Technical Indicator Summary Daily RSIs for the S&P 500 and Russell 2000 are neutral (>30 and <70). Technical Review The December S&P 500 futures finished fractionally lower on Tuesday, settling @ 6686.50. Lower Bollinger band support is 6621. Upper Bollinger band resistance is 6822. Option dealer gamma remains in negative territory as of Tuesday’s close. When option dealer gamma is negative, option dealers mechanically sell weakness and buy strength to hedge their exposure. Negative gamma for option dealers increases the odds of HIGHER realized volatility and LARGER percentage moves up or down from one day to the next. Market Outlook After a 100-point drop in early trading, the S&P 500 bounced off of the bottom of Hedgeye’s risk range to trade in the green before slipping back into the red by the close. The small-cap Russell 2000 handily won the day with a monster rally and a new all-time high close. Most stocks traded higher on Tuesday, but the large-cap names drug the S&P 500 into the red. JPM reported better than expected earnings and raised guidance on Tuesday, but company shares lost nearly -2% on the day. On the other hand, WFC shares soared over +7%! C shares gained nearly +4%. Federal Reserve Chairman Jay Powell was also in the news on Tuesday. According to the CME’s FedWatch Tool, rate cut odds are a 96.7% probability that the Fed cuts rates by 25 bps on October 29.

Technical Indicator Summary Daily RSIs for the S&P 500 and Russell 2000 are neutral (>30 and <70). Technical Review The December S&P 500 futures plunged -2.71% on Friday, settling @ 6595.25, below lower Bollinger band support at 6618. Upper Bollinger band resistance is 6822. Option dealer gamma flipped to negative territory as the December S&P 500 fell below 6617 on Friday. When option dealer gamma is negative, option dealers mechanically sell weakness and buy strength to hedge their exposure. Negative gamma for option dealers increases the odds of HIGHER realized volatility and LARGER percentage moves up or down from one day to the next. Market Outlook The idiosyncratic risk of a Trump tariff threat to China on Friday caught markets off guard and triggered a mechanical deleveraging event. It is fair to say that nobody saw this catalyst coming. Systematic positioning was high coming into Friday’s session, meaning that Vol Control funds and CTAs were heavily long US equities. In fact, we have acknowledged, thanks to Tier1 Alpha research, that an uptick in volatility, particularly above 1%, could trigger an avalanche of selling. The only thing missing until Friday was a catalyst. As noted above, when the December S&P 500 futures fell through 6617, the flows became even more negative as option dealer behavior flipped from buying dips (in positive gamma above 6617) to selling weakness (in negative gamma below 6617). As a result, Vol Control funds, CTAs and option dealers were all sellers on Friday. And the more the market fell throughout Friday’s session, the more they needed to sell. For example, for Vol Control funds positioning coming into Friday, a 1% drop in the S&P 500 meant that they had to sell about $12 billion in exposure, a 2% drop increases selling requirements to $45 billion, and a 2.5% is close to $75 billion. Is this another buy-the-dip opportunity or is there more downside to ahead? Because the VIX closed at 21.66, that puts the S&P 500 in a more dangerous volatility regime than when the VIX is less than 19. One thing is likely though, Monday’s move is highly probable to be greater than 1% in either direction. Earnings season officially kicks off next Tuesday with JPM and GS before the opening bell. Generally, we expect earnings season to be a positive catalyst for equity indices. And according to Jim Bianco, it appears that we will get the September CPI report next Wednesday after all! According to Hedgeye estimates, the September CPI is likely to increase by 18 bps from August to 3.10% within an expected range of 2.99% to 3.21%. It is also expected that an additional 2 million federal workers will be furloughed without pay next week thanks to the government shutdown. Now that volatility has broken out, there is a good chance we see more big moves in the days ahead, which could easily be to the upside or downside. According to the CME’s FedWatch Tool, rate cut odds are a 97.8% probability that the Fed cuts rates by 25 bps on October 29.

Option dealer gamma remains in positive territory as of Thursday’s close. When option dealer gamma is positive, option dealers sell strength and buy weakness to hedge their exposure. Positive gamma for option dealers increases the odds of LOWER realized volatility and SMALLER percentage moves up or down from one day to the next. Systematic strategies (CTAs and Vold Control funds) are the most invested (long equities) that they have been in the last 5 years. This means that a pick-up in volatility could trigger a substantial amount of mechanical selling. They are not saying that anything is imminent, but it is a warning not to get too complacent should market conditions change. Market Outlook Another day of US dollar strength may have been enough to finally unnerve US equity investors on Thursday. In the last hour of trading, mechanical buying, likely from option dealer hedging, pared losses across US equity indices. December US Dollar Index – daily chart Earnings season officially kicks off next Tuesday with JPM and GS before the opening bell. If the government shutdown persists through Wednesday, we may have to wait to see the September CPI report. So far, a lack of government reports thanks to the shutdown has not been a problem for US equity investors. According to the CME’s FedWatch Tool, rate cut odds are a 94.6% probability that the Fed cuts rates by 25 bps on October 29.