Traders are dumping equity protection and buting chaos protection as VIX tumbles near the year"s lows and Gold jumps back towards its 100-day moving average - and its highest level in a month.
Gold is up 9 of the last 10 days, at its highest since early Dec and testing its 100DMA... ($1292)
And while Bitcoin has stabilized, the divergence between the alt-currencies is closing...
Whereas many Wall Street strategists enjoy simplifying their stream of consciousness when conveying their thoughts to their increasingly ADHD-afflicted audience, the same can not be said for Deutsche Bank"s Aleksandar Kocic, who has a troubling habit of requiring a background and competency in grad level post-modernist literature as a prerequisite for his articles among the handful of readers who don"t already speak exclusively in binary. Here is an example of Kocic"s "unique" narrative style:
Volatility is a consequence of speed and speed is the result of fear. Acceleration of movement is a defensive maneuver, a tool of retreat -- high speed and high volatility represent sophistication of flight (flight to quality is an example of the speed event). However, absence of volatility is not necessarily synonymous with absence of fear. Volatility is low not only when things become predictable, but also if the distribution of risks causes paralysis, when the state of no change, regardless how uncomfortable it might be, becomes the least undesirable of all alternatives.
While a passage like that is far more likely to have been taken from a book by Lacan, Derrida, Deleuze and Guattari, Foucault or any other prominent POMO-ists, in this case it comes from Kocic" year end outlook which encapsulates many of the themes we have covered recently, most notably his recent take on the interplay between volatility and leverage, a topic which anyone who has read Minsky is quite familiar with, yet which Kocic decided to give it his unique post-modernist spin with the following "spiraling leverage" chart from one month ago...
... which he described as follows: "spiraling leverage cannot continue indefinitely. At some point, the bubble becomes too big and cannot be subsumed by a bigger bubble – the damage of its burst would become irreparable. Therefore, when that moment comes -- and we believe that moment is now – the market is facing a following dilemma."
The Deutsche Banker"s conclusion was stark and certainly dramatic:
"The tension created by these three choices is in the center of both economic and political discourse. It will shape the market dynamics in the future, beyond the near term. Taper tantrum and the US presidential elections were the two most recent episodes that have highlighted the risk distribution opened by these choices. Policy mistake appears less likely at this point. The financial conditions are as loose as they have ever been. Fed hikes are only going to tone this down, but it is very difficult to see how they can create overly tight financial conditions and cause economic slowdown. Nevertheless, negative convexity of the central banks in the bear steepening or generally high rates scenarios are making risk of volatile deleveraging alive."
Of course, Kocic could (far simply) have said that it takes more and more debt to kick the can, and keep the world"s biggest asset bubble ever created - with the explicit backing of central banks - from bursting. This is precisely what Bank of America"s Barnaby Martin did in far less words one month ago:
"the irony in today"s world is that central banks are maintaining loose monetary policies to generate inflation…in order to ease the pain of a debt "supercycle"…that itself was partly a result of too easy (and predictable) monetary policies in prior times."
* * *
In any case, fast forward one month later when Kocic picks up where he left off on his favorite "spiraling leverage" diagram, and decides to once again paraphrase Minsky"s conclusion that "stability is destabilizing" using just a few hundred extra words than is necessary, although since he does so in a "cool", Pomoist way, here is the paraphrase:
Persistent low volatility is like a sirens’ song. Low uncertainty engenders high leverage which leads to compression of risk premia and further buildup of risk, which, in the long run, destabilizes the system causing ultimately volatile deleveraging. This is generally harmful for the economy and requires stimulus injection in order to create an economic turnaround leading to subsequent decline in volatility and gradual releveraging as the system recovers. When described in terms of leverage and volatility, economic trajectories exhibit quasi-periodic pattern. These dynamic are shown in the Figure as trajectories in the vol-leverage plain across several “cycles”.
Starting with the internet bubble in 1999, we reach the 2001 recession and subsequent recovery on the back of the real estate boom (2003-2007). The figure suggests that after each volatile deleveraging (e.g. 2000 and 2007), subsequent sweep leads to a bigger bubble. After each sweep, amplitudes grow bigger and the damage more substantial, requiring a heavier hand in terms of policy response as crises they create become deeper and recoveries longer and more difficult.
Kocic then reuses the same chart he showed back in November to indicate the four distinct endgames should the leverage cycle be pushed into one of four final states of "instability."
Where the narrative differs from last month, however, is in the slight but perceptible shift to Kocic" conclusion: he now appears resigned that the current twist of the vol spiral is also the last one, beyond which the current financial and monetary system will no longer exist, something his just as gloomy colleague Jim Reid concluded not too long ago and which we described in "This Is Where The Next Financial Crisis Will Come From."
Here is Kocic explaining why we may be approaching the end of financial history (at least as we know it):
It is clear that the spiraling trajectory cannot continue indefinitely; it has to stop at some point beyond which there will be no more bubbles. In many ways, it looks like the post-2008 represents the last lapse. A new game has to be reinvented for the old future to materialize, or a different paradigm altogether has to take over.
As to what happens next, after the two sweeps of the spiral, both of which culminated with crashes, Kocic reverts back to his forecasting self and writes that "we arrived at the juncture point (2017) from which four possible trajectories emerge, none of them are looking very attractive at this point." For those who may have forgotten the November report, here they are again:
- Throughout the post-crisis period, policy response has been designed around an attempt to avoid the lower left corner of low volatility and low leverage. It is safe to say that we have been able to stay clear of this outcome.
- At this point, with regulated financial sector and restricted leverage, we have found what appears to be a “reasonable” base case trajectory – a middle ground between Japanese style liquidity trap and repeat of the same mistake of the previous lapse -- with regulated markets, lower leverage, and subaverage growth (a.k.a. Permanent state of exception).
- Alternatives represent risk scenarios and correspond to volatile outcomes. The lower right corner is the policy mistake territory of forced deleveraging (without inflation) triggered possibly by overly aggressive Fed.
- The most acute risk is associated with the path leading to the upper right corner where possible deregulation and reckless fiscal spending could trigger rise in inflation leading to stagflationary outcome with potential currency decline and forced unwind of the bond trade. Both of these trajectories represent high risk alternatives to be avoided.
Unfortunately, as recent social events have demonstrated, the current "reasonable base case" of a "permanent state of exception" is becoming increasingly improbable because the forced surreal financial relationships are starting to tear apart the social fabric itself. Not only that, but the fact that the "stability" has only been bought thanks to some $15 trillion in central bank liquidity is lost on only the biggest fools, and socialists, pardon - MMTers - in finance. Here again is Kocic:
As much as the base case trajectory appears as “reasonable” and a worry-free choice, its biggest problem is its legitimation. Easy money provided by central banks to restore growth was easy for capital, but not for labor. Policy response to crisis added further to inequality by blowing up the financial sector and inviting speculative rather than productive investment. The Keynesian bond which ties profits of the rich to the wages of the poor seems to have been severed, cutting the fate of the elites loose from that of the masses and the well-being of the economy.
