Thoughts on Markets & Volatility

A week that could (begin to) change everything.

Jul 12, 2024

A week ago, I wrote down some thoughts on the current investment landscape.

Only a few days have passed, but Thursday’s post-CPI market moves provided a glimpse of what can happen when record Dispersion combined with extremely crowded Short Volatility trades unwind — one of the main concerns I shared on that quiet July 4th:

“Ironically, one of the biggest risks is that Stocks will start moving in the same direction / at the same time — something which happens often throughout history, yet now isn’t expected to happen anymore. While the direction could be UP (and I’m open-minded to this possibility, perhaps even a Bubble-like blowoff with Index volatility and Stock correlations both rising), we are at point where even a small, normally ‘standard’ decline could be the spark that unwinds everything at once.”

At the time, I was open to the idea of a rotation — though it certainly wasn’t my base case — as many charts were at make-or-break levels, and threatening to “break”.

All things considered, my bingo card didn't have “Stocks rise together, causing Indexes to plunge”.

But this is what happens when crowded positioning goes too far.

And it remains a problem, even after yesterday.

On June 5 I wrote the following:

Which brings me to think about the main risks lurking in Global FX markets:
The famous “be careful what you wish for” — IF Bond Yields and the Dollar are turning down globally, due to a U.S. slowdown dynamic as some are thinking, then we could finally see the Japanese Yen advance sharply against most currencies. This could be devastating for stale Carry Trade positioning, as the Yen has been used as a funding currency and would force a severe unwind, creating volatility which could spread to other asset classes (it’s happened before).
In summary, beware the unintended consequences of bad positioning and extreme risk-seeking behavior, especially when an important macro shift occurs.

MELT-UP VS. MACRO

When Stocks are going up every day, nobody cares about "Macro".

Then one day, Volatility comes back, and all of a sudden Macro becomes essential.

But I believe Macro is always essential.

I also believe we’re approaching a critical point in markets, where having a basic understanding of Macro history is absolutely essential for survival.

Especially if liquidity and volatility start to shift.

Meanwhile (related), the S&P has now gone nearly 50 days without a 1% decline — a classic melt-up.

(*Yes, despite yesterday’s sharp losses, the S&P fell just 0.88%, supported by the internal rotation… though NDX wasn’t so lucky).

What happens on the other side of a melt-up?

Answer: things that were considered mathematically impossible, begin to happen regularly.

That’s what we saw yesterday.

Yet lost amid all the noise, is the fact that yesterday was not unusual.

What's unusual, as I wrote before, was what happened in the weeks before yesterday.

Yesterday was normal:

All excesses eventually get unwound (painfully), that's just normal market-clearing behavior.
At the end of the day, markets are (1) positioning and (2) flows. That’s it.
Even after yesterday’s moves, it's still the most crowded Dispersion trade in history, and one of the most crowded Short Volatility trades ever.
We know that Volatility increases at the turns — especially when Macro conditions shift, as they are now. Therefore, being attuned to them is essential, even to Equity investors.
What happened yesterday may have been a glimpse of a much bigger unwind that's still to come.
Yesterday, I wrote how the driving force of this unwind could develop, and will be tracking these themes & signals as we move forward.

WHAT’S NEXT?

I don’t have a crystal ball — but I’m watching my charts, signals, and most importantly keeping an open mind as conditions change:

Rates, the Dollar, the Yield Curve, Credit Spreads, unemployment and inflation — all are essential to the Macro picture — and most are in clear trends at this point.
I’ve discussed these themes regularly for weeks — and will continue to do so, as I believe they will become increasingly important to Equities.
Historically, markets celebrate the coming of rate cuts and overshoot to the upside after the Fed pauses. That's what they've always done — and this is where we are today. (*Related, I’ll share an important chart later today for reference, in a new Special Report I’m working on.)
We may be in a melt-up environment now, but everything has its time in the markets.
As I always say… short-term, everyone’s a long-term investor.
Then the bill comes due — and markets realize the implications of what rate cuts actually mean.
Understanding when and how that happens is essential.
Beware the lessons of history…

Later today, I’ll publish a new Special Report dedicated to an important historical pattern — which could be IN PLAY over the next few weeks.

It will be a reference guide I’ll update yearly going forward, as a reminder of what could be a significant historic turning point — in an election year no less.
I’ve seen this pattern repeat time and again, especially when the market was overbought in an extended Blowoff, and with big catalysts approaching.
I first learned this pattern in 1998, and never forgot it.

Stay tuned, back with more soon.

Thanks for reading.