“Henry Wellcome’s struggle with Silas Burroughs is a great reminder that investors and entrepreneurs should only partner with those they trust, like, and who have similar time horizons.”
-Intelligent Fanatics: Standing on the Shoulders of Giants
In the second of two books, Ian Cassel and Sean Iddings profiled the career of Henry Wellcome who helped build Burroughs Wellcome & Co. into a pharmaceutical powerhouse (eventually merging with Glaxo in 1995). The Intelligent Fanatics Project profiles some of the most successful operators and capital allocators throughout history that you may have never heard of. Both books are worth a read.
The difference in time horizon between Wellcome and Burroughs ultimately came down to capital allocation: M&A over R&D (framed as long-term in this case).
“Time Horizon” is a good way to explain away a lot of discrepancies in a the world of investing uncertainty: Underperformance, miscommunication, opportunity, risk.
Within a buyside framework time, horizon is a typical answer to behavioral or structural “edge”, specifically as a rebuttal to “crowded strategy” concerns.
On the sell-side, time horizon can explain away missed calls leading to hindsight bias, illusion of control, etc. It’s a slippery slope to convincing yourself “I really nailed this one” too much. As someone who’s never managed other people’s money, I try to remind myself of these behavioral traps often.
Back to the Global Macro Grind…
Our hope is to provide value-added macro research on multiple fronts, within a buyside framework. This morning we are repurposing our daily derivatives-market commentary. Ideally it will provide varying context to some of the recent underlying moves in the U.S. dollar, interest rates, and emerging markets. CLICK HERE for the accompanying 20-page slide deck.
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1. Russell Factor Performance (Context on ATHs)
The Russell 2000 Index was +55bps yesterday to new all-time highs in a down tape for the other major indices. Keith provided a good overview on Russell 2000 dynamics in yesterday’s Early Look between earnings, muted currency risk, and sector/industry weightings (energy, financials, high growth tech).
Although implied volatility continues to compress in U.S. equities, the difference between realized reality and expectations between something like the S&P 500/Nasdaq 100 and the Russell 2000 is notable. Long-term volatility expectations at-the-money (6Mth and 12 Month expiries) in the Russell 2000 is at all-time lows. The first chart below shows the volatility index ratio series both absolute and as a percentile for VIX/RVX (For 3 months, that ratio series has trended near all-time highs).
The “growth” factor has actually widened out its relative performance to “value” YTD. However, with value’s heavy weighting in financials and energy, volatility expectations in the value pocket of the Russell 2000 factor exposures is tightest to growth since last Jan-Feb when growth went on a value-crushing relative performance rager which widened out that factor volatility dispersion to all-time highs (a time series of this relationship is on page 7 of the deck). These sector/industry weightings are probably a reason why the factor performance divergences are less drastic in the Russell 2000 Index relative to other Russell indices.
YTD growth outperformance to value in Russell ETFs (bps):
- IWM (R2K): +432bps
- IWR (R-Mid): +585bps
- IWB (R1K): +636bps
2. DM Currencies (EUR, FXE)
Volatility markets are coming around quickly to the currency move with the USD index +30bps again this morning. In the Euro specifically (because it has been a topic we’ve highlighted as a risk quite a bit this year), it’s not only that IVOL at-the-money is higher (as seen in the deck above), skew has moved marginally less bullish.
This is the same dynamic as “risk reversal” option pricing or what we called out Monday with regard to net non-commercial futures & options open interest in currency markets:
“Last week all 11 FX net non-commercial futures & options open interest ex. USD was shorter on the margin. We saw the same trend this week: traders in 10 of 11 currency markets are shorter on the margin w/w against USD positioning that is longer”
*The following charts appear in order of the second section of the slide deck (slides 10-14)
- Chart1: IVOL premiums in developed market currency ETFs are quickly trending higher
- Chart2: IVOL premiums in DM FX ETFs now have some of the biggest TTM & 3Yr z-score factor scores in global macro.
