Behold the current market liquidity debate as heard at a leveraged loan conference panel in New York today and illustrated with stick figures.* The debate rages outside the confines of the loan industry in the pages of Fortune, Euromoney and yes, the FT. Read more
In February 2012, Macro Risk Advisors drew our attention to an explosion in the market cap of the TVIX ETP, the 2x Vix exposure ETP offered to the market by Velocityshares, but backed by Credit Suisse.
As it happens, that fact turned out to be a perfect forward indicator to a whole sequence of shenanigans and suspensions to come in the ETP, confirming a general rule in our minds that whenever ETP market caps explode, beware, there’s probably someone somewhere (not the dumb money, of course) unearthing an arbitrage at the expense of the vanilla investor.
Well, more than two years later — perhaps because 2x Vix exposure isn’t quite as sellable as it used to be — the recent volatility spike has flamed another curious explosion in market cap. But not in volatility hedging instruments that reward when volatility spikes up, but rather, their exact opposite: inverse volatility ETPs, which reward when volatility reduces. Read more
Oh look, vol…
Here’s Nomura’s Jens Nordvig charting the drawdown in risk assets since early September with the Vix up to 24.6 late on Monday, its highest since June 2012:
From the Reserve Bank of Australia’s assistant governor, and eminent CampAV robot attendee, Guy Debelle in a speech on Tuesday:
When volatility returns, for a number of reasons, including those I have already mentioned, it may well rise quite rapidly. One thing I am sure of is that the spike in volatility will be blamed, rightly or wrongly, on regulation-induced reductions in market-making.
But if we look back at previous market sell-offs, when market-making capacity was larger, we see that they were often quite violent too. Market-makers can pull back in an environment of rapidly falling prices, either directly, or indirectly by significantly widening bid-offer spreads. Market makers generally have just as much reluctance to catch a falling knife as any other market participant. They are after all intermediators of risk, looking to lay it off quickly, rather than being a warehouser of risk.
FX vol is edging back and we have the notes to prove it.
The question is whether they are reflecting an overreaction to a small jump, after a period of slumped volumes and returns, or a real shift with further to go? Read more
On the search for lost vol, complex systems and the limits of analysis from HSBC:
A curious feature of current conditions is that the explanation for the phenomenon is often taken to be self-evident. It’s caused by QE and low interest rates. It’s caused by lower trading volumes from hedge funds. It’s caused by lower risk appetite (even though risk premia are highly compressed). It’s caused by crisis fatigue and complacency.
Or, a history of vol, courtesy of Goldman:
A counterpoint to worries about the stuffy air of silence settling on markets arrives from Citi. Fear not the market calm, it is an unreliable sign of things to come.
There is little relationship between market volatility and future equity returns over any time horizon. Current low levels should not be seen as a clear sign of investor complacency and an imminent market correction.
Pickers of stocks cannot relax, however, because while market level volatility is low, it turns out that “style volatility” is up. Read more
Here’s your risk adjusted returns for May, from Barclays:
Apparently the first May since 2009 that global equity markets managed a positive return too. Not that it was overly exciting, according to Barc no macro asset moved more than 1.5 standard deviations and measures of macro volatility remained near multi-year lows. Read more
The curious case of vanishing volatility deepens, with the latest installment coming by way of the oil market.
From Harry Tchilinguirian’s team at BNP Paribas, this is apparently what the death of volatility looks like:
From a tame taper to a rate rage? And on its birthday too.
As Alan Beattie says, it was a year ago this week that the “taper tantrum” shook emerging markets, after comments from Ben Bernanke raised fears of the Fed tightening monetary policy. That sucked for EMs even if the reaction to the actual taper, which began in December, was much more chilled.
But it’s what happens when rates eventually rise that’s perhaps more interesting now. From Lombard Street’s Dario Perkins (our emphasis): Read more
Here is how a (now very sad) institutional investor was positioned during this year’s rally in bonds, commodities and equities according to Michael Hartnett’s latest Thundering Word at BofAML:
Very simply portfolios were positioned, in an extreme way, for Higher Growth-Higher Yields-Higher Dollar, and that backdrop is yet to transpire (Portfolios were also positioned for sub-7% China GDP and that also didn’t happen). Investors long Small Cap, Tech & Banks and short Gold, Government Bonds and Emerging Markets have been hammered.
More to the point, says Hartnett, those reeling institutional investors have been rushing into cash as their performances suffered. That was helped in no small part by the rally in Treasuries: Read more
How quiet is too quiet?
A reaction we keep hearing to the fact that volatility has seeped out of a lot of markets is that comparative calm should be expected. The supportive actions of central banks fit with the encouragement to keep taking risk, at least for now, as the unconventional easing policies should persist for a while. Read more
Tim Hartford directs us to a nice piece by John Cassidy in the New Yorker this week wondering why it is that hedge funds can still get away with making a killing when their performance is so underwhelming these days.
It is, in his opinion, a bit of a mystery.
