An Inflation Surprise – Invoking Volcker

Lately, there has been a lot of speculation on who the next US Federal Reserve chairperson will be. Many articles have been written speculating, opining, polling, and inferring the likely outcome as well as likely policy implications; we will not waste our time theorizing the same. Instead, we will focus on the technical aspects of the US treasury futures market and the underlying dynamics of US wage and inflation data.

Our view is that we could be due for an inflation surprise. Interest rate sensitive assets could be vulnerable, the slope of the US yield curve could steepen quite dramatically, and the reflation trade could be back with a vengeance.

Please click here to view the presentation.

A Melt Up in US Equities

  • Low levels of VIX get all the attention; the often attributed reason is complacency, the often prescribed medicine is caution.
  • Equity risk premium relative to Aaa rated bonds and Baa rated bonds do not scream over valuation.
  • We have put together a presentation in which we present 21 charts that should make any one predicting doom and gloom on the US equity markets reconsider their stance.
  • We too are guilty of having given up on this market way too prematurely but the breadth of the market, which got us bearish in the first place, is now showing signs of underlying strength and it behooves us to recognize it.

Please click here to view the presentation.

Long Vega of Vega – an update on the breadth of the US stock market

Breadth of the US stock market (number of new highs minus number of new lows) is pointing to continued weakness in the markets.

Over the last five years, on average, the price of the S&P 500 index has been about 20% above its long term mean. This dynamic broke down in June-2015 and it coincided with a text-book-correction: dropped 20%, tested support and bounced off. Since then, however, it has struggled to go over 16% of its long term mean. The last two times it tried to get above 16% (Feb-2017) and (May-2017) it turned back down. The market has lost its upside momentum.

Every time the ratio of 1 month S&P 500 volatility to 3 month S&P 500 volatility spikes, it, almost always, is accompanied/followed by a decline in S&P 500. Why would this time be any different?

When an asset that has been appreciating for the last 8 years turns lower even by small amounts, the introduction of negative daily returns to its return distribution tends to increase the volatility of that asset by a meaningful amount. While we are long volatility we think a better trade structure might be to focus on acquiring long exposure to volatility of volatility of the US stock market. In our view, one of the best trades for the next 12 months is to be long Vega of Vega. We will continue to develop this idea and post our thoughts on an ongoing basis.

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