MorningWord 11/12/15: Not A Zero-Sum Game

by Dan November 12, 2015 9:46 am • Commentary

In August, fears of systemic financial risk briefly roiled our equity markets. That was the first time those fears had bubbled up since 2011. Since then, central banks globally have at least talked the talk of accommodation, with some additional easing. And as we’ve seen with the central bank put for years now, the dip in equities was bought.

The table below (from Bloomberg) shows implied volatility (blue dot) of almost every major developed equity index. Most are ticking up above the one year average (orange dot). That makes sense when you consider two massive central bank meetings in the next month (ECB Dec 3rd and FOMC Dec 16th and one smaller one (from the BOJ on Nov 19th):


This summer’s volatility shock is likely to keep equity vol bid above pre-swoon levels, so the data above is not meant to be predictive, merely to suggest that as we head into 2016, the first year since 2008 that the daily effective rate was at least 25 bps, that we could be headed for a higher volatility environment.

For those who have been actively trading equities in 2015, you know that apart from the Aug/Sept swoon, index volatility was a real sleeper. But single stock volatility could be extreme with investors giving up quickly on secotr after sector while crowding into a narrower and narrower group of large cap tech stocks. Causing massive market cap gain gaps on the slightest bit of good news.  Make no mistake, this behavior is troubling.

The obvious example is Amazon (AMZN) gaining more than $100 billion in market cap this year alone, while stocks like Macy’s, Kohl’s, Whole Foods, Dillards and Walmart have lost between 30 and 40% of their value.  This can’t be a zero sum game where the prior groups losses are solely AMZN’s gain, yet the market is pricing it this way.  This relationship can go on for longer than one would think, but at some point in the not so distant future this fairly tale like all will come to an end. This is not me making a case for bricks and mortars retail, the secular shift in consumer trends towards online shopping has been going on since AMZN’s start nearly two decades ago, but you are telling me 2015 was the year that it all changed??  I don’t buy it, so for those that think that AMZN’s market valuation can grow to the sky, buyer beware.  To be fair I might have and probably wrote similar sentiment at any point in 2015, but crowding into a stock like AMZN is just not my thing.

I also want to draw your attention to some other hate selling, and one name in particular, Glencore, in the energy sector. This is probably the one company on the planet that investors feel a collapse could cause shock-waves in the commodity and credit markets. The stock is down 12% in England this morning placing it below important psychological support at 100 gpb for the first time in a month, now down 67% on the year:

Glencore PLC 1yr chart from Bloomberg
Glencore PLC 1yr chart from Bloomberg

And here in the U.S. the Valeant Pharma (VRX) saga which does not pose any real systemic risk other than the potential crisis in confidence that investors were so scarred during the financial crisis, and the unknowable adverse snowball effects of large hedge funds seeing values of large concentrated positions massively written down in short periods of time.  VRX has lost 70% from its highs this year, and white knight scenarios appear to be scarce as the story gets dirtier and dirtier by the day (not just speaking to the price action):

VRX five year chart from Bloomberg.
VRX five year chart from Bloomberg

And lastly SunEdison (SUNE), a stock that has been a hedge fund hotel.  A who’s who of fancy hedge fund holders who have seen the stock decline 85% from its all time highs in July.

from Bloomberg
from Bloomberg

At a time when the global equity footing feels precarious at best, with the backdrop of a surging dollar, investor crowding into a handful of universally loved stocks (AMZN, FB & GOOGL), in a challenging return environment with other large stocks and sectors blowing up or rolling over (energy, commodities, solar, biotech, most U.S. retail and lots in tech) seems like a less than attractive environment to commit new capital to global equities.