Month: October 2018

One week ago, with roughly half of earnings season in the books, FactSet and Bank of America revealed an ominous statistic about the jumpiness (or perhaps “peak earnings”) of the market: in a curious twist, companies that had reported positive earnings surprises for Q3 2018 were punished by the market, with their stock price decreasing by -0.5% two days before the earnings release through two days after the earnings. Meanwhile, and as one would expect, companies that reported negative earnings surprises for Q3 2018 have an average price decrease of -3.5% two days before the earnings release through two days after the earnings.

While the market penalizing companies for earnings misses is hardly a surprise, the lack of reward for EPS & sales beats is typically a later-stage bull market signal according to BofA strategist Savita Subramanian who wrote that “this suggests that the good news is priced in.” Putting these market reactions in context, the only time when the market had a sub-1% relative surprise reaction for beats was in both 1Q00 and 4Q07.

Now, Goldman’s derivatives strategist Katherine Fogerty points out another curious statistic about the bifurcation between single name and index vol: in the latest indication of just how nervous traders are about corporate earnings, with just over half of the S&P having reported results as of last Friday, the average stock moved +/-4.5%, marking the highest earnings move since the Financial Crisis (Q3 2009).

Of note, this is not due to overall market volatility because while the S&P500 was down just 2% during October 2009 (vs -7% October 2018), the average level of the VIX was 61%, substantially higher than 19% this month.

When broken out by sector, communications (comprised of Internet, Media, and Telecom stocks) exhibited the least ties to macro volatility on earnings and the largest absolute moves: the average stock in this sector realized a +/-7.0% move on earnings this quarter. After adjusting for sector performance, Goldman calculates a Residual Earnings Move of +/-6.3%. This is 2.1% higher than the average move these stocks have realized on prior earnings reports (2006 – present).

Goldman’s latest observations echo the analysis made by another member of the firm’s derivatives team, when on Tuesday strategist John Marshall showed that while fear has risen sharply at the single stock level “as put-call skew is now in-line with the levels following the February sell-off”, suggesting that investors fear gap-moves lower in single stocks over the next three months, the same thing is not true at the index (S&P500) level, where the put-call skew has declined since early October, “implying that investors aren’t seeing as much potential for a sharp sell-off from this new lower level in equities.”

Underscoring the single-name “paranoia” discussed above, Marshall further notes that while index put-call skew remains higher than single stock skew on an absolute basis, “such a large divergence between these two measures is unusual.” This divergence is shown in the chart below:

Discussing recent conversations with investors, Marshall says that this spread in the vol world is is indicative of a divergences in near-term sentiment: “Macro investors we speak with seem focused on picking a bottom in the SPX which is oversold relative to other asset classes” while at the same time, “micro investors seem increasingly risk-averse following big earnings-day moves.”

Whatever the reason, the increase in earnings-day moves over the past two years, discussed here most recently in August, is continuing this quarter.

* * *

So now that a clear pattern has emerged, how does one trade it? According to Goldman, the winning strategies going into earnings have been buying puts and strangles, while avoiding calls:

• Given the overall challenging tape, buying the closest out of the money one month listed put 5 days ahead of earnings and closing the day after produced an average return of 107%. This is the highest profit for this strategy since the Financial Crisis.
• Another trade that has fared well is buying the closest listed one month straddle 5 days ahead of earnings and closing the day after. Post crisis record earnings moves have helped drive an average return of 35% for this strategy, which isolates volatility.
• Given the 7% drawdown in the S&P500, buying calls has been extremely challenging. In fact, buying the closest out of the money call 5 days ahead of earnings and closing the day after has produced a loss of 36% on average. All figures exclude transaction costs.

One obvious counter to the above is now that it has been publicized, the trade will no longer work. Whether or not that means that single stock volatility will also collapse now that everyone rushes to hedge it (while pushing index vol higher as hedges are pulled) remains to be seen.

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Texas landowners along the US-Mexico border have reportedly been told this week by the US Border Patrol to expect a possible influx of “armed civilians” on their property as a Central American migrant caravan makes its way towards the United States, reports AP. 

