How Markets Don’t Work!

It's funny how the markets work.  Everyone expects one thing, and the market does the exact opposite.

Case in point:  The US gets its national credit rating cut, and every US Dollar bond and US Dollar bear in the world figures that this is it... this is the big one... finally, interest rates are going to spike higher!

WRONG!

Since getting the credit rating cut from AAA to AA, we have seen the US Dollar remain fairly steady, and US Government bonds have rallied huge!  In fact, intraday on Tuesday 9^th August, 2011 we saw 10 year bond yields go below the 2008 low, all the way down to 2.036% - resulting in higher prices. WOW!

You have to think about this now -- why would bond yields go lower than the 2008 low? What could possibly be looming on the horizon that is so awful that bond yields would pierce the low set during the greatest market meltdown since 1929?

In a word, RECESSION.

The Fed pretty much came out and confirmed this thesis when they said that they would keep rates at ultra low levels until at least mid 2013!!  That’s almost two years away. WOW AGAIN!  Do you know how bad the internal data must be if the Fed is publicly acknowledging that they will not raise rates for 24 months?

So How Low Can Rates Go?

The irony was not lost when, after S&P announced that it was cutting US credit rating, China publicly blasted the US over its "bloated welfare costs".

Imagine that -- a communist country putting America down for being too socialist!

The funny thing is that, since the USA lost its AAA rating, bond prices have soared in value. In fact, over the last three days the Chinese have seen their Treasury holdings appreciate by tens of billions of dollars. (bond prices rise when relevant market interest rates drop)

For all their tough talk about how reckless the Fed was being when it announced QE2, they must have been secretly high-five-ing each other as their 1.16 trillion dollars worth of Treasuries appreciated in value by an estimated $100+ billion!!

Since QE2 was announced, we've seen 10 year yields drop from 4% to 2%, and we've seen much steeper declines in the 2-5 year duration, which is where China has MASSIVE exposure.  So that $100 billion gain guesstimate could be very conservative indeed.

Did QE2 Work?

It sure did!  Just not for you and I.

In fact, I know you have been asking yourself who benefited the most from QE2? After all, equity investors certainly didn't win... the average US worker didn't win.

You want to know who the winners were?

The only winners were Government and other bond holders.  And by the way, want to know who the two largest holders of US government bonds are?

YEP! It’s China and the Federal Reserve!

Want to know what's going on?  Just look around at who’s got the biggest slice of the pie.

It's no surprise that it was the Fed, and the US’s next single most important banker - the Chinese Government.  The US didn't break the 2008 yield lows on a fluke -- the market is telling us something.  It is shouting from the roof tops that we will almost certainly experience a recession in 2012.

While equity prices rebounded, after getting pounded so relentlessly again, I'll be looking to fade the rally and get short some more stock because unless we see a miraculous turn around in the employment and GDP figures we are going lower as far as equities are concerned anyway.

But we may go to 1,250 on the S&P 500 first before we see 1,050.  So, nimble traders: have fun.  Longer term traders: wait for the roll over, at which point you'll be able to short 'em all.

In the meanwhile, I’m getting longer on secured corporate bonds from entrepreneurial corporations in Asia. 

The US Debt Downgrade – A look behind the scene? « Jaykeumarezz’s Blog

The US Debt Downgrade – A look behind the scene? « Jaykeumarezz’s Blog

Ahhh Sooo! Always suspected there was more to the downgrade.

Volatility Trading Myths!

The VIX volatility index is supposed to be a proxy for volatility. However, when it comes to the VIX, nothing trades quite like you think it should. 

Don’t Believe All the So-Called VIX Experts. According to an article by Adam Warner in Investor’s Place - "Ten years ago, most people hadn’t even heard of the CBOE Volatility Index, or VIX. These days, the “fear index” is covered by the mainstream financial media, and you can’t throw a stick without hitting someone who fancies themselves a VIX expert."

The problem is that half of these people don’t have any clue what they’re talking about. So there is a lot of misinformation out there surrounding the VIX and VIX trading products, including futures and ETNs. When it comes to trading the VIX, nothing moves quite like you think it should.

