Like the President of the United States, I like to “speak with myself,” on the important issues and that’s because “I have a very good brain and I’ve said a lot of things.”
One of the “things” I’ve “said” is that volatility in 2018 has been to a great extent confined to equities and when it comes to equity vol., this year’s uptick has been in some sense a U.S.-centric phenomenon.
Now to be clear, I’m not the only one who has said that. Lots of folks have elaborated on those points and they have “very good brains” too. But if you’re asking me who I’m “consulting with first”, I would have to say, like Trump, that “my primary consultant is myself because I have a good instinct for this stuff.”
As far as who the other people I’m consulting with are, I’ll just quote the President again and tell you that “I talk to a lot of people and at the appropriate time I’ll tell you who the people are.”
So again, “I’ve said a lot of things” about this volatility issue and here are some of those things, excerpted from a piece published earlier this month which, because I wrote it, by definition contains even more of the “things I’ve said”:
Clearly, the blowup of the short VIX ETPs in early February played a role in making the U.S. experience unique and the forced de-risking by systematic strategies (think: CTAs and risk parity) that unfolded in early February made things worse. While the wipeout of the ETPs essentially cleared the deck in terms of those products’ ability to turbocharge a volatility spike, it’s not clear that some of the strategies that were caught up in the subsequent deleveraging have rebuilt their positions.
Additionally, it looks like passive investors are contributing to elevated volatility stateside, an unsurprising development considering how manic the flows into and out of some of the more popular index funds have been this year. That same propensity for investors to pile into and out of the big ETFs seems to have contributed to the recent spike in stock correlations:
On the psychological front, there’s no question that the incessant headlines from the Trump administration are making U.S. investors nervous. Even ostensibly positive news seems to come not of its own accord, but rather in response to some previous headline that the administration thinks might have been misinterpreted or otherwise unnerved folks.
And then there’s the psychological overhang from the Mueller probe. Not having any idea what the next shoe to drop will be in the special counsel investigation is a constant thorn in the side of traders, as there’s no way to hedge it.
And then there’s the regulatory overhang in tech, which took the baton from trade war banter late last month when it comes to giving markets a reason to be nervous.
As far as equity vol. is concerned, recall the following chart from Goldman which shows you the disparity between two-month realized volatility on a bevy of European ETFs versus S&P 500 ETF:
All of that serves as a nice setup for a new piece out from Barclays called “Volatility: Made in the U.S.A.”, which finds the bank taking a closer look at how the evolution of volatility in 2018 has differed stateside versus how things have played out across the pond.
“The volatility over the past few months has been driven by negative catalysts, primarily made in the US,” Barclays writes, before showing you the following visual which they describe as “depicting four phases for equity markets broadly so far this year:”
Here’s the bank documenting those “phases”:
- December and January was characterized by exuberance about US tax cuts and a generally benign global growth outlook, which lead to a 7% and 5% rise in the SPX and SX5E respectively during January.
- This was followed by a rates tantrum, which lead to an equity sell off on the back of FED hiking fears. US and European equities dropped by about 10%.
- Then trade war fears started late February, leading to a renewed global risk off episode.
- Lastly, regulatory concerns about US FAANG stocks which make up about 1/4th of the SPX weight, unnerved markets over the past two months.
They go on to document this in more detail but one of the more interesting charts is shown below and depicts “the change in realized volatilities across GICS sectors for US and EU from the peak of the market in late January to now.”
We find that US volatility increased more than European volatility on an index and sector basis (the regression slope is only ~0.5), even though the ranking of winners and losers is actually not too dissimilar. US tech suffered the largest absolute volatility increase on the back of the FAANG debate and is a large 25% SPX weight (but only 7% in Europe). US financials, which account for 15% SPX index weight, also saw a significant RV increase due to volatility in longer dated US yields. While European financials are an even larger 20% weight, their realised volatility reaction was a lot more subdued. While materials volatility increased more in Europe, this sector only accounts for about 8% SXXE index weight.
So how anomalous is all of this? Well, quite, although it’s not unprecedented. Have a look:
Barclays takes a look at how forward looking markets are pricing things and ultimately, the expectation is that this state of affairs will stick around for about a year before “mean reverting” (they note that the 1Y1Y spread is positive and close to the median).
Of course that depends to a large extent on one man’s “very good brain” and whether all of the “things” he’ll invariably “say” going forward serve to exacerbate trade tensions, pile further pressure on Amazon (thus raising the specter of more tech volatility) or tip a more combative approach to the Oval Office’s exceedingly fraught relationship with the DoJ.
And look, maybe this is exactly what Trump wants. After all, he loves the idea of things being “made in the U.S.A.” – so why not vol.?