Corrections And The Coming '208 Seconds'

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Includes: SPLV, SPY, TLT, VXX, XLU
by: Michael A. Gayed, CFA

Summary

In so many professions and in so many aspects of life, a very small period of time can define one’s life in the eyes of the outside world.

Markets are no different. Stock market volatility (VXX), though often memorable and extreme, historically has been relatively short-lived.

To that end, global markets may be in their own 208-second juncture here as our indicators near term are flashing red.

"Over 40 years in the air, but in the end I'm going to be judged on 208 seconds." - Chesley "Sully" Sullenberger (as played by Tom Hanks)

Seeing the trailer to Clint Eastwood's "Sully," I was blown away by the elegance of the above quote. Take a moment and think about the truth of that statement. In so many professions and in so many aspects of life, a very small period of time can define one's life in the eyes of the outside world. Irrespective of your profession, more likely than not you are defined not by years of hard work, but by small periods that are extreme, painful, and largely unpredictable.

Anyone who has known Sully or worked with him for decades knows far more about his life, and his professional career beyond the "Miracle on the Hudson." Yet, I suspect that the image of that floating plane likely overwhelms any prior opinions of him. It is as if everything before that moment didn't even matter. This is what we, as lazy humans who think both fast and slow (ala Daniel Kahneman), do all the time.

Politicians are masters at this form of exploitation, focusing on the brief moments in time where one's leadership was suspect or questionable. Whole judgments are made on wildly small samples of time which can be highly consequential, regardless of whether the outcome is positive or negative.

Markets are no different. Stock market volatility (NYSEARCA:VXX), though often memorable and extreme, historically has been relatively short-lived. There are far more up days than down days. But when those down periods do occur and equities are gyrating wildly, that is when investors begin noticing the value of their accounts the most.

That is also the environment that traders and money managers are most remembered for in terms of how they handle those air pockets. As well they should be - any endeavor which does not follow a normal distribution but is susceptible to low probability/high impact events requires judgement in those tail risk periods.

To that end, global markets may be in their own 208-second juncture here as our indicators near-term are flashing red. For the past two weeks, the direction of market behavior has very much been in flux. After a severe sell-off in defensive sectors (NYSE:SPLV) two Fridays ago in a big down day, those defensive areas re-synced to outperforming on weak market dynamics.

Bond yields (NYSEARCA:TLT) globally are beginning to show signs of spiking as yield curve flattening turns to steepening. At first glance, one would think this is positive. After all, as shown in our award winning papers (click here to download), when long duration Treasuries underperformed intermediate, historically average stock market volatility began to fall after. But as this is happening, Utilities (NYSEARCA:XLU) also should be weakening. As shown below, the relative price ratio of Utilities divided by the S&P 500 (NYSEARCA:SPY) seems to be doing the exact opposite.

Why is this happening? It may well be that recent volatility has absolutely nothing to do with the Fed's upcoming rate decision. Predictably, markets' odds fell for a rate hike in September as volatility in equity markets picked up. What may be going on could actually have nothing to do with the US alone.

Take a look at the TED Spread which is at its highest level since 2011. The TED spread measures the difference between 3-Month LIBOR and 3-Month Treasury Bills. A sharply rising TED spread is often a sign of increased risk in financial markets globally. We are nearing that point.

Quietly as this is happening, the percentage of stocks in the S&P 500 below their respective 200-day moving averages appears to be rolling over. There is much more sudden weakness that is gripping markets beneath the surface than many may realize despite last week's positive performance for stocks.

Are we in the midst of the 2nd correction of 2016? I'll let you know in a few months. Sully couldn't have possibly known in the hours leading up to his landing that the plane he would pilot was going down, but he sure knew it in those 208 seconds. Aggressive internal weakness, coupled with the potential that broad headline stock averages AND bonds correct at the same time, means the next few weeks might result in much more than turbulence.

We will only know with hindsight if the 2nd correction of 2016 is no longer inching but actually here. For now, the odds have tilted enough to begin bracing for impact.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.