Monthly Archives: October 2014

Looking Forward (2015)

Now that the most recent “correction” is over, I’ve decided to reassess many of the strategies / themes I’ve followed. I’ve decided on the following:

New Themes
Neutral Rates – Europe and China will be exporting capital / deflation. US, however, will be strong. We might see the end of QE, but the path of rate increases will be slow.

Yellen Straddle – Taper be damned… It’s pretty clear that the central banks of the world are here to jawbone (or, in extreme cases action) stability. Not just economic stability, mind you, but also asset stability. The Yellens, Draghis, and Zhous will be replicating a short-straddle position accordingly.

Some people have been talking about the “Last Great Bubble” (belief in the Central Banks). Perhaps it’s true, but it’s not something to worry about in the short-term. Globally, the political willpower is there to bolster the economies of the world. The bubble will only burst when we receive a negative shock so large that we don’t have the political willpower to act.

Maintained Themes
Long Beta – We are in an era of low volatility (aside from potential spikes) and moderate earnings growth. Multiples will likely stay inflated for some time, making slightly levered beta a decent Sharpe proposition.

Long Activism – We continue to have cheap debt and share buy backs. The activists have become more vocal and powerful over the last year. I bet along with them.

Long IQ – Where would the best and brightest of Harvard, MIT, etc. go? Software AI are highly levered, and the returns on raw intelligence will be high for the next decade. I don’t believe the intelligence premium is recognized properly (I might have to test this at some point using scraped LinkedIn data).

Dropped Themes
Short Rates – Given negative carry, I don’t believe following the Goldman strategy is the way to go – especially since the world around us is slowing down. The risk/reward just isn’t there.

Long Growth – The easy money has been made in growth. Earnings growth will be more consistent/stabilized. The long growth names might be more priced to perfection at this point than we believe (ex: NFLX, AMZN). I don’t have a sense of where they should be valued at this point, so I will stay away.

Current portfolio positioning (ratios based off of my ES Delta). Yes, I got mildly spanked by AMZN post-close.

Positioning

Shorting more Euros

I added to my short EUR position this morning. This is an extremely crowded trade, but likely less crowded in the recent shakeout. The drift is down – but might be accompanied by sharp spikes (given positioning). I’m fine with that.

* I don’t care what Merkel thinks, austerity doesn’t work.
* Eurozone politics are worse than ours.
* 10-year Bunds < 1%. UST will probably stay at > 2%. Regardless, we’ll have positive rate differential / carry for a considerable time.
* US is not the epicenter of deflation/slowdown. Flight to safety will be towards dollar.
* US is in a tightening cycle (though probably slower than people think). ECB is contemplating buying corporate bonds (what?).
* These long-term themes generally take considerable time to play out. I will stay on the bandwagon until the assumptions no longer hold.

Will show better analysis later.

VIX and Returns

I’ve read numerous articles attempting to use the VIX (or a normalized VIX) as an indicator of market bottoms. In fact, CNN introduces it as the first factor in their “Fear and Greed” index. But instead of forecasting and prediction, perhaps we should be looking at it in a different way…

More risk should be compensated by more reward. VIX (which is constructed using the near and next-term options) does a fairly decent job of predicting forward volatility (top right). However, we don’t see a similar pattern in returns (especially in the 18-25 buckets). In fact, the forward returns drop in the 18-25 bucket. This is the case even when removing the 2008 financial crisis from the data set.

Possible conclusions?
1) When things get bad and uncertain, they’re liable to get more bad and uncertain (dumping positions is a valid play).
2) Market participants (in general) are more long than short. Given some level of leverage, higher volatility -> higher required portfolio margin -> more selling. By the time we get to > 25 (~1.6% moves / day), all the speculators have already been shaken out (hence, why the risk/reward normalizes).
3) I’m fooled by randomness (especially given the market crashes in the last decade) and the risk/return is actually consistent across vol buckets.
4) I’m fooled by bad math and faulty statistics.

VIX Forward

* Includes ~ 14 years of data, starting in 1/1/1990 (the back-filled VIX data).
* I haven’t looked at it 2nd order (ie, changes in VIX), but something I want to explore.

Not a way to live

It became blatantly obvious mid last week that things had gone horrifically wrong. So wrong, in fact, that the intra-day volatility inflicted Ebola-like symptoms upon me.

You see, I distinctly remember the day when my professor taught me to model VaR using a GPD (or otherwise fatter distribution). Unfortunately, the IB Risk Navigator lulled me into a false sense of security. A costly novice mistake.

As I recover from this travesty of a month, I’ve decided that being ultra-levered is not a way to live. I’ve established this blog not only to share my thoughts about the markets & tech — but also to second-guess potentially blunderous and impulsive trades.

P&L 20141021