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Donald Trump and Market Volatility

Trump’s Surge in the Polls, Comes with Stock Market Volatility

We’d like to personally thank the thousands of journalists who were instrumental in helping markets mis-price risk.

RCP = Real Clear Politics average of over 15 national polls

VIX = The Chicago Board Options Exchange Volatility Index reflects a stock market estimate of future volatility

As you can see above, stock market volatility is directly tied to Donald Trump’s election fortunes.  As “The Donald” has surged in the polls, so has volatility in the markets.  Over 1000 journalists globally have conditioned investors that this election is over, equity markets are NOT prepared for a Trump Presidency.

“Here’s what market pros are watching.  Activity in the VIX futures market and the Mexican Peso speak to a market volatility spike in the near term for U.S. equities. In the below chart, the spread between the 2 month VIX future and the 8 month is converging, just as it did Pre-Brexit. This is a classic vol spike early indicator. Get long and stay long volatility over the next two weeks.”

Quote from Bear Traps Report, October 31, 2016

Flattening VIX Curve, A Market Crash Omen

In this chart we see how much flatter (green line above) the VIX curve is today than it was last week (blue line) and even in August (orange line).   Elephants leave footprints, capital is piling in on purchasing near term insurance on the stock market, the green line says it all. 

This summer, the market was complacent and ignored coming risks.  Longer dated VIX contracts traded much higher than those in the short term. This gives you a very steep VIX futures curve as we saw last week. The market was not paying up for near term volatility as it was heavily discounting risks such as the U.S. election. The curve began to flatten yesterday, which gave us a proprietary risk signal that further volatility and weaker equities would be coming next.  Today we got it, as the short term VIX contract heavily outperformed the longer dated contract.  This was a market sell signal we shared with clients this morning.  Institutional investors were buying near term protection in the face of uncertainties such as Trump, Italian credit risk and a lower oil price, events we expect to continue.

Pick Up our Election 2016 Trading and Investing Themes Here:

As we advised clients yesterday, a sharp flattening of this curve leads to risk reduction across asset classes. Today, we saw that play out with equities and credits selling off.

Elephants Leave Footprints, Look for the Clues

Here, we see the convergence in the 2 month VIX future and the 8 month VIX future. Money is piling in on the 2 month, meaning people are paying up for short term insurance on the market. The 2 month VIX future is getting bid up, becoming more expensive. This shows the markets more near term fears.

Pick Up our Election 2016 Trading and Investing Themes Here:

Here’s our appearance on CNBC today

Join our Larry McDonald on CNBC’s Trading Nation this Wednesday at 2:30pm ET

Pick Up our Election 2016 Trading and Investing Themes Here:

In recent months, the Mexico peso has surged with Hillary Clinton’s chances of winning the U.S.  presidential election.  In a shocking development, since the 25th of October the currency is a whopping 3% lower against the U.S. dollar.

Since Friday’s news that FBI is reopening its investigation into Clinton-related e-mails,  the peso tells us far more than any new polls.  The currency is telling us she has lost a lot of ground, Trump’s chances are approaching 50%.

U.S. Dollar – Mexican Peso

Higher $ / Peso Below = A Weaker Position vs. the Dollar

A Year Ago 16.5 Peso’s to the U.S. Dollar, Today it’s 19

Since October 25th, ES1 (S&P 500 E-mini Futures Contract) is off 1.7% as the Mexican Peso has weakened.  CFTC data show, net-short positions on peso recorded before latest FBI revelations, fell 18% in week to Oct. 25.  They reached the lowest since May, but that’s changing fast, shorts are piling in.

Join our Larry McDonald on CNBC’s Trading Nation this Wednesday at 2:30pm ET

Join our Larry McDonald on CNBC’s Trading Nation this Friday at 2:30pm ET

Since late 2013, the investment strategy that has worked far more than others has a lot to do with meticulously tracking global political risk, especially out of China.  Investors who have been patient, sitting back while waiting for market fear have been rewarded by putting capital to work into panics.  Chasing rallies has been a fools game, keeping an eye on global systemic risk is the key to finding the next opportunity.

