Now playing.
ZH: Gamblers Have Never Been More Bullish On Stocks
"Black Monday. Although the event to which those two words refer occurred 30 years ago, they still carry the weight of that day—Oct. 19, 1987—when the Dow Jones Industrial Average shed nearly a quarter of its value in wave after wave of selling.
The PROLIFERATION of COMPUTER-DRIVEN INVESTING has created an illusion that RISK can be measured and managed. But several anomalous episodes in recent years involving sudden, severe, and seemingly INEXPLICABLE PRICE SWINGS suggest the next MARKET SELLOFF could be exacerbated by the fact that the MACHINES are at the controls."
Machines have systematically created a one-sided market. The primary machine-driven strategies are momentum and "low volatility". As I've described previously, these two "strategies" work in tandem to artificially suppress volatility while at the same time generating upward momentum. The selling of volatility futures funds the buying of S&P 500 futures. This works great on the way up by creating a ruler-like ascent with minimal volatility. However, financial markets are predicated upon two-way price discovery meaning that they need to price in underlying fundamentals on an ongoing basis. Markets also need to shake out speculators from getting too complacent. However, machines have totally eliminated valuation as a parameter in their equation. Momentum has become its own asset class, as has shorting volatility futures as a "risk free" yield strategy.
Now of course, volatility whether measured by the duration of this ruler-like ascent, or by implied options volatility (VIX) or by intra-day price range, is all at record lows. No real world risk has been priced in, so in the meantime, speculators have added ever-more leverage and beta to their trades. The junkiest stocks are now leading the market.
These dumbfuck momentum/compression strategies have been taken to level '11' during the past year. August's 1.5% one-day decline in the S&P had the same one day VIX % impact as the flash crash from two years ago. Moreover, it generated a staggering 10x increase in leveraged ETF volume. In other words, the pair trade has been taken to the logical conclusion of massively leveraged self-destruction. The trade can't be unwound without leading to a self-imploding rise in volatility:
For the past two years, gamblers got lucky, only because the global Central Bank sponsored rally rotated from the U.S. to Europe, to Emerging Markets and lastly now Japan. During each overnight selloff there was something else to buy that wasn't already overbought. Econodunces and pundits conflated capital misallocation as "global synchronized recovery".
Unfortunately nothing is undervalued anymore. There has been no "RISK OFF" event for almost two years. Brexit and Trump were mere buying opportunities along the way. Ironically, the machines sold both of those events limit down, but gamblers came in and bought them with both hands. Convinced that Central banks had eliminated any and all risks.
Low volume is another factor that has allowed relentless levitation to occur. As long as there was no heavy selling, algos maintained total control.
As soon as volume returns, the algos will lose control:
Nothing was learned from the 2010/2015 flash crashes. ETFs were a primary factor, especially stop losses sitting below the market that got activated on gap down opens. These stop losses created a divergence in price between the ETFs and the underlying, that generated additional selling momentum. For a time, many ETFs were pinned near zero due to automatic circuit breakers preventing them from rising back up to meet fair value. In other words, the stop losses and circuit breakers didn't work on the way down, but they kicked in on the way back up slowing the eventual recovery.
In the meantime since those two flash crashes, there has been an exodus from active funds into passive ETFs:
The key takeaway from Barrons vis-a-vis 1987 risk, based upon interviews with industry whores:
"Quantitative investors argue that they have learned from past mistakes and are less likely to be leveraged or crowded into the same trades"
In other words, "they lived happily ever after"
Gamblers are now ALL IN betting that a Black Swan event in low volatility persists indefinitely
Intra-day price declines (25 dma):
ZH: And finally, this:
