Portfolio Insurance, Real or Imagined

Volatility in currency markets is largely nonexistent, at least for now:

With central banks standing pat and little else to drive markets, the betting on low volatility itself is helping to drive trading, says Russell LaScala, Deutsche Bank’s global co-head of foreign exchange trading. He calls the situation “self-perpetuating,” adding that “these loop orders control the market absent any events.”

But this can easily be undone. If an economic or political event leads to a market swing, banks can suddenly forgo their hedging activities, looking to profit from any rise in volatility. That would remove a stabilizing force from the market. At the same time, investors who had bet on low volatility would get burned and rush for protection. That in itself would feed further volatility.

The risk is that the current situation proves similar to one that preceded the big selloff in stocks in January 2018 after a long stretch of ultralow volatility. 

What goes up when currency volatility increases? The underlying currency that rises & perhaps a currency hedged equity play in the area where the currency falls, or put options on overly extended high beta stocks. If there is a strong play there with limited holding cost that seems like a nice asymmetric bet at the moment.

The first quarter has been quite strong for both stocks & commodities.

The S&P 500 climbed to a five-month high last week, putting the benchmark equity gauge on track for its strongest first quarter since 1998. Meanwhile, U.S. crude oil rose to its highest level since Nov. 12, pushing its early year rebound to almost 30%. … Still, many remain concerned about this year’s rebound. One reason is that assets that are considered safer, such as Treasurys and gold, have also held steady after early year ralliesmaking it challenging for investors to piece together a clear trend of market momentum. Bond prices and gold often decline when stocks rally, a trend that has historically signaled faith in the economy. … about $60 billion flowed out of global stock funds from the start of the year through March 6, the largest such outflow to begin a year since 2008

The yield curve has remained quite flat in spite of the recovery in risk assets.

As of today’s session, before the close, the UST curve is absolutely ridiculous (again). The 5-year note is now trading almost equal to EFF (effective federal funds) once more, eleven bps less than the 52-week bill. The yield on the 5s is now significantly (4 bps) below the equivalent yield on the 3-month bill. Nominal rates from there down the curve are mere bps off the January 3 lows. This isn’t quite how “dovishness” was supposed to turn out.

The eurodollar futures curve is likewise revisiting the worst case (so far). As these contracts have predicted, LIBOR rates have fallen which doesn’t mean things are getting better. Outer contracts are being bid to prices above those from January 3, which suggests this huge, crucial market is starting to get the sense that “whatever” is going on its effects might alter the long run, too.

I recently read Howard Marks Mastering The Market Cycle & it is rich with quotable quotes. One that comes to mind:

in an interconnected, informed world – everything that produces unusual profitability will attract incremental capital until it becomes overcrowded and fully institutionalized, at which point the prospective risk-adjusted return will move toward the mean (or worse). And, correspondingly, things that perform poorly for a while will eventually become so cheap – due to their relative depreciation and the lack of investor interest – that they’ll be primed to outperform. Cycles like these hold the key to success in investing, not trees that everyone is assuming will grow to the sky.

After the extremist attacks at mosques in Christchurch, New Zealand three days ago, we might be off to the races with another round of terrorist garbage fueling more terrorist garbage as it was just reported by the WSJ Dutch police are searching for a gunman from Turkey who killed three people in Utrecht & wounded several others. Should more attacks happen volatility should rise & markets which were up decently today turned south on the news.

In case that terrorst garbage picks up further steam I just bought a LendingTree April put option with a strike price just below market. They’re up about 10% since the 7th & are up about 70% from their lows last December. High beta companies which fueled growth through increased ad spending & competitive acquisitions may see their share prices fall. Of course any decline like that which would be akin to what Quinstreet did might be another earnings report or two away, but anything that has moved 70% in a few months could easily give a bit back should things turn dicey.

The China trade war stuff keeps getting pushed out, with the latest whispered extension going into June, so it can be a fresh memory of a win for the 2020 election. There’s no incentive for Trump to rush it so long as the Fed is on pause & is perceived to own any market correction.

Meanwhile, green shoots abound as China’s ageing solar panels are going to be a big environmental problem.

Lu Fang, secretary general of the photovoltaics decision in the China Renewable Energy Society, wrote in an article circulating on mainland social media this month that the country’s cumulative capacity of retired panels would reach up to 70 gigawatts (GW) by 2034.

That is three times the scale of the Three Gorges Dam, the world’s largest hydropower project, by power production.

By 2050 these waste panels would add up to 20 million tonnes, or 2,000 times the weight of the Eiffel Tower, according to Lu.

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