With markets having put in a nice rally going into the Euro summit, there could be nice opportunities playing the outcome via volatility. Both the VIX and the “euro VIX” EVZ, could be possibly good hedges. If you agree even the slightest with Soros, the market could move nicely after the summit. Some thoughts by Vix and more.
It is not that difficult to come up with data and charts that have many investors wondering if risk and uncertainty are being underpriced in advance of the euro zone summit. Earlier today, I offered up one possible example in Euro Volatility and Risk. Since the VIX receives top billing in this space (and not too long ago carried the mostly tongue-in-cheek moniker, “Your One-Stop VIX-Centric View of the World…”), I thought a VIX-specific example might also be of interest.
The chart below shows the last three months of VIX data, with VIX candlesticks on the main chart on the top. The second chart from the top compares the 20-day historical volatility of the VIX (blue line) with the 30-day implied volatility of the VIX (red line), with the yellow area chart just below it calculating the HV minus IV. Much to my surprise the current 20-day HV is 144, while the current IV is only 98. In other words, the markets expect the VIX to be considerably less volatile in the month ahead than it has been over the course of the last month. I am not surprised to see the gap, but do the markets have the direction of the gap right? In terms of trading opportunities, if you disagree with the market consensus, then VIX straddles probably look fairly cheap right now.
John Hussman is still bearish. With the massive expansion of central bank’s balance sheets, this could get nasty going forward. Thanks god they don’t need to use those mark to market models at the Fed…
For nearly two years, the massive interventions of central banks have repeatedly pulled a fundamentally weak and debt-burdened global economy from the brink of resumed recession. The Federal Reserve’s balance sheet is now leveraged 52-to-1, with assets having an average duration of over 5 years, suggesting that if those assets were marked-to-market, an interest rate increase of less than 50 basis points would wipe out the Fed’s entire capital base. Of course, the Fed takes no marks on its assets when it reports its balance sheet, though it does occasionally take down the value of the securities in the Maiden Lane shell companies that it illegally set up to bail out Bear Stearns and other entities (in violation of Section 13(3) of the Federal Reserve Act, which Congress had to amend and spell out like a See-Spot-Run book as a result).
At a 10-year Treasury yield of 1.7%, interest on reserves of 0.25%, and a monetary base now at about 18 cents per dollar of nominal GDP (see Run, Don’t Walk), further purchases of long-term Treasury securities by the Fed would produce net losses for the Fed in any scenario where yields rise more than about 20 basis points a year, or the Fed ever has to unwind any portion of its already massive positions. So further QE by the Fed would effectively amount to fiscal policy. Moreover, the benefits of central bank interventions are becoming progressively smaller and short-lived (nearly log-periodic in fact, to borrow a term from crash dynamics). None of this restricts the Fed from embarking on further interventions. It just emphasizes how far the Fed has already descended into the deep.
To the extent that our measures of market action improve on some possible future intervention, and until the point where the market reestablishes an overvalued, overbought, overbullish profile, we might have some latitude to take some speculative exposure in the event of another round of QE. But without substantially greater improvement in valuations here, there would be noinvestment basis for that exposure, so our latitude wouldn’t be very broad (we estimate the prospective 10-year total nominal return for the S&P 500 to be back down to about 5% on the basis of our standard methodology).