Uncertain Confounding Rally: Options Markets Disagree

Confounding Markets are heading higher:   

Rising to much confusion in the face of so many potential bad news items out there:    Global interest rates are rising, turmoil in the U.S. Congress, a looming recession, a nascent but not fully birthed credit crisis, bubble behavior in A.I. related stocks.  This can be explained by one thing I always say, “Equity Markets are driven by supply and demand (aka flows of money) in the short term far more than by fundamentals.”  We are in one of those situations, stimulus money is still burning a hold in the virtual pockets of so many individuals.  Oddly, the banking problems exacerbated this as people pulled zero yielding funds out of banks and put it in brokerage accounts.  Those brokerage accounts now full of cash showed a new underweighting to equities.   Individuals and their financial advisors opened month-end reports and realized they were now underweight equities after all that new cash.  And wham rally, advisors were buying the whole market, individuals were likely buying the A.I. bubble. 

How does this rally end? 
It ends when money is fully allocated to risky assets and people start to need cash to pay for rent or their next vacation (the sector experiencing the highest inflation by the way).   

When does the stimulus money finally run out? 

Most strategists (including me)  thought that should have already happened.  At this point, I’m just watching the numbers.    And which numbers to watch are harder to find, previously, I was watching checking balances, now since cash left banks and went to money market funds, I’m watching some money market measures and M2 money supply to see when the latest increase starts to turn.  Right now M2 is declining and money funds are rising. 

OPTIONS MARETS SEE LITTLE UNCERTAINTY

In the face of this confusing the markets are handing out a very cheap way hedge U.S. stock markets.   Normally, hedging is expensive and not worth the cost.  Now is not one of those times.  We are presented with an opportunity to stay long but hedge.  The most interesting place is a potential breakout forming in U.S. small caps still at cheap levels relative to large caps. (Russell 2000 up 8% in the last five days).   So the idea, as equity markets rise and bond markets fall instead of selling stocks, let them run and use options to hedge the rest of the summer.   

Goldman Sachs produced some great research this week on low options prices in indices as of June 7^th.