S&P 500 Faces February Headwinds as Treasury Liquidity Drains and Small Caps Falter

The S&P 500 finished January with a modest 1.4% gain, but if you’re feeling bullish, now is a good time to check your rearview mirror. The market’s momentum is flagging, Treasury liquidity is evaporating faster than a meme stock’s credibility, and the “bigger is better” trade is back in full force. February is shaping up to be a test of nerves, not just for equity bulls but for anyone betting that the liquidity tide will keep lifting all boats.

Let’s start with the facts. The S&P 500, fresh off a string of record closes, has run into a wall of technical and macro resistance. According to Seeking Alpha, momentum is “waning,” and the technical setup for February looks less like a runway and more like a minefield. Small caps, once the darlings of the post-pandemic recovery, have been left in the dust. The latest round of analysis calls them “useless, for now”—harsh, but not inaccurate. Meanwhile, the real elephant in the room is the Treasury market. As Seeking Alpha notes, Treasury settlements and a rising Treasury General Account (TGA) have drained $64.3 billion from market liquidity, tightening conditions just as risk assets are looking for a reason to wobble.

It’s not just about the S&P 500. The entire risk complex is feeling the pinch. Geopolitical shocks are rattling nerves, and even solid corporate earnings are taking a backseat to the liquidity story. As MarketWatch put it, “there’s now a bigger risk for stocks than the economy or corporate earnings.” That risk is the relentless drain of liquidity, which is starting to look like the market’s version of slow-motion waterboarding.

The historical context is telling. Every time the Treasury ramps up issuance and the TGA rises, risk assets get a reality check. The last time we saw a similar setup was in late 2022, when stocks stumbled as liquidity was sucked out of the system. This time, the stakes are higher. The S&P 500 is trading near all-time highs, valuations are stretched, and the margin for error is razor-thin. Small caps, once touted as the next leg of the bull market, have failed to deliver alpha for years. The odds are stacked against them, and the “bigger is better” trade is winning by default.

Cross-asset correlations are flashing warning signs. Gold, often a safe haven in times of stress, punched through records only to give back gains. Bitcoin, the supposed new macro hedge, crashed through $80,000 and kept falling. The “Bye America” trade is back, with global investors rotating out of US risk and into anything that smells like safety. But with liquidity draining, even the safe havens are looking less safe.

The technical setup for the S&P 500 is precarious. Momentum indicators are rolling over, and the index is flirting with key support levels. The risk is that a break below these levels could trigger a cascade of selling, as systematic funds and algos pile on. The liquidity drain from Treasury issuance is the wild card. If the TGA keeps rising and liquidity keeps tightening, the market could be in for a rough ride.

Strykr Watch

The S&P 500 is currently testing support around the $4,950 level. A break below this zone could open the door to a swift move down to $4,850, with the 50-day moving average providing the next line of defense. Resistance is stacked at the recent highs near $5,000. Momentum indicators like RSI and MACD are rolling over, suggesting that the path of least resistance is lower. Small caps, as measured by the Russell 2000, are underperforming badly, with no sign of a turnaround.

Treasury liquidity is the key variable to watch. If the TGA continues to rise and settlements drain cash from the system, expect further pressure on risk assets. The correlation between liquidity and equity performance is as strong as ever, and traders would be wise to keep one eye on the Treasury calendar at all times.

The risks are clear. A break below key support levels could trigger a wave of systematic selling, with the potential for a sharp correction. If Treasury liquidity keeps tightening, the pain could spread across asset classes. Small caps are particularly vulnerable, with no structural bid to support them.

But for those willing to play defense, there are opportunities. A dip to the $4,850-$4,900 zone could offer a tactical long setup, with tight stops below the 50-day moving average. Dividend stocks, as highlighted by CNBC, may provide a safe harbor for those seeking income in a volatile environment. And for the brave, shorting small caps remains a high-conviction trade.

Strykr Take

The S&P 500 is walking a tightrope, with liquidity as the balancing pole. The technicals are flashing caution, and the macro backdrop is deteriorating. This isn’t the time to chase highs or bet on a small-cap renaissance. Stay nimble, respect the liquidity signals, and don’t be afraid to play defense. The next few weeks will separate the pros from the tourists.