Old Correlations Die Hard: Stocks and Bonds Tandem Sell-Off

Say it ain't so!

Most younger industry professionals (myself included) have only participated in the markets during the regime of risk on/risk off. You know, when stocks go up, bonds go down (and stocks never go down). However, I try my best to learn as much market history as possible as it is the best teacher for navigating the financial markets.

In the midst of this "bloodbath" of S&P falling ~2% in the last few sessions, we've seen stocks fall - What?!

Even more shockingly, we've also seen bonds sell off at the same time - How?!

Well, I recall long ago when watching Paul Tudor Jones' Trader documentary where he actually used rising bond prices and decreasing yield as a potential clue to rising equity prices (something I have alluded to in the past).


Clearly, I was obligated to look at the correlation further. Cue commandeered chart from PIMCO:

We are in a negative correlation regime today. However, the key word here is "regime". This is not a permanent state and should be treated accordingly. We should focus on potential causes for this relationship to revert. These periods last for prolonged periods of time, and thus the quants are too focused on "recent" (the last decade) of data to care.

Then you have this guy from the Illinois state pension fund.

Industry “experts” suggested we keep these investments to diversify our holdings and reduce overall risk. Yet we already owned bonds for that purpose.

Unfortunately, even for some market veterans, the warnings from history are not always heeded.

I took a look at a different time frame based on daily and weekly returns data.

Daily return correlation


Weekly return correlation 



In the last few weeks, we have seen a small bump up in correlation and general trend higher for the last year.

I know I've written extensively about inflation here and here. Disregarding fears of being branded that guy who's an inflation bug; here goes nothing.

Inflation once again is the key here. It will be the source of the next drawdown - a drawdown for both equities, fixed income, and high yield.

1) contrary to popular CNBC pundits' beliefs, stocks are not a good inflation hedge in the case of high inflation. Here is an excerpt from the newest edition of Intelligent Investor by Ben Graham with commentary by Jason Zweig.



While mild inflation allows companies to pass the increased costs of their own raw materials on to customers, high inflation wreaks havoc—forcing customers to slash their purchases and depressing activity throughout the economy.
 A negative 10% nominal return on stocks can easily materialize even in a 3% inflation environment. 

Furthermore, a rise in inflation expectations will undoubtedly lead to a rise in nominal yields purely from the calculation of the nominal yield from real yield + inflation expectation.


2) Structural reasons for a combined sell off also lies with the emergence of risk parity based investing. I've written about this in the past as well, as a form of a potential catalyst for increasing equity market volatility and an equity market drawdown. 


The drawdown controls for these funds do indeed work to sell off all assets across the board when volatility rises, building in structural reasons why markets can sell off in a cascading fashion. 

However, I want to note one major strategy change in my analysis: the asset class that will be affected is fixed income in TIPS or in the credit market.

Since treasury volatility is a fraction compared to that of an equity index, risk parity funds must lever up its exposure to achieve the equal diversification of risk. As this has occurred, we've also experienced a tremendous bull market in bonds, killing off any hints of volatility.  Which means that bond positions are even more levered than they otherwise would be in a higher volatility environment.

The negative correlation between stocks and bonds and their coinciding bull markets have fueled both the hedging and outperformance of risk parity. 

In my previous experience at my previous firm, the inflation bucket for risk parity holds not commodities due to its high/frequent roll costs but instead inflation-linked fixed income products - the product that I was in charge of trading. You can extrapolate the chart below to be true for inflation-linked bonds as well.

Historical real returns of nominal bonds:


Due to the OTC nature of TIPS (lack of centralized limit order book), the product lacks liquidity. We had already experienced severe problems trading switches and during drawdowns for French and UK linkers, and similar but slightly milder issues rolling and trading large programs in TIPS.

Credit is another bucket of risk parity. They also trade OTC. although historically boasting a higher volatility, the performance in credit since 2008 has also meant relatively sizable positions in credit must be built into the credit buckets of these portfolios as well. It is well documented how illiquid this asset class can become during times of economic or financial market stress.

During a cross-firms sell-off of risk parity, it would be easy for dealers to sniff out these large programs in TIPS and credit being moved at the same time. As a result, I suspected, they would simply shift mid-price far from the inter-dealer mids to take advantage, thus raising volatility further  - potentially enough to compound additional drawdowns in a reflexive cycle.

Recent risk parity sell-offs:


In conclusion:

To be clear, I know the short bonds trade is a crowded consensus trade at this point in time; in fact, we could be close to reversal to shake out some late arrivals to the party. Also, calling the top in equities has been a strenuous and fruitless exercise. This post is not a specific short-term market call regarding those assets.

