Isn’t it amazing how forgetful market participants can be? Not even a full month ago, sentiment was as if the (financial) world were about to implode. Just a week later the panic-induced market losses were already gained back and three weeks later the crowd is smelling new all-time highs again. What I’m concerned about is expectations seem to be that nothing unfortunate will happen again. I have become a bit concerned, as complacency seems to be EXTRAORDINARILY high. In such an environment, small shifts are enough to cause a market panic – there are a few signs to be aware of. And a new stock idea for my members to capitalize on that, too.

Summary and key takeaways from today’s Weekly
– The “bear market of 05 August 2024” seems already forgotten, at least when looking at further expectations.
– Options markets show a concerning one-sided assumption of “nothing can go wrong”.
– In the not unlikely case that something catches the crowd by surprise – there are several potential reasons – one should prepare accordingly. My latest stock idea is such a tool.

I think it is without any question that we’re living in exciting times, to say the least.

Does anyone remember the “bear market of 05 August 2024”, caused by a strongly appreciated Japanese Yen which caught one-sidedly positioned gamblers by surprise and led to a worldwide market panic? In the case of the Nikkei, the Japanese blue-chip index even had its worst day since the 1987 crash, so this wasn’t just a small hick-up.

Maybe early-August 2024 is already too long ago now.

– That’s the only joke for today. –

We have observed a very quick and dirty market shock caused by a mass liquidation of assets that was good enough to send the fear barometer, the volatility index VIX, to its by far highest level since the March 2020 panic and even the third-highest level ever (since the VIX has been published in 1993).

As if this weren’t enough, we saw one of the fastest melt-ups (from the VIX’ perspective), if not THE fastest. Only the Black Monday on 19 October 1987 was scarier, however, there was no VIX back then.

Part of the truth is, though, that most markets – with the exception of Japan – haven’t even started a real correction, as for example the S&P 500 did not even fall by ten percent from high to trough to even mark a real technical correction.

Media and headlines were already wheel-spinning.

Long forgotten, we are now in proximity to new highs again in the S&P 500 (the Dow made a new high earlier this week). While this by itself does not say anything negative, behind the scenes there are noteworthy developments in the making one should know about.

Don’t worry, I am not a crash guru, nor do I have any ambitions to join this infamous group. My job is to observe markets and to find attractive investment opportunities from a risk and reward perspective. Sometimes there are interesting setups – like now – where an idea can benefit from strange, asymmetrical market assumptions if and when a catalyst ignites a bigger move in the opposite direction.

As I am publishing stock ideas for my members (and my first such idea seemingly not working anymore), the challenge was to find another equity solution which benefits from a not unlikely coming market clean-up. We don’t even need a big crash – just a back to normal could shake through the ignorant fearlessness.

Besides potential upside in the case I am right, I also want to have limited risk.

The result is my latest stock idea with a monopolistic market position in a high margin business that benefits from such market craziness. All my members are receiving my new report in parallel to this Weekly.

Join me and my members on our journey to beat the markets!

^{active Premium PLUS ideas per 28 August 2024 market close; closed Premium ideas per 31 July 2024 market close; all data since August 2022}

When the boat is not only full, but full just on one side and everyone’s happy…

… there’s a risk to capsize.

While this might sound click-baity, these were exactly my unemotional thoughts when I went through the material I am going to discuss in the following.

Besides, I don’t care about clicks, I want to show my interested and open-minded readers new perspectives. When I wrote about coming dividend cuts not sparing even dividend kings, consumer stocks having a tough time or most silver stocks being garbage, first reactions were also laughter and ignorance.

Maybe I am lucky again. 😉

My longer-time readers know that I am not reading from tee leaves, but puzzling together hard data and information I come across. This is not about anything crash-guru related. I am looking at things from a macro lens, believing in cycles and interconnectedness as well as questioning risk and reward to find attractive investment opportunities through market anomalies.

I think this describes it best.

