Month: May 2017

As one would expect, last week’s report by Bank of America’s Benjamin Bowler, in which the strategist stated that “these markets are very weird“…

… and in which Bank of America warned that “US equities continue to set long-term records for instability“, prompted many questions from traders and investors.

For those who missed our take on the BofA report last week, what Bowler noted was that the -1.8% drop in the S&P 500 on 17-May represented a five standard deviation (5-sigma) event relative to trailing volatility, the third such outsized drawdown in stocks in less than a year, but only the 18th since 1928. Moreover, it was followed by the second-fastest retracement of a 5-sigma drop since 1928, illustrating the power of today’s “buy-the-dip” mentality.

So, in a follow up note released overnight, Bowler writes that he received a number of follow-up questions from investors sceptical that either the 17-May drawdown or the subsequent reversal were as striking as we suggested, given that the nominal decline in the S&P was “only” -1.8%.

But before we give Bowler the podium, here is the one observation that drew the greatest market response. When asked if prior low vol periods also saw frequent high-sigma SPX drawdowns, Bowler notes comparable periods to 2017 of ultra-low S&P realized volatility which include the early 1950s, mid-1960s, mid-1990s, and mid-2000s. What he finds is that while 3 sigma (or greater) daily SPX drawdowns were as or more frequent in these historical periods as they are today, the past year stands out for having generated an unprecedented number of 5 sigma (or greater) daily declines.

In other words, Bowler says “there is a certain “nonlinearity” to today’s market instability such that if US equities do jump from a state of calm to stress, such a jump is unusually large by historical standards.”

One could almost make the argument that the market is broken…

* * *

With that said, here is BofA’s vol expert addressing the most frequently asked questions that resulted from his report, and shows that “the capacity today for US equities to jump quickly from calm to sudden stress and back (“fragility”) is indeed historically unusual.”

Yes, US equities really are historically unstable

 

1. Aren’t high-sigma SPX drawdowns more likely when volatility is low?

 

This was by far the most commonly asked question, as intuition suggests that a 5? drop (for example) in the S&P 500 should be “easier” to achieve when prevailing realized volatility is low, as stocks need to fall by a smaller nominal amount. However, while this is the case for sufficiently elevated levels of volatility, it is in fact not true empirically for low to moderate levels of volatility. Indeed, Chart 12 shows no discernible bias towards high-sigma moves when S&P realized volatility has been 20% or lower, which encompasses the bulk (~80%) of realized volatility levels observed since 1928.

 

 

 

2. Did prior low vol periods also see frequent high-sigma SPX drawdowns?

 

Comparable periods to 2017 of ultra-low S&P realized volatility include the early 1950s, mid-1960s, mid-1990s, and mid-2000s. While 3-sigma (or greater) daily SPX drawdowns were as or more frequent in these historical periods as they are today (Chart 13), the past year stands out for having generated an unprecedented number of 5-sigma (or greater) daily declines (Chart 14). In other words, there is a certain “nonlinearity” to today’s market instability such that if US equities do jump from a state of calm to stress, such a jump is unusually large by historical standards.

 

 

 

3. Isn’t a high-sigma drawdown that’s small in magnitude easier to retrace?

 

Intuition again suggests that the smaller the size of a high-sigma SPX drawdown, the “easier” it should be to recoup the loss quickly. In other words, perhaps the S&P 500 recording the second-fastest (3 days) 85% retracement of a 5-sigma drop in history following 17-May is not that impressive since the nominal drop was “only” -1.8%. However, as seen from Chart 15, there is little historical relationship between the size of the 5-sigma 1-day SPX drawdown and the length of time it takes to recoup the bulk of this drawdown. For example, the Feb-94 5 sigma drop in the S&P was -2.3% and took 252 days to recoup, whereas the Jun-16 Brexit-induced drop was -2.45% but took only 9 days to recover. Moreover, the only retracement since 1928 that was faster (2 days) than the recent recovery occurred in 1962 following a much larger (-6.7%) nominal decline in the S&P.

 

 

 

4. Is there a “limit” to how much the S&P can fall in a day when vol is low?

 

The distribution of 1-day sigma (i.e., vol-adjusted) returns of the S&P is well-bounded in the sense that since 1928 we have never observed a drawdown larger than ~11-sigma. This  occurred on three separate occasions (Chart 16) – in Sep 1955 (when realized vol was 9.5% prior to a 1-day drop in the S&P of -6.6%), in Oct 1987 (when realized vol was 29.7% prior to a 1-day drop in the S&P of -20.5%), and in Oct 1989 (when realized vol was 9.2% prior to a 1-day drop in the S&P of -6.1%).