What I am trying to address is that this negative correlation labeled as risk on-risk off is cyclical, and the shift in cycles can potentially last a decade(s). I believe the inflation will be at the crux of the change and the beginning of the next correlation cycle. People like the Illinois pension guy, as well as other investors are clearly relying on this current correlation regime to hold.

These long everything investor of 2018 should tread carefully. The road you're on won't always suit the car you're driving.


Happy NFP Friday!
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Nico G
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February 2, 2018 at 11:31 AM ×

German equities - a benchmark for European investing - are getting hammered

Every year since2009 i write that Deutsche Bank is bankrupt. So there, reminder for 2018.

At some point Das Bank will take the European banking sector down. The carnage in German bunds ain't helping

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johno
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February 2, 2018 at 2:16 PM ×

Average WEEKLY earnings YoY actually slightly lower than previous month. I doubt this is the catalyst for an enduring dollar bounce.

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johno
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February 2, 2018 at 2:30 PM ×

Also, the UST custody holdings had their biggest up-week (a/o 1/31) since September, so maybe central banks aren't ditching USD for EUR reserves here. Thought I'd mention, since I brought it up the other day before the latest data reported.

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Shawn
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February 2, 2018 at 3:28 PM ×

a couple of thoughts here:

1) The Levine article is a wonderful example of inept pension fund management. I actually respect what the guy is trying to do. He identified a problem: "We suck at investing". But he has the wrong solution--abandoning active management and diversification in the name of long-term returns. His solution slashes absolute return allocation in favor of credit and get this for a contrarian, outside-the-box opinion...private equity! And then he writes a sarcastic, self-righteous WSJ article like this one to brag about firing pretentious, media-savvy hedge fund managers.

I'm saving this in a folder in my desk for next time my kids ask me to define "irony".

2) So yeah, the state employees and retirees of Illinois, and by proxy millions of people like them in wildly underfunded pension systems, are unprepared for this kind of blitzkreg.

All that being said, historical experience would suggest the type of (real) interest rate increases that would trigger such a move would result from a supply shock, usually trade wars, shooting wars, government insolvency, crop failures, oil embargoes, etc. The market clearly isn't betting on any of those things when the long bond has just cracked the magic 3% level.


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Shawn
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February 2, 2018 at 3:33 PM ×

Although I should add this....he's probably right about 80% of hedge fund managers that are selling alpha to investors and trading beta in the markets. They deserve to starve. But the solution to that problem isn't necessarily to abandon the asset class--it is to benchmark it properly to short-term bond returns plus a hefty liquidity premium. Really, it's not that complicated, dude.

Macro Man Consultants stands ready to help you out for the right price. Call me.

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johno
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February 2, 2018 at 5:48 PM ×

Stocks selling off, yet long bonds lower on a NFP report that was nothing-to-be-excited-about when looked at carefully (average weekly earnings and the non-supervisory #s). Interesting setup for a reversal. 10Y real rates also now close to top of range since the '13 taper tantrum, but that's less a reason for an immediate reversal.

In retrospect, should have been more patient with a USDJPY long. Got discouraged by lack of reaction to the 3-5y rinban up-sizing. Eventually the market paid attention with last night's operations. Given my view on 10Y, I wouldn't chase, and still not seeing an opening to short EURUSD. At minimum want to see inflation swaps breaking down convincingly to even think about it. Did hedge FX on European equities at 1.25 however.

Did GS top-tick commodities? Massively bullish notes released just the other day, and here we go down the chute.

A thought from earlier today -- when private bankers start pitching their clients long structures on BCOM, abundant liquidity starts being a brake on economic growth. That would be now!

Agree with your comments re HFs, Shawn. That IL pension guy is just as arrogant as the most arrogant HF manager. Issue is bench-marking. Taking merger arbitrage -- a HF strategy I traded on the buy-side -- I think if there were a properly constructed index of returns to passive investment in the deal universe, you'd find that many managers' fees outweigh their alpha, so they end up taking on stealth beta which their investors only discover in a down-market.

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Leftback
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February 2, 2018 at 5:51 PM ×

A few points:

1. The previous tantrums involving positive stock/bond correlations were short-lived (see above).
2. The contribution of risk parity funds to the overall investing universe is modest.
3. This isn't the first reflationary "spike" (or scare) since 2008 and it won't be the last, but it will be self-limiting.
4. Dollars and Treasuries will start to look very appealing - if and when global equities take their cue and start to melt down.
5. My prediction about AAPL wasn't spot on, but look - AAPL and GOOG are down 3% and pulling down on the Spoos and Qs.
6. Short vol ETFs are down 18% off the top since Jan 11. Someone has to own these, so someone is going to be hurting.
7. Chad, Brad and Thad over at the pension fund were playing with this stuff, possibly using leverage. Good luck, bros.
8. The real drivers of inflation aren't present - crude is topping out, weekly wages haven't budged (check hours worked).
9. The ingredients for a 1987-like event - or just a 2016-style correction - are self-assembling.
10. High yield hasn't cracked wider yet because of redemptions - but it isn't far off.

