WEEKLY MACRO NOTE - What Volatility?

Read time: 11 min

TABLE OF CONTENT:

• WEEKLY WRAP UP

• VOLATILITY & ELECTION CYCLES

• LURKING RISKS IN CRYPTO

• SENTIMENT

• ECONOMIC CALENDAR

• THE WEEK AHEAD

WEEKLY WRAP UP

There are two major risk events next week, US midterms elections on Tuesday and CPI on Thursday, so let's get through our usual weekly wrap up and move on to what lies ahead.As always my aim here is to try and help you contextualize the market is as broad a way as possible, for the more you look at the better.

Future expected volatility declined last across the board last weekThe VIX (SPX vol) declined -4.62% to 24.56, its lowest level in 9 weeks.

The MOVE Index (which measures 1 month implied treasury volatility) dropped -13.17% to 128, the lowest level since early September.For now, I think Treasury Vol may be more telling than Equity Vol if you are looking for a tool to help you gauge risk on/ risk off sentiment.

EVZ, Euro volatility was flat WoW at 11.92, also at the lowest level since Sept

The SKEW Index, which can be viewed as a broad measure of tail-hedging, just made its 4th lowest-ever close in a row.

The lack of tail hedging must be understood and viewed in the context of the growing trend of 'casino like' activity in the options market, where short dated options increasingly dominate the volume.

The Volume of options traded within 24H to expiry has doubled this year alone.Remember this next time you see a major move or trend reversal in a day and you find yourself scratching your head trying to explain.

The USD was flat WoW +0.11%, but remains in a strong bullish trend, and is only -3.5% off its most recent high.

Had it not been for the GBP/USD getting Pounded -2.7% after the BOE hiked by 75bps the Dollar index would probably have been lower still.The move in the GBP should not have come as a surprise to subs, as I pointed out last week, the BOE needed to be truly forceful and do a +100bps if they really wanted to support the currency.

The fact remains that unless you out-hawk the Fed then your currency will be penalised.And who can out-hawk the FED?

EUR/USD -0.08% WoW, and once again fails to find support above parity.USD/JPY -0.54% WoW as the BOJ continues to support its currency in the FX markets.

A currency to keep your eyes on is the Yuan, where volatility is rising. USD/CNH declined -1.32%, after making a 15 year high last week, as news of a potential reopening in China was making its rounds.This same news lead to a major rally in Chinese equities, with the Shanghai Composite +5.3%, but guess what? the rumour has already been dismissed by Chinese officials who reaffirmed their commitment to Zero Covid Policy. This is a gentle reminder as to why you do not make investing decisions based on what you read in the news.

Despite the Move index having one of its largest declines this year, bonds sold off and rates rose across the curve and around the globe.

Treasuries:US2Y +5.4% to 4.52%US10Y +3.66% to 4.16%US30Y +2.51% to 4.25%

US02Y

BUNDsDE02Y +9.41% to 2.12%, a new 15 year highDE10Y +9.14% to 2.29%and the German yield curve is edging ever closer to inversion

DE02Y

GILTsUK02Y -0.52% to 3.05%UK10Y +1.23 to 3.53%Bailey seems to have managed to calm the waters in the British sovereign debt market, but with Inflation still trending in double digits, and plenty more hikes to come, I would not be too complacent.

High Yield OAS Spreads, a key risk on/off metric that i like to use, widened in the US by +27bpsMeanwhile, in Europe, they tightened by -10bps.

This temporary divergence in risk on/off sentiment between the US and EA was also evident in equities, where the US was a sea of red, while Europe rallied for the 5th consecutive week.

The weakness in the US was primarily driven by MegaCap tach which is the largest component of both the Nasdaq and the S&P Index. The indices were penalised based on their allocations to these companies

NDX -5.97%, now down -35% from its all-time highSPX -3.35%RUT -2.55%DJI -1.40%

A brutal week for tech indeedAAPL -11.15%GOOG -10.23% to new cycle lowsAMZN -12.02%MSFT -6.14%META -8.48%

Meanwhile across the pond in Europe, the situation was quite differentSX5E +2.8%, now up + 13.5% from the lowsFTSE 100 (UK) +3.77%, its second-best week of the yearDAX (Germany) +1.63%, up for the 5th straight week & +13.3% from the lowsCAC (France) +2.29% also up +13.5% from the lowsFTSE MIB (Italy) +2.78%, up +15% from the lows.

Have Europe's problems been magically resolved by a +75bps hike by the ECB and BOE or is this just the 3rd Bear Market bounce of the year?

