Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24
How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - 17th Feb 24
Why Rising Shipping Costs Won't Cause Inflation - 17th Feb 24
Intensive 6 Week Stock Market Elliott Wave Training Course - 17th Feb 24
INFLATION and the Stock Market Trend - 17th Feb 24
GameStop (GME): 88% Shellacking Yet No Lesson Learned - 17th Feb 24
Nick Millican Explains Real Estate Investment in a Changing World - 17th Feb 24
US Stock Market Addicted to Deficit Spending - 7th Feb 24
Stocks Bull Market Commands It All For Now - 7th Feb 24
Financial Markets Narrative Nonsense - 7th Feb 24
Gold Price Long-Term Outlook Could Not Look Better - 7th Feb 24
Stock Market QE4EVER - 7th Feb 24
Learn How to Accumulate and Distribute (Trim) Stock Positions to Maximise Profits - Investing 101 - 5th Feb 24
US Exponential Budget Deficit - 5th Feb 24
Gold Tipping Points That Investors Shouldn’t Miss - 5th Feb 24
Banking Crisis Quietly Brewing - 5th Feb 24
Stock Market Major Market lows by Calendar Month - 4th Feb 24
Gold Price’s Rally is Normal, but Is It Really Bullish? - 4th Feb 24
More Problems in US Regional Banking System: Where There's Fire There's Smoke - 4th Feb 24
New Hints of US Election Year Market Interventions & Turmoil - 4th Feb 24
Watch Consumer Spending to Know When the Fed Will Cut Interest Rates - 4th Feb 24
STOCK MARKET DISCOUNTING EVENTS BIG PICTURE - 31st Jan 24
Blue Skies Ahead As Stock Market Is Expected To Continue Much Higher - 31st Jan 24
What the Stock Market "Fear Index" VIX May Be Signaling - 31st Jan 24
Stock Market Trend Forecast Review - 31st Jan 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

When the Market Moves Fast, Stuff Blows Up

Stock-Markets / Financial Markets 2014 Dec 11, 2014 - 06:26 PM GMT

By: John_Mauldin

Stock-Markets

One of my old rules of trading is that whenever a major asset class, index, or other benchmark has a sudden, rapid move in price, something blows up. Sky high.

That’s because people get used to regimes. They get used to a certain state of affairs with a lack of volatility. They become complacent. Maybe they stop hedging. Maybe they allow themselves to have unbounded downside risk. Maybe they start gambling.


In the last month, we’ve seen massive moves in the dollar and oil—and I assure you, someone is going to get hurt.

So far I haven’t said anything controversial. Energy companies are going to get hurt by lower oil prices. Exporters are going to get hurt by a rising dollar. A chimpanzee could figure this out.

But there are second-order effects. People are starting to figure out that Canadian banks are going to get hurt by the lack of investment banking business from the energy sector, and the stocks are getting punished.

And there are third-order effects too, which people will soon discover.

If you sit around and think hard enough, you can make these sorts of connections. Some people are very good at this. A commodity price moves fast, and they can figure out the point of maximum pain for some company far down the supply chain from the actual commodity.

I’m not that smart. But I’m smart enough to get out of the way when something big and important like oil moves 40%.

Let’s step into our time machine and set the dial to 1994. That was the year when interest rates backed up a couple of percentage points. Remember the bond market vigilantes? They were pricing in Hillarycare and a Democratic Party wish list, and they caned the bond market until interest rates were making borrowers squeal.

But what was interesting about 1994 was that in the grand scheme of things, interest rates didn’t go up all that much. Just a couple of percentage points. Now, if I asked you who you thought would get hurt by rising rates, you might say banks, hedge funds. And you would be wrong. Who got hurt by rising interest rates?

Procter & Gamble.

Orange County, CA.

Mexico.

Why did the first two blow up? Derivatives.

By the way, I’m not referring to derivatives pejoratively. I’ve spent most of my adult life trading them. They’re not financial weapons of mass destruction. What they do is take risk over here and move it over there. So if bank XYZ was negatively exposed to higher interest rates, they were able to offset that exposure to Orange County through derivatives.

Of course, the derivatives Orange County was trading were very exotic and clearly unsuitable for a municipality, but that’s a discussion for another time over a burger and a beer. The point is that rates moved, and they moved fast, and stuff blew up.

But not the stuff you thought would blow up.

Buying Volatility on the Cheap

So I know what you’re going to ask me next: What’s going to blow up?

Who knows? By definition, you can’t know, especially when the risk has been laid off through derivatives.

But this is how it works: Oil moves 40%, the dollar moves 10-15%, and someone’s out of business. It could be someone big. It could be someone systemically important, someone that could really spook the markets. So when stuff like this happens, I get myself exposure to things that gain from disorder (paraphrasing Black Swan author Nassim Taleb).

With the S&P 500 Index (SPX) at 2,050 and the CBOE’s Volatility Index (VIX) at about 15, systemic risk is vastly underpriced.

I’m not saying that stocks are too high, that I’m bearish. I’m just saying that the derivatives markets aren’t pricing in what could be a big unwind based on these oil and dollar moves.

Translation: volatility is cheap.

Is $60 oil bullish for stocks, long term? Absolutely. It is one of the most bullish things I can think of. One of my clients recently told me that this decline in oil will result in $100,000 in annual fuel savings for his business. Multiply that times everyone. So bullish. And the dollar, also long-term bullish. But in the short term, there’s an Amaranth out there somewhere, potentially.

Maybe it’s not a hedge fund. Maybe it’s a company like Coca-Cola (KO) that gets the majority of its earnings from overseas. Maybe it’s the railroads. The person who can figure this out wins the prize.

As I said before, I’m not that smart… just a former trader with scabs on his knuckles. But the funny thing about those traders—especially the ones over 40—is they have a nose for trouble. I’m all in favor of bullish developments, just not when they happen really fast and nobody is ready, which is how people get maimed.

Position: long three-month SPY puts, short Canadian Imperial Bank of Commerce (CM) and Toronto-Dominion Bank (TD) (the US-listed shares).

Jared Dillian

The article The 10th Man: When the Market Moves Fast, Stuff Blows Up was originally published at mauldineconomics.com.
John Mauldin Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in