Volatility

All you need to read and more.

After two months of quiet from the old world, Europe is again on the radar, pushing futures in the red, and the EURUSD lower, following a miss in March European Economic and Consumer confidence, printing at 94.4 and -19.1, on expectations of 94.5 and -19.0, as well as an Italian 5 and 10 Year auction which seemingly was weaker than the market had expected, especially at the 10 Year side, confirming the Italian long-end will be a major difficulty as noted here before, and pushing Italian yields higher (more on the market reaction below). The primary driver of bearish European sentiment continues to be a negative Willem Buiter note on Spain, as well as S&P's Kramer saying Greece will need a new restructuring. Lastly, the OECD published its G-7 report and reminded markets that Italian and likely UK GDP will shrink in the short-term. This was offset by better than expected German unemployment data but this is largely being ignored by a prevailing risk off sentiment. In other words, absolutely nothing new, but merely a smokescreen narrative to justify stock declines, which further leads us to believe that next week's NFP will be worse than expected as discussed last night.

Rising geopolitical tensions and high oil prices are continuing to help renewable energy find favour amongst investors and politicians. Yet how much faith should we place in renewables to make up the shortfall in fossil fuels? Can science really solve our energy problems, and which sectors offers the best hope for our energy future? To help us get to the bottom of this we spoke with energy specialist Dr. Tom Murphy, an associate professor of physics at the University of California. Tom runs the popular energy blog Do the Math which takes an astrophysicist’s-eye view of societal issues relating to energy production, climate change, and economic growth.

In the interview Tom talks about the following:

Why we shouldn’t get too excited over the shale boom
Why resource depletion is a greater threat than climate change
Why Fukushima should not be seen as a reason to abandon nuclear
Why the Keystone XL pipeline may do little to help US energy security
Why renewables have difficulty mitigating a liquid fuels shortage
Why we shouldn’t rely on science to solve our energy problems
Forget fusion and thorium breeders – artificial photosynthesis would be a bigger game changer

Moody's may never downgrade the US or France for that matter, but when it comes to its stable assessment of Dong Energy, its rock solid analysis truly stands out.

For every semi-positive data point the bulls have emphasized since the market rally began, there's a counter-point that makes us question what all the fuss is about. The bulls will cite expanding US GDP in late 2011, while the bears can cite US food stamp participation reaching an all-time record of 46,514,238 in December 2011, up 227,922 participantsfrom the month before, and up 6% year-over-year. The bulls can praise February's 15.7% year-over-year increase in US auto sales, while the bears can cite Europe's 9.7% year-over-year decrease in auto sales, led by a 20.2% slump in France. The bulls can exclaim somewhat firmer housing starts in February (as if the US needs more new houses), while the bears can cite the unexpected 100bp drop in the March consumer confidence index five consecutive months of manufacturing contraction in China, and more recently, a 0.9% drop in US February existing home sales. Give us a half-baked bullish indicator and we can provide at least two bearish indicators of equal or greater significance. It has become fairly evident over the past several months that most new jobs created in the US tend to be low-paying, while the jobs lost are generally higher-paying. This seems to be confirmed by the monthly US Treasury Tax Receipts, which are lower so far this year despite the seeming improvement in unemployment. Take February 2012, for example, where the Treasury reported $103.4 billion in tax receipts, versus $110.6 billion in February 2011. BLS had unemployment running at 9% in February 2011, versus 8.3% in February 2012. Barring some major tax break we've missed, the only way these numbers balance out is if the new jobs created produce less income to tax, because they're lower paying, OR, if the unemployment numbers are wrong. The bulls won't dwell on these details, but they cannot be ignored.

Household net worth has recovered (nominally) around $8.0tn of the $16.4tn lost during the crisis but there has been a regime-shift in terms of the volatility of household net worth since the late 90s. As Credit Suisse notes, this hugely increased and skewed volatility has fueled heightened risk aversion among consumers and retail investors. Just as non-financial corporations are hoarding cash (on the back of their memories of the credit crisis contraction in the money markets), the lesson corporate America will not soon forget is just as resonant with Households as they value liquidity and cash (and safety) much more highly now than ever before.