The Associated Press reported that these civilians say they intend to support the National Guard and Border Patrol to prevent the illegal migrants from crossing into the U.S.

But some see the move as a negative, arguing that the armed civilians’ presence would add even more tension should there be a confrontation.

Three activists told the AP they were going to the border or organizing others, and groups on Facebook have posted warnings about the caravan. One said it was “imperative that we have boots on the ground.” Another wrote: “WAR! SECURE THE BORDER NOW!” –Associated Press

Texas Minuteman militia president Shannon McGauley told AP that the group has members stationed at three points throughout the state’s border, and expects 25-100 more arriving in coming days. 

Militia border patrols are nothing new, as civilians will typically alert border patrol to apprehend trespassers. 

On Wednesday, President Trump issued a new warning about the caravan and its “very tough fighters and people,” tweeting: “The Caravans are made up of some very tough fighters and people. Fought back hard and viciously against Mexico at Northern Border before breaking through. Mexican soldiers hurt, were unable, or unwilling to stop Caravan. Should stop them before they reach our Border, but won’t!”

The Caravans are made up of some very tough fighters and people. Fought back hard and viciously against Mexico at Northern Border before breaking through. Mexican soldiers hurt, were unable, or unwilling to stop Caravan. Should stop them before they reach our Border, but won’t!

— Donald J. Trump (@realDonaldTrump) October 31, 2018

Trump then reiterated that the US military “is being mobilized at the Southern Border” with “Many more troops coming.” 

“TURN AROUND!” he added:  

Our military is being mobilized at the Southern Border. Many more troops coming. We will NOT let these Caravans, which are also made up of some very bad thugs and gang members, into the U.S. Our Border is sacred, must come in legally. TURN AROUND!

— Donald J. Trump (@realDonaldTrump) October 31, 2018

The caravan, which is now estimated at 4,000 people after many have turned around or accepted asylum in Mexico, is currently around 1,000 miles south of the US border and estimated to arrive in around a week thanks to organizations which have been aiding the Central Americans, including a reported organized busing operation. 

As Fox News report on Tuesday showed, migrants traveling with the caravan are being loaded on to chartered buses and transported to the next stop on the trail to the US, having refused Mexico’s offer of asylum, shelter and jobs should they opt to stay in the country. Fox News reporter Griff Jenkins revealed that multiple professional buses have lined up to board the migrants, as footage from the report showed.

Meanwhile, President Trump told Fox News on Monday that the migrants are “wasting their time” and said “they are not coming in,” adding that the US would build giant tent cities to house migrants who made it over the border, as opposed to the longstanding policy of “catch and release” by which migrants were assigned court dates and allowed to leave – typically never to be seen again. 

“If they applied for asylum, we’re going to hold them until such time as their trial takes place,” Trump told the Fox News host. 

“Where? We have the facilities?” she asked.

“We’re going to put up – we’re going to build tent cities,” Trump responded. “We’re going to put tents up all over the place. We’re not going to build structures and spend all of this, you know, hundreds of millions of dollars — we’re going to have tents.“

“They’re going to be very nice,” he added.

.@POTUS on facilities for asylum seekers: “We’re going to build tent cities. We’re going to put tents up all over the place.” @IngrahamAngle pic.twitter.com/fL3ALkNbz4

— Fox News (@FoxNews) October 30, 2018

At this rate the migrants are scheduled for a showdown right around midterms.

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“Happy Days are here again,” is the clear message from asset-gatherers and commission-rakers across the financial media space (as well as President Trump) as shocktober ends with a flourish of rebalancing exuberance prompting the goldfish-like memories of the trading community to forget the carnage of the last 20 trading days.

Former fund manager and FX trader Richard Breslow remarks that “I couldn’t help giggling on my way to work this morning,” as he reflects on the market and the media’s reaction to this dead cat bounce…

Via Bloomberg,

…not because global equity markets were all up. It was after reading reports from a number of commentators, who spent a good portion of the last few weeks asking what is going on with asset prices and settling on no definitive reason, that the worst is over and this time we should be looking for the moment to buy.

