“Don’t confuse the lack of volatility with stability, ever.”
-Nassim Taleb
While I have plenty of respect for some of the important contributions Nassim Taleb has brought to our profession, I would never, ever, confuse some of his thoughts as practical risk management processes.
Why would I take anyone’s thoughts on risk as biblical? I already have a bible and I don’t use that in my macro #process either!
If we shouldn’t confuse the all-time lows in volatility as stability, should we confuse an epic cluster of US stock market volatility (VIX trading in the 98th percentile of the last 5 years of readings) as instability?
Back to the Global Macro Grind…
Don’t expect me to write a book about the volatility of volatility this morning. I don’t have time for that and there’s a lot more I can learn about volatility by measuring and mapping it, across asset classes, in real-time.
What we know about the volatility of market prices is that they are non-linear and episodic. We also know that when the volatility of a security’s price starts to TREND bullish (from bearish), “investors” in the underlying asset start losing money.
That’s why I think one of the most important risk management exercises I can engage in every market day is probability-weighing whether or not a cluster of spiking volatility can morph into a Bullish TREND Phase Transition over time.
Just to review some @Hedgeye definitions:
A) A Bearish-to-Bullish Phase Transition in an asset’s volatility is bearish for the asset’s TRENDING price
B) A Bullish-to-Bearish Phase Transition in an asset’s volatility is bullish for the asset’s TRENDING price
If you have competition that doesn’t care about bearish or bullish Phase Transitions in volatility, take share from them. When the “vol of vol” is changing, there’s usually something causal (i.e. fundamental) that will eventually reveal itself as a consensus.
Put simply, Mr. Market usually starts discounting future “fundamentals” through the lens of volatility. If rising volatility starts to TREND, fund flows seek assets with falling volatility while they try to avoid those with rising volatility.
Is that one of the reasons why one of the more important players in macro markets, Bridgewater Associates, is currently one of the few vocal bears on European Equities?
A) I think so (front-month volatility in the EuroStoxx 50 just ramped to 28) … and
B) It’s nice to finally have some credible company on the short side of relatively “cheap” European stocks!
I don’t care what “relative value” one sees on the consensus surface area of a P/E multiple of an equity market if:
A) Growth and inflation are slowing, sequentially, from the cycle peak, at the same time … and
B) The market is “cheap” relative to one where growth is still accelerating … and
C) My TREND signal (price, volume, and volatility) is bearish
I shouldn’t say it that way. I am sorry. I should be more empathetic. I care about everyone. I don’t love dogs, but I can like yours. But I really don’t care if someone sees value where I see a short selling opportunity.
As market history has taught us, “cheap” gets cheaper when growth slows.
So what if Mr. Market’s recent volatility signal in the US Equity market is a leading indicator that the “peak” of the US economic cycle is in? While it’s somewhat more of an optical illusion than a year-over-year rate of change one:
- Our predictive tracking algo for Q118 US GDP is currently the LOW on Wall Street at +2.02% q/q SAAR
- We back into that 2.02% number using our +2.71% year-over-year nowcast
- The +2.71% year-over-year rate of change would be a new cycle high from the +2.5% y/y print we had in Q417
I’m calling the q/q SAAR read on GDP out for what it is. It’s a measure of sequential (quarter-over-quarter) momentum rather than a year-over-year one. I think most of you get the difference. The Question is, will the Old Wall and its media?
You probably also get the difference between an implied volatility PREMIUM and a DISCOUNT. We measure and map those, daily, in order to have discipline in making market timing decisions.
Unlike when the implied volatility PREMIUM on the SP500 ramped to +85% (vs. 30-day realized) last week, post the 2-day US stock market bounce, implied volatility has been crushed to a -20% DISCOUNT this morning vs. 30-day realized.
When analyzing markets through the lens of volatility, I’d never use a 1-factor model. Using a simple 3-factor model:
- Where’s the market’s price within the lens of the immediate-term @Hedgeye Risk Range?
- Where have market expectations moved in volatility space (premiums vs. discounts)?
- What is the market’s current positioning (futures and options net length)?
On that last point, don’t forget that as of last Tuesday, the SP500’s net LONG position was the highest it has been in years. At +249,638 net LONG contracts in SPX Index + E-mini, that registered and epic +2.77x on a 1-year z-score!
Since the low-end of the @Hedgeye Risk Range is -3% lower from yesterday’s close (down at 2543) and there’s short-term complacency AFTER the bounce embedded in that -20% implied volatility DISCOUNT, why would I chase yesterday’s close?
A: I won’t. Instead, I’ll wait and watch. And I’ll try not to confuse the practical process of measuring and mapping risk with words like “never” or “ever.” Those words are reserved for people selling popular books.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.70-2.90% (bullish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 6 (bullish)
DAX 118 (bearish)
VIX 13.58-40.54 (bullish)
USD 88.30-90.75 (bearish)
YEN 107.31-110.07 (bullish)
Oil (WTI) 58.11-67.03 (bullish)
Gold 1 (bullish)
Copper 3.01-3.18 (bearish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
