"Dust off the systematic hedging strategies, and get re-acquainted with the concept of tail-risk," is the ominous conclusion from MKM Partners' Jim Strugger's latest report. Despite every effort from central banks to maintain a low-volatility environment, the magnitude of the August 2015 'shock' not just for U.S. equities but across asset classes, was great enough for Strugger to conclude that a transition into a high-volatility regime had begun. Given the length of the economic cycle, bull market, and the rise in financial stress globally, Strugger warns a transition to a high-vol regime leaves ultimate damage in the &P 500 averaging 53%.
It appears the management team at FBRNY have decided that manipulating the US equity market via selling VIX has run its course (which started when Brian Sack left and Simon Potter took over) . As of this week - there has never been a bigger speculative long VIX position (implicitly bearish stocks). One wonders what the consequences are?
The S&P 500 is now up 12.5% from the Bullard lows in mid-October and has broken to new record highs over 2048 - within 2 points of Goldman Sachs year-end target. Since Bullard's comments, the S&P 500 has been up 19 days and down only 5 (and today will be the 23rd day in a row of closing above its 5-day moving-average - a record!) WTI crude oil prices are collapsing back to cycle lows below $75 but perhaps most notable is the plunge in 'implied correlation' - which measures the relative demand for individual stock protection over index macro protection. Implied correlation is at a record low - which suggests capitulation among those with macro overlays (like Carl Icahn)...
Early weakness and volatility was entirely suppressed once European markets closed and stocks traded in a shockingly low range amid dreadfully low volume. All the major indices closed red with the Russell underperforming (and Nasdaq outperforming) as stocks tracked (more loosely than normal) with AUDJPY once again. Treasuries ended the day very modestly lower in yield (30Y unch, rest -1bps). The USD traded modestly higher all day led by weakness in GBP and AUD (as JPY ended unch). Gold closed unchanged as copper (China), oil, and silver slipped. Credit markets remain skeptical and VIX closed higher on the day, despite the late-day ramp efforts to get the S&P 500 green - which failed.
VIX futures positioning hit another all-time record short just two weeks ago after collapsing to 12-month high levels as "Taper" concerns increased. From the start of July to the 3rd week of August VIX futures were sold in epic proportions providing the fuel to lift a plateaued stock market from taper-anxiety to new all-time highs (as nothing changed). Over 100 million contracts were sold in the 7-week period - a totally unprecedented amount of complacency. However, in the past 3 weeks, there has been an inflection; is this the end of selling, or are we about to pull VIX even lower with a concerted reflexive selling of even more shorts? As SocGen warns, this historic level of non-commercial short positions (read speculative) implies any market correction - or VIX-related spike - would increase short-covering and exaggerate the fall dramatically. With today's exuberant spurt lower in VIX, vol has caught back with stocks once again.
As Monty Python might have said, apart from AAPL; what has the market done for you today? S&P 500 cash managed (somehow) to cling to a green close while the Dow and Nasdaq ended red. Critically - markets went only one way all day - from upper left to lower right as we go out at the lows of the day - back again at the Draghi cliff edge and just below pre-QE levels. AAPL was a disaster - on heavy volume - as it pushed back down towards it 100DMA (over 3% from its opening highs today!) ending at its lowest in two months with its biggest slide in 5 months (last 14 days). Risk-assets in general tracked closely as while AAPL slide from the open, equity indices manage to hold opening gap gains until Europe closed and then it went pear-shaped. The USD slid all day but didn't 'help' stocks as JPY weakened more (carry offsetting). Treasury yields plunged - 30Y now down 12bps on the week. Commodities all gained on the day - led by Oil (with gold/silver lagging). Meanwhile VIX ignored the debacle, gapping lower at the open and holding down 0.7vols at 15.6% as HYG handily outperformed on low volume.
The reason the market is up today? Jefferies' Peter Misek hikes his price target on Apple from $800 tio $900 (the same AAPL which is now supposed to grow almost exclusively in China, and where as Apple Insider just reported "China's second-largest carrier may end contract sales of Apple's iPhone"). Yes, middle market, $100-$200MM high yield bond issuer Jefferies has an equity research group. And yes, after working at JPmorgan, Scotia, Orion, Alpcap, and Canaccord in the past decade, Misek finally has found a place he can call home (for more than 2 years), or at least until the next bonus renegotiation-cum-upgrade option time. And yes, Jefferies actually is moving the volumeless market for the first and only time ever courtesy of 1.000 implied correlation between the NASDAPPLEURUSD. Which is great. Maybe Misek will be right here.,, Unlike his calls on DragonWave for example, where he was buying all the way from $7 until $2, in the interim moving his Price Target from $9.00 to $3.50 to $10.00 to $3.00. Peter likes even numbers. He keeps it simple, except for his $699 PT on AAPL back in March- why $699? "It's one iPad." Sometimes he likes it complicated.
