Trader Fears Bear Stearns Redux: “The Market’s Fooling Itself”

Morgan Stanley’s Andrew Sheets’ – London-based head of cross-asset strategy – comments that “we’re heading into a summer that is going to remain volatile,” warning that:

“We have upcoming headlines on steel tariffs, we have upcoming headlines on China trade negotiations, we have Nafta, we have an uncertain political backdrop in Italy, we have a new government potentially in Spain. There’s a lot for the market to digest.

And, Sheets is not along, as Bloomberg reports, Wall Street strategists have a word of warning for investors hoping to recuperate this summer after a tumultuous stretch of market trading: Don’t rest on your laurels.

However, it’s tough to fight the constant barrage of mainstream media headlines proclaiming… Record highs for Small Caps; Record highs for Nasdaq; Record highs for tech relative to financials…


For credit investors, it’s time to get defensive to “weather what is likely to be a relatively volatile summer,” according to Wells Fargo & Co. strategists led by George Bory. They cite “heightened” concerns about trade wars, and the prospect of tighter monetary policy overshadowing an otherwise healthy economic backdrop.


But, as former fund manager and FX trader Richard Breslow notes one could be forgiven for looking from one screen to the next today and concluding everything is cool.

If you share the purported world view of the European Union Budget Commissioner Guenther Oettinger, markets have summed up all of the world’s challenges and concluded everything is okey-dokey.

And if traders are saying so, it must be true, right?

Via Bloomberg,

Equities are happy. Indeed, there isn’t a soul to be found who can’t help wondering if the S&P 500 will finally take a serious run at 2750. Safe havens are being eschewed. Emerging markets are again acting the temptress. Quite the snapshot of calm, cool and collected. There’s just one glitch. I don’t believe it any more than you do.

If this were just an example of asset prices not necessarily portraying an obvious picture of bigger world issues it would be one thing. That certainly isn’t something new. If it reinforces the understanding that while central banks may be plotting their QE exits they have in no way left the building nor harbor any intention of ever surrendering their keys, then I applaud the realism. We’ve yet to see traders show any sustained appetite to take on the powers that be. It wouldn’t even offend me to make the argument that it was doom and gloomers that proved to be the weak hands in this go-round.

The caution should be that in an increasingly complicated world, with challenges that are real but not necessarily imminent nor easily discounted, there is a tendency to skew investment choices to the simple. It’s the market’s way of fooling itself into thinking it can ring-fence the complicated stuff by ignoring it.

Don’t know what effect a trade war will have on Asian high-yield credit spreads? No worries. Buy E-minis while the other stuff sorts itself out.

This is precisely the way the argument went after Bear Stearns’ subprime funds became news.

Why would bad mortgages hurt good old fashioned stocks like AIG or General Electric?

Go back and reread what was being said about plain vanilla in the second half of 2007.

This KISS strategy might work for a trade but is ultimately asking for trouble. Especially if it reinforces a false sense of safety.

What looks like a conservative play to the risk-management department and the Var models might be anything but.

Correlation matrices may not all be a series of plus and minus ones anymore, but they are a lot closer to that than some pre-financial crisis anachronism.

You can’t have one world view for part of your portfolio and a totally different one for the rest. Choose your outlook and go from there but resist the notion that anything is an island.

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