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adamantic
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February 2, 2018 at 6:18 PM ×

That short has worked a wonder. I've spent the last year buying VIX calls... mercifully against a portfolio of hard rallying stocks.

If there's a vol spike and there's a rush on those inverse vol ETFs, long VIX exposure is the way to play IMO, rather than shorting SVXY/XIV.. and definitely better than buying puts on them.

A lot of risk has rolled over now. If I was a betting man I'd bet we just saw a mid-term top.


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Leftback
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February 2, 2018 at 6:40 PM ×

Here's what I posted on wednesday:

"Now imagine, if you will, that AAPL release a real stinker one day. Not saying this will happen tomorrow, but it will happen one day. Why? Well, because it's not a magic money machine, it's a company that sells stuff, sometimes less stuff than punters anticipated." (maybe this was THURSDAY)

"Active funds would then be keen to unload the stock, and the ETFs would be FORCED to follow suit and that drives volatility higher, which begets further index ETF selling, trailing stops and sell programs get activated, and before you know it, whoa it's down 6% AND yes, one of those LOWER gaps gets filled." (maybe this is FRIDAY - TODAY?)

Over in Asia, all of the AAPL suppliers and semiconductor stocks get hammered overnight. Shanghai and Tokyo have a mini-meltdown. The usual Asian contagion happens, with JPY and USD bid and AUD, KRW and everything else being offered. (SUNDAY? - btw AUD is already down against USD and JPY)

"Grandpa, and all the 12y-o HF managers wake up the following morning to find the Spoos are down 30, 50 handles and the market isn't even open yet! When the market opens, a number of participants find that their positioning is less than ideal, and a large spike in vol develops which unwinds a number of leveraged positions during the day until AAPL is off 10% and the other gap has been filled. All of this is predictable at some point, given the present relationships between AAPL, SPY and the VIX. The latter are derivatives of AAPL, to some extent." (MONDAY MORNING?)

"February, May, August? A whole new generation of investors will one day get to experience the joys of Global Gap'n'Crap."

(???)

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johno
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February 2, 2018 at 6:57 PM ×

To follow up on my last comment on 10Y, the correct answer was probably to buy the dip in EURUSD. Unless there's a hard catalyst, it's very hard to bet on trend reversal (on an intra-day basis, at least) just because market may have misread (IMO) some data.

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Leftback
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February 2, 2018 at 7:28 PM ×

Largest vol spike since August. It's probably nothing.... :-)

Nary a whiff of concern in the fixed income complex, however. It will take more than a single 50 handles down day to reintroduce Fear to the market. My bet is we will have to see the YTD gains erased before punters start to pay attention.

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Shawn
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February 2, 2018 at 7:42 PM ×

Wow. 44 pts in the S&P! Vol my friend, it's been a while.

Widespread panic hasn't reached currency markets. I'm skeptical so long as usd/jpy is bouncing through 110. usd/mxn trading at levels not seen since....wait for it...yesterday.

@Johno, per your point on merger arb, that wasn't my field but I would suggest to our friend at the Illinois BoI a benchmark such as this: the Barclays agg 3-5yr bucket +400bps. Maybe 300bps if you buy me a drink or two. (although the bond index duration might be shorter too)

From my understanding, the drivers of risk-arb should look something like interest rates and financing costs, plus a credit spread that represents the risk of a deal break.

Net returns like that, with what will be a lower correlation than intermediate-term credit, should be a very attractive proposition. Will most managers clear that hurdle? Levine will argue no, and he's probably right. And maybe that means you reduce that bucket by 80%, which is more or less what he's doing. But that's because of the lack of performance relative to a real benchmark, not relative to equity returns, not relative to fees, and certainly not because your average hedge fund strategy is too complex for a reasonably intelligent pension fund manager to understand.

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Nico G
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February 2, 2018 at 8:43 PM ×

Buystocks/FunnyMoney/Ghost of FM i wish you a nice weekend sweating and more so, a Monday continuation gap that will show you a different type of market

this price action is nothing - see you 20% under

no hard feelings

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IPA
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February 2, 2018 at 9:28 PM ×

Lol, Nico G, let's not get carried away. It's a counter-trend trade. Get what you can while you can. Be happy with what market gives you. I am very happy to take profits and scale out before the army of little boys drive by in toy cars.

