The Rally That Wasn't
The action on Thursday was telling. For now. I think.
Once again, equity risk in the U.S. was controlled by the now wildly volatile U.S. Treasury yield curve. Robust-looking July Retail Sales -- supported by Amazon's AMZN Prime Day, as well as similar events at Walmart WMT, Target TGT and others -- enthused the crowd. That optimism quickly faded to black as only 45 minutes later July data for domestic Industrial and Manufacturing Production as well as Capacity Utilization clearly illuminate a U.S. industrial base in overt retreat.
If not the domestic macro, what then did force broader equity markets sharply lower and then rally hard into the close? The answer lies in Finland.
Remember Olli Rehn? Big name from the European Debt Crisis of 2010 to 2015, and the sitting governor of Finland's central bank. Rehn also sits on the rate-setting committee of the European Central Bank (ECB). Midday, The Wall Street Journal published an article quoting Rehn as he opined on the possibilities that lie ahead for the ECB in September. Keep in mind that the ECB decides on Sept. 12, six days ahead of the Federal Reserve, but the Kansas City Fed holds its annual dog-and-pony show at Jackson Hole toward the end of next week. Volatility, both good and bad, is now a fact of life.
Fire for Effect
A few readers will know the term "Fire for Effect." This term applies when calling in artillery or mortar fire once coordinates are understood as correct and there is a need to saturate the impact area with shrapnel. This is exactly what the ECB is doing to try to do, according to Rehn. The industry already expects that the central bank, in response to a German economy (considered Europe's strongest) already in contraction, would be likely to cut the deposit facility from -0.4% to -0.5% while kick-starting monthly bond purchases -- known as quantitative easing -- to the tune of 50 billion euros per month (around $56 billion).
Rehn indicated that the recent weakening of the European economy "justifies taking further action in monetary policy, as we intend to do in September." Rehn implied that this coming stimulus package could be greater than currently anticipated, as he went on, "It's often better to overshoot than undershoot."
Does this mean the ECB changes rules limiting purchases to 33% of any single nation's sovereign debt? Does this mean the ECB at least talks about equities? Rehn did not rule that out. Does this mean the central bank tweaks the terms of Long-Term Refinancing Operations (LTRO) in an effort to cut the European banking industry a break? That group has been crushed by what negative rates have done to net interest margin. This is also why U.S. banks are so severely undervalued relative to tangible book value.
The thing Olli Rehn really did on Thursday was herd European investors into U.S. Treasury securities. First, German 10-year bunds rallied hard to yields below -0.71%. The influx of European money then spiked U.S. paper, which slam-dunked the entire Treasury curve. The U.S. 10-year note reached yields below 1.5%, and the 30-year bond to an incredible 1.927%. Thankfully, the U.S. curve has recovered somewhat overnight.
Keep in mind that the algorithms controlling U.S. points of sale are in tune with the curve. Traders don't need to worry in the very short term if a flat or inverted curve warns of recession, or even the end of the business cycle. They certainly can, and they probably do. That's another day's fight. For today, traders must understand what those who write these algorithms are doing. For the short term, their response is reflective of pressure impacting the curve, and they will react to technical levels over fundamental analysis. That's just the way it is.
My thoughts? As easier monetary policy permeates the global economy and central banks (coordinated or not) return to purchasing assets through the expansion of money supply, the performance of both equities and debt securities will correlate in the way that they did in the post-crisis years. (Psst.... The crisis never ended, it was suspended through artificial means, and coming policy shifts will be an attempt to go back to the same well.)
I may not agree in my heart with how the environment that I must exist in is created. I am a free markets kind of guy. That said, the mission as always is to excel in the environment provided and, where there is a mismatch in skill sets, to adapt as necessary in order to be able to excel. There is no whining. We find a way to win.
It is at that point that, regardless of corporate performance, equities likely benefit from the higher valuations afforded through a perception that "There is no alternative," also known as TINA. Does that happen before or after the end of the business cycle? Good news on trade certainly extends the cycle. There is no way to disguise that truth. It's also unpredictable.
What Can Be Done?
