Volatility Has Returned
Trump fires back at North Korea (again)... The U.S. military is 'locked and loaded'... Volatility has returned... Why we could see more downside ahead... One of our favorite whipping boys is plunging again...
Apparently 'fire and fury' isn't enough...
The war of words between President Trump and North Korea's Kim Jong Un escalated again on Thursday.
Speaking from his New Jersey golf course, the president denied that his previous remarks – where he vowed North Korean threats would be met with "fire and fury" – had gone too far. Instead, he said that he may not have gone far enough. As the Wall Street Journal reported...
"They've been doing this to our country for a long time, for many years, and it's about time that somebody stuck up for the people of this country and for the people of other countries," Mr. Trump said...
"So, if anything, maybe that statement wasn't tough enough... And I will tell you this, North Korea better get their act together or they are going to be in trouble like few nations ever have been in trouble in this world"...
Asked what statement would be tougher, Mr. Trump said: "Well, you'll see. You'll see."
We didn't have to wait long...
Following another round of threats from North Korea – warning that the U.S. would "suffer a shameful defeat and final doom if it persists in extreme military adventure, sanctions, and pressure" – Trump fired back again.
Early this morning, the president tweeted that the U.S. was ready to respond with military force immediately, if necessary...
Once again, the markets have taken notice...
Gold and silver rallied for the third straight day to two-month highs on Thursday.
The major U.S. indexes closed lower for a third straight day, suffering their biggest one-day losses since May's "mini-panic."
And despite the relatively small decline in stocks, volatility shot higher. The CBOE Volatility Index ("VIX") – the market's "fear gauge" – jumped 44% to its highest level since last November's election...
Regular Digest readers shouldn't be surprised by these moves...
We've been warning about these risks for months now. As we discussed in the July 25 Digest...
Even a small market decline could push volatility sky-high... Recall that stocks and volatility tend to trade inversely. In particular, spikes in the VIX usually occur during stock market declines. And the more sudden or sharp the decline, the bigger the jump in "fear" tends to be.
But that may not be the case today. Because so many traders are short the VIX, even a relatively small pullback in stocks could push volatility much higher. This is because traders have to buy the VIX to close their short positions, and this massive buying pressure could push it even higher.
In other words, we could see something of a "short squeeze" in volatility itself.
In fact, we saw a small example of this during the "mini panic" back in May. The broad market – as tracked by the S&P 500 – fell less than 3%. But the VIX jumped 50%... from near 10 to more than 15 over just a couple of days.
If we experience a broad-market pullback of 5%, 10%, or more – and remember, we're long overdue for one – volatility could easily double or even triple from here.
Unfortunately, it seems many folks were caught completely off-guard. As Bloomberg reported yesterday...
The biggest selloff in U.S. equities since May sparked an unprecedented rush for protection in the options market.
About 2.6 million puts and calls tied to the CBOE Volatility Index changed hands on Thursday, the most on record... About 3.4 call volatility options – a bearish equities trade – have changed hands for every put contract.
Again, we can't know if this is the start of the first meaningful pullback in almost two years...
The markets rebounded today... Stocks were up a little, while the VIX pulled back. Perhaps that's all we'll see.
But we're not ready to give the "all clear" just yet. Despite the small losses in the major indexes, many stocks have fallen much more. In fact, as of this morning, an unbelievable 200 stocks in the S&P 500 – 40% of the entire index – had already fallen 10% or more, putting them in official "correction" territory.
We remain cautious. We could see more downside before the "Melt Up" resumes. Stay long, but stay "hedged."
Another week, another new low for Snap...
In the meantime, one of this week's biggest losers will sound familiar to regular readers...
Shares of popular social-media firm Snap (SNAP) plunged again this morning following worse-than-expected second-quarter results. Both sales and revenue were weaker than analysts predicted. The firm also added fewer new users – and earned less revenue per user – than expected.
While the poor results are bad enough, the firm's troubled relationship with Wall Street – and even its own investors – is doing it no favors, either. As financial-news network CNBC reported this morning...
"The company's reluctance to provide guidance is driving the Street to make unachievable forecasts..." Drexel Hamilton analyst Brian White wrote in a note.
The absence of guidance is the latest example of Snap wanting Wall Street's money but not playing by Wall Street's rules. Snap remains at odds with index firms and investors over its multiple-class share structure that fails to give most shareholders a voting stake.
Jefferies analyst Brian Fitzgerald echoed White, saying that "even an overly conservative guidance would be appreciated" by shareholders, even if they don't have any say.
"Snap's unwillingness to provide Street guidance will continue to be a disservice to shareholders as estimates continue to fluctuate wildly and it introduces unneeded uncertainty into results," Fitzgerald wrote in a note.
SNAP shares were down another 14% today to a new all-time low. Shares have now lost more than 50% since they began trading in March.
New 52-week highs (as of 8/10/17): PowerShares Chinese Yuan Dim Sum Bond Fund (DSUM), KraneShares E Fund China Commercial Paper Fund (KCNY), Weight Watchers (WTW), and short position in GGP (GGP).
In today's mailbag, more on the "Escher Economy"... and some confusion about yesterday's decline. How's your portfolio holding up? Let us know at feedback@stansberryresearch.com.
"'The Escher Economy.' I think Porter has described this exactly correct. What a great description! ... It's pretty easy to see that our economic leaders lost track of reality, thought they could control the economy and have created a far worse problem than just saving and living within each individual's means even when excesses run wild. A far smarter strategy would have been to face the excesses of debt immediately and remove the blocks to the economy functioning, collusion, regulation and favoritism and let capitalism rebalance itself with far less debt.
"Bernanke and Draghi are lucky they're old because when the collapse comes society will sure be looking for a scapegoat. As the world economy becomes a drug addict it's becoming far more obvious these 'leaders' had no idea what they were doing." – Paid-up subscriber Al McInally
"What happened to the stock market yesterday? My entire portfolio of stocks/Mutual Funds/EFTs/bonds fell over $22,000 in value. Is this drop temporary or is this the start of the Melt Down?" – Paid-up subscriber Carolyn Furumoto
Brill comment: Sorry Carolyn, but do you actually read the Digest? We recall writing something about that on Wednesday...
"What, no crowing today about the sudden reappearance of volatility? You should take a bow..." – Paid-up subscriber Chris C.
Brill comment: Clearly, Chris has been paying attention...
Regards,
Justin Brill
Baltimore, Maryland
August 11, 2017