Friday, May 24, 2013
...hell, I don't even believe me. I mean, it really couldn't ever happen could it?
Could... it... ?
Japan's Nikkei 225 dropped ~75% from peak to trough back in the 80s and 90s. The NASDAQ dropped from 83% from peak to trough from 2000 to 2002. The Shanghai Comp fell from ~5900 to ~1800 in 13 months. We saw similar drops in Oil around the same time. These movements are not as few-and-far between as we may like them to be, or even think.
So what if I told you that if the oh-so promising looking analog between the S&P 500 from 1995 to Present and the Dow Jones from 1962 to 1975 plays out, that the S&P 500 Index will drop ... get this... 90% from its peak!
Yes, 90%. Which if the S&P 500 is at peak, at 1687, as the analog nearly perfectly predicted (it predicted 1681 which I will explain in this post), then we can expect a S&P 500 price below 200!!
So how in the hell did I get to this price? Here is the explaination:
First, I have written extensively on the S&P 500 from 1995 to Present mirroring that of the Dow Jones from the 1960s and 1970s. All expectations ride on this analog playing itself out. I've been mentioning this analog since January with my original post "NEO AND THE BLACK CAT" (click link to see story) but here is one of many charts I recently posted:
... and here is the post that I recently made where I told the story of the Dow Jones battle of 1,000 being a similar battle of the S&P 500 fighting the 1550-75 level, entitled: "A STORY WORTH READING" <--- click link to post
I also recently posted this chart as a summary to that story:
Now that we have established how relentless I have been around this analog, let's talk numbers.
First, how did I get to 1681 as a possible top? Very simple. In the 60s and 70s the Dow Jones struggles to get through the key 1,000 level. When it finally did it get through, it peaked at 1,067, or 6.7% greater than it's "struggle level". If we call the "struggle level" for the S&P 500 it's previous high then that leaves a 6.7% rise from 1576 to a price of 1681.
Here are some more charts that are critical to the analog and where it ends and how we get to below 200...
Chart #1: The percentage gains and losses from peak to troughs for both the Dow Jones of 60s/70s and the S&P from 95/Present. For these charts, we are assuming that 1687 is the top:
As we can see, the swings of the S&P are much larger (both up and down) relative to the Dow. Now, here is where it gets VERY INTERESTING:
Look at this table below and tell me what you see:
Do you see the pattern??
Each bull cycle higher is about 3x greater in percentage terms in the S&P than the Dow in this analog, and the bear cycles are about 2x greater in percentage terms.
This means that if the last bear cycle of this analog follows through, the -46.5% in the Dow's last bear cycle computes to roughly a 90% drop for the S&P 500 that it will reach a level at or below 200!!
This is what the early chart looks like assuming the analog comes to fruition with the last S&P leg dropping down by 90% from its highest level.
So the next question is HOW LONG DOES IT TAKE?
Looking at the peak to troughs in this analog, I took the days it took to reach each point and divided it by the percentage move. For instance, in the breakout performance of the S&P 500 from 1995 to 2000, each day (including weekends and holidays) was a gain of roughly 0.126% ( = total percentage move divided by days).
We can gain an idea based on the last leg down of the Dow Jones in the early to mid 1970s of how long the S&P 500 last leg down will be by comparing previous bear cycle data points (as we did in the previous instance above).
Doing such leaves us with a wide range in terms of time frame. On the short end of the scale, we have (revised) 1640 days from peak and on the long end of the scale, 2595 days from peak.
Again, to make it clear, these "days to trough" are gathered by comparing peak to trough percentages of the analog and then dividing them by how long (in days) it takes to get there.
Here is a chart w/ the final legs down - for the Dow which was completed and for the S&P 500 which is estimated on the short end of -0.13% per day (chart #1) and then the same chart but with the longer estimated time frame (chart #2).
My work around this analog (I believe) has now been completed. I hope these series of posts and blogs have been beneficial and if not... at least entertaining. Maybe one day we can look back and call these posts crazy-uber-bear-nonsense and wrong, and I hope so, but we cannot lie to ourselves around data specifically symmetrical data, or that which is analogous.
