Monday, June 26, 2017

Risk Parity Heaven

The volatility is super low.  The stocks are rising.  And so are the bonds.  These are perfect conditions for risk parity strategies.  They hedge equity risk by buying long term bonds.  It has been the right strategy this year.  Going long puts and VIX futures/options is going out of style.  The performance drag is too high, so funds have found cheap and actually positive carry hedges in the form of long bonds.

This is not a foolproof strategy, but it is nearly foolproof when the Fed put is out there.  It is always out there.  The question is where is the strike price?  Obviously, investors believe the strike price is much higher than what the Fed wants the market to believe.  If the S&P went down to 2300, would the Fed stop interest rate hikes and balance sheet normalization?  If so, then the market has it right.  If not, the market is being too complacent here thinking the Fed will rescue the market on any market corrections.

On the one hand, it seems the market is too complacent when it comes to the vulnerabilities of the stock market, thinking long bonds will go up enough to cover a sharp drop in stocks.  It's very possible that while long bonds go up in an equity market correction, but not as much as it has in the past 10 years.  The 30 year yield is not at a point where you will get explosive moves up in bonds.  In fact, I think you would more likely see a steepening of the yield curve where the shorter term maturities rally strongly on an equity market correction, while the 30 year rallies only mildly.

We have a gap up Monday in SPX.  And bonds are also higher.  And VIX is dying out there.  It is the overflowing with liquidity trade again.  Until bonds actually start going down, the equities are not likely to go down much, if at all, even with the complacency building up.  It's a dead market and a tough market.  A good time to sit on your hands and wait for a good setup.


Anonymous said...

Do you have any new price and time targets for spx before we can put in our shorts. At this point im leaning to 2550 and august time frame.

Market Owl said...

I think it will take months to form a top, probably starting next month and lasting through September. If tax cuts get passed this year, it could be the perfect setup for a top. If not, it makes it harder. You need to see good news and excitement and heavy fund inflows to make it easier to short. If you don't get the good news, the top will last longer and the market will continue to climb that wall of worry.

Market Owl said...

Want to emphasize you need to see bonds get weaker before you can have more confidence that equities is pushing up against resistance. Gut tells me we top out before we get to 2500. We'll see.

Anonymous said...

What you say makes a lot of sense. Im also seeing a lot of informercials for day trading and have people who have no experience talking about stocks and bitcoins and ethereum. Once the general public gets invested i think its time that gs and the vampire squid lowers the boom. Blow off top is coming soon.