Each of the previous bear market bounces has coincided with corrections and consolidations in the dollar, so the pause in the King's relentless rampage has undoubtedly helped relieve some pain in the old continent.

The same can be said for abroadAUS200 +1.40%, +8.5% from the lowsSouthAfrica40 +5.16%, + 12% from the lows

India is close to breaking out to new ATHsNIFTY50 +0.54%, and is only 2% from an all-time high.

This is not the place to go through India’s economic data, or the companies that compose the index, in detail. I will probably write a Data Dive on this in a few weeks, but for now, suffice to say, that IMO the main driver of strength in the Indian stock market is money fleeing China.

For years, China has been the most owned “emerging” market by Western funds, with the country in many respects now having become “uninvestable”, many EM funds, which have a mandate to be invested at all times, find themselves fire selling China and chasing India all at the same time.

While I understand, and conceptually agree with the case for India as a secular growth story, and there is little doubt that the country will benefit from companies moving production out of China (see Apple for example), even as a long-term investor, these levels do not attract me.

I shall wait and watch on this one.

The last thing I want to highlight is that Commodities rallied this week.This is No Bueno for Inflation.

CRB COMMODITIES INDEX +5.48%WTI +4.55%DIESEL +6%NAT GAS +13.14%COPPER +7.51%Copper in particular rallied on the China reopening news, it will be interesting to see what happens next week now that that rumour has been quenched.

Even agricultural commodities ralliedWHEAT +2.07%SOYBEANS +4.43%CORN -0.06%SUGAR +5.82%

VOLATILITY & ELECTION CYCLES

Looking ahead, on Tuesday we have the midterms in the US.Odds appear to strongly favour Republicans winning in both the house and senate.Frankly, it makes little difference to me who wins and what I want to discuss here has more to do with Flows than with outcomes.

Risk events have often turned out to be a tailwind for equities due to a curious dynamic.Traders hedge their positions going into the event by buying puts and then sell those hedges after the event.When traders buy puts they force dealers to hedge their book by selling into the market, when traders then sell puts and unwind the hedges they force dealers to get long the market.

This is a slightly oversimplified explanation but serves the purpose of helping you understand how the general dynamic that plays.

Anyway, I went back to look at some historical precedents.

2016 TRUMP-CLINTON Presidential Election

In the 2 weeks leading up to the event, the VIX rallied 80%, going from 13 to 22, and the SPX declined -3%.In the following 3 weeks after the event (and remember the big risk everyone was talking about was Trump winning) the VIX declined from 22 to 12 and the SPX rallied +5.5% to new highs.

SPX vs VIX

2020 TRUMP-BIDEN Presidential Election

If we look at the last Presidential election we see a similar dynamic play out.The VIX rose +70% from 24 to 41 in the 3 weeks leading up to the vote and the SPX declined -7.5%.After the event, the VIX quickly dropped back down to 22 and the SPX rallied +10% to new all-time highs

SPX vs VIX

But both of these were general elections, so it's not surprising that a high degree of risk was priced in before the events. Another point worth noting is that they both occurred during a bull market, so regardless of the impact of the option flows, the trend and path of least resistance were upward.

Now let's look at the last two midterms.

2014 MIDTERMS

In 2014 a similar dynamic seemed to play out, although on a slightly different timeline.The VIX rose at the start of October but then declined in the weeks leading up to the event and continued to decline thereafter, before rising again in Dec.Conversely, the SPX declined at the start of Nov, but then rallied in the 2 weeks leading up to the vote, and continued to rally thereafter, before stalling out in early December

2018 MIDTERMS

The 2018 midterms present a different picture.

The VIX declined -30% from 24 to 17 in the two weeks before the event, and then started rising thereafter.Conversely, the SPX rallied 5% in the two weeks leading up and dropped -5% to new local lows in the two weeks after.

Note that the major difference in this instance is that in 2018 the market was heading for a short, but brutal decline of -18% (remembered as a mini Bear market) due to the Taper Tantrum around Powell trying to do QT.

Is there anything meaningful that we can learn from this, and can this help you glimpse into the future and make better trading decisions?I will share a few bullet thoughts with you and leave you to decide for yourselves:

• Things change, and that past performance is no guarantee of the future.

• The impact of flows seems to be more pronounced during general elections.

• What will the impact of the now dominant short-dated options be compared to the past?

• The flows did not lift equities in the 2018 midterms, during the mini-bear market.

• As we approach this year's midterms, VIX has been declining for the last 3 weeks

As always remember that you never want to look at just one thing, and option flows, as dominant as they have become, are only one piece of the puzzle.

