I urge readers to consider that the February CPI data came in very hot, and after worrying a lot about the print for all of maybe fifteen minutes, investors wrote it off… is the current response something of a mirror image?
CNBC: Asian Markets Thursday Close
To be clear, the wide spread breakdowns felt across the globe are by no means something to be shrugged off. We just need to remember what kind of markets we're dealing with: namely, markets that involve a large degree of uncertainty.
Thoughts on Volatility
Hats off to Dave Bergstrom for providing this analysis on ES futures. We simply do not have that many instances of the drop witnessed yesterday from a standpoint of how many sigmas the move was in S&P futures. Pay attention that in each of the previous cases, the market did ultimately collect itself in fairly short order…
The problem is that four of the cases listed above have occurred since Brexit in June 2016. We still had a great deal of central bank intervention in those instances, and I think we'll be seeing quite a bit less of that going forward.
That's right Steve: we didn't crash. The previous statistical anecdote suggests, though, why it feels like a crash. When investors go several weeks without any meaningful drop, only to experience a four percent move "from out of the blue" (not really), it is going to cause folks to scratch their heads, write up reports, etc…
Now I am by no means suggesting that we won't crash. It is worth keeping in mind that the DM international index, the EFA, closed at a fifty-two-week low yesterday. US stocks are standing much prettier than most of its peers; that state of affairs may remedy itself before long, and not necessarily in a bullish fashion.
In keeping with Steve's Tweet, Vance Harwood gives reasons to believe that the volatility markets are likely in far better condition to handle the current jolt of volatility than they were back in early February. So far that certainly appears to be the case, and I agree that those who trade vol ETPs (VXX, UVXY, SVXY, TVIX) are probably not in for nasty surprises like deleveraging, event accelerations, or the like.
The historical data above show the VIX futures (including today, in yellow) since the FOMC meeting on September 26th. Recall that the term structure of volatility was exceedingly stubborn for a couple months.
I believed that VX traders would require something of a black swan in order to get over the hump more or less seen at Thursday's close (October 4, in orange). Evidently, we have it. Keep in mind that Treasury yields today are lower than they were last Thursday: this is bigger than a pure rates story.
Skew is trading at six-month lows. That means calls are live. The SPX options market is basically saying that big upside is very much on the table. Nobody has a crystal ball, and so anything can happen. But skew suggests that for those who buy and sell chunks of the S&P return distribution, they are not ruling out the real possibility of a major rebound.
Implied correlations are way up. As the annual implied correlations approach their maturities (in mid November), the correlations tend to gradually decline. That tells most of the story you see in the visual above. But the spike: that's all about current market action.
What this means is that sectors and individual names are moving higher and lower together; essentially there is a reduction in the level of diversification right now. As such, one's equity portfolio just got riskier, even if they hold a broad basket of holdings.
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The dialogue between these readers underscores the very nature of volatility: the perceived call to take action. When the markets just drift, that does not cause panic or much in the way of urgency. Buy-the-dip feeds this sense of false confidence.
When global risk assets melt in concert with one another, however, that serves as a reminder that these investments truly do carry risk other than the risk of missing out.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.