Sell-Off Lurking (HYG,GLD)
Not long ago we wrote about a market indicator we developed and brought public in the late 1990’s; something we refer to as ‘volatility compression’. We described it recently in a letter called Buy Everything Now!, so we won’t put you through the labor a second time, only to say that it’s worthwhile going back to re-familiarize yourself with the concept, because it’s once again popping red on our screens this week.
Don’t Touch my V-Spot!
Bottom line is this: the CBOE’s VIX indicator, a measure of implied volatility on 30 day SPX options, has now registered repeated multi-year lows over the last six week period.
Have a look –
The actual compression levels (along with what’s shaping up today to be another vice-squish of a day) give us an unprecedented and clear ‘sell’ signal for the near term (10 days to six weeks out). And while we would have jumped on this like a mad monkey on a dirty bird some years back, we’re a little more reserved these days.
The reason for our circumspection is a general unease that those numbers that have guided us in the past are still relevant today.
Sounds crazy, we understand. After all, we’re supposed to be the experts, and that’s what we get paid for. But honesty before all, friends, because in the end, the truth will be far kinder to our pocketbooks than any hyped-up, two-bit piece of showmanship. Unlike others, we’re not prepared to strut about like ad-libbing actors who haven’t prepared their lines. There’s no room in this business for posturing and self-glorification. Grandiosity inevitably leads to ruin.
As to madness, we’re not so keen on it, either, though we know well enough the quickest route there is via interstate PRIDE.
And that we intend to avoid that at all costs.
Better to take the back road and arrive later but intact, than to risk the speed and excitement of an autobahn to hell.
So who to trust?
It goes like this – there are currently two conflicting processes at work in the investment world – one that stems from geopolitical uncertainty (and is market negative), and the other from the massive liquidity that entered the system over the last decade to stave off a financial depression (and is still operative).
Which of these will prevail in the near term is uncertain.
What is clear, however, is that the geopolitical dominoes are falling almost daily.
To wit –
- Venezuela is now bust. As of Friday, it’s official. The country announced it’s ‘restructuring’ its national debt, an effort that will require more than just a stack of bamboo sticks and glue to accomplish. And as expected, oil jumped meaningfully higher after the announcement.
- Saudi Arabia, too, is now at the center of some potentially infernal martial activity. In the first place, it just imprisoned some of its most powerful princes, saw another ten killed when a helicopter carrying them crashed near the Yemeni border, killed another in a Capone-like firefight, and – of all things – last week intercepted a ballistic missile launched from Yemen toward its capital, Riyadh.
The Saudis have placed the blame for the projectile squarely at the doorstep of arch-enemy Iran, and added that they consider this “…flagrant military aggression by the Iranian-controlled Houthi militias which targeted the city of Riyadh… a blatant act of military aggression by the Iranian regime.”
Again, this is all bullish for oil (now up 7% over the last seven trading sessions) – but what would war do to the rest of the investment world, whose markets are by a great many measures already stretched to the breaking point?
It was precisely this that the head of the Chinese Central Bank was commenting on this week when he issued a report that stated “market risks are accumulating” that are, in his words, “hidden, complex, sudden, contagious and hazardous”.
Days later, J.P. Morgan’s strategy people said something eerily similar. In a discussion of ‘financial excesses’, they warned that it’s “the stuff we can’t see, hidden in the shadow world, outside the control of the regulators… that in the end leads to extremes.”
Shadows? Secrets? Hidden crypts?
The truth is much plainer. The problem resides in all that aforementioned liquidity that was pumped into the system and ended up in financial assets and not the rest of the economy, resulting in distortions that will very likely take years to normalize once the egg finally cracks.
Have a look –
In the chart above, Goldman’s researchers clearly show 1) the massive growth in asset prices over the course of the bull market against 2) the stagnant growth of the ‘real economy’ during the same time frame.
The gap is enormous and supports the notion that we’ve created a new asset bubble with all this intervention, one that will eventually have to explode.
And yet the question remains – have we hit the inflection point yet? Has time run out? Or do we still have weeks, or months or even years to go?
No one knows. And that’s why it behooves us to expect hairpin turns higher and lower over the months and years to come, and to prepare ourselves and our investments accordingly.
We’ll use options as usual – the tool of choice to insure against both rapid, disastrous meltdowns and giddy, surreal rises. And we’ll be equally prudent in our choice of strategies and instruments in order to avoid taking a cataclysmic loss.
And to that end, we offer the following.
On the previous chart, it’s clear that the worst performing item over the last decade has been commodities (in red, at right). And one of the best has been High Yield (red, left).
And it’s our feeling that that’s about to change. With oil breaking out and the chance of at least one regional war occurring in the near term, we’re predicting the performance gap between the two will collapse over the long haul. We’re playing it with the SPDR Gold Shares ETF (NYSE:GLD) as a proxy for the commodities and the iShares iBoxx High Yield Corporate Bond ETF (NYSE:HYG).
And it goes like this –- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
Wall Street Elite recommends you consider buying the HYG January 18th (2019) 87 PUT for $4.70 and selling the GLD January 18th (2019) 120 PUT for $4.85. Total credit on the trade is $0.15.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
With kind regards,
Hugh L. O’Haynew