Doug Kass: The New Regime of Volatility Is In Place

 | Jun 25, 2018 | 11:00 AM EDT
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Stock quotes in this article:

mu

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spy

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QQQ

* The Titanic May Be Soon Hitting the Ice
* Downside Risk Overwhelms Upside Reward

* The New Regime of Volatility Is In Place, Accelerated By the Possibility of Policy Mistakes and a Changing Market Structure
* Trade More, Invest Less: Think Trading Sardines and Not Eating Sardines


It's just another manic Monday

I wish it was Sunday
'Cause that's my fun day
My I don't have to run day
It's just another manic Monday
-- Bangles, Manic Monday

The Bangles "Manic Monday," was actually written by Prince, using the pseudonym "Christopher." Often compared to The Mamas and The Papas, " Monday, Monday" it was a 1986 release and the group's first big hit.

The proximate cause for the early morning future's drop (-17 handles) is the heightened trade tension between China and the rest of the world with the U.S. - something Jim "El Capitan" Cramer and I have been consistently cautioning about.

The leveraged ETFs and quant strategies (e.g., volatility trending and risk parity) and changing market structure may take it from there and could create a turmoil filled and volatility trading session today.

Donald Trump is Making Economic Uncertainty and Market Volatility Great Again as the second order impact on trade, global economic growth and business confidence is being upended at a time stocks are elevated in price and valuations (particularly against GAAP expectations). ( A talking head on CNBC just told my pal Brian Sullivan that "earnings quality is terrific." No it isn't, that Wall Street pablum and "Group Stink" as the gap between Non GAAP and GAAP earnings have never been wider. Stocks, measured against GAAP #s are preposterously inflated).

#MUVGA

Meanwhile, the partisanship in Washington, D.C. - on both sides of the pew - has never been more pronounced and a disquieting backdrop of animus and hostility reins. The impact of this condition on consumer and business confidence remain unknown.

Valuations are contracting, stocks are beginning to ignore good results (e.g., Micron Technology (MU) ) and the risks of policy (both fiscal and monetary) miscues are rising -- at a time in which monetary policy around the world is pivoting towards tightening.

Meanwhile, the benefits of the corporate tax reduction is trickling up and not trickling down.

Bottom Line

I was long as the S&P Index rose in early June. but I moved back into a net short exposure (via defined risk (SPY) puts and with a short (QQQ) ) at mid-month as signs of global economic ambiguities multiplied, investor optimism grew and the threat of policy mistakes increased -- and the downside risks were heightened as measured against upside reward.

Market Downside: 2400 to 2450
'Fair Market Value': 2500
Trading Range: 2550-2750 to 2800
Current S&P Cash (Adjusted for this morning's future drop): 2735

Here are the current reward versus risk parameters (based upon the -15 handle drop in S&P futures, 2735 S&P equivalent):

1. There are 310 points of downside risk against only 65 points of upside reward (compared to the top of the expected trading range) in my new pessimistic case (2400-2450). This is an overwhelmingly negative reward vs risk ratio (5:1).
2. Compared to 'fair market value,' (2500) there are 235 points of downside risk versus only 65 points of upside reward. That's a negative 4:1 ratio.
3. Against the expected trading range, there are 185 handles of downside risk and only 65 points of upside reward (to the top end of the anticipated trading range). That's a 3:1 adverse ratio.

There are more Shades of 1999 and signposts that FAANG may have peaked, while we face a new regime of volatility reflecting a host of factors and the possibility of increased economic and market outcomes (many of which are adverse).

A changing market complexion is occurring coincident with global monetary tightening - making equities and other long dated assets less attractive as the risk free rate of return expands.

I wish it was Sunday.

That's my fun day.

(This commentary originally appeared on Real Money Pro at 7:59 a.m. ET on June 25. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)

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