Brave words with ‘other peoples money’ as there were the obligatory hedges that the exact timing is left to the reader. Just in case there may be more bad news first. I couldn’t quite wade through the “logic” but it seemed to be some amalgamation of, all the bad news is priced in using a misreading of the Efficient Markets Hypothesis, a desire to make a random call based on the calendar turning in the hope of being a punditariat hero, or, more likely, a continuing belief that monetary policy makers can and will provide.

Whether they’re proven right remains to be seen, but it’s too early to make that call with any credibility. Especially given the obvious effects of month-end rebalancing and the upcoming midterm elections. The way traders have been faring over the last month makes it feel like the coin flips being made have a payout less than 50/50. Which probably means the statistical theories of Thomas Bayes is an invaluable read when trying to rebuild portfolios for the coming month.

I remember an amusing conversation with someone when thinking about whether to embrace the bad things are over declarations. It went, “Why are you following the advice of someone who has been consistently wrong? Because he is a smart guy who is due for a winner.” Many a hedge fund limited partner has regretted adopting that attitude when investing in a relaunch.

The economic news in Asia presented one disappointment after another. China’s manufacturing PMI fell to almost a two-year low. And the sub-indices offered no relief. South Korea’s industrial production was downright ugly as was that of Japan. And the equity markets didn’t care a whit. That might tell you something when deciding how definitively the all-clear has been signaled. At his post-policy meeting press conference BOJ Governor Haruhiko Kuroda talked about downside risks. Japanese CPI forecasts were lowered, consumer confidence was a miss and inflationary expectations rose thanks to the coming consumption tax hike.

In Europe, the theme of the day has been all of our problems have been solved. I’ve heard that one before.

Equities bouncing is a good thing, even if it won’t salvage anyone’s October. I still maintain that 2720 in the SPX is a very interesting technical pivot to watch. Of more interest to me, rather than debating whether or not to catch the falling equity knife, is contemplating what the dollar touching a new year-to-date high and sings of life in Treasury yields mean.

Especially for emerging markets. And then ask yourself why their stocks are rising so much on the day.

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UK Brexit Secretary Raab says a deal is expected by November 21st (in a letter to Hilary Benn, chairman of U.K. Parliament’s Brexit select committee):

“I would be happy to give evidence to the Committee when a deal is finalized, and currently expect 21 November to be suitable”

It seems the algos are buying this one…

 

We will see how long this lasts – three weeks is a long time in European politics.

As Brexit negotiations really start to heat up towards the business end of the procress, Statista has made a timeline of the key dates and events that lay ahead for the UK and EU as they attempt to move towards the planned end of the transition phase on December 31, 2020.

You will find more infographics at Statista

Full letter below:

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Treasury Secretary Steven Mnuchin is about to surpass Timothy Geithner’s achievement of selling a record amount of notes and bonds as he seeks to finance America’s soaring budget deficit.

According to the latest quarterly refunding statement, the US Treasury is about to sell a record amount of debt, surpassing levels seen both in the aftermath of the Great Depression and the Global Financial Crisis.

On Wednesday, the US Treasury Borrowing Advisory Committee unveiled that it will increase the amount of debt to be sold at the upcoming quarterly refunding auctions to $83 billion from $78 billion three months earlier. This will be the fourth straight quarter of increasing refunding auction sizes and is driven by the soaring US deficit shortfall, which in 2018 hit $779 billion the highest since 2012, as well as the Fed’s ongoing balance sheet shrinkage.

