Alpha Exchange

“Elections have consequences”. So said former US President Barack Obama. He probably didn’t have our trusty fear gauge, the VIX, in mind, but he may as well have.  We are one day away from the US presidential debate. I am not sure this one can deliver the same fireworks that resulted from June 27th. It may devolve into a food fight, with each side hoping to land a definitive blow. What I’ve learned about election risk with regard to derivatives through events like Brexit, the 2016 and 2020 US elections and certainly this one as well is that the clearing price for volatility is impacted by a decline in the willingness and ability to supply it to the market. The result, a VIX stuck at a reasonably high level. I hope you find this discussion enjoyable and useful.

Three hundred odd years ago, Sir Isaac Newton told us that “no great discovery was ever made without a bold guess.” My sense is he didn’t have the order book in Emini futures in mind, but his words do translate well to our world of financial instruments. In this short pod, I revisit the events of August 5th, a day when prices normally well discovered went dark. The implications are real and we ought to learn from this short-lived but real episode of instability. As we approach the “4 E’s” – employment, earnings, the election and the easing cycle – there’s a good deal to consider with respect to playing defense in markets.  I hope you find this interesting and useful.

Now the Chief Market Strategist at StoneX, Kathryn Rooney Vera comes from humble beginnings. As a teenager she cleaned houses in order to contribute to her family’s finances. In college, she changed her major to finance from liberal arts, seeing a more direct path to a well-compensated career. She would ultimately settle into the study of economics, a craft she continues to refine today in support of colleagues and clients at StoneX.

Our discussion surveys the process Kathyrn uses to find value in markets. She focuses on forecasting growth and inflation, the Fed’s response to these variables and the construction of trades that will capitalize on them. We review some of the recent cross-asset volatility and the role that positioning played. Kathryn rightly suggested that clients utilize protective option strategies in the period prior to August 5th.

She has also seen value in curve steepeners, embedding a little bit of the Sahm Rule notion that the Fed may find itself behind the curve. Lastly, she sees a favorable setup in the utilities sector, providing both the traditional defensive property through its linkage to rates as well as embedding an AI play that can empower it should the boom continue.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Kathryn Rooney Vera.

When an accident occurs, the insurance claims adjuster produces a report.  What does said report tell us?  The yen’s largely one way path lower took a dramatic turn that saw it rally by roughly 9% over just 3 weeks. The pricing fallout was everywhere – in curves, credit, correlation, convexity and carry. That’s a bunch of C’s, isn’t it. The cause of chaos: crowding. When markets misbehave, it’s natural to jointly evaluate two factors: the combination of “new news” and the “setup” going in. Over the course of this short podcast, I share some thoughts on this recent risk flare-up and what it tells us about market fragility.  I hope you find it interesting and useful.

Vineer Bhansali was recently among a small group of athletes who achieved the unthinkable, a 135 mile run in scorching heat, wind gusts and rain, all while traversing both the lowest and highest elevation points in North America. The Badwater 135 is considered the most difficult Ultra Marathon, an undertaking in which a guiding philosophy is, simply, “don’t die”.

As the CIO of LongTail Alpha, Vineer’s investment philosophy is also not to die – or, translated to markets – don’t get forced out at the wrong time. And in this context, he makes substantial use of derivatives, instruments that protect against the extreme events that markets all too often confront. Our conversation is a review of the August 5th risk event, exploring its causes and consequences. Unsurprisingly, Vineer sees the overconsumption of the Yen carry trade as a primary catalyst and he details the many ways in which printed, essentially free Yen made their way into risk assets of all shapes and sizes. He details how his firm navigated the flare-up, looking to trade VIX at incredibly elevated levels before the open.

With a view that the market price of insurance has come back to Earth too fast and with concerns that the recent risk-off may just be an appetizer for a larger unwind to come, Vineer argues that embracing insurance strategies is an important part of a long-term strategic portfolio plan.  I hope you enjoy this episode of the Alpha Exchange, my conversation with Vineer Bhansali.

Even if very short-lived, market vol episodes as protracted as that of Monday August 5th, demand our attention. In seeking some understanding of the why of successive 10% NKY moves and a 65 pre-open handle on the VIX, it was a pleasure to welcome Oliver Brennan to the Alpha Exchange. An FX vol strategist at BNP, Oliver brings theoretical training in physics to the related but also very different world of option pricing. In setting up the discussion, we first explore a series of past FX vol episodes including the Euro-Swiss break and CNH re-peg in 2015 and Brexit from the following year.  At the heart of these events lie economic imbalances and Central Banks that get tested by the market to hold the line.

