“When a long term trend loses its momentum, short-term volatility tends to rise. It is easy to see why this should be so… the trend following crowd is disoriented.”
-George Soros
The last 4-5 quarters of global economic growth have created quite the backdrop for financial asset price appreciation, equities in particular.
That’s our hindsight insight of the day.
We have all heard the term “global synchronized recovery” and regardless of what your view is, you probably wince a little with the phrase.
The trend of capital chasing growth opportunities has been a stubborn one to say the least the last 18 months. On a global scale, it may be explained away qualitatively with some version of:
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Global growth bottoms as investors are sitting in reliable currencies and owning lower volatility companies in established markets. The global recovery picks up steam. There’s a raw material demand story which supports commodities. Thus money flows into geographies farther out on the capital market line. The more frontier currency strengthens and equities generate positive momentum and volatility compresses. This feedback loop creates a decisive “trend”. |
Back to the Global Macro Grind…
Equity volatility across geographies was unprecedented in 2017. Average realized volatility based on daily closing prices was the lowest in 20 years in the following indices:
- S&P 500 Index
- Euro Stoxx 50 Index
- Nikkei 225 Index
- MSCI All-World Index
- MSCI Developed Market Index
- MSCI Emerging Market Index
It was the lowest in at least 40 years in the following indices:
- S&P 500 Index
- MSCI All-World Index
- MSCI Developed Market Index
We obviously could have added another 100 indices to the list…
We have a lot of respect for principles of trend following as a part our process.
One of the most important but nuanced translations we would make from the Soros quote is that “volatility” is not calculated from manic voting mechanisms like VIX and VXN. We’ve found this point to be highly relevant from a risk management standpoint, and this morning is really just a re-iteration of that process.
We’ve been asked what we make of the +25% w/w move in VXN, and the most elevated volatility surface in the QQQs since Trump came into office…
Here are a couple thoughts:
- We’re watching it. Some purer measures of longer dated volatility expectations are also at 1-year highs (i.e. variance swaps), but in the grand scheme of trends, this isn’t signaling all that much.
- Implied volatility (and thus implied volatility premiums) in indices or ETFs like QQQ and IWF are increasingly subject to earnings seasonality with 30-40% weightings to the FAANG. This dynamic is key for contextualizing macro vs. micro conditions (i.e. observing company vs. factor preferences). Earnings season and a market correction juiced the 30D implied volatility premium in QQQ to ~65% which is the highest since October.
- Was 18% annualized for 30-Day volatility in QQQ a big jump from 17% into Q3 2017 FAANG earnings at the end of October? No, not really when the question is asking if we’re steering the whole boat a different direction.
- As we show in the chart of the day implied dispersion has widened out in January in the information technology sector, but XLK tacked on another +142 bps of relative performance vs. SPY. Our response would be that this wide dispersion has been in place since the beginning of Q217 in many forms, and it’s one of many key factors we model & map to tell us if “this is the big one [market correction]” or if this is another correction within a BULLISH trend that we want to ride.
The technical rebuttal would be: yes, short convexity works most of the time, but a series of small negatively yielding bets can have extremely positive payouts in this low volatility environment.
The more general rebuttal would be to reference the pennies in front of a steamroller analogy.
We can come with plenty of reasons why the probability is rising that volatility should go up in 2018, but trends can be painfully stubborn. While we’re not usually calling for the “big one”, our process is about flagging thematic inflection points. We’ll be sure to communicate when the causal factors perpetuating the low-vol. environment reverse.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.60-2.75% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 7 (bullish)
Biotech (IBB) 112-120 (bullish)
XOP 36.30-40.38 (bullish)
RMZ 1083-1128 (bearish)
Nikkei 23074-24260 (bullish)
DAX 13125-13501 (bullish)
VIX 9.56-14.94 (bearish)
USD 88.30-90.69 (bearish)
Oil (WTI) 63.01-66.70 (bullish)
Nat Gas 2.90-3.40 (neutral)
Gold 1 (bullish)
AAPL 164.01-173.02 (bearish)
AMZN 1 (bullish)
FB 182-193 (bullish)
GOOGL 1147-1204 (bullish)
Bitcoin 94 (neutral)
Good luck out there today,
Ben Ryan
