Let me say up front: I’m not trying to scare anyone. $VIX 54 shock on Friday says people are already scared. My mantra remains: Keep calm. And I’m not one to scream bear after markets have already dropped and are in stress. As many of you know I’ve already done my warning screaming before this drop.
But I also want to be as realistic as possible with what’s going on here and the risks associated with it and offer a few perspectives and scenarios. So here goes:
We’re faced with the most critical time since the financial crisis. That’s not my opinion, this is what the $VIX says. It’s behaving in a very unusual and rare way and everyone better pay very close attention. When I made the $VIX 46 call in January it seemed like an idiotic call to make for $VIX moves into the 40’s are extremely rare. But it happened and $VIX hit 46 a week ago and now on Friday $VIX hit 54 before again reverting below the trend line I had originally drawn in January (see Big Calls).
What’s the $VIX really saying here? That the Fed and every central bank on the planet are at high risk of losing total control over these markets in which case $VIX could go to 90 and $SPX could ultimate drop to 1800-2000. That’s not hyperbole, that’s what the charts say, the same charts that told you $VIX 46 was coming and that suggested a big drop was coming:
— Sven Henrich (@NorthmanTrader) February 11, 2020
And here we are with long term fibs highlighting major reversion risk in the months and years to come if a global recession is unfolding:
Last week’s panic rate cut by the Fed was a complete failure. Again the Fed misread the market and the incompetence is stunning. On February 20 and 21 Fed speakers were arrogantly cheerleading and arguing no rate cuts were necessary. Two weeks later they panic cut. The Fed has been wrong and chasing reality for years now. Everything they’ve done has been in response to markets, the balance sheet roll-off was a failure and now they have expanded to record treasury holdings, their rate cuts since 2019 have all been ineffective and now coronavirus, which in fairness they couldn’t have possibly seen coming, is wreaking havoc on the entire market construct.
Nobody can blame the Fed for the coronavirus, but what I will blame them for is the asset bubble they have created. The multiple expansion they unleashed on markets in 2019 and into early 2020 were a complete reckless disaster and now we’re possible staring at the greatest bull trap ever.
Remember, bears were stupid right? That was the sentiment. Retail jumped long. Everybody and their mother were upgrading stocks and markets left right and center, who needs protection right? Well, total disaster and I mean total disaster. Small caps, transports, banks, more than a year of buying completely wiped out in a matter of a couple of weeks:
Complete collapse on the yield front to all time human history lows, but the disconnect being glaringly obvious way before the coronavirus hit as the trigger:
None of this is normal, none of this speaks of control or calm. These are signs of panic and price movements utterly out of control. A crash in various asset classes.
The banking sector dropped 28% from the December highs. Small caps have dropped 17% from the January highs. Transports nearly 25% from the January highs. This is a full blown bear market in these indices. And be clear: Last week this market behaved like a vicious bear market. Furious rallies, vicious sell offs in the blink of an eye.
Do not underestimate the damage that is being done here. Oil markets are completely collapsing. Saudi Aramco is trading below its IPO price. Shale producers in the US look to be in big trouble. Over one year of buyers in many stocks and markets simply under water with many trapped at much higher prices.
The risk: That some funds are getting wiped out and over-leverage and unpreparedness and fear among retail investors will cause the calm passive investing trend to turn into ‘get me out at all cost’ panic selling. A systemic deleveraging the likes of which we have never seen before. And then it wouldn’t matter if the virus situation improves. The damage will already have been done, companies would have to tighten belts, lay off people and the business cycle would turn in earnest:
Markets recently reached higher valuations than even during the 2000 dotcom bubble. We were at 159% market cap to GDP just a few weeks ago, but now we have the highest debt levels ever on top of that. A credit bubble with the highest corporate debt ever. The consequence:
This is not 2000, this is not 2008, this is an entirely different beast here. And it’s angry. Very angry. And these next few weeks/days even hours may be absolutely critical.
As of now investors are still hopeful that this correction here will just be like all the others we’ve seen under the control regime of central bankers. Short, confined to a few weeks at best, and then the rally monkeys will come back, especially if the virus will be contained.
But for now, whatever you think of the ultimate impact of this virus, the bad news hits keep coming and the economic damage that is inflicted is real.
The big macro concern remains the same: Let’s take the longest and slowest recovery business cycle & the most indebted global economy, use cheap money to jam markets to the highest market cap to GDP valuations ever and then shut down the global supply chain and then let’s see what happens with central bankers having the least ammunition available in any cycle.
Nobody can know how this plays out. But be sure they will try to save it and global stimulus is coming. The Fed will be eager to want to rectify its embarrassment last week. They will meet again in March, so will the ECB and the BOJ. The question is: Can they afford to wait this long? Can global fiscal authorities wait this long without offering massive stimulus packages?
The $VIX says they may not be able to afford to wait.
$VIX 54 was the highest $VIX reading since the financial crisis. This could mean a lot. Let’s look at this analytically:
Since the 1990’s monthly $VIX spikes to the 40s have been rare and all were contained in the sense they either marked bottoms or signaled major bounces in markets to come before new lows. Both are possibilities here. The big exception of course being the great financial crisis where $VIX spiked to 90.
