Money and Mark-ups
Highlights
- Behaviorally, it is human nature to repeatedly fall victim to the same mistakes.
- Ask the question, what does a market operator do with VIX sub 19 during a bear market?
- Money Velocity negative year over year and does not support market liquidity or economic growth.
Welcome to the official launch of “Friday Reading”. Once again, I am thankful for all readers that are taking the time to tune in and I appreciate the support. It is approximately 6:15am and I am having a cup of HOT coffee. I was not kidding when I mentioned, “grabbing a hot beverage” in the introductory letter. Speaking of the hot coffee topic, one of my poor habits is that I consistently burn the tongue or roof of my mouth by taking a pre-mature sip of coffee. At first, this is slightly painful, but then there is the persistent inconvenience of the scorched mouth which seems to linger for days on end. No matter how hard I try to avoid this undesirable fate, eventually I make the mistake again.
Just to be abundantly clear to those that may be unfamiliar with my work, I am not an “expert” by any means and I am a 26-year-old student of the “game” who is learning through the lens of taking real action each new day. For those readers that picked up this piece seeking “advice” or “hot stock picks”, no need to read any further. Close out of this publication and turn on CNBC or tune into YouTube where the washed-up crypto influencers are pumping crap coins into another month end. I’ve noticed those locations are where many of the “experts” and super “intellectual” individuals like to hangout.
Since March 6th, the last 2-3 weeks of news flow in the financial world has been rather chaotic. I would say that it is laughable, but I do not want to make jokes about something with serious consequences to the general public. In this space we do not focus on these “headlines”, but will lay out the flow that the consensus has generally been seeing on their screens. See Below:
2-YR yield (5.07%) reaches highest levels since 2007
Bloomberg publishes opinion piece supporting the case for 6.5% terminal rate
SVB Failure
S&P 500 Volatility Index (VIX) reaches 30s
Markets sell off
Consensus begging for rates cuts (they have been the entire last year)
2-YR yield drops off the peak -150bps to trough
MOVE Index (bond volatility) highest levels since GFC
Fed takes action to support liquidity in the financial sector
Bailouts
Markets bounce
*Breaking Headlines* “Banking crisis averted”
Futures higher almost every morning on “hopes” and “optimism”
S&P squeezes off the lows with relative weakness
VIX falls from 30s to sub 20
NASDAQ and Crypto Bull Market is back!
2-YR yield bounces 60bps off the lows and prices out rate cuts
Talk about the uncertainty of the crowd. No one knows what is actually going to inevitably happen, including myself. This is why having a data driven approach for investing on a full cycle duration is a resilient tool to block out the everyday noise. David Salem, Hedgeye Risk Management, recently said, “There is never full certainty, and despite having some general direction with the data, we do not know how this will all turn out”. This is not a quote word for word, but I appreciated this comment because it provided some calmness within a world of instability. The link to this discussion will be posted below in the “Resources” section.
To provide some context behind the recent movement in the VIX from 30s to sub-20, this has been one of the more rapid movements from highs to lows throughout the bear market over the last year. This fall in volatility comes into month end which has generally been a time where asset managers have “marked-up” the price of assets on their books to show a more favorable performance to their investors. In this case it is quarter end and they all need to showcase that “they never owned financials” and that “we have been invested in tech since January 2023”. In relation to crypto, these things get marked-up into month-end almost religiously. Nothing to see there. By the way, the largest futures position by open interest were BTC calls on the $30k strike and those expire today. Since we are talking about speculation, I will also mention that the uninformed volume has been chasing TSLA weekly calls at the $200 strike basically for the last 2-months now. The volume in that strike has been some of the largest by a single stock every day during the last week and those options expire today.
Back to the rapid decline in the VIX. The recent “positive” movement in the SPX index has occurred on relative weakness. This is supported by the low volume behind the move on the green days and higher than average volume on the red. Additionally, Tier 1 Alpha highlighted on 3/29/23 that short dated implied volatility fell approximately 25% from last week. Normally, this type of decline in volatility equates to roughly a 6% rally for the SPX vs. the 2% gain that has been achieved (link below). Posting my chart of the VIX below for some detail. In other words, voaltility has fallen dramatically in a 2-week time period and the SPX has barely moved higher.
*Tradingview VIX
During this recent move off the lows of the “banking crisis”, I pointed out last week that the majority of the “positive” movement in the overall indexes has been attributed to the strength of 7 Mega Cap Tech stocks. As for the banking problem that has been “resolved” or “contained”, here is their relative performance since March 6th, 2023 per Jim Bianco. There is a huge disparity between Mega Cap Tech and the weakness shown by the underlying companies within the banking sector and the Russell 2000. While the crowd piles into Mega Cap Tech, financials are unable to even put in a strong bounce off the lows. See the image below.
