Royal Bank of Scotland to investors: 'Sell everything'

The futures kept trading down after the close -- about another 1 percent, so likely that it carries through Europe and Asia and we open lower tomorrow. Guess we'll see if the buy the dippers show up tomorrow.

I have posted a lot about how for the last 2 years as the BOJ and ECB created the carry trade (taking over for the Fed) by buying everything in sight, and the VIX (fear index) collapsed and became one of the biggest signs of the bubble. That itself became a trade like bitcoin. ... monkey's shorting it relentlessly (easy money!), even though the potential upside was miniscule and the potential downside was huge. People have been trading it naked. The VIX traded below 10 a ridiculous number of days over the last year and a half, which essentially said there was no worry because of all the artificial liquidity they have pumped in and that central banks had destroyed our markets. Today, the VIX finally spiked, getting up to 38 on that price action. With that kind of move, it's actually surprising the Dow and S&P held up as well as they did, although as I said the selling has continued in the futures markets so there is still a little more washout at least.

The exchanges deserve some credit. When that selling came in the afternoon on programs dumping, the move was frenetic. But the exchanges held up really well and the market makers were able to pair off buyers and sellers without the kind of slippage you'd expect when the dow is down about 900 and drops to down 1600 in a matter of minutes. They should really be patting themselves on the backs.

 

The VIX (and the theory behind it, because this really only dates from the mid 80s) is a bit complicated, formula wise. But the way to think about it is that it simply looks at the options market and measures the price of index options to get a feel for how expensive it is to insure an equity portfolio. That gives you a proxy for how much fear is out there. When buying option protection on an equity portfolio is cheap. ... the VIX is going to register lower. When the price of that "insurance" goes up, the VIX is going to rise.

The VIX itself (because these trade as futures and options) became a trade in itself over the last several years, where people thought it was free and easy money -- it was example number a gazillion of monkey traders front running central bankers. You have central banks supporting markets and creating price distortions, not just in their obvious actions of buying trillions upon trillions of dollars assets to suppress yields, but also in terms of rhetoric, i.e. Mario Draghi -- "whatever it takes" to preserve the Euro. They destroyed honest price discovery, which in turn suppressed all volatility. This has had destructive consequences that we haven't paid the price for -- but it is coming. In terms of the VIX, I have watched for several years as everyone piled into one side of the boat to pound the VIX down. Some of those risk parity traders understand what they are doing, and think they can cover their leveraged portfolios in time. But a lot of that money is way dumber than people can imagine. You have created bad incentives and people have responded to them. And there are a lot of entities swimming naked -- way overleveraged, thinking nothing could go wrong (they have been conditioned to understand that central banks will always intervene and support their bubble markets).

After the last 2 years (and I have posted about this several times) in which the VIX was at ridiculously low levels and nothing could shake it (not a fear in the world, everything was lollipops and puppy dogs thanks to Yellen, Draghi, Kuroda, etc.) on Friday and yesterday, people got a small taste of the opposite. Yields starting to spike. ... and when that happens, you have debt levels that have exploded. ... and it costs more to service that debt. None of this nonsense works without a price fixer keeping it essentially free to borrow forever as more and more debt runs up.

The problem is that this isn't the end. Even if markets stabilize and we bounce, or they intervene again (I will not be surprised anymore) because they feel they can't let their bubble world pop, etc. there needs to be a massive deleveraging in order to get healthy. That is going to mean some chaos. Take the VIX options and futures. Take every debt market in the world (and consider this: The 2-year Greek note yields less than the 2-year U.S. Treasury note! It's bizarro world). Take even equity markets, which have been supported by phoniness -- stock buybacks on the back of all of the cheap money. There is a huge liquidity problem underlying every risk asset market out there. And a lot of people still don't get it. These central banks brought prices way out of whack by fixing the price of money to make it artificially cheap beyond anything we have ever seen. Bond yields lower, the Vix lower. Equities up, up, up. This permeates just about every asset. All of those things are VERY mispriced. When they reprice (either because the central banks voluntarily stop -- not likely. ... or because there is a credit crisis) there are going to be a lot of sellers and no buyers on the way down (and again, that is when central banks will try to become that buyer again if they keep doing the same stupid things). It may or may not happen in a disorderly way -- with various market crashes. But bond yields have to head a lot higher when the manipulation ends.

One other thing. ... Part of what is making this happen right now. ... The Federal Reserve, after 10 years, is FINALLY letting a small amount of that $4.5 trillion balance sheet roll off. ... meaning a small amount of their buying of U.S. treasury and agency debt that was suppressing yields has started to go away. At the same time, we just passed an ill-advised tax bill that is going to reduce revenues coming into the treasury. And fiscally? We are drowning in entitlements spending (which they don't even talk about) and at the same time, blissfully ignoring reality, the budget debate is circling around things like more than a trillion dollars of infrastructure spending, increasing military spending, building walls, etc. Add it all together, and you have 1) An "official" entity that was engaged in an incomprehensible scheme of creating money out of thin air and using that money to buy much of the debt the U.S. has issued. ... now trying to end that scheme (which became a rabbit hole for them). 2) And you have the U.S. looking at a trillion dollar + budget deficit (between the reduced revenues and the increased spending), meaning that we are going to have issue more bonds. You have the bonds in that treasury market severely mispriced from a decade of manipulation by the Fed. Who is going to buy those new bonds we have to issue because of the fiscal stupidity, at those way overpriced prices. ... OTHER than the Fed? Markets are finally dealing with that dilemma and the bond market started to reprice those bonds down (and drive up yields). This is just a small taste. Those same market participants are now sitting and waiting to hear from Jay Powell. ... You have our back, right?