I have talked until I have been blue in the face about my thoughts regarding how slow the Federal Open Market Committee (FOMC) has been to respond to the threat of an inverted or far-too-flat yield curve. Too many associate the need for policy movement with data dependency, which also is known as missing the forest for the trees. My rant has always been about yield curve repair and currency exchange rates. It has never been about past performance.
Oh, you hit a home run yesterday? Congratulations. Funny thing about today's game -- it's not being played yesterday.
So, it is still imperative that the Fed suppresses the short end of the yield curve. I think it key that the Treasury Department gets involved here as well. Not only could Treasury impact the curve through expanded issuance at longer maturities, thus creating scarcity at the short end, Treasury could simply tax foreign investment across a graduated schedule, increasing toward the longer end of the curve, in order to make longer-term yields less attractive to foreign accounts. This would also in effect reduce demand for U.S. dollars. This is not rocket science.
Am I out of my mind to discourage foreign investment? That is a possibility. Are such policies easily reversed once the business cycle is successfully extended? On that, I am not sure. I do know that in a less globalized world, which is where I think we are going, that we better figure out how to fight our own financial battles.
Trading Nvidia (NVDA)
I don't know if this is going to work. It may be close. Weeks, even months ago, I lightened up on semiconductors.
Don't get me wrong, I hung on to Advanced Micro Devices (AMD) . CEO Lisa Su had long turned my loyalty from Intel (INTC) toward AMD. The market had forced me to work my way out of Micron Technology (MU) . I had dabbled in Western Digital (WDC) and Taiwan Semiconductor (TSM) with, respectively, positive and negative results.
That leads me to Nvidia. This name, which is a holding of Jim Cramer's Action Alerts PLUS charitable trust, has been behind some of my greatest victories as a trader, as well as one of my most notorious blunders. (For those of you who remember that blunder, it took months of effort, but I won that fight and exited that position with a W. Yes, admittedly that's an ego thing.)
So it is that I entered Thursday night with a small, underperforming equity stake in the name. To be honest, I don't know if I will trust NVDA with a large position again anytime soon. However, I always look to drive revenue during weeks like this. Revenue generation comes into focus especially when markets are challenged.
I often discuss the use of options as a way to reduce net basis or simply protect equity positions, but I don't often discuss slightly more complex options strategies with readers. That said, I am going to explain what I did on Thursday ahead of Nvidia earnings as something of a tutorial. I don't really know if it worked just yet, but this is something good for the folks who may be less advanced in the use of options to possibly begin to think about.
Midday Thursday, Nvidia was trading $148-$149-ish. Options expiring this Friday were implying a rough $10 in volatility. An Iron Condor is a bet that the shares of the underlying security will stay in a range. The thing this really not-so-complex strategy entails is the sale of a bull call spread coupled with the sale of a bear put spread.
In this case, to the upside, I sold 157.50 calls and bought 162.50 calls both expiring today. To the downside, I sold 140 puts and bought 135 puts, again expiring today. This trade gained some popularity throughout the day as the volume expanded in particular for the two options on the put side, letting me know that I was not the only professional who saw this as an opportunity to raise some cash.
The max profit is simply the net credit realized. In my case, $2.25. Should the underlying shares close on Friday evening between $140 and $157.50, I keep the dough. The last sale I see in the overnight session is $158, so this may not be a winner, but I do still have that equity stake. S&P futures are higher as well. The potential for loss is limited. Should the shares close below $135 or above $162.50, well, I'll have to give back $5 for a net loss of $2.75 on the options trades. My break-even points are $137.75 and $159.75. Any close within that range means the iron condor was profitable. Any close outside will mean that it was not. Bottom line is this is an attempt to raise cash at limited risk.
Economics (All Times Eastern)
08:30 - Housing Starts (July): Expecting 1.26M, Last 1.253M SAAR.
08:30 - Building Permits (July): Expecting 1.27M, Last 1.22M SAAR.
10:00 - U of M Consumer Sentiment (Aug-adv): Expecting 97.4, Last 98.4.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 764.
The Fed (All Times Eastern)
No Public Events Scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)