“Brophy: I got it. I got it. I got it.
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:
- He is doubling down and posturing against the Chinese (I doubt it because he has already been quite hawkish in his trade rhetoric).
- 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).
- Is he not focused? (I don’t know)
- Was the statement part of a broader or more grand strategy? (I have no idea)
- He just felt like saying it, wants to humiliate China and is appealing to his base. (No clue, here)
- Is he playing chess while everyone else is playing checkers? (Doubtful)
- Is he testing the market’s response to a ridiculous policy that he has no intention of implementing? (Again, I am clueless)
- Is he overplaying his hand? (Clueless, Part Trois)
- Is it simple arrogance and ignorance? (Clueless, Part Four)
- 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.
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.
Doug Kass, since 2004 Doug Kass has served as President of Seabreeze Partners Management, Inc. He runs a hedge fund and individual managed accounts, co-authored “Citibank: The Ralph Nader Report” with Ralph Nader and the Center for the Study of Responsive Law in the 1970s and wrote "Doug Kass: A Life on the Street" two years ago (John Wiley). Since 2003 Mr. Kass served as a guest host on CNBC's "Squawk Box" and has guest hosted Bloomberg's "Market Surveillance" for the last five years. Along with Jim Cramer, Doug is the principal contributor to Real Money Pro.