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Living In A Post-Volatility World

Tyler Durden's picture




 

Submitted by Charles Gave via Evergreen Gavekal,

These are words that I utter with the utmost caution—this time, it really is different. I refer not to central bankers’ scurrilous efforts at monetary debasement, nor the spineless diplomacy of European political leaders, or even the cult of celebrity in the age of social media. In some guise, we have seen all of this before. No, dear reader, for something genuinely new to the modern experience, consider the right hand side of the chart on page two which displays annual variations in the S&P 500 since 1965.

What we see is that at the start of any 12 month period from 1965 to 2011, an investor in US equities could reasonably expect their performance over the coming period to vary between +25% and -10%. The average annual return over this period came in being slightly below 10%. But since 2012 something has changed. I speak only slightly tongue-in-cheek when I suggest that we may have entered a new era of the S&P 500 “exchange standard” whereby the US equity benchmark replaces gold as the asset that cannot go down and, to this effect, is manipulated by central banks.

Since early 2012, the upper limit of the S&P 500’s normalized performance has remained at about +25%. What has changed is the lower limit which has moved from –10% to +9%, leaving an average year-over-year performance of +16%. Such a performance is remarkable considering that US nominal growth has hovered at a less than impressive 4% through this period.

 

 

I have argued before that the new goal of central banks in an age of extreme indebtedness is to ensure that financial markets never again go down. Indeed, it is now clear that the guardians of money—whether the European Central Bank with government bonds or the Federal Reserve with equities—are first and foremost in the business of controlling asset prices. And it turns out they have been highly efficient at this task.

A slight problem may, however, emerge over time. Tools such as options let investors hedge against a downside risk suddenly emerging and have been built on the underlying premise that risk can be measured from the volatility of the underlying asset prices. In the case of US equity options, their value derives from the CBOE Market Volatility Index (VIX). On a minute-by-minute basis the value of the VIX is the critical input to models across the financial industry which aim to capture the value-at-risk. And from this value-at-risk reading, banks and other financial institutions calculate the leverage that they and their clients can “reasonably” take. Put simply, the whole derivative market is priced, one way or the other, from the volatility of the US stock market. In the case of the eurozone, the relevant benchmark for assessing risk tends to be volatility in the bond markets of the periphery.

In the case of US equities what are we to take from volatility being becalmed between +9% and +25%? On the face of it, we seem to have reached a managed nirvana as the market for derivatives and its underlying are “correctly” priced in relation to each other. There is, of course, the possibility of events getting in the way; in this case volatility could make an unplanned return, requiring those Black-Scholes models to be rapidly re-crunched, with obvious implications for option pricing and the amount of leverage that can be “reasonably” tolerated. In this eventuality, there will be a discrepancy between the “new” volatility and the derivative markets. And this re-pricing process could make itself felt on the underlying US equity market through a fierce feedback loop.

Hence, if and when a genuine price for risk reappears, the effect may be greatly magnified as it was in the US housing market a few years back under not dissimilar circumstances. As Karl Popper noted, volatility can be suppressed in a capitalist system, but it must ultimately reappear. Sooner or later, we will face a good deal of fireworks.

 

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Wed, 04/22/2015 - 16:38 | 6019583 RaceToTheBottom
RaceToTheBottom's picture

When there is no retail, do we really have volatility?

Wed, 04/22/2015 - 16:49 | 6019617 kaiserhoff
kaiserhoff's picture

Yes, eventually you run out of grater fools,

  or at least, solvecy.

Wed, 04/22/2015 - 17:15 | 6019688 RaceToTheBottom
RaceToTheBottom's picture

But there is only one FED, once you remove those alternate names.  

That is the faux market.

Wed, 04/22/2015 - 21:02 | 6020458 Wild Theories
Wild Theories's picture

In my short time in the markets(compared to peeps with decades of experience)

I've come to the view you'll almost never run out of fools, but you can run out of money and solvency.

Wed, 04/22/2015 - 16:38 | 6019585 Bell's 2 hearted
Bell's 2 hearted's picture

"Sooner or later, we will face a good deal of fireworks."

 

Equities will go down  

 

It will take a recession to do so

 

Central Banks have NOT eliminated the business cycle

Wed, 04/22/2015 - 16:42 | 6019597 NotApplicable
NotApplicable's picture

They've eliminated all productive businesses. Close enough.