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Leftback
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February 2, 2018 at 9:38 PM ×

Dow down 666 points. Of no significance whatsoever, but amusing all the same........

S&P 500 2,762.13 -59.85(-2.12%)
Dow 30 25,520.96 -665.75(-2.54%)

1929, 1987 and 2007 all featured days like this. Not the big one, but a sign of things to come. AAPL did indeed fill the gap that we noted at 163, the next gaps lower are 157ish, some chart support around 155, and then below that it a gap to 150.

Oddly enough, there was no sign of JBTFDers or the famous PPT today.

VIX closed at 17.21. Short vol ETFs down 20% off the top. A rough week over at the pension fund for vol selling bros.
That's a correction, for sure - now it's almost a bear market for vol sellers.

Asian Contagion over the weekend? I'd say it is at least 50:50, JPY and USD to rally against everything. EURUSD is massively overbought and would certainly go in the tank if DX spikes, and that would guarantee an interesting open on Monday.

VIX closed at 17.21. If it opens above 20 on Monday we'll start to see the influence of leverage and margin. We may also witness the knife-catching skills of the younger generation who are on vacation today but are frequently so erudite on up days - go ahead, son, make my day.

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johno
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February 2, 2018 at 10:26 PM ×

My guess is this is still a buy-the-dip episode. Argument is simply that markets (usually) don't go from bidding up 0.4%/day for 3.5 weeks to panic selling into a crash. Could be wrong.

Annoyingly, I bought VIX futures last night when I saw AAPL's Q2 sales guidance, but then the stock rallied hard and figured whoever was buying it knew better than me and closed out flat. Oh well.

Between a bursting of the crypto bubble and end of the phone cycle, I wouldn't be comfortable owning semiconductor stocks here, nor TWD or KRW.

Re merger arb, I think it's a pretty orthogonal risk premium (which is why I bother collecting it). Zero duration, and credit risk only matters if you have LBO's where sponsors or banks have room to litigate out of deals. Each arb is pretty independent from the others, unless you get a regime shift in government policies. It's some spread over cash, but I haven't seen anyone construct, say, a capitalization-weighted merger arb index (there are some wrinkles to doing that, not to elaborate in a macro forum).

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Unknown
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February 3, 2018 at 12:01 AM ×

The market has changed and is in need of an almighty flush.

Interestingly, there is sign of JBTFD - look at the short vol etfs increasing in market cap - this means the real convexity has not kicked in yet and we are probably setting up for the main event. SVXY, the smaller of the two, went into today short 125k VIX futures, and it ended today a magic short 125k futures despite the vol move which would have led to organic 20% covering. Extrapolating across the vol space, Id say we haven't seen the panic yet, there was no sign of covering, just risk adding and short covering. When that changes, and it will very soon, the price action will become extreme and you are going to see the worst move spike in vol in 30 years as the stabilizers that have capped price action disappear in a nano second.

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IPA
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February 3, 2018 at 6:59 AM ×

Guys, guys, guys... Tops are rarely climatic and are mostly a process. Let's just see what bulls got here in response. We have tendlines, averages, and some "backs" still to break. You care to explain the AMZN and NFLX up on a day like today? Don't bother... Cults die a slow death. Let the time work in your favor and please don't expect a quick death of the bull here. Be smart and use the rallies to re-enter shorts after taking quick profits here. I may need to stop posting for a while not to be singled out for cliche platitudes but I am going to get my 2 cents in before then. If you have been fighting the bull all along you should not be here telling me you were playing today's selloff in a big way. You got carried out on stretchers long time ago or by now your account is a peewee gun shooting blanks. Just be true to yourself, don't even worry about us here, as we really don't care. Mirror, baby, look in the mirror!! 20% overnight bear market fantasies aside, we have credible horizontal breaks to shoot back up against. Put them fib retracements on the chart but also make sure you watch for toy cars trying to run you over. @Shawn, that picture is forever etched in my memory :)

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Buy Stocks
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February 3, 2018 at 7:13 AM ×

Nico & Leftback clearly the resident monday morning quarterbacks :)

Fwiw we liquidated long equity positions on Tuesday. Why? because there was a clear trend-line break in an almost parabolic up-move in spoos. Did we then short and catch the 1000pt fall in the Dow etc? No. Happy to sit this one out and get ready to BTFD when it appears (probably next week). Look, while I appreciate a small pullback like this will get the perma-bears (like Nico) all excited, one might heed the words of a more erudite Greek: "One swallow does not a summer make".