Confused? You can thank Bernanke and Yellen for president Trump. Anyway, Kocic continues:
With subaverage growth and highly skewed wealth distribution, the economy is converging towards what for a growing majority increasingly resembles a zero sum game. To the vast majority, that is saying that the best days are behind us. This is the most difficult aspect of the base case scenario: There has been no political system in modern history -- inclusive, exclusive, democratic or oppressive, all the same – that has promised anything but better future to its constituents. For any ideology the gradient between the present and the future has always had to be positive. It is difficult, if not impossible, to conceptualize any political narrative capable of making the reverse acceptable. And in a context where economic growth is a universal metric of progress, problems with the base case become even more acute. The legitimation of the base case will continue to define the populist narrative as a voice of change. Politics will be shaped along the lines of looking to disrupt the status quo with quick short-term fixes, which could emerge as outright triggers of stagflationary trajectory.
Well, considering that years and decades of endless political lies that "the future is brighter" is the reason why the world finds itself on the edge of a social, political and financial catastrophe, and which has made a handful of people richer than their wildest dreams while pushing the vast majority of the population into considering that socialism - and even communism - may be a wise alternative to capitalism, perhaps it is not so bad that for once the truth will be told and someone will have the temerity to admit that no, the future will not be better, especially when one admits that after the next crash - and the wars that follows - the future, or as it will be known then, the present, will be the worst since the world wars.
And finally, for those who lament the disruptions to the status quo by populist elements promising "short-term fixes", well just look where said status quo got you: a world where the markets have to close their eyes and pretend they can exist forever in the artificial, central-bank created "permanent state of exception."
Which, thankfully, is impossible.
From the latest Weekend Notes by Eric Peters, CIO of One River Asset Management
Anecdote
“What are the odds we come across an opportunity in the coming 4yrs to earn 20%?” the investor asked his team.
“High,” they answered. “The odds are 100%,” he said, having seen this movie a few times. “So our cost of capital is 5% per year (20% divided by 4yrs), plus the 1% we earn on cash,” he said. His team nodded.
“Under no circumstances should we deploy capital unless it earns well more than 6% per year from here on out.” It made sense.
“What do we see that earns more than this hurdle?” he asked. His team’s list was as short today as it was long in 2016, 2011, 2009, 2003, 1998, 1997, 1994, 1992, 1990, 1987, etc. Today’s few opportunities have much in common with previous peaks: negative convexity, complexity, illiquidity, leverage, and/or all the above.
“Investors confuse a 7.5% average annualized return target with a 7.5% annual return target,” he explained. “They’re entirely different things.”
Targeting average annualized returns allows you to accept what the market gives you, while targeting annual returns forces you to leverage investments near peak valuations to hit your bogey. “Typical pension and endowment boards want incoming investment returns to consistently exceed outgoing flows.”
So most investors attempt to produce the highest return every year, no matter what it takes. “But that’s the wrong objective. Never underestimate the value of cash and patience in achieving the real goal; superior returns over the complete cycle,” he explained.
“Markets tell you what to do if you listen,” he said. “Near the highs, few opportunities exist to earn substantial returns, so you should take little risk. Near the lows, opportunities to earn attractive returns are abundant.” You should take a lot of risk. “This sounds simple because it is. It’s obvious. But obvious is not easy.”
After a record run of muted movement, will recent volatility send negative shock waves through stock market?
The recent uptick in stock volatility has some investors on edge (OK, it is mostly just financial news editors on edge). The truth is, while volatility over the past week has seen an increase, it is not all that far away from the historical norm. Last Thursday through Monday, for example, the Dow Jones Industrial Average (DJIA) experienced 3 straight “volatile” days, with daily ranges of between 1% and 1.6% on all 3 days. Looking historically, however, we find that the average daily range in the DJIA over the last 90 years is 1.6%. Even during the current bull market since 2009, the average range is 1.08%. Thus, the recent action should hardly be characterized as volatile.
The reason it perhaps seems so tumultuous is because we are emerging from a long stretch of calm in the market – record calm, at that. Prior to Thursday, the DJIA had gone 72 days without experiencing a daily range as wide as 1%. If that sounds like a long stretch, it’s because it is a record. In fact, the record prior to this recent streak was just 49 days in a run that ended in late February of this year. And prior to 2016, the record going back to 1928, according to our database, was a mere 32-day streak back in 1944 – less than half the recent streak.
Furthermore, historically, there have been just 16 streaks that have lasted as long as 21 days, i.e., 1 month.
Interestingly, this recent streak is the first of any of the 16 that saw 3 straight 1% daily ranges immediately following its culmination. So is mean-reversion starting to rear its volatile head here following the record calm? And is there a nefarious message to the sudden uptick in volatility?
* * *
If you’re interested in the “all-access” version of our charts and research, please check out The Lyons Share. Find out what we’re investing in, when we’re getting in – and when we’re getting out. Considering that we may well be entering an investment environment tailor made for our active, risk-managed approach, there has never been a better time to reap the benefits of this service. Thanks for reading!
After his provocative admission published earlier that he now checks "Breitbart daily and InfoWars too... You can no longer understand America unless you do", One River"s CIO Eric Peters published the following anecdote revealing an earlier moment of his life, when as a currency trader, he learned a valuable lesson following the spectacular blow up of Europe"s Exchange Rate Mechanism, or ERM, and why the lesson from some 25 years ago, leads Peters to conclude that "Today’s central bank volatility suppression regime resembles it, and will end in spectacular fashion".
Anecdote:
“Let’s step into my office,” he said. So I did. He was my boss. “The firm’s most important client needs help.” I listened, uninterested, unconcerned about clients, their problems. Barely cared about my boss. I had a game to play, solo sport, and loved it to the exclusion of all else.
“They need to do a very large trade.” A twenty-six-year-old proprietary trader’s mind is rather primitive. Which is good and bad. Being young and dumb allows you to see things elders can’t. And take risks one rarely should. In 1992, I’d done both. “They need to buy three hundred million Mark/Lira.”
Europeans established a mechanism to lock their exchange rates into narrow ranges to reduce market volatility and promote economic convergence. In theory it worked, in practice it didn’t. Politicians named it the ERM.
“What would you like to do?” he asked, calm. I stood there, processing. Such a sum was extraordinary even before the ERM blew up, which it just had. For months, I’d bought options in anticipation of its demise. Honestly, it was obvious.
The ERM encouraged speculators to build massive leveraged carry positions, discouraged corporations from hedging exchange rate risk, suppressing volatility and interest rate spreads everywhere. The process was reflexive.
