Why Eric Peters Is Betting All On A Volatility Eruption: "A Historic Reversal Is Coming"

Back in October, we discussed a report  that several hedge funds have sprung up in recent months with just one strategy in mind: preparing for the arrival of the "fat tail", i.e., betting on a sharp spike in depressed, comatose volatility. One among them, was One River Asset Management, a manager of $700 million led by Eric Peters in Greenwich.

Today, in his latest letter to investors, Eric Peters explains his logic and reasons - which are hardly unique and have been discussed here repeatedly over the past year - why he believes that for vol, the only way is up.

From Eric Peters Weekend Notes, Jan 7

Anecdote

To sell implied volatility at current 50yr lows, investors must imagine tomorrow will be virtually identical to today.

They must imagine that bond yields won’t rise despite every major central bank eager to hike interest rates and exit QE.

They must imagine that economies at or near full employment will not create inflation; that GDP will neither accelerate nor decelerate; that governments will tolerate historic levels of income inequality despite citizens voting for the opposite; that strongly rising global debts will be supported by structurally decelerating global growth.

And volatility sellers must imagine that nine years into a bull market, amplified by a proliferation of complex volatility-selling strategies and passive ETFs with liquidity mismatches, that we will dodge a destabilizing shock to market infrastructure.

I can imagine a few of those things happening, but neither sustainably nor simultaneously.

It is much easier to imagine a tomorrow that looks different from today.

Also consider that investment banks and asset managers have always devised creative strategies to make money once asset valuations exceed reasonable levels. These perpetual prosperity machines typically combine leverage and alchemy, transforming real risk into perceived safety. Examples abound. But in this cycle, a proliferation of cleverly disguised volatility-selling strategies has dominated.

Zero interest rates and quantitative easing left yield-starved investors with few ways to achieve their target returns. Wall Street’s engineers developed many wonderful solutions to this problem.  Their magnificence is matched only by the amount of negative convexity now lurking in investment portfolios.

As volatility has declined, investors have had to sell even more of it to sustain sufficient profits.

This selling reinforces the trend lower, which produces an illusion that legacy volatility shorts are less risky today than yesterday. Lower volatility thus begets lower volatility. And this also ensures that quantitative models reduce overall portfolio risk estimates, which allows (and in many cases forces) investors to buy more assets at prevailing prices.

This in turn reduces volatility, reflexively.

Naturally, the reverse is also true. Rising volatility begets rising volatility. And given the unprecedented volatility-selling in this cycle, this market is exposed to a historic reversal somewhere along the path to policy normalization. Which has now begun.

And visually, the feedback loop works until it doesn't.

 

asd

 

Comments

Oldwood Sun, 01/07/2018 - 20:05 Permalink

As someone who does not participate directly in this market, what does it mean to me? I'm all in cash and real estate (mostly residential).

Evan Wilson Oldwood Sun, 01/07/2018 - 20:15 Permalink

While it is hard to tell exactly, since no country has been stupid enough in most of history to do what we are doing now, I expect what will happen at some point:

1: Central banks will no longer be able to keep interest rates low/volitility low/asset prices high as the current process ends. (i.e. CB are unable to buy anymore assets to keep things going as they have been.)

2: When that happens, interest rates will start to rise -> then stocks and assets in general will fall.

At this point you 'will be sitting pretty' because you will be able to wait for the carnage to get going full blast, and pick what assets you want to buy, for rock bottom prices, at a price that you will want to pay. The best part is that since you are all cash, you will not even need to borrow or wait for some bank to approve a mortgage for you, you will be able to write out a check for the full amount.

I expect when all this finally happens, that you will do very well.

 

In reply to by Oldwood

Evan Wilson Evan Wilson Sun, 01/07/2018 - 20:18 Permalink

As a follow up:

While the value of your real estate will fall when interest rates ride, I expect that will not effect you since you, being in a good position, are in properties that are cash flow positive, so you don't care what the value of the existing real estate holdings are since you are making money every month and do not plan on selling.

Once the carnage gets going good, like 2008/2009, you will have another chance to get more cash flow positive property and build your (or a) retirement portfolio.

In reply to by Evan Wilson

SH_Resurrected hairball48 Sun, 01/07/2018 - 23:43 Permalink

Hmmm... Let's see... we see some kinda "liquidity crisis", within the public pensions that will, somehow, spread to the private sector (when most of the private sector doesn't have pensions), which, apparently, will require some kinda selling to raise cash "for retirees", driving "the situation" out of control and ultimately requiring marshal law.  ...all sounds like a majorly contrived plot for a sub-B horror/action movie.

In reply to by hairball48

J J Pettigrew Sun, 01/07/2018 - 20:23 Permalink

Algos...... we have not seen them sell yet......

Remember the lambasting of short sellers in 2008? 

How evil!

Algos know no geopolitical risks....

no bids...?  Still sell....now...must sell...now...

we are required to sell just like we are required to buy new highs...

 

Wm the Shrubber Sun, 01/07/2018 - 21:15 Permalink

Numerous strategists seem to be on board with the "normalization" meme, but this seems wholly at odds with global central banks, ex-Fed, continuing to pour monetary gas on the fire to the tune of $200+BN per month.  In a wholly fiat, coordinated global economy, it matters not from where the printing originates.  It only matters that it continually is maintained/increases.  And, at the first whiff of turbulence, is there any doubt at all that the Fed will reverse course?  My bet is that we are in this liquidity trap until something completely breaks.  And then, the real work of recovery begins!

pitz Mon, 01/08/2018 - 01:53 Permalink

What happens when rates rise and, faced with massive capital losses on bond and stock portfolios, the pension funds are forced to unload positions?  Could be nasty.

U. Sinclair Mon, 01/08/2018 - 04:18 Permalink

You can blow up a balloon until it pops.
Central banks around the world are stretching it till the end.
They have no other choice because when they stop blowing the balloon will deflate itself and take off without control.
In any case one of the two will happen.
We all had the same experience as a kid.
I guess central bankers didn't play with balloons when they were young.
They missed some learning of the natural laws....

Erwin643 Mon, 01/08/2018 - 06:57 Permalink

This is just a bunch of Greek salad bullshit. 

All I know is that if I try to go UVXY due to weekly and monthly bounded indicator readings on SVXY, I'm fighting the market and losing money.

I'll be shorting UVXY until it happens, then I'll just switch gears and go long UVXY.

 

mkhs Mon, 01/08/2018 - 18:28 Permalink

 

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No comments accepted?

Anyway, @Kiwimail:  What, are you racist.  They are Afro-American swans. ;)