Good luck and have a great Memorial Day Weekend.
Technically savvy or not, interest in volatility, beta, or not, one needs to should take the time and understanding how this setup echoes that of 2007 top.
As one should know, the VIX has a negative beta (negative correlation). As the S&P 500 prices moves higher (lower), the VIX does the opposite. Of course, there are days where both the VIX and the S&P 500 rise and fall together, but these days are not typical.
Beta itself is a measurement of how an assets price performance moves against the S&P 500. For instance, if beta for stock XYZ was +2 (or just 2), then that would indicate that on average, as the S&P 500 moves higher by 1% stock XYZ would move higher by 2%.
If we take a look at the past 1,000 days of the VIX and it's beta, it has averaged around -3.25. So as the S&P 500 moves higher by 1%, the VIX falls by 3.25% and if the S&P 500 moves lower by a 1%, the VIX rises by 3.25%.
However this average has been much lower, as low as -7 before. Because the VIX (in theory) cannot go to 0, as the S&P 500 moves higher, the VIX balances out at lows. When the S&P has even a small correction, due to the VIX at such low levels, the VIX rises hard. Therefore when the S&P 500 is down 1%, we see insane daily moves in the VIX (e.g. 10-20% gains in one day). This occurred in 2006-2008 when we saw the beta of the VIX decline heavily as stocks were making moves much higher as the VIX stayed around the 10 and 11 mark before the S&P corrected and the VIX shot higher.
What soon occurred was a reversion to the average, seeing stocks plummet and seeing the VIX launch to insanely high levels during the financial collapse. As the chart shows, the absolute bottom point of THE VALLEY OF BETA occurred after the VIX made its uptrend. In fact, the VIX was around 30 at that point. This is due to the long length of the input (1,000 days).
With this said, we are seeing the same thing yet again -
We are currently below the point in 2007 where the VIX makes a bottom. In fact, while the S&P made a new high on Wednesday (followed by one ugly reversal) the VIX made a low back in mid-March 2013.
If we reduce the input length from 1,000 days to 50 days, we see a very similar pattern forming with the beta of the VIX -
What is notable is that in the periods of large negative beta, 2007 and in 2013 where driven by a large leg higher in equity prices as the VIX based out followed by a quick period of selling, driving the VIX much higher. We then saw the trend of higher equity prices resume but the VIX never made new lows. The chart below shows the S&P 500 (in blue, left axis) against the 50-day VIX beta -
Again, this goes to the earlier statement that the VIX can't (won't) go to 0 and therefore a high negative beta occurs when the VIX remains at low levels with the S&P 500 rises before a quick correction in the S&P leads to huge pops in the VIX. It is my belief that we are in a similar situation to that of 2007 as we see suppressed volatility coupled with (and driven by) an influx of investors chasing higher equity prices and as prices correct, the VIX will begin to get its legs back under it.
Finally, I want to share the SKEW/VIX ratio chart dated back to the start of 1990 -
As I have stated in previous posts, this is one of my favorite ratio charts. The SKEW essentially tracks tail risk while we know the VIX tracks implied volatility, both for the S&P 500. The red line is a linear trendline while the black line is a 1,000 day moving average.
Unlike the charts of the VIX and beta, the SKEW and VIX have ranges. The SKEW can move from 100 - 150. As the ratio moves into the 10 - 12 range, it has indicated a lack of fear (or greed) and shows periods in which taking profits would be the best strategy while possibly building a "short book".
One of the most interesting parts of this chart is the peak that occurred in 1994 and then its move down, which was opposite of what the stock market did. This did not occur in the 2003-2007 bull run nor is it occurring now, mostly driven by a lower VIX. We saw 20+ VIX in the 1990s where, if seen now, some professionals would consider selling volatility all day long at those levels. Food for thought.
Have a good weekend.
