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Volatility Schmalatility and ContraryInvestor: Cycle Logical Issues?



February 02, 2010 – Comments (4)

Here is another excellent post by ContraryInvestor. I agree with their volatility assessment (I think it will be going up *a lot* this next year. Even if we get a trading range and not a crash, I think it will be a very volatile one). Hence my VXX pick in Caps today (I was waiting for an ending move on the VIX with a breakout and then buy the pullback, which is what we are getting today).

Here is my take on the VIX, from Volatility Schmalatility

Yep, the VIX is a squirrely beast indeed (are squirrels technically beasts? Rabbits certainly are, just see Monty Python and the Holy Grail for proof). Lots of break outs and breakdowns. Tales of angst and woe ... yet hope remains ... for more volatility?

Anyways, that's what I think. Volatility has been drawing inexorably down for over a year, just as the market has been inexorably rising the last 9 months. Yet, I don't think that trend will continue. In fact I expect it to rise pretty dramatically in the not-too-distant future.

The VIX was be putting on some serious positive divergence for a while, and I think the spike down a few weeks ago (while still maintaining positive divergence) was the end of the move. Here are my three longer term VIX charts:




Next is the ContraryInvestor Article


ContraryInvestor - Feb 2010


Cycle Logical Issues?

One of the early year themes we have been discussing on our subscriber site has been our expectation for an increase in market volatility.  Probably about three weeks back we wrote, “Unlike the consensus and big Street houses which have been predicting/expecting falling volatility in 2010 after an already accomplished death defying drop in volatility during 2009, we’re not so sure shorting volatility is such a wonderful investment idea right here.  Although we could be dead wrong, we believe 2010 will present us with a great opportunity to buy volatility.  We could be very close right now.”  We’re not reprinting this to proverbially pat ourselves on the back as the year is still very young.  Secondly, anyone spending time patting themselves on the back in this business are usually about 15 seconds away from having the proverbial rug pulled out from under them.  Anything can happen, so judgment is reserved for now as we’ll just have to see what happens on the financial market front as we move forward.  We think an increase in volatility is in store not only for the financial markets, but also in a much broader context we’d like to discuss in this missive.  We want to quickly talk about another type of volatility – economic volatility.  And we want to take a look at the long term in the hope that perhaps we can “see” the future more clearly.  Here’s the question that may indeed morph into an investment theme for 2010 and beyond that we’d like to pose.  Looking ahead, will the US economy be more or less volatile than we have experienced over what is close to the last thirty years?  Yes or no?  If indeed were are anywhere even close to the mark regarding our thoughts that economic volatility will increase, then that has direct and meaningful implications for equity and broader business valuations.  Let’s start digging through some facts.

Nothing like starting off with a visual, now is there?  In many a case, pictures can help clarify.  In the top clip below is an update of a chart we have shown you so many times you know it by heart – total credit market debt as a percentage of GDP.  And yes, in 2Q of last year we sat at a high never seen before in US history, about 125% above the ratio seen in December…of 1929.  The bottom clip is the very simple year over year rate of change in real GDP updated through 4Q 2009.   The issue is that from the early 1950’s (the earliest of official Fed data) through to the early 1980’s, the US economy was a whole heck of a lot more volatile than has been the case since (until recently, of course).  Economic rate of change highs and lows from the fifties through the seventies was a lot broader than has been the case subsequent.  We often hear a lot of folks explain this away as the US transforming itself from an industrial to a service based economy.  Less manufacturing dependence has meant less overall economic volatility, etc.  We've transferred the cyclical inventory and manufacturing swings offshore, right?  We’re sure you’ve heard the logic many a time.  But is that really the case?  Is it really just a function of domestic economic evolution, or is there something else going on here that ties right back into the keynote issue of the current economic and financial market cycle - credit?

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4 Comments – Post Your Own

#1) On February 02, 2010 at 8:51 PM, ChrisGraley (28.51) wrote:

You seem to be on the same page as anticitrade today binve!

his post

All I can say is Groundhog day Schmoundhog day! 

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#2) On February 02, 2010 at 9:10 PM, russiangambit (28.71) wrote:

Yes, US is determined to repeat all the Japanese mistakes only we are starting  from aa worse position.

It appears to me that so far the market don't beleive that FED will stop printing in March, otherwise it is hard to explain no reaction when we are so close to March.

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#3) On February 02, 2010 at 10:10 PM, binve (< 20) wrote:


All I can say is Groundhog day Schmoundhog day!

LOL! Thanks man :)


Yes, US is determined to repeat all the Japanese mistakes only we are starting  from aa worse position.

Amen to that. And the fact that those of us who point that fact out are thought of as crack pots just hammers home the snow job that the Treasury and Fed have performed

Thanks man!..

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#4) On February 03, 2010 at 10:35 AM, binve (< 20) wrote:

I don't know if anybody besides russian read the link to the ContraryInvestor article. You should, it is a *superb* analysis. Check out this passage (emphasis mine):

On average, US economic expansions from the early 1980’s to the current cycle have been twice as long as what was seen in the prior three decade period.  Again, was this due to the ascendance of the service economy, or was this being driven by virtually consistent acceleration in the macro US credit cycle?  You’ll remember that when we discussed the components of US final demand (a key analytical point for 2010) last year, we told you that the commonality in all economic recoveries/expansions historically has been the expression of pent up demand for housing, auto’s and an acceleration in consumer credit.  And wouldn’t you know it, all three relate to credit expansion in the macro.  If the prior cycle of maniacal mortgage credit expansion and it’s direct and significant impact on macro economic outcomes does not reinforce this conceptual thinking, we just don’t know what will.

So the important thematic question becomes, in the assumed absence of significant acceleration in the US credit cycle ahead as both households and corporations continue to delever, will the forward rhythm of US GDP become more volatile, perhaps as was the case from 1950 through the early 1980’s?  Will we experience higher rate of change highs and lower lows than has been seen since the early 1980’s?  Although this is a question no one can answer with any type of certainty at this point, we believe it’s very worthy of consideration and benchmarking as we move forward for if we are anywhere even near being on the right track with this thinking then increased economic volatility ahead will absolutely influence future investment outcomes, primarily valuations.  Referring back to the bottom clip of the first chart, the depth of the real GDP rate of change low in the current cycle looks much more like experience of the US economy from 1950-82.   An early marker of character change?  We'll see.

And as crazy as this may sound, we are now on the cusp of upside real GDP rate of change that could easily bring us back toward the top end of the prior range pretty darn fast do to comping against prior year disaster quarters.  But very importantly please remember that inventory rebuilds do not economic recoveries make.  Sustainable economic recoveries are driven by growth in final demand, and so far any meaningful upturn in final demand remains wildly tepid at best.  We suggest you keep an eye on the tone of real final sales.  Why?  It excludes inventories.  As the chart below shows us, as of 4Q 2009, year over year final sales are flat.

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