The sharp decline in the euro after Friday’s U.S. employment figure serves as a timely reminder of what happens when too many investors pile into a trade late in the game. Equity investors lured into the market by a strong earnings season may wish to take note.
That's from former macro manager Cameron Crise, and although I'm not sure Friday's decline in the euro (FXE) is the quintessential example of a crowded trade gone awry, I definitely agree with the general message.
For those who might not have been paying attention, the dollar (UUP) was even more vulnerable than it otherwise would have been going into the NFP print. Already riding a five-month losing streak, the greenback got hit hard on Thursday afternoon when WSJ reported that Special Counsel Mueller had impanelled a grand jury in the Russia investigation.
This is what happened to the broad dollar when that news hit the wire:
That came just as the dollar seemed to be finding a bit of a foothold after a truly abysmal series of monthly declines.
Had payrolls (or worse, average hourly earnings) missed, the bottom probably would have fallen out completely.
Meanwhile, the euro has been riding a truly incredible hot streak.
I'm sure you've read plenty about that. It's been the story of the FX world for the past two weeks and it's part and parcel of the epic franc plunge.
Well, the jobs number in the U.S. was of course a beat and the AHE print was decent too. Cue an impressive relief rally in the greenback and cue one of the worst days of the year for the euro against the dollar:
So that's what Crise means when he says "too many investors [had] piled into [the euro] trade late in the game."
You'll recall that bullish positioning in the common currency recently rose to the most extreme since 2011:
(Deutsche Bank, CFTC)
So yeah, if you were a johnny-come-lately to the euro party hoping to ride that last leg up to 1.20, you got burned on Friday.
Crise thinks that should be a lesson for investors in US stocks (SPY).
Again, I'm not sure that's a perfect analogue but the point is duly noted. The later you get in, the more risky your position is.
And when it comes to positions that a whole lot of people think are on the verge of going horribly wrong, the poster-child is of course the massive spec net short in VIX (VXX) futs, a position which we learned on Friday evening hit a new record as of Tuesday:
Now that position looks like it's being hedged pretty aggressively in other markets, but the overarching point is that what you see in that chart is exceptionally dangerous for obvious reasons.
Even without going into a discussion about what I (and plenty of others) have dubbed "the doom loop", one look at seasonality suggests that history is against this trade (bottom pane, 5-year average):
Also consider this from the same Cameron Crise:
One thing that is close to guaranteed is higher short-term volatility in the S&P 500. Even with earnings season in full swing, the two week realized vol of the index has been around 3%. Statistically, it’s hard for that to go much lower. What makes the low level of index vol somewhat surprising is that the average volatility for each of the stocks in the index over the same period has been more than 22%. The implication is that the average pairwise correlation within the index has been a little more than 1%. Again, there is only one way for that to go - up
Then again, as Goldman reminded everyone last week, the best of times in stretched markets are usually right at the end.
And on that note, I'll leave you with the following table brought to you by the good folks at 200 West:
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.