A Deer In Headlights

Last week something unusual happened that took everyone by complete surprise. The new job numbers came out and shocked everyone with a payroll increase of 528,000 in July. How did the market respond?

By doing absolutely nothing and acting like a deer in headlights, that’s how. So what exactly happened here?

The inverse Goldilocks scenario – that’s what. You see over the course of the past decade moral hazard and infinite spending fueled by our friends at the Federal Reserve had created an hitherto unprecedented mindset among investors and traders alike.

Every time more bad news came out the market jumped higher, much to the chagrin of the few remaining perma-bears.

But why and how? It doesn’t make any sense, does it?

Well it’s quite elementary, Watson. Since the onset of QE in 2009 market participants had slowly become accustomed to the Fed’s infinity put on the financial market. With the PPT placing a permanent floor under the market there was little to no reason to fear bad news.

In fact bad news slowly evolved into yet another dip buying opportunity.

And why not? After all the Fed had our back and evolutionary pressure on the investor class was greatly reduced to the point where long standing K-strategies were replaced by R-strategies.

In case you need a refresher: R-strategies (high number of offspring with little to zero care) thrive in unstable and unpredictable environments while K-strategies (low number of offspring but much care) thrive in more stable environments.

In other words, where previously hard work, good business practices, and a culture of competition served as evolutionary pressures in the financial markets, the Fed’s infinity-put had created a huge free for all whilst continuously punishing participants who stubbornly adhered to the old way of doing things.

So in an unstable and unpredictable environment filled with bad news everyone somehow made money as long as the Fed’s money printers continued to go brrrrrrrr….

All that unfortunately came to a sudden and ignominious end early this year when Powell dug deep and decided to channel his inner Paul Volcker.

After throwing a few obligatory taper tantrums market participants continue to be cock-sure that Powell will end up wimping out and return us back to the glory days of quantitative easing.

That’s the only way of explaining why the VIX – commonly referred to as a risk index – has managed to descend all the way to the 21 mark. We may actually see a print of 18 before it’s all said and done.

Suffice it to say that I beg to differ. Not just with the rationality of a VIX print this low given the economic iceberg we are heading toward this winter. But in particular when it comes to doubts as to Powell’s resolve to defend the U.S. Dollar.

Sure, there may be some dovish jawboning prior to the midterm elections but any uptick in U.S. economic activity is only going to strengthen Powell’s ability to continue hiking interest rates.

But we don’t even have to wait that long. I already see a few high flyers that make great candidates for selling a few far OTM spreads:

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  • Mike
  • last month

About the Author

Hey there, I am one of the founding members of Red Pill Quants. I used to work as a systems engineer in Silicon Valley until I left the industry in 2008 to become a full time quant trader. It's been fun ever since.