Investors Can Front-Run the Fed, but Complacency Will Torch You...

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    Investors Can Front-Run the Fed, but Complacency Will Torch You in the End

    Posted by Charles Sizemore | Jun 4, 2020 | Investing

    Wall Street is not known for having a particularly long attention span. For crying out loud, these are the people that continue to lend money to Argentina again and again despite the fact that the country has defaulted nine times in its history. Call it the triumph of hope over experience?

    Perhaps it’s the convenience of a liquid market that stirs investors complacency. If you knew you’d have to hold on to an investment for five years, you might be a little more selective about what you buy and the price you pay. But when you can unload shares in a fraction of a second, you tend to have a shorter time frame.

    It’s not as important to stay vigilant when you can always sell to a greater fool and do so quickly.


    I say this because investors are throwing caution to the wind again. It was less than three months ago that the world appeared to be ending over the COVID-19 pandemic. By some metrics, March 2020 was the most volatile month in history.

    And yet today, it would seem like nothing had happened. The S&P 500 is within spitting distance of positive territory for the year, and the Nasdaq is already there.


    Meanwhile, the CBOE equity put/call ratio — a popular quick-and-dirty metric for gauging investor sentiment — just hit its lowest levels since the February all-time highs in the stock market.
    For the uninitiated, the equity put/call ratio measures the volume of put options traded relative to call options.
    Investors buy put options to hedge against a market decline or to actually speculate and make money on one. They buy puts when they are scared or bearish. They buy call options when they expect prices to go higher, or when they’re optimistic and bullish.
    Perhaps not surprisingly, this tends to be a contrarian indicator. Investors perpetually scramble to close the barn door after the horse has already bolted, buying puts after a decline has already happened and buying calls when a move higher has already happened.
    Investor Complacency: The Fed Has Your Back

    I get investor complacency. If there is one lesson we’ve all learned since the 1990s, it is that the Federal Reserve has your back. Whether it was Alan Greenspan at the helm or Ben Bernanke, Janet Yellen or now Jerome Powell, whenever the market starts to look dicey, the Fed can be depended on to step in and flood it with liquidity.

    That’s what’s happening today. With the Fed committed to trillions of dollars of asset purchases and a zero-rate interest regime for the foreseeable future, investors are betting that capital continues to flood into the market indefinitely.

    They’re front-running the Fed.

    I get it. I really do. But a trade can’t stay that one-sided forever. Something will eventually come along and change the narrative. Will it be another uptick in COVID-19 cases? A failed vaccine trial? Election irregularities?


    Or, what if the Fed’s actions finally hit a tipping point that erodes confidence in the dollar or causes inflation to roar back?

    I don’t know what the catalyst will be, and it’s probably too early to pull the plug on long positions. But this is not the time for investor complacency. It makes sense to focus a little more on shorter-term trading strategies and, where possible, to hedge.

    If I were a betting man, I’d say we have several months or even a couple of years before this trade runs its course. But the time to start hedging and spreading your bets around is now.
 
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