The last couple of days has seen some really strange, squirrelly action.
On Monday the equity market rocketed higher at the open, but was immediately sold aggressively.
Monday’s trading in the S&P 500</a> </div>
Then yesterday, the market also gapped higher, and once again, was immediately sold hard. The only difference is that the market did not rest on the lows like Monday, but instead found a surprising bid at lunch, and finished in the upper half of the day’s range.
Tuesday’s trading in the S&P 500</a> </div>
I was not the only one who noticed the strange action. Yesterday Barron’s posted a piece titled “Why traders are Spooked.”
The hot topic Tuesday on Wall Street was far from ordinary, and had little to do with the usual worries about economic growth, Russia’s invasion of Ukraine, or China’s wobbly financial market.
Traders were scratching their heads, and even spinning conspiracy theories, about the unusual aftermath of Friday’s expiration of futures and options.
On Monday, just as the market opened, the price of many stocks surged so much that the settlement of derivatives tied to the Standard & Poor’s 500 index occurred at a price some 10 points higher than Friday’s closing price.
The article goes on to spin a bunch of different theories of why the S&P traded so funky, but I think analyzing the action too closely is a mugs’ game.
The bulls can make all the excuses they want, but a market that opens on the highs and then is immediately sold is not a healthy market. During the recent bull run and previous to this change of character, the market would often gap open higher and then just continue to rip upwards all day. The recent action is different.
In terms of my trading, the timing from this change of character couldn’t have been more ironic. I had just written a post called “Bull market never die of old age”, and the Market Gods in their infinite wisdom of trying to make me look as foolish as possible, seem to be testing my resolve.
My theory was that the bull market would not end until the bond market revolted. I had basically given up trying to trade the stock market from the short side as I viewed the bond market as a much better risk reward. I still hold to that theory, and believe that the bond market will crater first. However, from a short term perspective, we could easily get a tradeable stock market correction.
I made a mistake of underestimating the amount of market players that were counting on Yellen as being super dovish. Over the last couple of months I had been continually droning on about how the market was underestimating the Fed’s resolve in winding down the QE program. Last week when the Fed did eventually convince the market of this reality, I mistakenly assumed it would be instantly discounted. This is a mistake that I often make. I am prone to assuming that since I understand something as self evident – everyone else sees the same thing. The reality is that the process of the market adjusting to the Fed’s relative new hawkishness is going to take time. I need to be patient and not assume it is fully baked in after one week.
Given the terrible market action, I re-instituted a small S&P 500 short yesterday. Volatility is definitely increasing, so I need to brace myself for some bigger moves in both directions, but I think as long as the trading action is so squirrelly, a short position is warranted. Now watch the Market Gods really punish me for my flip flop with a rocket to new highs! There is nothing worse than a flip flopper!
The only thing that I have going for me is that the “Legendary” Gartman is super bullish:
I don’t mean to pick on Dennis, as I read him for years and think he is genuinely a nice guy. But even before he tempted the Market Gods by allowing himself to be referred to as “Legendary” he was never a great stock trader. I think his bond calls are often spot on and I would never fade him in that square. However, if Dennis is “aggressively bullish” equities, then I am happy as a pig in shit with my short position.
ECB turning dovish?
Like an infatuated 20 year old that keeps returning to a bad boyfriend/girlfriend, I am a sucker for the short EUR trade.
This desire to short the EUR is made all the worse due to the fact that I have been harking on the fact that the ECB is tightest Central Bank out there and that a natural consequence of that tightness is a higher Euro.
Have a look at the ECB’s Total Balance Sheet during the past few years:
ECB Total Balance Sheet</a> </div>
Considering the fact that the BoJ and the Fed are still aggressively expanding their balance sheet, the ECB’s continual shrinkage is causing the supply of Euro’s to decrease and resulting in a much higher Euro. Have a look at the Euro vs the Yen:
EURJPY Rate</a> </div>
The Euro has gone straight up. Japan and the US are basically exporting their deflation to Europe.
Over the past couple of quarters, certain ECB members have been trying to talk the Euro down, and I like a fool, have fallen for it a couple of times. Each time I have mistakenly assumed that they finally mean action. And each time, I have been disappointed.
Well, this time is different… really…
I can’t help but laugh as I write this, as I am sure that I will once again be disappointed, but I can’t help myself.
Yesterday Draghi gave a speech outlining his plan for the next stage of Europe’s recovery. Although it did not outright cite negative rates, it was a dovish speech. When you combine it with the fact that the German ECB member also opened the door to QE and negative rates, it looks like yesterday might have been a tidal shift in ECB’s relative hawkishness. At some point they are going to have to blink, and maybe, just maybe, yesterday was the day.
If you assume that the ECB will stop the balance sheet shrinkage, and that the Fed is going to gradually slow down their expansion, then relative interest rates will also increasingly play an increasing role in the currency level. Have a look at this chart of the German / US 2 year spread vs the EUR:
German / US 2 Year spread (in white) vs EUR (in yellow)</a> </div>
The EUR is due for a move lower, all we need is the ECB to allow it to happen.
I am shorting EUR and hopefully, this time it will treat me better. Although bad boyfriends/girlfriends rarely do change and your friends usually know better when they tell you to stay away, I swear Draghi has promised this time is different and that he really will change.
And just to take out a little of the direct US dollar exposure, I am also going to take this opportunity to short a little Euro against the Mexican Peso. I am going to use the Euro as a funding currency and go long a little of the Peso, picking up the carry. I have long been eyeing the long Peso trade and this seems like a good time to start the position.
EUR/MXN cross rate – going short</a> </div>
UPDATE: New position – Short EUR This time is different (although it never is and you should probably skip this trade) and the ECB blinked yesterday. Conviction 4
UPDATE: New position – Short EUR/MXN Conviction 1
UPDATE: New position – Short S&P 500 futures Conviction 2
Long the 5/30 year steepener. Will add to the position in the 160s.
Short CAD. Will add through 1.12. Stop 1.09. Conviction 4
Buy TIPS short TLT spread through long dated options. Conviction 3
Short 10 Year US Treasury Futures with half of position married to out of the money calls Conviction 4
Short US 5 Year Treasury Futures. I expect the Fed to continue to withdraw stimulus aggressively. Conviction 2
Short US 2 Year Treasury Futures. I think the downside is a move from 31 bps to 25 while the upside is a move up to 50 bps. Conviction 3
Short Mar and June 2016 Eurodollar vs long equivalent BAX futures. Conviction 3
Long March 2014 VIX Futures. Conviction 2.
Short Yen. Conviction 3
Short JGB futures. I can’t call myself a macro trader without this widow maker on the sheets. Small position for now, but will add aggressively at the first sign it is working. Conviction level: 1. No stop.
Long Yen volatility. I believe we are entering a period of increased volatility for the FX pair. Conviction: 3
Long 30 year US treasury volatility. Swapping half of this position into Yen volatility. Conviction 2
Long various deferred crude oil futures contracts. I own a variety of different expiries in years from December 2014 all the way to December 2020. Conviction level: 4. No hard stop.
Long precious metals smorgasbord. Long gold, silver and platinum futures. I also believe that the closed end ETFs (CEF.A CN Equity or PHYS US Equity) which are now trading at discounts versus years of trading at a premium are a good way to play this idea. Conviction level: 4. Using the year end lows as a stop for half the position.
Long grains. Long deferred corn, wheat and soybean futures. Conviction level:5. No stop period.
Long Ithaca Energy IAE CN Equity. See previous posts. Conviction level: 5
Long Input Capital INP CN Equity. I have not yet written this up, but I really like this story. More to come in coming days. Conviction level: 5