Market Memo: The Day After Tomorrow

Rapid Fire Opinions

Due to the recent volatility CitriniResearch will be attempting to strike it rich in Hollywood instead of providing equity research. Please enjoy the trailer for our upcoming feature-length film, titled…

THE DRAWDOWN AFTER TOMORROW

Director: Citrini

Executive Producer: Citrini

FADE IN

EXT. WALL STREET - DAY

The iconic bull statue stands amidst eerie silence. Ominous music builds.

NARRATOR: "In a world where stocks only go up..."

INT. HEDGE FUND OFFICES - DAY

TRADERS frantically type on keyboards, eyes glued to screens showing red charts. TRADER 1 shows the screen of his Bloomberg Terminal to TRADER 2.

TRADER 1 (panicked) Can you check this number on under the PnL% column for those puts we sold yesterday? Has to be wrong, right?

TRADER 2 (annoyed) Of course…dips get bought. Easiest alpha in the world. After all, stocks were down 1% yesterday. We’re lucky we got filled on our entire dip buy before some other pod did.

TRADER 2 beckons to a group of traders gathered across the office and points at TRADER 1.

TRADER 2 (boisterously) This guy doesn’t know dips get bought!

TRADER 1 (relieved, to himself) Right. Of course. Must be a glitch.

NARRATOR: "Until one day..."

EXT. CITY STREET - NIGHT

THE ELDERS in tattered suits huddle around a burning trash can.

ELDER 1 We tried to warn them. Stocks can go down.

ELDER 2 They called us boomers. Said we didn't understand. Said we’d get blown out.

ELDER 1 We did get blown out…

ELDER 2 (sagely) The market giveth, and the market taketh away.

TRADER 1 approaches, looking disheveled and holding a cardboard box containing the contents of his desk.

TRADER 1 (desperately) Is it true? The prophecies… Have we truly exhausted the world’s supply of dip buyers?

ELDER 1 Yes, my child. Stocks...can go down.

The Trader collapses to their knees and wails, arms outstretched to the sky as if to plead with some benevolent deity.

TRADER 1 The hubris. The audacity. We could have hedged with the VIX at 12. How could we have been so naive!

EXT. TIMES SQUARE - NIGHT

Broken screens display the CNBC “Markets in Turmoil” chyron, the S&P500 is down an unheard of 5% from its all time highs. A gang of former dip buyers in tattered Patagonia vests ride Citi Bikes through the streets, looking for traders who’s drawdown limits have yet to be breached.

FADE TO BLACK

TRADER 1 (whispering) It’ll bounce today…right?

END.

---

Oscar worthy, right?

…

Everyone’s a critic. Okay fine, we’ll do a real market memo.

The long-awaited multiple day >1% drawdown has arrived. The VIX has gained and not immediately reversed yet, the equity markets kind of caring about macro moment is here, geopolitics is a reason to sell stocks - whatever you attribute this to, the bottom line is we aren’t in up only mode anymore.

There has been competition for dip-buying alpha all year, culminating in a market where a -1% daily close was near impossible and almost universally followed by a massive V shaped recovery the next day. This lent itself to an environment where smaller and smaller dips were bought, ultimately rewarding the most aggressive of the dip buyers, and set up a market environment that would be intensely supportive of equities on a 1-2% decline but see widespread capitulation on anything more over a period of 2-3 sessions.

And, as I’ve been pointing out in our subscriber chat, when things become extremely rare (like a >2% drawdown on the index has been the past 6-9 months) and then happen for the first time, they tend to happen quickly and to much fanfare. This is basically a VaR shock but a mini-one - in reality not much has happened (see chart above).

Compared to the rest of the year, however, it seems brutal. SPX has fallen for seven of the last eleven trading sessions (through Monday). The macro environment, which equities have been relatively resilient to for the past couple months, is finally beginning to affect stocks and show up in the attitude of Fed Speakers.

This is a risk I’ve been pointing out since mid-March:

One year inflation swaps are currently above where they were during most of the Q3 23 selloff and seem ready to return to pre-SIVB highs:

That’s significant, as it means the last time rates were this high on the short end, real yields were actually about 70bps higher. That could mean more room for nominal rates to climb if breakevens go sideways or further up. Still, 5% is always going to be a significant psychological level for real money, so I’d continue watching it.

As I’ve mentioned numerous times in the chat, I believe we’re headed for a retracement down to previous all time highs. That’s at around 4800, but let’s call it 4850 because of the obvious frontrunning that’ll occur. The bullish reversal thesis hinged on two things - selling for tax purposes abating and then OpEx. I think it’s likely those things don’t end up providing immediate relief and we see continued weakness for the remainder of April, but I’d like to buy the dip once we get there.

This is why we have been hedging aggressively most of the year (most recently on 4/2 - 4/4). You may recall this from our Q1 Update:

While hedging resulted in us underperforming in March, so far in April it’s resulted in quite a bit of outperformance - nearly 2.5% worth.

Let’s discuss some things I notice could make for good plays as we reach a potential inflection in the market.

[PAYWALL BELOW]