Most mornings, I come into the trading session with a page full of notes.
Friday, I looked at the screen before the bell and wrote nothing down. I do that on days when I know it’s going to get pretty wild, because you have to walk into a session like that with your arms wide open.
The first thing I saw was the volatility futures. Forget the VIX for a second. Over the weekend, you’re going to see articles about the VIX crossing 20, and I don’t care.
The volatility futures are the ones worth watching, and they clearly see trouble coming.
The Vol Futures Flipped
Volatility futures are contracts that let traders bet on where the VIX will be on a future date. Normally, the next month costs less than the month after it, because more can go wrong over a longer stretch of time.
When the front month costs more than the next one, the curve is inverted. It means traders are paying up for protection right now.
On Friday, we were fully inverted by 40 cents, and then it hit 50. That’s a big inversion.
You could argue November has the election in it. But when I look at the S&P 500 options around the election, I see a mild bump in volatility, so whatever the vol futures are seeing, it’s right here, right now.
Cover up the S&P futures for a second and look at the volatility instead. It’s saying, “Hold me.” Nobody knows what this is going to look like, and the volatility market doesn’t trust a damn thing.
Junk Didn’t Get The Memo
Treasurys rallied big over the last few sessions. One fund didn’t come along for the ride.
HYG is the iShares fund that holds junk bonds, the debt of companies with weaker credit. Those companies pay higher interest because there’s a bigger chance they don’t pay you back. HYG didn’t rally with the rest of the bond market, and on a longer-term chart, it looks like it’s about to fall off the edge of a cliff.
It’s a product that does nothing until it does everything. In my opinion, we have a junk crisis, and I could see HYG drop below 70.
The last time it was down there, we were coming into COVID. That’s how serious this is.
A ton of data center debt is getting piled into junk right now. It reminds me of subprime, where nobody thought it was subprime because they threw it in with everything else.
Everybody assumes junk is junk. This is beyond junk. I’d call it distressed debt, and it’s packed right in there with the rest of HYG.
And HYG yields only about 5.3%, which is stupid. I wouldn’t buy it with anybody’s money, and I could make an argument that it should yield something like 12% or 13%.
People think interest rates are high right now, but they’re not high for the kind of risk that’s out there.
The Fed’s Catch-22
This week is a proverbial crap fest of risk, and there’s a Fed meeting right in the middle of it. What are those idiots going to do? Absolutely nothing.
CME FedWatch had the odds of no change at 89% on Friday, with roughly 70% odds of a hike in December.
If the market keeps tanking, the Fed won’t hike, because people getting their heads handed to them takes care of the inflation worries for them. And if the Fed does hike, I think it only causes more problems in the junk market.
Either way, keep one eye on HYG. It’s been doing nothing for a long time, and junk doesn’t send you a warning before it does everything.
To your success,
Don Kaufman
