Daily Wrap

It's a little tough in certain areas to look at the predictive assets such as FX futures when the algos were shut down yesterday, just look at USD/JPY vs ES yesterday after 2 p.m., have you ever seen them go in totally different directions to that extent over the last 2-3 years? I doubt it, as soon as that uncertainty hit the market, they shut down the algos, it seems that even the VIX/Market algo was shut down, although we could just be seeing a solid bid (real supply demand dynamics) in the asset which is a move to buy protection or a flight to safety.

At least one correlation algo has been restarted, AUD/JPY, note they don't want to get near the $USD right now as it popped which is the same reaction it would have had a year ago if disappointing QE news came out, T's fell and gold fell, all the same reaction the market would have to say the initial announcement of the QE taper or a possible rate hike.

I gathered most of these charts around 3 p.m. but I don't think there will be too much difference, I'll try to recheck them in case there's anything substantially different, but I doubt it would be anything that would change anything presented below.

As for the carry trades (JPY based... and watchout this weekend for potential trading desk failures out of China as they were ultra leveraged the CNY thinking it was going up forever, it got hit -.5% overnight on another default today of a steel mill so some of those trading desks just lost their jobs and accounts)

 USD/JPY in red/green and ES (SPX futures) in purple, note there's no correlation, if there was they'd have to run the SPX up and they don't apparently want the risk of doing that so they've stayed away from the mainstay Carry trade.

The EUR/JPY got smashed as well because of $USDX strength against anything it's paired with, that means the EUR/USD got slammed, thus the Euro doesn't look so hot against the Yen and this pair is obviously weak.

Remember earlier today I made a half-serious joke about the HFT arbitrage/correlation firms working all night...

"Overnight all correlation algos were turned off as the $USD trounced every pair, the USD/JPY should have sent the market flying higher, but the big algo firms shut them down and are probably re-callibrating them or spent all night doing so as all correlations are dead."

Well guess what, I wasn't that far off, what pair did they chose? AUD/JPY...

 By the 9:30 open it seems they had the correlations reprogrammed in AUD/JPY as it's nearly tick for tick after the US open.

These firms make big money, they spend big money to get microseconds faster than competition, being down overnight or through a trading day is a major loss.

As far as the AUD/JPY pair and 3C, I was seeing a bit of a negative divegrence in the pair and it has continued lower on that divegrence since this capture, now trading  from 92.68 to 92.57 which is just around the 10:30 a.m. reaction high.

If this pair continues lower it should take Index futures/the market lower as it is the only correlated carry trade with ES right now, they can't touch $USD because of the gains it put in on bad F_E_D news (at least that's what the dollar has done the last 5 years when the market is disappointed with F_O_M_C policy).

Now that we have a pair, we can try to predict where it's going using the single currency futures such as $AUD and JPY.

 This was what $AUD 1 min intraday looked like (that's about 11 p.m. last night to the far left to give you some idea of scale, you should be able to click on the chart to enlarge it).

 As far as the 5 min chart (and I don't trust 1 min charts to hold up overnight, a 5 min is more anchored and can hold overnight)  it "looks" like the $AUD is under a little accumulation, it "looks" like a small reversal process in place (U-shaped with a small head fake move). If this is the case, then the PCLN signals from earlier today would make sense, since they were so short in duration I decided if I play them I'd need leverage to make the risk worthwhile. 

Much in the same way, if the $AUD was going to lead the Index futures higher, it can only go so far on a gallon of gas, that's about how large the duration of this reversal process would be and they are almost always proportionate. A positive divegrence this size in $AUD would fit just about right with the duration of a PCLN long, very short term, but perhaps long enough for Window Dressing considering the t+3 settlement date would be Wednesday for quarter's end.

Is this a big deal "if" it holds, no not at all, it's a chance to make a little extra scratch and a chance for VXX to put in the flying (stronger than leading, and only seen in VIX assets) divergences that are such fantastic timing markers, whether going long VXX / UVXY or shorting the market and that has been the focus of this entire week.

