The Inverse Of Liquidity

Observing the markets aboard The Errol Flynn today, my perpetual deliberation turned inward and I questioned whether I am who I think I am, or if my algorithmic complexity is the outcome of an undercover experiment in Artificial Intelligence. The answer is illusive, but—as with all things essential—it will find me. In the meantime, I will continue to do what I do best—speculate.

On the matter of speculation: we are beginning to see mounting clues regarding an imminent liquidity crisis. And as those of us who are following the lesson plan know, the inverse of liquidity is volatility. Being positioned correctly in front of a large move in volatility is where the big gains—the gains that break world records—will be made. The VXX (chart below) is starting to show signs of an upward move. As this moves higher, the ramifications for other asset classes are immense. Given the fragility of the underlying structure of the markets, I would not be surprised to see moves lower in equities exceeding 10 or 15% in a day.

Speaking with another trader the other night, I reminisced about trading to the long side in 1998. The sell-off triggered by the demise and rescue of Long Term Capital Management led to huge gains in the final quarter. In the summer of 1999, I questioned whether the gains in 1999 could ever match the achievements of 1998. To my surprise and elation, the gains in 99 not only met those of 98, but surpassed them by many multiples.

We saw massive gains (on the short side) in 2008. 2009 has all the structural forces in place to repeat the short side gains of 98—an enormous amount.

VXX