1/13/11…all about the vol

…not the Tennessee Vols, but volatility. Perhaps you noticed today that Goldamn Sachs is projecting an 18% return for the S&P 500 for this year and on Monday said VIX volatility will hover between 16 and the low 20‘s for all of 2011. This is of course the same firm who put in a selling memorandum to wealthy investors buying $450 million ($2 million minimum) of Facebook stock that they reserve the right to sell, hedge, or short their own $50 million position at any time showing they learned from shorting an offering of CMB after they were dragged before Congress. Taking all these events together TB would suspect that Goldamn is going to short the SPX. Time will tell.

Volatility is a word bantied about and people nod, grmace, shake their heads even though few understand it…including TB. But volatility is as misused as ‘average’ in statistics since there in not just one but mean (which is most often used) and a median (the midpoint), and the mode (most often occurrence). Yet the median and mean are used interchangeably without explanation. For instance, the wealth gap has been concealed by using average (mean) income rather than the median which is way below the mean in the U.S.

If a number is truly random, which of course incomes aren’t, over a very large number of occurrences, the median and mean converge.

For a modal distribution however there can be a wide range of results, hence the bell-shaped curve that is used in statistics. This introduces the concept of ‘risk’ of being right or wrong. Approximately 68% of the risk of an event can be explained within two standard deviations of the mean and that is where volatility comes into play. But volatility (risk) can be measured in many ways and what we have been discussing is historical or realized volatility. This is not good enough for investment (especially speculative) purposes as the time horizon is too short so traders use a moving average of volatility so they can monitor the short term moves (the VIX (S&P 500 volatility) uses the implied volatilities of a wide number of strike prices on options contracts in the first and second month prior to expiration then roll out 8 days before expiration. Of course, shrewd traders can thus ‘game’ the trade. So this introduces ‘volatility on volatility’ to see how much of the risk is explainable. One would expect the two to come together just as an option converges with the spot price at maturity…but not always or exactly.

Which brings us back to the low level of volatility we are experiencing currently (in stocks, in bonds it is high), by any historical measure.

Just as TB has pointed to the large moves in stocks on below average volume, volatility is at historical lows and for a prolonged period of time…this in the middle of the greatest sovereign debt crisis in history? As Mork would say: “that does not compute.”

TB is now going to stop trying to explain this complexity and refer to an article sent to him by a friend (Here is the link: The Great Vega Short). It was from the Fourth Quarter 2010 client letter of Artemis Capital Management LLC and was written by Christopher R. Cole, managing partner. TB was so impressed by this article, yet he only understood about 60% of it that he forwarded it so some friends last night asking for comment and called Chris Cole who politely returned the call and we had an interesting discussion. TB was impressed.

TB asked for and received permission to discuss the article and here are some key points, the rest you will have to glean from the report which if you are a serious investor it would behoove you to do.

  • Who is the biggest holder of U.S. treasuries? Until the lat 1980’s that would have been the U.K., which was replaced by Japan until a couple of years ago when China donned that mantle. But is China still number one? No! It has been replaced, thanks to the combined bailout and now QE2 (TB’s apologies to the Cunard Line, by the Federal Reserve with $1.2 trillion!
  • The market registered some of the largest drawdowns in the history of S&P 500 realized vol dating back to 1950!!!
  • While stock volatility is low, the spread between the VIX index and 21 day realized volatility (and respective volatility of volatility, VOV) is at the widest levels in history!
  • The differential between S&P 500 realized volatility and 10-year US treasury % yield volatility is at the LOWEST level in history
  • An incredible 7 of the largest 50 (yield increases) in 10-year UST yields (as a percentage) since 1962 occurred in Q4 2010!!!

Cole also refers to a Washington Post op-ed piece from November 4 in the Washington Post in which Bernanke explicity stated that higher equity prices were at the forefont of the quantitative easing program. Why? To boost consumer wealth and help increase confidence and thus consumption. Wait a minute? If we are coming off the worst financial crisis in history caused by massive debt both public and private and we have a ‘true’ unemployment rate of about 17%, shouldn’t the focus be on rebuilding personal balance sheets? …especially since those most affected are nearing or at retirement age? Not according to the Fed and the number one rule is: don’t fight the Fed. They, after all, are the house!

