Macro Vol Commentary
For domestic equity markets, 2019 started off in a very similar manner to 2018, with a January rally that was a far cry from Q4 market fragility. Fed chair Powell’s dramatic policy U-turn wrong-footed many investors by entirely removing its upside bias on rates and standing in stark contrast to the hawkish stance that broke the “buy-the-dip” mentality that popped the low volatility bubble in 2018. With the Fed put strike back with a vengeance and the FOMC tightening cycle seemingly put on hold, January volatility was crushed throughout the US and the short vol trade was back in earnest. The decline in stress was broad based as implied volatility metrics fell across all 5 major asset classes.
On a similar note, despite Emerging market equity and FX vol among the first to rise from the low vol doldrums in 2018, the Fed U-turn was seen as overwhelmingly bullish for EM, as dovish US monetary stance reinvigorated investors desire to own EM assets and suppressed volatility in the region.
Meanwhile in Europe, macro data early in the year signaled some stabilization supported by French growth and German fiscal support. As a result, implied volatility metrics throughout Europe declined in January while EUR vol sits at historical lows. Given poor fundamentals and continued mixed equity returns, it’s hard to make the case in either direction with conviction regarding the European volatility environment.
Finally in Asia, stocks climbed higher fueled in part by optimism over trade talks between the US and China. As a result, implied vol in Asia followed the US and Europe falling in root time fashion in the frontend, and even more considerably in the far end of the curve.
With the recent Q4 market downturn directly in our rear view mirror, we still have significant long-term concerns over weakening macroeconomic conditions, global policy concerns, and market microstructure/reduced liquidity issues. Additionally, the higher rate environment makes cash a viable alternative to vol risk premia and the tendency for volatility to rise later on in the economic cycle regardless of policy are relevant considerations that we think prevent 2019 from playing out like 2017.
Cross-Asset Volatility Monitor
The complete about-face in volatility from December ‘18 to January ‘19 cannot be understated and is in plain sight with our latest 20 asset volatility monitor. Whereas December had over 50% of assets with a negative volatility risk premia “VRP” (i.e. 1-month realized vol was higher than current 1-month implied), this month only 1 solitary asset (Natural Gas) had a negative VRP. The remaining 19 assets all had a positive VRP, and some overwhelmingly so. Given this context, it is no surprise that short volatility strategies of almost any kind had a great month and reminded investors why short vol was so popular back when the Central Bank’s unprecedented dovish policy & rhetoric were sensitive to financial markets. Infact, every major asset class had a positive absolute return in local currency, which is the first time this has happened in over 12 years as indiscriminate selling in December turned into indiscriminate buying in January.
Echoing the drastic changes in VRP, the 1-Year percentile of implied vol is also a complete 180 from December, when nearly all implied vol metrics were at or near their 1-year highs. This month, as evidenced by the chart above, there is a fair amount of dispersion across assets as many equity index volatilities are not nearly as enticing as they were in December. However, both commodity and FX markets still seem to be reflecting an attractive premium within the implied volatility complex and are areas of focus when looking for unique dislocation opportunities going forward.
Important Disclosures and Definitions:
The viewpoints expressed in this report are solely those of Infinity Q Capital Management, LLC, (“Infinity Q”) and can change without notice.
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The indices and securities included in the Cross Asset 1-Month Probably Monitor are the 20 underlyings commonly assessed in reviewing the broad global volatility markets.
SPX Index: The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
SX5E Index: The EURO STOXX 50 is a stock index of Eurozone stocks designed by STOXX, an index provider owned by Deutsche Börse Group. According to STOXX, its goal is “to provide a blue-chip representation of Supersector leaders in the Eurozone.”
NDX Index: The Nasdaq-100 Index includes 100 of the largest domestic and international non-financial companies listed on The Nasdaq Stock Market based on market capitalization. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology.
UKX Index: The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index, is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange.
DAX Index: The Deutscher Aktienindex (German stock index) is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange
SMI Index: The Swiss Market Index is Switzerland’s blue-chip stock market index. It is made up of 20 of the largest and most liquid Swiss Performance Index (SPI) large- and mid-cap stocks.
AS51 Index: The S&P/ASX 200 measures the performance of the 200 largest index-eligible stocks listed on the ASX by float-adjusted market capitalization. It is considered the benchmark for Australian equity performance.
NKY Index: The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.
HSI Index: The Hang Seng Index is a freefloat-adjusted market capitalization-weighted stock market index of the largest companies that trade on the Hong Kong Exchange, and is consider the main indicator of the overall market performance in Hong Kong.
Kospi2 Index: The KOSPI 200 Index is a capitalization-weighted index of 200 Korean stocks which make up 93% of the total market value of the Korea Stock Exchange.
FAANG: An acronym for the US equity market’s five most popular and best-performing tech stocks, namely Facebook, Apple, Amazon, Netflix and Alphabet’s Google.
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Past performance is no indication of future results.