Look, It’s The Market Fragility Discussion Again
It's the same story over and over again. Stability breeds instability and modern market structure facilitates and amplifies the dynamic.
The short version is just that volatility determines exposure, so in calm markets, exposure and leverage rises. Time and again we've seen this conjuncture coincide with an "insulating" effect from dealer hedging flows, which act as synthetic "plunge protection," in turn keeping markets rangebound, driving realized vol lower still, dictating more mechanical exp
Option A. Invest in a hugely overbought market, that could correct dramatically for almost no reason at all.
Option B. Sit on the sidelines and watch your cash get eaten away by inflation.
These are the choices that our modern Fed has given us. Thanks Powell.
Along with appx 34% gains in SP500 since pre pandemic level . . . which could have instead been a big negative number had the Fed eschewed its modern ways in February 2020.
Hobson’s choice by design perhaps….
H-Man, it seems that at the end of the day you go with the flow and be resigned to Morton’s fork.
The way to understand it is to think of a bi-modal distribution or better yet, the proper model is not Gausian, but jump shift distribution. In a world in which there are just 2% corrections, declining vol, increasing leverage, the market is highly mean reverting to an upward trend. Yet, if you somehow, (who knows how) see the market down 7-10%, it is a completely different world of de-risking, deleveraging, higher vol feeding higher vol as CTAs, Vol Targeting, and short gamma take over. In short, the put bid should be mental under this bi-modal distribution construct.