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Minyan Mailbag: What's the Breaking Point?

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...intervention is staving off market forces creating an illusion of calm.

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Prof. Succo-

I write this because I have read the comments on Minyanville regarding the macro climate and risk profiles and find myself in complete agreement.


I have been trading option volatility in the futures markets for a long time now. Over the course of the past 7 years I have managed to make some good coin shorting equity vol (via the S&P 500 futures) when volatility spiked upwards. I hedge when required and always cut my positions when volatility flattens.

Well, during the market lift yesterday and continuing this morning I have completely switched my position to a small net long vol on equities for the first time in a long time. The macro situation is the scariest and the most complacent I have ever seen. I am beginning to think that the only question is what particular event will break the back of equities. Key worries? The list is long. The trade deficit, pending housing slowdown, overextended credit, low savings rate, bird flu, Iran, Iraq, terrorism, etc, etc, etc. We may or may not have a serious plunge in equities, but anyone who looks closely at the risk profile has to be concerned.

Cheers,

Minyan Robert


Minyan Robert,

I view this as correct thinking.

The risk/reward, risk premiums, compression…however you want to look at it relative to the macro situation is astounding. I believe the low volatility in the face of it is due to the immense liquidity being provided; in other words, massive intervention by central banks and governments.

This intervention is staving off market forces creating an illusion of calm. Low volatility, just like high asset prices, encourages investors to take more risk, an essential ingredient in keeping credit expanding. Of course I believe this only delays and worsens the inevitable market reaction. We have labeled this "compression."

The lessons of the fall of the Soviet economy, a socialist system of resource allocation, have been lost on nearly everyone.

-Succo
No positions in stocks mentioned.

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