Remember that super “bigly,” “big league”, unstoppable euro rally?
Yeah well between the NFP report and new hints on tax reform driving the dollar to its best gain since January, the common currency just slammed on the brakes and is on pace for its worst day of 2017 versus the greenback:
Now obviously that doesn’t change the big picture which, as a reminder, looks like this…
…but it does begin to suggest that we could soon see this gap close…
…and as Cameron Crise notes, it might serve as a cautionary tale for equity investors. More below…
Via Bloomberg
The sharp decline in the euro after Friday’s U.S. employment figure serves as a timely reminder of what happens when too many investors pile into a trade late in the game. Equity investors lured into the market by a strong earnings season may wish to take note. While positioning shake-outs are a natural (and healthy) part of any market, it’s useful to be aware that on a short-term basis stock index volatility is almost certain to rise.
- Hindsight is always 20/20, so it’s easy to say “of course the euro was due for a correction.” Getting the timing right ahead of time is rather more difficult, naturally. Market trends have a funny way of continuing for longer than correction-callers can stay in a position
- That being said, the dog days of August often see corrections in prevailing market trends. Since 2009, the S&P 500 has fallen by an average of 1.4% during the month. While professionals may be circumspect about the market, anecdotal evidence suggests that retail investors have piled in. If shoeshine boys aren’t giving stock tips these days, it’s because they’re too busy trading the Bitcoin fork
- Technology shares have done much of the heavy lifting in this year’s equity rally. Yet the technical picture has soured recently, with the NDX index putting in a key day reversal in late July. That usually presages at least a short term correction in the market trend
- Retail piling in at the highs, bad seasonality, and a negative chart pattern. None of these guarantee a dip in equities, but collectively they suggest that the near-term balance of risk has shifted toward lower prices. As we saw with the euro, even a weak catalyst can set the ball rolling.
- One thing that is close to guaranteed is higher short-term volatility in the S&P 500. Even with earnings season in full swing, the two week realized vol of the index has been around 3%. Statistically, it’s hard for that to go much lower
- What makes the low level of index vol somewhat surprising is that the average volatility for each of the stocks in the index over the same period has been more than 22%. The implication is that the average pairwise correlation within the index has been a little more than 1%. Again, there is only one way for that to go — up
- Corrections need not derail the underlying trend — indeed, by definition, they cannot. Yet they’re also an important part of the market micro-structure. A dip or a blip in equities is not only overdue, it is to be welcomed
