Author Archive for Surly Trader

Volatility is all About Liquidity

By Surly Trader

The S&P 500 tried to pull back yesterday, but as usual the late day trading pushed the loss to just 65 bps.  This has become the normal market.  In 2012, volatility puttered at 12.77%.  In 2013 it fizzled down to 11.07%.  YTD we have crept up to 11.73%.   These metrics tell you to expect daily gains and losses to be +/- .75%.  Very Exciting.

What does this market remind me of?  I would say the nearest example is 2004-2006 when volatility cycled between 10-11%.  What do these two periods in time have in common?  Extremely easy monetary policy provided by the Fed.

The most powerful chart to show you the impact of Fed provided liquidity plots realized volatility against the steepness of the yield curve as measured by the spread between the 10y and 2y treasury rates.  As the fed keeps the front part of the curve low through the Fed Funds rate, the steepness is held high.  A steep yield curve induces investors to borrow at cheap shorter rates and buy riskier assets to earn a spread.  Party on while the Fed provides the punch bowl.


(The current steepness of the yield curve is a great indicator for future market volatility)

The red line above is the steepness inverted, so higher numbers represent the curve flattening or the Fed taking punch away from the party.  Low numbers say party on.  The blue is the trailing 90 day realized volatility of the S&P 500.  When the Fed says to party, the volatility stays abnormally low.

Key point to make in this chart is that the red line is two years behind the blue line so the red line starts at 1/31/1977 while the blue line starts in ’79.   This implies that the tightening of monetary conditions or reduction in market liquidity takes about 2 years time in order for volatility to pick up.  If the curve can remain steep for another two years, then how large will the volatility dislocation become when the Fed does ease off the gas pedal?  Most punch bowls are provided for 2 years or less.  Right now we are in the 6th year of zero interest rate policy with a strong indication that they will maintain it well into 2015.  Maybe this time the volatility will come even before the Fed eases off the pedal?



S&P 500/Russell 2000 Spread

By Surly Trader

The spread between large cap and small cap stocks is a pretty simple metric, but it is hard to ignore historical correlation to corrections:



More interesting than the magnitude of the spread is that the Russell 2000 recently broke through its 200 day moving average while the S&P 500 was making new highs:


This same anomaly happened in July of 2007:



Draw your own conclusions.

Not Everyone Should Own a Home

By Surly Trader

On May 2, 1995 Clinton’s White House released the “The National Homeownership Strategy: Partners in the American Dream”.  You can download this fantastic historical document right here: National HomeOwnership Strategy PDF

They synopsis of the report and its desire can be summed up in the first few sentences:

For millions of America’s working families throughout our history, owning a home has come to symbolize the realization of the American Dream. Yet sadly, in the 1980s, it became much harder for many young families to buy their first home, and our national homeownership rate declined for the first time in forty-six yearsOur Administration is determined to reverse this trend, and we are committed to ensuring that working families can once again discover the joys of owning a home.

Well…guess what?  Homeownership was fairly range bound until politicians got their hands in it:




The political game continued with the Bush administration because of a political desire to make home-owning citizens (or possibly banks) happy.  We all know how that turned out.

It is extremely sad when you walk through the time series of events:

  1. Individual is tricked into buying an over-priced home with a non-amortizing or option ARM mortgage (most likely embedded with high fees)
  2. Loses home, down-payment, and money spent on the investment because housing prices drop precipitously and he/she lost job due to housing crisis induced recession
  3.  Institutions and wealthy individuals buy the houses in  (government subsidized) foreclosures at fire-sale prices
  4. Individual starts renting the same house from a “savvy” investor who continues to raise rental rates even though wage growth has been stagnant

Sounds like the plan worked out great…

Long-term Complacency

By Surly Trader

If you have been watching market news over the last few months, there have been plenty of articles talking about how low the VIX has gotten and how we are back to levels not seen since 2007 or earlier.  What they do not talk about is how the VIX is extremely short sighted.  At a one month measure, the VIX is looking through foggy scratched glasses while sipping on red bull.  What is more interesting to me is how long-dated options are pricing risk.  The volatility of the market over the next month is usually a bit easier to figure out than the volatility over the next year.  Now try to think about predicting the next 5 years…

Five year At-the-money implied volatility got north of 40% in the heat of the global financial crisis.  Ever since then the 5 year vol has been headed lower and most recently it has traded between 19-20% since the beginning of 2014.  This level has not been seen since 2007.  The fed has tamed the market.  The only real question is what happens when they let it go?


Anyone See a Correlation?

By Surly Trader

I have been told that China is slowing down. I have been told that with the US Fed tapering, some money is being drained out of the Emerging Markets and going to the United States. I have been told that the Emerging Markets will have reduced competitiveness that will benefit the United States.

I have no idea how any of this will end, but I can tell you factually that the S&P 500 has been very correlated to the performance of emerging market stocks and debt in the last few weeks. In particular, take a look at the rate action instigated by Turkey and its impact on the Lira along with its impact on the S&P 500. I would say they were pretty tightly correlated:



My guess is that the S&P 500 will find stability when the emerging markets find stability.  My guess is that stability will not be found for a few months and could provide an interesting market environment.  I will let the others pontificate on what will happen and spend my time analyzing what is actually happening.

GMO Calls for Another Ugly Decade of Equity Returns

By Surly Trader

Unlike the investment banks that prioritize making money off of their clients, GMO seems to think making smart investment decisions is the more important job.  On an annual basis GMO releases their 7 year forecasts for different asset classes.  Most recently they released a rather uninspiring forecast that puts US equities as one of the least attractive:



If you get a little skeptical about the forecast, take a look at their 10 year results from 1999-2009.  I can’t say that there are many who called it better:


Investors Love Obamacare

By Walter Kurtz, Sober Look

Some of the most unpopular policies often create tremendous opportunities. Take the Affordable Care Act for example. While the public is complaining bitterly about this legislation, some investors will be (or already have been) profiting handsomely. Venture capital firms for example are expected to rake it in by funding companies that provide healthcare-related software services (see story). At the same time, the equity markets have been bidding up the whole sector with the view that Obamacare will make healthcare firms more profitable. More subscribers and more people receiving care means higher revenues and outperformance for healthcare shares.

Healthcare vs SP500


Blue: healthcare index ETF, red: S&P500 ETF

By the way, is it time to take profits?

Bitcoin Mania Part II

By Surly Trader

There are three factual statements to be made about Bitcoin:

    1. It has created Millionaires
    2. It has captured the minds of millions who would like to become millionaires
    3. It will bust again

The last fact is that it is incredibly entertaining to watch.  It is a sideshow that represents market psychology in a small test tube.  The largest daily volume was about $67M which is a microscopic market in the investment world.



There is another market (and many others in history) that showed a similar trajectory with an ugly aftermath.  The most significant representation is gold in the late 70′s through the mid 80′s:



The more recent representation was silver and its quick march to $50:



My guess is that the size of the bitcoin market has allowed it to skyrocket at a faster pace, but it probably implies that it can go even further than the last Booms and Busts.