Today’s central bank volatility suppression regime resembles it, and will end in spectacular fashion. All such things do.
“I want to buy more!” I answered. My foreign-exchange options left me long the exact amount our client needed to buy. No other bank would sell them such a large sum. So naturally, I wanted more.
“You should sell them your whole position,” he told me, firm. I couldn’t understand, it made no sense. “Big customer orders like this usually mark the highs - never forget it,” he said. I left his office angry, irate, sold my whole position. And he was right.
Authored by Lance Roberts via RealInvestmentAdvice.com,
What the “heck” was that?
This past week seemed to be the story of Christmas coming early. Earlier this week the markets surged higher on hopes that “Ole’ St. Tax Cuts” would soon be here. But that dream seemed to be short-lived on Friday, at least at the open, as General Mike Flynn seems to embody the “Grinch” trying to steal Christmas.
But at the end of it all, not much actually changed. Well, except for the fact that volatility not only made an appearance as stock prices swung wildly in both directions, but also in Treasury rates. As expectations of tax reform grew, rates spiked higher but then sank just as quickly as fears of turmoil in the Administration sent money into the safety of bonds.
As shown above, despite all of the “sound of fury” the S&P advanced 1.53% for the week while rates, not surprisingly as money rotated from “safety” to “risk,” ticked up from 2.3% to 2.4%. However, while volatility finished week only up mildly, intra-week we saw volatility jump to nearly 15 before settling back at 11.
The sharp advance, as the market went all “bitcoin,” pushed well into 3-standard deviation territory above the longer-term moving average with overbought conditions pushing extremes. While the backdrop remains decidedly bullish, the sharp moved higher has all the earmarks of an exhaustion move which suggests some profit-taking cool things off over the next couple of weeks.
While the market is extremely overbought, the bullish trends remain intact. Furthermore, the month of December tends to bullish for equities which keeps portfolios allocated towards equity risk currently.
With the tax bill now out of the Senate, the real work begins as the House bill and Senate bill will go to conference to work out the rather substantial differences between the two bills. With neither bill even remotely approaching a “fiscally conservative” that will actually lead to stronger economic or reduced debts and deficits, it is a huge windfall for corporations.
This, of course, raises the question as to how much of the “tax cuts” are already priced into the markets.
One thing to be cautious of is the possibility this could well be a “buy the rumor, sell the news” event as we move into the New Year. As I stated last week, I see two potential outcomes:
Let me repeat from the last newsletter:
“As I see how December plays out, I will be seriously looking at adding a short-hedge to portfolios before year end. I will keep you apprised.”
This weekend, I am traveling to Florida to give a presentation on the markets and will be joined by some of my friends like Chris Martenson and Nomi Prins. It promises to be fun and I will fill you in on any great insights next week.
by Michael Lebowitz, CFA
The explosive rise of Bitcoin (BTC) has taken the investing world by storm, and for good reason. Over the past six months alone BTC has quadrupled in value. Since 2012, it has risen over 200,000%. To put that into context, had one invested 10k in 2012 they would be worth over $20 million today. The graph below shows the meteoric rise.
There are predominantly two camps with strong opinions on what the future holds for BTC. One generally believes it to be the currency of the future while the second camp thinks BTC is another financial bubble. Given BTC’s increasing popularity we thought it would be helpful to present these two competing perspectives and then offer our own assessment.
Believers in BTC claim it is quickly becoming a widely accepted global currency. To better understand their view let’s see how BTC meets the definition of a currency, both as a means of transacting (money) as well as a store of value.
Money: money is anything that two parties can agree is acceptable in exchange for goods and services. For example, if I pay you a case of beer to mow my lawn, the beer, in this instance, is money. However, for “money” to be widely accepted, the masses must ascribe similar value to it. While there is an increasing number of vendors accepting BTC, it is nearly impossible to use BTC to meet your everyday needs. Further, the value, or price of money, needs to be relatively stable to be effective. If a dollar bill bought you a case of beer today, but only a single bottle tomorrow and a keg the following week, few consumer or vendors would trust the dollar’s value. BTC’s value can fluctuate 5-10% on an hourly basis
Store of value: a store of value is something that allows one to save money and retain its value. When we save money we want comfort in knowing the money we earned can buy us the same amount of goods and services tomorrow that it can buy today. Again, the extreme volatility of the price of BTC makes it difficult to project how much purchasing power a BTC will buy you in the future. All currencies fluctuate but typically nowhere near the degree we are witnessing in BTC.
If the extreme price movements of BTC subside it is possible that BTC can serve as a widely accepted currency and the believers could be correct.
A second camp believes BTC is a financial bubble. The chart below compares BTC to other recent investment fads.
You will notice in all instances above the bubbles rise steadily in price before transitioning to an exponential increase prior to collapse. Often, in the so-called euphoric phase, prices go well beyond the point most investors think is reasonable. In this respect, BTC is following the path of prior bubbles.
Bubbles are not solely defined by price movements, but more importantly by a lack of supporting fundamental value. If you subscribe to the value of BTC as does the first camp, the rapid increase in price may well be justified. If you believe there is no value, BTC is showing the classic pattern of most bubbles.
We believe BTC can rise even further from current levels. That said, we question whether it has any meaningful fundamental value. In the textbook on sound investing, Security Analysis, Benjamin Graham, and David Dodd define investing as follows:
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Based on this very clear definition of terms, there is no way to classify BTC as anything other than speculation. Furthermore, while we agree with those in camp one that BTC might one day be universally accepted as money and a reliable store of value, we have one major problem with which to contend.
To help you grasp our issue, consider that an investor who bought Bitcoin a few years ago and sold it today would have accumulated a remarkable gain. Even better, unlike a capital gain on stocks, bonds, real estate and all other financial assets, that profit is tax-free.
Now ask yourself, how long will the government allow investors to avoid paying taxes on gains in BTC? Further, will the U.S. government, or any other government, cede control of its currency and ultimately the economy? We expand on this concept below from a primer we wrote on cryptocurrencies- Salt, Wampum, Benjamins – Is Bitcoin next?
The preamble to the U.S. Constitution states the purpose of the Federal government is to:
“…form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity.”
In other words, the government’s role is to protect the freedoms and liberties of its citizens. If the government has no ability to fund itself and is unable to provide defense and law enforcement it cannot uphold the Constitution. More precisely – the sovereignty of any nation, regardless of its form of government, rests upon the strength and integrity of its currency.
There may still be gains ahead for BTC, but the volatility of its price and still low adoption as a means of transacting pose obvious problems. The bigger risk, however, is given government incentives to impose taxes on the public and manage economic activity, the speculative value currently being ascribed to BTC does not seem durable and is therefore unlikely to survive.
by Doug Kass
“And I said to myself, ‘This is the business we have chosen."” –Hyman Roth, “The Godfather”
To me, stock price deception is seen with more frequency today than in any time in modern investment history.
