Liquidity is still abundant, and pre-election year seasonals are supportive; buy the dip?

Late summer dips, particularly in election years, have been historically shallow. According to our friends at the Stock Trader's Almanac, full-month July gains in excess of 3% (this July picked up 3.3%) have historically been followed by declines of just under 7% on average or a median of just under 5% (stats are based on the Dow Jones Industrial Average). The current correction based on E-mini S&P 500 futures has been roughly 5% and about 3% in the Dow. In the big picture, these corrections fall into the drop-in-the-bucket category, but that's par for the course during this time of year. Further, the Fed has pulled out all the stops and still hasn't been able to slow down the freight train loaded with liquidity injected into the economy in 2020. While they have sucked some of the froth out of the system, the M2 money supply is still well above levels seen before 2020, and we think this keeps the train on track for now. Thus, we suspect the path of least resistance for the major indices will be higher in the coming weeks. Here are some of our thoughts on this.

COT Report

We have pointed out the massive bearish short position in the futures markets for months. According to the Commitments of Traders Report (COT) issued by the CFTC (Commodity Futures Trading Commission), the historically significant net short position has been largely unwound, but speculators are still short the market; the longer equities hold up, the more likely short speculators are to cover their positions (creating motivated buyers).

There are also reports of under allocation to equities in many portfolios and the accumulation of sidelined cash. Given the overwhelmingly bearish narrative on business news, we would guess investors are hoping for a larger dip to employ the capital. However, when the majority are looking for something to happen, the markets deliver the opposite.