A relatively quiet day after the excitement of the last few as T+3 settlement day into Quarter-end bought little action until the last hour or so. Two main themes appeared for the whole day - VIX pushed higher all day - notably more than the equity move would suggest (which is interesting given our comments on the capitulative normalization of the short-end volatility term structure yesterday) though some looked like catch up to yesterday's blow-off, and Treasuries rallied consistently all day long (with the short-end notably outperforming - as 5Y also down through its 200DMA and saw its largest percentage drop in yield in 2 months). Stocks leaked lower from an early morning spike on German Ifo (stuck in a very narrow range for much of the US day session), FX markets were dull with JPY stable at its lows while the USD rallied very modestly (dragging FX carry off a little and not supporting risk), Oil wavered around with the USD once again (ending up a little) as metal traded lower with a bigger gap down into the last hour or so. Stocks remain notably rich to credit which underperformed once again today. The last hour saw financials and Discretionary stocks start to rollover and then Tech (mainly the majors as GOOG showed the biggest drop top-to-bottom but most did not close strong - though AAPL made new highs once again). Certainly did not seem like a confirming move today of the 35pt rally off Friday's lows as perhaps Quarter-End sees some chips coming off the table - though hard to read too much into today's action.

This chart tells millions of stories. That’s right: since 1984 (surely an appropriate year) while the elderly have grown their wealth in nominal terms, the young are much worse off both in inflation-adjusted terms, as well as nominal terms (pretty hard to believe given that the money supply has expanded eightfold in the intervening years). So why are the elderly doing over fifty times better than the young when they were only doing ten times better before? There is enough money to keep the economy flowing so long as there are opportunities for people to make themselves useful in a way that pays. With the crushing burden of overregulation and the problem of barriers to entry, these opportunities are often restricted to large corporations. These issues of youth unemployment and growing inequality between the generations are critically important. Unemployed and poor swathes of youth have a habit of creating volatility in response to restricted economic opportunity.

Gold managed a 1.8% surge today (back above $1690 and its 200- and 100-DMAs and its largest jump in 2 months) from Friday's close thanks to the combination of the ECB on Friday and Merkel and Bernanke today assuring the world that anything more than a 2% dip in stocks will not be tolerated. While Silver outperformed Gold from Friday's close, based on its 2-3x beta of the last year this was a notable 'underperformance' as Gold outpaced everything (beta adjusted). Perhaps importantly, the S&P 500 when priced in gold met and rejected resistance at a key level today - even with its nominal 30pt rally off of Friday's S&P lows. Volumes were abysmal with stocks well below YTD average and the S&P futures 20% below average and among the lowest few days' volumes of the year. Credit markets did not participate as exuberantly (though HY outperformed IG as you would expect) but the day seemed split into 4 segments: pre-Bernanke (quiet/sideways), Bernanke to US Open (rampfest, Gold outperforms, TSY rally), US Open to EU Close (TSY selloff notably, equities sideways, Gold rips), and then from EU Close to US Close (Equity/Gold/TSY rally as USD leaked lower). In FX, JPY was relatively stable at its lows after Bernanke's speech as the rest of the majors strengthened versus the USD (as EUR broke above 1.3350 once again). Oil managed a small rally on the day but underperformed the USD's 0.5% weakness from Friday as Treasuries were very flip-floppy today - ending the day with a small twist around 7Y (30Y +3bps). VIX made new lows and closed there as the term structure flattened further to its flattest in almost 4 months (with the largest six-day flatttening in 8 months).

Short term, the bulls will probably remain in control. 

According to Barron's as much as 91% of “triple” ETF’s might be owned by individual investors.  That figure seems shocking, and as the article admits, could be wrong, but it is scary.  The activity in TVIX the past few weeks does indicate a strong retail presence – we would like to think professionals didn’t bid something up to an 80% premium to NAV, knowing that the share creation process could be re-instated, virtually assuring that the premium would collapse to 0. We don’t see a need for these products except for small retail investors who can’t get leverage any other way, and we suspect they don’t understand how these things really work, as they are the most likely to buy and hold these things.