Our markets, influenced by massive central bank liquidity and dominated by passive strategies (ETFs, risk parity, and volatility trending), not only are inhibiting price discovery but also are artificially influencing price action — “buyers live higher and sellers live lower” — to both the upside and downside.
In some measure, this is reducing the authenticity and validity of stock prices and charts and is hurting the value of technical analysis, which may be basing its decisions, in part, on artificial patterns/prices/data. On the other hand, it benefits those who view the market without emotion and who are willing to buy extreme weakness and sell extreme strength.
Yesterday underscored the reasons why and how I look at stocks. I would emphasize, again, that I do not have a concession on the process and I recognize that others have different approaches that provide good investment returns.
But I have a logic in my approach and Wednesday’s bifurcated action and its selective and often extreme volatility underscores some of these principles that I have adopted over the last four decades and provides some additional lessons:
* Avoid Volatile and Unpredictable Stocks — It’s Gambling: In the last two days, Riot Blockchain Inc. (RIOT) has had a range from about $12 to $25. There has been no news to account for that volatility and random action.Other collateral bitcoin plays such as Social Reality Inc. (SRAX) and Xunlei Ltd. (XNET) have had similarly large trading ranges. No specific company news there, either. Given my risk profile, I never will trade in these stocks. Others believe differently and believe they successfully can skate on this thin ice, but I will stick to my risk appetite, and I believe all but a few professionals may be kidding themselves in rationalizing these stocks “tradeability.” This also explains my reluctance to trade bitcoin, which had a trading range yesterday of $9,290 to $11,377 — again, on no news.
* No Matter What the Charts Say, I Prefer to View Every Trade/Investment Based on an Assessment of Reward vs. Risk — Seize Those Opportunities: The dynamic of an upside/downside calculation and determining discounts or premiums to intrinsic value form the basis for my trading and investment decisions. Recently, I successfully traded two retail stocks, Macy’s Inc. (M) and Dillard’s Inc. (DDS) , on this basis. Consider Twitter Inc. (TWTR) , which at $22 a share looked technically solid. Nevertheless, I sold off a large portion of my position between $22 and $22.50 recently based on an assessment of a less-favorable upside/downside ratio. Others bought based on an improving chart. Both I and they are likely comfortable with our decisions, but the purpose of this missive is to further explain my tenets and methodology.
* There Are Many Great Charts That Lie at the Bottom of the Sea: Though one or two days don’t make a market, the artificiality of the markets may be underscored by two stocks yesterday — Micron Technology Inc. (MU) and Square Inc. (SQ) . Both recently looked fantastic technically. Embraced by many a talking head in the business media, both have been schmeissed in recent sessions. Like the Nasdaq 100 ((QQQ) was down $3 yesterday), they all looked good on the charts until they didn’t, and all provided little indication to prepare traders for the reversals. At times like these, it is increasingly dangerous to buy stocks on breakouts. Buying calls on these stocks moves one further to the end of the risk curve. This strategy may work well for some time in a trending market, but a swift directional change can evaporate profits and eviscerate a portfolio. Again, such a strategy should be limited to professionals, and even that body of traders may suffer from a steady diet of options activity, as academic studies show.
* Do Not Underestimate the Impact of Price Momentum Strategies on Individual Stocks and Sectors: Over the last month, technology, especially of a FANG kind, has soared and other areas such as retail have collapsed. The possible artificiality of both moves was evident in the reversals this week and yesterday. Amazon.com Inc. (AMZN) , as an example, was down by more than $45 on no news yesterday. Retail stocks such as M and DDS rose by 10% on Wednesday and 20% in the last week, also on no news. This may underscore (1) the reduced value of analyzing stocks on price technically, and (2) that opportunities are provided for those who are emotionless and have a sense of intrinsic values and legitimate upside/downside calculations.
* A Diversified Portfolio Is a Preferable Course: Jim “El Capitan” Cramer detailed the value of this approach late yesterday in a well-thought-out column, “‘Am I Diversified?’ May Be Boring, but It Can Help Avoid the Pain.” Please reread it. As a matter of course, and as most are now aware, I keep my individual stock positions as a low percentage of my total overall portfolio and often have 40 to 50 portfolio names. I am always diversified in position size (typically at about 2% to 3% each) and in sector exposure (limited to 15% of the portfolio). Recognize that when a trader or investor is only buying “good” charts, that is not being diversified. Rather, it is part of a process that leads to a binary outcome that may end badly given the likely artificiality of prices.
Bottom Line
The artificiality of stock prices has accelerated in recent years with the domination of passive investment strategies.
I will not trade/invest in stocks solely on the basis that they “look good” on the charts in this sort of setting, which is dominated by influences that create an under-appreciated degree of price deception.
For these reasons and others I will not buy breakouts and sell breakdowns; this may be the wrong approach in the environment we are now in.
Rather, an approach to buying value and breakdowns and selling seemingly irrationally based prices and breakouts is my investment cup of tea based on the fundamental and dynamic assessment of intrinsic values relative to the current prices.
Others disagree and I respect their ability to navigate differently. I am not taking a shot at their approaches; rather, I am saying what serves me well and what may serve the majority of conservative risk-based investors and traders well.
This is how I am handling the markets these days, and, frankly, will forever.
And … buckle up.
VIX futures spiked up to 13.47 during the session before reversing 12% lower and closing back down at 11.88. Today"s 13.47 intraday high was just:
Drawing trendlines from each Lower Low provides future resistance at several levels. After another failed breakout attempt, the only thing noteworthy for VIX bulls is that the Super RSI™ has registered consecutive bullish divergences as the RSI has made higher lows while price has made lower lows.
A good way to get an early "heads up" that VIX futures may be ready for a true breakout is to draw the trendlines on the RSI"s plot values. We can see that the RSI value is turned up and poised to break above the trendline from the August highs, but true confirmation of a long-term VIX bottom will require a break above the trendline connecting the two major swing highs from 4/17 and 8/11.
Check out Fibozachi.com to learn about modern technical analysis and trading indicators that actually work.
originally posted by the Soren K. Group on marketslant.com
If the title confuses you, do not be fooled. There is a short term outlook, that can change from day to day, an intermediate outlook that can change week to week, and a long term one. This changes month to month And they are not contradictory.
We are in a limbo area right now, where a short term bull leg is triggered with a decisive penetration above $1294.50. And any settlement below $1292.20 is a short term bear leg. Accumulators buy while shorters seek weakness to push lower. Physical accumulators do not chase. It is the shorts who will ignite this if it is to accelerate to the upside. We"d prefer a slow melt up to $1338 so no hot money buys, and shorts can delude themselves
Michael"s analysis echoes what we see longer term. Specifically, in 9-12 months he sees an upward move bringing us to $1400 minimum, and over $1800 maximum. This all happens as long as the market withstands any pressure down to $1229.
