In what I can only interpret as an obvious sign from the Market Gods – yesterday Canada Post left an unusual note explaining why the postman was unable to the deliver the mail for this customer in British Columbia.
The bear really was knocking at his door.
After a terrible omen like that, it should come as no surprise that the stock market had one of the worst days in quite a while.
The sell off was quite the reversal given Wednesday’s squeeze higher. At the time, I remarked that I didn’t understand the reason for the big up day. In hindsight I guess it is another example of how the Market Gods make this wonderful game as hard as possible each and every day. If it was easy, everyone would do it.
But there can be no sugar coating the ugliness of yesterday’s action. We slashed through support level after support level, closing at the lows of the day. In a wink of an eye, everyone who had bought stocks in the last two months is under water.
The breakout that got everyone so excited about a week ago has suddenly become a classic “pop and drop.” It caught all the weak late longs pushing too hard.
Not only that, but have a look at the date of the failed bar that pushed into new highs – September 19th. Do you remember what happened that day? Yup – you go it – that was the day that Alibaba came to market. Remember the euphoria? Remember the excitement of that day? Remember how bulled up everyone was? At the time I recommended time stamping that mania into your mind. In the midst of the CNBC cheerleading, it was hard to ever imagine stocks going down. But here we are, a week later and 45 S&P points lower.
As for my trading, although the Market Gods did scare me out of a portion of my Nasdaq short into Wednesday’s squeeze, I managed to hang on to the rest. I was also lucky enough to recognize that yesterday was going to get ugly, and I swapped my short S&P 500 index future calls into straight outright short futures. Although I am by no means calling for a crash, there is always the possibility and yesterday’s action reminded investors that stocks go both up and down. I want the direct short exposure in case the unthinkable happens.
A lot of investors are probably confused by the sudden downdraft – after all, everyone on TV is talking about the great stock market. Shouldn’t it go up? Why did it go down?
Here is a great list of the potential reasons for the sudden plunge by FBN Securities:
Month End: It’s the last day for underperforming or performing hedge funds to get names off the books so they don’t show up in quarterly report which equates to selling pressure.
Position Closing: Chatter that there was and maybe still is a massive asset allocator selling equities and buying bonds to rebalance books as the equity move made them a bit too long equities which again equates to selling pressure.
Holiday: There is very little liquidity because of the Jewish holiday making any selling pressure magnified however as of noon the S&P 500 is running +20% vs its 30 day average volume.
High Yield: Many High Yield traders have been trying to sell HY and IG bonds today with quarter end upon us, much like they did at the end of the June Qtr. Given the lack of liquidity and participants today, HY sellers have no bids to hit, so they have turned to selling equities and underlying names to hedge their positions or de-risk. Tuesday the slope of the BofA Us High Yield Master II OAS 200 dma turned higher for the first time since May 2012. The changing of trend has forewarned of equity markets largest reversals since inception of this HY index.
SKEW: SPX Skew is at some of its highest levels in years, showing traders are running for out of the money puts, usually spike skew is closer to a bottom then a top.
Volatility: VIX is up 18%, its biggest 1 day % move since July 31st.
TRIN: Highest intraday TRIN reading since Feb 3rd ’14, which is an indication of material selling pressure (the Feb 3 spike marked the years low).
Sentiment: Bears in the AAII survey jump to a 7 week high, majority of the new Bears moved from the Neutral camp rather then from the Bullish camp.
I agree that all of those reasons helped accelerate the selling, but they also missed the news that Russia was working on a set of retaliation sanctions that would allow them to seize any foreign assets. This is a big deal and could be the start of a very real trade war.
We haven’t even talked about the end of the QE program, but we don’t have to. There are plenty enough reasons for stocks to go down without it The reality is that the markets have been trading in thin air for quite some time and were due for a pause.
The damage done during this last week’s selloff is significant. Although we might get bounces from here, these will be opportunities to sell. No longer should you be buying first selling later. For the next little while, your first ticket should be a pink one – put away those blues for a bit. The trend has changed.
This morning I am noticing many dip buyers crawling out of the woodwork. Traders are assuming the bigger up trend is still in place. There is talk about yesterday’s “flush” being good news as it clears the decks and sets up a move back to the old highs.
Although today might rally, I would be very careful about getting too bullish. The market action is finally agreeing with the bears.
High Yield continues to act terribly
There can be no doubt that part of yesterday’s equity rout was due to the continuing poor action in the high yield debt market. HYG and JNK suffered their fourth straight down day and are now pressing up against the summer lows.
I have not spoken about it a lot, but I have been long puts on both HYG and JNK for some time. They have been quietly working in my favour and I am doing my best to just let it cook.