Goldman Sachs is wisely back beating on the capital flows warning drum.   Today, in a new report they estimate 56% and 87% of outflows took place through offshore yuan market in July and August; and that was before the latest surge in the USD.  Our data shows similar panic in terms of actual capital leaving the country.

As the Bear Traps Report did in June, Goldman Sachs started including yuan funds in its analysis of outflows in July, after noting that cross-border movement of the currency masked actual pressures.

As the U.S. Federal Reserve tries to make any move toward a rate hike, China has been the victim.  China’s currency, the yuan is pegged to the dollar.  A surging greenback makes anything China sells to the world more expensive, putting them at a trade disadvantage globally.

Pick up our latest report, “What the Great China Devaluation means for US Equities” here:

Yuan cross border payments surged to near $30B in August (that’s compared with a monthly average of $4.4 billion in the five years through 2014).   Outflows are far bigger than they appear in our view, China’s been cooking the outflow books since February in an effort to punish shorts.

After last year’s bloodbath, China’s foreign-exchange reserves appear to have stabilized and lenders’ net foreign-exchange purchases for clients have fallen close to a one-year low.

China’s currency outflows have been closely linked to surges in US equity market volatility, pick up our report here:

The most dangerous men on earth might just be those 13 central planners in a room in Beijing.  They can cook the books all they want but elephants leave footprints.  Money is still pouring out of China.  A surging amount of capital is exiting the country in yuan rather than in dollars.

Pure common sense will tell you such colossal cross-border moves can’t be explained by market-driven factors and need to be taken into account when measuring currency outflows.

Three month CNH volatility has been tame as speculators have been licking their wounds, preparing for their next attack, next move.

Behind the scenes there is some taboo control, unwritten rules as to how much the PBOC (China’s Central Bank) will allow companies to convert into dollars onshore.  As a result, they need to move the money overseas in yuan.  When you connect the dots, a 5 year old can tell you the cash hemorrhage continues out of China.

Companies in China are fearful of a depreciating currency, it’s a hot potato they don’t want to hold, so they sell it to offshore banks. This pressures the offshore yuan’s exchange rate.

USD/MXN opens 1.2% lower (stronger peso) as markets react to a weekend filled with drama.  The Donald Trump video scandal and more damaging WikiLeaks emails on Hillary Clinton have eyes on the peso to determine where the election blood really is.

Peso Bellwether 2016

The Mexican peso is an election 2016 bellwether, Trump’s very strong positions on trade and the immigration have put the peso in position as a decent election risk indicator.  A strong peso is a win for Clinton, loss for Trump in terms of real time capital flows on expectations.

Pick up our Election 2016 Report Here:

Debate Number Two This Evening

Two weeks ago as the first televised debate between the U.S. presidential candidates raged on, the Mexico’s peso began its move.

Hillary Clinton had such a low bar coming into the first debate.  The peso had been selling off violently for weeks heading into the big verbal shouting match on the issues.   Clinton’s health became a serious issue, lowering expectations dramatically.  When she appeared on stage in decent health, throwing punches without a wailing cough, the peso surged, USD/MXN plunged.  Pick up our Election 2016 game plan, investment themes and trade ideas here:

The peso jumped 1.5 percent to 19.013 per U.S. dollar within in an hour of markets opening in Asia on Monday.

Pick up the Bear Traps Report here:

Another ugly “jobs report” crushed the chances of a Federal Reserve rate hike.  Fed Fund Futures data plunged from 18% on Thursday to 8% on Friday looking at the chances of a November hike.

“We are an apolitical institution (we have no political agenda, ya right)…the jobs report was solid”

The Fed’s Mester (a dissenting hawk), October 7, 2016

In reaction to the sad jobs report, this weekend Federal Reserve Vice Chairman Stanley Fischer said there’s little risk that the central bank will fall “behind the curve” in the short term, while emphasizing that a gradual increase in interest rates will be sufficient to meet its goals.

This is a very dovish shift from Fischer.  In August in Jackson Hole, he was viewed by markets leaving the door open for two hikes in 2016.

