Buy Everything! Now! (EWP)

Buy Everything! Now! (EWP)

 

One looks at the numbers, does a double take and asks, “How the heck did this happen?  And how long can it continue? It doesn’t make any sense!”

 

Consider the bond market – now on a torrid rip higher that added 4% in the span of just ten weeks.  Nominal returns on ten year issues are a meager 2.16%, while the real return is now figured at a measly 0.36%.

 

What gives?

 

Why the buying thunder?

 

Where’s the fire?  And who’s behind the horde of purchases that swamped the market in the last two months?

 

More than that, why buy bonds at all?  And why now?  The dividend yield on the S&P 500 is a competitive 1.69%, while a great many blue chips offer a whole lot more.  And consider, too, that the S&P 500 has paid investors 17% in capital gains over the last seven months (since the election) and is showing no signs of letting up.

 

Why both bonds and stocks?

 

Why is everyone buying both?

 

And not only that, but what’s with gold these days?  Why is everyone boarding that bus, too?

 

Is there anything out there these people won’t purchase?

 

Have a look –

It’s unbelievable.  FIFTEEN PERCENT SINCE XMAS!

 

Why the spending spree?

 

And what to do with a VIX read that’s closing in on zero!

 

Have a look at this –

The VIX, a measure of implied volatility on 30 day SPX options, is now below 10.  Until one month ago, VIX had only sunk below that level ten times since 1990.  In the last thirty days, however, it has ventured below the ‘10’ line AN ADDITIONAL TEN TIMES.

 

And that has led many to wonder whether the CBOE’s famous ‘fear gauge’ is now signaling investor abandon, that light gaiety that assumes the market will rise indefinitely – just before it tops out and begins its headlong descent into HELL!

 

Or, rather, does it mean that we’re headed towards a ‘new normal’, in which VIX values plumb greater and greater depths while the market forges ever higher highs.

 

Hard to tell.  But historical data indicate that it’s unlikely we’ll see a continuation of the latest carefree behavior.

 

The following VIX distribution chart says we’re likely headed back toward mean values of between at least eleven and thirteen.

 

Take a look –

Nearly thirty years of data and only a handful of sub-10 occurrences.

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It’s our belief, however, that the actual, raw VIX number is of less import than a derivative value we began computing some fifteen years ago that we refer to as ‘volatility compression’.

 

We were pioneers in its development and use and hold staunchly to the notion that high compression days on the VIX are more apt to lead to meaningful selloffs on the broad market than straightforward low VIX values.

 

So what is ‘volatility compression?

 

In a word, it’s a measure of minimal daily movement on the VIX chart.

 

Below is a graphic depiction of the concept using Japanese candles –

The actual volatility compression reading is determined by subtracting the day’s high from the day’s low and adding it to the difference between the day’s opening and closing VIX reads.

 

A very compressed day would therefore offer a sum in the area of 0.3 to 0.5, though we’ve seen selloffs occur after readings in the 0.6 range, as well.

 

That’s not to say that a decline MUST be precipitated by a low volatility compression day.  It simply means that an extreme compression reading offers greater chance that a selloff is around the corner.

 

And where is the VIX today?

 

Despite the historically low VIX numbers posted over the last month, a look at the chart shows that we’ve yet to experience the type of compression required for a dump in the averages.

 

Have a look –

This is VIX for the last month.  As you can see, we had two incidences of relatively tight compression, the first on the ninth of May (that presaged a major, one-day selloff on the S&P 500) and another on the 25th of May.

 

Yet neither number came in tight enough to lead us to an imminent bearish forecast.

 

What’s compression got to do with it?

 

Many have asked us why we believe the compression figure speaks so directly and with such abundant correlation to an imminent change in market direction.

 

And the truth is we haven’t investigated it so thoroughly, nor did we feel the need to do so, as the numbers themselves provided proof enough that the indicator worked.

 

But if we had to hazard a guess, we’d aver that extreme compression days are analogous to that ‘Wile E. Coyote moment’ that comes just before gravity seizes hold and the inevitable crash to earth ensues.

 

Remember…?

It’s as if market players stopped, looked left and right, bought their options, but all WITH AN EYE TURNED BACK OVER THEIR SHOULDER, WONDERING IF THEY WERE DOING THE RIGHT THING.

 

In such a scenario, PUTs and CALLs get bought in roughly equal measure for roughly the same price all day, as no one is sure enough to stick his neck out and step deliberately in either direction.

 

And that’s what leads to the compression.

 

We think.

 

It’s that uncertainty, that ‘where to next?’ sense of anxiety, that also ultimately triggers the cascade of selling that follows.

 

This Week’s Trade

 

Speaking of cascades of selling, we believe Madrid and Barcelona may be in for a doozy in the near term.

 

Spanish stocks are among the most overbought assets on the planet, and the Spanish stock index is trending extraordinarily far above its long term moving average.

 

Have a look here –

As you can see, Spanish stocks have outperformed nearly all other investments this year, and…

they’ve stretched the limits of 200 day, moving average credibility.

 

Moreover, as the chart below shows, they’re also overbought according to the iShares MSCI Spain ETF (NYSE:EWP), a proxy for the Spanish Bourse.

With an overbought RSI reading (in green), and a significant gap on the downside yet to fill (in red), we expect EWP Spain to retrace to at least the $30 level in the near term, and perhaps as low as the bunched moving averages in the $28/29 range, where strong support arrives.

 

So…

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With kind regards,

 

Hugh L’ O’Haynew

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