Thursday, October 06, 2011

Equity Market Turbulence & More Comments from Kyle Bass

It's been quite a week for US equity markets. On Tuesday, the S&P had something like a 4 percentage point swing. It had fallen by more than 2% by around 2:30PM, then catapulted back to finish the day up by 2.2%.

My proprietary equity options volatility measure hasn't been in 'long' territory since August 1st. Now intra-day S&P moves are triggering proprietary equity allocation signals to move from 'long' to 'out' or 'short.'

I've written in several prior posts about my expectation that, barring a brisk market rise, that signal would move to 'short' by sometime this quarter. Tuesday's lows on the S&P pushed my equity signal to 'out.'

I constructed this proprietary equity long/short signal back in 2001. It has correctly signaled moves from long to short before the 2001 market decline, as well as the 2008 crisis. It hasn't signaled a false positive in ten years, but it's correctly detected, a priori, both major equity market hurricanes, as well as re-entry points very close to equity index market bottoms in the resulting period of severe decline.

Now, on any given day, the S&P can easily close in territory that moves the signal to 'short' for next month. Specifically, if the S&P return for this month is much worse than -2%, the signal will go 'out/short.'

Thus, I moved the bulk of my funds which were in equities into cash yesterday. Because the signal wasn't 100% solid, but only an intra-day low, I didn't move 100% of the assets.

For what it's worth, more than a few pundits and fund managers appearing on CNBC and Bloomberg have said they are doing the same in the past week.

Meanwhile, yesterday David Faber's noontime program featured a long segment with Kyle Bass at the latter's Texas Barefoot Economics conference. Bass reiterated his remarks from a few weeks ago regarding the hopelessness of the European situation working out with defaults and a damaged Euro.

Bass discussed how ludicrous it is to expect some nations, like Spain and Italy, to be guarantors of bad Greek debt today, then turn around and become receivers of further Euro help tomorrow. Bass referred, again, to his firm's original market research among Germans regarding their attitudes toward bailing out the rest of Europe, and added, this time, a reference to private conversations with senior German government officials. This smacks of the legwork Bass was known for, ex post, in the 2007-2008 mortgage crisis, as displayed on Faber's House of Cards documentary.

I've written posts about the House of Cards program, and Michale Lewis' The Big Short, both of which, in hindsight, spotlighted hedge fund managers who did their spadework to find bad mortgage debt, then bet their ranches against them, and won. Names like Bass, Paulson, Eisman, Burry, Ledley and Hockett.

This time, we're hearing and seeing those types of characters disclosing their current fears in real time on CNBC and Bloomberg. Or, in Bass' case, the same character.

Bear in mind that Tuesday's S&P yo-yo-ing was due to negative, then positive investor reactions to news stories coming out of Europe regarding its debt crisis and the fate of the little bank Dexia, which went insolvent earlier this week.

Then we have another recession, or the extension of the current one, which eased, coming in the US. And what appears to be a lame-duck president.

There's no good economic news anywhere you look. And it's way too early to hope that this is just a 'wall of worry' that equity indices will climb. This time, there are significant global financial and economic problems.

Oh, and Congress is close to passing anti-Chinese yuan policy legislation that will ring in a trade war.

Someone mentioned on CNBC this morning that any corporations which get caught by surprise by a Greek default should fire their senior management, because we've had since April of 2010 to see this coming.

For perspective, I took a look at the S&P levels and volatility since then. Beginning with that first Greek crisis in the markets, the S&P was at roughly 1110 to 1130. My proprietary options volatility signal rose to 'put' levels by early April, and stayed there for the next six months.

In the intervening months, the S&P has climbed as high as 1363 on 29 April 2011. Now it's back to where it was, more or less, at the start of the Greek crisis last year. Holding long equity portfolios generated by my proprietary strategy in the interim would have allowed an investor to realize gains for most of that period. Gains which would be rebalanced as portfolios rolled on and off. A sort of slightly more sophisticated variant of dollar-averaging, if you will.

But now, volatilities, and, thus, risk, in both my proprietary options and equities signaling systems have risen to critical levels amidst equity market levels which aren't providing concomitant returns.

As I write this post at about 1PM on Wednesday afternoon, the day before it will publish, the S&P is at 1131. A slight gain from yesterday. But in times like these, any one day's equity market performance isn't the point. It's the overall trend, or lack of one, coupled with instantaneous and recent volatility that guides my quantitative long/short signals. The qualitative economic and financial information I process provides context.

And now, the context and the signals are flashing to be mostly out of US equities.

1 comment:

Swaraj said...

The statement

Someone mentioned on CNBC this morning that any corporations which get caught by surprise by a Greek default should fire their senior management, because we've had since April of 2010 to see this coming.

points out the financial illiteracy that afflicts this nation.

The statement is analagous to a salesman reporting, "I was drunk when I put in the client order, they wanted to sell $250 Million, not buy $250 Million. Luckily, the trader managed to get out of the position with a little gain"

Those responsible for any significant exposure to Greece should be fired now regardless of whether Greece defaults. The bad judgement and the failure to correct that judgement is in no way mitigated by a lack of default by Greece.