Our own analysis remains unviolated adn fully intact. Funds are buying dips above the 12 month moving average, Volatility in the short term is starting to percolate, and long term volatility is flatlining. The low long term volatility implies the next move in Gold is not to be faded if accompanied by newly expanding long term volatility.
Simply put:
SKG Fund Finder - the 12 month MA said to buy in July/August on a settlement above the yellow line. Our refinement says now is when to buy based on line slope and risk /reward
GC (G)
I cautioned that an area of possible exhaustion for the move up from 12628 came in at 13077-81.
We rejected $43.9 from this, but this is now on hold. The trade above 12896 (-1 tic (10 cents) per/hour) put us above a small
formation that projects this upward $5.5 minimum, $14.5 (+) maximum. We have seen $9.4 of this so far. This will come in at
12881 (-1 tic (10 cents) per/hour starting at 6:00pm). If we break back below, look for profit taking to come in. The trade
above 12925 brought in $6.5 of the strength warned about above before rolling over. Decent trade below 12792 (+.3 of a tic
(3 cents) per/hour starting at 6:00pm) will project this downward $20 minimum, $24 (+) maximum; but if we break below here
decently and back above decently, look for decent short covering to come in. A maintained gap lower tomorrow will leave a
short term bearish reversal intact above that will warn of decent pressure, likely for days. Trade above 12990 is a sign of
renewed strength.
We broke above a well-formed macro line in the week of 8/7 that came in at 12629. The break above here
projects this upward $174 minimum, $493 (+) maximum—the maximum to be attained likely within 9-12 months. This line
comes in at 12294 this week, and rolls into (G). This is off hold, or you could wait for a decent break above the 12947-54 area
mentioned below for added confirmation. Within that we rallied up to a macro resistance line on 9/11 at 13522 that I said we
are looking for a multi-week smackdown from-- we were seeing some of this as we have come off $89.4, but this is on hold.
We left a medium term bearish reversal intact above on 9/18 that also warned of continued pressure in the days/weeks ahead.
We have seen $48 so far. This too is on hold. Within the bearishness I noted that a possible area of exhaustion for this move
down from 13624 comes in at 12732-644. We basically held this, but with a $1.6 violation, and rallied to 13084 before rolling
over and rejecting from it again. Decent trade below 12682 will project this downward $31 minimum, $97 (+) maximum based
off a well-formed formation. Decent trade above 12950 will project this upward $23 minimum, $47 (+) maximum based off an
‘ok formed’ formation; but if we break above here decently and back below decently, look for decent profit taking to come in.
Email Michael for subscription info : Michael Moor
Volatility Cycles more cleanly than price. it could stay low for months, but is far less likely to give false signals.
In Gold and Silver, we use 1.5 STD on BBands and relationships not shown here between historical and implied that corroborate or negate a signal- SK
Good Luck
Dear Readers:
"Day job" obligations are making it difficult to expend resources toward writing original pieces consistently. We do not have a Soren K. site but wish to continue writing. To do so we will need to incur expenses. Marketslant is kind to post our work and the work of others here. We hope to be setting up a Soren K. Group Patreon page in the next weeks to continue giving our original work, as well as proprietary research for Precious Metals traders. Anytng offered will be greatly appreciated.
We also hope to do the following for readers
Finally we are in the process of raising capital for a fund and are speaking to seeders in that pursuit. Between our SKG members we have 65 years trading experience in PM, Energy, and Equities. Among our group are algo writers, analysts, $BB Fund partners, lawyers, Wall Street bank executives, and other complementary minds. Trade ideas we execute when up and running will be shared with site Patrons as investors permit.
If you have an opinion, interest or wish to write please contact us at
Authored by Peter Tchir via Forbes.com,
We have all heard the VIX or volatility index referred to as the Fear Index or Fear Gauge. Rising VIX was meant to signal fear in the markets. That is how most investors have historically thought about VIX and traded it (directly or through Exchange Traded Products).
I have gone back in time and combined the total assets under management of XIV and SVXY (two short VIX products) and UVXY and VXX (the two largest long VIX products). There are others and it doesn"t account for the fact that UVXY incorporates leverage, but the point is the same.
The funds that in theory helped investors "hedge" their portfolios went from being the dominant species to those that enable investors to sell volatility.
Short VIX Funds are Larger than Long VIX Funds (source Bloomberg)
This has rarely been the case.
Typically investors had more interest in hedging their portfolios despite the evidence that the long VIX ETFs and ETNs had to continually perform reverse splits as their share prices drifted lower (some would argue "raced" lower is a more accurate description).
While the products looking to benefit on a volatility spike still attract inflows (otherwise their assets under management would be even lower), they have lost the competition to the VIX sellers.
The only other gap of similar size and duration was in late August 2015 - AFTER the market sold off and volatility spiked.
This time, it is occurring as stock markets are near all-time highs and VIX is still close to the all-time low it set just a few weeks ago (VIX is only calculated since 1990).
Whether this has finally reached a stage of complacency is anyone"s guess, but the "Golden Goose" of selling VIX that I wrote about in March of this year - is clearly not a secret.
I"m not overly concerned about complacency, it is after all, a slow and typically low vol period for domestic markets, but it is something that investors need to focus on.
A spike in volatility could be far more problematic than the market is prepared for as even a small spike could turn into a larger problem with so many people positioned the other way.
Authored by Lance Roberts via RealInvestmentAdvice.com,
It is always refreshing to step away from the keyboard for a few days and hit the “reset button,” which is exactly what I did last week. My wife and I took a quick trip to Mexico to get a little sun on our face while we wiggled our toes in the sand.
I came back astonished.
Over my 30-odd years of working with money in various capacities, I learned to “shut-up and listen.” This is particularly the case when you are in an airport lounge or packed like sardines in a missile-shaped tube hurling through the air at 35,000 feet.
People love to talk…if you let them.
I had a dozen “listening sessions” with a wide variety of people who each told me roughly the same thing summarized as follows:
You get the idea.
And just when I thought I was sure I had the most bullish views wrapped up – Kevin Matras fro Zack’s Research hit my inbox with the following:
“The S&P will double. And not just eventually. But over the next 5 years (or sooner).
Sounds like a Herculean task on the surface, but it’s really not. In fact, the market only needs to gain on average of 14.9% per year in order to do so. That’s not such a stretch given the market has been averaging 14.9% per year since this bull market began in early 2009, even though GDP (prior to this year) has only been increasing at an anemic 1.48% annual rate.
My 5-year doubling thesis also means that we won’t see another recession until stocks double again, nor will we see another bear market until stocks double again.“
So, there you have it.
No bear market until the market racks up another 2600 points and dwarfs every other economic growth cycle in history.