We are bumping up against some pretty serious support and are very oversold on a short term basis, so we are probably due for a bounce. Maybe a stabilization of the high yield market over the next few days will allow the stock market to also bounce.
But make no mistake about it, the high yield market’s weakness is telling you that all is not well.
We are in the beginning innings of a wind down from the Fed induced carry trade frenzy. In the last few years the Fed’s encouraging reassurances have fuelled a ton of speculating in a wide array of “carry trades.” Speculators have taken solace that there would always be plenty of warning before the Fed withdrew their accommodation. But with the change in tone in the Federal Reserve statements regarding financial excesses and the improving economic picture in the United States, speculators have realized that they cannot rely on the Fed 100% as they could before. Even if they think the Fed will be slow to raise rates, given the leverage, they cannot afford to be caught on the wrong side of the carry. Therefore they are selling first and asking questions later.
What we are seeing in the high yield debt markets is the wind down of this speculation. In the long run, it is a good thing. But in the short run it is going to cause problems. And who knows, if the speculation was more pervasive than the Fed realizes, it could cause a real problem.
However, the de-levering process has begun. Don’t try to catch any knives!
It’s not us – I swear!
Yesterday Doug Kass tweeted the following scuttlebutt about my disastrous short GoPro:
Don’t worry – it’s not us! I have only shorted a tiny little bit, and as it has rallied in my face, I have not added to it.
But I do want to say that we are getting close to the point where I might give ’em a little more. The stock is definitely trading like someone is in trouble on the short side. Even into yesterday’s tech drubbing, GoPro traded up and closed at the highs of the day. I know that there was some idiot on TV saying that GoPro offered “safety” in a volatile market, but if there was ever someone not understanding the dynamics of how markets work – this was it!
When I first wrote up the GoPro short idea I stated that borrow did not seem to be a problem. Well, I was wrong. The next day I started running into problems, so I moved over to shorting calls. Since then, the calls have sunk down to trading at intrinsic, and I am getting immediately exercised on my long dated short calls. My lending broker told me that GoPro was trading with a borrow rate at over 100%.
GoPro is trading in the classic “small float large short interest” squeeze fashion. It is going up because the shorts are getting bought in. Could it go higher? For sure – you never know how stupid these things can get. But make no mistake, at some point it is going to loosen up and GoPro will be halved in a week. I just hope that too many people don’t listen to the idiots on CNBC that try to portray GoPro as a safe stock. Short squeezes are anything but safe! For either side.
This cannot continue
As you know, I try to keep politics out of this journal. If I do speak about it, I try to make sure it relates to the market. But bear with me as I blur my self imposed line a little bit.
When it comes to the growing income inequality problem, there are many theories for its cause, but there is very little debate that it is getting worse.
Have a look at this chart that shows the change in participation of income growth during expansions for the bottom 10% and top 10% over the years.
I don’t want to debate whose fault this is, there is no sense at talking about the past. But I do want to highlight that this cannot continue indefinitely. It is not healthy and will eventually result in social upheaval. It’s not just me that feels this way – smart rich guys like zillionaire Nick Hanauer have written warnings about the instability of the current environment.
Wall Street is extremely myopic when it comes to trends. Often what passes for research is simply identifying the current trend and extrapolating it into the future.
This trend of the wealthy taking a larger and larger slice of the pie has created a very richly priced financial market. It makes sense as more and more money is being concentrated within the upper echelons of society. There is little inflation in things that regular people buy because regular people aren’t making any more money. But inflation in things that the rich can buy – whether that is private equity shares of tech stocks, old vintage Ferraris or 10,000 square foot condos on the Upper West side is running rampant.
Have a look at the chart of real estate broken down by transaction size over the last year:
I happen to think (hope) that we are on the cusp of a wave of wage inflation for regular folks, but I want to stress that if this imbalance doesn’t start to correct itself naturally, the tyranny of the majority will do it in a way that will inevitability take it much too far in the other direction.
Either way, I am a seller of the rich on a relative basis. We have hit the stupid levels where it can’t continue because it is simply too egregious.
And in case you think the wealthy are the worst, have a look at this chart that says a lot about the political class.
This is the worst form of inequality because it is brought on by the few that are supposed to be governing with the greater good in mind. Instead they are using that power to line their own pockets.
These social imbalances are going to eventually translate into market dislocations. These trends are just as unsustainable as using zero percent monetary policy to try to encourage borrowing to lift yourself out of massive recession caused by too much borrowing. Don’t make the mistake of taking the current trend and simply extrapolating it into the future – there is no way that this can continue for much longer.