Friday, May 17, 2013
Notes are either in the charts or are captions... two separate parts to this post: Technical Charts and Fundamental Charts.
Similar price pattern now to what occurred in the Dow back in the 1960s and 1970s. The Dow peaked out 6.7% above its breakout before falling ~50% in 18 months. (Dow chart below, before big fall, see previous post)
|5-Year Rate of Change for the S&P 500 Index|
|VIX Hockey Stick can be seen by watching its 50-day Beta. A repeat of 2007 occurring?|
|White line is 5 year UST yield - 30 year UST yield spread / Blue line (left axis) is S&P 500 Index|
|White is US Treasury Inflation Protected (TIPS) to US Treasury ratio / Blue is S&P 500 Index (left axis)|
|Could Silver be re-entering a bull stage? Cycles say "yes".|
|This chart indicates major a contraction in corporate profits in the coming years.|
|This chart says that the year 2016, the subsequent 15 year return (so since around 2000 - 2001) could be -2.5% if this trend holds true.|
I want to tell you a story. It's short and it's worth the 5 minutes of your day.
This is a story of persistence and patience... but not by who you may think.
In the 1960s and 70s the Dow Jones Industrial Average reached a milestone - Dow 1,000!! But make no mistake about it, that beautiful-once-three-figure index turned four figure did not come without major hesitation. Take a look at some of these charts to see what I mean:
January 1966: Dow touches 1,000 before selling down over 25 % by October of the same year!
|The Dow Jones 1,000 Double Top before the selloff!|
December 1968: The Dow touched 995, but once again fails! The Bulls could not follow through yet again! This time, the Dow Jones drops nearly 37% in roughly 18 months!
|The Dow tries again to break through 1,000 but fails!|
Q2 and Q3 of 1972: The Battle for Dow Jones 1,000 resumes but 980 seems to be the threshold. The Bulls, after over 6 years of fighting at these levels, are exhausted!
|Multiple Tops in the Dow Jones around the 980 level|
All seemed doomed. The Bulls looked to throw in the towel. All hope was lost... and with one last effort, the Bulls gave it their all...
November 1972: The Bulls Have Done It! They take out and run through Dow 1,000! All Hail The Bulls as they have finally defeated the Dow 1,000 Bears!! "We may now rest" they say...
|THEY DID IT! DOW JONES 1,000 HAS BEEN ACHIEVED!|
But as I said, the bulls were exhausted. They had no energy left in them. And it was no time to rest. The taste of victory was so sweet... almost too sweet... and then, the Bears, once thought to have been slaughtered, emerged from hibernation.
January 1973: The top is put in and the Bears finish what they came here to do. The Dow Jones collapses from a high of 1,067 to a low of 573 by October 1974... a low greater than the previous two occasions in which the Dow 1,000 Bulls made their attempt.
|With a grin on their faces, the Bears clean the meat from Bulls bones|
Now... I want you to take this same story, but instead of the Dow from the 60s and 70s, apply it starting in 2000 for the S&P 500.
No, it doesn't repeat word-for-word, but the stories Act I and Act II are identical. In Act I we get a high followed by a major down move (2000-2003). In Act II, we get a retest of the top which fails to break through, followed by a low which was lower than the previous low of Act I (2007-2009).
And now, present day, we are in Act III where we have FINALLY cleared the barrier we've been fighting for 13 years and the Bulls can claim victory... but the story didn't read that way in the past. In fact, it reads that the low market price in ACT III is even GREATER than that of ACT II.
Stop me if you've heard this story before...
Wednesday, May 15, 2013
Someone is going to be proven right.
S&P 500 seems to either be going to 500(~ish) or 2000(~ish) but hanging out in between? Don't expect it.
Why 500? My previous post on analogs have made this case (see Dow Jones from 1960s-1970s and compare it to S&P 500 from 1995-Present).
Why 2000? Because when capital flows get moving, the faucet knob gets stuck, especially when interest rates are this low and the velocity of money (M2) is again, this low.
Time frame? Probably sooner than most think.
