In September the great European Central Banking maestro startled the market with a pledge to expand the ECB’s balance sheet to levels last seen during the EU sovereign debt crisis. It seemed that maybe, just maybe, the Europeans finally “got it.” Up until that point their refusal to stop the constant shrinking of their balance sheet had resulted in the European economy importing everyone else’s deflation. But Draghi’s surprise cut into even more negative-r interest rates, combined with his promise to expand the ECB’s balance sheet, convinced the markets that this time he meant business. Hedge fund guru David Tepper summed it up best.
“Draghi wants inflation in the Euro zone. He will not stop,” said Tepper
Most hedge funds were quite optimistic about Draghi’s ability to fulfill his promises:
“Here are my best trades, ordered from easiest to hardest,” said one of the top ranked macro CIOs, exchanging ideas. Draghi’s fairy dust had finally settled; he’d been pleasantly surprised, and killed it. “Buy European curve steepeners now, buy European risk assets, buy 5yr/5yr Spain versus short 20yr Germany,” he explained. “Maybe these trades last a few weeks, maybe longer, doesn’t matter – get this right, add some smart convexity, and you could make your year by the end of October.”
In a mad scramble to put on risk, hedge funds poured into trades that would benefit from the new European growth strategy. And in case you don’t think that his comments and actions had an effect on the market, have a look at the trading of the Eurostoxx 50 index over the last few months.
It is no coincidence that stocks spiked higher on the day he surprised the market and then also topped on the day that they poured roughly €100 billion into the system with the first round of the TLTRO.
But this has not met expectations. It was hoped that the TLTRO would have more take up. Unfortunately there is very little demand for credit, so this type of balance sheet expansion is much less effective than straight QE. And in typical European fashion, very little else has actually been implemented in terms of Draghi’s pledge. I don’t doubt that Draghi will eventually follow through, but these are hedge funds that we are dealing with. They are not nearly as patient. And it is now obvious that they were overly optimistic about Draghi’s abilities.
Given the lack of progress, the last thing the hedge funds wanted to hear from yesterday’s ECB meeting was a steady as she goes announcement. Yet that is exactly what Daghi said. His basic message was; “we have made a lot of announcements and plans, let’s wait and see how go before we do anything more.”
European stocks were destroyed. The Eurostoxx 50 was down almost 3% on the day. It was ugly, ugly action. The hedge funds that had all been betting an the Maestro continuing to be able to sweet talk the market higher all bailed at once.
As for US stocks, at first they seemed to want to stabilize. For a little bit it looked like they actually might be able to shrug off the European news. But then the news that the Chinese military was rolling into Hong Kong, combined with the worsening European rout, overwhelmed the buyers.
But once Europe closed and the Hong Kong press conference occurred without incident, the market quickly ripped higher.
I said it yesterday, and I will repeat it today – there will be a time to get bearish again, but this is not it.
We are down a long way from this summer’s euphoria. At yesterday’s panic lows we were down over 100 S&P 500 handles from the top.
The technicians will all tell you how we broke all sorts of support and that things look bleak. These are the same technicians telling you a month ago that the market was hitting new highs and it was clear sailing since there was no resistance to be seen for miles.
Over the long run I think that the market is extremely scary and is set up to deliver negative long term returns. But the trader in me says that this is not the time to press bets on the short side.
For a little while yesterday it seemed my optimism (or maybe lack of pessimism is a better way to describe it) was misplaced. It certainly seemed quite scary in the morning. But into the hole I saw an extreme amount of bearishness. All of sudden my twitter stream was filled with forecasts that “we have to touch the 200 day moving average” and “no support for another 50 points” crap. These were the same guys who were previously buying every dip.
It is unemployment day and I want to spend some time getting ready for the number, so I am going to call it a day, but don’t forget – don’t get too bearish down here!
A quick update before I sign off. GoPro was pummelled yesterday as the founders donated some of their holdings to charity and the lockup on that stock was lifted. I got lucky with my purchase of the puts the previous day. And I got even more lucky by my decision to cover all of my position in the low 80s. A that point the stock was down $10 on the day and given that there is no guarantee that this donated stock is going to be sold anytime soon, I thought the borrow might still stay tight. I still hate it, and I have not made money in the name by any means, but I thought I shouldn’t look a gift horse in the mouth. Shorting this high flying name was probably a terrible idea to start with, so I am going to just slink off to the sidelines for a bit – happy that it could have been a lot worse.