Bubbles Bursting? More Like Market Flaws Exposed!

Wow – what a week last week! Many saw it coming and many actually welcome it. Much of it comes from flawed trading positions in a flawed market. It is a good reminder of the 1987 crash when markets rallied on portfolio insurance schemes where rising stocks would trigger larger positions in index futures which would trigger greater demand in stocks and so on and so forth. Then Germany started raising rates (sound familiar?) and the process reversed itself. It didn’t work so well on the way down! Portfolio Insurance schemes were inspired by Nobel Prize winner, Economist Prof. Wm Sharpe and among other things, used perfect market assumptions.

The Black line below is the 1982-1992 Bull Market where you can see the steep climb and drop when it crashed in 1987. The current “bull market” started 11Feb2016, the bull market starting in 2009 is in Green.

Source: Bloomberg

Matthew Bartolini, SPDR Americas Research: – … one of the reasons why we didn’t see such declines in high yield is that unlike equities, oil and rates, positioning wasn’t at extremes. Spreads are tight, but the compression has been driven more by treasury yields rising.

Equities: Sotheby’s Bubble Indicator vs. S&P500

Source: Bloomberg

Bonds: Betting on a Bond Bear Market has become a Crowded Trade and is similar to betting on rising oil prices (see below)

Source: Bloomberg

Top Chart is the Dow Industrials vs. Inverted Bond Yields (Blue) starting 1994 = Bond Bull Market

Bottom Chart is the Dow Industrials Vs. Inverted Bond Yields (Red) Starting 1963 = Bond Bear Market -> Stocks don’t necessarily do poorly in a Bear Bond Market

If things are a bit like 2013, Bonds could rally again! Unimaginable #1!

Source: Bloomberg

This month, markets started getting nervous. Still the most crowded trades were shorting VIX or S&P500 volatility assuming markets will continue to rally and volatility will therefore fall further. Volatility has been trading at pretty much record lows for over a year and still investors were convinced it would still go lower.

Source: Bloomberg

Volatility measures are still elevated. Here are VIX futures (Friday, 9FEB):

Source: WSJ-The Daily Shot

Part of the reason for volatility indices holding at these relatively high levels is the massive short-VIX unwind that has been taking place. This massive move probably has acted as a trigger for other algorithm programs!

Here is the VIX futures net non-commercial position reversing from a massively net-short to a net-long. Now traders are convinced there will be higher volatility and therefore further downside in equities!

Source: WSJ-The Daily Shot

And remember I am that lonely oil bear… look what happened:

Oil prices are starting to pull inflation expectations lower. Oil prices recovered a bit today.

Source: Bloomberg / WSJ-The Daily Shot (12Feb2018)

In any case, I remain an oil bear. Still looks like a crowded long…

Speculative accounts remain extremely bullish on crude (as of Feb. 9).

Source: WSJ-The Daily Shot

Oil vs. US Dollar Index (Inverse) – Oil looks toppy and the USD oversold

Source: Bloomberg

Oil and Equities want to trade together, so being bearish on oil implies being bearish on stocks, but the oil bulls assume greater demand on higher global growth, It will be more like electricity needed to fuel growth and so oil will play a lesser role  going forward.

Source: Bloomberg

From Rockefeller Treasury Services (12Feb2018) “Push me-pull you: The yield gain is not warranted by inflation data, but could persist anyway because of the budget/deficit. It could also get a push from the reallocation effect if equities perform badly, although today looks okay. Separately, we get some important data later like eurozone flash GDP, also on Wednesday. This is all pretty scary. Maybe it’s time for a thoughtful retreat.

Maybe, maybe not.

Stock investors remain concerned about the US economy overheating, pushing inflation and rates higher.

That’s why the correlation between economic activity and the stock market has broken down.

Source: BofAML / WSJ-The Daily Shot

Economists have also stuck with their traditional models using traditional fundamental input, forgetting sometimes how technology, Moore’s Law, Emerging Markets, the Fall of the Wall, urbanization has made much of their input far from normal. Modern algorithms tools reflect patterns and trends and input that could be temporary and are usually not anticipating surges or collapses from unexpected conditions or trading strategies (see IAV link: https://www.invest-a-vision.com/wp/artificial-intelligence-is-only-as-good-as-the-data-input-and-those-who-program-it/). Mostly they fail to see the differences in the mechanics of the various markets around the world. This creates major distortions in the relationships of much of the input. The behavior in the market reflects a lot of immaturity, short termism, greed and perhaps a lack of understanding of fundamental challenges and new behavioral influences. There are still considerable efficiency gains and general development that allow growth to carry on. Imagine the Unimaginables for 2018 reflects some of this!

Here are some interesting links:

The Chinese Stock market before and after the Lunar New Year (2011)

The Chinese Year of the Dog

Source: Bloomberg

Bubble Indicators part 3- Animal Spirits Make a Comeback/Chinese New Year

 

 

 

 

 

 

 

 

 

 

 

 

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