Risk Aversion Taking Hold

naufalsanaullah's picture

I have written pervasively about the dollar-equity correlation and the causality behind it, given the literal trillions in liquidity (if accounting for fractional reserve leverage) gifted to primary dealers (aka Wall Street banks & their prop trading arms). The carry trade that spawned from this correlation has driven risk assets higher as the funding currency, with its 25bps interest, declines to finance it.

"The dollar is now driving risk assets, including Gold and Credit assets."


-Rick Rieder, Managing Director, Blackrock Fixed Income Alternatives

The risk asset carry trade funded by the USD only works as long as the cost of borrowing for the dollar remains low (check) and the dollar continues depreciating on a relative basis to other, higher-yielding, currencies. And this is where things start to get interesting.

The trade-weighted US Dollar Index (/DX) surged on December 4 (which also happens to be Jay-Z's birthday) on record volume in the futures market (with over 40,000 contracts traded) and in the subsequent trading days it broke out of its long descending channel (defining the USD's downtrend since May) and through its significant 50DMA resistance line (which had been providing perfect resistance the entire way down the channel). Meanwhile, pairs with higher-yielding currencies (such as EUR/USD & AUD/USD) sold off (with the EUR/USD down over 4000 pips from highs). Meanwhile, the Bank of Japan announced a fourth stimulus, which sent the Yen plunging and the revival of the Yen carry trade at hand into a sizable rally in the currency (after perpetual decline for over a decade due to the Yen carry trade), to replace the dried-up USD carry trade. Indeed, the USD/JPY posted its biggest weekly gain since 1999.

With the dollar finding a newfound bid (deleveraging is a bitch), the implications for risk assets are tremendous. Equities sold off from highs and are approaching a pivotal move from their monthlong tight channel, which could spell huge trouble if the move is down (as I expect and am trading off of). Beta equities led the decline, and leading indices and stocks are pointing down as well (Goldman's lower highs and lower lows come to mind). Commodities also sold off, particularly precious metals. The GLD ETF posted record volume on a huge plunge in price on Friday.

The risk aversion driving the possible (short-term) bottom in the USD & driving the carry trade toward implosion is an obvious instance of mean reversion, as the POMO liquidity fueling the carry trade has dried up (last POMO was late October) and the real economy's issues take stage once again. Dubai concerns led equities down during the holiday week last month and talk of liquidity extractions via reverse repos scared more equity longs (otherwise known as bagholders at this point).

Today, the Treasury announced the results of a $29B 1-mo Tsy auction with an astounding bid-to-cover of 5.33 and a 0.000% yield. Apparently primary dealers thought it prudent to tender over $120B in bond bids for literally zero yield. The suspects? Debt deflation and debt monetization. And now that the Treasuries part of QE is over, the sole reason PDs are picking up $29B in 28-day bills for no yield is risk aversion. Bond markets continue to imply deflation since June, while CDS spreads (particularly sovereign, clustered strongly in Europe) widen substantially for the first time since March lows. Fixed-income is a great leading indicator for equities, and divergences in the different markets almost always prove stocks wrong. Zero (and even negative briefly while last week) yields on 1- & 2-mo Tsys as equities print year highs is a clear divergence between reality (credit) and perception (equities) primarily allowed by the unprecedented liquidity injected directly (and almost exclusively) into risk assets.

Both China and America are addressing bubbles by creating more bubbles and we're just taking advantage of that. So we can't lose.


-Lou Jiwei, Chairman & CEO, China Investment Corporation (China's sovereign wealth fund)

The S&P 500 is pricing in absurd growth prospects (with perpetual 120+ as-reported P/Es) at these levels, as insiders continue selling at record paces (82:1 sell-side ratio last week). The Citigroup Economic Surprise Index, after bottoming in January (less than eight weeks before the equity market low in March) topped out in September and has been plunging in recent weeks, showing new data and reports are not meeting priced-in expectations. The sharp drop-off is analogous to the Surprise Index's performance in the weeks leading up to the fall 2008 meltdown.

Japan reported a 1.3% annualized GDP growth for Q3 yesterday, substantially missing the 2.8% revision estimate and the 4.2% preliminary figure. The sequential QoQ figures came in at 0.3% act vs. 0.7% rev est vs. 1.2% prelim. The lack of an inventory bounce led to the downward revisions. This of course provides BoJ more political capital to phase in more liquidity injections. An eerie analogue may manifest in the United State's GDP figures, as reactionary government stimulus wears off and the President's 47% approval rating (and central bank's 21% approval rating) necessitate much more fear and uncertainty before more spending is permitted.

Technically, the S&P has finally broken down from its rising wedge but remains in its monthlong horizontal trading band. A breakdown of the channel's support implied a sharp selloff, given the lengthy duration the channel has held up. This is a precursor to a pivotal move and the downside risk remains high. A break below roughly 1085 would be a technical short trigger for that trade thesis, with the 50DMA right below to offer another potential breakdown trade trigger.

The Nazzy has been in a rising channel since April, but the highs have been getting sluggish in recent weeks, and a rising wedge is forming inside of the channel, as the index enters a long-term resistance zone. This is very bearish and is a leading indicator to the S&P.

While the S&P and Nasdaq have been testing recent highs yet failing to make new ones, the leading small-cap Russell 2000 Index has printed a lower high and lower low, as it approaches a breakdown of its rising channel that has defined its rally since April. A divergence like this is not to be ignored.