 

Put differently, with realized vol around 5.7% prior to the 17-May sell-off, the most US equities could have fallen that day if history is any guide was -3.96% (= 11 * (5.7% / ?252); see Chart 17). For context, the last time the S&P 500 fell that much on a single day (on a close-to-close basis) was on 24-Aug-15, although that represented only a 3.5-sigma event at the time when measured relative to trailing EWMA volatility. With realized vol closer to 8% today, an 11-sigma drop would amount to a -5.5% decline in the S&P 500 (Chart 17); the last comparable drop occurred on 8-Aug-11, when the S&P fell -6.7% or 4.4-sigma.

 

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Authored by Nick Cunningham via OilPrice.com,

After the nine-month extension of the OPEC deal, there is a growing consensus that oil might bounce around in the $50s and $60s for the rest of the year. But as we move into 2018 and beyond, there is a great deal of disagreement among analysts about what happens to oil prices.

One school of thought is that the severe cuts to upstream spending that have stretched into a third year are sowing the seeds of a supply shortage around 2020. The IEA is probably the most recognizable forecaster that falls into this camp. The agency has repeatedly pointed to the fact that new oil discoveries are at their lowest level in 70 years. "There were no discoveries because there is no money for exploration. You find something if you look for it," the IEA’s executive director Fatih Birol said earlier this year.

The IEA says the industry must step up spending if they are to avoid a supply crunch in a few years’ time. “[W]e are emphasising an important message: more investment is needed in oil production capacity to avoid the risk of a sharp increase in oil prices” by the early 2020s, the IEA wrote in a March report.

Alan Bannister of S&P Global Platts echoed that warning more recently, pointing to natural depletion from conventional oil production – which still makes up the vast majority of global supply – on the order of 3 to 4 percent per year. “We’ve not really seen the effect of that yet, because all the projects that were put in place three years ago when prices were high are still being completed – we’re still seeing extra volume coming on,” Bannister told CNBC in an interview. But because the sharp cutbacks in upstream spending means that there will be many fewer barrels coming online to replace depleting fields, “it does sow the seeds for a potential super bull run…It could go well over $80 in the next two to three years,” he added.  

But other analysts have an entirely different view, expecting oil prices to remain low for the foreseeable future, although for varying reasons.

Some focus on peak demand, which mainly comes down to alternatives to oil. The most fervent believers in both electric vehicles and autonomous vehicles argue that oil demand is nearing a peak, so there is little chance of another major bull run. Tony Seba, co-founder of tech-focused think tank Rethinkx, says that demand will peak by 2020-2021 and will plummet thereafter, forcing oil prices down to $25 per barrel by 2030. "At $25 a barrel, that means deep-water, sands, shell oil, fields, most are going to be stranded, and also all the refineries and pipelines associated with these expensive oils are also going to be stranded,” Seba told CNBC.

Even if more mainstream oil forecasters don’t see such a dramatic scenario on the horizon, they do see some supply-side forces that prevent an oil price spike. Namely, improving technology and falling breakeven prices for shale production could put a ceiling on the price of crude for the next few years. For example, Morgan Stanley just downgraded its forecast for Brent in 2020 from $70-$75 to just $60 per barrel. The investment bank said that about 1.5 mb/d of new supply that it had expected would be needed in 2020 will no longer be needed because of much better results from shale.

Goldman Sachs agreed with that sentiment a few weeks ago, stating that they are growing more confident that longer-term oil price range is “drifting lower.” Goldman says it sees lower prices over the next five years because of the “growing visibility on the sources of future supply.” And they also pointed to the resilience of U.S. shale as a principle reason for oil prices remaining low not just for the near-term but into the 2020s. Goldman cites the surprise profitability of shale companies today even though oil prices have bounced around at $50 per barrel, their ability to ramp up supply, and the abundant capital that Wall Street is willing to shower on shale drillers. 

So, we have dramatically different visions for what might play out over the next five years. On the one hand, there are those worried that the depth and length of the current downturn will merely create a stronger bull run in five years. Today’s cutbacks create tomorrow’s shortage.

On the other hand, there are those that think the oil market is fundamentally different than in the past. Shale has truly altered the supply picture, and the downturn in prices has been met with steady innovation, leading to the cost of the marginal barrel to structurally fall. As a result, oil prices could remain low for years, if not forever.

For 2017, analysts are converging on a consensus for oil prices, but the forecasts for what happens after 2020 are diverging.

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President Trump's angry tweetstorm this morning blasted Democrats, saying they no longer want Carter Page to testify in the investigation into the Russian election meddling, becuse he would counter previous testimony by former FBI and intelligence officials.

As a reminder, The Hill notes, last week, Page, a former adviser to Trump's campaign, said he would testify before the House Intelligence Committee in early June.

Page, who advised Trump on foreign policy, also said he obtained legal counsel.

 

Page has been the target of lawmakers investigating possible ties between Trump's campaign and Russia during the presidential election.

