Earlier this year, when the retail “meme” mania was in full swing, I suggested the day-trading Reddit crowd wasn’t the only cohort deserving of the “gambler” label.
“Let’s be honest without ourselves,” I wrote, in February. “Individual traders, no matter their background and no matter how experienced, are just gamblers. Self-directed investors building a portfolio for themselves and actively hedging that portfolio is one thing. But there’s a fine line between that and a gambling addiction.”
At various intervals since, market swoons were blamed in part on the perceived absence of gamblers — minnows, whales and everyone in-between. September’s selloff was no different. In a Friday evening article, Bloomberg cited “fading gambler spirits” for a hodgepodge of recent down days.
I suppose there’s some truth to that depending on how you define “gambler” and, more importantly, how you map the knock-on effects of their activity (or lack thereof). There are allusions to mechanistic flows in the linked Bloomberg piece, but not much in the way of in-depth, granular analysis like that found here.
Bloomberg described Friday’s rally as evidence that ETF outflows and hesitancy on the part of retail dip-buyers doesn’t “doom a rally that had lifted equity values by $10 trillion in the first eight months of the year.” That kind of superficial analysis is woefully inadequate during stretches when spot is pushed and pulled by dynamics not amenable to summary treatment.
“We are seeing some [evidence of vol softening], potentially aided locally by the large put spread collar roll [which] created >~$16B of vega for sale,” Nomura’s Charlie McElligott said Friday afternoon. He flagged monetization of downside hedges and the vanna impact of customer puts going OTM. “Both create delta to buy, with extreme ‘short gamma and delta’ dynamics capable of trading to the upside too on dealer hedge flows chasing any stabilization or rally,” McElligott went on to say, before suggesting the de-allocation impulse from vol control (i.e., the mechanical selling triggered by the spike in realized volatility) may have peaked, thus reducing a key source of supply which might have capped upside moves during previous sessions.
Nobody is asking everyday investors to become experts on modern market structure, but at the same time, you should be apprised of the extent to which there is almost no value whatsoever in analysis that doesn’t mention these dynamics during periods when volatility expands.
In any case, the S&P logged a third weekly loss in four and the Nasdaq 100 had its worst week since February. At the same time, bonds have failed miserably as a hedge. The rates selloff is inseparable from equity weakness in part because the benchmarks are heavily weighted to secular growth shares.
The amount of duration embedded across markets makes a rapid rise in yields particularly onerous. In simple terms: Far from cushioning an equity drawdown, your risk-free asset is the source of the problem.
As the fourth quarter dawns, questions abound. The gridlock in DC is set to persist. Nancy Pelosi underestimated Progressives’ resolve and ultimately lost a staring contest with Pramila Jayapal, who made good on a threat to stymie the infrastructure bill until she can secure assurances on the larger social spending plan. Pelosi and Joe Biden admitted Friday evening that more time is needed, while Jayapal conceded Progressives may have to settle for a top line figure much lower than $3.5 trillion. Joe Manchin, on the other hand, will almost surely need to come up from his $1.5 trillion “red line,” or else risk becoming a pariah — I think it’s safe to say that even his fellow moderates would be disappointed if his position admits of no flexibility at all, leading to the collapse of Biden’s agenda.
Meanwhile, Congress needs to avert a technical US default. And the Fed is poised to officially unveil plans to taper asset purchases next month. You know the story.
For BofA’s Michael Hartnett, the combination of “higher inflation, hawkish central banks, peak GDP and profits” adds up to low (or negative) returns for stocks and credit.
Rallies should be sold into the November taper, he said, in a note, adding that the trimming of monthly bond-buying, the slowdown in China, tighter financial conditions, a stronger dollar and buyback blackouts “all raise [the] risk of a Q4 ‘event.'”
“Think 2018,” Hartnett said.
I struggled to make the distinction between “investor” and “gambler” for about 2 seconds. Life itself is a constant stream of choices made by weighing risk and probability. Self-identified gamblers are often much more studious in their decision-making. The derisive label is often misplaced.
I see little chance of a technical default, Delta case rates starting to roll over, movement toward a compromise among Dems, deflationary pressure on commodities emanating from China, plenty of cash on the sidelines, and the taper as a non-event (in that it will only be announced in Nov. and won’t begin in earnest till 1Q22). Therefore, I’ll take the other side of Mr. Hartnett’s bet.
I think Harnett is correct that risk is elevated here in 4Q.
However, I think the key question in the short term is whether risk is increasing or decreasing. If increasing, reduce exposure; if decreasing, increase exposure. Its a continuum, not binary.
What are the biggest risks? I think: virus, Fed, debt default, and add China.
Are these risks increasing or decreasing? Virus surge is fading (US and global). Fed next move is well known. Debt default is a low probability event. China is starting to raise “credit impulse” (i.e. CCP is blinking).
Yes there are other risks, but I think they are quite secondary. Suppose infrastructure bills are killed, Biden agenda dies, Democrats dissolve into fratricide, tommorrow? As a human I would be appalled. As an investor, I’d ask: how will that impact corporate earnings over next 1-2 years?
Now, if Harnett is reiterating that expected longer term equity return from this level is weak, I think he is correct.
Is the Fed really going to taper? If they start to taper and stock sell off, then what are they going to do?
I think they should probably taper, regardless of what asset prices do, if there is any substantial inflation. I’m just wondering if they have the resolve or if they will cave in.
My guess is the Fed won’t actually be able to execute their taper. I am/have been expecting the “Q4 event” which will have 2 major results:
First- Dems get it together and deal with all the necessary agenda items: infrastructure 1 & 2, debt ceiling, filibuster, voting rights (THE MOST IMPORTANT!!!). I would not be surprised to see it generate a lot of anger on the part of the Dems and some scorched earth may follow (expanding SCOTUS, Puerto Rico and DC statehood).
Second- The Fed blinks and “delays” the taper in a wink-nod scenario that sees Jerome get another term.
Of course you can’t have a “Q4 event” without some serious Santa Claus rally silliness pushing the S&P to 4800 (possibly 5000) before OpEx in Dec. H is spot on with the OpEx adjective volatility all year especially in month 3 of the quarter which are buyback blackout at its peak.
Of all the risks enumerated accurately in the comments above….the “known UNknown” is how China’s property bubble unwinds. Or can it be inflated further to kick the can down the road at least until the “President for Life” gets confirmed again next year to secure his grip. How exposed is the American financial system to European banks and other entities that are more exposed to China ?? What is the real risk of contagion when the second largest economy in the world succumbs to a liquidity crisis when lenders stop lending and there is no incremental buyer of property at a higher price ??
As a long-term resident of Asia, my sense is that US (and other international) markets consistently misprice risk emanating from this part of the world. So it was last year with the pandemic, when most of us here knew it was a game-changer, but the US and European markets traded for a number of weeks at valuations implying that the virus wouldn’t meaningfully impact them. I see parallels with the current questions around Chinese housing markets. Yes, the Chinese government has advantages that other modern governments do not to contain fallout but that doesn’t (or shouldn’t) imply omnipotence. Once the collective realisation that Chinese property valuations are excessive truly sinks in, what will be the impact on the US, UK etc. I suspect quite a bit more than your average investor realises.