Today will almost certainly be the busiest trading day of the year, as the Russell indexes go through their annual rebalancing/reconstitution. But, as ConvergEx's Nick Colas notes, Friday’s close will be the end of a trade that began almost 2 months ago, as traders began handicapping which equities would be included for the first time or swapped between various Russell indices. Since the beginning of May, for example, the stocks that will be added to the Russell 2000 are up 11%, and those being deleted from the same index are down 2% over the same time period. In short, for one day – and this is the day - every U.S. equity market participant, no matter what their investment mandate, needs to think like a trader. Throw in a little Greek drama going into the weekend, and it could be quite a day...
The current asset bubble depends on a number of perceptions that could easily be put to the test by unexpected developments. There is a widespread consensus on a number of issues. This includes the belief that the economy will strengthen, that the emergence of “price inflation” is practically impossible, that “QE” will always guarantee rising asset prices, and that central banks have everything under control. Now we learn that in addition to this, a surprisingly large number of traders has no experience beyond the ZIRP & QE era of recent years. Meanwhile, the market’s underpinnings in terms of liquidity exhibit numerous weaknesses.
With over $4 trillion invested in Russell index-linked products, this year’s rebalance combined with the “Will they/won’t they” Fed rate increase debate could make for an eventful start to summer.
Suddenly the narrative that “everything is awesome” is showing to not be as “awesome” as it was first proclaimed. Merely a few months have passed since the ending of QE and praises of awesomeness everywhere are morphing into questions more akin to “Oh no: not again!” And with that we are now watching those who pushed, pulled, and levitated that narrative scramble desperately to push another narrative back onto the stage that worked so many times before: “Every sell off over the last 6 years has shown to be a profitable buying opportunity.” i.e., Just buy the dip (JBTFD). Yet it would seem these dips; are far different.
In the aftermath of Michael Lewis' book "Flash Boys" there has been a renewed surge in interest in High Frequency Trading. Alas, much of it is conflicted, biased, overly technical or simply wrong. And since we can't assume that all those interested have been followed our 5 year of coverage of a topic that finally has earned its day in the public spotlight, below is a simple summary for everyone.
The banker suicide wave that started in late January has now become an epidemic, and it seems to be focusing on one bank: JP Morgan. After the first suicide that took place in JPM's London headquarters, ending the life of 39 year old Gabriel Magee, a vice president in the investment bank’s technology department, next it was 37 year old Ryan Crane, an executive director in the firm's program trading division, who died under still unknown circumstances. Moments ago a third JPMorgan banker committed suicide, this time at the JPMorgan Charter House Asia headquarters in central Hong Kong, where a 33 year old man who was said to have been an FX trader for JPM, just jumped to his death.
Ordinarily we would ignore the news of another banker's death - after all these sad events happen all the time - if it wasn't for several contextual aspects of this most recent passage. First, the death in question, as reported by the Stamford Daily Voice is that of Ryan Henry Crane, a Harvard graduate, who is survived by his wife, son and parents at the very young age of 37. Second, Ryan Henry Crane was formerly employed by JPMorgan - a bank which was featured prominently in the news as recently as two weeks ago when another of its London-based employees committed suicide by jumping from the top floor of its Canary Wharf building. Third: Crane was an Executive Director in JPM's Global Program Trading desk, founded in 1999 by an ex-DE Shaw'er, a function of the firm which is instrumental to preserving JPM's impeccable and (so far in 2013) flawless trading record of zero trading losses.
This morning we showed several charts that "Market Bulls Should Consider", as the mainstream media, analysts and economists continue to become more ebullient as we enter the new year. This weekend's "Things To Ponder" follows along with this contrarian thought process particularly as it appears that virtually all "bears" have now been forced into hibernation.
The third stage of bull markets, the mania phase, can last longer and go farther that logic would dictate. However, the data suggests that the risk of a more meaningful reversion is rising. It is unknown, unexpected and unanticipated events that strike the crucial blow that begins the market rout. Unfortunately, due to the increased impact of high frequency and program trading, reversions are likely to occur faster than most can adequately respond to. This is the danger that exists today. Are we in the third phase of a bull market? Most who read this article will say "no." However, those were the utterances made at the peak of every previous bull market cycle.
The risk of a more meaningful reversion is rising. It is unknown, unexpected and unanticipated events that strike the crucial blow that begins the market rout. Unfortunately, due to the increased impact of high frequency and program trading, reversions are likely to occur faster than most can adequately respond to. This is the danger that exists today. Are we in the third phase of a bull market? Most who read this article will immediately say "no." However, those were the utterances made at the peak of every previous bull market cycle. The reality is that, as investors, we should consider the possibility, evaluate the risk and manage accordingly. With the current bull market now stretching into its fifth year; it seems appropriate to review the three very distinct phases of historical bull market cycles. While the current bull market cycle may not be set to end tomorrow; it seems sensible to take a pause to question mainstream beliefs.
While the recent Federal Reserve inaction is bullish for stocks in the short term there are plenty of reasons to remain somewhat cautious. Stocks are overvalued, rates are rising, earnings are deteriorating and despite signs of short term economic improvements the data trends remain within negative downtrends. Investors, however, have disregarded fundamentals as irrelevant as long as the Federal Reserve remains committed to its accommodative policies. The problem is that no one really knows how this will turn out and the current assumptions are based upon past performance. Complacency is not an option; it is critically important to understand that market reversions do not occur without a catalyst. Whether it is the onset of an economic recession, a natural disaster or a financial crisis - there is always something that sparks the initial selloff that leads to a full blown market panic. With this idea in mind here are 3 rising risks that investors should be paying attention to.
Being bullish on the market in the short term is fine... The expansion of the Fed's balance sheet will continue to push stocks higher as long as no other crisis presents itself. However, the problem is that a crisis, which is 'always' unexpected, inevitably will trigger a reversion back to the fundamentals. The market will eventually correct as it always does - it is part of the market cycle. The reality is that the stock market is extremely vulnerable to a sharp correction. Currently, complacency is near record levels and no one sees a severe market retracement as a possibility. The common belief is that there is 'no bubble' in assets and the Federal Reserve has everything under control.
The current belief is that rising interest rates are a sign that the economy is improving as activity is pushing borrowing rates higher. In turn, as investors, this bodes well for corporate profitability which supports the current valuations of stocks in the market. While this seems completely logical the question is whether, or not, this is really the case? Increases in interest rates slow economic activity, with a lag effect, which negatively impacts earnings, margins and forward guidance. Ultimately, and it may take several quarters to manifest itself fully, the fundamental deterioration leads to a reversion in stock market prices which, ironically, will then lead to the next decline in rates.
While there was little macro news to report overnight, the most notable development was yet another USDJPY-driven crash in the Nikkei 225 which plunged by a whopping 576 points, or 4%, to 13825, while the Yen soared to under 96.80 in the longest series of gains since mid-June before recouping some of the losses on pre-US open program trading. The reason attributed for the move were reports that Japan would adhere to pledge to cut its deficit which is the last thing the market wanted to hear, as it realizes that boundless QE is only possible in a context of near-infinite deficit spending. The index, which has now become a volatility joke and woe to anyone whose "wealth effect" is linked to its stability, pushed not only China's Shanghai composite lower by 0.7% but led to losses across the board and as of this moment is seen dragging US equity futures lower for the third day in a row.