Fast and Furious.

For the second time in three days, Florida recorded more than 10,000 new coronavirus infections in the space of a single 24-hour period.

Saturday’s rise was 11,458, a new record and, as far as I can tell, more than any European state recorded on the worst days of Europe’s outbreak.

That, folks, is a dubious statistic. If Florida (in its current condition) were a European country three months ago, it would be the epicenter of the region’s epidemic. By contrast, New York (the old US epicenter) reported just 726 new cases.

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Overall, more than a dozen states have recorded record daily increases over the first several days of July, underscoring the contention that, at least when it comes to infections, the genie probably isn’t going back in the bottle. At this juncture, the nation is just betting that fatalities don’t ultimately spike.

The Trump administration is fully aware of this, all belabored attempts to downplay the surge notwithstanding. Indeed, NBC says the White House is now readying a new strategy which can be roughly summarized as “just live with it”.

“Administration officials are planning to intensify what they hope is a sharper, and less conflicting, message of the pandemic next week… after struggling to offer clear directives amid a crippling surge in cases across the country”, Carol Lee, Kristen Welker, and Monica Alba report, citing senior officials who said “the crux of the message is a recognition by the White House that the virus is not going away any time soon – and will be around through the November election”.

This marks an exceedingly rare instance of the administration finding itself confronted with a reality so inescapable that denial is no longer a viable strategy. “Fortunately”, scapegoating is, which is why Peter Navarro on Friday delivered one of his most inflammatory interviews to date.

China “spawned the virus”, Navarro told MSNBC. “They hid the virus. They sent hundreds of thousands of Chinese nationals over here to seed and spread the virus before we knew”.

“Peter, what are you talking about?”, Ali Velshi wondered, on live television.

I won’t trouble readers with the rest of Navarro’s sordid, conspiratorial tale, but suffice to say it presages a continuation of recriminatory bombast aimed at Beijing, and when you add in legislation aimed at punishing China for human rights abuses and the Hong Kong national security law, you end up with a pretty combustible mix.

In any event, with the White House prepared to acknowledge (both tacitly and, it sounds like, explicitly) that the virus isn’t going away, you can probably expect equity volatility to linger too.

On Thursday, I talked at some length about the grind lower in realized vol, which is prompting mechanical re-leveraging from systematic strats. Implied is a bit of a different story, and you can read more in the linked post, but what I wanted to highlight on Saturday, is some new color from SocGen’s derivatives strategy team whose Sandrine Ungari kicks things off with a flourish in an intro called “Fast and Furious”. To wit:

Fast. Fast like how financial markets have priced in pandemic risks. Fast like equity investors guzzling down stimulus ‘Kool-Aid’. Fast like retail investors re-entering the equity market and rushing to buy penny stocks.

Furious. Furious like how output plummeted as quickly as in wartime periods. Furious like the rebound in bond issuance. Furious like the emotion of Black Lives Matter protests. 

She continues: “In decades to come, the first half of 2020 will be remembered for the speed and fury of economic and political events [but] in the here and now, we must ask: what comes next?”

We know what doesn’t come next: The eradication of COVID-19. And therein lies one of the biggest challenges to the outlook for volatility, and thereby for any derivatives strategist whose job it is to make recommendations.

The team relies at least partially on the probabilities assigned under the scenario analysis from SocGen’s economists to formulate their cross-asset volatility forecasts.

Disconcertingly, the following downside scenario is assigned a 30% probability:

In the downside scenario, a second wave emerges globally and relatively quickly, as the easing of the lockdown measures leads to a resurgence of new cases. This should lead to a resumption of at least some lockdown measures but not a full freeze of the economy as we saw in March and April. The probability of this scenario stands at 30%.

You’d be forgiven for suggesting that scenario is already materializing.

Ungari doesn’t mince words. “The outcome is heavily skewed to the downside”, she writes, adding that “the probability of a second wave is relatively high [and] this would also have a sustained impact on global growth by further closures of small- and medium-sized enterprises, among the largest employers globally”.

That outcome, she laments, “would likely further deepen the current consumer-led depression” and would clearly manifest in equities and likely higher volatility.

Obviously, one has to take account of central bank support, fiscal stimulus, and the effect of the myriad feedback loops that can suppress equity vol. if things remain some semblance of well-behaved. But, ultimately, SocGen’s equities derivatives team says they’re comfortable in assessing “that risks to volatility are tilted to the upside”.

