MorningWord 6/24/13: If you are waking up this morning and the price action in China surprises you (Shanghai dropping 5.23% to bring it to down ~13.5% on the year), it really shouldn’t. If you respect the technicals of markets and underlying components and asset classes, this sort of price action has been building for months. We have mentioned it frequently that the under-performance of EM, the widening gap of out-performance of the SPX to almost everything else, the cratering of resource commodities, the fairly unprecedented short fluctuations in currencies and bond yields, ummm Japan and now the Shanghai nearly in Bear Market territory from the 52 week highs made in February (down almost 20%). The five year chart of the Shanghai Composite (below) is quite possibly one of the worst charts I have ever seen.
So what does it mean for U.S. investors that Chinese equities are approaching our financial crisis lows, Russia is down more than 16% ytd, Brazil’s Bovespa is down 23%, down 18% in just this month, most of Europe is now in the red and almost anything that hinges on emerging market growth is now teetering? Well, if you are primarily in U.S. equities and bonds, then you are on the best block in what is becoming an increasingly crappy neighborhood. We have been advocates of selling rallies for weeks as the breadth on the latest breakout appeared fairly weak as it was narrow and lacked conviction. We are not believers in the notion of “decoupling” and quite frankly are perplexed by FOMC Chairmen Ben Bernanke’s rosy assessment of the U.S. economy last week that suggested the Fed could stop QE at some point as early as mid 2014. Now it seems a little silly that a guy like me, a simple options trader, could question the validity of the Fed’s economic forecasts, but let’s not forget that these guys are the ones who used the words “subprime mortgages and contained” endlessly in 2007 & 2008.
It is our belief that it is only a matter of time that global economic weakness will hit our shores and the first realization of this will be what seems like the perennial summer Q3 guide down from U.S. multinationals citing weak demand globally. Let me be clear that I have no clue whether or not the correction from the recent highs turns into something serious, and frankly I am not rooting for it. I guess the only thing that my colleagues and I have tried to do whether we are in a raging bull market or the 10% corrections that we have had each year is offer alternatives to the same old advice that seems to permeate the financial media.
Now I think it is fairly safe to say that if someone utters these words to you: “I didn’t invent the rainy day, but I have the best umbrella” they are probably trying to sell you something at a time when you are most vulnerable and you should probably take a step back. But when I think about the Webinar that we hosted last Monday (slides here) detailing the potential for a “summer swoon” and how to use options to protect your portfolio or trade individual names with defined risk, there is something that kind of rings true. We are not in the business of getting individuals to trade options. We are in the business of helping individuals to understand their different uses, and we can’t think of any time more important than prior to and during monsoon season.
So what to do now? With this morning’s opening we will likely be down about 6% from the all time highs made in May which seems like a fairly orderly and reasonable, but possibly conservative reaction when you consider what’s going on in the global economy and subsequently in risk assets globally. We remain in the camp of selling rallies, but will continue to be opportunistic and take profits on sell offs and even add a long biased trade here and there, but we don’t think there is a silver bullet for the uncertainty that the FOMC just unleashed on risk assets. As we have been saying for weeks, it makes sense to prepare for that is likely to be a very different volatility regime for the coming weeks/months.
If the sell-off in U.S. equities starts to take on a bit of the velocity that has been witnessed in bonds of late (TLT down almost 13% from the May Highs) and a little panic starts to reign, then we could see some very good support down near the 200 day ma in the SPX around 1500. The one year chart below of the SPX shows the bounce Friday off of the 100 day moving avg on what was a classic consolidation day after 2 bid down days and now with the futures lower pre-open in sympathy with Chinese weakness, a break below 1575 would be meaningful (as Enis outlined in his MacroWrap this morning at the previous all time high here) and then all eyes will be on the the April low around 1540 (with the 2001 highs of 1753 along the way) and then in a panic maybe just maybe u see 1500 which would get you to the old 10% plus peak to trough draw-down from the highs.