Next week will be relatively light in economic reporting, and with no HFT exchange IPOs on deck, and the VVIX hardly large enough to warrant a TVIX type collapse, it may be downright boring. The one thing that will provide excitement is whether or not the US economic decline in March following modestly stronger than expected January and February courtesy of a record warm winter, will accelerate in order to set the stage for the April FOMC meeting in which Bill Gross, quite pregnant with a record amount of MBS, now believes the first QE hint will come. Naturally this can not happen unless the market drops first, but the market will only spike on every drop interpreting it for more QE hints, and so on in a senseless Catch 22 until the FRBNY is forced to crash the market with gusto to unleash the NEW qeasing (remember - the Fed is now officially losing the race to debase). For those looking for a more detailed preview of next week's events, Goldman provides a handy primer.

While stocks staged an 'interesting' recovery this afternoon, it was not enough to save them from a fate-worse-than-death - a red-weekly-close! The only (and therefore) largest drop in the S&P 500 of the year (after GS long stocks call) was dominated (beta-adjusted) by the largest 30Y Treasury yield improvement of the year (after GS said get short Treasury futures). It seemed we reverted to good-is-good, but bad-is-better trading this afternoon (though technically we perfectly filled the ES day-session gap from Wednesday), as dismal global macro data spurred a surge in commodities, rally in stocks (carried by the QE-high-beta faves Energy/Materials/Financials but not Industrials notably), compression in Treasury yields, a drop in the USD as QE-hope was back on (and Lockhart helped a little in the last hour with some punchbowl temptations). Futures volume was below average but not dramatic though cash (NYSE) volumes were on the weaker side. The small drop in the USD was dwarfed by the pop in commodities as Silver outperformed but only Gold managed to get back into the green for the week. Oil popped $2-3 around the US open but remains down on the week. Treasuries are 15-20bps lower in yield from their Tuesday highs and 2s10s30s has dropped modestly on the week. AUD reverted from yesterday's late lows and rallied (mildly supportive of the equity move) but JPY kept on rallying (with a small selloff this afternoon) leaving the USD (DXY) in that same very narrow range for the week ending the week down 0.55%. Broadly speaking risk assets did not participate as positively as stocks this afternoon as HY (and HYG) underperformed stocks once again though VIX managed to end under 15% again as the TVIX compressed back down close to its NAV and VXX closed at new lows as the term-structure flattened a little more. Oh yeah, and BATS and AAPL flash-crashed...

For those curious why it is that the TVIX experienced a 50% plunge earlier today, as described here, perhaps the question should be directed to the SEC who may be better suited to answer just who, when and why had advance knowledge of Credit Suisse's announcement, after the close, that it would "reopen issuance of the TVIX." And since this is a rhetorical question, perhaps a better one is why does one participate in a market in which the fine print is always ignored, and is always used against the retail investor. Not that there is anything wrong with that of course - after all caveat emptor. Especially when none other than one of Ben Bernanke's favorite scholars on shadow banking (i.e., forced complexity) Gary Gorton said the following: "Liquidity requires symmetric information, which is easiest to achieve when everyone is ignorant. This determines the design of many securities..." Alas, when it comes to novel instruments such as levered ETFs that work as a closed end mutual fund hybrid, except when they don't, the only one ignorant is you, dear retail investor. Cost to your P&L: 50% in one day. Finally if for some inconceivable reason that doesn't work, just call the Credit Suisse ETN desk at 212 538 7333.

High-frequency traders have caused U.S. commodity futures prices to disconnect from market fundamentals of supply and demand since the 2008 financial crisis. An extensive and detailed analysis by the United Nations Conference on Trade and Development just confirms what we have shown again and again (most recently here in Silver) that HFT's impact on the world is not all unicorn-tears and liquidity-providing. Markets are more exposed to 'sudden and sharp' corrections, and as Reuters notes "The strategy of those involved in high-frequency trading tends to reinforce the correlation between equities and commodities". In a somewhat stunning conclusion from an academic treatise, the authors find "We are not saying that it's all about speculators and (that) fundamentals don't matter. But we are saying that they tend to matter less, except in extreme cases,". Unlike other studies on the linkages, the UNCTAD study uses tick-data and finds correlations rising and trade size dropping as frequency increased dramatically since the crisis in 2008. Critically, one final consequence is that investors seeking to diversify or hedge against other investments in their portfolio are often disappointed as the increased HFT creates a destabilizing effect on commodities (increasing volatility) and can often create bubbles.