Trader Demands You Show Same Amount Of Respect For QT Days As You Do Great White Sharks

Read more from The Macro Tourist

I love the ocean which is ironic as I live on a Great Lake more than 1,500 kilometers from the Atlantic. But you put me anywhere near an ocean and I guarantee it – I am jumping in. It doesn’t matter if the water is 15 degrees, I have to go for a dip.

Not having grown up with all the ocean-life, I try to rationalize my slight fear of sharks by convincing myself that my apprehension is like many other people’s fear of bears. Having spent many weekends at a cottage in the Canadian wilderness, I probably have an overly casual attitude towards bears. To me, they are just big raccoons. Yeah, a hungry grizzly deserves your complete and total respect, but most black bears want absolutely nothing to do with humans. After seeing dozens upon dozens in the wild, you realize they are not so scary. And this logic is what I use when thinking about sharks. Most of them want nothing to do with you.

However, I recently stumbled upon this research group that tracks different sharks, but specializes in Great Whites.

It’s called OCEARCH, and if you ever want to go swimming in the ocean again, then I suggest you steer clear of their site. These scientists capture Great White sharks and then track them in real time when they pop to the surface.

For example, here is a map of the sharks currently swimming off the U.S. coast.

Most of those blips on the map are “little” five-footers, but that one off the coast of Natucket is a twelve-footer.

And I used to believe the big scary Great Whites were only in deep water off the coast of Australia or South Africa, but OCEARCH has taught me that some of the biggest ones enjoy cruising right off the Canadian coast.

For example, look at the OCEARCH tracking map for Nova Scotia.

What does any of this have to do with trading? Well, although I don’t mind swimming around sharks that weigh 200 or 300 pounds, Luna-the-shark weighs over 2,100 pounds. I figure that to her, I look like the perfect size snack.

Just like the massive Western Canadian grizzlies, these animals deserve our respect.

And this is how I view Quantitative Tightening days. Traders, investors and portfolio managers should respect these periods.

Remember, the Federal Reserve is in the process of shrinking their balance sheet. And this does not happen in a nice linear manner, but rather occurs in a lumpy fashion as treasury-notes mature. These days are often referred to as “QT days”.

Now I don’t understand exactly how these QT days affect the market, but just as I firmly believed QE days goosed risk assets higher, I am equally sure QT days affect in the opposite direction.

I am not sure if QT days are anticipated by the market and therefore weigh most heavy in days preceding the maturity, or whether the days following trade poorly due to the removal of liquidity.

The truth of the matter is that there is probably no correct answer and no one will ever know. Yet my feeling is that just like when there is a 2,000+ pound shark swimming around, you want to be careful.

I have done some work creating a table of various assets that might be affected by the removal of U.S. dollar liquidity – S&P 500, Euro currency, the U.S. Dollar Index and gold.

Many market participants have highlighted the consistent poor performance of the Euro currency on QT days. Others are convinced a stock market short is the best way to play it as there has often been at least intra-day weakness to cover a short sale.

It’s most likely a little more nuanced. To illustrate this I have created a chart of the S&P 500 with all the QT days highlighted with an arrow.

I have marked three different occasions with an orange arrow. This is far from scientific, but these were periods where it had been a while since the last QT day and the S&P 500 had run up a fair way.

If you look closely, the red arrows saw declines the week before going into the QT day, and then often spiked lower around the actual maturity day. Yet instead of this being the start of a big move lower, these “red” days often marked a short-term low.

Which brings me to my interpretation of the opportunity presented from last week’s QT day.

Although many market pundits will view the recent ominous developments in the credit markets (large widening in all credit spreads) or stock market weakness as the start of a larger move lower, I don’t hold the same view.

Last week was most likely the result of the Fed’s balance sheet reduction. Liquidity was removed and risk assets traded poorly.

Now, this doesn’t mean it’s not the start of a bigger bear market, but just that is isn’t necessarily as ugly as it seems.

My guess is that the follow through on the downside will be much less vehement than the bears predict (hope). Heck, I would even go so far to say the coming week might see the balance of power shift back to the bulls.

I don’t fully understand the effect QT has on the market by any means, but I know that it causes risk assets to trade heavy, and that shorting into the QT hangover is probably not the best bet.

---