The Smart Money's Bailing As Market Complacency Surges

Authored by Adem Tumerkan via,

The turbulence throughout the markets last week – thanks to Italy – has given investors their first taste of a frothy summer.

Especially the ‘smart money’- they’re bolting for the exits...

The Smart Money Flow Index (SMFI) is a leading-indicator in markets. That means when the SMFI drops sharply, usually the equity markets are right behind it.

And we haven’t seen the SMFI drop this much since the Great Recession of 2008 and the 2001 Recession. . .

What’s going on?

Last week I wrote about the forgotten economist – Hyman Minsky – and his excellent work about the Financial Instability Hypothesis (FIH), which details how an economy shifts through three stages.

From lowest risk to highest risk the stages are: hedged, speculative, and ponzi.

But probably the most important takeaway from the FIH is this simple sentence. . .

The periods of low volatility and market calm are the seeds for high volatility and market chaos in the future; then back the other way around.

Let me show you this using the last 10 years of the CBOE Volatility Index – the VIX – which gauges market volatility.

Like Minsky stated, the periods of market calm are breeding grounds for high market volatility.

Out of the last 10 years, roughly 85-90% of the time was peace and quiet. But the 10-15% were wild spurts of sharp chaos and turbulence.

What we can make out of this is “don’t confuse the current calm markets as signals everything is going to be OK.”

Unfortunately, that’s what the crowd is doing. . .

Things have gotten so peaceful that according to Goldman Sachs, Wall Street isn’t too far from record ‘quiet’ levels.

Looking at the single-stock ‘implied volatility’ throughout the S&P 500, it’s down 21% on a 3-month basis.

What’s implied volatility – informally known as iVol? This is the mathematical and artificial way to try and estimate how volatile something is – and will be – on the stock market. It’s most commonly used in option trading via the Black-Scholes Option Pricing Model.

Putting it simply, iVol is the estimated volatility of a security’s price and how traders price in the future price fluctuations.

For example, If the crowd’s bearish and expecting turbulent times, then the iVol will be higher – thus requiring more risk premium. But if they are instead optimistic and expecting calm markets, the iVol will be lower – settling for less risk premium.

So, with implied volatility down 21%, the equity markets are expecting calmer markets ahead...

This sort of ‘market complacency’ is where having optionality is key.

Borrowing ideas from the philosopher-esque former trader – Nassim Taleb – one needs to set themselves up with only ‘positive optionality’.

Positive Optionality is a situation where you have an asymmetric risk-reward setup; meaning unlimited upside with limited and fixed downside.

For example, buying car insurance offers this type of positive optionality. You pay small fixed premiums every month for complete protection during an unlikely chance of an accident.

Worst case scenario? You lose the small monthly premiums – no more, no less.

The upside scenario? There’s a freak-vehicle accident and your insurance company covers all your significant medical bills and replaces your totaled car with a brand new one – mountains more than what your small premiums cost you.

Negative optionality is the one writing the insurance – the one responsible for the huge payouts.

Remember that scene in The Big Short movie when Christian Bale’s character Mike Burry went to Goldman Sach’s and bought customized mortgage default insurance from the bank – and they laughed at him?

Unlike the bank that only wanted fixed monthly premiums and couldn’t see the bigger picture of risk – Mike actually understood positive optionality.

Later – during the crash of 2008 – Goldman Sach’s was on the hook to pay Mike a huge sum when the housing market bellied-up. Netting him a massive profit.

So, what’s this all add up to?

With the ‘Smart Money’ leaving in droves, and markets becoming too complacent – this gives us a subtle opportunity – and warning.

Take advantage of the low-implied volatility the market is pricing in while ignoring the smart money rotating out of equities. The Smart Money knows that all this ‘peace’ will be followed by spurts of high turbulence – eventually.

During this period of mis-priced risk, complacent markets, and false confidence – be long anything with positive optionality.

Now, go re-watch The Big Short. . .


Snaffew Consuelo Tue, 06/05/2018 - 15:11 Permalink

based on M1 money supply, the price of gold should be $13k/ 1980, based on M1 money supply, the price of gold should have been $400/oz---it hit $800 on the overshoot.  Are you saying the world will go to hell if they actually even remotely fairly value gold?  then bring it on---fair value for amzn is $200, but the world isn't falling apart because it is priced at $1700.

In reply to by Consuelo

Number 9 Tue, 06/05/2018 - 12:53 Permalink

I only worry about market fundamentals and how the price of oil relates to the rice in China..

It is a very long and tedious process so I have to take a lot of morphine to clear my head so I can make the big trades for that lowlife pos jamie dimon. 

Jump you fvkr


hola dos cola Tue, 06/05/2018 - 12:54 Permalink

What’s going on?

No need to ask. And fcuk your analysis.

Just watch the agenda. Up next: Defeat after Defeat after Defeat for you know who.

That's enough reason to pull your money outof the markets. Especially as he'll take it out on the market... for his buddies. (That excludes you, ofcourse)

HermanVanCuckold Tue, 06/05/2018 - 13:08 Permalink

Wont surprise me if this "market" has 6-9 more months of upside/topping to go.

So whats everybodys favorite long vol instrument?

Personally I like a mix of long dated puts on usual suspects + pet rocks/pet rock stocks.  Might be wrong across the board lets see

shizzledizzle Tue, 06/05/2018 - 13:11 Permalink

Is it smart money when a machine is handling it? I question the SMFI as it's premise is probably no longer sound.


"The main idea is that the majority of traders (emotional, news-driven) overreact at the beginning of the trading day because of the overnight news and economic data. There is also a lot of buying on market orders and short covering at the opening. Smart, experienced investors start trading closer to the end of the day having the opportunity to evaluate market performance."

hola dos cola shizzledizzle Tue, 06/05/2018 - 13:42 Permalink

The retard can twitter anytime.

Reuters set it up this morning, Bloomberg 'leaks'. (re: million barrels)

You know why he didn't twitter it. WS begged him to bag this one. They'll call for him later, no doubt, early days still.

And they help him bag his million barrels. (won't happen, not without some more market manipulation for his contributors from WallStreet)

In reply to by shizzledizzle

Nov1917Sucks Tue, 06/05/2018 - 13:17 Permalink

There is no "money" in the stock market, its just stock certificates. If you are going to discuss where the "money" is and where it is going, should you not be explaining where it ACTUALLY is and where it is ACTUALLY going!

Consuelo Tue, 06/05/2018 - 13:21 Permalink

It must be a bail from 100,000' edge-of-space sorta parachute ride, because this smart money bailing thing has been reported for well over a year now...



taketheredpill Tue, 06/05/2018 - 13:22 Permalink


"Later – during the crash of 2008 – Goldman Sachs was on the hook to pay Mike a huge sum when the housing market bellied-up. Netting him a massive profit."


Left out the part where Goldman refused to mark the CDS to market until they had covered as much of their short as possible.


Captain Nemo d… Tue, 06/05/2018 - 13:43 Permalink

The most important takeaway from the FIH, is this simple sentence?

The periods of low volatility and market calm are the seeds for high volatility and market chaos in the future; then back the other way around.

Genius. If that were not the case volatility would either drop to zero and stay there or increase unbounded. FIH.


rex-lacrymarum Tue, 06/05/2018 - 15:05 Permalink

Minsky is hardly "forgotten" and his theory is flawed. Stability does not "create instability" all by itself, that makes zero sense. He identifies various classes of borrowers of decreasing creditworthiness, which is fine - but he forgets to mention how it is even possible for all these additional borrowers to suddenly get funded. Where does the money come from? He simply sidesteps this question as if it were unimportant.