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Why is volatility dropping going into the Fed meeting?
It's happening again—the CBOE Volatility Index, a measure of how panicked investors are about the stock market—is down again today. It's been mostly in a downtrend for three weeks, ever since briefly spiking over 50.
Those fears have not gone away. Yet the VIX has been dropping. What does this mean? It is implying that traders believe the Fed decision this week is not going to create a lot of volatility…whether they raise rates or not.
That seems a bit strange, given this is one of the biggest Fed meetings in years, and a rate hike is still very much on the table, and no one is quite sure what the market reaction will be if they do raise rates.
What's going on? The short answer is that on a longer term basis, the VIX is elevated—it's been trading mostly between 13 and 16 for the past couple years, with occasional spikes over 20.
Still, it's not elevated much. At 22, the VIX is implying a move of roughly 2 percent up or down in the S&P 500 in the near-term.
That's not much; many think given the uncertainty about the implications of a rate hike, the VIX should be in the 30s.
Why aren't investors panicking and buying more protection? Volatility traders I have spoken with in the past couple days offer several explanations:
1) Many traders DID panic and buy protection: worries over the Fed raising rates, along with concerns about China imploding, is precisely why the market suddenly turned south three weeks ago and the VIX briefly spiked over 50.
Traders who bet on a spike in volatility won: they sold their positions and made a bunch of money.
2) The majority of traders are taking their cues from the Fed Funds market, which is assigning the probability of a hike to only roughly 30 percent. Because buying protection has become more expensive, many traders have concluded it is not worth the price.
3) even if the Fed raises, most traders believe it is "one and done" (for a while), and that the beginning of hiking cycles has been very strong for the markets.
One final point: there's not a lot of panic about the coming months either. VIX futures contracts for October, November, and December are all in the low 20s as well.
So does all this mean that the markets are free and clear? I don't think so. Global growth—not the Fed—is the issue that is clearly the most concern for the markets.
You can see this in oil, which many consider a proxy for global growth. Big daily moves in oil definitely have translated into moves in equities, particularly energy, basic materials, and industrials. According to Credit Suisse, 70 percent of the volatility in oil on a daily basis is transferred into U.S. equities.
That's a sign that global growth is the big story to watch.
I'm just back from a week in London, and if you think New York shows signs of massive outside investment, you should visit London.
It is literally a different city from the insular place of 20 years ago. Whole swaths of the city have been completely rebuilt, much of it from the ground up.
The neighborhood I stayed in, Shoreditch in the East End, was traditionally a grimy, working-class neighborhood, the home of Jack the Ripper's murders and Dickens tours. The famous Old Spitalfields market, a rundown marketplace 30 years ago, has been completely redeveloped with tony shops and upscale pubs.
Everywhere, the influx of foreigners is evident. The cabs, the restaurants, and the stores were filled with Turks, Somalis, Ethiopians, Lithuanians, and Syrian employees. The famous Selfridge's department store looked like a United Nations meeting; I heard dozens of languages in a 20-minute walk around the four block-long floors.
How they can afford the place is a mystery to me. It's still one of the most expensive cities in the world. A typical subway ride is about $8, depending on how far you go. A pint of bitters is roughly $7 to $9. Fish and chips in a small hole in the wall is $16.
Oddly, an Uber ride is a great deal—often less than $10.
Given how dynamic London has become, it's surprising the stock market is not doing better. The FTSE 100, a basket of the 100 largest firms listed on the London Stock Exchange, is the worst performing market in Europe this year, other than Greece.
Europe this year:
With the jobs report out of the way, it's time to look ahead. Two developments next week may impact markets: 1) China economic data, and 2) the start of the analyst conference season.
Next week there will be a raft of China data that will get a high degree of scrutiny, including Trade (9/8), CPI/PPI (9/9) and Retail Sales (9/12).
Any signs of stability there might calm the Chinese market.
More importantly for U.S. stocks, the analyst conference season begins. This is not normally a big market mover, but with the global uncertainty traders will be looking for comments from CEOs on the state of their business for guidance in pricing stocks.
This will be the first time many tech, industrial, and financial companies will have the chance to address investors since their conference calls, which were several months ago.
The Fed's Beige Book report was filled with commentary mostly positive on the U.S. economy, and collectively implies that a rate hike in September is definitely not off the table.
Some excerpts hint at this:
1) "economic activity continued expanding across most regions"
2) "Retail contacts in a majority of Districts reported that their sales and revenues continued to expand."
3) "Most Districts reported increased auto sales."