In my view, any cycle that we have seen this week which we have been looking for, but VERY specifically prepared for last Friday by closing all puts (most) and opening a couple of long call hedging positions which was perfect timing, was not like past market cycles that were meant to move sentiment and emotion like the February rally, in this case I feel very strongly that the long term positive in the VIX futures is close to breaking out and when we have a long term divegrence like you'll see, we always return to the short term charts as a timing indication which again, IS WHAT THIS WEEK HAS BEEN ABOUT, it's just the market and VIX trade mirror opposite (usually-today not so).

Leading Indicators... *Leading Indicators are compared to the SPY/SPX in green unless otherwise noted

Here we have what we knew a week and a half ago was going to be the manipulation lever to move the market, HYG, because of the POSITIVE divergence in HYG, I expected this week's move up since Monday to have occurred last week, that wasn't the case, but eventually HYG did manage to pull the market north and as I stated, it's my view and was my view before the move even started that this move in the market to the upside wasn't meant to do anything other than push VIX futures to the downside where they could be accumulated on the cheap and thus far they have been.

Since last Friday to today the SPY has moved +1.68%, this is what we were looking for, but not for any market average head fake move, for VXX accumulation which is done on a decline which has been -7.24% on the week since Friday's close.

Today HYG is CLEARLY underperforming the SPX which is a show of weakness in the market lever to lift the markets, remember we first saw distribution in HYG Tuesday, Wednesday it was huge comparatively and now we are seeing it in price.

HYG is fantastic for fooling the algos in to thinking that institutional money is taking a risk on stance and it's a lot cheaper to move one asset (HYG) that is correlated via algos, thus letting the algos do all the work of moving the market than to accumulate enough of each of the major averages and their most weighted stocks to move them. There's another advantage as well, if you are trying to sell of short the averages in to higher prices or demand, you need to invest so much in the cycle, that means you need to first sell all of those accumulated shares that were bought just to make the market move before you can ever get to net selling or short selling.

 Here we have High Yield Credit vs the SPY/SPX.

The reason we use HY Credit as a leading indicator is because it is used as a "Risk On" asset by institutional money, but almost exclusively by institutional money. How many of you have traded credit? Furthermore the credit markets are much better informed than the equities market, thus the Wall Street maxim, "Credit leads, stocks follow".

Unlike High Yield Corporate Credit which is very liquid, High Yield Credit above has NO correlation to market manipulation, thus it is a good proxy for HY credit in general as HYG does have a correlation asa market lever on its own and with VXX and TLT as part of the SPY Arbitrage.

The point in this chart is that we went from in line vs the SPX last week to the SPX's pop this week and credit didn't bite, it sold off  at the red arrows rather than follow another risk on asset, equities, that's why we use it as a leading indicator.

 This is a more specific look at HY Credit today vs the SPY, it's selling off as the SPY bounces on what I expected yesterday to be a dead cat kind of oversold bounce. Why would credit go risk on if this is just an oversold bounce?

Pro Sentiment Indications...

Today we saw early selling in sentiment and again later larger selling, pros are not following along in a happy song.

Our second sentiment indication we use shows the same except more acute, they didn't buy in to the oversold bounce at all.

As far as VXX or Short term VIX futures, we normally would have expected some downside with the SPX up a bit, at first I suspected that the correlation algos for VIX/SPX were also shut down, but looking more closely as the day went on, it looks like one of the rare instances in which actual demand pushes prices above where they should be according to the correlation model and that's what we saw today in VXX, there was demand for protection.

*I inverted SPX prices (green) to show what the usual correlation would have been since the VIX and SPX usually trade mirror opposite, if the correlation were exact, these two lines would move exactly together, but they don't VIX futures are bid enough that demand is pushing price above the algo controlled correlation.

 Yesterday Treasuries got hammered which sent yields up given us an unreliable leading signal there, this is how treasuries have reacted over the last 5 years when disappointed with F_E_D policy or concerned, $USD up, Gold and TReasuries down, when they like F_E_D policy it's $USD down, gold and Treasuries up.

Today however we did see a flight to safety in treasuries as they outperformed the correlation vs the SPX which is also created by inverting the SPX's price.

 As I just mentioned, because Treasuries got slammed on the policy announcement yesterday , one of my favorite leading indicators, Yields moved up making it look like it was supportive of further risk on moves in the SPX, but this was a natural reaction as yields move opposite Treasuries and the fact T's were slammed sent Yields higher, t was not a leading signal, just an anomaly because of the F_O_M_c.