 

An intelligence dossier alleged Page met with Russian officials while working for the campaign.

 

Page said in a letter dated May 23 to Rep. Adam Schiff (D-Calif.), the intelligence panel's ranking member, and Rep. Michael Conaway (R-Texas), who is leading its Russia probe that allegations of Russian interference in the election are false conspiracy theories.

And now it is being reported that Page will not be asked to testify. This has enraged President Trump…

So now it is reported that the Democrats, who have excoriated Carter Page about Russia, don't want him to testify. He blows away their….

— Donald J. Trump (@realDonaldTrump) May 31, 2017

…case against him & now wants to clear his name by showing "the false or misleading testimony by James Comey, John Brennan…" Witch Hunt!

— Donald J. Trump (@realDonaldTrump) May 31, 2017

Of course, we will never know why Democrats decided they do not want to grill Page in their standard '5 minutes of fame' public hearing, but one wonders just what is holding them back from such a spectacle?

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One month ago we reported that according to Beacon Policy Advisors, a new name had emerged as potential replacement to Janet Yellen as head of the Federal Reserve: that of former Goldman COO and current Trump National Economic Council advisor Gary Cohn.

“The buzz among those who claim Cohn confides in them is that he would like to eventually replace” Yellen, assuming Trump decides to move in a different direction when the chair’s term ends in early February, Beacon Policy Advisors said in a daily report for clients in late April.

“On paper, Cohn likely meets Trump’s expected top two requirements for a Fed chair candidate,” the Beacon analysis said, specifically citing Cohn’s advocacy for deregulation and his likelihood to keep interest rates low as Trump seeks to implement his pro-growth economic policies.

Now, as Axios reports, this story is being validated by none other than Gary Cohn’s inner circle. According to Mike Allen a shake-up of the White House staff has put Cohn in contention to replace Reince Priebus as chief of staff. While such a move had long been speculated, Allen added that a late surge in support among confidants of Trump could lead GOP lobbyist David Urban to get the job.

However, as Axios notes, citing Cohn’s Friends “after his current gig, Cohn would love to be named … chair of the Federal Reserve.“

As a reminder, Janet Yellen’s term as Fed chair expires in February 2018. And while their relationship has been far less contentious recently, during his presidential campaign, Trump accused Yellen of collaborating with President Barack Obama and Democrats to keep interest rates low to ensure a victory for his competitor Hillary Clinton. His personal attacks led to speculation that he could even fire Yellen if he won. Since then, however, Trump has had a change of heart, and during an April WSJ interview, he stated that lower rates are in fact prefereable and said he may even reappoint Yellen.

Of course, if Cohn were appointed Fed chair it would add yet another person with Goldman Sachs ties to the Federal Reserve’s key positions. Cohn was Goldman’s president and COO before leaving to join the Trump administration.

Below we list some prominent former Goldman employees currently employed by the Federal Reserve:

• New York Fed president, William Dudley, previously Goldman’s chief economist
• Minnesota Fed president, Neel Kashkari, previously worked at Goldman
• Philadelphia Fed president, Patrick Harker, previously a former trustee of the Goldman Sachs Trust
• Dallas Fed president, Robert Kaplan, previously vice chairman at Goldman in charge of investment-banking operations.

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Authored by John Mauldin via MauldinEconomics.com,

Sometime this year, world public and private plus unfunded pensions will surpass $300 trillion. That is not even counting the $100 trillion in US government unfunded liabilities. Oops.

These obligations cannot be paid. A time is coming when the market and voters will realize this.

Will voters decide to tax “the rich” more? Will they increase their VAT rates and further slow growth? Will they reduce benefits? No matter what they decide, hard choices will bring political turmoil.

And that, of course, will mean market turmoil.

The Great Reset Will Cause a Horrible Global Recession

We are coming to a period I call “the Great Reset.” As it hits, we will have to deal, one way or another, with the largest twin bubbles in the history of the world. One of those bubbles is global debt, especially government debt. The other is the even larger bubble of government promises. The other is the even larger bubble of government promises.

History shows it is more than likely that the US will have a recession in the next few years. When it does come, it will likely blow the US government deficit up to $2 trillion a year.

Obama took eight years to run up a $10 trillion debt after the 2008 recession. It might take just five years after the next recession to run up the next $10 trillion.

Here is a chart my staff at Mauldin Economics created in late 2016 using Congressional Budget Office data. It shows what will happen in the next recession if revenues drop by the same percentage as they did in the last recession (without even counting likely higher expenditures this time).

Source: Mauldin Economics

And you can add the $1.3 trillion deficit in this chart to the more than $500 billion in off-budget debt—and add a higher interest rate expense as interest rates rise.

The catalyst could be a European recession that spills over into the US. Or it might be one triggered by US monetary and fiscal mistakes. Or a funding crisis in China, or an emerging-market meltdown.