“With the federal funds rate modestly below the neutral rate, the current stance of monetary policy should be viewed as modestly accommodative, which is appropriate to foster further progress toward our objectives,” he said in prepared remarks for a speech on Sunday in Washington.

“But since monetary policy is only modestly accommodative, there appears little risk of falling behind the curve in the near future, and gradual increases in the federal funds rate will likely be sufficient to get monetary policy to a neutral stance over the next few years,” he said.

Pick up the Bear Traps Report here:

Pick up the Bear Traps Report here:

Political Leaders Don’t Realize the U.K. has become a Colossal Financial Institution with a Country on the Side

The Bank of England has no room to raise interest rates to protect the plunging Pound and deal with pending inflation.  As you can see above, 5yr forward inflation swaps exploded to the upside this week.  The market is pricing in a coming inflation surge.  The UK economy is far too pound sensitive in inflation terms.  Many investors don’t realize the significant amount of floating rate mortgages with teasers in the UK.  The country would experience a housing crisis if rates rise too quickly. 

The UK’s global economic position is heavily reliant on trust in its banking system and capital inflows, much from the Middle East and Russia.   The current Brexit policy path is in direct contradiction to the main economic engine supporting the UK.

A Banking Explosion Near Danger Levels

In 1960, the UK’s banking balance sheet to GDP was 40%, by 2010 it was 450%, today nearly 600%; and “oh by the way” Brexit is this engine’s mortal enemy.  A nasty side effect of globalization is barreling toward us.  As developed markets globally produce less and less every year, they’ve become a shell of their former selves.  There comes a point where a country can become far too dependent on financial engineering.

The UK’s colossal current account deficit has the Bank of England fighting with one hand tied behind its back.  After decades of making mathematically unsustainable promises to labor unions (trying to buy votes), the UK is at its breaking point for its currency.

Hard Right Turn by the UK’s May

Prime Minister Theresa May’s harsh migration stance unveiled this week on will only exacerbate a worsening UK economic situation.   We feel this was a trigger with a heavy hand on Thursday night’s flash crash in the Pound, please see the chart below.  Far to the right of Donald Trump on immigration, her proposal requiring UK corporations to publicly list foreign workers “draws Nazi Germany comparisons” according to Bloomberg news.

With debt to GDP surging from 40% to 90% in recent years, the UK’s current account deficit is now a troubling -6% of GDP.  An economy heavily funded by a banking system, high level of external long term debt and real estate confidence; these engines are crumbling under the weight of Brexit risk pointed at them.  The Pound is losing support from all sides, has a way to go on the downside.  See our latest report below:

Pick up the Bear Traps Report here:

The UK is essentially an offshore bank heaven.  When politicians begin messing with their trade agreements and banking counter parties, that spells trouble far more significant than the man on the street may realize.

An Incredible Week for Sterling

Since 1970, there have only been seven instances when the Pound fell 15% vs the U.S. dollar in six months. Since May, the pound is off nearly 13% against the greenback.  We’re living in financially significant times indeed.

Pick up the Bear Traps Report here:

This chart below is representative of what US economist got all wrong about Federal Reserve rate hikes in 2016.  So many sell side firms start with the view of the chief economist and work down from there in terms of their view on interest rates, forex, credit and equity views for the year.  So misguided.

What Did They Miss?

The dollar and all the global leverage tied to it, blew up the street’s view in 2016.  Over the last 14 months, nearly every meaningful surge in the dollar has been followed by a substantial surge in equity market volatility, cutting the Fed off at the past in terms of their “lift off” plans.

Pick up the Bear Traps Report here:

As you can see here, every major spike in equity market volatility over the last year was led by a surge in the U.S. dollar.  Economists have been blind to credit risk (thanks to the easy money gravy train since 2008, there’s over $10T globally) tied to the dollar.  In a consumed state, economist have been focused on lagging indicators like U.S. economic data.  Credit risk vetoed the Fed’s policy path in 2016, economist never saw it coming.  They were too busy lecturing us on U.S. jobless claims and the coming 4 rate hike of 2016.  One sorry and confused bunch.

Pick up the Bear Traps Report here: