Friday, June 10, 2022

Morning Note: More On Those Underlying Forces

Well, nope, (headline) inflation did not peak in April after all, with May's headline print coming in at 8.6%, versus April's 8.3%. Ex out food and energy and "core" inflation came in at 6.0, which actually was a titch lower than May's 6.2%. 

While indeed stocks might've rallied on tamer numbers (they're falling as I type), and while I suspect we remain very close to peak inflation for this cycle, as we've stressed, the notion that it'll get to a level (without, that is, a near-term inflation-crushing recession) anytime soon that would have the Fed backing off is, in our view, quite the faulty notion. I.e., any such rallies in equities (and they will come, rest assured) given the present setup, and at present overall levels, would be, in our view, rallies to fade.

In Wednesday's morning note we broached the topic of options positioning that could notably move the needle on equities in the near-term. 

Here's a snippet:

"When, for example, options dealers (sellers) are on the hook for a great deal of put (bets on, or hedges against, the market dropping) exposure, they short the underlying stocks (or indices) in order to hedge their own downside risk. I.e., they sold the puts, so they're on the hook if the market tanks. Shorting the underlying securities protects them against potentially devastating losses in that scenario.

Now, let's think about that action among the options dealers. If they're shorting (selling) stocks into a broad selloff it can exacerbate the overall downside momentum."

Yesterday's SP500 meandered more or less directionless throughout the session; that is until it dipped its toe below the 4,100 mark, setting off a waterfall of selling into the close. 

Ironically, per the options experts over at Spotgamma:

"...we could get a pretty quick and violent drawdown to 4000 with a heavy CPI print as there remains large put strikes <=4100."
Well, the CPI print of course didn't come till this morning, but, make no mistake, the sellers of the 4100-strike puts were forced to add to their own hedges (short more stocks) in a hurry to cover their respective you-know-whats.

Once again, from Wednesday's post:
"...they're on the hook if the market tanks. Shorting the underlying securities protects them against potentially devastating losses in that scenario."

"If they're shorting (selling) stocks into a broad selloff it can exacerbate the overall downside momentum."

Therefore, again:

"...understand that when market moves seem to make zero sense with regard to what you believe you know about the world at large, there are underlying forces at play that have more to do with traders, hedgers, dealers and so on jockeying for position than they do anything fundamental..."

Now, let's extrapolate a step further: Recall that a shorted stock is one that's been borrowed and sold. I.e., the borrowed shares have to be paid back... The shares, that is, not the dollars received upon selling them. Meaning, all of those shorted stocks have to be bought back, then returned to their original owners. 

Get where I'm going? The seeds of future aggressive rallies in stocks are sown within a heavily-shorted market. 

Yes, make no mistake folks, there are more fireworks to come -- in both directions -- as the present setup plays itself out.

Asian equities (save for China) got trounced overnight, with 14 of the 16 markets we track closing lower.

Europe's messy this morning, with 14 of the 19 bourses we follow trading down as I type.

US stocks are reeling to start the session: Dow down 579 points (1.77%), SP500 down 1.80%, SP500 Equal Weight down 1.73%, Nasdaq 100 down 1.95%, Nasdaq Comp down 1.82%, Russell 2000 down 1.14%.

The VIX sits at 27.61, up 5.83%.

Oil futures are down 0.76%, gold's down 0.90%, silver's down 1.10%, copper futures are down 1.79% and the ag complex (DBA) is down 0.72%.

The 10-year treasury is down (yield up) and the dollar is up a whopping 0.80%.

Among our 38 core positions (excluding cash and short-term bond ETF), only 3 -- MP Materials, AMD and carbon credits -- are in the green so far this morning. The losers are being led lower by Dutch Bros, Latin American equities, Nokia, European equities and uranium miners.

Here, again (featured this last month, i.e., timely these days), is me quoting me quoting Jesse Livermore last July:

I concur with Jesse Livermore's call for patience, but only when the macro work's been (being) done and, therefore, the investor is sitting tight on a fundamentally sound, diversified portfolio:
"The reason is that a man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figured it must do. That is why so many men in Wall Street, who are not at all in the sucker class, not even in the third grade, nevertheless lose money. The market does not beat them. They beat themselves, because though they have brains they cannot sit tight."
Have a great day!

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