Whatever the cause, the next recession will be just as global as the last one. And there will be more buildup of debt and more political and economic chaos.

It May Be a Complete Reset

The Great Reset will also bring an increase in volatility. And the correlation among asset classes will once again approach 1.0, as it did during 2008–2009.

If I’m right about the growing debt burden, the recovery from the next recession may be even slower than the last recovery has been. That is unless the recession is so deep that we have a complete reset of all asset valuations.

I don’t believe politicians and central banks will allow that. They will print and try to hold on as long as possible, thwarting any normal recovery, until markets force their hands.

But then, I can think of at least three or four ways that politicians and central bankers could react during the Great Reset. Each of the four ways will bring a different type of volatility and effect on valuations.

Flexibility will be critical to successful investing in the future.

I think the answer lies in diversifying among noncorrelated trading strategies that can invest in any asset class.

*  *  *

Join hundreds of thousands of fans worldwide, as John uncovers macroeconomic truths in Thoughts from the Frontline. Get it free in your inbox every Monday.

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What a total farce. After Market News International reproted a dismal 4-month low drop in Chicago PMI this morning which sparked a decent reality check drop in stocks, they decided to change their mind.

0945ET – U.S. MAY MNI CHICAGO REPORT BUSINESS INDEX AT 55.2; EST 57.0 – lowest since Jan 2017

1121ET – CORRECT: U.S. MAY MNI CHICAGO REPORT BUSINESS INDEX AT 59.4 – highest since Nov 2014.

And so stocks are rebounding.

 

Meanwhile, MNI had a complete press release with a full breakdown substantiating the earlier report showing the 4 month lows in the Chicago PMI. Here is the original note.

 

Also quite conveniently, employment has been revised dramatically higher, from 53.7 to 57.1

So “Fake Data” or just more Covfefe?

Chicago PMI went full covfefe

— GreekFire23 (@GreekFire23) May 31, 2017

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A Russian warship and submarine fired four cruise missiles from the eastern Mediterranean at Islamic State targets near the Syrian city of Palmyra, the Defense Ministry said on Wednesday, as reported by CNN and Reuters. The strikes targeted militant ISIS “shelters” east of the ancient city, which housed heavy equipment and militant troops transferred from the Islamic State’s capital of Raqqa.

The strike, which Russian press said was the first of its kind since November,  was carried out by a frigate named “Admiral Essen” and submarine named “Krasnodar. The vessels fired Kalibr cruise missiles on combat vehicles and militants outside the Syrian city of Palmyra, the Defense Ministry said. The four cruise missiles were fired from the eastern Mediterranean, it noted in a statement. The submarine fired its missiles while submerged.

Still image taken from video footage and released by Russia’s Defence Ministry
shows bombs hitting what Russia said were Islamic State targets near Palmyra.

According to the MoD, “[the ships] targeted an area east of Palmyra, where the militants’ heavy weaponry and manpower were located. The militants moved there from Raqqa. All targets were destroyed.”

??????? #??? ?????? ??????????? ????? ??????? ???????? ????? «??????» ?? ???????? ??????????? ???? ? ?????? ???????? http://pic.twitter.com/93ui5jDMUB

— ?????????? ?????? (@mod_russia) May 31, 2017

“The Admiral Essen frigate and Krasnodar submarine of the Russian Navy conducted strikes by four Kalibr cruise missiles on objects of the ISIS terrorist grouping near Palmyra from the eastern part of the Mediterranean Sea,” the Ministry statement said. The statement said the strike “confirmed the high combat readiness of the Russian Navy forces.”

Russia had warned the United States, Turkey and Israel before launching the missiles, the ministry said. It did not say when the strike took place, but Russian news agencies quoted Kremlin spokesman Dmitry Peskov as saying that Defense Minister Sergei Shoigu had personally told President Vladimir Putin about the military action late on Tuesday.

On May 25, a large Islamic State convoy, comprising 39 vehicles and 120 militants, was spotted outside Raqqa, a Defense Ministry source told RIA Novosti on Saturday. “The terrorist convoy of 39 pickup trucks was detected and destroyed by the Air Force on its way to Palmyra,” the source said, adding that the vehicles were equipped with large-caliber machine guns.

The Defense Ministry said it had worked with its partners in plotting the flight path to assure that the missiles traveled only over desolate areas and posed no danger to civilians.

The last time Russia fired Kalibr cruise missiles from its ships at militant targets in Syria was in November last year, the RIA news agency said. The Black Sea Fleet also carried out three cruise missile strikes on terrorist targets in Syria back in August, destroying a command post and munitions production site.

Separately, Reuters adds that photographs published on Wednesday by Turkish bloggers for their online Bosphorus Naval News project showed a Russian Syria-bound ship passing through the Bosphorus carrying a consignment of military trucks.

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