These are extraordinary times with great uncertainty for everyone. We hope that our Inside Volatility Newsletter provides you with useful insights and historical context to help you navigate this difficult period.

On a personal note, we would like to express our gratitude to our amazing health care workers. These people are heroes. Period. End of story. They go to work and have no idea what’s in front of them. They are willing to put their work, caring for those impacted by COVID-19 and other ailments, ahead of everything else. THANK YOU ALL!


Sign, sign
Everywhere a sign
Blocking out the scenery
Breaking my mind
Do this, don’t do that
Can’t you read the sign?

Source: Five Man Electrical Band

The financial and global health systems are giving us quite a few signs lately. Most of them are very concerning. One of the most frequently referenced is the research and visual that the Johns Hopkins research center put out about global cases of COVID-19.

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Source: CSSE @ Johns Hopkins

Coronavirus has been spreading across the globe with responses varying from nation to nation. The economic impact won’t be apparent for quite some time, but growth expectations have shifted dramatically for the foreseeable future. Consequently, risk has been repriced across virtually all asset classes.

On the basis of (nominal) GDP, China ($14.14 trillion) has the second largest economy in the world behind only the United States ($21.44 trillion). Last week analysts at Goldman Sachs slashed their forecast for Chinese growth to a negative 9% in Q1 from previous estimates for 2.5% growth. Goldman also cut their forecast for U.S. GDP growth to 0% from previous expectations for +0.7%. Jan Hatzius, the firm’s chief economist, calls for a 5% contraction in Q2 for the US.

The exogenous shock introduced by coronavirus is playing out in real time with widespread ramifications. The signs are quite literally everywhere.

In capital markets the signals have grown to a cacophony of concern. The S&P 500® declined from an all-time closing high of 3386.15 on February 19 to 2280.52 on March 18. That’s a 32.6% move in the global benchmark for equity markets in less than a month.

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Source: Bloomberg

Here’s a look at the front month VIX® futures contract (rolling) since they were introduced in 2004. The recent move speaks for itself. The lead month futures traded to their highest level on record and March (2020) was the highest futures settlement value ever at 69.74.

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Source: Bloomberg

On March 18, 2020 the VIX® Index hit a new all-time closing high at 82.69. The intraday highs from October 24, 2008 (89.53) have yet to be breached. On that session more than 11 years ago, the Index closed at 79.13. A VIX® Index measuring ~80 means that 1 month SPX options are pricing in expected daily (close-over-close) moves of +/-5%.

The three trading sessions between Thursday, March 12 and Monday, March 16 made the VIX® Index appear “relatively low” despite the significant move higher. On the 12th the S&P 500 declined by 9.51%. On the 13th, markets reversed course and jumped 9.29%. The massive oscillations continued on Monday with an 11.98% slump. The last time the large-cap index experienced three consecutive +/-9% moves was in 1929.

One could argue that the long-term relationship between gold and silver values is indicative of financial uncertainty, or the lack thereof within the global economy. The chart below comes from MacroTrends and illustrates the historic premium the market is putting on gold relative to silver. At present, it takes about 122 ounces of silver to buy 1 ounce of gold (reference: silver ~12.25 and gold ~1500).

Gold has been outperforming silver for nearly nine years. On Easter Sunday of 2011 (futures reopen Sunday evening) the gold to silver ratio declined to 31.60 which was the narrowest the spread had been in decades. Silver had been outperforming as commodities generally exploded higher in the wake of the Arab Spring (early 2011).

Gold tends to outperform during times of crisis. As fears of a global pandemic have spread in recent weeks the spread between gold and silver has blown out to historic wides.

Historical inflection points:

Year

Event

Gold-Silver Ratio

VIX

1941 (Spring)

US involvement in WWII begins

97.3

n/a

1991 (Feb)

US involvement in Iraq/Kuwait (Operation Desert Storm)

99.5

36.20

2003 (Mar/Apr)

US begins bombing Iraq in escalation on global War on Terror

76.3

35.10

2008 (Oct)

Zenith of Global Financial Crisis

77.1

80

2020 (Mar)

COVID-19 spreads; Concern about Global economic slowdown / Recession / Depression

122**

82.69*

 

* March 16: All-time closing high
** Unprecedented

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Source: MacroTrends

Further “signs” of economic concern:

  • Natural gas plummeted to 24 year lows.
  • Crude oil (WTI) is at 18 year lows.
  • Gasoline futures at lowest levels since shortly after September 11, 2001.
  • The British Pound is at levels last traded in March of 1985. That’s before the Plaza Accord (September 1985).
  • The US Dollar Index, which is a weighted measurement of the value of the USD versus a basket of major foreign currencies, is at levels last seen in 2002. There’s concern about a global shortage of dollars.

The graph below outlines the relative weightings of the other major foreign currencies in the “basket” that makes up the Dollar Index (DXY). Translation: if DXY is moving higher, the Euro (EUR) is almost certainly weakening and vice versa. 

Currency

Percent

Euro (EUR)

57.6

Japanese Yen (JPY)

13.6

Pound Sterling (GBP)

11.9

Canadian Dollar (CAD)

9.1

Swedish Krona (SEK)

4.2

Swiss Franc (CHF)

3.6

Keep in mind, much global trade, many loans, and all major commodities are USD denominated. Generally speaking, a stronger US Dollar puts pressure on (Dollar denominated) commodities. The Fed announced a coordinated effort, alongside other major central banks, to enhance “swap line effectiveness” – which may alleviate the ongoing USD funding issues.

This market dynamic is arguably worth watching. 

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Source: Bloomberg

Unsurprisingly, the Goldman Sachs Commodities Index reached its lowest levels since December of 2003 last week.

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One more sign: The Federal Reserve Bank of New York uses a model that takes “the slope of the yield curve, or ‘term spread,’ to calculate the probability of a recession in the United States 12 months ahead.” This is yet another example of the potential importance of term structure (alongside the VIX® Index and other commodities). The Fed looks at the difference between the 10-year yield and the rate of 3-month Treasury notes. This data is lagging and may likely move higher in short order.

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It’s difficult to imagine a scenario where the global economy quickly returns to something resembling “normal.” Since the 2007/2008 crisis, with the exception of summer and early fall of 2011, investors and traders have grown accustomed to fairly shallow pullbacks in equity markets. In hindsight (much easier that way), every one of those selloffs was an example of volatility being the source of future returns.

The current “risk-off” trade has been unique in terms of its velocity and the amount of opacity about the future. Time will tell whether March 18 or some day in the not too distant future becomes an inflection point. There was a quarterly expiration last Friday which was precipitated by the largest open interest in SPX options ever.

Overall, the “signs” have been mostly disheartening, but as Thomas Fuller and optimists say “it’s often darkest before the dawn.”

Curious about what happened throughout history on March 24?

  • 1630: Roger Williams is granted a charter to colonize Rhode Island

  • 1860: Andrew Jackson (the ship, not the 7th US President) set a record by sailing from New York City to San Francisco (around Cape Horn) in 90 days. Set sail Christmas Day 1859 and arrived March 24, 1860.Note, average flight time (2019) for a trip from NYC to SF today is five hours and 43 minutes.

  • 1883: First ever telephone call between New York and Chicago

  • 1936: Detroit Red Wings beat the Montreal Maroons 1 – 0 in the 6th OT period setting a playoff Stanley Cup record

  • 1989: The Exxon Valdez spills ~11.3 million gallons of oil off the Alaskan coast

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 Video - Lower Global Economic and GDP Forecasts