This Is What It Sounds Like...When the Regime Dies

After a few go-go years in the stock market, it is easy to forget what a choppy market looks like.

Here it is folks. Simple as that. I can cite any number of reasons, valuations, growth underperforming-too-high-expectations, trade tensions, an all around bumbling US government from top-to-bottom, and a central bank that is bound and determined to take the punch bowl away.

In the end, nobody can tell you exactly why the market can’t get out of its own way. All we know for sure is that the momentum trade is dead--RIP Mo-Mo! Look, readers of this blog will know I am not big on short-term calls, technicals, or other forms of market prognostication. But the reason I posted this chart is because I do believe the market has a certain style of trading over relatively long periods of time. Some call them “regimes”. I believe the market saw a regime change with the short-gamma/short-vol implosion trade that started at the end of January.

That crushed the momentum traders--and to make matters worse, there have been a couple of times where it looked like stocks were finally going to get on the canvas and start trading like 2017 again--only to fall into another 50 point intra-day death spiral.

That is how equities trade in years when the market just kinda stinks for one reason or another. Look back at the chart above.  There are years like 1994, 2008 and 2011, when various and sundry financial crises were crushing profits and market confidence. Similarly, in 2000, the market had finally run out of dot.com buyers. But then think about years like 2002, 2003, or 2015. The market simply couldn’t get over its various forms of anxiety.

Does that mean it is straight down the elevator shaft for equities? No, I don’t think so, not without a significant downside catalyst--a big drop in growth, a sudden cliff in employment, or some kind of credit event, or the dank roadkill-like stench of one ahead.

And yes, that serves as a nice segue into the latest update on the roadkill known as US money markets. No rest for the wicked...chalk up another 5bps higher in the libor-ois spread vs. this time last week.  

Yet...and yet!! I continue to believe we are seeing the beginning of the end of this move wider in spreads.  Repo levels remains stable, indicating there is no broad grab for easy financing from big players that are desperate for dollars. And the chart below shows that the spread of commercial paper rates over OIS--and tbill rates over OIS, actually came down a bit last week.

Which makes this week’s move wider in libor/ois spreads all the more perplexing--the market wasn’t fooled--front end swap spreads (proxied here by the 2yr treasury future vs. swaps, “TU invoice” and the 3m6m libor/ois swap) either chopped around or moved modestly tighter.

One of the highly respected analysts at one of the sell-side banks published a piece on Friday mentioning that a more arcane piece of the new tax code eliminated a tax incentive for companies--mostly foreign banks--to use the cross-currency swap market to fund foreign operations--instead pushing them towards other funding sources, like commercial paper. I don’t have the piece (teammacroman2@gmail.com if you have a copy!!), so I can’t opine on it--i’m not even sure I’m selling the thesis correctly from the headline I read--but it is a compelling hypothesis from a guy that really knows his stuff.  

Either way--that leaves “just plain old credit” as the residual. The bloodbath in equity markets combined with “basically unch” risk-free rates led to a tit-for-tat widening in credit spreads.

Add this stress--or at least the return of some semblance of sanity--to credit markets at large, combined with some indications that the move in libor is hitting markets outside the US, and the picture starts to make sense. The latest catalysts are all modestly negative--and that has the power to unwind the positive narratives that supercharged stock markets throughout the past two years.

I like to believe that brings the market downdraft to a simple solution--an inversion of catalysts, a regime change, and a momentum break--all of which combines to cause a reversal in flows. Maybe it's more complicated--but I think it illustrates that the market will need a new narrative--and probably a lot of time-- to push to new highs.

Shawn
TeamMacroMan2@gmail.com
@EMInflationista