Wednesday, February 07, 2018

Happy Days are Here Again (until those short vol trades unwind)


As I expected there was some follow through in the markets overnight yesterday, only to be completely erased by the morning in NY.  In case, I haven't mentioned it recently, the stock market is no longer a mechanism through which we value companies.  The stock market is a game simulation run on thousands of competing supercomputers and humans are just along for the ride.

Ignore those pictures on your evening newscast of guys in funny jackets looking up at a screen - this is what the stock market really looks like.....



Yesterday, in the morning there were cries from various pundits that the "Markets are broken, we can't let the machines kill our precious markets!!"

However, these same voices have been silent as the markets we all grew up trading have been transformed from actual platforms for investment into useful tools of those with the fastest quantum computers.  Most of Wall Street it when stocks move up every day because it validates their positions and makes them look smart.  I prefer to focus on real reason why you should invest in Company X vs. Company Y or why the global economy is growing or contracting.  These are antiquated ideas in today's world, I know.

Today there are more Exchange Traded Funds than there are public stocks available to go into those funds.  That's like saying you walk into a grocery store with 100,000 products for sale, but they have 200,000 carts sitting outside for you to use.  What's more valuable, the goods inside the store or the 200,000 carts sitting outside?  Well, for the past 10 years the markets have fallen in love with the carts because they are uniform, easy to trade, easy to manipulate and very easy to fit within an program trade.  Earlier this week one very popular trade, the short volatility trade (basically betting on calm markets) which had climbed in value of $10 to $144 in six years, went to $0 basically overnight.

This is just one small example of a greater problem with our markets, the speed of trading and the automated trading rules in place have created a market that acts like an escalator on the way up (climbing neatly 0.25% every day) but one that can fall like a broken elevator overnight.

No one has any clue what the next step for the machines will be (I suspect we bounce around quite a bit from here - maybe up 1-2% before down another 5% this week or next). However, I do believe two things remain a distinct possibility in 2018 -

1) another meaningful flash crash of 10% or more

and

2) The possibility that this kicks off the next move toward accurate valuations for stocks as a variety of overly complex financial products unwind.  This would imply that the market could fall as much as 40-50% from these levels because we have a toxic soup in the markets today - excessive valuations like in 1929, 2000 and 2008, mixed with exotic products like in 1987 and 2007.

* None of this is investment advice.  These are my own observations and opinions.

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US Budget deficits heading back over $1 Trillion in 2019?

If you recall, after the great recession the Federal government took on a number of extraordinary measures to try to prevent a global economic meltdown.  I believe these measures were excessive and will ultimately lead to more pain in the future for our economy as our debt burden ballooned to $20 trillion, but hey, what do I know. 

Well, the combination of more spending by the government and declining tax revenues is projected to lead to trillion dollar deficits again in next six months.

"The Committee for a Responsible Federal Budget, a Washington fiscal watchdog, said the red ink may rise in fiscal 2019 to $1.12 trillion. If current policies continue, it said, the deficit could top a record-setting $2 trillion by 2027."

Washington addiction to overspending remains as strong today as it's ever been.

Cheers!


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