Coiled Spring Capital Mid-week report 8/16/23

We have been at this game for over 2 decades, and drawdowns in the stock market always feel worse than what we originally expected. We were correct in getting defensive towards the end of July in our positioning, but we still have some thematics in play and thus specific long exposure. That long exposure has performed worse than we originally anticipated and are leaving us chock full of frustration. In hindsight we should have de-leveraged more than we did. Alas, here we are.

There are some real evident risks hitting the market and the macro has become increasingly cloudy. The market is getting pelted daily with macro negative news flow out of Asia, the US and Europe.

Worries around the shadow banking system in China have surfaced, coupled with property developers defaulting, and economic figures continuing to disappoint. This reduced growth and higher risk environment has forced the government to inject more liquidity into the market, but it hasn’t abated the slide. It’s always hard to determine how deep and wide these things can go but at the very least it is a headwind for global growth.

As a result, the MSCI China index has lost -10% in 2 weeks.

The Hang Seng is similar. These are not small moves in such a short amount of time.

The Chinese Yuan is getting hit as a result and now approaching levels not seen since late ‘22.

Europe (UKX Index) is also taking a beating and down almost -5% since the end of July.

And now the Nasdaq is down -6% since the end of July.

With the SPX down -4%.

To say that Aug hasn’t been kind to global markets is a bit of an understatement, since it’s only halfway done.

We correctly surmised that the market would bounce this week in our weekend report, but that bounce lasted only 1 day, and the selling reverted. Sometimes the selling pressure is too great, and we have to adjust, which we did and removed any index long exposure at around break even.

The lack of buying in the market supporting price levels is indicative of a market that was too bullish at the end of July. We talked about the NAAIM exposure being over 100% at that time vs 12% back in Oct at the lows. This number is now back to a very reasonable 65% but late buyers into the stock market have gotten scorched. Those late buyers returning back to the market will likely require something materially changing in the macro.

Currently, LT Treasury yields are exploding higher. We wrote about this in the weekend report as a major new risk for the equity markets to digest. Here is the excerpt from that report:

And since that report, the yields for long term treasury paper continue to press higher, where the 10 year is now the highest since Nov of last year.

The 30 year rate is now the highest since Oct of last year.

But even with the release of the hawkish FOMC minutes today, Fed Fund Futures are not pricing in more hikes and cuts are still slated to begin early next year.

Here are the probabilities on Tuesday’s close.

vs. todays. Very little difference despite a hawkish Fed.

What does the bond market see that the Fed doesn’t? We have discussed the notion of a credit event if rates continue to rise in the face of a slowing global economy. Maybe the bond market is suggesting this? At this point it’s not our place to speculate what’s happening under the surface but we can see what’s unfolding in front of us.

So let’s review…

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