MorningWord 7/8/15: Volatile Compounds

by Dan July 8, 2015 9:36 am • FREE ACCESS

In case you missed (sarcasm font needed), there is some funky stuff going on in China as it relates to their stock markets. Government regulators in an attempt to stabilize the sell off have halted any activity that would bring more supply to the markets, most importantly halting existing stocks and putting the kibosh on secondary offerings and IPOs.  We are obviously witnessing the reversal of a severe supply/demand imbalance that has caused eye-popping gains leading up to last months highs, and an all out panic to liquidate now.

Our equity markets don’t appear to be too bothered by the volatility in China and the uncertainty surrounding Greece as the S&P500 is just a touch above the unchanged point for the year and just 2.5% off the all time highs made in May.  Since the collapse of Oil that started a little more than a year ago, we have been vocal about the strong likelihood that extreme volatility in commodities, currencies, bonds and global stock markets will at some point find its way into U.S. stocks, but it hasn’t yet. The relative strength in the U.S. stock market, treasuries and the dollar make sense as a sort of flight to quality, but Monday’s move in oil (down nearly 8%), gold’s inability to rally, and Chinese stocks disregarding unprecedented stabilization methods suggests to me that things are starting to get unhinged, despite the backdrop of complacent U.S. investors.

Yesterday’s intra-day reversal of n early 2% from the lows in the S&P 500 (SPX) to close up 60 bps, and this morning’s 60 bps decline in the SPX as I write, is reminiscent of the sort of volatility that was common in past crisis periods, but nearly unheard of in the last few years. The push and the pull and traders finding themselves off sides will be typical in a period where want to quickly reduce risk on fears of macro issues worsening, while also wanting to plow back in on the first sign of a European deal or a reversal in Chinese equities. This duality in the trader’s mind means morning moves that could completely reverse by noon and large daily moves that could be rendered completely irrelevant by a big move in the other direction the next day.

As someone who was a very active trader in the aftermath of the dotcom burst in the early 2000s, and the financial crisis later in the decade, I can tell you that sort of price action is far from bullish. Counter trend rallies can be fierce, and challenge your conviction, but just as you bought the dips in during the QE fueled rally, it could be time sell the rips as global markets come to grips with the post FOMC world.

I am not suggesting to get balls short. I have been clear for months that I do not see the value proposition to committing new cash to stocks, but I suspect we have to go lower before we can go higher.  If there is some sort of can-kicking resolution to the situation in Greece, and the SPX re-tests the prior highs near 2125, I suspect that would be a good spot to lighten up on some positions that are questionable and possibly slap on some protection for those positions you want to hold onto.  The most important take-away, is be cognizant that the investment ground may be moving bellow your feet, and it could happen all at once.