Morning Report: Sell-off is “technical fear,” not “real fear” 2/6/18

Vital Statistics:

Last Change
S&P Futures 2593.8 -14.0
Eurostoxx Index 373.2 -8.8
Oil (WTI) 63.4 -0.8
US dollar index 84.0 0.0
10 Year Govt Bond Yield 2.74%
Current Coupon Fannie Mae TBA 103.591
Current Coupon Ginnie Mae TBA 103.688
30 Year Fixed Rate Mortgage 4.33

Stocks are lower after yesterday’s bloodbath. Bonds and MBS are down.

There was no real catalyst for yesterday’s sell-off. The economic data has been great, earnings have been good, and nothing has really changed fundamentally. The canary in the coal mine economically is credit spread behavior, and we have not seen any major movement there. To put things in perspective: We are 8.5% off the record highs set last week. That doesn’t even meet the threshold for a correction, which is defined as a 10% drop. Don’t forget that a lot of money has been hiding in the stock market because bonds have paid nothing for so long. As the Fed hikes rates, short-term money instruments begin to come back on the radar screen for many investors. Investors have been spoiled over the past few years. Low volatility made people a lot of money in some trades, and it also made investors complacent.

In fact, THE trade of 2017 was short volatility, and it blew up yesterday. Retail investors can trade volatility via VIX futures, and there are exchange traded funds that mimic movements in the volatility indices. VIX is a “fear index” and it is generally associated with major downward moves in stocks. The “short vol” trade made something like 100% last year, and the mechanics of exiting it can cause all sorts of technical trading issues that can affect stocks. If all the speculators are short volatility, then their exit from the market can add to the destabilization. It is tough to explain, but think of a marble in a bowl. That is “normalcy.” If the marble is off-center, it is attracted to the center. That is what typical buy low / sell-high stock market behavior is like. Too many sellers come in, and the buyers emerge which stabilizes things. But, when the crowd is generally short volatility, it is like the bowl is flipped over and the marble is on top. So when the marble is off-center, it is more likely to move away from equilibrium, and the further away it gets, the more the momentum builds. That is what a short squeeze in volatility feels like, and that is what happened yesterday. I am hearing that the mechanical covering in the exchange traded notes is largely done. However, the real money resides in the over-the-counter market and there is simply no visibility there.

You can see the correlation between high VIX and market-moving events below. There is an old market saw: “VIX is high, time to buy. VIX is low, time to go.” You can see the volatility spikes which generally correspond with major events, like the end of the dot-com bubble or the financial crisis. There is no catalyst to speak of here, so I have to imagine this will be short. Yesterday was technically-driven “fear” not “real fear.”


By the way, whenever you hear the term “convexity-related buying or selling” that describes sort of the same phenomenon in bonds, although the magnitude is much less than it is with stocks and VIX. Convexity buying and selling generally refers to the behavior of mortgage backed securities and interest rate hedging. We did not see much activity in credit spreads yesterday, and that is a good sign. If credit spreads are increasing, that means investors are becoming worried about the economy going forward. While spreads moved a little, it wasn’t much.

Bonds rallied hard on the flight-to-quality trade, which gives LOs a chance to retrieve some loans that may have gotten away from them last week. Take advantage of the drop in rates to review your pipelines and see if any borrowers might want to lock and / or consider a refi. Given the massive home price appreciation we have seen lately, the switch out of a FHA into a conforming loan with no MI still makes a lot of sense. You might only have a short window here.

As an aside, Jerome Powell took over as Fed Chairman yesterday as Janet Yellen heads to Brookings. Welcome to the party, Jerome!

Interestingly, the move in markets yesterday caused the Fed Funds futures to take down their estimate of a March hike from 78% to 69%. While it is a low-probability event, the Fed could ease up on rate hikes if the sell-off continues, provided that inflation remains below target. If inflation passes the target and hits the upper 2% range, then they will probably stick to script regardless of what happens in the markets, barring a crash of some sort.

Home prices rose 0.5% MOM and 6.6% YOY in December, according to CoreLogic.

As an aside, I will be on a panel at IMN’s MSR conference in NYC March 26 and 27. Should be a good event.

36 Responses

  1. In all seriousness, I think you’d have to be insane to bang a college broad today.

    And these dudes are wising up. Plus, with more broads in college than dudes, and hypergamy in play, gonna be some lonely times for somebody.


  2. Worth a read:

    “She killed 115 people before the last Korean Olympics. Now she wonders: ‘Can my sins be pardoned?’
    By Chico Harlan February 5 at 7:04 PM”


  3. The desperation by the #Resistance is palpable:

    “Don’t let pay increases coming out of tax reform fool you

    By Rick Wartzman and William Lazonick”

    Liked by 1 person

    • Peeking beyond the PR, our analysis finds that major corporations are planning to spend more than 30 times what they are putting in the wallets of employees on buying back their own stock — a practice solely meant to lift the fortunes of shareholders.

      Which would include anyone in an IRA or other retirement plan with stock in said company. And would presumably help keep the company solvent so that it continue to employee people.

      If it was going into yachts, I could get them complaining. But this seems more about keeping the companies in solid shape. What’s wrong with that?

      Whatever. The ultimate message is: you getting to keep more of your money is bad. If the money going into corporate stock buy-backs was going as taxes to the federal government to waste and burn, would we be writing this article? No, no we would not.


    • @jnc4p, @brentnyitray:

      And in 1982, the Securities and Exchange Commission adopted a rule that allows executives to massively buy back the company’s stock without fear of being charged with manipulating the share price — even though that is precisely what they are doing.