Below is the chart of the S&P 500 Index Rate of Change from 2000 to Present. The parameters are set at 260 weeks, or essentially 5 years:
I have put Fibonacci Retracements on the 2000 highs (in red) and the 2007 highs (in black) down to each of their corresponding bottoms. What we can see is that from the 2000 high fib rec, in 2007 we peaked out between the 38.2% and 50% marks. In fact, it peaked at roughly 46.5% which is highlighted by the red dashed line.
In 2007, we currently reside right below that same mark, w/ the 46.5% mark in a dashed black line. Below is a closer look.
On the first chart, in purple, I have put a regression trendline from the 2000 high to the most current figure. The regression TL is the dashed purple line. The solid colored purple lines are +/- 1 standard deviations from the mean. As we see in the first chart, the trend is down as we are nearing the +1 standard deviation line, a sign of potential major resistance (cyclical change).
These two factors (retracing the same as 2007 before the "crash" and the fact that since 2000 we ROC is in a downtrend) could easily make one take the bearish case of the S&P 500.
But... there is a bull case to be made...
First, going back to the first chart, after we bottomed and the ROC trended along for some 2 plus years, it moved in a parabolic like fashion. Right now, the current trend in the ROC has not seen such a move. Could this mean we have more to go?
Another bullish sign is that the regression trendline from the 2000 top to the 2007 saw it move +2 standard deviations (red lines). If we look at the 2007 top to the most current top (today), we have not had that large of a move:
There is something to be understood here and that is the ROC at 260 weeks is a sluggish indicator. This is due to the large parameter setting. To emphasize this, I have included a S&P 500 price overlay w/ the 260-week ROC:
As you can clearly see, the ROC chugged along from 2003-2005 as the S&P 500 made a large move off its cyclical bottom, as highlighted by the first yellow box. Then, when the S&P made its last big leg higher, the ROC went parabolic before the "crash" occurred, as highlighted by the red box.
We have seen similar action from the bottom of 2009 up until 2012 and the ROC is finally playing catch-up (it's been roughly 50 months, or 200 weeks, since the 2009 bottom).
The question is, can we expect one last leg higher? Or have we formed a bottom and we should expect much higher prices moving forward? Let's face it, in nominal terms, we have no resistance above as we have snapped through the double top.
Or... is this it? Are we just about tapped out and can we expect a major sell off to occur?
One may argue for valuations and their historically extreme levels (see earnings yield, PE10, Tobin's Q, Market Cap to GNP for a few) while others argue that the Fed's expansive balance sheet has been highly correlated to the rise in equity prices. Both would have valid points.
I leave you with two last charts... charts that I feel tell a story. Anyone who has read my blog in the past has seen this chart before:
Why this chart? It is of my opinion that we are seeing an almost repeat of the 1937 top in the equity markets. More specifically, in the case of this chart, the Dow Jones of 1929-1939 is a representation of the financial sector in the US, such as the XLF ETF.
We are seeing gold miners (and gold) get murdered day in and day out, all while stocks are rip-roaring higher. This is very similar to what we saw in the mid-1930s as gold miners peaked well before the Dow Jones did. However, as the Dow sold off in 1937, Gold Miners based out and caught a huge bid, revisiting their highs all while the Dow sold down further.
During this period, the dollar was backed by gold. Of course, that is no longer the case. The question is, if this should occurs again it would seem that the fundamentals would have to be different. Massive Inflation? Possibly. But time will tell.
And finally, to drive home the chart above, thanks to Doug Short who built this chart for me, I present this:
What is this? Very simple.
The red line is the Market Value of Corporate Businesses excluding the financial sector. The blue line is Wages and Salaries + Corporate Profits.
As we can see, since 1950 these two lines trended very well together, many of times being the same value. Whenever the red line got above or below the blue line, they reconnect, even if it was some years later. However, since the early 1990s, the red line has dramatically moved higher than the blue line.