Equities traded in a very narrow range (aside from an early day-session stop-run) amid extremely low volume in equity cash and futures markets and ended the day modestly lower (holding the post-Draghi gains). However, a funny thing happened on the way to the equity bull market; HY and IG credit have underperformed since mid-day Friday, VIX (+1.3vols to 18.03%) has risen notably since the open on Friday - completely shrugging off equity's strength, and while Treasuries saw a great deal of ugliness at the end of last week - and a pull back would be expected - they notably outperformed (relatively speaking) their equity cousins today. The USD gained 0.25% today as the EUR dropped a notable 0.5% but only WTI reacted to that (by dropping 0.67% today) while Copper and Gold trod water and Silver spurted to a high-beta 1.7% gain (crossing back above its 50DMA for the first time since mid-March). As Unilever and Texas Industries issue debt at record-low coupons we also note that IG/HY advance-declines lines are extremely high and along with implied-skewness in SPY options suggests a very high level of complacency.
What can we say? From the better than expected GDP this morning Gold and the USD (and Treasury yields) diverged from the QE hope trade - but stocks didn't. Then came the statement of the entirely sublime obvious from someone somewhere about Draghi's normal pre-meeting meetings and we were off to the races to test recent highs. Treasuries exploded higher in yield, Gold popped, USD weakened (as EUR popped), and stocks ripped. But...Treasuries reverted back to pre-Draghi-levels, EUR tumbled and the USD ended near the highs of the day, Gold gave back most of its spike gains and closed in the middle of its day's range as stocks just wouldn't give up the dream. For a 2% rally in S&P 500 e-mini futures, VIX fell only modestly by 0.9 vos to 16.7% - which is above last week's close (while stocks end almost 2% above last week's close). Amid the heaviest volume in over a month and the largest average trade size in over a week, ES closed at almost 3-month highs. It appears to us that unless Draghi and Bernanke - who now seem engrossed deep in the inter-continental thermonuclear currency war - both do their bit next week (which the market has now more than fully priced in given the dismal fundamentals) then this is becoming farcical but as Maria B said "a rally is a rally, right?" Ask the ZNGA and FB buyers of the rally on IPO day. Stocks ended the day notably decoupled from risk-assets amid Treasuries worst day in 9 months.
After surging away from risk-assets into Friday's close (only to revert yesterday) and once again surging into yesterday's close, broad derisking among most risk-assets finally saw US equities catching-down to that reality in the short-term today - as they broke the EU-Summit/Spain-Bailout/Greek-Election shoulder and ended comfortably below the 50DMA. Short-end Treasury yields made new record lows as belly to long-end all fell notably close to those record lows (with 10Y back under 1.50% and 30Y under 2.60%). The USD rallied back from a 0.3% loss on the week to a 0.1% gain - thanks mostly to EUR's new 2Y low at 1.2235 intraday and AUD weakness (as JPY remains better on the week - more carry unwinds). Commodities plunged - far exceeding the USD-implied moves - with WTI down over 3% from yesterday's highs and Gold and Silver in sync down around 1% on the week. Staples and Utilities were the only sectors holding green today (marginally) as Industrials, Materials, and Energy (all the high beta QE-sensitive sectors) took a dive. It seems the message that no NEW QE without a market plunge is getting through and the reality of a global slowdown looms large. Credit outperformed (though was very quiet flow-wise) but HYG underperformed - cracking into the close - as it just seems like the most yield-chasing 'technicals-driven' market there is currently. Slightly below average volume and above average trade size offers little insight here but a pop back above 19% in VIX (and a 2-month flat in term structure), a rise in implied correlation, a rise in systemic cross-asset class correlation, and the leaking negatives of broad risk assets suggest there is more to come here (especially given the BUBA's comments this morning and a lack of real progress in Europe). The ubiquitous late-day ramp saw aggressive trade size and volume (with a delta bias to selling) as it remained far below VWAP.