      I get that a massive buy-back could affect share price, but aren’t there other reasons for wanting to buy back stock? Why shouldn’t companies be allowed to buy back as much of their own stock as they want?


      • Sure. Management’s job is to maximize shareholder value, and that means finding investment opportunities / expansions that are higher than the company’s cost of capital. If they cannot find anything that covers their cost of capital, then they should return capital to shareholders, who can deploy it more efficiently.

        Buybacks are in general preferable to cash dividends because taxes are due immediately on dividends, while capital gains can be deferred until the investor sells.

        As far as buying back all the stock they want, you have to make sure that all shareholders are being treated fairly, and the company isn’t just taking itself private without paying a control premium…

        Liked by 1 person

    • It’s great now that we’re actively rooting for the economy and/or stock market to do well (or not) depending on who’s in the White House.

      Liked by 1 person

  4. Krugman seems unusually reasonable and non-hyperbolic on his column on the recent stock market dip:

    I mean, for him. A different tone from his post-election prediction that the Stock Market was going to crater in the wake of Hillary’s loss. Weird.


  5. Dropped by Plum Line. They are Woke as F*** over there! I mean, really, the whole WaPo is.

    But too many people positing too much too often. It’s impossible to keep up with. Only good for the people who just want a place to type their fantasies about Trump getting arrested and tried by a jury of Mexican-Americans.


  6. Spent a little more time over at PL. It’s been a while. The cognitive dissonance and the complete dimension B thinking is just amazing . . . and disheartening. We are permanently in our tribes, and there just isn’t going to be a lot of cross over. There can’t be.

    1:11 PM CST
    Waldman is dead on, as usual. He writes: “Nobody had ever thought of it before, but that’s part of the genius of the GOP: they aren’t constrained by traditional norms.” I would clarify by saying that the GOP is not constrained *by ethics of any kind*. This is the fundamental difference between the GOP and Democratic Party. The DP still has allegiance to ideals of fairness and the common good. The GOP simply doesn’t care about anything except gaining power and riches by any means available.
    Ignore UserLikeReportReplyShare7
    1:15 PM CST [Edited]
    This is SO true! If we cannot agree on common rules of “how to play the game” then we’re headed toward becoming a banana republic! In the UK, their democracy has worked very well because their leaders all shared a common sense of decency (being gentlemen who did things the proper way). Their party differences never destroyed their democracy as ours is tending toward now.
    Ignore UserLikeReportReply
    rapid transient
    1:16 PM CST
    The Democratic Party represents people while the GOP represents money is speech, corporations are people

    Then one guy said something, I quoted him exactly, and then I was told he didn’t say the exact thing he quoted . . . I was also I was told I needed to wake up or we lose our Democracy.

    Also, I got this for saying I think all politicians are mostly cut from the same cloth:

    Kevin_Willis, nihilism and passivity is not wisdom. If you’re too lazy to tell the difference between decent and evil, that’s your problem. Quit foisting it on the rest of us. I know you are not a troll, but you are very much worth ignoring anyway.

    And out I go. Human beings are not prepared for the modern era. All I got to say about that.


    • KW:

      I actually largely agree with this:

      If we cannot agree on common rules of “how to play the game” then we’re headed toward becoming a banana republic!

      It is for exactly this reason that I so strongly object to the progressive theory of constitutional interpretation and the politicization of the judiciary that it has produced.


      • I largely agree with it too, in the abstract, the problem is their assertion is that the left and the democrats are ALREADY playing by the “fair” rules (and perhaps have always been) and the Republicans aren’t, so the problem is make the Republicans play by the rules the Democrats lay down and everything is going to be awesome!

        Same guy holds up the UK as the template for civility and how things should be done. Having lived there, you have to have something to say about that. 😉

        The argument always circles around to the same lizard-brain calculus that it’s all about the good guys and bad guys, and if we can only get rid of the bad guys, things are going to be awesome! And then the create a delusional representation of what’s going on. And they are personally ego-invested in that delusion, so can’t be challenged.


        • KW:

          Having lived there, you have to have something to say about that.

          Well, the first thing I would say is that his comment about the UK suggests that the “common rules” he is talking about are not the ones that actually matter. Norms for “civil” interaction between politicians are not the same as laws.

          But apart from that, the “civility” within Parlaiment is actually significantly less than it is inside Congress. Debates in Parlaiment can actually get quite rowdy and unruly, with lots of shouting and booing while people are speaking. Certainly none of the faux-civility about “my esteemed colleague from across the aisle” that you get in congress. And one of my favorite quotes of one British politician talking about another was when anti-American MP George Galloway (who actually formed his own party when he got expelled from Labour for bringing the party into disrepute) took the occasion of the London bus and subway bombings of 2005 to blame the US, and MP Adam Ingram responded by accusing him of “dipping his poisonous tongue in a pool of blood”. Not exactly the epitome of upper crust British civility!


      • @scottc1: “It is for exactly this reason that I so strongly object to the progressive theory of constitutional interpretation and the politicization of the judiciary that it has produced.”

        Well, they have no choice, because the Republicans are soulless monsters bent on the destruction of the country. The crisis is existential! The means justify the ends!


  7. By the way, nice summation Brent. Easily tops anything on MSNBC yesterday.

    Liked by 1 person

    • I love how they get to define bias as saying that trans-women are biologically men and that, by definition, is not the same as being a woman.

      It’s not a matter of words meaning different things to different sides, it becomes “words have no meaning”. There is no communication in that environment.


  8. Drudge has a priceless picture of Schiff up right now.


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