With corporate profit margins this high, a lack of jobs for the youth, a growing 65+ years and older workforce, structurally threatening high levels of debt both in the public and private sector (see student loans), it is hard for me to wrap my head around the fact that wages and corporate profits are going to play catch up. Also, history shows that the market value of corporations has "chased down" Wages + Corporate Profits, so this occurrence seems very unlikely. With a lack of jobs comes a lack of income and with a lack of income comes a lack of investment. This is coupled with a negative investing demographic in the US. This does not fundamentally speak to higher equity prices in the US.
I think I have made my bias clear: I am negative on US equities and therefore I do see the S&P 500 visiting the levels not seen since 1995 of around 500, BUT I do not rule out the possibility that massive inflows could still be ahead and a price of 2000 on the S&P 500 is NOT out of the question. If this occurs, it will be my belief that this will be driven through more Fed easing plus international investment.
Monday, May 13, 2013
Please note: when speaking about volatility, I am always referring to implied volatility unless otherwise noted. Also, "vol" refers to volatility, not volume.
At the end of last year/ beginning of this year I had many posts discussing volatility, specifically how this year I see expect to see it return with some vengeance. So far, we have seen a large pickup in volatility in three assets: gold, silver, and the Japanese yen. Yes, there have been other asset classes that have seen some pickup, but these three are the most notable.
The big question on everyone's mind is: do we ever see a major pickup in US equity volatility? Historically, high levels of volatility equals lower equity prices. One of the great trades of 2012 was what some have called "The Great Vega Short".
In a nutshell, "The Great Vega Short" was a simplistic strategy of buying front month S&P 500 Puts (also know as long Gamma) all while selling later dated S&P 500 Puts (or selling Vega). This trade took advantage of the wide spread between the implied volatility between the two different expiration periods. For instance, one may buy June 2013 1630 Puts on SPX while selling the December 2013 1530 Puts. This is an example and not a recommendation.
Another way to look at this is using $VXV and $VIX. The $VXV is the VIX dated 3-months out while the $VIX is, of course, the S&P 500 implied volatility (cash index). The spread between the $VXV and the $VIX is the chart below:
As one can see, back in August 2012, there was a great opportunity to sell later-dated SPX Puts and buy front month SPX Puts. As this spread compresses, the "buy gamma/ sell vega" strategy pays off. At the moment the spread sits around 2.5 points. It is my opinion that this strategy is not very effective at these levels, but rather a return to the 5 point range makes more sense to enter such a trade.
If the inverse occurs, that is the spread moves deeply negative (and it has before, downwards of some 20 points), we would be selling front month Puts and buying later dated Puts. When this occurs, the implied volatility curve steepens at the front end and flattens out towards the back end (the later months).
As fear grips investors, front month volatility becomes more expensive. We are seeing this in gold right now as an example. The chart below shows the implied volatility curve for Gold, the S&P 500, the Russell 2000, and the EM Equity ETF (EEM)on a quarterly basis starting in June 2013 and going out to June 2014 (chart was created yesterday, 5/12).
As you can see, the Gold implied vol curve starts up high and slops down. For those who do not trade options much, this means it is more expensive to buy front month options that later month. When I say expensive I am not referring to the premium one lays out to the buy those options, but rather how much the market is pricing in a move.
A look at the S&P 500 implied vol curve tells the complete opposite story, where front month volatility is much cheaper than buying protection one year out. The "slope" of this curve has been quite consistent for some time for the S&P 500, with a few blips here and there.
The chart below is a year-to-date percentage change of the implied volatility for Gold, the S&P 500, the Russell 2000, and EM Equity ETF, and Oil.
The picture above is very clear: there is fear in the (paper) gold market as investors trying and protect their portfolio's by buying Puts and driving premiums higher. Equities, nor even "black gold" has experienced this flight for protection.
Another way I look at this is the actual implied volatility points (rather than % change). Here is the same chart, but in implied vol point terms:
There are a few points to be made about the chart above:
1. At the beginning of the year, gold vol and S&P vol did not have much of a spread difference. Then, gold vol rocketed leaving S&P vol behind, and in fact near YTD lows.
