It's August, and the Markets Are Sweating
There's no time to rest this summer with the yen shake up, the 'carry trade,' and the move in stocks. Now let's look of signs of a bottom.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
I was going to write about why the market has become far too optimistic about what the Fed might do for it -- mainly a response to those calls for a half-percentage point cut in September. But given what is going on in global markets and all the red in the U.S. futures, that's probably only a secondary event.
So, instead, let's focus on our bearish stance on equities, with an eye on the risks we're seeing play out right now, and what we need to see to believe we're near a bottom -- and why I'm watching the "ETF Spiral"and selling down positions across the board in fixed income.
First, the risks:
- The "carry trade" and the related yen move. The sell-off's likely causes were the move in the Japanese yen and the carry trade (the low-interest rate currency loans and the changing of the borrowed money into other currencies). The Nikkei is down 12% overnight and almost 20% in August. The Japanese currency is back to 142, a level not seen since the start of the year. Presumably, the yen needs to stabilize for markets to stabilize, but will that be sufficient at this stage, or has too much been triggered?
- De-risking. We have not seen fund flows showing any form of capitulation. We continue to watch that closely and expect we should finally see some serious de-risking, which will be a requirement to form a bottom. Again, we have seen de-grossing and rotation, but not a lot of de-risking. The ProShares Trust TQQQ, the ProShares UltraPro Short QQQ SQQQ, and that Nvidia NVDA fund, GraniteShares 2x Long NVDA Daily ETF (NVDL), have all showed more “buy the dip” than panic last week in their flows.
- Volume selling strategies. Every registered investment adviser I know has been a big proponent of volume selling strategies. Extra income. Hey, if you like it at 80% of today’s price, write a put. That all works so long as people have the true tolerance for risk or the money to buy the stocks when the puts are triggered (otherwise they need to sell something). I always believe that when people say “if this stock gets to X, I will buy a lot” they really mean: “If this stock gets to X for no good reason, I will but a lot." Well, there are possibly good reasons stocks are trading to these levels, making buyers hesitant. I often think of volume selling strategies as picking up nickels in front of the steamroller. As the steamroller nears, expect this to put pressure on stocks and to heighten volatility. Need some exhaustion here, which we haven’t seen yet.
- Fake passive. “Passive” sounds, so, well, “passive,” but when 50% of every dollar invested in a major index goes to relatively few stocks, it becomes more momentum than passive, and this unwind could just be starting.
- Abysmal liquidity. While we still don’t think the lows are in, some major 2% moves could easily occur.
- Geopolitical risk. We have been seeing a divergence between our estimate of geopolitical risk and the market perception of geopolitical risk. From Iran, to North Korea, to Russia, the market is suddenly catching up to us on the risk of escalation and expansion.
- Warren Buffett sales. Certainly not something we pay close attention to, but announcements of Warren Buffett selling down certain positions doesn’t seem to have helped anything.
What now?
Watch for discount to net asset value to increase on fixed income exchange-traded funds. For the first time in ages, I have some concerns about credit.
Lower yields and risk-off do not bode well for high yield (the best hedge for interest rate risk in high yield is typically to own Treasuries). The Russell 2000 futures are now back to early July levels, before their historic pop and high yield tends to be more correlated to the Russell 2000 than other equity markets. If we see selling and outflows from high yield (I expect we will), I will be staring closely at the discount to net asset value the ETFs trade at. I am worried about the "ETF Spiral," in which the arbitrage community selling bonds to buy the ETFs puts more pressure on bonds, triggering new waves of selling. This is not my base case, but am watching it closely.
Don’t expect help from the Fed, or even the BOJ, either, though the latter seems more likely to do something to slow that appreciation in the yen.
It's less bearish now that we’ve added an additional 4% or so to stock market declines, but I don’t see signs of a bottom yet. The 200-day moving averages remain my target, with an increased risk of going through them. While we are likely to get some tradeable bounces, don’t get too “cute” trying to buy this dip. At least not yet.
On the fixed income side, I will be selling down positions across the board, but especially in closed end municipal funds (so long as the discount to net asset value doesn’t increase too much) as we have some very large profits this year in the space, which was our favorite fixed income trade to start the year.
So much for a nice quiet summer....
At the time of publication, Tchir was short QQQ, long SQQQ and XLE.
