It's never easy when bonds and stocks decline at the same time, but despite the much-publicised death of the "risk parity" strategy, I don't think the past few weeks' price action qualifies as decisive evidence. After all, the S&P 500 is down a mere 0.6% from its peak in the beginning of June, while US 10-year futures are off only 1.5%. In writing this, though, I remember that many punters in this business use leverage. This acts as an accelerant not only for the volatility of their PnLs, but also for the speed with which a meme can take hold in the peanut gallery. I sympathise with the plight of bond traders in Europe where the dislocation in yields has been particularly nasty. When yields are near zero, or even negative, the relationship between small changes in yield and prices can be brutal. This is even acuter in Japan, where the BOJ might soon have to actually defend that 0% target on the 10-year yield, to avoid an accident in the domestic asset management industry. In the U.S., the 10-year yields has been altogether less dramatic, but big enough to raise questions about whether we have made a switch from a flattener to a steepener.Read More
Traders and strategists on Bloomberg TV had one overarching message last week. It's boring out there, too boring. John C. Bogle's Vanguard and Larry Fink's Blackrock have turned passive investing into a volatility crushing monster. Indexation is an immovable force, which takes no prisoners, evidenced by the fact that the return on the main U.S. stock indices is driven almost exclusively by five major names. Trying to beat the tide by picking stocks—both long and short—is proving nigh-on impossible for active managers. Adding insult to injury, the bond market is a snoozer too. The curve can't figure out whether to steepen or flatten in response to the Fed' slow hiking cycle—I am betting on the latter—and yields have been range bound as a result. Clearly, investors aren't easy to please. When volatility is soaring, they assume foetus positions and cry for central banks to rescue them, and when low volatility finally arrives they deplore the lack of opportunities. Maybe it is just a question of the porridge being neither too hot nor too cold, but when punters start complaining about low volatility my spider sense goes off.Read More
Normally put options serve as protection for large, mainly long only, asset managers. Picture an investor committee meeting at a large pension fund in the wake of a equity market drawdown. The core portfolio is down, but the astute and prudent portfolio manager dodged the bullet by buying put options on the market or the funds individual stock holdings. This is the way it would normally work, but there is nothing normal about the current market.
A WSJ piece by Ben Eisen and Aaron Kuriloff this week alerts us to the topsy-turvy world of financial markets in an environment where the "reach for yield" is the only game in town. In short, in a desperate search for regular income and "yield" some pension funds in the U.S. are turning to the nuclear option of selling put options. I will let Eisen and Kuriloff describe the madness;Read More