Meanwhile….Back On Earth
Before I go further, let me clarify one thing.
As a portfolio manager, I am neither bullish nor bearish. I don’t really care which way the market is headed personally. If it is rising, as it is now, I am long equities. When it reverses that trend, I will either be short equities and long bonds and cash.
That’s my job.
My job is also to pay attention to the risks that could quickly remove large chunks of investment capital from my client’s portfolios. Like any professional gambler knows, you can only play the game as long as you have a “stake” to play with. Lose your capital, and you lose the game.
In the movie, “The Perfect Storm,” George Clooney plays the Captain of the “Andrea Gail.” The Captain, after having a bad start to the fishing season, convinces his crew to go out one last time and they venture well past their usual fishing grounds leaving a developing thunderstorm behind them. After ignoring repeated warnings, a desperate Captain, and crew, head into a confluence of two powerful weather fronts and a hurricane in order to cash in on their bounty.
They all died.
Investors today, after having missed out on the first few years of the current bull market cycle, have now decided to throw all caution to the wind and ignore the repeated warnings in hopes of attaining the “riches” they have been promised.
And, like the “Andrea Gail,” they are currently heading into a perfect storm.
Currently, there are many articles pointing our various risks in the market. One that caught my attention over the weekend was a note on the volatility index by Kevin Muir.
“For the longest time, I felt the concerns from the VIX were overblown. For years, market pundits have been bandying about charts meant to scare investors about the potential dislocation in the VIX market. I even wrote a piece called, The VIX Article no one will like.”
He is right. For the last several years, each time the volatility index hit new lows, there were fears of a massive reversal on the horizon. Yet stocks marched higher while the volatility index made even lower lows.
But Kevin goes on to make an important point:
“Yet the frenetic pace of VIX shorting has intensified to a level that frightens me. There is now $1.2 billion of market cap of the inverse VIX ETF XIV, with another $1.3 billion of SVXY (another inverse ETF). This is insanity.
If we get a sharp move higher in VIX, there will be a snowball effect. If it is big enough, monster positions, like $2.5 billion of short VIX ETFs will have to be bought back in a hurry. And let me break it to you, there is no one large enough to take the other side of that trade. At least no one willing to do it without extracting many pounds of flesh first.”
Kevin is absolutely correct.
The only question is how far does it have to rise before the “margin calls” begin to occur. More importantly, volatility runs very long cycles which, unsurprisingly, follow the psychological investment cycles of the market from fear to greed back to fear.
But that is not the only problem.
Once the $VIX trade begins to fail, investors will find themselves almost immediately confronted the “high-yield bond storm.”
American corporations are levered to the hilt with total corporate debt surging to $8.7 trillion – its highest level relative to U.S. GDP (45%) since the financial crisis. In just the last two years, corporations have issued another $1 trillion of new debt NOT for expansion but primarily for share buybacks to boost bottom line earnings per share.
Note: This is also why “repatriation” won’t lead to massive economic growth, wages or employment. Instead, it will go to share buybacks, dividends, and executive compensation.
For the last 9-years, the Fed’s “zero interest rate policy” have left investors chasing yield and corporations were glad to oblige. The end result is the risk premium for owning corporate bonds over U.S. Treasuries is at historic lows.
I have written for some time that during the next market reversion, the 10-year rate will fall towards “zero” as money seeks the stability and safety of the U.S Treasury bond. However, corporate bonds are an entirely different issue. When “high yield,” or “junk bonds,” begin to default, as they always do, which is why they are called “junk bonds” to begin with, investors will face sharp losses on the one side of their portfolio they “thought” was supposed to be safe.
Let the panic selling begin.
As shown below, when the rout begins, the yields on junk bonds sharply deviate from that of the U.S. Treasury bond. Again, the 10-year Treasury rate is not going higher anytime soon, but everything else likely will.
Of course, as investors begin to get battered by the “volatility and junk bond storms,” the subsequent decline in equity valuations begins to trigger “margin calls.”
As the markets decline, there will be a slow realization “this decline” is something more than a “buy the dip” opportunity. As losses mount, the anxiety of those “losses” mounts until individuals seek to “avert further loss” by selling.
There are two problems forming.
The first is leverage. While investors have been chasing returns in the “can’t lose” market, they have also been piling on leverage in order to increase their return.
It is often stated that margin debt is “nothing to worry about” as they are simply a function of market activity and have no bearing on the outcome of the market.
That is a very short-sighted view.
By itself, margin debt is inert.
Investors can leverage their existing portfolios and increase buying power to participate in rising markets. While “this time could certainly be different,” the reality is that leverage of this magnitude is “gasoline waiting on a match.”
When an “event” eventually occurs, it creates a rush to liquidate holdings. The subsequent decline in prices eventually reaches a point which triggers an initial round of margin calls. Since margin debt is a function of the value of the underlying “collateral,” the forced sale of assets will reduce the value of the collateral further triggering further margin calls. Those margin calls will trigger more selling forcing more margin calls, so forth and so on.
Unwittingly, investors have compounded their risks by piling into exchange-traded funds under the mistaken assumption it is an “easy way to invest.”
Over the past 9-years, the number of ETF’s available to investors has now eclipsed the number of stocks available for them to invest in. This leads to a liquidity problem and the risk of a “disorderly unwinding of portfolios.” As the head of the BOE, Mark Carney, warned:
“Market adjustments to date have occurred without significant stress. However, the risk of a sharp and disorderly reversal remains given the compressed credit and liquidity risk premia. As a result, market participants need to be mindful of the risks of diminished market liquidity, asset price discontinuities and contagion across asset markets.”
The issue of liquidity is not a small one.
Investors mistakenly assume there is ALWAYS a buyer at the price at which they wish to sell.
This is wrong.
While the answer is “yes,” as there is always a buyer for every seller, the question is always “at what price?”
At some point, that reversion process will take hold. It is at that point where the storms all collide into a massive wave of panic driving selling. It will not be a slow and methodical process, but rather a stampede with little regard to price, valuation or fundamental measures.
It will be the equivalent of striking a match, lighting a stick of dynamite and throwing it into a tanker full of gasoline.
Importantly, as prices decline it will trigger margin calls which will induce more indiscriminate selling. The forced redemption cycle will cause catastrophic spreads between the current bid and ask pricing for ETF’s, junk bonds, and option pricing. As investors are forced to dump positions to meet margin calls, the lack of buyers will form a vacuum causing rapid price declines which leave investors helpless on the sidelines watching years of capital appreciation vanish in moments.
Don’t believe me? It happened in 2008 as the “Lehman Moment” left investors helpless watching the crash.
Over a 3-week span, investors lost 29% of their capital and 44% over the entire 3-month period. This is what happens during a margin liquidation event. It is fast, furious and without remorse.
