There were some readers who took offense at our "bloodbath" recap of yesterday's market action (modestly different from that provided by MarketWatch). And, all else equal, a modest 28 step drop in the E-Mini/SPX would hardly be earthshattering. However, all else was not equal, and based on peripheral facts, the reason for our qualifier is that as of last week virtually nobody was prepared for a move as violent and sharp as the one experienced in the last minutes of trading yesterday. In such a context a "mere" 1.5% drop in the futures market has a far more pronounced impact on participants than a 10% or even 5% drop would have had, had traders been positioned appropriately. They weren't. So what was the context? Let's find out.
First as the NYSE just reported margin debt just soared to a near five year high, with Margin Debt at a whopping $327 billion, surpassing the highest print since the Lehman collapse, and the highest level since February 2008. Not only is everyone all in based on , but they are all in on nearly record amounts of leverage.
As noted previously this happened just as the net long positioning of specs soared to an all time high.
In short - the "sidelines" speculator money is already all in, and is using gobs of leverage.
Second, when it comes to high beta, or traditionally the most volatile stocks, those that serves as either leaders or laggards in the market in its year end phases, we take a look at the Russell 2000 Mini speculative exposure as shown by the CFTC's weekly Commitment of Traders update. The chart below needs no explanation: the net non-commercial spec longs in the Russell 2000 have never been more bullish. If the market, which is priced to absolute levered perfection disappoints, the high beta exposure will be annihilated.
Third, and last, for all those who have had a sinking feeling ever since June that something was even more broken with the equity market, more so than usual, we have just one chart to prove all of them right. As this chart of net non-commercial CoT VIX exposure shows, starting in June and continuing ever since, the net exposure in VIX futures has gone down in what is virtually a straight line.
But what changed in June? Well, as some may recall, something very substantial - the head of the Fed's Markets Group, i.e., its trading desk, got a new head: one who has been rumored to have a different PPT style to his predecessor Brian Sack - a style that involves the relentless selling of VIX to take advantage of a market which is drowning in reflexivity, and in which the movement of the vol surface has a far greater impact on the underlying asset than any fundamentals or news flow: want to send the market higher (and have an infinite balance sheet at JV partner Citadel courtesy of your backstop, then just sell, sell, sell VIX).
At least we can now scrap the "rumored" part.
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So to all those who are confused why a 1.5% drop in the market constitutes a bloodbath, now you know: with no hedges on, with massive margin exposure on, and with everyone all in, the last thing the market can sustain is selling, any selling, or else the dreaded margin calls start coming in and PMs have to satisfy margin insufficiency with more selling, setting of an avalanche of even more selling, which ends where, nobody knows. In fact one can argue that in this context a modest 1.5% drop may have a greater impact on sentiment and positioning than a whopping 10% drop did as recently as 2008 when everyone was more or less positioned to expect precisely such a thing. Because if one is 99% levered, a 1.5% move lower just wiped out all equity.
But hey: a few more percent and one can be certain that Wall Street's unofficial branch of government, the Fed, will get a solemn request by such representatives of "the people" as Chuck Schumer to "get to printwork" as soon as possible...