Marketview: Volatility Half-life



The wild week started off with a gap lower. On Tuesday, the market lost over 1% on high-energy selling and short-term treasury yields got blown out on a relative basis. Eventually, the market found some support and an oversold state at $SPX 1646. On Thursday morning there was a rumor of a deal floating around which caused the market to gap up and never look back. It’s very rare that an uptick in volatility (1% down, 2% up!) leads to an immediate sustained run higher. If the volatility is going to compress, it will do so over time. Anticipate retracement and retest of lows.

Shutdown Victim

Janet Yellen was unceremoniously announced as the administration’s pick for Fed Chair via a White House email rather than a press release. This was due to the fact that the government website for performing such duties was not functioning due to the shutdown.

No Edge

Experienced traders love times like this because volatility means opportunity for short-term gains. For everyone else there is very little in the way of sober analysis that can explain the extreme movements. If you don’t have the ability to trade in and out of positions it’s okay to admit you don’t have an edge in this environment. This environment happens to be one of the most pure examples of market mechanics, external events, and game theory coming together to create volatility.

Consider the fact that on Monday there was very little additional information from what we knew Friday and yet the market decided it was time to force the hand of complacency. On Thursday the rumor was that there was a deal. Then people realized it was just a “chance” of a deal. Finally, just an agreement of a meeting. Did the realization of these details slow the squeeze? Nope. Once the events had been set in motion they became self reinforcing, regardless of the changing narrative. It’s the old story of too many people on one side of the trade getting pressed. What happens when the next crumb of news comes out?

The only thing close to an objective edge is the same in 95% of “crisis” cases: align with the status-quo and hold firm to the view that cooler heads will prevail and this will all blow over. It can be a rough ride in the interim — and watch out for that 5%.

Leadership and Rotation

Over the longer sample, industrials and basic materials sectors are showing the best relative strength overall. The biggest gains came from utilities and consumer staples which have both been beaten down badly in the last few weeks. Financials also had a strong showing and if they can regain footing might provide a lift to the market. Consumer discretionary (which was strong all September) and basic materials (which remains strong) underperformed.


Skew and Asymmetry

From our vantage point, momentum has slowed, indicators are pointing to a negative skew, and upticks look like unsustainable bear-fueled rockets. Consider the fact that several years of gains have already registered in the first half of the year and yet most are looking for and end of year markup. It appears obvious that downside risk is deserving of attention, yet this is a minority view. Can we make new highs? Absolutely. If the market wants to squeeze every last short out, new all-time highs would surely accomplish that. A close above $SPX 1710 is a level I would consider a line in the sand the for near-term. Above that, the path of least resistance is higher.


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