Whether it is Trump's trade threats (and potential Yuan 'weaponization'), Fed tightening, or global synchronous economic slowing, there are plenty of reasons to be less sanguine than the always-sunny Nasdaq portends (hey, just look at the Dow) but that is not why former fund manager Richard Breslow thinks "markets look really ugly this morning."
It's not about equities being down or yen up, as Breslow notes, it's the dearth of liquidity!
In fact, as the former FX trader points out, it is the lack of liquidity that drives prices in the immediate aftermath of any event, distorts coherent analysis of what is going on and is creating an enormous disincentive to trade. And it’s all circular because cause and effect are rapidly reinforcing each other. It’s not healthy when the most honest answer to why an asset moved the way it did is, “People were the other way around.”
And the virus is spreading. Doesn’t seem to matter what you look at. The reaction, and descriptions, that followed the election in Turkey or the Chinese cut of the reserve requirement ratio are just a couple of today’s examples. As a side note, global trade tensions aren’t really waxing or waning every time S&P 500 futures play at making fools of the latest round of weakest hands.
In many ways, traders are smarter than they’re given credit for. And yet, they constantly set themselves up to be fleeced. The re-election of Turkey’s President Erdogan wasn’t nearly the surprise you would have expected given the portrayal of what the odds actually were in the lead-up to balloting. Traders were short the lira going in and weren’t about to get out despite momentum for the trade having stalled last week. They expected the vote to skew the way it did. They got everything right, except the ensuing 12 hours of gamesmanship.
The three-percent drop in USD/TRY had everything to do with the buyers having already bought and nothing to do with traders supposedly liking certainty or expectations that a leopard can suddenly change its spots. There was no thinking going on here. That came in when the cross got to an important chart level that has shown its relevance more than half-a-dozen times in the last month.
As far as today’s behavior in Chinese stocks is concerned, the lesson policy makers need to relearn is that well-telegraphed policy changes don’t work. They just set up a similar dynamic of weak hands being caught-out looking for a free lunch. Any nerve soothing will have to wait for another day.
The reality is that event trading is a strategy to be used sparingly when liquidity goes missing and marginal positioning is increasingly leaning in one direction. Keeping your powder dry to take advantage of the aftermath has been working much better.
The former is gambling at a time when the odds keep getting worse. The latter represents a far more viable business proposition. Market structure, not market-making is a bigger reality in today’s world.
Just consider that the last week saw the dollar's net positioning explode long by the largest amount ever...
And bond shorts remain near record length...
And VIX shorts are piling back in again...
What could go wrong?