Here are the details of the TBAC’s proposal:

• Auctions for 2-, 3- and 5-year notes will increase by $1 billion in both of the next two months; last quarter Treasury implemented increases in all three months
  • As a result, the size of 2-, 3-, and 5-year note auctions will increase by $2 billion, respectively, by the end of January. 
• Auctions for 7-, 10-, 30-year notes to be raised by $1 billion in November and then kept steady through January
• Auctions for 2-year floating-rate note will rise by $1 billion in November
• Auctions for TIPS will see various changes with total tips issuance rising $20 billion-$30 billion in 2019, however there will be no TIPS supply changes over next three months; a new CUSIP 5-year will be added to the TIPS calendar, with the new security to be introduced October 2019

In total, the Treasury will sell $83 billion in long-term debt next week – consisting of $37BN in 3 Year notes, $27BN in 10 Year notes and $19BN in 30 Year notes, versus $78 billion in August’s refunding week sales.

Meanwhile, as noted on Monday, the net amount of new cash raised by the Treasury this quarter is expected to be $425 billion, a slight reduction from the $440 billion forecast made by the Treasury in July.

Notably, Bloomberg notes that the debt issuance at this quarterly refunding will surpass the previous record of $81 billion set by former Treasury Secretary Timothy Geithner in 2009 when the U.S. was issuing record amounts of debt to fund its recovery from the Great Recession. Of course, this time borrowing is surging as the economy hums along at a 3.5% annual growth rate and unemployment is near a half-century low, a paradox which many are confident will end up making the next recession that much worse as the US will have little fiscal dry powder.

While the announcement came in line with expectations, it helped push 10Y yields to a session high of 3.16% before the move faded back to 3.14%, almost unchanged on the day as Treasury vol remains non-existent.

As Bloomberg notes, the Treasury release may draw more attention to rising federal deficits less than a week before midterm elections: Trump, who is expected to sell $1.3 trillion in total Treasury debt this calendar year, had often criticized Barack Obama for running up the budget deficit, and in 2012 recommended banning lawmakers from reelection if Congress couldn’t balance the budget.

Meanwhile, between the Fed’s quantitative tightening and Trump’s deficit-busting policies which has sent the US debt soaring, some say it is only a matter of time before debt buyers of US paper boycott the relentless increase in issuance with demands for far higher interest; for now Treasury Secretary Steven Mnuchin has dismissed any such worries.

“The market has handled the supply very well,” Mnuchin said earlier this month, adding that demand for U.S. government bonds remains strong.

For now, perhaps, but recall that the US Treasury is on track to sell $1.34 trillion in new debt this year, more than double the amount sold in 2017. As such, it’s only a matter of time before bond buyers hit the reset button and start demanding far higher interest rates, unless of course the US economy slumps into a recession when the calculus will be dramatically revised as there is a great rotation out of stocks into bonds, offset by an even greater increase in the net supply of US paper.

Finally, putting all of the above in context, the US Treasury paid over half a trillion dollar just to fund interest on all this debt. This number is set to explode higher in the coming years.

 

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Authored by Lance Roberts via RealInvestmentAdvice.com,

“Brophy: I got it. I got it. I got it. 

[thump] 

Brophy: I ain’t got it.” – Mel Brooks, High Anxiety

Arriving at Los Angeles International Airport, Dr. Richard Thorndyke has several odd encounters (such as a flasher impersonating a police officer, and a passing bus with a full orchestra playing inside it). Dr. Thorndyke remarks:

“What a dramatic airport!”

He is taken by his driver, Brophy, to the Psycho-Neurotic Institute for the Very, Very Nervous, where he has been hired as a replacement for Dr. Ashley, who died mysteriously. Brophy has a condition of nervousness, and he takes pictures when he gets nervous. Upon his arrival, Thorndyke is greeted by the staff, Dr. Charles Montague, Dr. Philip Wentworth, and Nurse Charlotte Diesel. When he goes to his room, a large rock is thrown through the window, with a message of welcome from the violent ward.

During the movie, Thorndyke suffers from a neural disorder called “High Anxiety”, a mix of acrophobia and vertigo, and tries to overcome the infliction.

We Live In Mel Brook’s Crazy World Now

With an intraday move of almost 4% – the S&P futures fell by a remarkable 100 points from the day’s high to the day’s low. A large sell program at around 3:30 p.m. abruptly moved the market down by fifty handles in one of the largest sell programs I have ever seen hit the floor. (The day’s swing in the Dow Jones Industrial Average exceeded 900 points!)

