Wednesday, March 04, 2020

Observations During These Unusual Market Conditions

Below are a couple of fresh observations from the morning of March 5th:

*  In the chart below, going back to late January in the SPX futures, we can see the course of the recent market activity (each bar = 500,000 contracts traded).  Note the sequence of green bars in the middle display, showing net volume transacting at the market offer price (i.e., buyers more aggressive) vs. the market bid (sellers more aggressive).  Observe, however, that the aggressive buying could not move price above the March 3rd highs.  This pattern shows up in markets ready to reverse, and we can see how trapped buyers have been exiting overnight.    

SentimenTrader points out that all 10 major market sectors have traded in the same direction for six of the last eight sessions.  Usually, when we see market bottoming, we see a reduction in correlations among sectors, as some areas of the market hold up better than others.  That isn't happening yet.

*  A nice way to see if fixed income investors are anticipating economic weakness is to track the relative performance of investment grade bonds (AGG ETF is one example) versus high yield bonds (HYG ETF is an example).  When we see AGG notably outperforming HYG, we know that markets are pricing in increasing odds of default for the high yield issues due to anticipation of recession.  Of late, we've been seeing flight to safety, not speculative buying of higher yield bonds.

I've had a record number of phone calls, emails, and Skype chats in recent days.  The uncertainty of the Coronavirus outbreak and volatility of market reactions has created unusual trading and psychological conditions.  Here are a few takeaways from the conversations:

1)  Many traders focus on the stock market, but the collapse in yields among Treasury instruments is perhaps even more significant.  Who would have thought a little while ago that we would be seeing a 10-year Treasury yield under 1%?  As SentimenTrader notes, this flight to safety has been associated with stock market rallies one to two months forward.

2)  Figuring out who is in control of the market is at least half the battle.  I like Brian Shannon's use of the anchored VWAP for this purpose.  When we see a potential turning point in the market, constructing a VWAP from that point provides a useful reference.  Take note:  That same anchored moving average concept can be applied to the NYSE TICK to identify the balance of buying and selling from a given point.  

3)  Keeping your holding period constant in a fast market exposes you to unexpected risk.  The market is moving much more per minute and per hour than it had last year.  There is more volume trading, and the market is moving more for each unit of volume tradedMike Bellafiore notes the value of "scalping" in this environment:  containing the holding period is a form of risk management for the flexible trader.  Getting stuck in fixed opinions has hurt traders recently.  Open mindedness has been every bit as valuable as conviction.

4)  Are we looking at the correct tail risk in the Coronavirus outbreak?  I hear a lot of people talk about the "overreaction" to the virus.  The great majority of people don't die from the virus, you might get sick for a while, and that's it.   But what if antibodies to the virus are weak and people who contract the virus:  a) continue to harbor the virus and spread it and b) are susceptible to reinfection?  A "biphasic" disease would mean that we could be dealing with the fallout from the virus for far longer than expected.  And, yes, we are getting reports of reinfection, which could complicate the burdens placed upon healthcare systems.

Operating with confidence in an uncertain environment is dangerous.  Knowledge begins with what we don't know--and the open-mindedness to continually revise our assumptions as new information emerges.

Further Reading: