I’ve read all the headlines explaining today’s drop in stocks, and yesterday’s and the day before. The chaos at OPEC and in oil prices. Fears that the economic recovery is slowing. Thoughts that inflation isn’t a worry and that instead we should fret about deflation.
There is some truth to all these explanations. But I don’t see much of the way in news to support a major change in market trend and sentiment. (In fact, I find it interesting that this trend has taken shape in a kind of news gap between the June Federal Reserve meeting and the beginning of earnings season on July 13.)
And when I see a big, fast move like that of the last three days or so without much in the way of news to change investors’ view of the world, my thoughts turn to computers and program trades. And I have to consider whether these machines that look relentlessly for opportunities to make a buck on a trend that too far, on a chance to arbitrage two asset classes, on some temporary miss-pricing have found something that in the short term is driving the market trend.
In this case my suspicions focus on bonds. To me this move looks like a decision to buy bonds and short stocks because the price of one asset–bonds–has fallen too far behind the increase in the price of another asset–stocks.
In the first half of 2021, nobody much wanted to buy bonds. The yields were minuscule and “everyone” that the price of bonds was headed down, down, down because inflation was picking up and the Federal Reserve was going to first trim and then end its bond purchases on its way to raising interest rates.
In the last year, for example, Treasury yields rose more than 85 basis points as bond prices fell.
With that as a reasonable scenario, portfolio managers didn’t rush to buy bonds and many professionally managed portfolios wound up with underweight positions in bonds as stock prices climbed and as managers didn’t top on their holdings with bonds.
I’m not a computer (I don’t even play one on TV), but the pricing logic of the last few days told those machines that the trend had run too far. Buying bonds–when they were so cheap and disliked–looked like a good play versus stocks that had traded from one historic high to another.
Now there’s a always some chance that a mis-priced asset will get more misplaced, but in a situation like this it doesn’t take much in the way of news–OPEC chaos or a 2,000 jump in weekly initial claims for unemployment–to put some momentum behind that computer trading.
Today, the yield on the 10-year Treasury fell another 3 basis points to 1.29%. The yield is now down 24 basis points–a huge move in the Treasury market–in the last month.
I don’t know that the move downward in Treasury yields and upward in Treasury prices is completely over. I can make a case that rising volatility in the stock market has increased demand for Treasuries from investors looking for a safe haven. One measure of short-term stock volatility, the CBOE S&P 500 Volatility Index (VIX) climbed another 17.47% today, July 8, to 19.03. Back on Friday July 2, the last trading session before the Fourth of July weekend, the VIX closed at 15.07. That’s a jump of 26.3% in the “fear index” in less than week. Treasury yields could have another day or more to move lower on a continued demand for safety.
Today the Standard & Poor’s 500 was down 0.86% and the Dow Jones Industrial Average fell 0.75%. The NASDAQ Composite was lower by 0.72% and the NASDSQ 100 was off 0.60%. The small cap Russell 2000, which has been hit especially hard in the last week, slid another 0.94%. The iShares MSCI Emerging Markets ETF (EEM) plunged 2.08%.
If I’m right and this trend has been driven by those trading computers, I’d expect that the machines are busy at work figuring out when they can make a few basis points or more on arbitraging this trade in the other direction. My best read on that machine intelligence is that with a Friday looming–and Fridays are often down days when markets are nervous–those computers would be looking to make a bit more money on continuing to bet this trend tomorrow.
But every drop in the price of stocks is likely to be telling the computers that the profitable trade is to reverse this trend and buy stocks as earnings season starts on July 13.
Tomorrow, I’ll be looking to sell some of the VIX Call Options I bought as a volatility hedge (not all because I’m still looking for more volatility in September or so), and to add a long play on an earnings surprise in stocks likely to deliver a big earnings surprise in the next few weeks. The stock play on this that I’ve already got on is the Call Options in Advanced Micro Devices (AMD). I’d look to be buying more of those and maybe the Call Options on a similar stock or two over the next few days after a week of selling in the technology sector.
Stay tuned. (Danger, Will Robinson!)