An overview of the major events next week within the context of the capital markets, which could be at inflection points.
Risk is no longer priced into anything. Volatility has gone to sleep. Uniformity of thought has taken over the stock market. Complacency has reached a point where even central banks have begun to worry about it: the idea that markets can only go up – once entrenched, which it is – leads to financial instability because no one is prepared when that theory suddenly snaps. But all this bullishness, this complacency is only skin deep. Beneath the layer of the largest stocks, volatility has taken over ruthlessly, the market is in turmoil, people are dumping stocks wholesale, and dreams and hopes are drowning in red ink.
According to Goldman, the median company’s EV/sales ratio is now the highest in 35 years, surpassing even the dot com bubble.
Aside from an opening short-squeeze that saw 'most-shorted' stocks surge 0.8% in the first 15 minutes of the day, stocks did very little for the rest of the day. Ranges were extremely narrow with whatever lift stocks got based on small AUDJPY (carry) sparks but the Dow and S&P end the day red (Nasdaq and Russell 2000 green). Nasdaq was driven by AAPL exuberance (what no a new iPhone model??) which grabbed the Tech sector to the best peformance on the day. Utes were the biggest losers as rates reversed early gains and Treasury yields (especially 30Y) surged 6-7 bps from their per-open low yields. The big story was precious metals as Silver and Gold surged on the day. Silver is now up over 9% in the last 3 days - its best run in 22 months. Interestingly, VIX was pushed notably lower on the day (but it appears investors are moving hedges further out in time - to September). Credit notably underperformed. Today was all about pre- and post-Europe (as normal).
A new meme is spreading in financial markets: The Fed is about to turn off the monetary spigot. US Printmaster General Ben Bernanke announced that he might start reducing the monthly debt monetization program, called ‘quantitative easing’ (QE), as early as the autumn of 2013, and maybe stop it entirely by the middle of next year. He reassured markets that the Fed would keep the key policy rate (the Fed Funds rate) at near zero all the way into 2015. Still, the end of QE is seen as the beginning of the end of super-easy policy and potentially the first towards normalization, as if anybody still had any idea of what ‘normal’ was. Fearing that the flow of nourishing mother milk from the Fed could dry up, a resolutely unweaned Wall Street threw a hissy fit and the dummy out of the pram. So far, so good. There is only one problem: it won’t happen.
A funny thing happens when there is only one driver of economic market growth, any chance of intelligent fact-based, logic-induced, fundamental-biased investing becomes reduced to the rubble of momentum-chasing leveraged beta. No matter how much your 2-and-20 taking manager explains his 'process', the charts below show that the thundering herd of 'dumb' money that used to be so useful in identifying the extremes of market hubris and dysphoria appear to have overwhelmed the world of 'smart' money. Hedge funds have never been more net long US equities; hedge fund returns have never been more correlated to the market; hedge funds have never produced so little alpha; and hedge funds are as leveraged to this beta as they were at the top in 2007. This will not end well...
The 'most shorted' names in the Russell 3000 are up a remarkable 1.4% today compared to 0.45% in the index itself. The short-squeeze off the NFP gap-down lows is impressive indeed. From the open last Friday, the 'most short' names are up 6.6% against the index up only 3.5% as the dash for trash continues in the face of increasingly dismal data. The last 2 times that the 'most short' index was this squeezed relative to the index was late-December (before the equity dip) and mid-Fed (before the equity dip). Just as we warned here and here, the inexorable flow of easy money means the dash-for-trash (as remarkably ridiculous as it seems - though as now know nothing is allowed to fail ever again) has been the winning trade; though as we note below, there is a limit to the 'squeezability' and we appear to be there in the short term.
The 'down-up' streak is over, long live the next streak. Precious metals had a big day with Silver and Gold surging 1-2% (among the biggest moves in 7 months); Treasuries pushed higher in yield from the open but faded rapidly into the close to end unchanged ay 1.75%; Commodities in general were bid on the back (supposedly) of China's lower inflation print; IG credit was bid while HY credit (spreads not the HYG ETF) rolled over into the close. What was most evident was the total and utter failure of the 3:30pm Ramp - it seems our discussion of the farce last night brought a world of front-runners to the game and ruined the Algos day as instead rallying S&P 500 futures dropped 4 points in the last 30 minutes - this is the biggest 3:30-to-4:00 loss in six week (and 3rd biggest of year). The world was celebrating another new all-time high in the Dow and the S&P gave back half its gains to close +4 points; but the Dow Transports closed -0.3%, and the Russell 2000 (for so long Bernanke's policy tool) ended -0.23%.