A good source to catch up with recent developments in the form of charts, is to scan through Twitter / X (past the breakfast or holiday photos and buy-every-dip posts). From time to time, you can find really cool stuff and get a feeling for how the broad market sentiment is like.

After I saw several charts, all with the same core message, I instantly knew this was not only my next Weekly, but that there needs to be an asymmetric stock opportunity to potentially cash in on this myopia I am going to show you below.

But before we dive into it, first the max chart of the VIX, the volatility index on the S&P 500 which in a nutshell tells you what participants are expecting over the next 30 days (based on current options on the S&P 500 – there are no direct VIX options!).

Without spending too much time on it, just take home that we have just seen not even a month ago the third-biggest spike on this index to a level above 60.

Only during 2008 and 2020 did we see higher overall levels crossing even 80.

The famous Black Monday on 19 October 1987 had no VIX at that time, but reverse-calculations indicate to an incredible level of 150 – just as a side note (see here or also described well in this book here).

However, this time the VIX jumped from 20-something to over 60-something – only to close in the 30s and all this just on the same day.

An insane, unprecedented move.

There was massive stress and fear in the system – though honestly outside of Japan not much happened when looking at market indices.

In the past, such upside-crash tops were build over several weeks, if not months before a final panic-selling occurred. This time, we had some bubbling the weeks before and then a blow-out and melt-down just in matter of hours.

Now, in 2024, it seems that this time is different (please read this as an ironic statement).

What followed the fastest melt-up of the VIX was the fastest crash of the same.

If you look closer on the chart above, you’ll see that the other big spikes are surrounded by some other, lower vertical lines, signaling that both moves, up and down, always took some time.

The VIX usually behaves contrary to the S&P 500. It tends to shoot up very fast when the S&P 500 tanks, but it comes back, though more slowly, in times of a rising or at least sideways moving market when fear dissolves.

Strangely, this all happened somehow in a very short time.

So, the real crash happened in the VIX, having lost ~75% from peak to now, signaling the consensus is now “everything will be fine” and “we’ve seen the storm already”.

As corporate earnings, especially from the biggest companies like Big Tech, but also consumer companies like Wal-Mart (ISIN: US9311421039, Ticker: WMT) have been relatively robust (not great, but no disaster, either) and a rate cut by the FED next month is a foregone conclusion, what could go wrong?

This seems to be a very one-sided, even myopic perspective.

Let’s take a look at the options market, where expectations can be seen. Below on the first chart from a newsletter of the WSJ last week, is an almost shocking spike in average daily VIX options volume (both, puts and calls).

So far in August – and the month isn’t over, yet – we’ve seen even higher activity than during March 2020 and overall way more than during other months.

Going a step further, one could assume that this had to do with hedging activities and / or speculative crash bets, i.e. a higher VIX (before and during the turbulences).

But, what happened is that suddenly now everybody seems to be shorting the VIX – betting on higher markets, or more precise, mostly against another shake up.

The next two charts show first the up and down of the VIX and second the development of assets under management in inverse VIX ETFs – bets on a downturn, respectively no rise anymore of the same (the VIX, not the markets).

^{source: The Daily Shot on Twitter / X, see here}

What’s so shocking is not the overall direction, but furthermore the intensity of the movement. Big money and very high conviction make this look like a safe bet.

Almost needless to say that we are seeing again a strong risk appetite and a VIX on a level that’s below historical averages – as if not only nothing happened, but furthermore, as if everything’s alright.

A few days ago, we also had the put / call ratio (i.e amount of put options vs. call options on the S&P 500, also known as PCR) reaching levels it hadn’t seen since July 2021 – three years ago.

Such a low PCR shows over-optimism, while during a panic sell-off we’d see a figure roughly double as high, at least above 1x.

Going a step further and as there are no direct options on the VIX, one of the most common ways to short the VIX is via so-called short-ETFs.

I will neither recommend this one or any other such ETF, because most people can’t trade them here in Europe anyhow while eligible buyers should know the risks. Besides, I am looking for stocks that could benefit from such situations without the big drawdowns you will see below.