Currently, with complacency and optimism near record levels, no one sees a severe market retracement as a possibility. But maybe that should be warning enough.
Where the majority of mainstream punditry gets it wrong, in my opinion, is they keep saying we “can’t have another ‘great financial crisis’ again” because things are different.
That’s true.
NO market “mean reverting” event has EVER been based on the same issues that caused the previous event.
The next event won’t be the same as any past event either.
Only the outcomes remain the same.
The “perfect storm” is coming.
Originally posted by Soren K. Group on Marketslant.com
Update 10:55 am: like clockwork, the hourly and 4 hour charts that warned of overbought risk proved good guides. Gold pulled back $5.00 since this post. Now to watch the rest play out.
4 hour VBS says slow down. a little...
Original post 9:35AM
No Whammies: First to get it out of the way... We are knocking on wood, because while we have not seen what Gold can truly do in this cluster-uck of a global situation, we must remember that governments are always looking for new ways to undermine the renewed confidence in Gold"s remonetization. Even as Gold climbs and undermines confidence in FIAT currencies globally like a snowball rolling down hill reinforces its own descent, Supranationals are keenly aware of its potential to undermine national control over money.
Governments Rule: They are now battling this war on 2 fronts. The Bitcoin effect which reminds people that money is money because people agree it is so, and not because a government declares it to be so. There was a time before nation-states when money was borderless and universal. But nationalism and monetary controls created captive tax bases and monetary cattle for politicians to milk and if necessary slaughter with inflation or depression. Bitcoin has re-awoken the public to the notion that money is universal. Pre-Bretton woods, that was still so. Gold was money. The USD backed by Gold was the currency.
The Wall is To Keep You In: Make no mistake about it. Governments are building walls around their citizens. walls to keep domestic consumption inside them. Walls that let corporations benefit from global pricing, essentially creating arbitrage for these companies to buy cheap elsewhere, and then sell to the domestic sheep their Governments keep penned in. Governments Can Stay Irrational Longer than We can Stay Liquid. So, do not underestimate the power of the incumbent politicians to keep those pesky alternatives to FIAT subdued and in their proper place.
Another way is to deny BTC deposits unless higher hurdles are met by US
banks to "know their customer". What cannot be destroyed or co-opted
will be controlled. BTC is about to come to daddy and the FED is
going to try to tame it. Or at least regulate US ownership.
Government has put all its eggs and controls in one basket after the TBTF 2008 disaster. The border collies that herd our monetary risk actually consolidated things in even fewer baskets using exchanges , a la Fannie Mae, to keep a closer eye on things while increasing systemic risk. And with that exchange power comes exchange oversight and loss of autonomy in a crisis.
Gold is in a momentum sandwich now. Volatility is overbought short term, nowhere intermediate term, undervalued long term.
So one can imagine this scenario as possible if not likely: We close above $1289. The market pulls back or drifts. If the hourly gives a signal higher again, it will drag the 4 hour along for the ride. Then we will have a serious breakout play in terms of volatility and hopefully follow through in direction.
Gold is doing what we have said it would do since last month. And so far, while November may almost be over, we are seeing the signs of it being a worthwhile place to pin on your charts as the beginning of the next significant surge higher. So, if November is memorable, Then 2018 will likely be unbelievable.
Gold has had a nice run and Volatility is due for a break or "inhale". Do not be surprised if we pull back a bit.... next chart gives confirmation that we should be careful
This chart says we are NOT in a momentum based buy breakout yet and warns of an over extension and subsequent pull back while the hourly catches its breath. Then we see a breakout set up
The Daily chart says a settlement above $1289 gives the go ahead for a nice set up to be long risking a print under $1289 with a 3 day target of $1313.00
This holy grail of charts has already given us the buy signal based on what hedge funds use to "punt" Gold on the long side. On our own system, a November close will determine if the momentum has the ability to increase upwardly. If it does, then we will have 2 compelling, complementary systems saying buy dips to $1255, and buy rallies above the August high. Last time we had a potential widening on the VBS with the market above the Fund Indicator (Yellow line) was August/ September 2009. That signal sent the market up relentlessly for 3 years from approximately $1000 to $1700, assuming you bought and sold when the "Fund Activity" indicator advised as much.
That is a breakout. And while we have called for $1700 as a target recently, that is not the projected target. We have to handicap our own system, if not the global power structure that can keep a damper on things if needed. The original signal set up is $50 one way technically still unknown... then $200 in either direction thereafter. There will be volatility. The monthly chart Bolinger band outer boundaries tell you where it will begin
Suffice to say, if $1200 is the new base area, and we MAY be getting a signal come November end that another 2 year rally is to start.. at what price do you think that puts Gold ?
Good Luck
Earlier we showed a variation on a VIX chart from Citi"s Hans Lorenzen which, if it doesn"t impress, or scare you, then nothing probably will.
However, leaving readers unimpressed - and unscared - will not satisfy Lorenzen, which is why the credit strategist who works together with the godfather of rational doom, Matt King, and has been warning for weeks that now is the time to sell credit, unloads in one of the more effusive missives of dripping negativity to hit during this holiday week when one after another equity sellside analyst has been desperate to outgun each other with their ridiculous 2018 year end S&P forecasts.
And while Lorenzen touches on many things, at its core, his warning is straight out of Shumpeter: the longer nothing changes, the greater the crash will ultimately be, a topic which DB"s Aleksandar Kocic dissected over the summer, even defining an entirely new term in the process: metastability.
So without further ado, here is Lorenzen explaining why "embellishing the status quo will be the market’s undoing.
Ultimately, extreme valuations, the lack of risk premia, and a lack of responsiveness to tail risks are merely symptoms. The real question is what the skewed incentive structure resulting from that backstop has done to the fabric of markets after so many years. To our minds the answer is that trades and strategies which explicitly or implicitly rely on the low-vol environment continuing, are becoming more and more ubiquitous.
Realised historic vol is de facto an exogenous input to much of the risk management framework that underpins modern finance. With lookbacks extending a few years, an extended period of market stability reduces VaR measures and improves Sharpe ratios. Both allow / encourage investors to take more risk – driving valuations higher and vol lower still, creating a self-reinforcing dynamic. Intuitively, returns should follow flows – money is deployed and the asset price goes up. But in the real world the causation works the other way.
What this means in real-world terms:
Long periods of one-way markets breed survivor biases. The fund manager with lots of beta outperforms, the cautious fund manager underperforms. Either the latter gets on the bandwagon or soon enough outflows from the fund will ensue. Over time, fewer and fewer “critics of the regime” are left standing.
In an asset class where the upside is constrained, like in credit, that dynamic is further reinforced by the fact that a fund manager has to take more and more beta relative to benchmark in order to sustain the level of excess carry that will merely cover costs. The lack of volatility and the super high correlations between credits and the index (Figure 24), leave precious little scope for alpha (Figure 25).
