Saturday, February 18, 2017

The Big Long: Musical Chairs With Capital

"While the music is playing, you've got to get up and dance"
- Chuck Prince, Citigroup CEO, 2007

Low volatility has been conflated with low risk. As it was in Y2K, the dumb money outperformed right up until the implosion...

The trickle away from stock pickers and toward indexes has turned into a flood, with more than half a trillion dollars heading into passive funds over the past 12 months

"The tidal wave is showing no signs of stopping, threatening all but a select few and making active investing a dangerous ocean to swim in."

It's now considered 'dangerous' to manage risk. Because volatility compression algorithms are giving the delusion of low risk:

"The more money you put in, the lower the risk"

We can thank Skynet in conjunction with Central Banks for systematically obliterating all hedging strategies. Global CBs ex-U.S. offer unlimited carry capital for leveraged momentum trades. It all works great in one direction, and then unwinds instantaneously on the way out. 

Financial managers play the game because they have no (career) choice. Compliments of imported 0% poverty capital, zero sum speculation is the new "yield", until it's not. Musical chairs for capital, wherein all of the chairs get taken away at the exact same time. Temporary paper profit is chosen at the expense of long-term capital preservation. 

Hedging is the worst of all possible career options - right up until the nano-second when the machines decide that it's no longer even an option. And then those who have a timeline longer than the current bonus cycle will realize that they just got monetized again. Their capital was merely a flash in someone else's P&L.

Speaking of volatility versus risk...

Rest of the world with VIX:

Risk exposure (black line) versus Index hedging (CPCI):