The most important bellweather in equities, of course, is Goldman Sachs (GS). It has started a downtrend while the S&P is stuck in choppy action. This has extremely bearish implications for equities.

Silver & gold have had strong rallies since the big technical breakouts in early September but they are weakening as well as the carry trade reverses course. Expect silver to underperform gold as they correct, as liquidity premia increase. Silver's failed breakout at $18 is cause of concern, and suggests liquidity is drying up fast. Oil & copper, two big barometers of aggregate demand, have printed technical breakdowns, as well.

Again, as I have been stating, breakouts in the Dollar Index & in the VIX ETF (VXX) through their 50DMAs are huge short triggers for me in equities & commodities, particularly high-beta equities and bubbly hoarded commodities. The Dollar Index has already spiked through its 50DMA and VXX is approaching a possible breakout soon.


This search for returns has already started a new asset-price boom - an echo bubble – in stock and commodities markets, setting the stage for the next bust when the relevant financial data disappoints. The Fed’s current stimulus program is helping to push securities higher, but is not producing much benefit for the economy.


-James Melcher, President & Founder, Balestra Capital

In other news, happy 20th birthday to me. Officially no longer a teenager.

Disclaimer: although the author may be long or short any of the securities mentioned above and none of the material above may be construed as investment advice or recommendation, the author's current positions in the securities mentioned above are: long /DX, VIX; short /ES, /NQ, /HG, /CL, EUR/USD, AUD/USD, GS.

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Thurgy's picture

Gee, these charts look sorta familar

ATG's picture


One thing about being 20 is a more open mind.

Big4 Asset Allocation Subscription Models confirm

Bulls: VIX, RUT, USD, Peso,

Fed Funds, 2, 5 & 10 year Notes

Bears: Kiwi, Silver, Gold, NDX, Gold, Copper,

EAFE, GSCI, Nikkei, SP400, SP500, Pound, DJIA,

Aussie, Euro, Bonds, Swissie, Ruble, Loonie, Yen,








Anonymous's picture

How can stocks be allowed to crash before midterm elections??

ATG's picture

No clique claque controls the market indefinitely,

particularly when volume increases on declines

and drops on rises:



Titanic move coming and unlikely to be up:



Dr Horace Manure's picture

This was written by a teenager????  Maybe there is hope for the world.

As I read this post, I was struck by how easily I was understanding every word he wrote.  Many ZH posts are puzzles I have to figure out.  There was no puzzle here.

This leads me to conclude one of two things.   Either this is so overly simplistic that even a dullard like me can read and comprehend it, or, this is brilliantly written.

I'll let the wiser heads here at ZH debate that issue.

Where do I buy stock in naufalsanaullah?


Lionhead's picture

I agree; naufalsanaullah, this is one of the best technical posts I've read here at ZH. Clear charts, concise analysis, and zero voo-doo methods. I look forward to your articles and big picture analysis. Keep 'em comin'...........

Thurgy's picture

Lionhead - you mean there is TA and Voodoo TA?  Please elaborate

dnarby's picture

Jesus H., 20 years old?  Keep this up and you'll be the next JP Tudor.

Anonymous's picture

Actually, you are still a teenager until you hit 21. 20 is the last, and tenth, of the "teen' years that start at 11.

Anonymous's picture

Echo previous poster

Anonymous's picture

I mean: kudos to the poster and yes more plain English would make ZH even better.

SimpleSimon's picture

I hate you!! You are just 20??  Don't you know at your age you are supposed to be drinking some Kool-Aid and chanting the Change mantra?  I propose that brilliance be taxed and redistributed to those...less brilliant, starting with Uncle Ben.

Brak82's picture

i quit the Kool-Aid-Subscription at the age of 26, never felt better.

Anonymous's picture

24-year old CPA here; been reading and posting on ZH for over a year now. Our generation hasn't completely degenerated... yet.

AnonymousMonetarist's picture

Can you spot the Nancy Capitalist?



'The best approach here if at all possible is...to make sure the system is resilient in case an asset-price bubble bursts.' Large price misalignments are 'not obvious to me.' -B.S. Bernanke, the Oracle of Eccles

'I’m scared and leaders should look out.' - Donald Tsang, chief executive of Hong Kong

Market is 'not massively overvalued.' - Janet Yellen, High Priestess

The American rate stance and falling dollar has led to 'massive' speculation. - Liu Mingkang, chairman of the China Banking Regulatory Commission

It's wise to beware of 'false positives' when assessing potential asset bubbles. - Donald Kohn, High Priest 

'It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.' -Lou Jiwei, the chairman of the CIC, China’s sovereign wealth fund 

'How long can this go on?' - Lee Dorsey

'Keep on with the force don't stop.Don't stop 'til you get enough.' -Michael Jackson

'The truths you hold to be most dear are lies told to you by liars.' -Anonymous Monetarist

'Dude.' -Jeff Lebowski

'For 'tis the sport to have the enginer. Hoist with his own petar, an't shall go hard.' - William Shakespeare

'Frak the frakkin frakkers.' -Kara Thrace


Anonymous's picture

Always posts compelling reads, but this is like the 3d or 4th bearish call he's made over the last year and none of them have worked yet. Still very impressive analysis though. Hope you're right this time. Hard to make sense of a rigged game.

Unscarred's picture

Nice post. Don't drink too much tonight.

bbbilly1326's picture

Happy Birthday, and many many more.  Thanks for sharing your expertise with us. 


However, I keep hearing "It's gonna crash" ......"and big this time" and it keeps not happening.  We ain't in Kansas anymore.