AS WE START A NEW DAY ON WALL STREET …. MAY THE INVESTMENT GOD’S BE WITH YOU ………          

2018 Interesting Skews Going Forward

2018 Interesting Skews Going Forward

Here are the 4 key categories where Goldman sees abnormal volatility going forward:

  • The Dow Jones Industrial Average ETF (DIA) returned 28% last year (on realized vol of 7) yet the options market is pricing in that the ETF generates less than half of the return in 2018 on double the volatility (11% / 14.3%, respectively).
  • High Yield option investors are also pricing in elevated volatility potential, as well as high level of concern, as suggested by elevated normalized put-call skew levels across tenors. As an example, iShares iBoxx $ High Yield Corporate Bond ETF (HYG) returned 6% last year on a realized volatility of 4. The options market is pricing in the potential for the ETF to trade up or down 7% by January 2019 expiration on a realized vol of 7, double the realized volatility of 2017. A similar setup is seen in the SPDR Barclays High Yield Bond ETF (JNK).
  • Consumer Discretionary ETF investors are also positioning for higher volatility in 2018. XLY returned 23% in 2017 on a realized volatility of 8%, generating among the highest Sharpe ratios in our universe. Option investors are pricing in that the XLY returns +/-13% by January 2019, yet realizes a volatility that is 73% higher than what we saw in 2017.
  • Options on Technology focused ETF QQQ and the Technology Select Sector SPDR Fund (XLK) are both pricing in the potential to return substantially less returns in 2018 than in 2017 yet the options market is expecting higher volatility for both. January 2019 $160 straddles for QQQ cost 14%, suggesting the options market is pricing in the potential for the QQQ to close up or down by this amount by expiration. This is substantially less than the 33% return that QQQ posted in 2017 on a realized vol of 10%.

To summarize: “Option investors are pricing in BULLISH views in Energy, Staples, and Financials, but BEARISH High Yield and S&P500. We look to skew as a measure of sentiment, and compare 1yr skew today to levels seen over the past five years.”

Large Cap Areas Of Interest In 2018

Large Cap Areas Of Interest In 2018

There has been abnormal changes in fund positioning in recent months, in financials and real estate, consumer, and energy and materials:

  • Financials and Real Estate: With the sector expected to benefit from tax reform and deregulation, Financials have emerged from a 15-month long underweight in 2017 to hit the benchmark (S&P 500) weight, driven by Banks and Capital Markets. Broken out from Financials as its own sector in 2016, Real Estate saw the biggest increase in  exposure across sectors in 2017, with its relative weight rising from .33x a year ago to .40x today — the highest level in our data history since 2009.
  • Consumer: PMs cut back on Discretionary and Staples exposure throughout 2017, with relative weight in Discretionary today at an 18-month low and Staples at its lowest level since 2009.
  • Energy and Materials: These two sectors saw the biggest drop in relative weight last year as managers continued to shun commodity exposure. The relative weight in Energy has dropped from .87x a year ago to .76x (although is neutral on a beta adjusted basis); and Materials dropped from .95x to .86x today, its lowest level since 2009.

2017 VIX Index Ends On Lowest Reading Ever

2017 VIX Index Ends On Lowest Reading Ever

The VIX index average during 2017 came in at 11.1. That is the lowest reading ever — by more than one and a half points — since the VIX inception in 1986. By way of comparison, the daily average for all years since then was over 20.
Likewise, the maximum level reached by the VIX in 2017 was 17.3. That’s the lowest maximum level attained in any year since inception—-and 60% lower than average.

Personal Spending Trends For The Third Quarter

Personal Spending Trends For The Third Quarter

The Department of Commerce reported today the third quarter biggest driver of marginal spending was car sales (technically Motor Vehicles and Parts), which increased by $15.6 billion to $463.5 billion but they pulled back on gasoline purchases, which was the single biggest detractor to spending, subtracting a marginal $3.5 billion in PCE, to $283.6 billion.

“Long Bitcoin” Is The Most Crowded Trade On Wall Street… Again

“Long Bitcoin” Is The Most Crowded Trade On Wall Street… Again

According to BofA’s latest, just released December monthly Fund Managers Survey, in which 172 participants with $480bn in AUM responded to dozens of questions, among which “what do you think is the most crowded trade.”  “Long Bitcoin” is once again viewed as the most crowded trade according 32% of the respondents, followed by “Long FAANG+BAT” at 29%, and “Short Vol” in third with 14% of the responses.

Gold vs Bitcoin

Gold vs Bitcoin

Gold and Bitcoin are going in the opposite direction….but… Goldman says “The market cap of bitcoin is c.$275 billion versus gold at $8.3 trillion. Even all of the cryptocurrencies combined have a market cap less than $500 billion. While the lack of liquidity and increased volatility may keep bitcoin interesting, it is unlikely to convince investors looking for the kind of diversification and hedging benefits which gold has proven to possess over its long history.”

There is still room to go but almost everyone is in the pool and we’re less than 6 percentage points away from the bubble highs of 2000.

Systemic Risk In A Nut Shell

Systemic Risk In A Nut Shell

Looking at the hard economic impact of the Great Depression (1929-1932) and the Great Recession (2007-2009), leads us to the eminent role played by banks in both.  It then comes as little surprise that the banking sector captures all the attention. However, what remains to be looked into, and perhaps more worrying in today’s environment, is the role of prolonged periods of uptrend and low-vol on the asset management industry. This is where the risk builds…as everybody gets overly comfortable and ultimately concentrates in the same investments.

In 2014, the Financial Stability Board (FSB), an international body that makes recommendations to G20 nations on financial risks, published a consultation paper asking whether fund managers might need to be designated as “global systemically important financial institution” or G-SIFI, a step that would involve greater regulation and oversight. It did not result in much, as the industry lobbied in protest, emphasizing the difference between the levered balance sheet of a bank and the business of funds.

The reason for asking the question is evident: (i) sheer size, as the AM industry ballooned in the last few years, to now represent over 15trn for just the top 5 US players!, (ii) funds have partially substituted banks in certain market-making activities, as banks dialed back their participation in response to tighter regulation and (iii) , funds can indeed do damage: think of LTCM in 1998, the fatal bailout of two Real Estate funds by Bear Stearns in 2007, the money market funds ‘breaking the buck’ in 2008 amongst others.

But it is not just sheer size that matters for asset managers. What may worry more is the positive feedback loops discussed above and the resulting concentration of bets in one single global pot, life-dependent on infinite momentum/trend and ever-falling volatility. Positive feedback loops are the link for the sheer size of the AM industry to become systemically relevant. Today more than ever, they morph market risks in systemic risks.

Volatility will not forever be low, the trend will not forever go: how bad a damage when it stops? As macro prudential policy is not the art of “whether or not it will happen” but of “what happens if”, it is hard not to see this as a blind spot for policymakers nowadays.