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A 2Q Letter


racemize
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Thanks. Interesting read, the volatility stuff especially. Current levels are indeed low and mystifying. Consider this: Every crash or crisis in modern times carried with it higher levels of volatility than the one before it. We'll see what the next one brings, but in my opinion it is foolish to underestimate volatility.

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Wanted to add something that relates to the letter that is of use.

 

http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=tables&key=50&category=8

 

Im not a quant guy by any stretch of the imagination but the VIX over the last 10 years has been higher 99.5% of the time.

The second chart says current margin debt is a bit less than $250M? Doesn't seem like a massive amount versus a market cap of ~$20T, but I guess it's meant more as a measure of underlying bullishness/complacency than as a measure of actual systemic risk.

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Guest Cameron

Wanted to add something that relates to the letter that is of use.

 

http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=tables&key=50&category=8

 

Im not a quant guy by any stretch of the imagination but the VIX over the last 10 years has been higher 99.5% of the time.

The second chart says current margin debt is a bit less than $250M? Doesn't seem like a massive amount versus a market cap of ~$20T, but I guess it's meant more as a measure of underlying bullishness/complacency than as a measure of actual systemic risk.

 

That would be 250B, and thats on the NYSE I don't have the NASDAQ numbers

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Guest Cameron

This might be a better chart to look at.

This is in billions and is current margin debt on the NYSE.

 

An interesting viewpoint you'll notice that the chart is flat until an uptick in the late 1980s then falls then picks up in 1994-1995.

This is around the time quant funds became popularized, renaissance technologies, Citadel, DE Shaw etc.

 

Also the first ETF the S&P SPDR started in 1993.

 

The second chart is the best one I can find right now, looks like it correlates slightly or maybe its confirmation bias.  :-\

Screenshot_from_2017-07-30_23-18-06.png.82671d597be50cb7d1876d3cc77a31e3.png

us-equity-flows-etfs-mutual-funds_10-years_2007-to-2017.jpg.aaf0f6e7c32b65b409fdee8b17ad4722.jpg

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That would be 250B, and thats on the NYSE I don't have the NASDAQ numbers

Sorry, that's what I meant. Still doesn't seem like a huge percentage to me. As you point out, a good chunk of this is likely hedge funds. If a fund like Greenlight is 120% long and 100% short I don't see that as being as systemically dangerous as being say 220% long which is what people may infer from the chart. Having said that, I do agree that the lack of volatility can lull people into a sense of complacency and a perception of less risk.

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Guest Cameron

That would be 250B, and thats on the NYSE I don't have the NASDAQ numbers

Sorry, that's what I meant. Still doesn't seem like a huge percentage to me. As you point out, a good chunk of this is likely hedge funds. If a fund like Greenlight is 120% long and 100% short I don't see that as being as systemically dangerous as being say 220% long which is what people may infer from the chart. Having said that, I do agree that the lack of volatility can lull people into a sense of complacency and a perception of less risk.

 

While 250B does seem like a low number, and I am not to sure how the NYSE gets their specific numbers so we could only be seeing a part of the story. What you can infer from the chart is that before the tech and housing crisis you saw a quick acceleration in margin debt. Today we have reached those same levels (and gone higher) yet with a more gradual pace that has happened over the last 8 years. I would assume this is what Mooney means by complacency.

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I would submit that we should look also at graphs that show margin debt as a % of GDP.

Graphs are less impressive/scary but this specific variable certainly points to some complacency.

Thank you for the letter.

I am mystified too by the extremely low levels of volatility.

However (only a personal/subjective opinion), I find it presently feels like when one stands in the eye of a hurricane/tornado.

I worry about rogue winds.

I'll stay in the basement for a while.

 

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Guest Cameron

I would submit that we should look also at graphs that show margin debt as a % of GDP.

Graphs are less impressive/scary but this specific variable certainly points to some complacency.

Thank you for the letter.

I am mystified too by the extremely low levels of volatility.

However (only a personal/subjective opinion), I find it presently feels like when one stands in the eye of a hurricane/tornado.

I worry about rogue winds.

I'll stay in the basement for a while.

 

Its at 1999-2001 2007-2008 highs

Screenshot_from_2017-07-31_08-31-42.png.a5795809d39ee1c4497cde9023a442c5.png

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Add to this that > 50% of the market is driven by trading algorithm, and that most of the algo's will have fairly similar rule sets (everybody copies). As they all buy/sell largely the same universe, at the same time - a bet against the market, is a bet that one of these algos fails (triggering a run) as market complexity keeps compounding.

 

A bet on a systemic collapse, driving at least one or two players to fall onto the 'too big to fail' safety net. A DB, or HCG, all over again.

The only question is whether the dice are weighted or not, and in what direction.

 

Feeling lucky?

 

SD   

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Regarding margin, I think it is more a signal as to what people are doing as opposed to a systemic risk in and of itself. As an example, I saw this on Seeking Alpha recently.

 

https://seekingalpha.com/instablog/8508161-edward-frost/4899379-make-money-shorting-options-every-month

 

Basically, he is shorting very short term, out of the money index options using contracts for difference to increase the leverage. That's like picking up nickels in front of a steamroller, where you've attached a booster rocket to the steamroller.

 

Maybe people are always like that, but that level of greed/reach for yield and lack of risk aversion seems like a bad sign to me...

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Guest Cameron

 

 

Maybe people are always like that, but that level of greed/reach for yield and lack of risk aversion seems like a bad sign to me...

 

This relates to the large amount of inflows to ETFs, for vol. to stay low the pace of inflows has to keep up so you have this gradual buying up, if inflows grow but at less of the pace they are at now since people may be moving large amounts of money since they discovered index investing, you would see vol. pick up leading to selling from the algo's which would lead to more selling by ETFs then algos and so on I could be wrong but I think thats what Mooney was talking about.

 

Speaking on greed for yield, I would argue that we may not have not have euphoria in the market but there might be some euphoria over ETFs SPY index fund is getting billions of dollars a day in inflows while at market highs because people may not be accessing the risk, rather they feel safe because they are buying the whole index 

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