“Fear tends to manifest itself much more quickly than greed, so volatile markets tend to be on the downside. In up markets, volatility tends to gradually decline.”
-Philip Roth
It has been a fun ride the last couple of months. As I have written in the past, the "everything" rally makes even mediocre traders, like myself, feel smart.
Yesterday was an excellent reminder that things can change in terms of market sentiment ... and rather quickly. Things were going as predicted in a low volatility and positive gamma environment, and then whammo! In less than two hours, the SP500 dropped ~-1.5% and the VIX (a measure of stock market volatility) popped some +7%!
The immediate reaction from market pundits, and the financial media, was that 0DTE options were responsible for this sharp intraday pull-back. In fact, the headline at the top of Bloomberg this morning is:
“What Killed the US Stock Rally? Fingers Point to World's Hottest Derivatives Trade”
Our partners at Tier1 Alpha had a different take on the matter. According to their analysis, they find it unlikely that 0DTE options were at fault:
- First, remember that a bulk of these contracts are hedged with further OTM options without ever touching the futures market. Given the current levels, there was plenty of liquidity for market makers to hedge these positions.
- Second, our option volume by DTE model implies that a bulk of these transactions are taking place either at, or near the money. In other words, 0DTE flows were following the market, not the other way around.
So, what happened? Well, the real cause was more likely year-end rebalancing from mutual funds. Given the massive outperformance of equities versus bonds this year, this explanation certainly seems plausible. But the real tell: the selling occurred at 2:30pm, which suggests systemic selling.
Isn’t it nice to have friends who truly understand market structure?
Back to the Global Macro Grind…
On the economic data front yesterday, December U.S. Consumer Confidence accelerated and came in higher than expectations at +110.7. This increase was widespread with the Present Situation Index jumping by +12 points and the Expectations Index, a view of consumers’ short-term outlook for income, business, and labor conditions, increasing by more than +10%.
Given the rally in assets and decline in inflation, it is not a total surprise that consumers are feeling better about things. This increase in confidence takes us back to levels of July this year. The obvious risk of economic data coming in “too hot” is we get even more hawkish talk from the Fed. Whether the bond market cares about what the Fed says is, of course, a completely different matter.
Over in Europe, consumers are, well, much less confident. The two key confidence reports from Europe yesterday changed very little and remained sharply negative:
- January German Consumer Confidence came in at -25.1; and
- December Eurozone Flash Consumer came in at -110.7
There is also one common theme in all three consumer confidence reports from yesterday. Namely: the consumer is still worried about inflation.
The other interesting data this week from the U.S. relates to housing. We had acceleration across the board in U.S. housing data. The most noteworthy jump came in Single Family Housing Starts, which were up +18% M/M and +42% Y/Y and highlighted in the Chart of the Day.
This monthly housing data is prone to wide tracking errors and month-to-month fluctuations. But given the decline in rates and low national inventory, it is not a surprise to see Starts accelerate.
The other important acceleration in U.S. Housing this week came in the NAHB Housing Market Index, which increased to 37 for December from 34 in November. This index remains well off its highs, but is likely just starting to see the follow through from lower mortgage rates.
The commentary from the report is even more telling. According to the NAHB:
“With mortgage rates down roughly 50 basis points over the past month, builders are reporting an uptick in traffic as some prospective buyers who previously felt priced out of the market are taking a second look.”
As my colleague Josh Steiner notes, a 1% move in rates equates to a roughly 10% change in a consumer’s home purchasing power. So, no surprise, consumers are back to take a another look.
This isn’t all bad news of course, but it probably does have the risk of making housing a continued tailwind for inflation. In fact, according to RedFin, home prices in the U.S. remained up +3.7% Y/Y for November. And that was back when rates were more restrictive...
As for our positioning, at the moment these are the top Macro ETFs By Size Rank in our Portfolio Solutions product:
- FDRXX, TFLO, BUXX, TBIL, XLU, FXB, GLD, IAK, INDA, NLR, URNM, SMIN, AAAU, SPLV, SHY, BNDD, URA, KBWP, MTBA, EWZ, ETHE, PINK, EIS, BITO, EPHE, GDXJ, GXG, SPMO, GDX
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 3.85-4.36% (bearish)
UST 10yr Yield 3.75-4.23% (bearish)
UST 2yr Yield 4.20-4.80% (bearish)
SPX 4 (bullish)
NASDAQ 14,306-15,013 (bullish)
RUT 1 (bearish)
Tech (XLK) 185-194 (bullish)
Energy (XLE) 80.43-86.17 (neutral)
Utilities (XLU) 61.67-65.31 (bullish)
Shanghai Comp 2 (bearish)
BSE Sensex (India) 68,907-71,963 (bullish)
DAX 16,509-16,830 (bullish)
VIX 12.07-14.88 (bearish)
USD 101.57-103.99 (bearish)
EUR/USD 1.077-1.099 (bearish)
GBP/USD 1.253-1.279 (bullish)
Oil (WTI) 68.07-75.36 (bearish)
Gold 1 (bullish)
Uranium (URA) 28.00-29.90 (bullish)
MSFT 365-377 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
