The market's wild ride is telling us something really important

[bostonangler]

For days, since the stock market's brutal selloff on Friday and Monday followed by a Tuesday marked by wild swings, this has been the conversation going on in offices across global Wall Street:

 

Traders, who had been levered up to their eyeballs, are speaking to their risk managers. And their risk managers are explaining that, according to the new model that factors in a new economic reality, they'll have to borrow less money to play in the market.

Volatility, these killjoys will say, has returned. After laying dormant for months, the VIX, Wall Street's volatility index, has roared back to life.

"The VIX is now pricing the equivalent of a 2% S&P 500 move up / down each day for the next month," according to the Chief Investment Office at UBS Wealth Management. "The market-implied probability of another sell-off in excess of 5% over the next two weeks is about 25%."

In other words, even after the dust settles from the breathtaking selloff we just saw, we’ll still be living in a riskier world.

Every man for himself

 

Now, the stock market is not the economy. The economy is doing well. But investors are in fact adjusting to very real changes in economic conditions. It’s a world that’s growing faster, but with more risk.

This is a moment Wall Street has been waiting for since the financial crisis. Not because stocks were overvalued, or because of a Trump rally, or because tax cuts were priced in.

Instead, we have reached the end of an economic cycle of trust.

 

Some economists, specifically Martin Nowak, a mathematical biologist at Harvard, believe that markets move in cycles of cooperation. When everyone's working together for a common goal, we get rich. Then bad actors realize they can game the system, and start misbehaving. Trust breaks down and suddenly everyone is sniping at everyone else. The market becomes riskier until cooperation is seen as the only remedy. Then the cycle starts again.

For years the entire world has been coordinating its interest rate policies, working together to ensure a uniform gravitational pull for money around the world. If that’s not cooperation, I don’t know what is.

 

But as growth takes hold, bringing inflation with it, central banks will have to start looking out for themselves. If inflation in the US does pick up faster than expected, and the Federal Reserve decides to raise rates based on the health of our domestic economy alone (not the world's), that will shift the gravitational pull of the financial universe.

For central banks, saving the world from getting sucked into a deflationary pull by keeping rates low is no longer their singular concern. It's every man for himself.

 

Y'all are late

Back in 2014, Dylan Grice, a portfolio manager at Aeris Capital, wrote a paper on this cycle of trust theory at a time when markets were riding high, but the world was looking riskier. Russia had just invaded Ukraine, and corporations were suing one another or being sued at a record rate.

At that time though, central banks were working in a cooperative mindset, coordinating their efforts to ensure maximum global stability through interest rate control.

 

"What we do think we know is that financial markets are playing with a very cooperative mind-set while the key players and factions in the outside world are not," Grice said. "Non-cooperators are on the ascendancy and the investment climate will soon reflect this."

That brings us to today, when inflation — a force unseen really anywhere on the planet since the bottom dropped out in 2008 — has returned. That could inject uncertainty about interest rate policy into what was our incredibly stable mix, creating an environment where central bank cooperation will no longer serve as a buffer against the realities of the world.

 

Interest rate policy is not the only place where we can observe cooperation fraying more dramatically thanks to inflation. Consider the weakness of the US dollar, another piece of the inflationary puzzle. Its weakness already has some on Wall Street warning of a "cold currency war," with an administration making unconventional statements about the strength of the dollar injecting a new level of uncertainty around the world's reserve currency. 

 

I’m not saying that all these risks are going to bring us down. I’m saying that our defenses are lower now. Everyone in the market has new risk factors to consider. This is what Wall Street is spending days of horror reimagining.

The market is not an omniscient indicator of the future; it is a survey of the way we think of the future in the present. So with that in mind, tell me. Haven’t you felt like the world is a more unforgiving place lately?

[Pitcher]

Thanks for this article. We have gone back done today to test the 100ma low on the Dow. Ugly day but I did well trading VXX 3 times. I’m starting to see the 50 ma curl down. If the down trend continues and the get a cross down of the 50x100 and the 50x200 down (death cross), You will really see a sell off and an end to the 9 year Bull run, imo.  I’m still thinking we double bottom and start slowly going back up,  but I will trade what I see.  For home gamers watch Spy, VXX, Xlk and all the so called FANG stocks for plays up on a rebound or short on a 50x200ma cross down   There is always a counter play if you know how to play this game. Today I saw some monies being rotated into the densive stocks.  Good luck to all who trade or have money in the stock market. We may be in for an unwinding like we haven’t seen in 6-7 years.  Buckle up!!

[new york kevin]

The financial markets in EU are selling T Bills, while we are also selling T Bills to pay for the new debt levels. Bada bing ... we have inflation cuz we have to pay a higher percentage yield on the new T bills inorder to sell them. Oh and do not forget the fiscal policies of Obama who never saw a deficit he didn't like, and artificially/manipulated low interest rates for 8 years. If Republicans hold their margins in the House and Senate, or even increase their positions you will see deficit reduction in Trumps 3rd and 4th year.

[bostonangler]

28 minutes ago, new york kevin said:

The financial markets in EU are selling T Bills, while we are also selling T Bills to pay for the new debt levels. Bada bing ... we have inflation cuz we have to pay a higher percentage yield on the new T bills inorder to sell them. Oh and do not forget the fiscal policies of Obama who never saw a deficit he didn't like, and artificially/manipulated low interest rates for 8 years. If Republicans hold their margins in the House and Senate, or even increase their positions you will see deficit reduction in Trumps 3rd and 4th year.

 

Sorry Kev but that is fantasy... The corporate welfare and higher debt just passed our conservative controlled government is going to be bad for the economy. Go back in history and read about cutting income and increasing debt... It is a formula for failure... The only way to change things is by taking the tough steps of increasing income and reducing spending... No one in Washington wants to be the bad guy...

 

B/A

[Pitcher]

Agree, the great unwinding is under way. Fed unwinding their debt, higher interest rates, 10 year going up( some will go back into bonds and take money out of the stock market). Our Budget Bill with more deficit spending (why?), and a possible trade war with China.  You could see this coming a mile away. I’m in cash and Day Trading for now. Damn, we need the RV to save our ass, haha!!

The thing to do for most is to turn off the TV and all the hysterical talking heads. The Boys on Wall Sreet are loving this correction. Crooks

[bostonangler]

Pitcher, I'm with you. Every market presents opportunity. People fall in love with their investments and that becomes their pitfall. I know, because I learned the hard way years ago. I learned it can be hard to sell into a profit. You want to believe if you are up 30% you can go up 40%. I learned to take my profit and reinvest. People right now with their 401Ks or other investments are thinking I've done great. I know I'm losing some money, but it has to bounce back... Well the lesson here is... No it doesn't have to bounce back. I tell people "Hey, you made 30 or 40 percent, perhaps even more. May be you should rebalance your investments, maybe move your money around". Folk did you hear me??? If you are up, take some profits and reinvest!

 

But most will hold and wait and next year be wondering where all their money went. , like you have taken some profits and I'm now sitting on cash waiting to buy some great stuff cheap... JMHO

 

B/A

[Pitcher]

I went 100% cash after the first week of Jan.  I was kicking myself for a few weeks but I just had a feeling this last month was a blow off top. I’m in no hurry to get back in. We’ll wait; watch, and see what happens. Did you see Nvidia, rev up 34%, up 19.46 AH!! 

[new york kevin]

Yes the market correction is under way, and yes T-Bills are being turned in on their call in Europe.