Here we can add another piece to the short vol conundrum, because the closer spreads get to the lower bound, the more explicitly being long credit in itself becomes a short-vol position. With less and less upside remaining, owning credit risk become a question of generating a small amount of carry (or premium) for taking future downside risk – essentially, akin to selling a put option.
Meanwhile, as spreads collapse, as dol implied and realized vol, we are all “happily” ignoring that more risk is being issued into the market than ever before (Figure 26) and that the credit quality of the market keeps slipping – for the first time ever the market cap of the BBBs is about to overtake the rest of the € IG index (Figure 27).
What happens next should be familiar from the last financial crisis: the infamous step up in risk:
When the conventional asset class of choice no longer offers a “decent” return potential, money looks to the next one on the quality spectrum for a pickup. IG funds holding BBs and AT1. DM funds buying EM debt. European and Asian funds holding more and more $ fixed income. Corporates moving their liquidity from money markets to short-dated IG credit funds. Mandate creep in the investment criteria. Even synthetic structured credit is making something of a comeback. The list of tourist trades goes on and on. Most of these too are predicated on the status quo - if volatility and risk premia were to rise, retrenchment back towards the original / natural asset allocation would be swift and uncompromising.
And then, one day, the market will finally discount that the central banks are no longer set to injection trillions in liquidity: that"s the moment the public finally begins to admit the emperor is not wearing any clothes.
You could rightly argue that many of these factors are generic to every bull market. The fact that volatility clusters is exactly because of these (and other) selfreinforcing dynamics. But the implicit ceiling on vol / cap on downside from the central bank backstops has, in our view, allowed them to run for much, much longer than would have been possible in a market operating on its own devices.
You could argue that there is nothing to worry about as long as fundamentals remain strong. But those looking at the economic data, corporate earnings or leverage trends to indicate the next turn in markets are looking in the wrong place, if you ask us. Over the last 50 years, only 2 out of 19 corrections in US credit were led by a recession. 12 had no overlap with a recession at all. In half the corrections, there wasn’t even a discernible turn in the leading economic indicator beforehand. Plainly, there is a long history of market corrections being triggered by other factors than fundamentals – Black Monday in 1987 and the correlation crisis in 2005 are two obvious examples.
Still, judging by the current state of the market, Citi writes that traders "evidently don’t expect a sharp market correction to happen tomorrow."
While the probability of a next-day loss still feels quite low there is an obvious temptation to stay invested a little bit longer for professional investors, tasked not with delivering a return of money, but a return on money and with high frequency. The process of judging that near-term probability manifests itself in the frenzied search for “triggers”. Surely, if one could just get a slightly better call on the next trigger, then it’d be possible to get out just in time before everyone else jams the exit? We don’t dismiss the importance of triggers. Indeed, when you look back at the last fifty years, nearly every major correction in credit can be associated with a triggering event (Figure 28). With hindsight everything is easy.
Here Citi has some advice: don"t look for triggers; instead focus on the big picture.
We are sceptical that hunting for the next trigger is worth the effort. If a trigger seems obvious, then it’s probably obvious to everyone and chances are it will be too late. Triggers are often latent – the long-term problem is obvious, but it is ignored until suddenly it explodes without much warning (think the Greek sovereign debt crisis). Multiple factors often have to combine to create a triggering event – the GFC wasn’t just about sub-prime, it was about excessive leverage, inadequate regulation, unchecked financial innovation, misaligned rating methodologies, inadequate backstops and a host of other things. The last couple of years have seen several widely peddled “triggering events” crystallise with remarkably little shake out.
So what about the big picture? Here one can argue that in recent years the market simply wasn’t vulnerable with so much central bank money behind it. However, Lorenzen believes that "2018 is different." As we see it, it is now increasingly vulnerable to a mid-cycle, “technical” correction, based on what we have discussed above:
Lorenzen then branches into some chaos theory for good measure:
In the context of a self-reinforcing, herding market, the pivot point where the marginal investor is indifferent between putting more money back into risk assets and holding cash instead is fluid. But when the herd suddenly changes direction, the result is a sharp non-linear shift in asset prices. That is a problem not only for us trying to call the market, but also for central bankers trying to remove policy accommodation at the right pace without setting off a chain reaction – especially because the longer current market dynamics run, the more energy will eventually be released.
And while not intended to be a conclusion, or even a punchline, the next line from the Citi strategist should scare the living daylights out of anyone: it is a direct admission that central bankers have now lost control.
That seems to be a growing fear among a number of central bankers that we have spoken to recently. In our experience, they too are somewhat baffled by the lack of volatility and concerned about the lack of response to negative headlines.... Our guess is that sooner or later in the process of retrenchment they
will end up going too far – though that will only be obvious with
hindsight.
Frankly, that"s about the scariest admission from one of the world"s biggest banks that we have read in a long time.
* * *
As for how this period of cataclysmic metastability ends, here is Lorenzen"s dire conclusion:
In a fairy tale, turning points come suddenly and unexpectedly. Everything that has long been taken for granted is suddenly in pieces. In that sense markets are not all that different. People have gotten used to the paradigm that has been built up since the Great Financial Crisis. It has been tested on several occasions – 2011, 2012 and 2015 – and on each occasion central banks have overcome the challenge, thus ultimately reinforcing the regime.
The emperor in Andersen’s story was only able to parade around naked because the social norms, customs, conventions and vested interests that had built up over time were so strong that even the blatantly obvious was better left unspoken.
Similarly, the low risk premia, the low level of volatility, the lack of responsiveness to tail risk and spillover of systemic events, the reluctance to sell etc. to us are all indications that the market now has an almost Pavlovian response to central bank liquidity. The mere thought of it is enough to still leave us salivating, even when it is patently in the process of being turned off. Yes, excess liquidity will remain in the system even after central bank net asset purchases fall to zero, but as we have argued, if that money has chosen to stay out of the securities market now, then why should it seamlessly come flowing in at these valuations when the backstop is moving out the money?
While our conviction in the exact timing and magnitude of the paradigm shift is admittedly low – hence the deliberately very wide range in the scenario forecasts – it is unwavering when it comes to the broader point that central bank asset purchases will remain the key driver of markets. Exactly because trades and strategies have been built up around an assumption of the status quo, we fear that the inflection point, if / when it comes will be anything but smooth and linear. Indeed, the longer we remain in the current paradigm, the greater the chance that it ends up being both sharp and painful.
One of our favourite quotes pertains as much to markets as it does to economics:
“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”
? Rudiger Dornbusch
Surely, that is a sentiment which the emperor who had his vanity and pride shattered so abruptly from the least likely angle would recognise all too well?
We end with one of our favorite pictures: the one we call Yellen"s moment of epiphany haw it all ends.
No wonder the Fed chair can"t wait to get the hell out...
