Stand Aside! The Bull Is Out

We're bullish. Are you? Since the lows seen in late August, we had been playing it safe. Risk, as we call it, most commonly refers to equities and the carry trade. We're now bullish risk in general, and we've many reasons for that. We'll talk about some of them in today's snippet. The bull is out, and you'd better stand aside especially if you're short.

However, we were (and still are at the time of writing), approaching this cautiously because from where we stand, we see another hurdle that has yet to be cleared before we can be outright bullish risk. We took most of our trades off the market when the SPX reached 1989, and are waiting to turn on a dime. So far, that has paid off well.

For any serious and committed buying, 1995 on the SPX has to be cleared. FX carry looks heavy to us, and are also at their respective pivotal zones. If we were to see continued ramp in risk, we want to see higher correlations and lower implied volatility.
— Business Of Finance, 9 September 2015

We said on 7 September that risk was squeezing, and that we wouldn't be aggressively positioning ourselves in either direction. That turned out well. A few days after, we wrote that risk had broken out but we weren't yet convinced that bulls were in control. Again, that paid off well.

Between 9 September to the end of that month, there was one critical event that everyone and their pet dog was intently eyeing. You guessed it right, the September FOMC meetings. The uneventful events dearly spooked the markets, creating a lot of volatility on the surface, and eventually led to risk falling hard with most global equity indices re-testing their respective lows in August or even trading below them.
 

But were we surprised? No one bit. If anything, this year's narrative from the Fed should have adequately taught us not get hopes up too high, higher than the point underlying asset prices were implying. We're not going to banter retrospectively here, but this is an important point we wish to reiterate.

 Fueled by a renewed re-risking trade of significant proportions, and a weaker U.S. dollar post September's FOMC meeting, emerging currencies (EM FX) and the carry trade have rallied greatly from their respective lows. Asian currencies were particularly strong, no surprise because they were one of the hardest hit during the correction. Currencies like the Malaysian ringgit, Indonesian rupiah saw their largest 2-day gain in more than 6 years late last week. Included in this chart complex is the Indian rupee, Mexian Peso, Turkish lira, Brazilian real, Thai baht, New Zealand dollar, Australian dollar, and Singapore dollar.  Chart by Business Of Finance

Fueled by a renewed re-risking trade of significant proportions, and a weaker U.S. dollar post September's FOMC meeting, emerging currencies (EM FX) and the carry trade have rallied greatly from their respective lows. Asian currencies were particularly strong, no surprise because they were one of the hardest hit during the correction. Currencies like the Malaysian ringgit, Indonesian rupiah saw their largest 2-day gain in more than 6 years late last week. Included in this chart complex is the Indian rupee, Mexian Peso, Turkish lira, Brazilian real, Thai baht, New Zealand dollar, Australian dollar, and Singapore dollar.

Chart by Business Of Finance

Certain markets lead others, and it all depends on where the broad market is trading at. The vicious selloff in August, climaxing with an unforgettable day now known as "Black Monday", was heralded by many waves of liquidations and momentum hedging. In such conditions, we're always looking beyond the surface - beyond what price action on say the SPX or aussie-dollar.

The bounce in Asian EM FX composite is the strongest in 6 years. Mega rally after a mega selloff. #Wow #Surprise #Asia

Posted by Business Of Finance on Thursday, 8 October 2015
 The VIX, also called the "fear index", tracks the implied volailty of S&P 500 options. One of the telling indications that the second down leg of the correction in equities wasn't going much farther down, was the divergence between the VIX and stocks. The persistent erosion in front-month volatility suggested that some hedges had already been lifted.  Chart by Business of Finance

The VIX, also called the "fear index", tracks the implied volailty of S&P 500 options. One of the telling indications that the second down leg of the correction in equities wasn't going much farther down, was the divergence between the VIX and stocks. The persistent erosion in front-month volatility suggested that some hedges had already been lifted.

Chart by Business of Finance

By focusing on lesser watched markets, markets that are much larger than the stock markets of the world, it is totally possible correctly second guess beyond the tape. There's a lot of precedent that equity markets are amongst the last markets to rally out of a correction.

And second guess did the so called smart money do very well. One good example was how implied volatility on SPX options weren't printing new highs (inverse to stock prices) when the second leg of the correction unfolded. That hinted that most of the hedging had already been done, and whatever selling left in equities was probably done by technical players which had little to do with why the global markets corrected in August.

Risk driven by the dollar

Excerpt from September FOMC minutes:"After assessing the outlook for economic activity, the labor market, and...

Posted by Business Of Finance on Thursday, 8 October 2015

For our well documented view on this, read the snippet on our thoughts orbiting the future trajectory of the Fed's policies. In short, a weaker dollar be the trend for the medium term as 2015 rate hike expectations continue dwindling. The long dollar trade is still prevalent in the FX sphere, and has room to normalize further. In a $5trn/day market, even a blip in sentiment driven by important events can have huge effects on other asset classes just as we've seen. For reference, as of Friday's close, Fed Funds interest rate futures implied an 8% chance of an October liftoff.

Yes, the FOMC events did add a tricky dynamic, and their disappointment in September sure didn't help. But the gist was that there was not much selling left in the tank. Markets just didn't want to head lower. The weaker of global stocks indices, such as Germany's DAX (not helped by the massive VW emissions scandal), and most EM equities, did print lower lows but we didn't really buy those signs. Our proprietary indicators were signaling a divergence between where risk should have traded at, and where it was actually trading - markets were oversold both technically and mathematically.

Key levels lie close ahead

On to where we currently stand, markets are at key technical levels on the charts. Fundamentally, nothing has changed, literally, so there's nothing to talk about here. Between the markets we watch, emerging currencies (EM FX), the carry trade (FX carry), and implied volatility look to be the strongest. EM FX has seen very strong buying against the U.S. dollar, this has intensified after last week's release of the September FOMC minutes.

 Global equity indices such as the S&P 500, Nikkei 225, EuroStoxx 50, and Hand Seng Index have rallied after retesting the lows of August, mostly driven by unwinding of long dollar positions and a global re-risking trade. Many markets are currently at technically important levels.  Chart by Business Of Finance

Global equity indices such as the S&P 500, Nikkei 225, EuroStoxx 50, and Hand Seng Index have rallied after retesting the lows of August, mostly driven by unwinding of long dollar positions and a global re-risking trade. Many markets are currently at technically important levels.

Chart by Business Of Finance

The more broadly followed FX carry has also outperformed developed market equities such as the SPX and Nikkei. Bond yields are still in a down trend in the medium and long term. Gold and the other precious metals have shot up and cleared important technical resistance levels, possibly indicative of a big shift in hawkish sentiment.

How we're playing this

Why we were bullish risk since Friday. The Dow has rallied more than 1,000 points since the lows after Friday's disastrous NFP print. #Logic #BuyTheDip #ShutUpAndTakeMyMoney

Posted by Business Of Finance on Thursday, 8 October 2015

We've been long equities since the middle of last week. We're also long the Aussie dollar against other selected currencies. We were long gold but got shaken out too early in hindsight. Our gross exposure is on the heavy side. We're obviously betting on direction here. There are certain markets we prefer over others and will be capitalizing on both the continuation of the re-risking trade besides others.

Again, we're fully willing and ready to flip sides on a turn of a dime, as and when the markets tell us we should. We aren't in love with our positions, you should never be.

But until then, we're not fighting this bull. We're riding it.