Daily Brief | March 9, 2023
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Fundamental
Last year, Simplify Asset Management’s Michael Green, an active manager focused on creating portfolios mimicking traditional constructions like 60/40, albeit with less realized volatility (RVOL), thought a dot-com-type collapse was unfolding under the surface of the indexes.
In an interview for an upcoming Benzinga article, Green explained to your letter writer that he maintains today’s action is similar to the early 2000s.
Prior to 1999, “many of the early winners in the dot-com cycle had already started to falter and, as we came into the market peak for the Nasdaq (INDEX: NDX) in March of 2000, the Nasdaq was much higher and the market was much more narrow,” Green says. “This is 2021 into 2022.” Green adds that the S&P 500 (INDEX: SPX) correction didn’t begin until late-2000, and the homebuilder- and energy-type stocks were the ones that outperformed, as we saw in 2022.
Ultimately, a recession hit in 2001, and credit deteriorated, Green explains, revealing fraud among many high-flyers of the dot-com boom. Many were unprepared, Green adds, drawing parallels to 2022 events concerning the likes of FTX.
In 2023 and beyond, Green thinks the economy and markets are set for a bumpy ride. He projects that rising interest rates cause pain for businesses that received a stay of execution in 2020 through PPP loans and subsidized borrowing.
“Many of them put in two- or three-year paper as a stopgap,” he explains. Now, due to the higher rate environment, “companies can’t refinance, so we’re seeing Blackstone Inc (NYSE: BX) and Brookfield Corp (NYSE: BN) hand in keys.”
As put in yesterday’s letter, the deterioration in markets has, in part, been “offset by a lack of inventory,” as well as the hesitancy to sell (i.e., lack of supply). However, the marginal impact of one new person “in distress … [may] set a new clearing price” that changes valuations for everybody. Green says that investors know supply will cause markets to weaken, and that is why products like Bitcoin (CRYPTO: BTC) are intact.
“If we tie up stuff in bankruptcy courts for the next three or four years, nothing will get done,” Green elaborates. “That’s part of what we’re seeing in the crypto space where part of the strength for Bitcoin is simply the absence of sellers as we navigate our way through bankruptcy on many of these entities.”
As an example, Voyager Digital Ltd (ex-OTC: VYGVF) claimants “desperately [sought] to submit a bid to prevent Bitcoin from having to be sold” because these sales would pressure prices and “increase the damage across the entire crypto universe.”
Green went on to add his firm objection to Federal Reserve’s (Fed) policy choices noting that deterioration is threatening the “commercial real estate bubble … and residential real estate” currently afloat on a “lack of inventory.”
The “multiplier effect” will be a serious challenge for markets; monetary policy drives fiscal policy and this has an impact elsewhere on geopolitics, manufacturing, and so on (e.g., the cost of interest rates offset by credits to households, the relocation and addition of manufacturing at home and outside of China), which only serves to boost inflation over the short term and further complicate things for the Fed.
Positioning
With data very unreliable and markets fearful of a 2020-like decline, 2022 was a far more orderly year than expected.
“I think people were extremely well-hedged,” he explains. “There was a tremendous amount of exposure that had been purchased for deep out-of-the-money, relatively long-dated [put options], and that created conditions under which the volatility surface, beyond six months, was extremely elevated heading into 2022.”
Green says one-year variance swaps and implied volatility (IVOL) on at-the-money S&P 500 puts was “in the neighborhood of 25-30%, … which is very expensive … [and this] implies a level of daily price movement that is difficult to achieve.”
Consequently, investors’ hedges did not work. Green adds that “having learned their lesson from 2022, people have by and large abandoned those types of hedges and have instead moved, even as skew moves to near-record cheapness, … to spreads” and shorter-dated options (e.g., 0 DTE).
With a vast majority of these shorter-dated options exposures held short by investors, this creates conditions of suppressed volatility that can last; dealers own volatility and in hedging that, they promote mean reversion-type activity (i.e., instead of institutions writing calls against long exposure out one-month, they are writing calls against long exposure out one-day, and this supply of options has dealers pressuring the market on their initial hedging and supporting the market on later re-hedging) over the very short-term. In other words, when investors sell those calls, the dealer receives them and sells futures to hedge. This “pressures the market lower which causes … the delta of that option or replicating exposure to decline and, now, the dealers have to buy back that exposure and push the markets upward,” later, because the risk they are exposed to by that exposure has declined (i.e., lower delta). See the image below.
This options activity may become problematic. If there is a gap, investors’ “scramble to hedge those positions” may lead to even larger movement, given that the market “is not prepared to provide liquidity,” generally speaking.
Green suggests that investors can side-step a lot of the turmoil by allocating some or all of their portfolio to bonds. Any cash remaining could be used to amplify portfolio returns in a fixed-risk manner (e.g., buy bond and SPX options and options spreads).
More detail to come in the next sessions. Hope you enjoyed this (rushed) letter.
Technical
As of 8:30 AM ET, Thursday’s regular session (9:30 AM - 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,988.25.
Key levels to the upside include $3,999.25, $4,013.00, and $4,024.75.
Key levels to the downside include $3,975.25, $3,965.25, and $3,947.00.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: Areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
Separately, Capelj is an accredited journalist with past works including interviews with investor Kevin O’Leary, ARK Invest’s Catherine Wood, FTX’s Sam Bankman-Fried, North Dakota Governor Doug Burgum, Lithuania's Minister of Economy and Innovation Aušrinė Armonaitė, former Cisco chairman and CEO John Chambers, and persons at the Clinton Global Initiative.
Connect
Direct queries to renato@physikinvest.com. Find Physik Invest on Twitter, LinkedIn, Facebook, and Instagram. Find Capelj on Twitter, LinkedIn, and Instagram. Only follow the verified profiles.
Calendar
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.