The Spyders peaked at over $270 at around 10:10 a.m. and bottomed at under $260 (with 30 minutes left in the trading session). Spyders closed the day at $263.86.

Talk about High Anxiety!

As I write this morning’s missive the market volatility has continued. When I started writing this column, S&P futures were +18 and Nasdaq futures were +38 . They are now essentially flat, on no new news.

What Was Trump Thinking?

Since early 2018 I have warned that the return of The Orange Swan introduces more uncertainty – “Making economic uncertainty and market volatility great again.” #MUVGA I have and continue to caution that Trump’s behavior and his (hastily crafted) policy – conflated with politics – are now hurting the markets.

Case in point, futures rose early on Monday after the president said that he is going to make a great deal with China.

Then, in the middle of Monday’s volatile trading session (at around 2 p.m.), the president added fuel to the trade war with China with another threat to introduce more tariffs on the rest of China’s imports to the U.S.

As I wrote late in the day, Karen Finerman, on CNBC’s Fast Money, asked an interesting question – why did Trump bring up the Chinese tariff debate again?

After all he already has stated (as has Steve Mnuchin) that the stock market is a real-time judge of the administration’s economic policy and he must have known that his comments would be market unfriendly.

So, what was it?

Here are some possibilities:

1. He is doubling down and posturing against the Chinese (I doubt it because he has already been quite hawkish in his trade rhetoric).

2. Is the president simply oblivious and doesn’t care about the impact of his actions? (That’s hard to believe because we are so close to the important midterm elections).

3. Is he not focused? (I don’t know)

4. Was the statement part of a broader or more grand strategy? (I have no idea)

5. He just felt like saying it, wants to humiliate China and is appealing to his base. (No clue, here)

6. Is he playing chess while everyone else is playing checkers? (Doubtful)

7. Is he testing the market’s response to a ridiculous policy that he has no intention of implementing? (Again, I am clueless)

8. Is he overplaying his hand? (Clueless, Part Trois)

9. Is it simple arrogance and ignorance? (Clueless, Part Four)

10. Is he trying to change the narrative from the bomb mailings and the terrorist act in Pittsburgh? (You get the point by now!) 

I Have Warned About The Growing Risks of A “Flash Crash” in 2018

Back in December, 2017, I warned:

Surprise #9: Volatility Spikes, Causing a Major Flash Crash

“Though large daily drops in the markets are rare, the factors that could contribute to a quick drop have increased.

Investors have been concerned about the VIX for years, but the positioning has now moved to an extreme. Such positioning could accelerate a market drop as the chances of a flash crash have escalated.

Hyman Minsky has warned about the risks of becoming numb to the risks associated with a period of stability amid rising asset prices; it is not only inevitably followed by instability, it inevitably creates it.

In a world in which the chances of an external market shock are rising and at a time when volatility is cratering and stock prices never decline, the risks of a flash crash caused by the one-sided market positioning in VIX futures is increasing and are at a higher probability of occurring than at any time in history.” – Kass Diary, 15 Surprises for 2018

Kill The Quants Before They Kill Our Markets

Most observers are of the view that there is order in our markets today – that fundamentals and/or technicals are understandable and analyzable stars that shine above us and give us direction.

If you believe the market’s volatility is a function of the earnings reports, trade wars or interest rates concerns – I believe you are mistaken. Rather, this is the cruel cocktail consisting of the proliferation of ETFs and other quant strategies.

But, its not our “fathers’ market.” These factors used to be an important determinant to stock prices – they still are, but markets are now too frequently punctuated by the influence of ETF flows and risk parity leveraging or deleveraging.

As an example, it’s commonplace, in a market that moves by nearly 1000 DJIA points from high to low for bond markets to exhibit a “flight to quality”, for gold to rise and/or volatility to explode to the upside. None of this happened yesterday. There was no movement in bond yields lower (bond yields were up one basis points) nor a rise in the price of precious metals (gold fell). Credit spreads would also normally widen in the sort of volatility we saw on Monday – this, too, did not happen. And, importantly, volatility rose by a mere 50 cents.