In the theory of rational expectations, human predictions are not systematically wrong. This means that in a rational expectations model, people’s subjective beliefs about the probability of future events are equal to the actual probabilities of those future events. Now, we think that rational expectations is one of the worst ideas in economic theory. It’s based on a germ of a good idea - that self-fulfilling prophesies are possible. Mainstream economic models often assume rational expectations, however. And if rational expectations holds, we could be in for a rough ride in the near future. Because an awful lot of Americans believe that a new financial crisis is coming soon - 75 percent of respondents said that it’s either very or somewhat likely that the country could have another financial crisis in the near future.
When it comes to popular finance myths, cash hoarding by corporates may be one of the most perpetuated. It's not that the data is wrong; US companies are holding more cash on their balance sheets than at any time in the past, as a report by Moody's this week notes. What's misguided is the narrative, in Citi's view, in particular among equity investors. What they most take issue with is the implication that corporates have lots of cash to return to shareholders. Indeed, there's plenty of data to the contrary that challenges the prevailing notion that corporates are the picture of good health.
If it's a day of the week ending in 'y' then sure enough the Dow is green - 10 days in a row - best run since Nov 1996. The cash S&P's all-time high remains a day or two away at 1576.1 but today's late-day ubiquitous idiocy (first via VIX and then via HYG) took it within a point of the all-time closing high of 1565.15. Volume - take a guess! Trannies outperformed as 4 different stocks were short-squeezed this time to drive half the index's performance (CNW, R, KSU, and UNP). VIX daggered lower to new cycle lows ending at 11.05% at its lows. Away from that tom-foolery, stocks were 'supported' by USD weakness as GBP ramped higher on pre-budget excitement and EUR just because why not; Treasury yields ended the day near the lows of the week - entirely in keeping with the highs of the week in stocks... USD weakness helped WTI rise on the day - now best performer on the week among the commodities with Silver lagging on the week (while gold limps higher). Just another day in dystopia... ahead of the CCAR Part 2.
Following up on our recent discussion of the worst-is-first rally that we have all been witness to in the last few weeks, we thought it noteworthy that the 'most-shorted' names in the Russell 3000 and the index itself have now recoupled from their epic divergence post-QE3. We have seen five large short squeezes 'engineered' since the lows in March 2009 - and given Citi and BofA's 17% gains in December alone, we suspect (and have heard from more than a few funds) that year-end is bringing some forced buy-ins as SecLend desks become a little more activist.
The broadest US equity indices began to fall following the 2nd Presidential Debate in mid-October, and stabilized after the 3rd Debate. Weakness was well balanced with the 'most-shorted' names staying in sync with the indices (in a more systemic risk-off manner). Hurricane Sandy appears to the beginning of traders pressing the most-shorted names (we would suspect this was beta chasing on expectations of weakness) and then once the election results were known the most-shorted names really outperformed (i.e. fell considerably more than the index). As the chart below shows, just as the Washington 'cone of silence' began, the Russell 3000 had fallen 6% in November (and 8% from the 2nd debate), while the Russell 3000's Most-Shorted Index had dropped almost 10% for the month (and 12% from the debate) for a massive 400bps outperformance. The following two weeks led to today where the most-shorted index has been squeezed 9.25% higher to catch up to the broad Russell 300's performance for the month. As the month closes, the index and its most-shorted names are perfectly in sync and unchanged with one another - thus reducing dramatically the fast-money ammunition for further squeeze potential.
Confused at why the stock market has risen phoenix-like this week amid no-news on the fiscal cliff, a lack of closure on Greece and EU budgets, and a further collapse in Japan's trade balance? Wonder no longer; for the explanation is simple - a massive and dramatic short-squeeze has created a 200bps outperformance this week among the most-shorted Russell 3000 names. Impressive indeed; sustainable? One wonders if an "expert network" was used by various known and unknown CT-based hedge funds for "advice" to ramp stops in the highest beta, most shorted stocks in a market in which volume would be so abysmal any entity which already controls 10% of NYSE volume could do with the market as it saw fit?