2. The Gold vol - Oil vol spread has reached zero a couple of days ago. Since the CBOE has tracked the gold vol index, this has never occurred.
3. Gold has a lower beta than the market, and a significantly lower beta than both the EM Equity ETF and the Russell 2000.
If we look at the same data, but this time on a 2 year chart, we will find that gold and the S&P 500 implied vols are very correlated and oil, EM, and the Russell always have higher implied vols consistent with their beta:
Of course, correlation is extremely important, especially when talking beta. Since the $GLD inception, here is a weekly chart of $GLD and its 30-period correlation to the S&P 500:
In more recent times, we have seen the negative correlation between gold and US equities, but one can also see it has its ebbs and flows. If history hold true, we should see these two assets begin to become re-correlated.
So what do we have here? We have gold, a typically positive correlated asset with equities (thus positive beta) has had a major lift in implied volatility, creating a wide spread between gold implied volatility and the S&P 500 implied volatility. History tells us, this spread will compress. Question becomes, do we have a "vol suck" in the gold market or do we begin to see equity volatility, specifically in the S&P 500 begin to lift higher?
I believe the latter and this one chart sums up why:
The green line is the 4-week average of the $VIX - $RVX spread, or the difference between the S&P 500 implied volatility and the Russell 2000 implied volatility. The blue line (left axis) is the S&P 500 price. What is concerning about this chart is the obvious divergence between the S&P 500 price and the implied vol spread between the SPX and the RUT. Moreover, the 4-week average is back to levels not seen since 2008 and 2010, right before sell-offs occurred.
But just to add another layer of worry on the markets, here is one more telling chart:
This chart is the 4-day average of the $SKEW / $VIX ratio (in green) and the S&P 500 (in blue, left axis). To know what the SKEW index is, read the segment at the end of this for the CBOE's "clean" explanation. What is obvious here is again, the divergence between price action of the SKEW / VIX ratio and the S&P 500. The 4-week high of the ratio was made back in March all while the S&P continues to make new closing highs day-after-day.
In summary, volatility is present but expect more. Equities (domestic and international), bonds, and many commodities have continued to remain flat when it comes to volatility but there are many indications out there that the tides may be turning such as the potential end of "The Great Vega Short" in the S&P, the rarely seen wide implied vol spread between gold and the S&P, the implied vol difference between the S&P and the Russell, and finally the SKEW / VIX ratio.
The signs are present... but in the end we must not forget what really matters... what drives markets: sentiment. With sentiment comes flows (in and out of asset classes). If sentiment for the US equity market continues to remain positive and global flows continue into the US, nothing else matters.
Sometimes one can see THE storm ahead while others doubt such an event will occur. Conversations about the financial market landscape I've been recently having remind me much about Michael Shannon's character (Curtis) in the Jeff Nichols 2011 film "TAKE SHELTER". Curtis sees (and hears) THE storm of storms coming while no one else can. The question becomes is he crazy (which he even questions himself) or will he be proven right?
Introduction to CBOE SKEW Index ("SKEW")
The crash of October 1987 sensitized investors to the potential for stock market crashes and forever changed their view of S&P 500® returns. Investors now realize that S&P 500 tail risk - the risk of outlier returns two or more standard deviations below the mean - is significantly greater than under a lognormal distribution. The CBOE SKEW Index ("SKEW") is an index derived from the price of S&P 500 tail risk. Similar to VIX®, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options. SKEW typically ranges from 100 to 150. A SKEW value of 100 means that the perceived distribution of S&P 500 log-returns is normal, and the probability of outlier returns is therefore negligible. As SKEW rises above 100, the left tail of the S&P 500 distribution acquires more weight, and the probabilities of outlier returns become more significant. One can estimate these probabilities from the value of SKEW. Since an increase in perceived tail risk increases the relative demand for low strike puts, increases in SKEW also correspond to an overall steepening of the curve of implied volatilities, familiar to option traders as the "skew".