Category Archives: Strategy & Scenarios

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Steppin’ On The VIX

I’ve been trying to come up with new lyrics for “Puttin’ on the Ritz,” starting with a new chorus – “Steppin’ on the VIX.” So far, abject fail. I guess I’m not a poet or songwriter.

But this market is all about selling volatility. The trade has worked well for a long time. But it has built up a huge short position, figures in excess of $40 billion are being bandied about. I hear that this is mostly retail interest at this point. The pros are well aware that there are two sides to every trade, and somebody is on the long side, big time. Don’t forget the crazy fat kid.

Nothing Unusual Here

Zero hedge of course. Just for the record.

That Which Is Not Seen

Alhambra Partners

After tax, corporate profits are still slightly less in Q2 2017 than in Q4 2014, and barely more (+3.4%) than in Q1 2012 five years ago.

SocGen’s Albert Edwards:

Our Ice Age thesis has always called for US and European 10 year bond yields to converge with Japan. We still expect that to happen, with the downward crash in US yields likely to be particularly shocking. There is mounting evidence that underlying US CPI inflation has already slid into outright deflation in exactly the same way that Japan did seven years after its credit bubble burst. Hence we repeat our call for US 10y bond yields to ultimately converge with Japan and Germany at around minus 1%.

In short, stocks are grossly overvalued and Treasury bonds are similarly undervalued. Not news, of course, just some confirmation bias.

Steppin’ On The VIX

Just hearing the song “Puttin’ On The Ritz.”

Seriously, it is interesting to watch this at work. Today it has been particularly obvious, with VIX and XIV moving in different directions. Different in the sense of the implied direction in the case of XIV. XIV is the big inverse VIX ETF. Of course, it is priced off the VIX futures price index, not the VIX itself which is a cash index calculated from option prices. I presume the movement of XIV means that the VIX futures are being sold and XIV is following along.

As I write, XIV is unchanged on the day and the cash VIX is up 3%. To me this indicates shorting of the VIX futures in an attempt to pressure the market higher.

There is a massive speculative position shorting VIX via futures and associated ETF instruments. The counterparties (“commercials”) are using the futures as a hedge, I presume.

Using VIX futures provides great leverage to market manipulators. I think these futures contracts are the most dangerous thing the CFTC has ever permitted, and will lead to a 1987-style catastrophic outcome when these shorts are forced to cover.

Extreme Crazy

I was going to say Peak Crazy, but we all know things can always get crazier. Some things that spring to mind.

Political craziness: Mob violence on left and right, blatant defiance of federal law by city politicians, attempts to rewrite or at least deny history, demonization of Trump, Putin and anybody associated with them, and so on. Immigration in Europe – it’s that 4.7 kids per woman in Africa that nobody dares to talk about. Not to mention the crazy fat kid.

Fiscal craziness: Federal funding of runaway price increases, notably in university tuition, prescription drugs but also many other subsidized goods and services. Gross under-funding of state and local pension schemes even under ludicrous assumptions about future returns.

Monetary craziness: Central banks threatening to tighten but pumping away, consumer credit at record highs in US and elsewhere (Canada, that’s you I’m talking about with highest household debt in the world), government deficits keep growing. Subprime crdiet still gowing while defaults rise. Most of all, ICOs. People pouring money into blockchain-based tokens. Really?

Market craziness: Housing bubbles in China, Canada, Australia, UK and some US cities. Massive (record) risky speculation in many markets – short vol, long crude for example. Setups (risk parity) similar to portfolio insurance (remember 1987?).

I could go on. But I won’t. I’m just grumbling while I wait.

Portfolio Insurance

A strategy called portfolio insurance, which nowadays we would call a form of dynamic hedging, is widely blamed for the 1987 crash. This strategy, in effect, creates a ‘stop-loss order’ that gets larger in size and closer to the current market price as volatility gets lower.

The combination of shorting volatility, option hedging and risk-parity strategies sets up a very similar situation. Make hay while the sun shines, but thunderstorms are likely.

The Economy In One Chart

Source: WSJ

Fed Folly

Lacy Hunt from Hoisington Management.

Hubris

Janet Yellen today:

“Will I say there will never, ever be another financial crisis? No, probably that would be going too far. But I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will.”

Seriously? If nothing else, the coming pension tsunami virtually guarantees it. It is truly scary that this powerful person seems to live in an alternate universe.

GLWT.