Let me be clear: This is such a rare event it can’t be predicted, but with $VIX 54 on Friday it is clearly a risk. $VIX broke above what has been the historic line in the sand for volatility events before being saved into the close:
So let’s also be clear: There is clearly an opportunity for control to be re-established. Central banks have managed to control volatility every single time it reared its head since the GFC. But right here and now they are challenged more than ever since the crisis. This is very binary. They either retain control or not.
In 2008/09 when they didn’t retain control this happened:
$VIX ran to 90. What’s notable here is that the $VIX 90 spike did not happen at the beginning of the bear market. It happened later when $SPX was already down 30% off the highs. It happened after months of selling and chopping. Worse: $VIX 90 was not the bottom in markets. While $VIX calmed markets continued on their path of lower prices for months before finally making a low in March 2009. So be clear: Just because $VIX makes a high does not mean markets bottom. It has meant that in recent years when central banks remained in control. It does not mean the same thing when they are not in control.
The same can be observed in 2000:
Here too we can observe $VIX spikes into the 40s. But both occurred deeply into the bear market.
So what we are witnessing here with $VIX at 54 just a few weeks after all time highs is UNPRECEDENTED. Except for one event: 1987.
The $VIX didn’t exist back then, but the old $VIX, the $VXO, did. And guess what? It still does exist and we can chart it:
How about $VIX 170? Yes, stuff happens.
With $VXO I could actually make the case for $VXO to reach the 50 area and then hitting a potential trend line. This offers another scenario altogether. Instead of a $VIX spike to 90 we may hit that $VXO trend line first and then a big reversal.
That is if the linear chart is relevant in such a spike scenario. If the log chart is relevant then you’re look at risk to 75:
All this implies lower price risk for $SPX of course with the 2750 area being the next big area of support should current lows at 2855 fail to hold:
Were this to happen this may well be a big bounce area. Whether this would be a meaningful bottom or a tradable bounce that ultimately fails it totally unknowable. As of this moment this too is a speculative scenario, but technically very well founded.
Call 2750 or so the final defense line for central bankers.
There is another scenario altogether. It’s the one that says central bankers can re-establish control and fast.
Speaking for this: First off we’re looking at 7 open $VIX gaps, possibly 8 if markets again open down on Monday (Weekend spreads are down -500 on $DJIA as of this writing, but this may change by tonight or Monday):
I’ve never seen this many open gaps on the $VIX. Ever. And certainly not in this short time frame. My mantra: All $VIX gaps fill eventually. So this is something to keep an eye on.
Indeed Friday’s harsh reversal in $VIX into the close shows how quickly these $VIX gap fills could come once control is re-established. This is now a market balance issue.
But again, just because $VIX drops doesn’t necessarily mean the ultimate market lows are in.
Also to consider: The 2015 play book:
The ebola scare and the China RMB devaluation all contributed to the sudden swoon. A retest occurred and then suddenly it was all over and a massive rally occurred out of the blue.
I’m not calling for a complete repeat here of course, but I’m outlining another possible script, especially as the chart right now looks somewhat similar:
In addition to $VIX gaps $SPX is suddenly sporting a number of big gaps above:
I suspect there will be efforts at some point to fill all or at least some of them.
For now the larger market shows us what we’ve seen before:
As we’re back inside the consolidation zones of the recent past it appears quite obvious we’re in a critical phase of control.
We’re witnessing the most profound challenge to central bankers since the GFC. Their appeasement of markets since 2009 has left us all vulnerable. The constant subsidy of markets and the economy as led us to the largest credit and asset bubble in our lifetimes and the architects of the monstrosity have left themselves weak and depleted. They are now begging for fiscal stimulus from governments that are traditionally slow to react. The big bazookas will come the question whether it will be too late.
Fact is markets last week failed to recapture the big trend line:
Unless they can recapture this fast, i.e. this in this next week or two it looks to be a massive bull failure.
The $VIX is screaming from the top of its lungs: Intervene NOW! There is massive damage inflicted underneath with potential for far reaching systemic ramifications and the very same people the called for calm and higher prices in February are suddenly waking up to all this.
Markets are massively oversold at the moment, but oversold can stay oversold if systemic selling commences in earnest. The up and down of last week highlights not only the bear market nature of this market at the moment, but also accentuates an important tactical message: Don’t be stubborn about anything. There is massive risk to the downside as well as the upside.
Technicals matter big time, a message I keep trying to highlight and I’m glad Mohhamed El-Erian also made this point this week:
— Sven Henrich (@NorthmanTrader) March 6, 2020
Hence I maintain: Keep calm and keep an eye on the big technical wheels that are turning here. For the very immediate hours ahead this market either defends a higher low, retests low or make new lows. In this high volatility environment anything is possible and may well be dependent when we get a global stimulus announcement. If we make new lows I’ve outlined the next big support zone. But above all: Watch the $VIX. It’s been telling a story since January. We’re in the middle of a $VIX shock and if doesn’t get controlled soon bad things will happen.
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