But wait a minute…another prong of QE2 was to, despite massive issuance of bonds, keep interest rates low so as NOT to spook investors and ultimately the stock market? Well, we decide to fight the Fed there in the inexplicable implosion of bond prices that began last October following the short, sharp rally on the announcement of QE2..guess it is OK to fight the Fed on that despite the fact that the US is arguably in the best condition of the industrialized sovereign nations.

Cole compares this to writng a ‘naked’ put to collect the premium but then placing yourself at limitless risk as the Fed is continuing to do this and amplifying it. But the Fed is not the ultimate source of repayment: you are, you, the taxpayers of the U.S.

In our conversation he said he has had numerous conversations with other hedge fund managers who cannot explain this phenomonen either (another rally yesterday ant eh 3rd straight session of about 950 million shares or about 100 million below average of the last 12 mos).

In the words of a prior chief investment officer of a company TB worked for, and had declining respect for, “I never met a rally I didn’t like.” That statement cost him and our company a great year. Do you want to be like him or ask “why is the market this strong?” Cole, and TB say, we could be in for a longer rally but you had better be prepared for a major correction (ties into TB’s theme of a secular bear market). One month does not a year’s performance make. Interestingly enough TB read this morning where some hedge funds see a correction on or about January 31st. Are you ready if it does come?

Sorry this is so long and TB hopes you will go to the link which thanks to charts and two wonderful analogies makes it fall into place.

. . . - - - . . .    . . . - - - . . . (S.O.S.)

Morphing: Goldamn to Treasury to Citi (as with Bob Rubin).

Rubin who repeatedly told us of how smart he was in bonds and how in 10 years he made $100 million of course created the mess we are in (along with cohort Larry Summers), convincing both Clinton, and a GOP Congress that needed little or no convincing that Glass-Steagall, which had served us well for more than half a century must go (that fact made evident to them by Reagan embracing Contintental and taking moral hazard to an even higher level). Of course, Rubin went on to his buddy’s (Sandy Weill) Citigroup and made nearly the same amount in two years and when the merry-go-round stopped, he said he had no idea they had so much risk. Bull-pucky! He also said he didn’t understand these types of investments…of course he didn’t attend meetings and several people from Citi that TB talked with told him that he harangued them that they weren’t taking enough risk…be like Goldamn, which ironically is opposite to what eventually happened when Goldie had to be bailed out and became a bank.

A Bloomberg article yesterday exposed how the chief enforcement officer at the SEC cut a deal with Citi, after dinner with a close personal friend who also happened to represent Citi. The fine sounds big to most people but it was a pittance…also, despite it being obvious that both Prince and Rubin concealed the mounting losses at the bank, they were left out of the settlement, only two lesser officers were fined – without admitting guilt. Here is the link…don’t read on an empty stomach!


Lastly, TB watched to last night’s memorial service which began more like a pep rally (weird), included the strangest invocation TB has ever heard, and ended with Obama showing true leadership (of course the FOX pundits compared it to the length of speeches following Oklahoma City and 9/11). Eloquently, Obama expressed what TB has tried to do this week, as opposed to both Limbaugh’s and Palin’s attempts at vindication by blasting the extreme right…both are loose cannons and lack gravitas…totally. Their time has passed…hopefully. We need leaders!

It wasn’t the shooting however that was caused by the rancor, but it did raise the thing nobody in politics has been willing to come out against: the declining standards of getting one’s point across. Note too that it was a New York Republican who proposed making it illegal to carry a gun within 1,000 feet of an elected official…how would you know where they were? Are we going to search everyone? Meanwhile sales of Glock’s in Arizona have gone to the moon in anticipation of a ban…ah, that’s the ticker, more guns! But gun control is not the answer…it is far too late for that.

But it is not too late to retake civility. Ratchet down the rhetoric…convince people of your point not ram it down their throats and try to fire them up to act out. When did a discussion become trying to outshout your opponent or his/her audience?

Have a great day!


Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries...as he sees it...and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Copyright TBD Capital LLC, January 13, 2011.


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