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Is The Double Dip The Statistical Equivalent Of A Traffic Ticket? And Guess Which Sole Asset Class' Implied Vol Declined In The Past Month
A few days ago, BNY's Nicholas Colas was kind enough to share his perspectives on why traffic congestion and market structure are comparable, especially in the context of record high cross-asset correlations. Continuing on this series of roadside analogies, today the BNY analyst compares the economic double dip to a traffic violation, and specifically the probability of getting two speeding tickets in the span of one day. "What are the odds of being caught speeding twice in one day? One in five? One in ten? Pretty remote, one would think, given that the ratio of police to motorists on most roads is 1,000:1 or greater. I can tell you from direct and personal experience, however, that the odds of that event are much, much higher than you think. I had my driver’s license suspended for 30 days in 1997 for two tickets, issued on the same day and only a few miles apart. Here’s the thing: most people, after receiving one ticket, will drive more carefully immediately thereafter. But I, working through the math I referenced above, thought “No… The odds are actually in my favor now. I can, in fact, speed with impunity.” This proved to be an error. As it turns out, going substantially faster than the general flow of traffic will gather the attention of the law. This offsets the theoretical odds against discovery, and then some. Oh, and driving a bright yellow car. I should have mentioned that, too." And once again, the specter of market uncertainty raises its ugly head, this time in the form of spiking implied volatility, which has jumped for every asset class in the past month... except gold.
Full note from Nic Colas:
With capital markets worried about a U.S. “double dip” back into recession, today we examine what sectors/assets classes reflect the greatest amount of concern over this potential outcome. There are now scores of exchange traded funds (ETFs) – and related option chains - tracking everything from tech stocks to gold to high yield bonds. It is therefore a straightforward exercise to look at the “VIX” (the widely known measurement of “fear” related to the S&P 500) for these asset classes and industry sectors. At the top of heap in terms of “double dip” worries: tech stocks and high yield bonds. Their “VIX’s” have jumped +30% in the past month. In the middle of the pack: both emerging and developed economies outside the U.S. And not sweating the chance of a second U.S. recession: gold. The yellow metal was the only asset class to see lower implied volatility (the technical term that “VIX” actually tracks) over the last 30 days.
What are the odds of being caught speeding twice in one day? One in five? One in ten? Pretty remote, one would think, given that the ratio of police to motorists on most roads is 1,000:1 or greater. I can tell you from direct and personal experience, however, that the odds of that event are much, much higher than you think. I had my driver’s license suspended for 30 days in 1997 for two tickets, issued on the same day and only a few miles apart.
Here’s the thing: most people, after receiving one ticket, will drive more carefully immediately thereafter. But I, working through the math I referenced above, thought “No… The odds are actually in my favor now. I can, in fact, speed with impunity.” This proved to be an error. As it turns out, going substantially faster than the general flow of traffic will gather the attention of the law. This offsets the theoretical odds against discovery, and then some. Oh, and driving a bright yellow car. I should have mentioned that, too.
That is an admittedly embarrassing – but hopefully useful – allegory for the whole “recessionary double dips never happen” discussion that dominates market attention at the moment. Economic historians will (rightly) point out that two recessions back to back are relatively rare occurrences. The only one in the modern era occurred in the early 1980s, as then-Fed Chairman Paul Volker raised interest rates to cool rampant inflation. It was effectively a medically-induced coma for the U.S. economy, squashing inflation through a self-inflicted, sharp economic downturn. The first recession, just 2 years before, had been caused by the spike in energy prices created by the Iranian revolution. Aside from that doubleheader, recessions do tend to be solitary events.
However, as my bone-headed speeding story highlights, circumstances matter a lot when it comes to “unusual” events. Customarily, we don’t have double dips because consumers and businesses have some ability, and desire, to start spending again after a period of recession. They usually just need a little nudge, in the form of lower interest rates, to start buying large durable goods or perhaps take out a mortgage for a new house. That spurs employers to start hiring, and the virtuous circle of economic growth kicks into gear. The challenges to that upbeat trajectory at this point in the cycle are manifold:
- Still low consumer confidence
- Ditto for corporations
- Regulatory uncertainties that undermine hiring plans
- An unpopular President, and a doubly unpopular Congress
- A central bank that seems to have been overtaken by events. By the way, there is good fun to be had checking out Paul Volker’s old testimonies in front on Congress from the “double dip” period of the early 1980s. This was long before smoking was banned on the Hill, and Chairman Volker regularly ran through a full Churchill sized cigar while opining on monetary policy. Google Video has some of the clips online.
