VIX Explanation; Regime Shift for Gold; Valuations

Quant Insight’s research is built on an analytical framework for understanding asset price movements and valuations. Their analysis distils signals from its quantitative tool that covers thousands of securities in real time. The secret sauce is that they use algorithms to untangle and isolate which macro variables (typically correlated) that are driving asset prices. Another attribute to their model is its ability to identify which assets will be most sensitive to changes in a particular macro factor. and when a particular theme is out of regime altogether (i.e that cannot be explained by macro factors). They’ve just put out a note that that looks at recent shifts in regimes. IN: VIX. OUT: Gold. QI explain that the VIX spend most of 2017 out of regime, but this changed abruptly last week. VIX is now well explained by and highly sensitive to actual volatility and real yields (as well as credit spreads). Meanwhile, Gold seems to have broken down, say Qi. The metal had been well explained by real and nominal rates, QE expectations and the US Dollar for the better part of 2 years. This is no longer the case, say Qi, and is a red flag that signals increasing volatility ahead. Qi models can be useful in this volatile environment to identify new regimes, drivers and the pattern under the noise. Click below to request more information on Qi. The beauty of the Qi system is that they can tailor their analysis specifically to the exposures, in a very timely fashion.

CCFs and the Italian economy

Longview Economics recent report takes a deep dive into the economic impact of Italy’s proposed Fiscal Credit Certificates, which are proposed by parties representing 60% of the Italian vote. The idea is that if these parties win the election and the CCFs are approved, they will encourage greater consumer spending and corporate investment in Italy. Longview take the opposite view. They believe that if the CCFs are introduced, they will result in reduced revenues for the state and a disappointing impact on growth. With reduced revenues for the state, Italy’s already parlous fiscal situation will deteriorate, with consequently negative impacts on BTPs. Spreads of BTPs over other European government bonds are already wide and Longview expect this to worsen if the CCF plans comes into force.

What Else Could Go Wrong for EM Equities

Alexander Redman and Arun Sai of Credit Suisse maintain a positive stance on emerging equities which are at a mid-cycle performance phase vs the US; they note the fundamentals haven’t changed despite recent price action. But whereas a year ago they were looking for positive surprises to lift from the gloom, now investor complacency towards emerging equities and currencies drives them to look at developments that could individually or in combination derail the bull run. The risks they identify include the US exiting NAFTA, 10yr bond yield above 3% or dollar strengthening, a China growth shock, underwhelming US-led global capex rebound, valuation correction driven by US earnings disappointments, +$80/bbl oil, and geopolitical developments in Brazil, N Korea or South Africa. CS client can view the full note on the CS Plus platform.

Risk Parity and the Terminal Rate

In this piece Cam Hui of the Pennock Idea Hub in Canada has considered the effects of Risk-Parity funds on the bond market. Using three different analytical techniques, he concludes that Risk-Parity strategies did not exacerbate the downturn in bond prices. In the second part of the report he looks to see if the bond market is repricing the terminal rate or, if the inflation breakeven is just normalizing. While both factors are at work, Hui attributes most of the rise in nominal rates to inflation breakeven normalization. Click below to contact the provider directly to request trial access or access to this particular piece.

Will Bonds Kill Equities?

In this note Ewen Stewart from Walbrook Economics published last week Ewen Stewart assesses the outlook for the yield curve in the US and Europe and the subsequent impact on equities. While US and European Sovereign yields have been diverging, global equity markets generally take their cue from Wall Street and have reacted negatively. Stewart is relatively sanguine about the pace of any further US bond yield rises and concludes that they are unlikely to be matched by significantly higher yields in UK Gilts, or Eurozone sovereigns. Bottom line, Stewart believes that the recent equity market correction is an over-reaction and would use as an opportunity to but UK/European equities. Click below to contact Walbrook directly to request trial access to read this piece.

Short Vol Unwinds: Snake Eats it’s Tail

There’s a huge amount of complexity involved in the explosion of volatility as an asset class and what the ramifications of that might be should this be unwound, especially in a disorderly one. One of the leading experts in this field is Chris Cole, CIO of Artemis Capital. Last year he gave two incredible interviews to RealVision TV about this market and the growing dangers of the short vol trade. Cole describes this as a self-reflexive cycle where you have accommodating central banks, keeping liquidity flowing, doing preemptive strikes on financial risk, leading to massive amount of share buybacks, which are a vol compressing. This becomes a massive self-reflexive, self-reinforcing spiral, says Cole. As far as analogies go, Cole references the concept of Ouroboros, which is this idea of a snake eating its own tail – which typified what was happening last year – in the sense of the stock market was buying itself back, the only vol market in history with lower and lower volumes ever. But when a snake becomes confused and sick, (As the vol market has become in recent days) it will look at its own tail and think of it like food, and it’ll begin to eat itself and self-cannibalize. Click below to take a free trial to RealVision to listen this this fascinating interview and understand what some of the major risks may be in the days and weeks ahead.