To be clear, the whole piece is quite extensive (and this is a separate note from that cited in “‘We Need To Re-Evaluate Our Understanding Of Volatility’“). I wouldn’t want to give the impression that the technicalities aren’t discussed — they are, at length. But, as ever, I try to hew as closely as possible in these pages to concepts and macro themes that are readily digestible and/or applicable if not for the “average” investor, then at least for most serious market participants, while avoiding getting so far into the arcana as to make the discussion opaque to all but a handful of readers.

With that in mind, let me just touch on the five key factors in SocGen’s equity vol. outlook.

First, the bank notes that real rates “tend to lead equity volatility by 2-3 years”. That, in turn, means volatility could stay elevated for an extended period despite rates having been cut aggressively to the lower bound.

Second, SocGen notes that although fiscal and monetary policy prevented a credit apocalypse, “questions on solvency are still in focus as parts of the global economy are being shut down again owing to a second wave of the pandemic”.

Spreads, the bank writes, “remain 1.5x-2x times wider compared to six months ago, and aggregate distance to default measures are much smaller”. This echoes commentary from Deutsche Bank’s Aleksandar Kocic, discussed late last month in “The Big Question Still Has No Answer“.

Third is liquidity. This topic should be fresh in readers’ minds. On Friday, in “The Role Of (Il)liquidity In History’s Greatest Bear Market Rally”, I revisited how diminished market depth can magnify flows, both in selloffs and in rallies.

One of the key points from that linked post (and, really, one the most crucial concepts to grasp in modern markets) is that market depth is a function of volatility. As the latter rises, the former deteriorates, and that becomes self-fulfilling as selling into a thin market leads to larger price swings, driving up volatility further, and around we go. The presence of algos in market making exacerbates this. Here’s SocGen with a quick summary:

It is common for algorithmic liquidity providers to program liquidity to vary inversely with volatility. As a result, liquidity drops when volatility increases, and lower liquidity takes volatility higher. We would need to see a large proportion of the previously seen vol selling flows come back for short-term volatility to drop, but it is difficult to envision confidence in vol selling given how high realized volatility is. While it is possible that front end vol settles down and liquidity returns, it is unlikely to happen over a very short period of time and we should see liquidity remain impaired in the short term.

That’s somewhat at odds with the discussion from Thursday (here), but SocGen is speaking in more general terms than Nomura’s Charlie McElligott, a ruthless tactician who, while steeped in the macro narrative, will gladly harvest gains next week (or even tomorrow) if the opportunity presents itself, irrespective of whether the thesis behind a given near-term trade is or isn’t entirely consistent with the medium- or longer-term narrative. You’re also reminded that, on Thursday, Charlie noted “sticky” implied, citing a dearth of discretionary/fundamental buyside willingness and/or risk-capacity to short vol.

Moving along, SocGen talks about earnings uncertainty. Here again, regular readers are primed thanks to “Shattered Dreams (Wile E. Coyote)” and “Prayers And Fundamentals“.

“Despite volatility being elevated in absolute terms, it is relatively low when compared to the level of earnings uncertainty”, the bank says. They go on to note that ambiguity around profits is less of a problem in tech which “could help keep the feedthrough to equity vol low”.

But, that dependence creates another potential problem — namely, “it may mean that any significant change in tech sector profitability could lead to a reset higher in the estimates of earnings uncertainty”. That’s an often overlooked point. We depend (heavily) on tech for reliable top- and bottom-line growth come hell or high pandemic. But what happens if that were to get upended by, say, a Facebook advertising boycott (just to throw one possibility out there)?

Finally, SocGen flags the political risk that accompanies the Hong Kong situation, the never-ending ongoing Brexit talks, and, of course, the US election.

Ultimately, you might be inclined to call most of these “known unknowns”, but I’m not sure that works. The evolution of the virus is largely out of human control. It could mutate tomorrow, for example. The US election is unlike any in the nation’s history, and I still contend that if the vote is close, America’s notoriously litigious president will not simply go gentle into that good gilded penthouse. It’s also far from clear what fate will befall the US corporate sector, which came into the crisis over-leveraged, only to take on another ~$1.3 trillion in new debt during the first half of the year. Will that be serviceable if, for example, earnings don’t rebound in line with expectations?

And so on, and so forth.

2020 is not just another year during which you can write off indeterminacy by reference to some version of that old adage: “There’s always uncertainty”.

This really is a unique period in history.

On the bright side, that invariably (i.e., by definition) means opportunity.

“The current crisis is unparalleled in the extent and reach of its implications and how proactive central banks and governments have been in trying to offset the economic fallout”, SocGen says. “As we look forward to the recovery, trends are not yet fully clear, and therefore investment opportunities still exist”.

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