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Unknown
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February 3, 2018 at 10:06 AM ×

Who said anything about bear, just a massive liquidation of bad positioning that will rank up there in the annals. A real bear will take a long time to get equities back to 1200-1600, but not calling for that all to play out this instant, instead a self reinforcing gap down seems like reasonable odds.

I haven’t been shorting this on the way up, but I think you have higher odds than implied of unleashing certain feedback loops that have arisen and become crowded due to the preceding market behaviour.

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Unknown
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February 3, 2018 at 10:09 AM ×

Also, we enter higher equity volatility regime, 20 for year with higher rates and macro vol and the death of the comfort blanket

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adamantic
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February 3, 2018 at 5:11 PM ×

@IPA would usually agree, but markets surprise, and a gap down seems pretty likely, as per @Unknown's comment.

Unlikely to see a nice topping process that allows all the recent punters to get out at a small profit..

Gap down beckons, and a really tough decision for anyone who bought stocks, or wants to try their hand at the short side.

You could literally feel the desperation to get into the market the past few weeks, like bitcoin at 20k.

Surely data can only worsen from here..

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Nico G
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February 4, 2018 at 5:04 PM ×

Buystocks it's a shame you don't post your trades as they happen, but 4 days later. Do tell us when you buy the dip though, as you buy it, it will be informative. Do it as a courtesy to all the dudes you routinely abuse here. I need to repeat I am not a permabear at all, but i don't like one way markets. US equities could tank 20% or even 30 or 40% and still look super bull-healthy on a long term monthly chart.

but parabolic blow off are a bitch so yeah i am entitled to expect much more damage. People expected a one way blow off to 3050 or so? amid rates shooting up? nonsense. The January frenzy might be all they could print for the year since market needs to fully reprice higher rates. I have a shoplist of blue chips ready for my daughters' trust but i'll buy them when noone wants them. You'll be surprised, but even Amazon will be 50% cheaper one day

IPA i do not understand why you can't believe a future trading account can survive 20% adverse heat. Sure it shrinks, but when sized correctly, all bets survive and you'll only judge them at exit even if entry sucked large ass

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IPA
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February 4, 2018 at 6:18 PM ×

@adamantic, while I am with you on how market always wants to inflict a pain by surprising us all, I have to remind you that element of surprise evaporates with predictable human nature even in the new age of algos. How many times have the shorts been burned in this rally trying to pick tops? Memory is a harsh thing... I am also a student of charts and they tell me the following story about how the tops developed after strong uptrends in recent bull markets: 2000 (7 mo), 2007 (5 mo), 2015 (4 mo) - these were all multi-month processes, hardly a surprise. You had time to mobilize an army and produce weapons for the entire military campaign before the real and final attack began.

@Nico G, while I am totally against letting any position (let alone the largest one in your portfolio) go against you by 20%, I wish you luck, I really do. It's within our minds that our trading enemy mostly resides. We think too much, we get ourselves into these troubled fantasy trades we ourselves create. I am going to upset so many here but I will stay the course on my redundant message. While I myself can see that this rally is unprecedented and cannot be handled or approached like many before (which I even said here days ago), I have zero credible info in front of me as of right now to call this selloff anything other than a pullback within a very strong uptrend. What does one do with a counter-trend short in the most unprecedented bull market in history? One covers quickly not to get burned for the thousandth time, takes profits methodically and scales out, trails the stop, re-shorts on rallies at resistance and retracement levels and at double tops. We are traders, we predict with a plan and precise objectives, we don't fantasize what if and go for the lottery ticket, we stay in business by staying real!

Do you hear that, @Buy Stocks? Staying real! You are the driver on the picture above. Let's start by making your toy car look a little more real and finally open your first trading account.

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Buy Stocks
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February 4, 2018 at 9:37 PM ×

NicoG the master of hindsight trading berating me for not posting trades in real-time LOL ! This from the guy who was short several hundreds of ES contracts, had the market move several thousand points against him (he was down millions), disappeared for like 12 months and comes back here claiming all is well. Hahahaha... I f*cking love the internet!

IPA, would love to return the insult, but need to prepare for CME open. Maybe another time ;)

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Leftback
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February 5, 2018 at 11:13 AM ×

Nobody is Monday morning quarterbacking here, so put that away. I made an entire prediction last week and posted it here - a scenario of what would happen one day if AAPL missed earnings guidance - and a lot of that already came to pass. Also posted at the same time that we were short SVXY and IWM.