- Chart3: Directionally, volatility skew (or risk reversal pricing) in the Euro is increasingly less bullish on that same duration as “chart2”.
- Chart4: The shift in skew generates some of the most divergent TTM & 3Yr Z-Score factor readings in global macro for the Euro (positive Z-scores translates to marginally higher cost of hedging downside relative to betting on upside in a currency via options markets).
- Chart5: Just off the all-time highs in speculative bullish futures & options open interest in the Euro currency, the long crowd rotation could have prospective legs.
Conclusion: The Euro currency volatility surfaces are being pulled higher and more bullish toward the USD – Investors are starting to worry about the currency move which took some time to develop. That’s the typical sequence to break long-standing trends.
3. Emerging Markets (EMB, EEM, TUR, EWW, EWZ)
Many pockets of the emerging market landscape continue to get clobbered..
After yesterday’s market session in the U.S., the I-Shares Emerging Markets ETF (EEM) is -3.5% m/m and -1.4% YTD compared to +1.9% YTD for SPY.
Here are some of the worst m/m performers in Emerging Market equity ETFs:
- Turkey (TUR): -18.3%
- Mexico (EWW): -14.4%
- Brazil (EWZ): -10.9%
- South Africa (EZA): -7.2%
- Emerging Markets (EEM): -3.5%
Implied volatility (volatility expectations backed out of option pricing) trades very similarly in EEM vs. SPY when we look at it within the context of history. Any of the volatility comparison charts in the deck will demonstrate this point.
The takeaway for me in Emerging market equity options markets is much like what we called out last week with regard to Mexico & Turkey (these are places where vol markets have taken note over the last week, especially in Turkey): Investors are not positioned for more of the same from a performance perspective. Any spillover from those equity markets that are crashing has shaken volatility markets much less than I would expect. If there was a real behavioral shift in sentiment that was starting to pick up steam. Maybe that’s a good reason there is more to come.
Implied volatility premiums in the Emerging Market ETF (EEM) are nearly flat on multiple durations. This pricing set-up of course is driven by heavy weightings to China, South Korea, and Taiwan which have held in well. However, even in something like Mexico (EWW) which is -14.4% m/m, front month implied volatility has repriced just 7% higher for a 30D IVOL premium of +12% over realized volatility. This is notably a muted move in volatility given some of the underlying market performance. We’ll leave it to others to prescribe a macro narrative because Mexico has been a source of news of late.
Again, on this topic of volatility expectations (implied volatility), the set-up in EM equities is somewhat contrary to what we see in the currency ETFs or the EM bond market for example (ETF: EMB), where implied volatility in front month contracts has seen the largest step-up in global macro m/m (+78%).
*Most of the charts in the deck are based on volatility data screening for a universe of well over 100 tickers across global equities & FICC.
The average OAS on the Barclays EM USD Aggregate Bond Index is ~10bps off the 05/09 high of +273, which was the widest spread since April of 2017.
We hope this multi-duration derivatives-market color gives you a unique view of potential phase transitions across global macro, whatever your time horizon. Please reach out with any thoughts or questions.
Our immediate-term Global Macro Risk Range (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.96-3.13% (bullish)
SPX 2 (neutral)
RUT 1 (bullish)
NASDAQ 7168-7476 (bullish)
Energy (XLE) 74.23-79.44 (bullish)
REITS (RMZ) 1047-1080 (bearish)
Industrials (XLI) 71.82-75.66 (bearish)
VIX 12.21-16.39 (bullish)
USD 92.06-93.63 (bullish)
Oil (WTI) 68.85-72.44 (bullish)
Nat Gas 2.72--2.89 (bullish)
Gold 1 (bearish)
Copper 3.00-3.10 (bearish)
Corn 3.93-4.06 (bullish)
Good Luck Out There Today,
Ben Ryan
Macro analyst