The last month has seen much of the “double dip” debate come to the fore, with a worsening labor market picture headlining other data reflective of a weakening economy.
In the graph that follows this note we take a look at what sectors and asset classes seem most “worried” about the chance for another recession. We take the measure of this seemingly “emotional” assessment by looking at the 30 day forward implied volatilities for the exchange traded funds associated with different industrial sectors, asset types, and U.S./foreign stock markets. Don’t be scared off – that’s just the same concept as the CBOE Volatility Index, or VIX. A higher VIX usually means more near term worries about the market. A declining VIX means investors are generally more confident that stocks will rise in the near future. A few observations:
- U.S. stocks as a whole have seen increasing IV in the past month, to the tune of 22% higher than the same time in July. That’s a sign of concern over the near term, of course, but it also serves as a useful baseline for other asset classes.
- The most notable increase in IV is actually in the option chain for the most popular High Yield Bond ETF (symbol HYG). Here, IV has actually spiked by 31% over the last 30 days, more than stocks. We hear a lot about investor complacency as it related to bond investments, but it does seem that options traders, at least, understand that a double dip might be just as bad for non-investment grade credits as it would be for stocks.
At the other end of the spectrum, and sitting in splendid isolation, is gold. The precious metal has had a pretty good month, up almost 5%. What might be more impressive, however, are the lower levels of apprehension about gold’s next move. The IVs related to the GLD ETF actually fell over the past 30 days, indicating some sentiment that gold is not heading for a fall in the near future. We see that kind of contraction in IVs when assets rise (VIX tends to go down when stocks rise, for example). But given that every single other asset class we looked at saw rising IVs versus last month, we can only look at the ‘Gold VIX” as a real sign of confidence in the metal. Or, of course, a real skepticism in everything else.
Among the major industrial sectors, technology seems to be bearing the brunt of the double dip fears. It’s IV is up 23% over the past month, more than U.S. stocks overall. Telecomm as a sector was up more, but it’s coming off a low base, and there are not many stocks in that index to begin with. No, the move higher in the “Tech VIX” really catches the eye. I confess to liking tech as a leveraged play on not getting a double dip, but my enthusiasm seem to be counter to the market’s perception that there is a lot of risk in the sector.
Interestingly, worries about overseas markets – in both emerging and developed economies – seem pretty middle-of-the-pack as far as asset classes go. The EAFE developed market ETF (symbol EFA) and the emerging market fund (symbol EEM), have seen their “VIX’s” rise by only 11% and 13%, respectively.
Full note (PDF)
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Got Gold?
India's Gold ETF Assets May Soar 17 Times on Refuge Demand, Executive Sayshttp://www.bloomberg.com/news/2010-08-30/india-s-gold-etf-assets-may-soa...
Unlike Midas, every thing Ben touches turns into pieces of paper we call 'benjamins'.
Oooh, oooh! I can't believe I got here early enough to say:
Gold Bitchez!
Okay, where's my prize?
I junked you because I sensed a microspec of hope, optimisism or fun in your post and wanted to crush it right away - I am practicing my skills to go into banking and destroy the company while making myself fat and rich.
Demoralization bitchez! :)
I junked you because as a psy-ops exercise, I can't let those with a sense of humor about the current financial situation get away scott-free.
I apologize, and at the same time cut up your creditcard with big scissors, like they do at the fancy restaurants.
:)
I junked you because it was easier than reading the original blog post.
I junked you as an exersize in validating the rules of karma that what comes around will go around. But you can forgive me and put a stop to it if you want.
You guys make excellent points. So I decided to junk me too.
Damn, it feels gooooood.
Junk Bitchez
The story that 1980 and 1982 was the only pair of years post WW II with a double dip is incorrect. There was a major worldwide recession in 1958. There was a milder but definite recession in 1960 as well. The 1960 recession undoubtedly elected John F. Kennedy, who ran on the pledge to get the economy moving again. And so the money-printing began . . .
Sorry for 2nd post, but the 1929 downturn was a double dip. There was a recession (depression as it then was called, of course) in 1927. In other words, there's nothing magic about when a 2nd downturn occurs. Not that the 2007 downturn truly ended.
Gold; 30% annual increase in paper terms. Gold retains its purchasing power over 5000 years.
Now that's a numeraire you can rely on.
China's Wage Inflation Is Causing Companies to Shift Production to Mexico
It ain't happening, dan. American corporations have gone the Mexico route before, being there done that. The corruption is just as bad as China but the work ethic is missing. Mexico is a dead end road.
