Volatility

We wouldn’t say that it is “never too late” to prepare for potential disaster because, obviously, the numerous economic and social catastrophes of the past have proven otherwise. There simply comes a point in time in which the ignorant and presumptive are indeed officially screwed. We will say that we have not quite come to that point yet here in the U.S., but the window of opportunity for preparation is growing very narrow.

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Ironic, because it is precisely CNBC's constant cheerleading of what little viewers it had left that pushed the market to such nosebleed levels that on August 24 it suffered its second flash crash in just five years. It is even more ironic, because instead of a rational, objective coverage of the newsflow, the constant stream of cherry-picked, double seasonally adjusted good news is precisely why viewers had left the Comcast cable station in droves realizing the disconnect between the economy and stocks is simply too gargantuan to stomach, and that they are being lied to.  As a result, it wasn't until the much dreaded market crash that viewers finally came back. At least some of them.

"In theory, investors can exit an open-ended mutual fund or an ETF at will. But the growing popularity of these funds forces them to invest in an ever larger share of less liquid bonds. If everyone wants to exit at once, prices could fall very far, very fast. A lucky few may get out in time. Others will probably get trampled."

The growing roar of 'the establishment' crying for help from The Fed should make investors nervous. While your friendly local asset-getherer and TV-talking-head will proclaim how a rate-hike is so positive for the economy and stocks, we wonder why it is that The IMF, The World Bank, Larry Summers (twice), Goldman Sachs, China (twice), and now no lessor nobel-winner than Paul Krugman has demanded that The Fed not hike rates for fear of  - generally speaking - "panic and turmoil," however, as Krugman notes, “I think it would be a terrible mistake to move. But I’m not confident that they won’t make a mistake."

• All surveyed analysts expect the Bank of England to keep monetary policy unchanged, with the bank rate at 0.5% and the Asset Purchase Facility at GBP 375bln
• Headline UK CPI printed at 0.1% for July, still well below the BoE’s mandated 2% target
• The accompanying minutes release is expected to once again show an 8-1 vote split in favour of keeping rates on hold

"August Sucks," concludes MIT Quant guru Andrew Lo, reflecting on the systematic-trading strategy effects on markets, and it's not going to get better any time soon. As he explains to Bloomberg, "algorithmic trading is speeding up the reaction times of these participants, so that’s the choppiness of the market. Everybody can move to the left side of the boat and the right side of the boat now within minutes as opposed to hours or days." As we have noted many time, Lo explains how "crowded trades have got to the point of alpha becoming beta," warning that volatility-targeting strategies (such as Risk-Parity) are not only "exaggerating the moves," but he cautions omniously reminiscent of the August 2007 quant crash, "I think they are creating volatility of volatility."

While we already knew that China was selling - and following the record selling of FX reserves in August, so does everyone else - an even more interesting question emerged: who is buying? Thanks to the WSJ we now know the answer: "A little-known New York hedge fund run by a former Yale University math whiz has been buying tens of billions of dollars of U.S. Treasury debt at recent auctions, drawing attention from the Treasury Department and Wall Street."

When it comes to crisis, SocGen notes that there is an abundance of case studies; and against the backdrop of the uncertainty shock delivered by China and the subsequent market tumult, market participants have been looking to the history books for clues as to what could happen next. While individual crises create their own risks, SocGen warns, the overriding risk  is that markets are taking less comfort today from the idea that central banks may step in with further QE-style liquidity injections to save the world.

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If the market is right, Goldman warns that current cross-asset-class volatility appears to be pricing in a lot of economic damage. As they note, VIX doesn’t just trade the economy; it also has a strong and often humbling element of risk sentiment baked in.

Last week, amid China's sweeping crackdown on "subversive", "malicious" sellers, Chinese authorities took Li Yifei, chairwoman of Man Group Plc’s China unit, into custody. Or maybe they didn't. After resurfacing, the hedge fund manager now claims that reports of her arrest were untrue and that she was merely on vacation - "meditating." 

Overnight we got an unexpected call from perpetual optimist JPMorgan (yes, we all miss Tom Lee), which released a report by Mislav Matejka warning that it is not "time to re-enter the US" because "upside is limited at this stage of cycle." To wit: "some of the longer term cycle signals are increasingly worrying, with rising risk that US equities start making sustained losses next year. At best, the upside potential for the US remains limited, in our view." Still, just like BofA, JPM felt the need to hedge: "too early to position for recession." 

Hedge Funds are apparently dusting off their notes on how to hedge

The data point everyone has been waiting on is out and, just as we tipped weeks ago, China liquidated nearly $100 billion in USD assets during the month of August in support of the yuan.