Seeking Alpha: The Biggest Week in 2 Years and the Summer Crash of 2011

“It’s easy to have faith in yourself and have discipline when you’re a winner, when you’re number one. What you got to have is faith and discipline when you’re not a winner.” – Vince Lombardi

Since June 8, I’ve been publishing article after article arguing for why the market was likely to undergo a substantial decline at some point during the summer. My reasoning for arguing that the conditions favored a Summer Crash? First, the overwhelming bearishness that existed toward bonds. Second, the fact that the bond/stock price ratio had been trending higher since mid-February. Third, intermarket relationships, particularly relating to junk debt spreads, were reaching extremes.

And then came last week, the market’s biggest weekly move in 2 years. To put the week into context, the enormous comeback in risk assets in 5 days at quarter end ranks as being in the top 2.5% of all weekly gains for the market since 1950. Perhaps more stunning was the complete collapse in bonds and substantial increase in yields in government debt. Incredibly bright traders and bond managers have been commenting as of late that the move was breathtaking back into risky debt, and that it was nearly impossible for anyone to make money as a result because of the speed of the price action.

Markets have a funny way of doing the unexpected. For me, the move was particularly frustrating since I had just written a piece arguing for further declines for Mr. Marc Faber, who was kind enough to publish it alongside his Monthly Market Commentary just last Thursday. Was I completely wrong, or is this another head-fake that can still result in a Summer Crash? Let’s take a look at the price ratio of Bonds to Stocks to see what really happened last week. As a reminder, a rising price ratio means the numerator/TLT is outperforming (up more/down less) the denominator/IVV.

Bonds (TLT)/Stocks (IVV) – A Summer “Ratio” Crash

(Click charts to enlarge)

The blue line is a rolling 20 day (1 trading month) moving average. The relationship of bonds to stocks completely collapsed last week. In my series of articles arguing for a Summer Crash, I made the argument that the TLT/IVV price ratio should actually be closer to 1 given the stunningly low yields we saw just prior to last week’s move, and given the magnitude of outperformance in defensive sectors such as Consumer Staples (XLP), Healthcare (XLV), and Utilities (XLU) for the bulk of the year. One week gave back six week of bond outperformance relative to stocks, sending the price ratio to mid-May levels.

Are the conditions for a Crash now erased because of a single week that ranks in the top 2.5% of all weeks going back to 1950 for equities? Does the move even make sense given that there were weekly fund outflows out of equities last week? Sure, one could argue that Greece is resolved for now, but what about Portugal? Spain? Ireland? Forget about country sovereign risk – what about junk debt?

Equities tend to go through periods of hightened volatility when junk debt falls/yield rises, coinciding with an opposite move in Treasuries. When credit spreads widen, it’s a big warning sign. Take a look below at the price ratio of the SPDR Lehman High Yield Bond ETF (JNK) relative to the 7-10 Year Treasury Bond ETF (IEF).

When the ratio rises, it means credit spreads are compressing. When the ratio declines, it means credit spreads are widening. When credit spreads widen by a substantial amount (as they did minutes before the May 6 Flash Crash happened), watch out. Yes – there was a massive comeback in junk debt last week, which ultimately is what caused equities to recover as violently as they did. However, the move is too extreme. The JNK/IEF ratio has not gone back to new highs. If anything, the ratio appears to be headed back down again.

In conclusion? There was a reverse crash that happened last week, but these ratio relationships still need to be resolved. Given still historically low yields and still elevated outperformance in defensive sectors, I continue to believe the price ratio should be closer to 1, not 0.703 as it is now. What would confirm this is if Junk debt relative to Treasuries collapse once again and give back all of the outperformance gained last week.

Time will tell of course. The only thing I know for sure is that markets fluctuate.

via Seeking Alpha

SMB: The unprofessional summer trader

This is the time when all the tweets and blogs start about hitting the links, or grabbing drinks early, or heading for the beach.  If you have ever traded prop at a big firm you will see seats empty on Friday after 1pm.  There will be many who do not come back from lunch on a Thursday.  Missed Mondays and long weekends are a given.  I just do not get this.

When I first started trading we considered it a privilege to be connected to the inside market.   Well it is.   It was not that long ago when the banks had a monopoly on connectedness to the inside market.  Never forget that.  Trading is a privilege.

In this world of over-stimulation and immediate feedback do young traders expect too much action all-the-time from the market?  If you have to sit and just watch stocks trade from 11am to the close without a trade is that so horrible?  You are not laying concrete on an overheated highway.  You are sitting in a comfortable chair, A/C blasting, surrounded by friends, with access to the internet and music and TV.  Part of trading is waiting, just being on your desk, ready to pounce on an unexpected opportunity.

If you do not have a vacation planned then sit in your seat and focus.  Trading does not mean always having positions. A great deal of trading is gathering data so that you can gain an edge for a future trade.  That might be intraday, or the next session or next week.  But if you not at your seat because you deemed a session too uninteresting for your full focus then you are not preparing yourself for that next great trading opportunity.  This is not you at your best as a trader.

Once you accept that you can conclude a day not worth your full attention you become a lesser trader.  If you step onto a trading floor you are there to work.  All day.  With all your focus.  Anything less is unprofessional.

 

http://www.smbtraining.com/blog/the-unprofessional-summer-trader