Re: long topping processes, etc.. who the hell knows? If this was a Top, and who knows, it was more like the NASDAQ top of 2000, an almost classic blow-off spike. That one certainly wasn't rounded. 2007, which I remember very well, had a number of long rounding processes, and was so long in happening that I questioned my sanity on many occasions (cf. 2017).

Interesting comments from Unknown, who clearly studies the dynamics of vol and is intimately familiar with that market, perhaps in a professional capacity. He/she is right that convexity and feedback loops are powerful and under-appreciated. There was a faith in the low vol believers that approached the faith of Madoff investors, and a similar fate awaits them.

Watch the credit markets for spreads to begin to crack wider. That's where the real panic usually begins. Once real money starts to pull out of HY and buy Treasuries, then small caps will collapse and we will move into a real risk-off environment. This is obviously nothing as yet. Those HY punters are leveraged and institutional and at least have some understanding of their VaR, unlike retail participants in the junk bond space who are clueless. Most equity punters are (obviously) momos, who will turn and run quickly if the market turns downwards. The passive investors in the equity ETF universe are, to put it kindly, simply sheep waiting to be fleeced, or worse.

There is still time for some kind of intervention (for those who think that markets are manipulated, and i will leave that open), but at the moment it looks as though the market is going to gap lower, which seemed the logical expectation on Friday. VIX has broken above 18, and a run at 20 seems not unreasonable at this point. We'll see how strong the stomachs are in the short vol complex pretty soon.

Very large, historically extreme, spec positions: long crude oil, long spoos, short VIX, USD and short Treasuries. All waiting to reverse. That's when the real fun begins.

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IPA
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February 5, 2018 at 1:37 PM ×

@Buy Stocks, you can insult me all you want. I was actually returning an insult you threw at my fellow commenters. When you insult one of us you insult us all. Something you've been doing baselessly ever since you appeared here. The real question is why? That may be above my pay grade and for your shrink to answer.

On the Internet and the fun it brings to places like this... No need to point fingers at anyone. You are the main culprit here. "See you at Dow 40K" and then you sell your entire position at a minor trendline break? We don't give a shit, really, but if we get heckled by you on daily basis for trading two ways we are certainly going to put you on the spot for saying things like that and then stamping your exits in hindsight. If you are not man enough to call it in real time you don't call it at all.

As for Nico G and LB, they both call their trades in real time. Internet is the place to put yourself to test, in front of the entire board here, in writing and for everyone to see, wether right or wrong. Check back a week and a half ago for my comments on NQ to go to 6690 and then look at today's low. What was your real-time call? Crickets...

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Buy Stocks
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February 5, 2018 at 3:20 PM ×

Blah blah blah... did you all BTFD like I suggested? +300pts on the Dow so far and rising... Nico wrong again :)

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Buy Stocks
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February 5, 2018 at 3:27 PM ×

My bad, almost +400 now (LOL). #bearmarket :))))))

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February 5, 2018 at 3:31 PM ×

LB, it's (IMO) probably worth it to take the time, effort, and money to be gamma hedging. Although premiums just went up. Short gamma and collecting time decay is a more dangerous play. Collect premium as a seller, but risk loosing big...pay premium for the shot at a large move in the underlying in a delta nuetral/long gamma play

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Nico G
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February 5, 2018 at 4:08 PM ×

i jumped an astonishing 44ft off a wave kicker on that Zanzibar reef today - 25 knots, 12m Vegas, just before high tide

i've decided to publish my kite jumps here in real time

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IPA
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February 5, 2018 at 4:42 PM ×

Stalking XOP long here. The thinking is rig count has bottomed and OPEC cuts are showing no cracks. WTI is not letting below 64.50 and that may be a sign of buyers lining up below. They want them to chase. I would like to grab XOP @ 34.70 with a tight stop and try to ride it above 42. This will be an on/off trade around the core long for me throughout the year, but I am interested in mostly going long on the dips and scaling out on the rips. I am out of my WTI short for a small profit. Buyers are clearly in control here.

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Leftback
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February 5, 2018 at 4:59 PM ×

Spoos Gapped, then the 12 y-olds came in to JBTFD, which filled the gap perfectly. Now we may be entering the Crap phase.

Note that the small cap ETF bounced, but the gap wasn't quite filled. The bounce in high yield has been more or less erased.
Our vol selling heroes are also down on the day.

Keep your eyes on those three sectors where the leveraged punters congregate: inverse vol, high yield and small caps.

WTI has to correct - b/c everyone and their grandmother are long. You may have to start that trade a few times and take it off again, as we did with the inverse vol ETFs. Nobody wins every time, but good ideas usually come to fruition eventually.

