Week in review June 3-7 2013
Russel 2000 0.34%
TLT(Barclays 20 year us treasury index) -0.94%
“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves” (Peter Lynch)
June started off ominous as we saw a continuation of the largest selloff the market has seen in 2013. On Thursday’s low (1598 in the S&P 500) the marked had slumped a total of 5.27% from the year-to-date high (1687), and the CBOE volatility Index VIX had climbed to 18.51. Technical analysts look for the S&P500 to be at a relative low while the VIX is at a high. This coupled with an increase in volume signals that there is a culmination in the selling. When the S&P fell below the 50 day moving average of 1606 the selling pressure peaked and when the dust settled, the SPX closed at 1643 for the week. This rally got wind in its sail from the lukewarm American job report this morning, giving American investor’s confidence that the economy is on stable ground, and that the Fed tapering may not be as soon as some thought.
The market slump first began in the US with a hint of Fed tapering, which has caused significant volatility in the bond market. The Fed comments eventually caused equities to fall, giving us a taste of what could potentially happen when the fed does actually start its tapering. If the market is this volatile when the fed suggests it could tapper, what will happen once it actually does? And what will happen if they decide to unwind? Traders of volatility are certainly expecting a rocky third quarter. To take advantage of that possibility a popular trade this week was to use this short term spike in volatility to take profits on their current hedges, and roll them out into the fall. We still view that the larger risk in the US market is in treasuries, but, as we have seen, volatility has a way of spilling over in the short term to equities. This morning former Fed Chairman Alan Greenspan attempted to calm nervousness in the equities markets by stating "The most important positive force in the economy at the moment is the fact that equity premiums are so high, which means the downside on stock prices is quite limited," he said. "If we can get stock prices to rise, which they will if this thing stabilizes, then you get a lot of asset-growth effect on the economy." Suggesting that downside risk in equities is limited due to the high yields they are paying while at the same time warned of a potential black swan bond event if the fed does not unwind their assets correctly.
The market was also heavily impacted this week by the tremendous volatility coming out of Japan. The Nikkei was 20% off its highs in 11 days…and six of those days were up! This is a cautionary sign of what can happen when there is an abrupt change in fiscal policy. The carry trade, (sell yen, buy higher yielding assets) had become more crowded than rush hour traffic. Japanese markets had been on a tremendous tear all year long. The Fed Japanese bank was printing money at a tremendous rate, and many people were scratching their heads sitting on the sideling thinking this is too easy, I need to get long the Nikkei. That mentality helped the Nikkei rise 40% from November. However what goes up fast can sometimes go down fast when it corrects. As soon as there was a hint of negative economic data everybody wanted out at the same exit. People thought the fiscal policies pronounced by ABE would not be enough to pull Japan out of deflation. Simply put, the Nikkei had gone to fast too soon. The stock market had grown ahead of the economy on speculation. However in America there is a saying, “don’t fight the fed”. In Japan, with their powerful fixed income market, that saying should hold true. If the BOJ is committed to create inflation, it will eventually create it. Therefore we were buyers of the Nikkei this week on weakness.
What we are watching for next week June 10-14
June option expiration is two weeks away. If prices are stable options will start to decay more rapidly as the week progresses. The first three days of the week is light on economic data. Typically on light economic data days we see the market continue its current trend. We will be watching to see if Japan will continue to rally off the good economic data out of the US on Monday.
How are we positioned to profit from that?
We continue to hold our long equities portfolios. We are not going to fight the Fed or the BOJ. They continue to ease and we will not jump too far ahead of them. Traders should consider the lesson learned from the Japan carry trade, you don’t need to swing for the fences, remain long but hedged. This week we took advantage in the pop in market volatility by selling out some of our volatility hedges. And for some strategies we were able to get short volatility at which will be profitable if the VIX remains below 16. We maintain our core strategy to balance long stock positions with a tradable volatility hedge.
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