In the modern struggle between old-school balance sheet fundamentals and computerized, trend-measuring “quants,” the robots seem to have won, as more than 70% of today’s markets trade on algorithms working at 15 gigaflop speeds.
I’ve taken to referring to this market as the “terminator market;” one that is driven by impersonal formulas and extremely expensive software rather than human intelligence.
I’m not here to mock this new style of investing, as it can and does work – until it doesn’t, usually due to some unforeseen human event, which machines can neither predict nor control.
I’m often reminded of John Meriwether’s infamous disaster of a hedge fund, Long-Term Capital Management.
It had two Nobel Laureates and tons of applied math software designers on its expensive staff in 1998, none of which prevented that $125 billion fund from tanking with historical panache when the Rubel went one direction and the computers went another.
Alas, Long-Term Capital didn’t last very long…
But rather than get into the minutia (or debate) of artificial intelligence vs. human common sense, below I’m simply going to employ both fundamentals and quantitative technicals to measure the state of our current markets and the direction of your money.
And what do both approaches tell me?
The Quant Signals – Volatility Ahead
As to the purely technical indicators, they are providing ample evidence of trouble ahead.
Last Monday, the quants (aka the CTA funds) saw the S&P dip below their key selling support lines (what the fancy lads call “negative gamma”).
Without getting lost in Greek market definitions – this essentially means that buying support is weakening, and hence the markets saw their biggest daily drop for the year.
The quants are worried. As we enter August, the traders exit for vacation, and thus markets typically become less liquid. This is a bad convergence, a perfect setting for volatility spikes.
The VIX, which is the market’s “fear indicator,” helps measure this volatility. The quants also have another scale, the VVIX (which essentially tracks the volatility of the VIX), and the VVIX seasonally spikes in late August and September.
The quants are forecasting two waves of pending volatility moves this autumn: first, a sell-off, as we saw last week, that sent the VIX above 20 and the VVIX above 100.
Specifically, the quants were watching the big market movers and players (hedge funds), who had been super bullish (buying) in June and July and using other bullish strategies (selling puts and shorting the VIX futures).
Such moves created a herd mentality, and then, as of August 1, that herd got nervous and began selling rather than buying U.S. stocks. This is flow-tracking 101, and it matters. There is now mathematical evidence of “risk-off” for the coming fall season.
And sure, there will be a rebound. The dip-buyers are programmed to buy the dips. They’re machines, after all.
Nevertheless, signals from the CTAs, the macro funds, and the trend-following algos are telling us that the big players are going market-neutral this fall, which means less buying support and thus more market volatility – both up and down – but mostly down.
As hedge fund alumni, we know this pattern well.
There is growing evidence that the CTA funds will do more selling than buying this autumn, hence adding pressure on price declines, the key trend to anticipate, especially (and typically) at the tail end of the month when risk-parity funds (i.e. funds going both long and short) rebalance their portfolios.
Finally, the quants are tracking global stock market sentiment indicators, which, driven by fears of an escalating trade war, are deteriorating and setting up a summer-into-fall pattern dangerously reminiscent of the technical patterns seen leading up to the 2008 crisis.
In short, there are technical reasons to be cautious as we finish Q3 and head into Q4.
The Old-School Signals – Recession Ahead
The above data is, of course, highly important-and it’s based on charts, flows, trends, and very sexy math. Most of the foregoing “quant data” is agnostic to the otherwise glaring signs of a classic, good old-fashioned recession, which we also track.
As we’ve noted for months, the classic (old-school) patterns of flatlining/declining GDP, a dying middle class, massive retail closings, trucking and rail slowdowns, PMIs at dangerous lows and a totally rigged to fail market supported by a dishonest Fed and a now tired (rather than “mid-cycle”) business cycle ALL point toward an imminent recession.
Recessions, of course, matter. They kill portfolios for the unprepared.
The Fed, of course, is a powerful body, and it can postpone a recession’s official entrance in ways difficult to gauge (i.e. by boosting retail investor hope with media-complicit promises and more magical rate cuts or even magical money printing down the road).
But know this: The Fed can only postpone recessions; it can’t prevent them.
In the end, I believe a recession on Main Street (which the Fed effectively ignores) will ultimately trigger the recession on Wall Street (which is all the Fed sees and bows to).
One doesn’t need a quant fund or a degree in applied math to see the U.S. rotting all around you as costs rise despite mythical inflation data.
Furthermore, old-school common sense reminds us that where growth and earnings go, so too goes the stock market. In their recent announcements, the Fed forgot to tell you that both earnings and growth are set to go much lower in Q3 and Q4.
And that’s pretty telling.
Summing It Up
Whether one looks just at the modern robots, the math, and the quants, or whether one tracks the old-fashioned and common sense lessons of Fed history, earnings, and growth, all signs are currently pointing to a volatile autumn.
In the meantime, get ready because I’m going to show you one of the weakest sectors of the market on Friday.
I won’t spoil it for you, but I’ll just tell you that Warren Buffett has a lot to lose…
Catch you Friday.
5 responses to “You Need to Watch Your Step As We Move Into Autumn”
August 14 2019