More Market Pain: The VIX, Swaption Vol, EMFX And Some Investing Philosophy

The Market: “Good morning!! How was the long weekend?”

Trader: “Great I guess, party at the in-laws. How ‘bout you?”

The Market: “I spent the last 72 hours furthering my plans to cause you more pain.”

Trader: “Really...Why?”

The Market: “Bwaahhhhhhaaaaa….assume the position!!”

We can get into the cycle of looking for where the next bounce is going to come from, or if this is the second inning of a larger market collapse. What seems clear to me is that this is what we can expect from the market--far greater swings and moves on lesser news. That is an indication that liquidity is drying up and there isn’t new money coming in to chase valuations higher. The high valuations and tight credit spreads that practically every market commentator highlighted in 2017 are finally taking their toll.

Don’t take my word for it, take a look at the 5yr chat on the VIX.

I can name from memory each of the events that are north of current levels. That’s not showing off my grasp on market history--it is an illustration of the fact that they were all *big* events. Or just *events”. They had a name. They had a story.

This market seems like just the opposite. It is a selloff looking for a story. Is it anxiety over tech? Is it fear about the impact of a trade war?  Or...is there just nobody on the bid anymore?

My money is on the latter….yet what continues to befuddle me is the lack of movement or realized volatility in other asset classes. This is a regression of the vix against 3m/10yr swaption volatility.

Quite frankly it is a pretty worthless regression analysis but I wanted to pull up a chart that illustrates just how low interest rate volatility is compared to equity volatility.

There are also those that are looking for a USD to move higher as market stress increases. These two factors are probably two sides of the same coin. I went over some of the factors driving CAD and AUD last week. JPY has also traded by its own twisted logic...strengthening earlier this year on the back of of optimism about global manufacturing demand, local growth, and BoJ stealth tapering--and then as market stress increases, which has usually put a bid into the yen, it simply does nothing.

What about the spicy stuff...high-beta EMFX? Surely the high risk/high carry currencies have sold off?

Meh….not really. TRY has its own problems...if we throw that one out, the big “loser” in this chart is BRL at -1.5% YTD….a loss in the spot price you made up in carry!

FTQ assets like treasuries aren’t rallying...rate vol isn’t moving much...and EMFX is showing unseasonable warmth. The rest of the picture isn’t quite adding up to me--at these levels I’d lean towards some combination of these assets--like buying receiver swaptions and selling EMFX as a better expression of a bearish view than simply selling stocks.

On a more philosophical note, over the weekend I came across the excellent “Behavioural Investment” blog. It is a succinct, well-written set of posts on various investing issues that animate me--like cognitive biases, misplaced incentives, and the perils of generating alpha. The most recent post was entitled, “Things That Fund Managers Don’t Say Enough.”

Here are a few of my favorites, with my editorial comments in italics:

 

“It was a genuine mistake – our analysis was incorrect, but I will make sure I learn from this for future decisions.”  CIOs don’t appreciate this level of humility from the PMs. Most would respond with “And next time I’ll make sure to hire someone that isn’t learning on my dime.”

“Although the trade was profitable, the situation did not develop as I had imagined and its success was actually just a dose of good fortune” I always appreciated the bloomberg header of a good friend…”Better lucky than good!” There’s a guy that fears nothing.

“I appreciate that recent market volatility feels significant, but I don’t want to focus on it because, on a ten year view, it is likely to seem meaningless”.  More PMs would be willing to say this if they had a ten year lockup on their investors’ money.

“I appreciate that I previously held a high level of confidence in this view, but, after careful analysis of new evidence, I realised that I was wrong”. There are dissertations to be written about this one...if you’re hired to manage money you’re self-selecting as smarter than the market--so when the market shows you that you’re wrong, it is hard to admit….because some important people think you’re smarter than the market!!  How often do you see a professional athletes publicly admit they got worked by the competition? Pedro Martinez once said the Yankees treated him like they were “his Daddy,” and he literally never heard the end it.

The lesson: know what you’re good at, stick to it. Stay humble, and don’t be afraid to admit mistakes within that circle of competence. And while there is good reason to stray outside of that circle from time to time--don’t allow you’re mistakes (and thus by definition, you’re successes) there to be big enough to have to be explained to someone more important that you.

Shawn
TeamMacroMan2@gmail.com

@EMInflationista