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Did a Hedge Fund Liquidation Rattle the Stock Market?

Stocks were mixed today as a large hedge fund reported to be Archegos Capital Management was forced to unwind billions of dollars in stock positions after facing margin calls. The $30 billion hedge fund had to liquidate holdings in U.S. media stocks and Chinese internet ADRs such as Viacom CBS Inc. (VIAC), Discovery, Inc. (DISCA), Baidu, Inc. (BIDU), Tencent Music Entertainment Group (TME), and others. The fire sale also was felt at various investment firms such as Credit Suisse Group AG, Nomura Holdings, and other subprime brokers sold off sharply today as they warned of significant losses tied to the selling of the Archego's stock positions.


With the margin call coming at the end of the month, end of the quarter, and the start of a holiday-shortened week, traders are increasingly concerned about further market volatility.


The news of the liquidation of Archegos revived memories on Wall Street of the Long Term Capital Management debacle many years ago. Is the Archegos situation a unique and one-off scenario? Will the liquidation of the hedge fund adversely impact investment firms and the financial markets?


Despite the recent strong selling in select media and Chinese internet ADRs, what are technical conditions saying about the financial marketplace?


VIX Index (VIX – 17.21)


The SPX implied volatility index (VIX – 20.74) or the fear indicator has been subdued over the past week as it hovers near the bottom of its 7-month trading range in the high-teens (18.68-20.28). VIX is also currently trading below its 50-day ma (23.24) and 200-day ma (25.50) and below the Jan/Mar 2021 short-term downtrend at 27-28. A convincing move above this resistance zone confirms a breakout and the start of higher implied volatility leading to a potential sharp jump in VIX toward the top of its trading range near the high-30s to low-40s. Except for the 2/19/20-3/23/20 COVID-19 pandemic bear decline (SPX declined 35.41%), the VIX Index has only generated quick but unsustainable rallies resulting in SPX corrections of -5.75% to -9.91%. Another SPX correction is possible. But the VIX index is currently not displaying signs of increased fear in the marketplace, at least from a near-term perspective.


10-year US Treasury Yields (TNX – 1.721%)


Despite the advance from the 2020 low (5.05%), TNX continues to trend higher. The 7-month channel breakout also suggests TNX can retest its late-2019 highs at 1.949%-1.971%. The US Treasury markets have been reliable in forecasting pivotal turns in the economy (i.e., recession, inflation, etc.). Declining rates (higher bond prices) convey increasing concerns of a slowing economy and the fear of a stock market correction. On the other hand, rising rates (lower bond prices) suggest investors are expecting an economic recovery and a sustained stock market rally.


US Dollar Index (USD – 92.96)


The US Dollar Index is the dollar's value in global markets against a weighted basket of six currencies. The index will rise if the dollar strengthens against the basket of currencies and fall if it weakens. USD is important. It is an excellent indicator of the relative strength of the US Dollar around the world. USD also helps confirm general trends in asset classes such as commodities, fixed income, and stocks. The most direct relationship remains the one that exists between the USD and commodity prices. Commodity prices fall as the USD increases in value and vice versa. On the macro front, global investors will also use USD as a hedge against global risks and uncertainties. A sharply rising USD warns of the potential of a flight to safety as macro money managers seek the safety of the reserve currency.


Technically speaking, USD has rebounded strongly from the 1/6/21 low of 89.17 as the index appears to be establishing a bottom. It is now approaching key resistance at 92.72, coinciding with the 200-day ma. A convincing move above this resistance zone signals the next USD rally toward intermediate-term resistance at 94-95 or the extension of the late-Jul 2020 breakdown, Sep/Nov 2020 highs, and the 38.2% retracement from Mar 2020-Jan 2021 decline. A breakout above pivotal resistance signals the start of a sustainable intermediate-term recovery to the high-90s. Although the USD has improved over the past month, it is too early to confirm a sustainable intermediate-to-longer-term trend reversal. A rising USD above key resistances may pressure commodities prices and warn of rising macro risks.


CRB Index (CRB – 187.53)


Commodities, as represented by CRB Index, are an inflation indicator and a proxy for economic conditions. Rising commodity prices signal strong demand for commodities and hints of a recovering or expanding economy. Falling commodity prices warn of weaker demand for commodities and a slowing economy. The recent strong rebound in commodity prices bodes well for an improving economy if rising commodity prices do not accelerate out of control.


CRB has broken out above the pivotal May 2018 downtrend (178). The breakout confirms an intermediate-term reversal and suggests the next CRB rally to 201.72-206.95 (2018 highs and the 38.2% retracement from 2011-2020 decline), and above this to 217 (2011 downtrend). An overbought condition has triggered consolidation to initial support at 184-186 (Apr 2020 uptrend, and 50-day, 10-wk, and 30-wk ma), and below this to 175.5 (extension of the 2018 downtrend breakout), 166-168 (prior neckline support and 30-wk ma), and then 154.5-159.5 (Nov 2020 breakout and 200-day ma).


Conclusion:


Dow Jones Industrial Average rose 98.49 points or 0.30% today. But many US indexes closed lower by the end of the day as investors continue to monitor the fallout of the forced liquidations of media and internet positions held by the US hedge fund, Archegos Capital Management. Although other overleveraged funds may need to sell stocks to meet their margin requirements, the broader market handled the news in an orderly fashion today. The fear indicator (VIX Index) remained subdued given the Archegos incident. Asset classes such as the 10-year US Treasury yields, US Dollar, and the CRB Index also showed few signs of distress.


The end of the first quarter is upon us. It will be interesting to see if the start of the new quarter brings about the continuation of the strong 1-year bull rally or more market volatility?


Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

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