However today as there was a flight to safety bid in Treasuries, we saw Yields remain as flat as can be even though the SPX gained ground, thus we have a slight negative dislocation there, not so obvious, but if you look at the trajectory of both today you can see the non confirmation in Yields.

 This is a closer look at them intraday, you can see they are actually selling off as more protection is bid in the flight to safety trade in to treasuries.

 I found this chart of commodities vs the SPX very interesting, I don't think this had too much to do with the F_E_D even though precious metals were down, but there were down yesterday as well, just a bit more today.

What I think we are seeing here is a reaction to the overnight default by HighSee Group  Steel on  CNY3 billion of debt. This is the second or third default, China via banks and local governments have always come to the rescue of companies ensuring no defaults, Chaori was the first, thus investors who thought they had a risk free lunch ticket quickly found out that they are in big trouble.

Furthermore, the shadow banking system in China has been one of these companies pledging commodities (like steel, iron ore, copper which has been ruthlessly hammered) in return for capital, now the banks that are flush with capital as evidenced by the low shibor rate are not lending, they are not doing new deals as dozens have been cancelled since Chaori and  THEY ARE PUTTING IN CASH CALLS ON THE LOANS, THE COMAPNIES HAVE NO ALTERNATIVE BUT TO RAISE THE CASH BY SELLING THE PHYSICAL COMMODITY, just look at copper recently. In any case, since we didn't have that big of a move in Gold today vs yesterday it seems clear to me that the default of another company has caused wider cash calls and more commodity selling to raise the cash the banks are demanding.

This is why I talked about Aluminum as a possible way to play Chinese weakness without chasing copper , AA, ACH, etc. as those are commods that haven't been hit yet, but this wave of defaults is just getting started and it should push global commodity prices lower.

In any case the point here is the problems in China are far beyond most people's understanding, they are literally having a Bear Stearns 2008 moment and we'd be wise to get in front of this where we can.

 HYG as mentioned yesterday saw increased negative leading divergences, that continued today so I think we are getting close or are at the end of the market manipulation lever's support of the market.

 The 5 min chart is what I wanted to see go negative, it sure did fast yesterday and added to that today.

 Ultimately the HYG divergence that we saw before hand and knew this was going to be used to move the market (thus all the repositioning last Friday) only reached a 10 min chart, once the divergence there is destroyed, the market has no more support and as of now, HYG was leading 2 days ago, it's now any longer.

VXX saw accumulation today even though it didn't move down, that sounds like fear and real supply and demand which is rare to see, but fear is the strongest emotion.

 3 min VXX today

And the increasingly leading positive 5 min VXX

This is the long term VXX accumulation that was heading higher when it should have been moving lower during the Feb. rally, the large position is in place, this is why we have returned to short term charts this week looking for the timing, because a large position has already been accumulated and was done so during the February rally which should tell you something.

As for the ramp in Financials today, the F_E_D's bank stress test results came out and 29 of 30 passed, so I wonder why Financials would rally +1.63% in front of a wild card unknown? Usually they'd be flat or selling of in anticipation of the release, unless...

Hey, stranger things have happened.  There was some intraday distribution in the sector especially in to the 2 p.m. hour, I imagine this will present a trading opportunity just because of where the larger trend is and the probabilities, but I don't think we are there quite yet.

 The larger trend /probabilities on the 4 hour chart, but also on numerous other timeframes.

XLF/Financials intraday...

What adds credibility to the trend above and the probability financials set up a nice short based on probabilities is the fact that financial Credit was not buying the move that equities were today.

There's a notable divergence between stocks and credit, which one do I trust? I think you know.

Finally as far as futures go as of now, which of course is very early...

 ES intraday 1 min tonight thus far with a negative, this usually won't hold overnight, but the 5 min is much better in that regard.

The 5 min is showing distribution on every attempt to move higher.

I'll check futures again later tonight and see if anything is moving or new correlations back on line, don't forget volatility tomorrow as we have Quadruple Witching options expiration and we also have window dressing in to the end of the first quarter.