This is all the recession proof one needs. The only debate that we should have is: Is this a structural are just recession caused problem.
I say both, and both are caused by bad leadership. And by having a president that cries like a baby and always points his little finger to Bush as the source of the problem without doing shit about it, isn't going to make things better.
There is just a shortage of presidential candidates that can make the right economic decisions.
THE ONLY one who did was Reagan, and the reason he made the right decisions was because he had Alsheimer and left the choices to people who knew what they did. Conclusion: Presidents should only have a protocollair power and shut up about everything else.
It's unfortunate none of your parents common sense trickled down to you.
Trickle down economics have been discredited, have you been hiding under a rock or something?
Debt-I'm with you on "both."
But remember the O's interview with the Money Honey? Higher cap gains taxes are to "level the playing field" vs. to maximize revenue generation.
And Saul comes back to the conflicted Shapiro --
http://online.wsj.com/article/SB1000142405274870414780457545579167360900...
So I think that O and gang are playing a different game from what we would think. They are smart, they have different interests in view.
- Ned
He essentially reaches a correct conclusion (odds of being burned a second time are indeed greater than most people might assume), but I'm not sure I would want to trust the analysis of this one after seeing a few basic flaws, both in portraying the problem and then reasoning through it.
First, if the ratio of police to motorists is really 1000:1 (which it certainly could not be), then one would be very afraid of the proverbial speeding ticket. He of course means that that ratio is 1:1000.
But having been stopped once in a day if that is the relevant ratio, the odds of being stopped again are essentially the same as before. This is a sampling problem which at this ratio of police to motorists implies replacement of the sample is essentially insignificant.
The more important population ratio is one of police to seriously offending motorists, which I would define for simplicity's sake as those who speed greater than 10mph in excess of the limit (most drivers assume and may police confirm that the first 5mph is a "gimme"), which might only be 1:50 of the motorists, meaning that the police to serious offender ratio is only 1:50.
He correctly notes that most other caught offenders would modify their behaviour after being caught the first time. This would almost certainly "improve" the odds of being caught a second time since the lack of their "replacement" in the sampled population signficantly affects any subsequent sample we would draw from it.
In common terms, he would be termed an egghead with no common sense. Among eggheads, he simply failed to set up the problem correctly. In any case, he needs a little more learning.
Nick Colas used to be an automobile industry sell side analyst. I think Nick's problem is that following GM, Ford and Chrysler for extended periods, and searching for reasons that one might want to own their equity, causes dementia.
He's a great guy
What are the odds of being caught speeding twice in one day?
The odds are exactly the same the second time as the first in the abscence of a change of behaviour because the two events are statistically independent. Bright yellow cars have sweet fanny adams to do with it.
if people in the financial markets think that "losing" once implies less chance of losing again if they maintain high risk behaviour (as apparently they do) then we really are fucked.
My record is 3 speeding tickets with a time interval of exactly 1 minute. 3 times I drove through a red light and 3 times the camera's flashed me.
I tried to explain it to the officer that this should be seen like making the same grammatical mistake 3 times in a row in 1 spelling test, and that I only should be fined 1 for my 3 mistakes, but it didn't work...
3 times 175 euro.
And the funny thing was: I was speeding because my boss called me for a urgent meeting AND THAT JACKASS DIDN'T WANTED TO PAY ME BACK THE FINE! Since then, I always come to late when I have a meeting with him.
STEVE FORBES BELIEVES IN GOLDSTANDARD!!!
http://www.thedailybell.com/1328/Steve-Forbes-on-Overseas-Wars-the-Comin...
Daily Bell: You have studied economics for most of your life, it appears. Do you consider yourself of the Austrian school? Are you surprised by the progress the Austrian School has made in the 21st century?Steve Forbes: The basic tenets of the Austrian School have withstood the test of time, and while I may have some variation of views on how you'd implement say, the gold standard, I think the basic tenets are absolutely there. Hayek, Mises and – though he's not considered a fully part of it – Schumpeter had insights on entrepreneurship. Liberty is good, government domination is NOT!
Daily Bell: You mentioned a gold standard. Should the Western world return to some sort of gold standard? What would it be? Is it feasible?
Steve Forbes: We will return to a gold-based monetary system. I don't think we'll go back to a 1920s or 20th century-style gold standard. But I think monetary policy will be tied to the price of gold, which manifestly it is not today. So, yes, a gold-based system is coming back, and it will be good!
Gold good.
Paper or plastic... bad.
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