I used the 3:30 p.m. “woosh lower” to add to my trading long rentals. It was not an easy tactic as markets were in a scary free-fall (a likely occurrence that I predicted previously in my Surprise List 10 months ago).

Tactical Approach to an Anxiety-Driven and Machine/Algo Influenced Market 

Throughout 2018 I have been looking at a projected S&P range of approximately 2550-2800. (In September we overshot the top end of my range by about 120 S&P points.) 

My “fair market value” calculation has been about 2500 and my pessimistic case has circled around the 2400 level.

I have been consistent with my forecasts – and I continue to basically have the same range projection (2550-2775), “intrinsic value” of (2500) and pessimistic case (2400). 

There are numerous reasons to be cautious today – a changing and more problematic market structure, a monetary pivot, trade rhetoric/wars, ambiguous global economic growth, political (The Orange Swan) and geopolitical uncertainties, etc. The market is still “a full on Monet”.

The new regime of volatility is now another bona fide reason to sit on the sidelines.

All these factors, I have argued, cap the market’s upside to levels much lower than believed by the consensus.

Nevertheless I am sticking with my process and trying to trade unemotionally and let the market’s wild moves work to my advantage. (In days like yesterday it was tough to divorce myself from the volatility in order to reach for opportunity – but I purchased the late afternoon “woosh” based on the move to the lower end based on my projected the 3-6 month trading range of 2550-2775 and what the current price provided in terms of reward v. risk. (At around 3:30 p.m. S&P cash traded at about 2598 – within 50 handles from the estimated low of the range).

Unlike many talking heads I do not confidently make these projections – as I recognize that the plethora of fundamental outcomes as well as the dangers of a changing market structure (in which too many are on the same side of the bullish boat and an increasingly large amount of traders/investors worship at the altar of price momentum).

The global stock markets are damaged (non U.S. markets led this decline which, in many stocks, are already in bear market territory) – it’s still “a full on Monet!”

“It’s like a painting, see. From far away it’s okay, but up close it’s a big ol’ mess.” 

I am still of the view that we made important tops in late January, 2018 and in September, 2018 – and that tops are processes, not events.

But, when anxiety and fear are elevated, trading opportunities abound.

Bottom Line 

I started Monday on an optimistic note, “The Case For an Oversold, Contra Trend and Playable Rally Higher Increases in Probability” – and, on cue S&P futures rose by over 30 handles in the early going:

The last thirty minutes of trading on Friday bears witness to the disproportionate role of passive strategies (ETFs and risk parity and other quant strategies that worship at the altar of price momentum – and exaggerate short term market movement – in which the Dow Jones Industrial Average moved up and down in excess of 400 points.

This unnatural backdrop – which showed a sharp drop in the last few minutes – was likely artificial and provided yet another short term trading opportunity.

As I have been harping on, the market is dynamic and we, or at least I, have to unemotionally and opportunistically trade in order to deliver superior investment returns. The machines and algos should be taken advantage of. (I covered my (SPY)  short on Friday at very nice prices and for a quick, few hours, +$4 to $5 gain.)

Though I have little idea how long it will last, there are several factors that may contribute to higher stocks in the next few weeks:

* As the Reporting Period (for 3Q2018 earnings) Matures, Buybacks Will Soon Be Back

* Investor Sentiment Is Dismal: The CNN Fear & Greed Indicator is at an ‘extreme fear’ level.

* Many talking heads in the media, formerly bullish, are now fearful.

* An Oversold Market: Several market Indices are 2-3 Standard Deviations Below 50 Day Moving Averages.

* The End of Mutual Funds’ Fiscal Year: Loss taking may soon be over as the month and fiscal year end on Wednesday.

As previously mentioned, I (unemotionally) purchased the “woosh” lower on Monday and I am temporarily net long based on my calculation of upside reward v. downside risk.

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