4) "Districts reporting on the banking sector mostly tallied increases in both business and consumer loan volumes."
5) "Reports on residential and commercial real estate markets across the Districts were mostly positive."
6) "Most Districts reported modest to moderate growth in labor demand."
7) "This tightening of labor markets was said to be pushing wages up slightly in selected industries or occupations"
Given the global uncertainty, most in the trading community have turned decidedly against raising rates in September. The issue is not a 25 basis point hike; it's a small number. The issues is the Fed's credibility. Many traders say the market volatility is signalling the market is having a confidence issue with the Fed's analysis and intentions.
Judging by the Beige Book, it seems the odds of a rate hike are a bit higher Wednesday than it was Tuesday. I'm not so sure there will be a huge response in the stock market if they do raise; I'm more concerned about the bond market, where a sudden spike in rates is a real possibility.
This makes Friday's jobs report even more important. Consensus is for a gain of 220,000 jobs. A very low number--say, below 170,000---will likely be greeted as an indication the Fed is unlikely to raise rates.
Similarly, a very high number—say, north of 280,000—would likely confirm that a rate hike is a very real possibility.
We gapped down 2 percent at the open and stayed down.
You can blame it on China's poor manufacturing numbers if you want, but the number was in line with consensus. This was a broader selloff than that. The whole market was down roughly 3 percent. OK, industrials like GE and United Technologies down 2 to 3 percent, I can understand. Commodity names like Exxon or DuPont down 2 or 3 percent make sense. They all have international exposure.
But telecom and utilities? They were all down 2 or 3 percent as well.
U.S. stock markets opened lower after Chinese PMI data came out last night. The number came in at 49.7 in line with expectations, but at a three-year low, the first reading below 50 since February, implying contraction.
Surprisingly, some traders are suspicious of this number. They note many factories near Beijing have been closed for weeks in order to clean up the pollution ahead of the Thursday military parade, and that the September numbers will be better.
Maybe. What's odd is that the prevailing wisdom has been wrong again on China.
The theory has been to go long China for the early part of this week because of the enormous military parades on Thursday celebrating the end of World War II, or at least China's war with Japan. Markets will be closed in China Thursday and Friday.
Yet the Shanghai Composite ended down 1.2 percent, and the Shenzhen fell 4.6 percent.
You really have to wonder at what is going on in China. Four regulatory agencies have issued a joint statement "encouraging" listed companies to take action to shore up their shares. These suggestions include:
1) Pay dividends, which very few Chinese companies do.
2) Buy back more shares. They will provide tax breaks to help do that.
3) Do more mergers. State-owned banks will be encouraged provide loans to companies to do those mergers and acquisitions.
4) Do more restructurings.
Fed Vice Chairman Stanley Fischer may have insisted "I will not, and indeed cannot, tell you what decision the Fed will reach by September 17," but the market is reading his comments as hawkish.
There are other issues weighing on stocks overnight.
2) China's Manufacturing PMI will be out tonight. There is concern it could be weaker than expected. China's Shanghai Composite was down 0.8 percent on reports the government would no longer buy shares. (We'll see.)
3) U.S. crude was down as much as 2 percent before the open, though it rallied somewhat near the open.
And, of course, there is the issues of that extraordinary rally on Thursday and Friday.
There are still plenty of bears betting that that rally will have trouble sustaining itself in early September.
The rally held for a second day, but not without a ridiculous amount of drama.
You know me, I never judge the markets. Don't yell at the stock market, that's always been my motto.
But today? The Dow went up 2 percent in the last 45 minutes.
THAT, is ridiculous.
Once again, looking at a chart of the Dow really doesn't do justice. This is the way to look at the day:
Open gap—up 200
Mid morning rally—up 180
Mid-afternoon swoon—down 300
Late-day rally—up 330
Traders bought stocks hand over fist. There were seven stocks advancing for every one declining.
Volume was heavy once again, though not as strong as early in the week.
A 10 percent rise in crude made energy stocks the star performer.
If you just look at the 300-point rise in the Dow, coupled with yesterday's better-than-600-point rally, you might be tempted to say that we have turned the corner. But the crazy intraday moves do not inspire confidence. We need to see a few boring August days before traders believe the worst is behind us.
There's a new bogeyman in town: market on close orders (MOCs) which most traders blamed for the big decline in the last hour of trading yesterday. But what are they? Who is buying and selling at the close? Let's take a look.
What is a MOC? A market on close (MOC) order is a market order executed at the close. That means the order gets executed at the final price, regardless of what the price is.
Who places MOCs? All professional traders can put in MOCs: institutions, mutual funds, hedge funds, ETFs.