SVIX is one such short-VIX ETF.

The problem is you need to be right very quickly to earn money with them (and to cash out quickly again!), otherwise you’ll lose money over time, even if you’ve been directionally right sometime later in the future.

How so?

In a nutshell, these ETFs need to constantly replace expiring or too short-term contracts, depending on their duration profile (there are short-term and long-term variants), with longer-dated ones.

As the latter, more into the future contracts, are usually more expensive – except during a hefty panic – because there’s more time left and priced in (time value), so-called roll-yield (losses) are created on top of management fees.

Below, you see (both year-to-date, i.e. for 2024 so far):

• on the left the short ETF SVXY which has been trending down, but spiking up sharply in early August, similar to the VIX
• on the right the VIXY, which is the opposite (roughly, not exactly), i.e. betting on a falling VIX or having an inverse relationship by rising when the VIX falls and vice versa

Good if one had been right, but ugly when not, especially in the second case.

Assuming one could trade them (better don’t, even substitutes to them), this looks like a good thing on the surface. However, the above mentioned roll-yield losses sum up quickly, as the following long-term charts of again the two above show:

^{same sources like above}

From time to time when their prices go too low, they re-split, that’s why the tops are so high. So you see, holding such stuff long-term is a slow-bleeding therapy with guaranteed losses the more time passes.

Full suicides are also available on the market, namely if one chooses even more exotic alternatives with daily expirations and / or built-in leverage and then gets caught on the wrong foot.

Below, there is shown an ETP that went bust in 2018, when spiking volatility killed it.

I am not saying that these instruments above will share the same fate, but better leave them on the side.

Now a few words regarding the “nothing can go wrong” theme.

Does anyone remember that a stronger Japanese Yen was the problem?

The Yen, by the way, is not just another of the Asian currencies, but it is the world’s third most important and biggest currency after the USD and the EUR – despite Japan’s dire debt situation and its malaised economy. The Japanese in turn are a significant investor in from their perspective foreign, i.e. international assets.

The recent issues had to do with two things. First, the famous carry-trades and second Japanese investors in foreign markets.

The first is a known phenomenon, where investors borrow in cheap Yen to invest in higher interest areas like the USA or Europe (or exotic places with even higher yields) to benefit from the big spread between the underlying interest rates.

So let’s say one can borrow for 1% in Yen and buy government bonds for 4% elsewhere – theoretically a 3% safe gain, in case the Yen does not appreciate. If it devalues, there are currency gains on top.

So in a nutshell, a carry-trade is a leveraged gamble on different interest rate levels with currency risks / chances attached to it. As long as the Yen devalues like it did (until it didn’t anymore), there are even currency gains for the borrowers. A suddenly rising Yen, however, causes pain, as liabilities in Yen rise, too, causing a forced liquidation (e.g. to fulfill margin requirements).

The second thing and way less discussed, but interconnected, is that Japan as a strong export nation with still one of the biggest economies in the world, has also been a big oversees investor which makes sense especially in the light of low to non-existent domestic interest rates.

Japan is the single biggest US creditor of federal debt with more than a trillion USD in foreign exchange reserves (i.e. foreign bond holdings) which – and this is no coincidence – were accumulated aggressively when interest rates in Japan dovetailed.

But of course it doesn’t stop here.

Japan’s ministry of Finance lists also among others 206 tr. JPY (~1.4 tr. USD) in direct and 289 tr. JPY (~2 tr. USD) in “portfolio”, i.e. indirect oversees equity investments. Both together roughly make up the equivalent of the current entire market cap of Apple’s stock, just for reference.

And this is only part of their international assets.

As these are not only more volatile, but also in many cases more liquid than bonds, it should be no wonder such rapid crashes occur when someone with deep pockets needs to raise money quickly.

So any wonder, a higher Yen (lower foreign currencies) causes pain in the system – Japanese investors, respectively those with JPY exposure, suffer foreign exchange losses in such a scenario. When Mr. Margin calls, there’s no time for a perfect exit. The time is now in such a scenario.

