If you would like an email sent to you when I update the blog please send an email with "subscribe" in the subject line to traderbob58@gmail.com. To be removed use "unsubscribe".

Search This Blog or Web

Friday, September 16, 2016

Daily update 9/16 Correlation and leverage make for potential problems

No upside follow through today.

It was an inside day for SPX.  It might have been pinned for option expiration.  Breadth was -63%.  New highs came in at 35 near where they have been.  New lows were 18.  The consolidation at the lows continues.  Support held this week.  That is about all we can say at this point.

The futures appear to be forming a little symmetrical triangle.  Those are most commonly a continuation pattern, but in the markets nothing is 100 percent.  The trend lines are pretty steep so it won't be long before we break out one way or the other.

The short and intermediate lines on the bull pressure chart are showing a good bit of separation.  The long term lines remain positively crossed.  The internals are getting somewhat weaker.

I keep saying the dollar is going to go up and it keeps not doing it.  The down trendline and the 500 DMA are getting pretty close together now.  A resolution on whether this is a consolidation to go higher or a top should be coming soon.  DXY has been very good at finding support at that 500 DMA so a break down below it would greatly increase the odds it is forming a big top.  Today's strength was largely at the expense of the Euro.  I think what happens here is important so I will keep watching it.

Next Wed. is another FED meeting.  The current rate hike expectations for that meeting are 15%.  A rate hike would be totally and completely shocking.  What happens next week could depend on what bonds do.  The economic data has been very weak lately so further selling in bonds would likely have little to do with the economy.  Stocks are short term oversold so there is always a chance for a bounce next week, but the price pattern points to higher odds of a break down.  It is possible the support we saw this week was option related (it was certainly helped by the big move up in AAPL).  If that was the case it would be gone next week.  If this is going to be a short term bottom then I think the bulls need to show up right away on Monday. 

This is an interesting chart.

Stock correlations go up during sell offs and normally down when going up.  This cross market correlation chart is showing markets moving in coordination.  Unfortunately there is not a lot of history on this indicator.  We can see it was rising in 2008 when markets were tanking which makes a lot of sense.  It rolled over and headed lower as the bull market in stocks really got going.  The sharp turn higher in 2014 seems unusual.  Why are cross market correlation getting so high?  We saw last Friday both stocks and bonds getting hammered.  Which brings me to something that might cause problems for markets.  I had seen some talk about risk parity funds, but I really did not know what they were about.  Then I ran into this little interesting piece of info.  Source

Wall Street just loves to engineer investment fads and take them to unsustainable extremes.

Portfolio “insurance” in the 1980s … dot-com stocks in the ’90s … and subprime mortgages before the 2008 crisis … are just a few of the fads that ended badly.  Well, the latest fad on Wall Street is something called “risk parity funds” and it’s destined to end badly too.  A risk parity fund is a type of hedge fund that takes highly leveraged bets by going long stocks and U.S. Treasuries at the same time … on super-margin.  In theory, an investor is hedged because oftentimes stock and bond prices move in opposite directions … when stocks slump, bonds rally and vice versa, so you’re hedged.  That’s nice in theory, but the reality is stocks and bonds don’t always move in opposite ways!  These funds have $400 billion in assets, but they routinely leverage anywhere from two- to three-times that amount … for a total investment of over $1 trillion today … and it’s a ticking time bomb.

That $1 trillion number really struck me.  Bonds are clearly in a bubble and that kind of leverage in a bubble cannot be good when it pops.  With stock valuations so high with the refrain it does not matter with low rates.  What happens if the bond bubble pops and rates are no longer so low?  If there was ever a situation where stocks and bonds good sell off together for more then just a day or two this is it.  These funds thinking they are hedged could end up getting hit with a double barrelled shot gun.  The unwinding of leverage is the number one cause of market crashes.  The problem is figuring out when the bond bubble has burst far enough ahead of the crowd to keep from getting run over in the rush to the exits.   That might be pretty tough.  It could be happening now or not.  Maybe we still have a long time to go.  With trillions of dollars with negative rates there is absolutely no question whether there is a bubble or not.  That makes no rational sense whatever.  A bubble anywhere tends to cause problems everywhere when they burst.  The global bond market is way bigger then global stock markets so this time will be no different.  It is just a matter of time before things blow up.  How long is anybody's guess.

The market and status pages have been updated.  Have a great weekend.


No comments:


The information in this blog is provided for educational purposes only and is not to be construed as investment advice.