*Bianco Research
Here is a chart that I created that demonstrates the performance of the Russell 2000 vs. Mega Cap Tech since the start of 2023. The spread is rather remarkable and leads me to the conclusion that the entire market is being floated by the performance of 7 companies essentially.
*Tradingview Mega Cap Tech vs. IWM
Recently, I had the pleasure to listen to a podcast with speakers
and Dr. Lacy Hunt (link below). Incredible listen with a wealth of knowledge and experience. Dr. Hunt is a world-renowned economist and the Executive Vice President at Hoisington Investment Management. I first heard about him from the source, Danelle DiMartino Booth, who in her own right is a very reputable and accomplished economist. She referred to Dr. Hunt as one of her mentors, which made me interested to learn more about his work.After listening to the conversation, some of my biggest takeaways were to zoom out and understand that the processes of monetary expansion and the draining the excess liquidity takes time to play out in the markets. Currently, the economy is essentially moving from a period of one of the greatest monetary expansions of all time to conditions of negative liquidity on a year over year basis. I do not want to butcher his work of “other deposit liabilities” (his preferred metric for market liquidity), so I will be using “M2” which is my recent favored metric to gauge the trajectory of market liquidity. For those that are unfamiliar, M2 is money supply and this metric has not been negative dating back to the 1960s, which makes this a relatively recent phenomena that markets are experiencing for the first time in decades. See the image below.
*Fred M2
Dr. Hunt points to the extreme level of risk taking that is taken during the extended periods of excessive monetary expansion. When money enters the banking system, the money is immediately put to work. Under these conidiations, liquidity in the system is rapidly accelerating. These types of policies encourage individuals to take risks beyond what should normally have been taken. I note that as US treasury yields fell as they did during QE, the push for taking risk grows and investors have to reach even farther out on the “risk spectrum” to earn a return on their money, which induces speculation. Note the chart above the peak of M2 is where ARKK peaked and the price of BTC peaked for the first time.
Lastly, for those thinking who may think that the “banking crisis” has been resolved or all the other underlying problems within the economy have gone away, here are some thoughts from Dr. Hunt. At the first glimpse of trouble, phase 1 is where the Fed attempts to patch up the problem by making liquidity more available (this recently happened with the bailouts). A few examples listed below:
- Washington Mutual 2008
- IndyMac 2008
- Wachovia 2008
- Bear Sterns 2008
Each problem that got “patched up” by the Fed’s intervention was seen as solved and the markets moved forward without second thoughts of danger. The provision of liquidity did not solve for the any of the underlying issues that the excess liquidity from 2001 to 2007 created from extreme and unwise risk taking. The same liquidity response by the fed is being introduced to the markets at this time in March 2023, and again it will not solve for all of the poor decisions that were made during the 2020-2021 liquidity bubble. Phase two is where unwise risk taking is exposed and that is also called gravity of the cycle.
Along with this liquidity back drop mentioned above, consumer credit is at all-time highs, interest rates on that debt continues to rise to extremely elevated levels, 30-60-90 delinquencies are accelerating, real household earnings have been firmly negative for months, standard of living is declining, and the fed continues to tighten financial conditions at one of the fastest paces in history. Perhaps these cracks in the banking system started as a “duration problem”, but given the combined back drop with the average US consumer, my view is that this will end as a credit issue.
At this time, strategically it makes sense to raise liquidity given that credit and money will be in high demand for the foreseeable future. A great place to start could potentially be Mega Cap Tech, which has essentially been the markets “safety trade”. I sold short incrementally yesterday, will sell incrementally again this today if given the opportunity, and will be selling to anyone who is willing to buy at these levels over the next couple weeks (if the opportunity is there). Not sure how long this opportunity will last, but I am looking to wisely take advantage in a risk adjusted manner.
Funny enough or really not funny, the crowd is chasing stocks once again (for the 6-7 time over the last year) with the VIX sub-19.5. Makes me think about all the times where I took that pre-mature sip of coffee. It is the magic recipe for getting burned.
Happy Friday,
Aaron David Garfinkel
Resources
Mike Green and Dr. Hunt Podcast
https://www.simplify.us/news-media/kis-ep22-lacy-hunt-bank-runs (Simplify Website)
(Apple Podcast)
Hoisington Investment Management Q4 Review and Outlook
https://hoisington.com/pdf/HIM2022Q4NP.pdf
Hedgeye TV
Tier 1 Alpha 3/29/23
https://mailchi.mp/9c34eefd6163/market-sit-rep-march-29th-2023-8-vega-points?e=95ac435818
Jim Bianco
Good stuff! Thank you.
This is the type of level headed analysis people needs more than ever right now. Looking forward to seeing you grow Aaron.