Sometimes I feel like after 25 years staring at the screen I might know a little about the markets. Then the Market Gods throw in days like yesterday just make sure that I don’t feel that way for too long.

Yesterday’s trading was one of the more confusing days I have seen in quite some time.

It didn’t feel like one of those “I have to put $2 billion to work into the S&P – just sit on the bid all day long” grinds higher. That I would have understood. There was also no real news that should have caused the upward scramble.

It was just a good old fashioning bull skewering of the bears.

http://themacrotourist.com/images/Azure/BullSep2514.png

The action felt reminiscent of the big up moves you get in the middle of bear markets. Many investors don’t realize it, but most of the biggest one day moves have occurred in the midst of bear markets, not bull runs. Here is a list of the biggest one day Dow Jone moves by points and percentage.

http://themacrotourist.com/images/Azure/LargestSep2514.png

As I reflected on this observation my colleagues rightfully poked fun at me that the previous three day decline can hardly be construed as a bear market. And they are indeed correct.

But it doesn’t change my feeling that yesterday’s rally was a little manic and did not make a lot of sense. It had the air of short covering to it.

Stupid stuff like my terrible GoPro short were exploding higher:

http://themacrotourist.com/images/Azure/GPROSep2514.png

While they chased all the crap, real companies like banks were left behind. Have a look at this chart showing the trading in the Nasdaq 100 versus the Bank Index.

http://themacrotourist.com/images/Azure/NDXBKXSep2414.png

And most worrying, even though the stock market exploded higher, the high yield debt market had a terrible day.

http://themacrotourist.com/images/Azure/HYGSep2414.png

The high yield debt market has actually had a terrible three days. The junk bond market has been just as bad.

http://themacrotourist.com/images/Azure/JNKSep2414.png

I would understand if the corporate bond market was down because of a back up in risk free rates, but spreads are widening.

I don’t expect stocks to follow credit spreads tick for tick, but having the high yield bond market continue its bear move should have at least limited yesterday’s upside for stocks.

But the two markets seem to have diverged.

http://themacrotourist.com/images/Azure/HYGSPXSep2414.png</p>

Let’s have a look a little more closely at this summer’s trading.

http://themacrotourist.com/images/Azure/HYGSPXCloseSep2414.png</p>

This might be a case of “it doesn’t matter until it matters.” You will notice that in June when the high yield market rolled over stocks at first shrugged it off. But eventually the stock market followed the high yield market lower. Then they both rallied together out the hole.

Maybe I am looking too closely. Maybe the backing up of high yield debt is nothing to worry about. Maybe the fact that the banks aren’t rallying with the speculative junk is perfectly healthy… Maybe…


I just don’t know

I can point out all the reasons why this rally is crap, but that doesn’t stop the fact that it is happening. And who cares why it is happening, the money you make (lose) from the rally is still the same colour.

The real question we need to ask is whether last week’s selling was an end to the bull run, or simply a correction in the upward move of the past few months.

http://themacrotourist.com/images/Azure/SPXGIPSep2514.png

Could yesterday be a one or two day rally within a new emerging downtrend?

The truth is, I don’t know. And ferocity of yesterday’s rally caught me off guard.

One of my theories to explain yesterday’s action is that the previous week’s sell off had scared many professional traders. Anecdotally I saw many shifts to short side of the market. Guys that had been bulls the whole way up were buying puts and selling stuff to lock in gains. Sentiment seemed to get negative quickly There were lots of “Alibaba top” calls.

When that selling slowed down, suddenly the newly minted shorts looked around and realized that there were no offers at that price. These were especially weak shorts and they headed for the exits. That might explain why yesterday’s action had a short covering feel to it.

The other side of the argument might be that George Soros’ reflexivity has fully engulfed the equity market. We have hit the speculative finale that might be short in time, but the most volatile. Often the largest upward swings are experienced in the final innings of a mania. That might explain why the crap was all rallying. And it might explain why nothing else matters for the equity market. It is going up because it is going up.

I wish I could write in here that I am sure which one of these scenarios is occurring, but I just don’t know. I am no yogi, and with all my trading lately the level of my intelligence is debatable, but I am going to take comfort in these words from the Yogi Jaggi Vasudev:

The sign of intelligence is that you are constantly wondering. Idiots are always dead sure about every damn thing they are doing in their life.

I did buy back a little of my Nasdaq short yesterday. It would be great if I could tell you that I did it in the morning at good levels, but only traders on twitter seem to be able to manage that all the time. It would be even better if I could tell you that I know what I am going to do from here, but I can’t. I am still trying to make up my mind.


The real “Maestro”

I have to give Draghi credit, that guy can really jawbone markets. He is truly world class at accomplishing what he wants through words alone.

http://themacrotourist.com/images/Azure/DraghiSep2514.png

He is walking such a fine line, but he never seems to stumble. He needs to appease the Germans who do not want the debt monetized, yet the rest of Europe is slipping into a deflationary spiral that he needs to halt. The easiest way to do this would be to engage in a US/Japanese style QE, but that option is limited due to political concerns. Draghi managed to get his LTRO program past the Germans, but there is no real demand for credit so it has been a bust.

Wouldn’t it be great if he could get the Euro down, but without actually engaging in QE? After all isn’t a too strong Euro the real problem for the Europeans?

There has never been a huge appetite for QE at the ECB, but the US/Japan/UK/Swiss balance sheet expansion has foisted all the deflation onto the EU. The Euro has risen because the ECB has been relatively so tight with its balance sheet expansion. Wouldn’t it be great if the deflation could be arrested without actually having to engage in the same reckless policies as the other countries?

During the last week Draghi has continued to talk the Euro lower with sweet whisperings of more balance sheet expansion. The Euro has responded by sinking to new lows for this move.

http://themacrotourist.com/images/Azure/EURSep2514.png

As the Euro sinks, there is less and less need for Draghi to actually follow through with his pledges to expand the balance sheet. Maybe he can accomplish his goal by allowing the currency to do the easing for him.

It is masterful on his part.

His handiwork can be seen as the relationship between the Euro and the ECB balance sheet has broken down.

http://themacrotourist.com/images/Azure/EURLOTSSep2514.png

Draghi’s pledges have allowed the Euro to focus on the fact that rates are negative in Germany and rising in the US.

I have always said that negative rates have never been tried in an economy of this size and that we should be watchful on how this affects the market. Could these negative rates be the real driver in the Euro’s recent dip? Did Draghi realize this, and could he simply be helping the market along?

My suspicion is that Draghi & Co. have just introduced the next weapon in the currency wars. I expect as the Euro falls against other countries’ currencies, these other nations will follow Europe by lowering their rates – even into negative levels. That taboo has been broken.

I always thought the yield curve would get really steep as financial repression is the only way out of this mess. I just never thought it might get really steep with the front end dipping into negative territory.

How an Italian Central Banker has managed to accomplish this move while maintaining his credibility is one of the greatest feats in the history of modern finance. The financial press dubbed Greenspan the “Maestro”, but Draghi should really take that title.


Positions

http://themacrotourist.com/images/Azure/PositionSep2514.png</p>