 

Wed, 04/22/2015 - 16:44 | 6019600 madbraz
madbraz's picture

Not if you fake data and pretend its never here

Wed, 04/22/2015 - 16:56 | 6019642 Bell's 2 hearted
Bell's 2 hearted's picture

put me down for TPTB want the occassional collapse (as long as they have heads up)

 

Shock Doctrine & "Tanks in the Street" moments allow TPTB to take more control ... and fleece main street ... and buy Apple @ 50% off 

Wed, 04/22/2015 - 16:39 | 6019589 buzzsaw99
buzzsaw99's picture

there is no market

Wed, 04/22/2015 - 16:42 | 6019596 Panem et Circus
Panem et Circus's picture

Exactly.

Wed, 04/22/2015 - 16:44 | 6019601 disabledvet
disabledvet's picture

What is NOT normative post World War II is "the even lower" in rates post 2008.

 

The response from the Fed's action while extreme was also extremely NORMATIVE.  QE was simply classical Keynsian "reflation" which the Fed had done in response to every downturn save 81-82.

 

Hence interest rates always moved higher "eventually" at the long end and "carry" was created this allowing credit to be extended confidently since all agreed the money would be worth less going forward.

 

That has not played out this time. Instead interest rates have fallen even more...this in spite or perhaps because of huge double tops in commodities and massive Federal largesse and a war,

 

In short the default risk of 2008 not only still remains but appears to have grown larger.

 

Everyone here knows the recovery meme has been total bullshit since Day One.

 

Folks who have been short treasuries (pretty much all of Wall Street and apparently the Federal Government as well?!) are DEAD.

 

All monies are now spent executing on Generalplan Ost...

Wed, 04/22/2015 - 16:52 | 6019630 Bell's 2 hearted
Bell's 2 hearted's picture

It is the debt overhang, stoopid (not you)

 

all developed countries are suffering from this disease

 

until debt written and/or paid down ... demand will be weak ($$s needed to service debt for PRIOR consumption) ... anemic growth, at best

Wed, 04/22/2015 - 17:08 | 6019712 RaceToTheBottom
RaceToTheBottom's picture

The invisible hand of the market had its fingers ripped off.

If it wants to move, eventually it will find a way to move...

Wed, 04/22/2015 - 16:56 | 6019644 Crocodile
Crocodile's picture

February 11th & 12 was the end of volatility as it magically disappeared despite the obvious volatility.  At first I thought it was a flash crash or short squeeze to make a "new normal" range, but silly me.  Imagine the TVIX going down 300% since January and the VXX at 80% and it just keeps getting less volatile by the week.

Wed, 04/22/2015 - 17:01 | 6019670 BellevueTrader
BellevueTrader's picture

Silly Crocodile...VIX is for kids

Wed, 04/22/2015 - 17:11 | 6019729 asteroids
asteroids's picture

There are NO more bears to take the opposite side of the trade, all gone, dead. The current situation is incredibly dangerous.

Wed, 04/22/2015 - 17:39 | 6019848 Crocodile
Crocodile's picture

What about the Russian Bear or the Polar Bear?  I digress.

Wed, 04/22/2015 - 17:05 | 6019692 Crocodile
Crocodile's picture

We have a jobless recovery as noted in 2009 (wink, wink). 

In Unemployment Report, Signs of a Jobless Recovery http://www.nytimes.com/2009/09/05/business/economy/05jobs.html?_r=0

--------------------------

 

Stop the 'jobless recovery' madness! http://archive.fortune.com/2009/11/06/news/economy/jobless.recovery.fort...

This is an interesting read; we hear the same rhetoric now as in 2009; read the entire article.  Excerpt: "But job and wage growth have been weak for a decade. Total private sector employment has dropped since the Yankees held their previous victory parade, in 2000.

That means there has been no net private sector job growth over a nine-year span where the U.S. population expanded by 11%, according to the Bureau of Labor Statistics." -

 

Wed, 04/22/2015 - 17:07 | 6019709 SDRII
SDRII's picture

3 words: "risk free rate"

Wed, 04/22/2015 - 17:53 | 6019890 Inthegreen
Inthegreen's picture

95% of the people here hope the economy and the whole US just chrases.   Everybody really hates the world

Wed, 04/22/2015 - 18:56 | 6020099 Keltner Channel Surf
Keltner Channel Surf's picture

If the chart is likened to an EKG, with an additional plot of volume beneath, it could be labeled the Death of Trading as a profession.  Shame, 'cause I was finally getting the hang of it :)

Hoping the period going back to late Jan, the worst I've seen in staring daily at every 15m bar of markets for ~ 4 years, is the calm before the storm, not the calm before enbalming.

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