INSIGHTS

Stefano Sciacca

Fri, Mar 20


Vol-of-Vol: When Volatility Is Not Enough

Volatility of volatility is a concept that might seem quite “unconventional” to non-financiers, but it is indeed an extreme case scenario that tends to happen in times of exceptional market distress. We can define vol-of-vol when the VIX, the volatility index on the US Stock Market, experiences steep swings both upwards and downwards. This is of course happening around the index all-time-high of roughly 85 and after having consistently and persistently fluctuated above the 60 level. The “Fear” index, that is how the VIX is commonly called, mirrors markets’ expectations for the next 30 to 90 days. Extreme volatility on the VIX underlines the increased likelihood of an imminent potential black swan like shock on the markets. This has to be of course contextualised with the oil price war, which seems unlikely to be put to an end any time soon, the COVID-19 emergency and the consequent disruptive impact on supply and demand chains and the global trade freeze.

 

The new black swan event is now shaping in the form of a liquidity shock, in times when the major central banks are actually injecting an unprecedented amount of liquidity simply to prevent the boat from sinking. The Federal Reserve recent interventions have been in part ignored by the markets which seemed to be more concerned of liquidating any risky asset to cover losses and a general lack of US Dollars. Given that the majority of worldwide debt has been issued in USD, big corporations and banks have a great majority of their liabilities denominated in USD, whilst they invested that money in property, plant, equipment, working capital and other assets in local currencies. This is the reason why many companies are now facing a great liquidity risk driven by the strong dollar appreciation and an “unbalanced” balance sheet. In the meantime, interest payments have to be met (and they are USD denominated as well) along with top-line growth unlikely to bounce back at least for the next couple of quarters, profitability, margins and earnings will massively affected for the next upcoming months. Companies have already suspended not only outlook and guidance, but also dividend payments and shares buyback programmes. Basically, the main price drivers of what seemed to be an ever-lasting stock market bull cycle are likely to disappear and not come back any time soon.

 

Monetary policy updates, fiscal stimulus, households support measures, mortgage payments waiving are all being price in by these turbulent markets which have not been considerably moving over the past week. After reaching a “bear” market low around 2280, the SP500 has sharply and nervously fluctuated between the 2300 and 2550 level range. What comes next? Sentiment is mixed as it seems quite unlikely that a bottom has already been reached as all major “real” economy-related news flow continues to be very negative. On the other hand, long term projected investors keep buying solid cash flow generating companies which have showed signs of resilience over the past recessions. Recession that seems now as close as never before. Jobs will be lost, middle-class will suffer, housing market will struggle and business investment will massively slow down. The great hope, as many respectable economists suggest, is that this time will be more painful but quicker. The big mistake was to believe we would ever been again in this situation, trying to prevent at any cost a downturn in the economy, especially through debt. Debt is and also will be the real enemy of our society. Debt is what make companies and common people believe they can afford the unaffordable and ultimately leads to collapse. The central banks have fed this “beast” for decades and now we are paying the consequences. My biggest hope is that in the future we will have a currency (or a commodity?) which is independent from any central bank’s decision. I also hope that at some point in our lives we will have central bankers and government leaderships to work together for the best of each country, careless of any financial markets’ developments and purely focused on organic and sustainable real economy growth.

 

Next week our macro spotlight will be on?

 

Monday:

  • Chicago Fed National Activity Index – US
  • Consumer Confidence Flash - Eurozone

 

Tuesday:

  • Jibun PMI – Japan
  • Markit PMI – FR, DE, UK, US, Eurozone
  • Retail Sales – US
  • New Home Sales – US
  • Richmond Manufacturing Index - US

 

Wednesday:

  • Ifo Business Climate – DE
  • Inflation Rate – UK
  • Retail Price Index – UK
  • Durable Goods Orders - US

 

Thursday:

  • GfK Consumer Confidence – DE
  • Loans to Companies & Households – Eurozone
  • BOW Quantitative Easing – UK
  • GDP Q4 - US

 

Friday:

  • Industrial Profit – China
  • Nationwide Housing Prices – UK
  • Personal Income & Spending – US
  • Michigan Consumer Sentiment – US

 

Chart of the week

Fact of the week

 

The ECB just launched 750 Euro worth of Quantitative Easing.


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