Market Volatility Bulletin: Stocks Give Optimism Another Try

Summary

• US stocks emerged with a winning session on Monday, and are giving "green" another try in Tuesday's session.
• The German Constitutional Court has given the ECB three months to "fix" QE to bring it in line with treaties. doesn't seem to bother risk assets too much.
• The VXX implied vol term structure is reasonably flat, with a dip at the front end. more closely resembling the pattern from six months ago when calm reigned the markets.

Market Intro

Another day in paradise! After a tough beginning to the month of May, US stocks (SPY, DIA, QQQ, IWM) pushed through a down Monday pre-market and managed to close out the day a winner. Tuesday is tacking on gains, as investors are giving another crack at the recovery narrative.

This on the heels of a positive session for European markets (VGK) and a mixed session in Asia (AAXJ).

Thoughts on Volatility

It's an interesting question. In theory, no taxation ever needs to occur: governments can just print and then spend the money they want. So, government spending is basically accomplished by:

• Taxation in the Present
• Currency devaluation
• Borrowing (Taxation and/or Currency devaluation in the future)

Endless borrowing is not a viable solution, and governments may not have as much runway as they seemingly believe as it relates to the problem at hand.

I must confess that I've wondered whether the Italian and Spanish economies shut down to such a large degree in part because they figured it would make is easier to borrow from a larger body like the ECB.

As mentioned, European and US stocks are higher today, and the Euro has only weakened a tad against the USD. So for now the story is being treated as something of a "nothing burger" - and unfortunately, it probably is (Who cares about treaties?).

Germany is right to openly question the extent to which it is the ECB's role to create pinpointed support for segments of the Eurozone economy, rather than the economy as a whole. The counterargument is that saving the whole sometimes means saving the part. And that's true, except that such allowances are easier to make when debt levels in the parts that need saving were low to begin with.

The S&P is nearing 2900 once more as I compile today's thoughts. And even so, the aftermath of the crisis is only beginning to be felt.

Organizations from disparate segments of the economy are likely to feel the impact for weeks or months to come; others simply won't make it at all. Of course, Chapter 11 BK allows for rebirth, and so we may find that the shutdowns are temporary for many firms.

Term Structure

Spot VIX is down about 7% or so since Monday's close, and down about 16% since hitting 40ish in the pre-market.

M1 fell 5.25% off from Monday, and 3-4% dips in the M2-M5 is what's observed currently.

As the HV30 continues to fall, the memory of a harsh March is gradually subsiding. The onus appears to be on the long-vol position (VXX, UVXY) to muster some energy while the momentum continues in favor of shorting volatility (SVXY).

MarketChameleon: VXX implied vol term structure for various time frames

Dark green is today's volatility term structure on the VXX. It's quite flat, with a dip at the front end. Vol was very low six months ago, and of course it was sky-high last month.

Today's dip on the front end of the term structure is taking on the more familiar shape that the product has largely featured over the years. To be sure it is higher in absolute terms, which makes sense. But the shape appears to be moving into place toward its more familiar pattern.

That is not at all to suggest that I am saying the term structure intrinsically has a "natural" pattern. My suspicion is that if these products manage to last several decades, we will find that the last ten years or so was more exception than rule to the relatively narrow range in patterns we observed.

Wrap Up

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Analyst’s 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.