“Volatility clusters, due to dependence.”
-Benoit Mandelbrot 

When I’m not happy about missing a big move in volatility, I go right back to The Brot to review my mistakes. 

Volatility clusters, and I’ll miss some of those moves (like I just did on the long-end of the Treasury market). Episodic and non-trending volatility is often a buying opportunity though. 

As Mandelbrot taught me in The (mis)Behavior of Markets, “when the volatility jumps, it plugs in new parameters to make the bell curve grow; when volatility falls, new parameters shrink the curve.” (pg 222) 

Back to the Global Macro Grind… 

The last time the UST 10yr Yield shot towards 3.15% (in May of 2018), I was on the right side of the Quad 2 economic data. Remember, in Quad 2 you short duration (long-term Treasuries) and buy the living daylights out of Growth, High Beta, and Momentum

On this recent 1-month, +29 basis point ramp in the UST 10yr Yield, I got caught trying to re-position for Quad 4 in Q4 too early. Remember, in Quad 4 you buy duration (long-term Treasuries) and short Growth, High Beta, and Momentum. 

If only I could be like these anonymous people on Twitter nailing every move to the day and basis point, all of the time! 

Risk Managing The Machine - zop

Regardless of who’s nailing it, my goal is to be as good as I can be at this profession. I take my #process for market-timing as seriously as anything I do. And I do so because that’s what saves and makes my family money. 

In today’s Chart of The Day, I’m showing you one of the quantitative tools I use to improve my market-timing. It’s also an important tool to gauge both market sentiment and positioning. We call it our Macro Performance & Dispersion screen. 

Once you’re done looking at the YTD Return column, focus your attention to the next column to its right – the IVOL PREMIUM/DISCOUNT column where we’re showing 30-day implied volatility vs. 30-day realized: 

  1. Post a 3-day correction, the SP500 (SPY) has moved back up to an IVOL PREMIUM of +36% vs. 30-day realized
  2. After a -1.7% down day this week, Industrials (XLI) have seen its IVOL PREMIUM pop to +36% as well
  3. Post the decline, LT Treasuries (TLT) have seen their IVOL PREMIUM rip to +25% vs. 30-day realized 

As your eyes move from left-to-right across the columns you’ll see where: 

A) IVOL premiums and discounts were the day prior
B) IVOL premiums and discounts were  1 week ago
C) IVOL premiums and discounts were 1 month ago 

And yes, almost 20 years into this, this is what I read before I go to bed at night. It’s all about measuring and mapping the rates of change of numbers, not reading someone’s qualitative tweets on how the market “feels.” 

Back to what these numbers are telling you about Treasuries (TLT): 

A) If you bought long-term Treasuries (TLT) 1-month ago, you were buying them with a complacent IVOL DISCOUNT of -10%
B) If you bought long-term Treasuries (TLT) 1-month ago, you were also buying them near the top-end of the @Hedgeye Risk Range 

Rule: don’t do that. 

And I actually didn’t do that. What I did was I started buying Treasuries on the 1st part of the correction instead of doing what better timing would have been (i.e. starting to re-load long TLT in the 3.10-3.13% range for the UST 10yr Yield). 

By my scorecard, however short-term the mistakes, mistakes are mistakes. I can and will try to learn from every one of them. 

Especially if you are evolving your risk management process in The Game that we are in as opposed to the game we used to play, you too are very much aware of the impact of: 

A) 85-90% of daily trading having become “systematic”
B) the constant delta-hedging associated with hedge funds running tight net exposures
C) quants (The Machine) reacting quickly to reversals in 1-month price momentum 

I can go on and on about this and I do in one-on-one client meetings and teach-in forums. But this, friends of the modern macro gridiron, is the next frontier. We must continue to develop a repeatable process to conquer it rather than complain about it. 

This quantified risk management process runs parallel to our data-driven research #process. If that didn’t have us going into Quad 4 in Q4, I wouldn’t see this +25% IVOL premium in TLT as a buying opportunity. Again, that’s what clusters of non-trending volatility present. 

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now: 

UST 10yr Yield 2.92-3.12% (neutral)
SPX 2 (bullish)
NASDAQ 7 (bullish)
VIX 11.13-14.49 (bullish)
USD 93.25-95.11 (bullish)
Oil (WTI) 67.91-72.75 (bullish)
FB 157-167 (bearish)
Bitcoin 6101-6715 (bearish) 

Best of luck out there today,


Keith R. McCullough
Chief Executive Officer

Risk Managing The Machine - 09.26.18 EL Chart