Why put in orders to buy and sell exactly at the close? Some may simply want the last trade because they want the price of the stock before the next morning's open.
Many accounts will judge their performance (for the day, week or year) against the close.
Mutual funds, for example, typically only price their assets once a day, at the close. If you put in an order in the middle of the day to buy or sell a mutual fund, the price of that fund will depend on the closing prices of the underlying stocks.
Likewise, if you put in an order to buy or sell a mutual fund after the market closes, the price of that fund will depend on the closing prices on the following day. You do not get the opening prices, since almost all mutual funds only price once a day, at the close.
How do they know how much there is to buy and sell at the close? Brokerage houses send in orders to buy and sell individual stocks at the close throughout the afternoon. At 2 PM, the NYSE aggregates the data and publishes an imbalance feed for individual stocks that have buy or sell imbalances in excess of 50,000 shares. Floor brokers can see these indications, but they are not public.
These indications are updated continuously. On a typical day, there might be buy or sell indications on a few hundred stocks, though typically there are only a few dozen that are really large and might affect the closing price.
At 3:45 the NYSE publishes the MOCs to the public. NASDAQ publishes at 3:50.
The NYSE does not publish an aggregate of all the buy or sell orders. However, some floor brokers will aggregate all the orders and float informal buy or sell imbalances for the whole market.
CNBC will often mention these informal indications going into the close. You might hear, for example, "There's $400 million to sell at the close."
You get this by adding up the dollar value of all the buy orders, the dollar value of all the sell orders, and then subtract. For example, if there is $1 billion to sell, $600 million to buy, you have a $400 million sell imbalance.
Why publish MOCs? The purpose of publishing the imbalance in individual stocks is to attract liquidity. For example, if there is a buy imbalance of, say, $50 million on Pfizer, that is a signal for sellers to come in and offer stock, and vice-versa.
How are MOCs executed? At the NYSE, the designated market maker (DMM) sets a closing price for the stocks that he or she is responsible for at or just after the close.
What are average aggregate MOCs? At 3:45 PM, it is fairly typical to see a buy or sell imbalance of $300 to $600 million. $1 billion is on the high side of typical.
What happened yesterday? At 2 PM, there was roughly $1.5 billion in aggregate for sale (numbers vary depending on who is doing the estimate), a large number. But it got worse from there, and by the close there was roughly $3 billion for sale, a very large number.
The NYSE does not break out the numbers by who is buying and selling. However, the MOC is traditionally weighted with institutional orders, most of which represent mutual fund flows from retail investors.
Do MOC orders tell us anything about the close? There have been many attempts at this. With the advent of big data, there has recently been attempts to aggregate the orders and see if any trading patterns could be ascertained.
However, there are certain days when orders are so imbalanced that it's clear the final closing prices would be higher or lower.
Yesterday was one such day. It wasn't just that the aggregate orders worsened going into the close, it was the size of the sell imbalance was so great there was no chance that "buy" orders coming in at the close would be sufficient to move any of the indices to the upside.
When traders realized this, they sold ahead of the close.
Once again, the markets have opened up strongly. We'll see if they close that way. In the last four trading sessions:
1) A lot of stock has been sold
2) A lot of protection has been bought
3) Sentiment indicators are at historic extremes
I struggle to describe how far some of these indicators have gone, but by any measure—option put/call ratios, movement in the VIX, or Relative Strength Indicators (RSI)—we are at extreme levels.
Another indicator to look at is the 50-day moving average for the S&P 500, one of the most-watched technical indicators.
According to our partners at Kensho, the S&P 500 is 4.35 Standard Deviations from its 50 day moving average.
It's hard to describe how rare that is.
To give you an idea of how far out we are, one standard deviation means that an event would occur outside the range 1 in 3 times.
Two standard deviations one in 22 times.
Three standard deviations one in 370.
Four standard deviations 1 in 15, 787.
4.5 standard deviations one in 147,160 times
That's where we are, between 4 and 4.5 standard deviations. What has happened here statistically happens somewhere between one in 15,787 and 147,160 times.
Meaning, like, almost never.
Kensho's data only goes back to 1980. There has been one time this has happened: August 8th and 9th, 2011, which is when Standard & Poor's downgraded U.S. sovereign debt.
In the following week later there was a notable snapback:
S&P 500: up 7.5%
Russell 2000: up 10.4%
Energy: up 10.4%
Materials up 9.9%
That's a good sign, which makes complete sense.
Of course, this is only one datapoint, one event. Which highlights what strange times we are living in.
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