Tuesday, Feb 2

Last week’s events with retail equity traders, Reddit forums and short squeezes closed off a January we are unlikely to forget very soon, particularly as far as the US is concerned. However, this final verse of the January chapter had much more serious market consequences for markets than earlier events (It is hard to believe still just how much happened in January). So in today’s briefing we highlight some recent pieces from analysts who have looked beyond the headlines and the ”David versus Goliath” narrative to explain what this means for market stability and second order effects. While some say this is a ”tempest in a tea cup” but others argue that it exposes some of the fragilities in the market and the ability of investors to hedge risk. We also highlight research looking at the latest Covid variants which analysts suggest markets aren’t prepared for and we also look at who and what drives global capital flows.
  1. Equity volatility portfolio hedges Ollari Consulting

    1. The Reddit trading strategy + short gamma + no supply = big problem

    As far as Christophe Ollari is concerned the single most important chart to look at currently is the VIX which shows a stubbornly persistent high implied vol regime, with last week’s Reddit’s trading “strategy” having triggered another gamma shock, in a market where there is no longer a natural supplier of implied equity volatility. This is a problem he says. Ollari outlines how this has come about in this note, which boils down to the fact that vol has effectively become the positioning toggle of the modern market structure. In other words, investors now have less confidence in the traditional equity hedges such as bonds and currencies, which means  there’s one hedge left; long equities implied vol. With no supplier. 
  2. retail investing systemic risk US equities TrendMacro

    2. GameStop: Reddit where credit is due

    The GameStop affair is a tempest in a teapot, and an excuse for everyone to project their political and market biases, writes Don Luskin from TrendMacro. He says last week’s events were a classic short-squeeze, like the VIX blow-up in early 2018. The only difference, he says, is that this one was catalyzed by retail investors on Reddit. Luskin doesn’t believe they did it single-handedly, without opportunistic hedge funds and prop-desks piling on, and he doesn’t see retail participation here as classic evidence of a market top as these retail blow-offs are in over-loved momentum stocks — this is a sector-rotation into under-loved cyclicals given up for dead after the pandemic lockdowns, he adds. Luskin also makes tbe interesting point that we can’t know to what extent the recent round of “stimulus” payments fuelled this. More broadly, when assessing the systemic risks posed by last week’s events Luskin notes no evidence of systemic credit risk for instance and equities are in a long-overdue correction. Ultimately he says these recent events won’t be long-lived: the usual risk indicia — the dollar, Treasury yields and credit spreads — haven’t moved. Steady oil prices suggest no business cycle risk. Luskin predicts this will all be forgotten in a week.
  3. market volatility VaR MI2 Partners

    3. It started in a chat room, could it end in a VaR risk event

    Julian Brigden from MI2 Partners has for the last couple of weeks been highlighting the growing potential of a major VaR risk event, in a recent report ”Opportunity, Threats, and Instability,” detailed signs of increasing fragility, then last week’s Game Stop/Reddit forum scandal happened, which Brigden says effectively creates something similar to a massive ”short gamma” position, that he says accelerates the odds of a VaR risk event and broad de-risking happening, Brigden reckons the market is very poorly equipped for this higher volatility referencing a chart which shows that the outstanding shares in the VIX ETF (VXX) are right back to where they were just before last February’s VIX explosion.
  4. Covid market narratives Epsilon Theory

    4. The Zimbabwe Event; why markets aren’t prepared for (501.V2)

    A few weeks ago we highlighted a piece from from Ben Hunt of the Epsilon Theory called the ”Ireland Event”, which was a sobering report warning of how an “Ireland event” could see Covid-19 cases surge in the US. Hunt has just published a new note on the Covid virus variants and their potential impact on real-world, market-world and narrative-world, with a particular focus on the South African variant (501.V2). Hunt is a brilliant observer of real world and market narratives, and the Epsilon Theory has developed a system to track them. To his mind, (501.V2) poses a real danger for markets. He writes, ”In real-world, these variants create political upheaval and spark regime change. In narrative-world, these variants create scenarios of vaccine-resistance. Complacent markets are prepared for neither.”
  5. Global capital flows StoneX

    5. The gnomes of Frankfurt will decide the fate of the world

    The investment decisions of German insurers, Swiss bankers, and Japanese pension funds will determine whether the US experiment with Modern Monetary Theory will succeed or fail, whether President Xi’s imperial dreams come true, whether the 2020s will be inflationary or deflationary, and whether the US dollar follows the same fate as the British pound and loses its global hegemony according to the latest note from Vincent Deluard at Stone X. He explains that Germany and Japan’s excess savings must go abroad: since negative rates effectively tax domestic investments, central banks purchases, which exceed government deficits, shrink the pool of fixed income assets for private investors, and the lack of IPOs, coupled with rising buybacks, will eventually make Japanese and German equities as rare as the pangolin. The US Treasury market, which offers higher yields even after currency-hedging costs, should attract the excess savings of financially-repressed “gnomes” , according to Deluard, but it has not, with the dollar now tending to decline when yields have risen, following the “capital flight” pattern of emerging markets during balance of payments crises. Due to their positive real yields, he says, China’s government bonds are an attractive alternative to US Treasuries. Southeast Asian assets, a traditional recipient of Japanese surpluses, will also benefit from the regional integration of the continent, says Deluard, and lastly, the vaccine-driven recovery in tourism, the rise of work-from-anywhere, and massive fiscal stimulus should redirect German savings towards Spain.