Risk Is Squeezing

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.

 The S&P 500 is trading in a classic consolidation. While the range remains relative wide, we are not expecting anything too much. Other risk proxies such as carry and volatility are signaling more downside.   Chart by Business Of Finance

The S&P 500 is trading in a classic consolidation. While the range remains relative wide, we are not expecting anything too much. Other risk proxies such as carry and volatility are signaling more downside. 

Chart by Business Of Finance

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.

 The net position for large speculators on VIX futures was a record high (2 weeks ago) based in CFTC reporting, while the VIX curve remains inverted (an anomaly). Meanwhile, speculators are quite short on SPX futures, which conflicts what we're seeing in the VIX. Something has to give.   Chart courtesy of Zero Hedge

The net position for large speculators on VIX futures was a record high (2 weeks ago) based in CFTC reporting, while the VIX curve remains inverted (an anomaly). Meanwhile, speculators are quite short on SPX futures, which conflicts what we're seeing in the VIX. Something has to give. 

Chart courtesy of Zero Hedge

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. 

 n August, 173,000 jobs were added against expectations of 220,000 and down from July's 245,000. However, average hourly earnings beat expectations, rising by 0.3% against expectations of 0.2%, and up from July's 0.2%. The biggest beat of all was perhaps in the U3 unemployment rate which fell to 5.1% from 5.3% in July, better than estimates of 5.2%.  Chart courtesy of Zero Hedge

n August, 173,000 jobs were added against expectations of 220,000 and down from July's 245,000. However, average hourly earnings beat expectations, rising by 0.3% against expectations of 0.2%, and up from July's 0.2%. The biggest beat of all was perhaps in the U3 unemployment rate which fell to 5.1% from 5.3% in July, better than estimates of 5.2%.

Chart courtesy of Zero Hedge

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.