at WTI Crude Oil.

S&P 500 Index (SPX) 3841.47 gained 73.22 points or +1.94% last week making new closing and intraday highs on both Wednesday and Thursday. The operative upward sloping trendline from the October 30 low at 3,233.94 now crosses just above 3800 with the 50-day Moving Average down below at 3694.15.
CBOE Volatility Index® (VIX) 21.91 slid 2.43 points or -9.98% last week. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, slipped 2.16 points or -11.46% ending the week at 16.68%.

Readings under 20% encourage the bulls.

VIX Futures Premium

Another bullish indicator from the VIX Futures Market: Friday's premium at 16.58% places it will into the bullish green zone between 10% and 20%, vs. 2.69% on January 15.

Since most of the volume and open interest are in the two closest futures contracts measuring the volume-weighted premium relative to the standard 30-day VIX provides a good real-time sentiment indicator based upon actual commitments of large Asset Managers and Leveraged Funds.

Setting the Stage

Although the S&P 500 Index set new closing and new intraday highs on both Wednesday and Thursday, every day last week ended in the Risk Off rotation column meaning cyclical growth stocks that depend on an expanding economy lagged the secular growth favorites. While it could be attributed to earnings reporting, another variable needs watching.

U.S. Dollar Index (DXY) & (DX) 90.24.

After closing above the operative downward sloping trendline on January 8, it continued up, made a pivot, and retreated to form a potential Head & Shoulder Bottom pattern.

Should it now reverse and close above the Neckline setting, off the pattern, the Measuring Objective at 92.59 is above this chart. Since the driving forces include interest rate differentials and GDP growth rates, if the economy slows again due to Covid-19, "carry trade" money could return to the U.S. Dollar seeking to earn the interest rate differential and push rates lower once again. If so, cyclical trading positions, like commodities and emerging markets could be disadvantaged. 

WTI Crude Oil (CL) 52.27 basis March Futures closed the week just .15 lower after making a wide trading range on Friday. On a further decline, a close below 51, the steep and likely unsustainable operative upward sloping trendline from the November 2 low at 35.00, would indicate the start of an overdue correction. However, seasonal strength could limit any decline since futures are in backwardation by 5.80% out to March 22 indicating high near -term demand.

From the CFTC's Disaggregated Commitments of Traders - Options and Futures Combined report, COT as of last Tuesday January 19.

One way to measure trend momentum is to watch open interest since it needs to keep expanding to sustain price trends both up and down.   
This Z score chart standardizes changes in WTI Cash prices and Futures Open Interest putting them on a comparable scale.

Until March 10, 2020, open interest had been trending lower since peaking on May 22, 2018. Then the quick advance corresponds with the rapid price decline that began on February 18, 2020, as shorting increased. Next, open interest peaked again on April 14, 2020 as shorts began covering, followed by a price low on April 21, 2020. Since then increasing open interest (blue line) appears to confirm the current price advance.

While there could be a short-term weakness if the U.S Dollar Index advances as suggested above, it appears a new long-term uptrend cold be underway especially if Covid-19 vaccination counts begin to increase.

Bubbles & Sentiment

Numerous surveys and indicators claim equity markets or some sectors such as technology and Bitcoin are in Bubbles. For example, Bank of America's monthly fund manager survey recently reported Bitcoin topped the "most crowded position" replacing tech stocks.

Others include Bloomberg's fear/greed indicator well into greed territory, extremely high margin debt level, doubling of single stock option volume to 8%, along with the AAII Survey at 42.5% bullish, "Optimism [as of January 20] is above its historical average for of 38% for the 10th consecutive week."

National Association of Active Investment Managers (NAAIM) reports its Exposure Index representing leveraged long positions reached the second-highest level going back to 2006.

Of course, one thing Bubble calls and sentiment extremes have in common is a lack of useful timing. For example, our Bubble file has articles as far back as 2013 although the numbers have increased recently. Additionally, sentiment indicators are like making contrarian trades. “Markets can remain irrational longer than you can remain solvent.” – John Maynard Keynes

Shot Squeezes

Another disquieting feature of the current market condition relates to short squeeze activity in individual stock with high short ratios. It's as if some day traders are playing a video game with real money.

Consider this from the Irrelevant Investor. "These [Robinhood] traders are moving from stock to stock. They squeeze all the juice until there’s nothing left and then move onto the next one. Right now, they’re squeezing the shorts." 

For example, here are three stocks from Friday's Top 5 stocks with the greatest IV change from yesterday.

Numbers 1, 2, & 4 with Implied Volatility above or near 200% are likely short-squeeze candidates. Remember that for every call bought there is a call seller that will likely hedge the exposure risk by buying other calls or stock.

In addition, reports an extreme short U.S Dollar futures position could potentially set off short another squeeze and push the DXY above the Neckline on the chart above with negative consequences at least temporarily for commodities, especially crude oil.

Strategy

In bull markets, the best strategy is to stay long equities and/or ETFs and then tactically hedge pullbacks as they begin developing since ordinary pullbacks can become corrections when something unexpected happens. Then corrections can become downturns when something else unexpected happens, and downturns can become bear markets when many unexpected things change medium and long-term fundamentals.

This is important earnings reporting week with several of the FAANGs and other market leaders on the calendar Tuesday and Wednesday. While the usual futures and options indicators remain friendly to the bulls, increasing Bubble calls along with sentiment at extreme highs suggest the time may be near to begin considering some hedges especially if the market fails to advance on good earning news.

Summary

Another week of new closing and intraday highs by the S&P 500 Index although with renewed concerns about Covid-19 slowing the economy along with Bubble calls and market sentiment at extreme highs the response to this week's earning reports by market leaders should be closely scrutinized especially with the U.S Dollar attempting to turn higher again. In the meanwhile, increasing open interest in the futures market suggests crude oil could trend higher.