LURKING RISKS IN CRYPTO

I am neither a perma-bear nor a perma-bull, the same goes for companies and asset classes, I neither hate nor love them. They are what they are.I have owned BTC and other cryptos in the past, and will most likely own them again at some point in the future.But each and every ticker must be viewed agnostically, so as to not skew your judgement.Getting to this Zen state is not easy, it requires fighting your own biases, but then again, so much in trading does.

Is Bitcoin Digital Gold? is Crypto the money of tomorrow?I don't know.

All I know is that Crypto has only existed during a secular bull market, we have barely 10 years of data, so all the models on crypto cycles you see are close to being worthless and meaningless. That said, at its simplest level, so far crypto seems to be the most risk-on asset class in the world.It has a strong inverse correlation to Liquidity and the size of the Balance Sheet.

So right now I would have to see a lot of positive price action and strong momentum to make me change my assessment that crypto is in a bear market.While shitcoins may be getting pumped, BITCOIN, the real bell weather, is only +15% from its cycle lows, but -70% from its all time highs.

You have to take any movement in any crypto that is not BTC or ETH with a pinch of salt.Volumes on exchanges are extremely low, and in many cases phoney. It does not take much to pump a token.

This leads me to the "Lurking Risks" I want to discuss.

Earlier this year we had a few major blowups in cryptoverse.Celsius, Luna, Voyager, just to name a few.

Some interesting information came out this week regarding legendary crypto billionaire Sam Bankman-Fried, the FTX exchange and his hedge fund Alameda.Alameda reports north of $14B of assets on its balance sheet, but almost 90% of those are cryptocurrencies.40% of Alameda's assets are the FTT token, issued by Sams other company, the FTX exchange.10% of assets are SOL, another token he was very involved in launching+ other crypto tokens.

Supposedly Alameda has $8B in liabilities.

According to Coindesk’s report, Alameda owned $5.8 billion FTT tokens in June of 2022. According to market aggregator CoinGecko, this is equivalent to 180% of the total circulating supply of the tokens....

Hmmmm

How different is this from the Celcius scheme?

Liquidity is an often overlooked metric in finance.The basic principle is simple, how much and how rapidly can you sell an asset without impacting its price?

There are barely a few hundred active addresses transacting in the FTT token...Yes, this is a major issue. If Alameda were to try to sell their FTT, probably $5B of value would evaporate from its balance sheet.

Sam, FTX and Alameda are huge.They are systemic.

The thing is, all is well and good while cryptos are rising and volumes on the exchanges are strong.High volumes = Revenue for FTX = cash flow for Sam.

But if Coinbase's most recent earnings reports tells us anything, it is that volumes on crypto exchanges are in the gutter.

The above info is based on a report from Coindesk, some further research by Dirty Bubble Media and the tremendous work of @otteroooo on Twitter.https://dirtybubblemedia.substack.com/p/is-alameda-research-insolvent

I am not trying to make a big implosion call or anything like that.Some of this info may be disproven, FTX will probably be fine and Sam may well continue to be a Billionaire.

The only point I want to make is that far too many risks lurk under the surface in crypto, and the longer this bear market continues, the more likely they are to emerge.

The final flush has not happened yet, and it may still be months away.I urge caution.

SENTIMENT

For the second week in a row sentiment is quite clearly bullish

Active Investors long exposure increased again, albeit only slightly.

As Mega Cap tech made new lows for the year a short the NASDAQ as finally emerged in CFTC Futures & Options positioning although on the other side to that traders got long the SPX for the second week in a row.Once again the main thing that jumps out to me is that now major 100k contracts long the EUR.....Oh and maybe a few people got squeezed in the Yen with that position being reduced by a fourth.

According to the AAII survey we have the lowest level of Bearishness since April of this year, and a significant change from just 3 weeks ago.

ECONOMIC CALENDAR

Another busy week with many earnings.

THE WEEK AHEAD

Next week is event packed.Other than the midterms you have US Inflation data that gets reported on Thursday.

Will it be 7.9%, 8% or 8.1%?The question you should be asking yourself is, structurally does it matter?You should expect inflation to come down from here, that should be to no one's surprise.

Could one of the two events yield a rally in US equities?Yes, they could.

Does that change anything?No, it doesn't.

If last week selling US equities was the obvious trade, then this week it is selling Europe.

We remain in a bear market, but clearly, the risk-reward favours shorting Italy, Germany and France over the Nasdaq, where a rally in MegaCaps from oversold levels can occur at any moment.

If there is one thing that I know about next week, is that it is going to be a volatile one.

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Antonio C. Nobile

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