Business As Usual


“Who has deceiv’d thee so oft as thy self?”. – Benjamin Franklin (ed.), Poor Richard’s Almanack

Last week was said to be about buying dips, or perhaps the resilient stock market shrugging off Trump troubles to focus on how great the economy really is. It wasn’t. Most of last week’s trading was about making money from short-term trading, nothing more, nothing less. While the most important event last week from the broader perspective may have indeed been the administration’s woes (and only time will tell in that respect), the most important event last week from the market’s point of view was the monthly options expiration.

Options dealers don’t have absolute rule over the market, nor do they have the firepower to overcome the biggest headlines. But they do know how to take advantage of less-than-hysterical conditions and push the markets a certain way. So do the quant programs who follow them, and who also make up the majority of trading volume.

Consider the SPYder ETF (NYSE: SPY), the most liquid and actively traded market ETF. It closed last week at 238.31, a closing you could have picked off several days earlier. Consider also the SPY put and call options that were due to expire Friday afternoon (technically Saturday, though for all intents and purposes, shortly after Friday’s close). At about 2:30 Friday afternoon, there were approximately 900,000 (900K) puts still outstanding with a strike price of 240 or less, about 250K at 238.5 or more (where they would be in the money). On the call side, there were 320K due to expire below 238 (in the money) and about 700K due to expire above 238 (potentially out of the money).

Two large components of options pricing are volatility (of the underlying instrument) and time to expiration. So unless you purchased the 238 call strike in the waning moments of Friday, you would almost certainly have lost money, though the calls did finish with an intrinsic value of $0.31 each. The 730K or so remaining puts with a strike of 238.5 or less still outstanding with a couple of hours to go finished worthless or virtually so, while most of the holders of the remaining puts above 238.5 (and so in the money) would have lost money or seen their positions crater in value the last couple of days. All of the calls above 238.5 – and there were about a million still outstanding with two hours to go – finished at exactly zero. In sum, a pretty good day for options dealers.

So did the markets “shrug off Trump worries (Tuesday’s big drop) in favor of the economy,” or did the dealers make another killing? I’d say the latter. So long as we are in the current market phase – an old bull market that is very expensive but not quite dead – we are going to keep seeing this month after month, aided and abetted by Trump traders who will keep betting on every headline that looks like part of the magic growth formula, if only because everyone else will. That will last until the jobs reports begin to roll over. Until then, it’s just trading as usual.

The Economic Beat

April industrial production was the highlight of a quiet week. On the surface it looked good, with both overall and manufacturing production climbing by 1% (seasonally adjusted) on the month. On closer inspection though, it’s too early to break out the bubbly. Much of the gains are due to mining (i.e., oil), up quite a bit (7%) over the last year on a seasonally adjusted basis. On an unadjusted basis, total industrial production is up 0.9% year-on-year, and is barely above last year’s lows. At 102.64, the unadjusted index is more than a percent below its average of 103.9 over the last four years. Oil was a drag on activity last year and is responsible for most of the gains this year – in ancillary categories as well – but industrial production overall has been anemic, despite some of the latest rhapsodizing by perpetual promoters.

Those same promoters have been non-stop boosting the recent readings in the Philadelphia Fed survey, which rose from 22 to 38.8 in its latest reading (zero is neutral). It sounds impressive and so was much more broadly reported than the New York Fed survey, which fell into contracting territory with its reading of (-1.0), down from 5.2 and new orders at (-4.4). The decline is not drastic, but it is at odds with a Philadelphia Fed reading that has been sporting very high levels for months with little activity to show for, this month’s industrial report notwithstanding. You won’t hear that on the national news.

Over in housing, builder sentiment is running very high (70 vs. neutral of 50), even if overall activity is restrained compared with prior times. Usually the sentiment index tips off the starts number the next day, and while a revision is always possible, it didn’t appear to be the case this time. Housing starts through April have about the same growth rate as a year ago (5.6% vs. a year-ago 5.4%), while single-family starts are definitely easing, at about 7% growth vs. 9.4% a year ago. This kind of variation can happen throughout the business cycle, but merits closer watching when the cycle is as mature as the current one. The sector is good, not great, with even the most expensive areas (which get all the headlines) showing signs of cooling off.

The coming week has more housing news in the form of sales of new homes Tuesday and existing homes Wednesday, along with the federal mortgage resale price index. There will be a couple more Fed regional manufacturing surveys, Richmond on Tuesday and Kansas City on Thursday. The reports of the week should be durable goods orders on Friday, released along with the first revision to first-quarter GDP (consensus is for a slight uptick from the initial estimate of 0.7%). The FOMC minutes are released on Wednesday, and are unlikely to provide anything more than a bit of fodder for the talking heads to chew on for a day or two.