To clear things up a bit, here are eight VIX trading myths you don’t want to fall for.

VIX Myth #1 – You Can Buy and Sell the VIX

Reality: You cannot buy and sell the actual VIX. You can buy and sell VIX futures, but that is a very different thing. VIX futures can trade at premiums or discounts to the VIX. In fact, they almost always trade at premiums to the VIX.

VIX Myth #2 – You Can Own the VIX Via Futures

Reality: VIX futures cash out when they expire based on a VIX settlement price. So unless you roll out, your position will vanish.

VIX Myth #3 – A Rolled Position Will Track VIX Moves

Reality: VIX futures price based on where the market expects to see the VIX on a given date in the future, i.e, the day the VIX expires. That estimate may or may not move on a given day with a move in the VIX. The further out in time the future is, the less it will track VIX moves.

VIX Myth #4 – VXX Tracks the VIX Better Than Futures

Reality: The iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX) is an exchange-traded note that is based on a hypothetical rolling 30-day VIX future and trades like a regular stock. However, it does not track VIX moves particularly well. In fact, it underperforms over time so long as VIX futures trade in an upwardly sloped term structure. And VIX futures virtually always trade that way.

VIX Myth #5 – You Can Chart VXX Like a Stock

Reality: Since VXX trades like a stock, you may think you can chart it like a stock. Wrong. Run, don’t walk, from anyone who tells you about a key chart point on VXX. The VIX is a statistic, and VIX futures trade based on estimates on a forward price for that statistic. VXX creates a hypothetical constant duration 30-day VIX future and, therefore, loses money each day simply rolling from the nearest month future to the next month out if the next month out trades at a premium. Hence VXX is really just a number relative to itself the day before. It’s the tail of a tail of a tail of a dog.

VIX Myth #6 – Holding VXX Can Protect a Portfolio

Reality: VXX works fine as a short-term trading vehicle. On a day-to-day basis, it will track about 50% of the VIX move. However, it is terrible as a portfolio hedge for the reasons listed before, namely that it loses money over time in an upward sloping VIX term structure. Owning and rolling two- to three-month VIX futures works better.

VIX Myth #7 – VXZ is a Good Portfolio Hedge

Reality: The iPath S&P 500 VIX Mid-Term Futures ETN (NYSE:VXZ) is similar to VXX, but it tracks four- to seven-month VIX futures instead of 30-day VIX futures. VXZ has done relatively well since its inception and has outperformed VXX by a wide margin. But while it doesn’t have the contango trouble of VXX, the VIX curve gets pretty flat out that far. I would also caution that VXX and VXZ only listed in January 2009, and thus, neither has had to show its mettle through a VIX storm. Four- to seven-month VIX futures almost always hold their premium to the VIX, but would move to a significant discount in a serious VIX explosion. In 2008, they lagged by 20-30 points. So I suspect VXZ would not provide great protection when you wanted it most. It’s a fine volatility proxy in a quiet market, but if the goal is insurance, it may disappoint.

VIX Myth #8 – High VIX, VIX Call Buying is a Signal to Get Out or Get Short

Reality: I don’t agree with the above, but I can’t actually prove it wrong. I will say this though, the VIX is a mean-reverting statistic. A high VIX and excessive VIX call buying (and actual SPX put buying) represent extreme nervousness and/or bearish sentiment. In theory, that’s a time you want to buy, not sell. But take that with a grain of salt, because trends do take on a life of their own, like the VIX explosion and market implosion of 2008.

If you really want to trade volatility you’ve got  to trade VIX products. Email me for details.

S&P downgrades US debt to AA+ - FT.com

S&P downgrades US debt to AA+ - FT.com

Wow!!! This has to be the most stupid decision made by any Rating Agency.

Reminds me of the time when rating agencies gave a country with a population of more than a billion, an army of more than two million, the world's largest producer of gold, the world's factory with one of the most entrepreneurial societies in the world - a risk rating significantly lower than for a country with a population of around 300,000 and whose only export was fish.... I'm sure we all remember Iceland!