Ponzi World (Over 3 Billion NOT Served): Self-Imploding Capitalism.
“The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak” (ZH/Hussman/Faber)
Too late. I already opted for the first option years ago. It was a choice between a low return on capital or no return of capital, so I chose the former. Everyone thinks that they will be that one guy who gets out at the very top – you know, like Alan Greenspan. Fortunately, you don’t have to be a retiring Central Bankster to realize that a set of widely ignored factors have coalesced to make meltdown inevitable.
Capitalism taken to the logical extent possible will inevitably self-implode with extreme dislocation.
Unbeknownst to the Corporatized Borg at large, the self-destruct sequence has already been inadvertently activated as follows:
Carry Trades Unwinding
First off, carry trade unwind risk was always the greatest risk created by Quantitative Easing and despite the rolling dislocations in Emerging Markets, it’s still being ignored. These various high risk Emerging Market countries were primary beneficiaries of Fed largesse as it temporarily propped up their currencies and their debt markets. Now during the unwind phase, the currencies are collapsing and interest rates are rising. Meanwhile, investors are just starting to realize that these trade deficits (current account balances) are totally unsustainable. In a desperate attempt to stabilize its currency, Turkey raised interest rates by 4% overnight which of course will kill the economy. This is all just deja vu of the 1997 currency crisis which started in Thailand and spread throughout Asia.
Don’t Worry. Be Happy
“China is being engulfed in a financial crisis that might end up in its own version of the credit crunch. There are running battles on the streets on Bangkok and Kiev as authoritarian regimes totter. Turkey is sinking, and may soon not be able to fund its current account deficit. Argentina is going through another currency crisis. There is no shortage of drama coming out of the emerging markets. And there is no shortage of reasons for the markets to work them themselves up into a panic.” (“Why An Emerging Markets Crash Wouldn’t Matter”)
Key Stock Market Risks
It starts with the buy-the-dip (BTFD) and buy-the-all-time-high (BTFATH) rote mentality that got us here. Investors have been programmed by Central banks, to buy every dip automatically. They are now doing so on auto-pilot.
Loss of Leadership
As we saw with Apple last year, eventually even the most beloved of stocks gets played out and rolls over. Notwithstanding cogent arguments around cash on hand and relative valuation, that stock is still wallowing well below its all time high. Currently, the momentum stocks which have been leading the advance since 2008 have been getting hammered recently on heavy volume. Meanwhile, as we see below, the ratio of small caps (R2K) to blue chips (Dow) is rolling over, indicating a rotation to safer names.
The problem with sector rotation is the fact that as I have shown too many times (see: “Aw Fuck, Not this again!”
), all sectors are highly correlated, therefore blue chips are as played out as growth stocks. This is all manifesting itself in a market that is using up buying power to go nowhere. As we saw today, the TRIN which usually trades in a range between .5 and 5, was at a rock bottom .5. However, the market was only up nominally. Low readings indicate heavy buying.
Without sector rotation as a viable alternative, investors can hedge using options, which makes sense since as I’ve also shown too many times to mention (see: “Slowly at First, Then All At Once”
), hedging using index options has gone out the window. Central banks killed market volatility and without volatility, options expire worthless, ergo no option hedging.
Volatility Will Explode: Making Hedging Impossible
If all investors reach for options protection at the same time, a couple of things happen. First, buying at-the-money put options forces market makers to short the market lower to hedge their put selling. If I buy an at-the-money QQQ March put option at a current price of $2/option, I have achieved 43:1 leverage given that the price of QQQ is $86. With $5,000 of options, I can control ~$200,000 of underlying capital. Place that in the context of institutions buying millions of dollars worth of put options and you see that buying puts is a massively leveraged form of short selling. Anyone who says that buying puts is not shorting the market, doesn’t understand how the options market works. Market makers who sell the puts HAVE to short to keep their book neutral. Therefore, given that all investors are currently under-hedged, once prices are pushed lower, and demand for options increases, then option implied volatility will sky-rocket as the cost of at-risk capital goes up commensurately. At some point hedging with options will not be cost feasible. Buying options in the middle of a sell-off is like trying to buy fire insurance when the house is already on fire. Too late.
Let’s not forget about margin risk. NYSE margin is at an all time high, meaning speculators are massively leveraged. Therefore as their positions move against them, margin clerks will sell down their holdings which is what we saw during Y2K wherein the selling was relentless as selling begat selling as prices moved lower. It was non-stop liquidation for weeks on end.
Everything Gets Privatized Including the Market Itself
Once you take rotation and hedging off of the table, the only alternative left to protect capital is selling. That’s where it gets really interesting, because the underlying structure of the market has changed radically since 2007. All of the major stock exchanges became publicly traded companies between 2002-2010 which is why they adopted the High Frequency Trading model – i.e. to boost commissions. Ever since then, real human investor volumes have been drying up, while HFT algos duke it out with each to front-run the remaining trades. Taken together and stock market volumes are at a 15 year low
. Therefore, when large scale investors get serious about selling down their positions, it’s highly unlikely there will be anyone or anything on the other side of the trade. HFT bots are not programmed to lose money or take outsized risks. They are programmed to jump in and out of the markets on a millisecond basis and otherwise maintain a neutral book.
And that’s the anatomy of a meltdown.
aka. Risk Appetite