Thursday, September 14, 2023

Morning Note: Second-Level Pavlov

Here's the opening to a post I penned back on April 20, 2020:

"Keynes suggested circa a century ago that trading (as opposed to, I'll say, investing in) markets is not about assessing fundamentals, it's about what traders think other traders are going to do. And for the more savvy traders, it's about what they think other traders think other traders are going to do."

Now, despite what are in our view deteriorating fundamentals, against what has become, let's call it, a difficult inflation backdrop, stocks have staged an impressive, extended, rally off of precisely the level (3,500 on the SP500 back on Oct 16th of last year) that we targeted when trouble began brewing back in early 2022... Thing is, we dubbed that to be the level that would ultimately (should recession ultimately ensue) be the floor for only the first leg down for a bear market that would see yet another, final, investable level somewhere below our initial target.

Well, not that we're complaining -- as we've been able to make money despite our hedging and diversification -- but, clearly, that next leg down is taking its own sweet time in developing.

So, rather than expounding herein on the trillions of free money giveaways, excess savings, student loan payment moratoriums, yada yada, that have aided conditions along to this point (items that btw have either halted, diminished, or are on the cusp of halting), I'll simply state that the opening quote above pretty much explains it -- the market is simply trading with a call it second-level Pavlovian mentality that when things get the least bit ugly, the Fed will be there first to ring a bell (say stuff), then, if that doesn't work, to lay down the bowl (stimulus) that will have the world lapping up equities with ravish passion.

Well, thing is, there's the closing paragraph to that 2020 message (quoting our friend, colleague and renowned expert on all things options and hedging, Hari Kirshnan):

"In his outstanding, and instructional, book The Second Leg Down, Hari P. Krishnan points to the huge risk that exists when large investors are all "wired" in the same way (the last line should resonate with clients):   emphasis mine...

"If large investors are all wired to react to price moves in the same way, volatility can appear out of almost nowhere. As the financial ecosystem becomes less diverse, the risk of spontaneous crises increases. Many risk systems use similar inputs, such as volatility or the level of cross-correlation in the market. This can produce common exit points and severe congestion as a large number of systems are trying to reduce positions en masse. No amount of fundamental analysis can tell you how to avoid these so-called “flash crashes”. Flash crashes are dependent on price action and positioning. The adage that the goal of markets is to produce the most pain to the largest number of investors is appropriate here. The only defences for a lower-frequency trader are to avoid leverage or to use options as insurance."

So, what do we think savvy traders think other traders think other traders are going to do? And when? Hmm....."


Asian stocks were mostly green overnight, with 11 of the 16 markets we track closing higher.

Same for Europe so far this morning, with 16 of the 19 bourses we follow trading up as I type.

US equity averages are higher to start the session: Dow by 151 points (0.44%), SP500 up 0.43%, SP500 Equal Weight up 0.70%, Nasdaq 100 up 0.31%, Nasdaq Comp up 0.35%, Russell 2000 up 1.09%.

As for yesterday’s session, US equity averages were mixed: Dow down 0.2%, SP500 up 0.1%, SP500 Equal Weight down 0.4%, Nasdaq 100 up 0.4%, Nasdaq Comp up 0.3%%, Russell 2000 down 0.8%.

This morning the VIX sits at 13.13,down 2.60%.

Oil futures are up 1.80%, nat gas futures are up 2.31%, gold's down 0.10%, silver's down 1.44%, copper futures are up 0.39% and the ag complex (DBA) is up 0.31%.

The 10-year treasury is down (yield up) and the dollar is up 0.38%.

Among our 34 core positions (excluding options hedges, cash and money market funds), 26 -- led by URNM (uranium miners), AT&T, XME (base metals miners), MP Materials and EWZ (Brazil equities) -- are in the green so far this morning... The losers are being led lower by VNM (Vietnam equities), SLV (silver), TLT (long-term treasuries), LEMB (local currency emerging mkt bonds) and Dutch Bros.

The ultimate risk being:
"...the future we encounter is likely to be very different from what most people expect." --Ray Dalio
Have a great day!

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