Below is now the Japanese Yen.

On the left over five years with a clear devaluation trend. But to the right and more interesting, the short term move higher (stronger currency, USD down that’s why the chart goes down).

If you look closely, you’ll see that we are now having even a stronger Yen than during the panic in early August. Everything’s fine, right?

^{source: both Trading Economics, see here}

Those who wish for lower interest rates by the FED should think twice.

I think over time, the JPY will devalue massively and even surpass the 200 barrier to the USD, but in the short-term, one should think about the following.

While a symbolic move seems to be forced upon the FED expected and priced in, the logical consequence is that lower US rates would only intensify the appreciation of the Yen – I thought the markets don’t want a higher Yen?

You see, it won’t be that easy going.

Either the FED risks another carry-trade blow-up with forced asset liquidations or they don’t lower rates at all – this way frustrating markets and likely causing turmoil anyhow in the sense of fearing over-tightening and being behind the timeline.

“Team transitory”, anyone?

It is also thinkable that even despite the Yen not appreciating further, another similar market reaction like in early August 2024 could happened again.

Why?

Well, lower US interest rates have never ignited bull markets in response, to the contrary. Let’s leave the special case of March 2020 aside, but on all other occasions lower interest rates were done in an already weak economy – igniting further sell-offs.

If this is done in tandem with a falling USD, then foreign investors start to make exchange losses – not a good prerequisite for investments, as those pressured ones will be forced to liquidate at some point.

Below, you see that there were recessions when interest rates were lowered. Never have rate cuts signaled the end, but further an intensification of an existing downtrend.

Below, you see the S&P 500 – please notice that markets tanked during recessions which aligned with lower interest rates. I used the log-scale to smooth out the parabolic moves.

^{source: macrotrends, see here}

If this weren’t enough, we also have the presidential election in the US which is a topic for itself. Certainly it looks like anything thinkable, but definitely not like a smooth ride…

Any geopolitical escalation is on the table all the time, too.

Or what about suddenly higher oil prices which are good enough to send inflation higher again? Libya for example just made some headlines.

We are talking about the 16th biggest producer which doesn’t sound like much, but it’s roughly on par with Nigeria or Qatar.

There are many reasons or potential catalysts why it is unlikely (not impossible, but unlikely) we’ll see only rising markets as if nothing were together with low or even further falling volatility. If one assumes so, what I wrote is void.

Otherwise, one should think about a trade how to benefit from potential market turmoil (again, not even a big crash is needed).

My former idea Flow Traders (ISIN: BMG3602E1084, Ticker: FLOW) maybe even could benefit in the short-term. However, I am not convinced of the current management and also the fact that FLOW has lost massive market share in its core market (see my article here), are unnecessary and avoidable risk factors.

Likewise, its competitor Virtu Financial (ISIN: US9282541013, Ticker: VIRT) with a similar, though not exactly the same business model, could be an idea to think about. My guess is it could do better than Flow Traders, especially over the long-term. However, there are a few things I don’t like about Virtu, like among others:

• its four-class (!) share structure
• the holding company (which one buys via the stock) owning only less than 60% of the underlying operating business
• its leveraged balance sheet
• it is also not the undisputed market leader, but one of many
• and a few things more

And this is how I came to my latest stock idea for my members – a partly monopolistic, partly oligopolistic business with very high margins, a robust balance sheet and the interesting setup to do well in rising and even better in falling markets. On top, with the recently high trading activity of options and potentially more in the case of market turmoil, my idea is set to benefit strongly.

It is a big, highly liquid stock without any time expiration risks or guaranteed losses over time like those VIX ETFs bring with them.

Conclusion

The “bear market of 05 August 2024” seems already forgotten, at least when looking at further expectations.

Options markets show a concerning one-sided assumption of “nothing can go wrong”.

In the not unlikely case that something catches the crowd by surprise – there are several potential reasons – one should prepare accordingly. My latest stock idea is such a tool.

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