An expectedly low volume day saw equity futures wiggle around VWAP until the day-session open at which time Energy and Materials sectors surged to lift stocks 10 pts higher into the European close. Commodities all surged - led by Oil with its 'Hormuz'-premium pricing in - and while the USD weakened after the European close ( driven by EURUSD bouncing off the 50% retracement of the EU Summit spike), equities also lost ground and rapidly reverted back down to VWAP. The strength in gold and silver was interesting as they extend their gains from pre-Summit lows (gold up over $70) and most notable to us was the recoupling of risk assets broadly with equities. Gold and stocks are seemingly back in sync and so are (separately) the USD and 10Y Treasury yields. After stocks hit VWAP they rapidly resurged back up to the highs of the day and closed there dragged up by a push into the green by HYG (with both stocks and high-yield seeing some sizable blocks going through at the highs). VIX closed down very modestly at 16.6% but most notably was the rise in implied correlation (and implicitly index vol - VIX - from around 1045ET into the close, even as stocks rallied). It would seem that the rise in WTI back over $87.50 (and Brent over EUR80) has been the 'risk-driver' for much of this rally (with CONTEXT - broad risk proxy - playing squeeze catch up to equity's health). In summary, equities are up over 5% as oil is smashing higher due to pending Hormuz strait closing and WAR; Germany and Finland basically saying NEIN to EU Summit deal as it stands; JPM in an energy market probe and BARC told to lower rates by the government!! All is well in nominal, central-bank, asset-value land.
The NYSE volume today was abysmal. According to BBG data, this was the lowest volume day in over a decade and even compared to other July 1st (or holiday weeks) this was the lowest volume print. Average trade size for the S&P 500 e-mini futures was also very small - almost the lowest of the year as low volumes and the narrowest high-to-low range for ES in over two months still managed to hold on to small gains for the day. In the face of this relative exuberance, Treasury yields dumped down 5 to 6 bps across the board remaining the most cognitively dissonant of risk assets on the day. HYG underperformed (as HY and IG credit indices were very quiet and reracked along with ES for most of the day). HYG did end Friday notably rich to intrinsics so this makes some sense but is unusual for a positive close in ES (as we note that 16 of the 24 times in the last year that HYG has closed red and SPY closed green, SPY has gone on to lose more in the next few days). EURUSD lost quite a bit of ground (again seemingly ignored by US equities) as USD rise 0.35% from Friday's close (albeit with AUD rallying modestly along with JPY). Oil retraced almst 50% of its spike gains from Friday but then pushed back up over $83.50 into the close and while Silver and Gold flatlined ending practically unchanged, Copper also lost a little ground (2x beta of USD) on growth slowing from China's data we assume.As with pretty much any rally, financials, energy and tech were the higher-beta winners all gathered perfectly correlated around 0.6% gains on the day (but we note that JPM and Citi remain negative from Friday's opening print). VIX ended the day below 17% (down a measly 0.25 vols) - its lowest close in two months - and while implied correlation managed to make modest gains (to around 65%) risk assets in general were only moderately correlated as equities outshone CONTEXT on the day.
Another interestingly odd day. One of the lowest (non-holiday) volume days of the year but a big pick up in average trade size as the S&P 500 e-mini futures shrugged off Treasury strength, USD strength, and Gold's somnambulism seemingly led by an energy sector focused on only one thing - the bounce in WTI. Copper also drifted higher even as the USD leaked modestly higher (as assume the two got some hopium-infusion from China RRR cut rumors early on and sustained momentum as liquidity disappeared in many risk markets. Credit once again was a split-decision with the CDS markets underperforming (and notably thin from our discussions) while HYG (high-yield bonds) decided to lead the way (also on one of its lowest volume days of the year). Treasuries remain in a tight range over the last few days, as EURUSD limps lower, but VIX had a high vol day with its move higher in the face or rising stock prices (up to 20% vol at one point) providing some ammo for the late day surge in stocks as it was sold hard to close -0.25 vols only around 19.5% (as implied correlation broke 71% before plunging into the close).
We have discussed the use of correlation (cross-asset-class and intra-asset-class) a number of times in the last few years, most recently here, as a better way to track 'fear' or greed than the traditional (and much misunderstood) VIX. As Nic Colas writes this evening, a review of asset price correlations shows that the convergence typical of 'risk-off' periods in the market is solidly underway. While we prefer to monitor the 'finer' average pairwise realized correlations for the S&P 100 - which have been rising significantly recently, Nic points out that the more coarse S&P 500 industry correlations relative to the index as a whole are up to 88% from a low of 75% back in February. In terms of assessing market health, a decline in correlation is a positive for markets since it shows investors are focused on individual sector and stock fundamentals instead of a macro “Do or die” concerns. By that measure, we’re moving in the wrong direction, and not just because of recent decline in risk assets. Moreover, other asset classes such as U.S. High Yield corporate bonds, foreign stocks (both emerging market and develop economies), and even some currencies are increasingly moving in lock step. Lastly, we would highlight that average sector correlations have done a better job in 2012 of warning investors about upcoming turbulence than the closely-watched CBOE VIX Index. Those investors looking for reliable “Buy at a bottom” indicators should add these metrics to their investment toolbox as a better 'mousetrap' than the now ubiquitous VIX.