Vol Rises; Now What?

The increase in volatility experienced in recent days is unlikely to subside short-term, says Ed Clissold, Chief US Strategist at Ned Davis Research. History suggests volatility should increase, but it does not declare the cyclical bull market has to end. Most major peaks form via a topping process – failed rallies where the popular averages may or may not make new highs but fewer and fewer stocks participate. Many corrections resolve themselves. NDR does not rule out a topping process is starting, but rather points out their models are not providing enough evidence to support that conclusion. Click below to request access to the full note.


Negative Gamma

In reference to yesterday’s vol product liquidation, MI2 Partner’s Julian Brigden says such events typically create opportunities and, short term, this has created some interesting price divergences, he writes in this note published late yesterday. For example, the spread between VXN (Nasdaq volatility) and the VIX, which typically trades at a premium, is trading at over a 4 vol discount, the most extreme in 15 years. Brigden first highlighted this spread in December, in a piece entitled “US Equity Rotation at 30,000 Feet”. In it, he outlined the fundamental vulnerability of the equity market, that whenever the spread of the VXN over the VIX hit 6.5-7.5% either the VXN needed to move lower, or we risked a broader push higher in market volatility. With yesterday’s move, it appears that we have ended up with the latter, says Brigden.The other extraordinary price event has been the speed of the VIX’s rise, which over the last few days has exploded. It’s 14-day RSI, which never sustains moves above 82, closed at 91, i.e. the highest close since 1991. Extreme moves like this are typically associated with blow-offs, but this time it’s different. The problem is that, in marked contrast to 2013 or 2015, when bond weakness triggered equity wobbles and higher vol with inflation pressures building, it is going to be far harder for central banks to put Humpty Dumpty back together again. If that is the case, yesterday’s liquidation move may, if we are lucky, set a short-term base in stocks. But higher volatility is going to gradually eat away at the risk-taking abilities of all leveraged players from hedge funds to risk parity funds. MI2 maintain an Ammo Index, which measures the ability of leveraged players to absorb a VaR shock, before they have to liquidate their underlying portfolios. It’s already through the lows of 2000, Brigden shows in the report. Clock below to request trial access to read the full piece here.

A New Macro Environment; Easy Money No More

However one cuts it, writes Louis Gave from Gavekal Dragonomics, the investment environment has changed. A year ago, oil was falling, the US dollar was rising and US bond yields were low. Today, these three important prices have changed direction by 180 degrees. Market participants should therefore not be surprised that the market’s momentum is shifting. The assets that did so well when oil and interest rates were falling and the US dollar was strong, are unlikely to welcome the about-turn in these three key prices. In this light, gave says the current sell-off can perhaps be seen simply as the markets adapting to a very different macro environment—an environment in which making money will become more challenging now that the world’s central banks are no longer printing it hand over fist. In this report Gave addresses some key questions amid this market sell off. 1) Are equity and bond markets “cheap” enough to warrant deploying more capital? 2) Could this dip trigger forced selling from leveraged market participants or other “weak hands”? Gave reckons this is probably not a buy the dip scenario and many participants will unlikely want to increase risk (Pension funds, and hedge funds (for different reasons)). Gave suggests that markets most likley to receive a bid are those US. Click below to request trial access from Gavekal to read this full note.

VIX: The Day of Reckoning Finally Came

Back in mid December we highlighted this piece from Macro Risk Advisors that explained the inherent dangers of short vol products like XIV and SVXY and their potential to ‘’blow up’’ causing large market disruption in the process. In this note, written at the close of US trading yesterday, MRA write that the day of reakoning came yesterday. They explain how XIV and SVXY have effectively been wiped out, and are down ~95% in a single day. MRA explain that the weighted 1-month VIX futures basket tracked by these products (weighted roughly to 35% Feb VIX futures and 65% March VIX futures) went from 15.24 on Friday 2/2, to close at 29.81 on Monday 2/5 – a 96% single-day increase. What was the market impact of XIV and SVXY liquidating their risk?  According to MRA, XIV and SVXY were both short approx. 200,000 VIX futures (or 200 million vega). 95% of that short volatility risk was covered yesterday, most likely in the minutes leading up to the 4:15 futures close, the report says. This was likely the primary driver of the massive move higher in VIX futures from 4 to 4:15, and potentially a significant contributor to the S&P futures selloff in this time period, MRA conclude. Has the major ‘’blow up’’ event happened?  MRA say given that the short vol products have covered 95% of their risk, the “VIX blowup” event has effectively already happened. If the upward pressure on VIX (and to a lesser extent, downward pressure on S&P futures) was driven mostly by the VIX ETPs, that source of pressure is now gone. The report then goes on to discuss 1) Did XIV and SVXY officially liquidate? 2) What are XIV and SVXY worth now, and why are they still trading above NAV? MRA are the ‘’go-to’’ firm on this market, and have an extensive knowledge base. Click below to request trial access to their research to keep abreast of market developments.