Wednesday, June 30, 2021

When Genius Failed To Exist

Today's financial pundits are mental midgets standing on the shoulders of intellectual giants. Therefore they are oblivious to the fact that this gamified alchemy is the exact opposite of what created prosperity in the past...

The stock market just closed out its (Second) best first half since 1998 which directly preceded the LTCM (Long Term Capital Management) debacle. We also learned back in April that more money poured into stocks since the election than in the prior 12 years combined. Since that time, inflows have continued their record pace - ETF inflows are almost at a new record only six months into the year. What we are witnessing is the ideal recipe for panic meltdown. 

Going back to 1998, Long Term Capital Management (LTCM) was a massively leveraged hedge fund managed by financial PhDs who were considered geniuses on Wall Street and in academia. The collapse of their fund in the second half of 1998 almost brought down the global financial system. They had made various asinine assumptions about the correlation of risk assets that were true most of the time but categorically failed when markets went into meltdown mode following the 1997 Asian Financial crisis. In other words they were oblivious data miners who assumed the past could be endlessly extrapolated into the future, hence they blindly ignored all imminent signs of risk and focused solely upon statistical probabilities. Which is the way all of today's quantitative/algorithmic trading programs work. Ignorance is bliss. More on that later. The book that described the entire debacle was called "When Genius Failed". Hence, the title of this post. The net result of that collapse was a massive Fed bailout that inadvertently lubricated the melt-up phase of the brewing Dotcom bubble. 

The Dotcom bubble itself was abided by the asinine belief that valuations, profits, and even sales no longer matter. All that matters is internet page views aka. "eyeballs". That new "business model" consisting of massively unprofitable companies going public at a record rate soon found the natural limit of fools with money to burn on worthless IPOs. At that point, the "smart money" rotated to the Big Cap safe havens - Microsoft, Intel, Dell, and Cisco. And then those stocks imploded bringing down the entire casino.

A divergence very similar to what is happening today:

When the Fed sponsored DotCom bubble collapsed, they lowered rates to a multi-decade low 1.5% which set off the melt-up stage of the brewing housing bubble. At the time, Fed Chairman Greenspan lauded the "financial innovations" taking place in the subprime lending market and he encouraged borrowers to load up on adjustable rate mortgages (ARMs). ARMs had been previously unpopular in the U.S. market because they shift all interest rate risk from the lender to the borrower, offset by a minor interest rate reduction. Within months, Greenspan jacked up rates 17 meetings in a row and imploded everyone who took his advice. But not before Wall Street had figured out how to package subprime dog shit into self-destructing weapons of mass destruction that inadvertently imploded the global financial system. 

And here we are again in the midst of a monetary fueled housing bubble:

So, what to do? The Fed bailed out Wall Street on the systemic meltdown they had created. AND paid them in full on their bets that the whole shit show would collapse.  Then the Fed lowered interest rates to 0% and started pumping money directly into financial markets. Thus inventing socialism for the rich.

Fast forward to today and the Idiocratic beliefs that attend this post-pandemic bubble are first and foremost the ubiquitous faith that assets are worth whatever price the last fool paid for them. In addition, the belief that central banks are omnipotent. The other obligatory delusion is the studied ignorance of accumulated market fragility which is a net result of 13 years of continuous monetary bailouts.

At this lethal juncture, low volatility is conflated with low risk. Which has been proven to be an asinine assumption over and over again these past years and decades. Nevertheless, serial bailouts have kept this critical hypothesis alive. 

"Volatility is the most common risk metric of a stock. The main aim of the volatility targeting technique is to manage the portfolio’s exposure in such a way that the volatility of a portfolio is as close to the target value as possible. In other words, to ensure that the amount of dollar risk remains the same. To do this, the portfolio manager has to increase or decrease the amount of leverage, depending on the volatility"

Here we see that S&P 500 volatility is at a three year low:

Here we see that these algo controlled "volatility targeted" markets are making new all time highs this week amid the lowest number of stocks confirming this rally in 18 years. I calculate the number of stocks BELOW the 50 day moving average at every S&P all time high: 

Below we now see that this past month June 2021 officially has all top ten highest option skew values in recorded history going back 30 years. Which from a statistical point of view is a Black Swan outlier event. In a random distribution, the probability that a top ten skew value will appear in a given month over 30 years is 1 in 36 (2.7%). The chance that all ten would be in the same month is .027 to the tenth power: (0.00000000000000027). In other words, "someone" is making massive bets that this gong show is ending.

As a reminder, skew represents deep out of the money option bets on a "Black Swan" market event:

"The SKEW index is a measure of potential risk in financial markets.

SKEW values generally range from 100 to 150 where the higher the rating, the higher the perceived tail risk and chance of a black swan event"

As we see the highest values happen to be the last four trading days of the best half since 1998:

Amid all of this asinine risk, it's ironic that FINRA finally got around to fining Robinhood for causing "widespread and significant harm to customers" during the Gamestop debacle. Which incited the suicide of one young trader who woke up to an erroneous -$720,000 account balance.

However, in the meantime since that debacle in late January, the Robinhood platform has added record numbers of new users, Congress has officially sanctioned Reddit pump and dump schemes, and margin debt has reached new all time highs. In other words, this fine is totally meaningless with respect to addressing the increasing fragility of market structure. A fragility that is hidden behind the collapsed volumes and volatility that have been extremely profitable for options market makers.

Suffice to say that the number of young people who are now at risk of waking up to negative account balances is quite unthinkable. All aided and abetted by a profoundly corrupt financial services cartel that has now captured regulators and effectively neutered them. 

Which ensures that they are always barking up the wrong tree. Penalizing the pissant Robinhood platform while the real risk is officially sanctioned.

"This week alone, 18 companies are seeking to go public, including Chinese ride-hailing company Didi Global in what will be the biggest IPO of the year...That’s the most companies in a single week since 2004"

 June was also the busiest single month since August 2000"

The majority of the returns are going to the (pre-IPO) institutional buyers.” 

FOMO [Fear of Missing Out] is the biggest thing"

(FYI, my IPO data includes SPAC IPOs)