What Keeps Wall Street Up At Night (Quarterly Edition)

Two quarters ago it was the muni implosion, last quarter it was sovereigns blowing up (again). Now, it's oil, and the stench of out of control inflation sending precious metals to daily all time record highs, that is keeping Wall Street up at night (yet doing nothing than seemingly providing one after another "buy the dip" opportunity). Every quarter the prevailing investing and spec opinion focuses on one key bogeyman in the wall of worry and refuses to let go, even as, or particularly because of, the Fed, in conjunction with the HFT-controlled market, sells vol to the point where everyone pretends risk is under control. Of course, it isn't, and neither the muni crisis has gone away, nor the threat of sovereign insolvency, nor pervasive inflationary threats (just buy gas in Europe). However, the fact that the Fed systematically takes on one conventional wisdom risk factor after another, and sells into every vol rally, almost certainly via curve exposure, but arguably via equity volatility indices as well (see thought by Artemis Capital on the subject), masks the symptom of an underlying systemic collapse until the market focuses on the next hotspot, which the Fed may or may not be able to resolve. And since we have finally moved on the biggest Fed artifact of all: inflation (and rampant one at that), the Fed's ability to extend and pretend the inevitable correction that needs to happen to push oil down to sub-$100 may be now coming to an end.

Here is how Bank of America's clients determine what the key concerns were for the past two quarters:

Below is Jeffrey Rosenberg's commentary on how and why Wall Street has now made it into a habit of selling into any fear drop.

Our quarterly survey of largest risk to the outlook has been a good source of contrarian trading strategies. From last autumns’ deflation concern (contrarian viewpoint: interest rates should rise), to December’s US municipal risks (contrarian viewpoint: credit risk overstated) to today’s concern over rising oil prices (contrarian viewpoint: oil market uncertainty overstated), each of these concerns have failed to deliver a significant asset price correction. The last one – oil market concerns – still lies ahead of us in terms of the lagged impact of rising gasoline prices on consumers, but the market’s fears (as judged by implied volatility in options) indicates improvement in confidence that a “super spike” can be avoided eroding one of our original motivations for a tactical underweight recommendation.

In other words, BTFD until BTFD as a strategy fails spectacularly and the trade of aligning with the Fed always and forever no longer works.