He adds that even though institutional money is putting pressure on fees — in some cases leading to the traditional 2 and 20 model being sliced to 1.4 and 17 — it’s hardly enough of a cut to justify the lackluster performance.
Furthermore, the biggest and most successful funds don’t seem to have this problem. Their ability to attract money on those terms suggests there’s no end of rich people happy to throw their money at them. Read more
Do ETFs impact the volatility of the underlying stocks they are based on?
A new paper by Itzhak Ben-David, Francesco Franzoni and Rabih Moussawi suggests they do. Read more
Crowded trade alert.
Chris Cole, of volatility fund Artemis Capital, has an insightful piece in the latest edition of the CFA Institute Conference Proceedings Quarterly warning about one of the most popular trades of recent times: the shorting of volatility via Vix ETPs.
The speculative shorts on Vix futures as a percentage of open interest, for example, are already running at an all-time high. In Cole’s mind this now equates to the shoeshine boy trade of the modern era.
One of the ironies, he also notes, is that the trade simply synthesizes a much less efficient version of a 3-4 times leveraged position on the S&P 500. Read more
Remember the Great Moderation, those sunny days of fun and laughter before the Great Recession stomped into town and set fires everywhere? (Imagine if old Uncle Bernanke and his canasta partner Mr Monti didn’t have that hose handy..?)
Well, Goldman Sachs have taken a look at just how far memories have faded by the way that disaster risk is now priced. It may be that the US was singed first, but it is far more relaxed than Europe. The overall return to moderation, however, is not yet complete. Read more
Citi’s Hans Lorenzen is inciting a rebellion against central bank repression. Now more than ever, he suggests, is the time to fight the Fed.
First, he notes, realised volatility in credit is down almost 90 per cent from its peak two years ago, and spreads are now at 50-year lows. He blames this on central banks, which are “suppressing risk across markets”. Read more
The working theme at FT Alphaville towers is that we’re in somewhat of a damned if we do taper/suspend QE, and damned if we keep going with it.
There is, as we’ve long been noting, good reason to suspect the economy cannot handle any more quantitative easing in its traditional form.
What’s more, we now know that even the whiff of tapering — which is anything but an unwind, as we’ve noted here – can cause undue chaos in risk assets. In which case, perhaps tapering isn’t as much of an option as many believe it to be.
After all, QE reflects the sovereign put. It’s the government subsidy which takes volatility away. If you stop dishing it out, there’s every chance bad things may happen.
And the following chart, which comes to us by way of Aurelija Augulyte, reflects this relationship perfectly: Read more
Yes yes — suddenly, a bad last day of May for the stock market:
Before we comment about the strange behaviour of the Vix this week, we’d like to engage in a bit of a thought experiment.
There are two hypothetical scenarios that we’d like you to consider.
The first relates to the rampant nationalisation of everything:
What happens to market prices and volatility in an economy where government intervention becomes de rigeur every time prices misbehave?
Taken together, the policy vol crunch and regret factor must be putting the remaining bears in a paroxysm of remorseful fear.
He’s very quotable, Nomura’s Kevin Gaynor. Read more
Remember the whipsawing days of 2008? The days when commodity prices couldn’t get crazier?
Not since Andy Haldane noted that an impatient market was not a happy market, has the BoE looked at the issue of high frequency trading and its effects on market quality – and particularly price discovery – in such depth.
From the abstract of the Bank’s latest working paper, by Evangelos Benos and Satchit Sagade, on Monday (our emphasis): Read more
Central bank puts have done a great job of removing tail risks.
Such is the conclusion of the team at Bank of America Merrill Lynch upon analysing the remarkable drop in trade conviction of late.
In FX, the move in volatility has been notable… Read more
Oh dear, many an FX trader is gonna be disappointed by this one — history suggests FX volatility is heading down, not up, as we exit November.
From Deutsche Bank’s Alan Ruskin… Read more
There’s basically nothing happening. Sure we’ve got plenty of rhetoric, a Swiss franc floor and QE — but FX volatility is touching recent lows:
Volatility guru Christopher Cole, who heads up the volatility fund Artemis Capital Management, is known for making interesting arguments when it comes to volatility and risk. Previous philosophical thoughts have questioned the concept of volatility, proposed that risk itself is changing, and that QE and other forms of government intervention are warping volatility beyond recognition.
His latest note, though, takes us to an entirely new dimension of market abstraction. Read more
Oops, we missed this from Macro Risk Advisors on Tuesday — the charts track realised volatility being higher on days the S&P 500 has closed up than when it’s fallen, so far this year. Which, they say, is a little unusual.
How much longer does this go on?
Spanish 2-year bond yields at 2.9 per cent – down from 6.6 per cent when we first said there was something to what Draghi was saying about convertibility risk. The Italian 2-year’s at 2.3 per cent. Longer-maturity debt has also rallied, despite falling outside the remit of the European Central Bank’s OMT purchases. Read more