“You don’t know where you’re going until you know where you’ve been”
-English Proverb
An individual the Hedgeye Macro Team knows well did a brief TV segment a couple of weeks ago. Without remembering the segment title exactly it was called “Navigating Tumultuous Markets” or something. The segment started with the anchor quoting the VIX and near all-time highs for the S&P 500 Index and then asking why the heck “tumultuous” was in the title of the segment.
The guest went on to point out that economic data and financial markets in many places had crashed, or were crashing, naming about 10 examples.
The VIX trades at a 13-handle this morning on the bounce. It’s 10yr median and average are a 16-handle and a 19-handle, respectively. We don’t ignore levels, particularly at extremes, but we believe rate-of-change can be an important temperature gauge.
Here’s a question:
If the VIX went from 40 to 30 to its 10yr average of 19, is your expectation for the near future going to be any different than if it went from 10 to 15 to 19 in a much shorter amount of time? Or are these 19s the same?
Back to the Global Macro Grind…
Below we repurpose a daily note that centers on contextualizing global macro derivatives market color. How do yesterday’s returns fit into longer term trends? What was the return path to get those returns? How have recent market moves shaped consensus expectations about the future as seen in derivatives market pricing? That’s what we try to hash out. It’s a Rate-of-Change Breakfast. Please reach out with questions on anything below.
Here are our three topics this morning:
- Commodities-Raw Materials (Rate-of-Change Bloodbath Globally)
- SPY IVOL Premium Migration (Simple Process Point)
- Sector Dispersion (Explanation of the Typical Consensus Chase)
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1. Commodities – Materials – If you’re long of anything that typically is under pressure with bouts of USD strength, it’s been a volatile couple of weeks. The most recent USD move has crushed many Emerging Market and Raw-Material linked financial assets. We study global volatility trends by tracking rates-of-change for a universe of well over 100 tickers across asset classes and geographies with liquid options markets.
Shorter term negative correlations between the US dollar Index and CRB Commodities Index have tightened up back near YTD highs which were reached back in January when we had opposite currency/commodity trends.
Of the global macro universe mentioned above, the most sizable rate-of-change in realized volatility and implied volatility (volatility expectations) w/w is centered in markets most sensitive to the USD. So, the future volatility expectations have popped most in markets that have crashed and become more volatile (chasing and forced hedging):
Below are the biggest w/w step-ups in 1Mth Implied Volatility (the cost of hedging):
- DBP: +33%
- GDX: +33%
- THD: +28%
- JNK: +26%
- EUFN: +23%
- SX5E: +23%
- XLE: +22%
- TWSE: +22%
- CAC: +22%
- AMZN: +21%
As a risk management point, we use this color alongside our risk range process to try and opportunistically book gains and put on hedges (i.e. not hedge when the cost of hedging pops +33% in a week like in precious metals).
Takeaway: A bounce and relief rally does not change our view on USD strength and commodities/Emerging Market over the intermediate-term. We believe this trend has more room to playout into year-end.
2. Simplified Process Point (SPY IVOL Premium) – For those new to the process, we’re always very interested in how implied volatility (volatility assumptions backed out of options prices) changes relative to realized volatility under different return scenarios. What we’ve found is that implied volatility usually gets pushed lower in periods of short-term strength.
In other words, it gets cheaper to hedge when the market is going up. When it corrects, demand for insurance goes up afterwards. Our goal is to use these reactionary trends for market color.
As an example with the S&P 500 SPDR ETF in the month of August, implied volatility traded at a discount to realized volatility when the market took a peak at all-time highs the first week of August, and now, after a correction, the cost of hedging has surged.
Hopefully this is some helpful commentary from our top 3 things note back on 08/07:
“VIX – rising stock prices to lower-highs on #decelerating volume (total US Equity Volume -6% yesterday vs. 1-mth avg) with the vol of vol signaling we’re close to the low-end of the VIX range at 10.75 isn’t a spot to be as complacent as protection has become post the AAPL move – Tech (XLK) has an implied volatility DISCOUNT of -14% vs. 30-day realized this am”
Takeaway: Backing out the volatility assumption in the cost of market insurance is an important complement to our risk range process.
3. Sector Vol Migration (Dispersion) – There is a market “implied volatility premium” which we mentioned above with the S&P 500 (SPY). We can also map how the cost of hedging has changed at the sector level. We call this factor “implied dispersion”. The cost of hedging near-term downside (for a month) traded relatively wide in the slow-growth yield sectors like Staples, REITs, and Utilities heading into this week which ultimately looks backward.
Now that market volatility has stepped up on a correction, relative short-term hedging costs have popped the most in the Energy and Materials sectors. Our goal with this analysis is to get in front of changes in volatility pricing. We have a strong dollar view with obvious sector implications which you know, but we don’t play that view by buying puts after they go up 50%.
Takeaway: Like the IVOL premium factor, we also typically see that consensus sector preferences in the volatility space (hedging costs), are also driven by recent performance.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.85-2.99% (bearish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 7 (bullish)
Utilities (XLU) 52.75—53.77 (bullish)
REITS (VNQ) 81.36-83.49 (bullish)
Industrials (XLI) 74.30-76.74 (bearish)
VIX 10.84-15.59 (neutral)
USD 95.00-97.11 (bullish)
Oil (WTI) 64.95-68.32 (bearish)
Gold 1176-1212 (bearish)
Good luck out there today,
Ben Ryan
Macro analyst
