2 weeks after the "Black Monday" of August 2015, risk is going nowhere. While we have positions that are short risk (that are already deep in the money), we are approaching the risk trade with a strategy of caution.
By risk we refer to equities, corporate bonds, volatility, and carry. The squeeze is most apparent in the S&P 500 (SPX), while volatility still trades at a premium to what our risk context implies.
So where do we go from here? We have no idea. Don't trade the squeeze. Trade the breakout. If we do get a head fake, cover your losses quickly and reposition accordingly. Questions about China and the Fed are floating around financial media, and will probably remain as strong headwinds to directionality going forward.
But we note that the term structure of the VIX (SPX vol index) has been in steep backwardation (spot higher than forward), leading many to believe that the "smart money" has not lifted their hedges, or are still buying downside protection.
Normally, the VIX curve is upwards sloping (spot lower than forward). An inverted curve might indicate that short term protection is more sought than long term protection. The chart below juxtaposes what we're seeing in the SPX (underlying for the VIX), and the VIX itself.
One of them will be 'right' and one will be 'wrong'. Although we do not make predictions, we have logical basis to believe that the squeeze in risk is distributive rather than accumulative. Only time will tell and we're going to trade which ever direction the markets moves in.
Following Friday's questionable August NFP jobs report (where the jobs added figure missed big while unemployment beat), we are not an inch closer to properly guessing if September will bring the first Fed Funds rate hike in more than 7 years.
We were watching Friday's market reaction to the worse than expected NFP report, and was surprised that the dollar was actually bid, after selling off initially on a knee jerk. Most of the press reported the news as a miss, and several investment banks and their research desks actually came out with dovish revisions to when they think (or do they mean guess?) Chairwoman Janet Yellen will hike rates.
For now, it seems September is off the table for most. We still see a hike later this month as a possibility but are placing the odds on an October liftoff instead, as we've said in March. Good to note that several Fed officials commented that a 5.1% unemployment rate is very close to full employment.