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Shawn
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February 5, 2018 at 5:24 PM ×

I think most here will recognize I tend to be agnostic towards intra-day charts--so my commentary here can be taken without emotional baggage. But I can't help but notice today's gap, bounce, and trading back to the lows is a sign of some strong hands/flow among sellers. Also the theme among the financial media as flipped, now there is a wsj headline that reads, "after stock rout, investors worry over steeper declines".

A month ago the same story would have read, "after stock rout, investors wave in more risk."

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Buy Stocks
admin
February 5, 2018 at 5:26 PM ×

Spoos Gapped, then the 12 y-olds came in to JBTFD...
With a >1% rise in the first hour of cash open, surely most BTFD people would take profits no? Agree vol sellers will be having zero fun tho.

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IPA
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February 5, 2018 at 5:49 PM ×

@LB, I hear you on WTI. I am a bit torn between the time frames here. Like to be out rather than confused. But when I zoom out I see another possible leg up if 64.50 holds. I think WTI is heading for 70 but this time I would like to use XOP only as the trading vehicle to play that bounce, as I think the reward will be 2 to 1 vs WTI. Traders miss moves all the time, totally agree with you. Well, unless you are @Buy Stocks, of course.

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adamantic
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February 5, 2018 at 6:27 PM ×

@buystocks you top ticked the day you muppet

I landed on the short side of WTI, based on spec positioning, rising oil rig count, and ofcourse, having a risk off trade on.

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Leftback
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February 5, 2018 at 6:44 PM ×

Spoos are now lower than they were when "Buy Stocks", you know - bought stocks... assuming he actually has an account :-)

For those who have been skeptics of the correction thesis, we now have a lovely example of Bump and Dump. The small cap ETF, IWM is now in the red, YTD. Well played, tiny punters, buying at or near the top again with a P/E > 100, well played indeed! Oh, but I am sure you can just Buy and Hold, or Dollar Cost Average!!

Vol sellers are having a rough lunch hour and may have to "Buy Vol" as VIX > 20; for now they are taking it - in the derrière. [We express this using French, because Macro Man always intended this to be a classy blog. Stay classy, friends!]

Yes, folks, we'd like to point out that the venerable relic, the Dow Jones, is now down 1000 points in two days, and it officially Gapped and Crapped today. Welcome aboard, Mr Powell! Dame Janet is not going to be saving any tiny punters today, not even "Buy Stocks" or his 12y-o bros "Tiny Tool" and "Sell Vol".

Biggest vol spike since October 2016! In retrospect the writing was on the wall when Spoos and VIX started to synch.

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February 5, 2018 at 6:49 PM ×

@Buystocks, I get jbtfd I really do and you know what, for the last God knows how long I agree free beta long equities whilst CB selling vol. Eek out those returns whilst there is F all going on in rates. But and it's a big but, we are in a macro blog, I'm assuming we are selling macro risk. why the hell would I be paying for equity risk exposure to my macro guy? If I was looking at my risk report for my macro allocation and seeing equity exposure instead I would be pulling my money quick smart. As an investor i pay my macro guy for macro risk not equity index beta risk.

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Leftback
admin
February 5, 2018 at 6:56 PM ×

{Over at the pension fund}

Chad here, just talked to Risk. Yeah, we fired him before Christmas, at the end of our most Brotastic year of Asset Management here at the pension fund, but we had to re-hire him on Friday to explain VaR again. Of course we expected everyone to "Buy Stocks" today and "Sell Vol", obviously.

It's gnarly here, dudes. First of all, we are now down 20% YTD in our vol book. We are still lying about the leverage, obviously, in the hope this turns around. Risk keeps mentioning something called "LTCM", we're not sure what that means, though.

Brad is trying to get a job in something called "Fixed Income". Thad is vomiting in the server room. Weak shit, dudes....

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IPA
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February 5, 2018 at 6:58 PM ×

Guys, I think it's a bear trap in WTI right here. Be careful... I am long XOP now.

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Buy Stocks
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February 5, 2018 at 7:54 PM ×

adamantic - Buying the cash open and taking profits into a 400pt rise isn't what I'd call top-ticking the day. However you're probably new to all this, so in the interest of sharing, I'm going to point you to this insightful tome: https://www.amazon.com/Trading-Dummies-Michael-Griffis/dp/1118681185/ref=sr_1_2?ie=UTF8&qid=1517860115&sr=8-2&keywords=trading+dummies

LB - I "bought stocks" in 2009, and have traded the long side ever since. My charts show US equities still somewhat higher. Sorry if it bruises your ego :)

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Leftback
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February 5, 2018 at 8:11 PM ×

Vol sellers are now getting a serious introduction to The Woodshed. Brutal, even more brutal than we had predicted....

