MorningWord 1/25/16: Vol Around the World

by Dan January 25, 2016 9:35 am • Commentary

Your guess is as good as mine how the U.S. Fed crafts their message about monetary policy this week. I do assume that the reaction in U.S. markets will be volatile. The SPY at the money straddle is offered at almost 2.25% of the underlying etf price ($190), if you bought that, and thus the implied weekly move, then you would need a 2.25%, or about $4.25 move in either direction to just break-even, that is more than double the one year average implied weekly move over the last year. A few months ago savvy options traders would be chomping at the bit to sell that weekly implied move. But with multiple multi-percent intra-day moves over the last few weeks, volatility assumptions have changed.

from Bloomberg
from Bloomberg

Last month the Fed hiked rates for the first time in 9 years. It was partly meant as a sign of confidence in the health of our economy. Now there are clues that the Fed may backtrack too quickly. That could have the exact opposite effect on investor sentiment. Despite the improvement in employment data the last few months in the U.S., it’s unlikely our economy could decouple from a massive debt deleveraging cycle in emerging markets, that has weakened global growth and exported deflationary forces. But who knows? Maybe China is NOT experiencing a hard landing. And maybe low commodity prices are the very thing that finally allows for a reflation of global growth (from what looks to be under 2% in almost every country on the planet (ex-China of course)).

The “Fed Put” during the QE and ZIRP period was vol dampening, as it was mainly intended to focus on our economy, and our risk assets. While they were in place, the only real bouts of volatility came from abroad, European Sovereign Debt Crisis and global growth scares, largely China. We had the occasional self inflicted wounds from time to time with congressional budget negotiations nearly turning into credit defaults but markets ultimately shrugged them off as the political embarrassment made it less likely we’d see the same in the future.

The main point is that since the end of QE (in Q4 2014), and ZIRP (last month) we have seen our markets without the training wheels. And that has resulted in increasingly frequent periods of risk asset volatility.

Again I have not clue whether the Fed is right on their timing, but one thing is for certain; the current market volatility is NOT simply imported from overseas. Much of this started after the end of QE. The end of QE produced  a ramp of the dollar and an implosion of industrial commodities. We can’t de-couple from weak growth overseas, because we’re connected to it and contributing to it.  Yeah, yeah only a few percent of S&P earnings come from China, but nearly 50% come from outside the U.S..

Dollar strength has not been a friend to U.S. corporate earnings and I am hard-pressed to see it weakening a whole heck of a lot without the Fed doing an absolute about-face on monetary policy. And if they do that, the dollar may go down, but so will everything else.

I remind you of what I feel will unfortunately be a fairly prescient warning from the WSJ’s John Hilsenrath on August 17th, 2015:


And that brings me to U.S. corporate earnings.  I suspect we see wildly divergent results in the energy & commodity sectors (e.g. AA & SLB) continued skepticism about earnings and sales growth for rate sensitive companies like we saw last week in the banks (e.g. BAC, C, JPM), poor visibility and squishy guidance from industrials and cyclical tech with heavy exposure to emerging markets and the strength of the dollar (e.g. CAT, DE, INTC) and crowding in yielders that put up solid results (e.g. VZ).  Beat up sectors like retail, consumer discretionary, autos, homebuilders etc could see relief bounces from an oversold condition in the broad market, but uncertain forward guidance is not likely to be viewed as a buying opportunity as long as the macro is dominating headlines.