We shift to a discussion of the setup going into early August in the Japanese Yen. Always an investment currency because of its balance of payment profile, Oliver argues that carry trades had gotten especially extended as dollar/yen trended so consistently higher. Market participants were long calls and long carry, and the dealing community was especially exposed to an increase in both realized and implied vol. He notes the absence of corporate supply as well of Yen vol in this recent event, something that exacerbated the repricing. With the tails especially under-owned, the more than 6% sell-off in dollar/yen caught the market well off-sides.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Oliver Brennan.
 

What a week in markets and one that should give us a lot to chew on with respect to how and why risk episodes materialize. There are certainly some conclusions at the ready and first and foremost is that vol is the only anti-fragile asset. In the trading action on Monday, August 5th, we see the reflexive nature of vol exposures and the manner in which asymmetric outcomes can result. In this short podcast, I share some of what’s on my mind in trying to uncover the “why” of these seismic moves. Out of this, you’ll hear some of my thoughts on product innovation and market liquidity structure. I hope you find it useful.

With deep roots on the sell-side, serving in strategist roles at both Miller Tabak and BTIG, Dan Greenhaus is now Chief Strategist at Solus Asset Managment, a multi-billion dollar AuM firm with expertise in distressed and high yield investing.  Our conversation considers economics in theory and practice, differentiating classic academic training from the role someone like Dan plays on a trading desk supporting clients, portfolio managers and an investment process.

Here, Dan shares the importance of understanding what’s in the price and details his efforts to evaluate consensus by talking to other strategists around the Street to understand baseline expectation. This is some part of what he describes as his role as blindside tackle at Solus, working to identify areas of macro uncertainty that may be under-appreciated.

We talk about the current state of the economy and the stance of Fed policy. On the latter, Dan argues that while the impact of tighter policy on slowing has been much less rapid than anticipated, it has worked. And while he’s successfully faded the repeated calls that the consumer was going to crack over the past two years, he now sees signs worth paying close attention to. He points to simple measures like weekly jobless claims and also puts stock in Visa’s recent earnings call in which weakness was cited across multiple spending categories.

Dan’s study of prior Fed easing cycles suggests that rate cuts have typically come too late to offset broad-based economic weakness. Will this time be different?  Perhaps, given the strength of both household balance sheets and fiscal spending. But, as with everything in the realm of markets and investing, Dan properly asserts that we must approach forecasts with humility.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Dan Greenhaus.

With early career roots in both equity derivatives and relative value fixed income, Lisa O’Connor is now the Co-CIO of Multi-Strategy Assets and Solutions at BlackRock. Here she oversees her team’s development and delivery of a long only, systematic asset allocation process on behalf of the firm’s clients.

Our discussion first considers some of the lessons Lisa has derived from market risk cycles. In reflecting on vol episodes, she asserts that markets become very focused on relative value during times of crisis. That is, in higher risk environments, there’s much greater differentiation across risk categories, as investors evaluate which assets can truly be defensive or at least weather the storm.

We talk next about the model portfolio process and the mix of quantitative and fundamental factors that drive the asset allocation decisions. In contemplating the role of duration as a portfolio ballast, Lisa is concerned about risk premia in the back-end of the curve as a function of fiscal deficits. Instead, she sees value in diversifiers like gold, especially as China is increasing its holdings.  We also spend time on AI and the challenges of being too little or too heavily invested. In looking for evidence that the roaring capex cycle may have peaked, she is following emerging signs of spending discipline from hyper-scalers and tracking the reported ROIs from investment out 18 months.

Lastly, we talk about the Fed easing cycle and its potentially positive implications for the market pricing of equities with more balance sheet leverage.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Lisa O’Connor.

“Walking on a tightrope” is an idiom that conjures the notion of danger – of exceptionally little margin of safety and of particularly significantconsequences should things not go as planned. Markets feel this way - asset prices are full, Sharpe ratios high, correlations low, political polarization intensifying. 

In this discussion, we review the recent role of correlation in breaking the more than 500 day streak over which the S&P 500 failed to move down by 2% in one day. We also talk about out the highly unusual VIX curve, with some portions of it in contango and others in backwardation.

Hope you enjoy it and find it useful.