Got to love it when your ETF is down 20% on the day. Looking at you, SVXY, just getting completely mauled. The "vol event" has now wiped out 4 months of gains!

The long bond has caught a bid. High yield is just starting to catch a whiff of the fear out there.

I doubt we hear anything about this in the media but some vol punters are going to go completely broke this week, surely there are going to be margin calls tomorrow, if not already happening right now.

100 Spoos and 1000 Dow points. Serious dumpage!!

Come on Buy Stocks, if you were there on March 6, 2009 you'd know LB was buying too - how big's yer .. conviction now?

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Buy Stocks
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February 5, 2018 at 8:25 PM ×

My latest trade just locked in >+900 Dow points in less than 10mins (this trade done across the entire US equity complex). Because BTFD apparently doesn't work. Hahahaha

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Leftback
admin
February 5, 2018 at 8:27 PM ×

That may have been the climactic selling event for the time being. Smelling a sustainable bounce here.
We covered all IWM and SVXY positions.

It was an entertaining day.

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Unknown
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February 5, 2018 at 8:32 PM ×

feel a bit cheated here, SVXY should have been down about 35% at one point and traded 30% above fair value after the suspension was lifted.... Vix futures held in way too well, feels like a vol selling crowd is still in there, wasn't really the vol spike I was looking for.

Vix spiked out to 35 but 2nd vix future only went to 20.5. By comparison, during flash crash vix went to 40 and 2nd vix future went to 45. Im guessin the vol crew are keeping this way way way in through dip buying? Would have loved to see them face the zero moment...!

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Leftback
admin
February 5, 2018 at 8:59 PM ×

VIX 35. It's been a while. That wasn't THE BIG ONE but it was a taste of things to come perhaps, and there most likely will be some changes of underwear among vol sellers. I am sure the regulators will reimburse you for any shortfalls caused by the market breaking, Unknown.

They are on our side, right? ;-)

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Unknown
admin
February 5, 2018 at 9:11 PM ×

i spoke too soon :)))))

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Shawn
admin
February 5, 2018 at 9:17 PM ×

you have to hand it to brad, chad and thad, they managed to bundle this thing across the line into 2018 and collect their 2017 bonuses before leaving the restaurant without paying the bill.

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Unknown
admin
February 5, 2018 at 9:45 PM ×

my my my having a problem calculating the nav today are we?

Watch out on vix chaps - I'm no expert, but if you've got to clear somewhere between 300mm to 1bn vega, it aint happening here.

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Belektron
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February 5, 2018 at 9:47 PM ×

Massive stops after close in VIX futures and relevant ETFs spilling over to spoos. After 30%+ moves after market close I suspect significant margin calls being calculated right now. What happens tomorrow at open?
I thought it was a good time to buy, but market action after close tells me it might be premature...

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February 5, 2018 at 9:51 PM ×

I have to hand it to IPA on the SVXY put idea made about 4 months ago (and I recall LB liking the idea). The only thing off on that call was the expectation of a Jan dump.

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Unknown
admin
February 5, 2018 at 10:03 PM ×

I hope they bought the ticket too

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Buy Stocks
admin
February 5, 2018 at 10:54 PM ×

XIV termination event anyone? :)))

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Unknown
admin
February 5, 2018 at 11:00 PM ×

I fukin hope so. Implied nav was down 96%. Imagine some people huddled in a room right now.

Better not spiv me out of a trade of the trade of fukin lifetime

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Leftback
admin
February 6, 2018 at 2:37 AM ×

So bizarre when you see that something catastrophic might happen to an ill-advised investment vehicle that is full of clueless punters, at first everyone says you are talking bollocks, and then you see the thing start to splinter and finally it happens, and it happens faster and even more disastrously than your wildest expectations!!! Shades of 2008.

LB has had a few runs at the SVXY trade, but in the end was concerned that there would be no-one left to pay on the other side of the trade that we simply used front month options in SVXY and we were out of there before the close today. In other words, we got paid, left some money on the table, [possibly an enormous amount on the table] but we are safe from central bank saves, regulators and even bankruptcies of a major holder. I hope everyone gets their big payday for this.

No idea who was on the other side today, but no doubt tiny punters must be hurting. I really hope the options sellers who had to buy the puts back today was my broker, that always appeals to me as they constantly trade against clients….

Btw we are also massively long US30y. It just seemed like an ideal squeeze candidate if there was a market meltdown.

Now the last thing to fall into place for us would be a global liquidity shortage, driving a squeeze of the dollar shorts. We have a ton of UUP calls. You just know CBs would respond to that with liquidity injections and bond yields will plummet.

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