Balance sheet

Expect Nasty Volatility & Shocks This Summer

Expect Nasty Volatility & Shocks This Summer

With the stock market heading no where for the last 4 months of this year, it is high time we took a step back and view things from a systematic angle. As we approach the "sell in May and go away" phase of the year, equity returns are looking more vunulrable to adverse shocks, and flares in volatility.

YTD, the S&P 500 is almost unchanged, down marginally. Bonds (quality) and commodities (short USD) have been the best performers for the last 4 months. Vol of vol (VVIX) has remained elevated but is not yet deemed to be at alarming levels. What's in store for us may be a surprise. Or actually maybe not.

When we piece this puzzle back in a way BofAML calls the "3P's of Positioning, Policy & Profits", we can come to the conclusion that the risks are skewed south, and things could turn uglier very promptly. Therefore, it may be wise to expect very moderate returns from equities. One may wish to overweight cash, bonds, and gold while avoiding equities and non-IG corporate credit.

Are Money Markets Warning Of An Unknown Unknown?

Are Money Markets Warning Of An Unknown Unknown?

It has been deftly espoused that there are two types of unknowns - known unknowns and unknown unknowns. And because risk is most commonly associated with uncertainty (i.e. unknowns), there are some risks that can never be completely hedged against - unknown risks.

Earlier last week, the 10-year swap spread went negative for the first time since 2010, making this one of the only 4 occasions since 2007 that spreads have defined financial gravity. The 5-year swap spread is on the verge of being negative, which if happens would make it the first ever in history.

The take away condensation for readers would be to prepare for unknown unknowns. 7 years of zero interest rates have distorted markets and their pricing engines on an unimaginable scale. Models that price risk, and dictate where billions of dollars flow into on a daily basis have been so badly screwed by artificially suppressed borrowing costs that a positive shock to the system knows no bounds.

Plainly said, we don't know what to expect. You can't hedge a risk you haven't yet seen. Be cautious!