Humanity just suffered two left-tail events in succession. Pestilence came calling in 2020 and then, in 2022, war came to NATO’s doorstep.

I’m always careful to show the proper respect for the plight of those for whom disease, famine and war are a fixture of daily life. We like to pretend we’ve come a long way as a species, and in many respects we have, but for far too many around the world, life is synonymous with perpetual tragedy and uninterrupted suffering.

With that important caveat, the last two years felt like a sadistic joke at humanity’s expense. Millions dead from a literal plague and the specter of a global conflict involving nuclear weapons shattered the relative calm and stability that characterized life in the Western world and developed economies for much of the last several decades.

The war is still raging, of course. Explosions rocked major Ukrainian cities this weekend. And we probably shouldn’t use the past tense when discussing the pandemic just yet. China on Saturday conceded that tens of thousands have died since COVID restrictions were eased last month (independent estimates put the number in the hundreds of thousands).

But purely from a macro perspective, the situation appears to be improving, at least at the margins. And that has implications for investors who, worn down by the Fed’s efforts to purge the QE-era mentality (i.e., leveraged-long risky assets and bonds), had little use for downside hedges by late 2022. Low exposure and large cash Overweights made hedging against additional downside somewhat superfluous. If there was anything that needed to be hedged, it was the “risk” of explosive rallies.

That helped explain a handful of purported “mysteries” pondered by the financial media last year, including a “too low” VIX and ostensible strangeness in a few options metrics. I repeatedly suggested there wasn’t anything mysterious about most of it. For reference, the most recent articles on that subject can be found here and here.

Below, find a few (very) short excerpts from Nomura’s Charlie McElligott, who tied all of the above together in a way I think is helpful when it comes to thinking about where we’ve been and where we might be going:

The potential set of ‘things that could go really wrong’ aren’t realizing at this moment, so demand for ‘wing-y / tail-y’ outcomes (especially downside) remains light and we see the probability distribution compress:

• ‘Immaculate Disinflation’ in the US, as Fed ‘over-tightening accident’ risk passes with terminal rate projections off the boil and a ‘pause’ well in sight
• US economic growth holding firm, led by still-strong labor and services
• China ‘zero COVID’ being lifted, with reopening providing a boost for the global economy and pushing back against global recession fears
• Deep European recession viewed as avoided thanks to the energy crisis cooling
• Ukraine / Russia relative stability maintaining

As I’ve stated repeatedly since spring of last year, it’s been a ‘short delta, short skew’ trade for much of the past year — because as global central banks were forced into an impulse tightening to crush demand-side inflation through tighter financial conditions, it has been a slow, grinding, ‘controlled demolition’ of legacy risk- / asset- exposures.

In turn, said ‘grinding’ de-grossing of exposures, in the case of equities, meant a ‘crashless’ selloff, very orderly in fact, which by 2H22 meant that skew and put skew were historically at all-time extreme lows, as there simply was not enough exposure on anymore to require ‘crashy’ downside hedges. Instead, all the ‘crash’ protection demand was for right-tail upside trades, because nobody had the underlying on.

Well, as people begin scrambling back into adding exposure, taking up nets and deploying cash into longs, we are finally beginning to see nascent signs of skew / put skew firming — because investors are finally going to have something that requires hedging again!