At the onset of the 2007 credit crisis, and systemic breakdown of the US financial system, something had to be done, and done quickly. In order to keep the economy rolling the US Federal Reserve implemented three separate quantitative easing programs. These programs helped push the S&P 500 futures (ESM16:CME) up over 220% from its lows. The rally that followed has given the US economy the ‘jolt’ it needed to get things back on track, but eight years into the process, and after a December rate hike and a global market collapse, the fed backed off from its plan to do mutable rate hikes in 2016. Essentially keeping intact the zero borrow cost and the long equities trade that we have been seeing over the last several years. Most traders like myself thought it was a bad idea to raise rates in December, but that didn’t stop the fed from pushing ahead. Now there is talk about a possible June rate hike. What is it that keeps the S&P going up? What is the driving force and how long can the rally last? I could come up with my own theories, but a story sent to me from the PitBull lays out what most of us already know or thought. It’s a scary process that seems to have no end in sight.
Below is the story, it’s something I suggest you read and not forget. While the markets are going up again, it is not the rally that worries me, it’s whats going to happen when the free money trade disappears and the central banks have no money left to lend. There is an old saying that ‘what goes up, must come down’ and that’s what scares me.
A Broken and Elusive Market
“Chuck Rhoades — for all his ambition, the guy has had a safety net all of his life. You and me, we never had a net. That’s why it can never work — in the long term, you under him.”
— Bobby Axelrod (played by actor Damian Lewis) in Showtime’s Wall Street dramaBillions
The markets are no longer something that some people invest in. They’re now something that some people game.
Our markets are no longer controlled by passionate players who trade or invest in brilliant entrepreneurs, superior company managements and emerging growth companies. Instead, they’re too often controlled by forces like gamma trading and risk-parity strategies.
As this chart from subscriber “Tattoo522” shows, central-bank policy has depressed volatility (as measured by the VIX):
So has the absence of natural price discovery in the stock market, which no longer resembles a pure reflection of the real U.S. economy.
Many of us who have made our living using natural price discovery on the long side and exploiting frauds and questionable accounting practices on the short side are growing more and more uncomfortable.
Of course, betting that ploys from the world’s central bankers will eventually blow up and produce worldwide pain is one option. That outcome seems ever more likely as our monetary authorities try to defer the pain by moving “all in.” But predicting when such a meltdown will occur remains difficult.
Consider yesterday’s stock-market action, which was importantly influenced by speeches made by two Federal Reserve “rally boosters” during the trading day. New York Fed President William Dudley and Minneapolis Fed President Neel Kashkari both voiced support for gradualism in U.S. rate hikes.
Stocks focused on that and again ignored fundamentals like the steepest, most-consistent slide in profits since the 2008 financial crisis. Price-to-earnings ratios rose close to levels not seen in some six years, while futures are rising even higher this morning — putting a new all-time-high for stocks in sight
Personally, I’m disaffected with the entire market mechanism. It was once the driver of capitalism, serving as a freely floating market that was influenced by the winds of economic change. It was gently guided by central-bank policy at times, but not so muddied that its dirty water looked like a black hole of uncertainty.
Compare that to today’s disproportionate role of gamma trading, risk-parity strategies and other quant activities. Amid an absence of natural price discovery, the market all too often serves as a trap for traders and investors who rely on fundamentals and technicals.
Now you might ask that if the current degree of monetary intervention is the “new normal” and an apparently healthy situation without adverse consequences, what’s the problem?
Answer: This situation isn’t without adverse repercussions. The market’s margin of safety isdisappearing and stocks are decoupling ever further from the real economy.
Instead, it seems like we’re simply flying at “ludicrous speed” further and further into today’sBizarro Investment World.
While the YouTube Clip is funny and goes with the story, the lightspeed comments are not going to be so funny in the end, or when the easy money trade comes to an end. I am not a predictor of gloom and doom, but I think it’s important to understand why the markets are going up again and what the eventual repercussions will be. As we have said many times; these are not our fathers markets and charts. In the past history has been a good guide for the markets, but when you are in unknown territory like we / the markets are in now, it’s only natural to be worried about the outcome.
I do not know when the markets will reverse, and as day traders we have one function, that is to get in and get out and not to fall in love with our positions. We live in an ever changing economic environment, and while the markets are going up it’s not the up that worries me, its what’s going to happen when they really start going down and what tools the government will have left to support it. You can take it from there…
In Asia, 10 out of 11 markets closed higher (Shanghai Comp -0.66%), and In Europe, 8 out of 12 markets are trading lower this morning (DAX -0.29%). Today’s economic calendar includes the Weekly Bill Settlement, Jobless Claims, Philadelphia Fed Business Outlook Survey, Chicago Fed National Activity Index, FHFA House Price Index, Bloomberg Consumer Comfort Index, Leading Indicators, EIA Natural Gas Report, 3-Month Bill Announcement, 6-Month Bill Announcement, 52-Week Bill Announcement, 2-Yr Note Announcement, 5-Yr Note Announcement, 7-Yr Note Announcement, 5-Yr TIPS Auction, Fed Balance Sheet, Money Supply and earnings from GM, MSFT, SLB, SHW, LUV, SBUX, UA, VZ, V, and others.
Our View: We have a busy economic and earnings schedule today. Despite a 300 handle (point) rally in the S&Ps there still has not been any major pull back, and with the S&P back at 2100.00, the spoos either have to start selling off, pull back, or do some back and filling to keep going up, which is what I think it’s going to continue to do. It’s a butt ugly trade that only has one side; the buy side. Our view; buy weakness which is what we should have been saying the whole time.
As always, please use protective buy and sell stops when trading futures and options.
- In Asia 10 out of 11 markets closed higher: Shanghai Comp -0.66%, Hang Seng +1.82%, Nikkei +2.70%
- In Europe 11 out of 12 markets are trading lower: CAC -0.44%, DAX -0.28%, FTSE -0.49% at 6:30am CT
- Fair Value: S&P -6.21, NASDAQ -8.21, Dow -80.00
- Total Volume: 1.4 mil ESM and 6.9k SPM traded
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