Thoughts on a quiet July 4th

On the current investment landscape:

Thoughts on a quiet July 4th

On the current investment landscape:

• Volatility-selling trades are everywhere: particularly in Equities, Currencies and Rates, portfolios are widely Short Volatility, either outright or indirectly — whether they know it or not.

• Dispersion trades are everywhere: by some accounts, there are record bets that Index volatility will remain extremely low while individual Stock volatility will stay high.

• (Individual Stock movements relative to their Volatility are at a 30-year high. Will all the bets that this will continue be correct?)

• Related, U.S. Index correlation is near 30-year lows.

• Also related, U.S. Single-stock correlations are near all-time lows.

• Are all these massive trades, like others throughout history that eventually "got too big", contributing to some of these distortions? And how vulnerable are they?

What's the biggest risk to investors?

• 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.

• Meanwhile, the last time the S&P fell 1% was more than two months ago.

• Historically, when low-Volatility streaks such as this one finally ended, if conditions were right (and Short Volatility positions extremely crowded as they generally are today), markets went through some rough times.

• IF and when this low-Volatility streak is broken, history suggests something important may be happening.

• (No one will think "something has changed". Most will brush it off as another dip to buy. Maybe they’ll be correct, but history suggests otherwise.)

Meanwhile, under the surface:

• Many of the signals I watch are at all-time "high risk" levels, while others are already deteriorating — which tends to happen ahead of an important Top in Equities (with varying lags).

• While Indexes continue to make new highs, the number of new lows continues to expand. (There are very few positive or sustainable precedents for this in history.)

• The number of S&P stocks beating the market is at a 50-year low.

Fundamentally:

• The pace of U.S. growth has slowed down considerably since the first quarter.

• U.S. consumers are falling behind on their bills, credit card and auto loans.

• Low-income households in particular are worrying even more about inflation.

• Unemployment is slowly rising.

• Credit spreads are slowly deteriorating (widening), especially the lowest-quality areas which tend to lead important turns. Default rates and downgrades are already potentially on a deteriorating path.

• Rising unemployment and credit spreads, when they cross a certain threshold, have a high correlation to stock Volatility. (And Volatility-selling trades are everywhere.)

• Trend signals for the Yield curve are showing the potential to finally dis-invert over the next several months. These signals have been silent this entire cycle, despite the endless calls for a recession (all of which proved to be wrong) — but finally, these Trend signals for the Yield curve are slowly waking up.

• Think historically — what causes the Yield curve to finally dis-invert?

• Meanwhile, the elephant in the room — inflation — is falling but remains relatively sticky. And the Fed is stuck higher for longer (for now), due to the enormous loosening of financial conditions they unleashed late last year.

• Energy and particularly Gasoline prices are showing strong upside potential, just as consumer savings are depleting — historically an accelerant for eventual economic slowdown/recession. IF this persists or even worsens in the coming months, it could have major implications. I’m watching this area closely.

• By design, if this combination continues the Fed will likely be late in responding to deteriorating fundamentals. Just as they were late in responding to inflation. (As I've always said: this is a feature of the Fed, not a bug. And imbalances create opportunity.)

• Some high-beta, leading indicators of liquidity peaked in Q1.

• Two of the most prominent Wall Street bears were pushed out of their roles, as bank politics & clients likely “capitulated for them”. (Bull Markets eventually charge through every cynic, just as Bear Markets maul every cheerleader.)

• An investment magazine recently put a lottery-ticket surfer on its cover, as a reference to the explosion in 0DTE options trading. (Regulators as usual are asleep at the wheel — also a feature of extended cycles, not a bug.)

• Related, exchanges are facilitating after-hours options trading, adding to the potential for Volatility spikes when liquidity is at its worst.

• (I'll add to this expanding list over time, as needed.)

Final thoughts:

Yes — the Trend remains up particularly in S&P and NDX, and especially the big-cap Tech winners of our age.

Nevertheless, remember that all cycles come to an end — market cycles, profit cycles and economic cycles will intertwine forever. (Despite the growing belief that some Stocks are no longer cyclical, and can grow their earnings forever.)

If and when the next big cyclical shift comes — and it may come sooner than most expect (…it usually does…) — be open-minded to the lessons of history, and don't blindly buy the first dip.

Be flexible that something bigger may be underway — and with it — the return of significant uncertainty and Volatility.

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Happy 4th, enjoy the long break.

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