“Said woman, take it slow, things will come together fine… all we need is just a little patience…” ~ Guns N’ Roses
“The February employment report almost certainly means the Fed will no longer describe its policy intentions as “patient” at the conclusion of the March FOMC meeting. And it also keep a June rate hike in play.” ~ Tim Duy
The strong jobs report showed how much this market fears a rate hike
Stocks folded like a cheap tent on Friday after the US jobs report crushed expectations. The carnage in the Dow and the S&P was significant. Bonds and utilities were also crushed. Gold and gold stocks were drug out into the street and shot (more on that shortly).
Moves like this show you just how foolish — and dangerous — markets can be. The more overextended and shaky the long case becomes, the more potential you get for downside volatility surges where the bottom just falls out.
And the catalyst for this drop should not have been a surprise either. The jobs report was outlier-level strong, but not that much of a shocker in context of recent events. The fears represented were not new or unexpected. The market simply chose to switch-flip from nervous complacency to mini-panic, par for the course in shaky spots.
From a price action perspective, the S&P is now in “gotcha” mode, as in, for anyone who was complacent about recent bullish activity, Friday equaled “gotcha!”
Markets ignore data points and risks, then foolishly overreact to those same data points and risks, because this is what PEOPLE do
Academia says a lot of stuff about markets that doesn’t make sense. Are markets rational? No. Are markets efficient? Kind of but not really. Do markets discount the future with perfect accuracy? Ha ha, that’s really funny.
Some of the worst academic ideas are the ones suggesting the market is “perfect,” as in, reflecting perfect information, or perfect information or some such.
These ideas come out of the specific needs of academia — for example the need for elegance. A school of thought needs elegant theories and pretty mathematical equations, which are much easier to work with (and build academic careers around) than messy theories and a lack of tidy equations.
So they come up with stuff and try to retrofit reality into an artificial box. They reverse engineer messy reality to their laughable rigid theories, and try to say “this is how the market works,” and then get hostile when real world practitioners (without PhDs or fancy equations) dare to disagree.
If you throw most of that stuff away, however, and understand that markets are a bunch of people — and since when are people perfect — making emotionally biased decisions by the seat of their pants, it all makes a hell of a lot more sense.
Are markets generally rational? Yep. Are markets sometimes wildly irrational? Yep. Do markets do the best job they can but sometimes botch it? Yep. Are markets prone to goofy theories or bad ideas? Yep. Are markets generally smart but sometimes amazingly dumb? Yep.
You know who else that paragraph describes? People…
Short utilities, one of our biggest trades, crushed it on Friday.
We have been pounding the table for the “utes” and how crowded a trade they were. In particular, we noted the interest rate sensitivity of utilities, and the foolishness of money managers who sought haven in SPDR Select Sector - Utilities (NYSE:XLU).
On Friday XLU was one of the biggest droppers, in both absolute percentage and relative volatility terms. The jobs report was like yelling “Fire” in a crowded theater.
The WSJ had a piece out over the weekend showing utilities’ tendency to decline sharply ahead of interest rate tightening cycles. Here is the graphic:
Gold stocks were slaughtered on Friday too — but we were already gone!
The media does not understand trading. The majority of investors certainly do not understand it.
That is why, over and over, you hear the assumption that trading is about making predictions. But that’s not the key thing. Successful trading is not about making good predictions. It is about making good decisions.
Winning traders do not have a crystal ball as to how the future will unfold. Instead they gather information and data, and become aware of various scenarios. Then they use new information to make logical decisions as scenarios confirm or disconfirm.
We were long Market Vectors Gold Miners (ARCA:GDX) because we liked the pattern and the backdrop, but also because gold stocks were a hedge against a weakening dollar.
The USD could have weakened as markets interpreted Yellen as dovish. If this had happened, our bullish dollar positions would have softened, and gold stocks would have run higher.
Instead, the opposite happened. The hawkish Fed scenario intensified, the dollar got stronger (greatly benefiting our USD positions), and gold and gold stocks cratered.
The hawkish Fed scenario helped us a lot — in our bullish USD and short XLU positions, which are very large. But we got out of long GDX — our alternate scenario holding — before Friday’s bloodbath because that is what price told us to do.
Price is your friend…
Meanwhile long bonds may have topped out… as shown by a potential bottom in ProShares UltraShort 20+ Year Treasury (ARCA:TBT)…
Fears of a Fed hike also whacked bonds hard. We recently wrote of a potential major top in bonds.
The bullish action in TBT, which inversely mirrors long bonds, backs up that notion (we are long TBT now).
Again this stuff isn’t rocket science. It is just understanding scenarios and data points and paying attention to price!
Disclosure: This content is general info only, not to be taken as investment advice. Click here for disclaimer