Market Volatility Bulletin: Stocks Fall In The Early Session, Neg-Rate Corporate Instruments Approach $1T First Time Ever

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Includes: ACWI, AGG, DIA, IEF, IWM, QQQ, SPY, SVXY, TLT, UVXY, VXX, ZIV
by: The Balance of Trade
Summary

In an ongoing pattern, US stocks drop alongside sovereign bond yields as the economic outlook dwindles.

Negative-yielding corporates have muscled up to $1T now, a new record.  Volatility should be higher as risk-assets work to make heads or tails of the situation.

Realized vol is quite elevated, with updrafts and spills very much fair game.  The term structure is quite flat presently.

Market Intro

CNBC: 9:33AM EST

US stocks (SPY, DIA, QQQ, IWM) got the jitters on Wednesday morning as bond yields (IEF, TLT, AGG) fell yet again. As discussed in yesterday's MVB, bond yield movements appear to be calling the shots as to stock market sentiment.

Spot VIX is up about 3 vol points to 20.60 after getting crushed in Tuesday's session.

Thoughts on Volatility

Interesting link, Stevie Vixx. One could argue that the response to the GFC was to have governments get deeper into debt to spur demand, while central banks financed the deficits by lowering the cost of funds and snuffing out volatility in capital markets (as an aside, that is not exactly my own take on the situation, though fairly close).

During Volker's time, total US debt (government, mortgage, corporate, etc.) as a share of US GDP was much lower than it is today. I don't think the impact of a large rate hike would be the same today as it was then, though eventually we may well find that such a set of hikes is necessary, whether policy makers want to or not.

Because the initial conditions are not the same, we cannot expect the same set of results in the future if a vigorous set of rate hikes were deemed the least-bad policy path.

For the time being, however, markets are clearly nervous falling rates rather than rising rates. We saw this in reverse shortly after President Trump was elected and rates climbed rapidly on a prognosis of higher growth and higher inflation: financial markets marched indefatigably upwards, with only the rare and short-lived pullback, up until late January 2018 when ascending rates finally began chilling market sentiment.

The visual above begins in January 2015 and continues through the present. Bull sentiment is down but not out, while bear sentiment has not stirred much. For now, SPX sentiment is still on the high side without being in nosebleed territory. I interpret this to mean that investors are nonplussed by plunging rates, but not concerned enough to give up on the longest bull market in the US for at least 130 years.

That's $1T worth of corporate securities with a negative yield! Mr. Bianco mentions the doubling since mid-July (one month), but I'm always suspicious on these kinds of reports, as I wonder how many hovered just above the positive line thirty-one days ago.

Still, we are in uncharted territory in terms of the raw volume of negative-yielding instruments trading in the fixed income markets. It would be positively natural in my view for risk assets such as global equities (ACWI) to whip around some as the implications for these securities is debated in the open market between buyers and sellers.

Term Structure

In the context of the last few years, we're observing at present quite a flat VX futures curve. Both the F1-F2 as well as the F4-F7 simply don't have much indication of roll yield either to vol shorts (SVXY, ZIV) or vol longs (VXX, UVXY). As of this morning at least, the M1 contract was snuggled up pretty tightly against spot VIX: again not much in the way of roll decay.

For the present at least, one has to put greater focus on where they see the VX futures heading than on collecting yield. This goes out in particular as a warning to vol shorts, who in my experience often consider roll decay to be a birthright.

And there's plenty of realized volatility on tap at present. So far it's behaving itself pretty well. But we're getting a lot of market chop, and a fair bit of news flow kicking the SPX both higher and lower. It's best just to be aware that the response magnitudes are quite different today than they were a couple weeks ago, and to adapt trading strategies (within reason) to the current environment.

Wrap Up

If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, I thank you for your ongoing contributions in the comments section.

I've heard that same comment about how we "should consider it normal..." ST brings up the first difficulty with such an argument, namely that inflation and other forms of government default render these instruments something less than truly risk free. Beyond that, we have thousands of years of history of positive nominal yields, and an extremely short window of time where we've witnessed negative nominal yields, and so there is quite a robust argument to be made that sovereigns "ought" to pay for the privilege of borrowing funds from the private sector.

Still, it really comes down to supply and demand. If negative rates are the price of money that sets the quantity supplied equal to the quantity demanded - absent quasi-government institutional intervention - then I'd shrug my shoulders and chalk the historical anomaly up to markets doing what they do best: surprise us. Monetary largesse does not justify to my mind what savers "should" get for parting with risk-free funds, at least until we've had a great deal more time and research to understand what the higher-order effects are of such policy.

Thank you for reading.

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.