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Fear collapse.. - The One Eyed Deer 16th November

Updated: Nov 21, 2023

A truly startling collapse in the price of protection.

This collapse of the volatility index to virtually rock bottom lows indicates the bounce in equities has not been a rational act of price discovery, but rather a refill of the bravado tank. In regaining sight of the highs, market participants have regrouped as if this were the BEGINNING of something.

There are of course volatility supply forces at work as well. Dealers are long gamma at this spot level so there is no vol bid from them. This also allows the short CTA crowd to more easily protect their shorts with reasonably priced calls. I posit that the extensive short position so telegraphed last week has significantly reduced. Record volume trading in Russell2000 calls for example.

As important a factor as positioning is to market direction, it does come and go quite quickly. Perhaps we can get back to earnings revisions.

Sell VIX puts around the 14-14.5 level. We have done this three times in the last few months. They burn away very quickly.

Where the rubber hits the road..

I don’t want to harp on HOG. It’s just one little position (it is a favourite though), but during the squeeze it shows you what happens when reality and fundamentals can catch a breath amongst the theatrics of headline indices and media.

This speaks volumes to the “magnificent seven” effect. The two things about to execute Harley are a downturn in discretionary spending, and higher cost of capital. This is becoming apparent to a critical mass of observers and the price is suffering accordingly. It got caught in the early squeeze updraft but could not continue on, mainly because CTAs don’t bother shorting such a small name, but also because reality cannot be ignored forever.

The reason market shorts grew to the size they did is because it is becoming apparent to a critical mass of observers that a downturn in discretionary spending and higher cost of capital are entering, stage left, and that that is bad for business.

How to kick a thirty year habit..

Thirty to forty years of ever-easier money. Permanent Fed balance sheet expansion. Global central bank coordination. Corporate buybacks. Everybody doing everything they can to keep stocks going higher.

One has to be very cynical of any corporate buyback announced in the current rate environment. Sure, if you're a coal miner and you have spent the last two years basically digging money out of the ground, and you have retired all your outstanding debt, and your shares are trading at 2 times earnings, then buy your shares back, please. But if you are a homewares retailer, on ten times, with contracting earnings estimates, then maybe you're announcing a buyback to game the stock price higher for the benefit of executive option packages?

Of course, buyback records were set at the market high in 2022. Of course, corporates were borrowing as much as they could at 0.1% to buy shares back. As history unfolds it will be very clear how much capital was torched with this record-buying-at-a-record-high. But this part of the habit is at least fading.

There is such a thing as a hurdle rate for conducting a buyback. Corporates are going to continue to find better things to do with their costlier capital than to prop up the CEO's retirement fund, and who knows, if cost of funds gets too hot, they may even ISSUE shares.

Watch out for a significant name to actually raise capital through share ISSUANCE, which may be very much cheaper than debt, and to catch the whole market off guard. Remember that the wisest description of the share market is that it is a place you go to SELL a company, not to buy one.

Has the inflation threat collapsed?


If you to correlate it to Rolexes then definitely.

I will confidently call that there will never be another bull market in luxury watches ever, ever again. It only existed in the first place because of covid. It exists on pure copium (as the kids call it these days) at the moment as it proceeds to completely round-trip to pre-covid levels where it will stay again forever. If this is the type of thing feeding into inflation numbers then those numbers are indeed under more pressure. BUT, there are other types. How about services inflation..

I'm not sure your dentist, accountant or tutoring centre are going to pull back on pricing in a hurry. Inflation can be triggered in a heartbeat if people sense that prices might be getting away from them. We here at OED think it is going to lurk in the shadows for a long time to come, and sending markets vertical in anticipation of its demise is exceedingly premature.

The progress of our bigger positions.

Bond market commentators are all gushing over "King" Bill Ackman's recent call of the top in rates. We beat him to it by a day. The index of our spread position between TLT and QQQ looks like this.

Yes, it has drifted back towards our entry point, but this is a slow moving beast, and will experience way less volatility than outright equity index positioning. The short equity leg has been matched by the bond recovery, dampening the potential damage from the enormous equity squeeze.

The Gold/Silver ratio looks to be pushing away from the top of its range. You can still sell it here around 84. We will be looking for exit at low/mid 70s.

Wrapping up

The squeeze has squuz. Positioning has neutralised. We look forward to the Fed having little effect on the rate market as enormous pipelines of bond issuance keep bond prices from running away, and hence rates buoyant.

Our bigger positions remain the same this week, with the slower moving bond/equity spread likely to be a medium to long term performer, and the GSR starting to come in with more velocity.

On the radar (21st) is NVDA earnings, wondering if the AI dream continues to deliver.

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