Artemis Capital, which 3 months ago brought us "The Great Vega Short – Volatility, Tail Risk, And Sleeping Elephants" which has so far predicted the volatility regime in the new "centrally planned" normal to the dot is out with a new must read report: "Is Volatility Broken? Normalcy Bias and Abnormal Variance" analyzing the fascinating phenomenon of Negative Panic and how it translate into Negative Volatility.Here's the PDF.
As Artemis notes: "The regime resembles a more extreme version of the volatility curves experienced between 2006 and early 2007 prior to the onset of the credit crisis. The new paradigm of volatility officially began after the May 2010 Flash Crash but the most extreme changes have coincided with announcement of the Fed's second quantitative easing program in late-August." What does this mean for capital markets in the new normal: the stunning conclusion: "As the economic recovery has taken hold many people are cheering a return to normalcy, hence driving spot volatility lower even as many systematic risks remain unaddressed.
The optimistic case for markets going forward is supported by improvements in the labor market, much higher asset prices, and the best corporate profits in a century... but something just doesn't feel right. The steep volatility curve and high skews are a reflection of this unease. In the end it is hard to come to terms with this sense of normalcy while looking at some very abnormal facts. For example, is it normal for the US to pass China as the largest holder of its own debt? Is it normal for the Federal Reserve to purchase an estimated 70% of the new supply of that debt5?
How can inflation be normal when a broad cross-section of food and commodities appreciate 23% in only six months?6 Or when global inflation contributes to violent protests, revolutions, and war that spread across the Middle East and Northern Africa causing oil price shocks? Can we say it is normal when the European Union bails out its third member nation in under a year? Or when the Swiss Franc appreciates nearly +30% against the USD in only nine months, cancelling out a +27% gain in the Dow Jones Industrial Index from currency devaluation alone? Why is it so easy for markets to return to normal after a massive disaster in Japan threatens the financial viability of the world's third largest economy and purchaser of US debt?....MORE, including the 10-page paper in Scribd format.
Tuesday, April 12, 2011
"Must Read: Is Volatility Broken? Normalcy Bias And Abnormal Variance" (VIX; VXX; TVIX)