Volatility Rising As Dollar Tries To Bottom
Weekly Notes With Tiho — Issue 13
Location: Belgrade, Serbia
Monday was an interesting day, especially following last weeks events.
Most stock markets around the world are reversing their losses, while volatility is calming down.
Firstly, let us look at the week that was.
Gold was the best performing asset last week and an asset that I’ve been tracking closely over the last couple of weeks due to its technical coiling pattern.
Treasuries also did well.
The US Treasury 2 Year Total Return Index hit a new record high, while the 5 Year Total Return Index is less now than 150 basis points below its record from July 2016.
The drawdown on the Long Bond is still meaningful, though the recovery has been decent over the last 6 months.
Regular Twitter followers should remember that I was extremely bullish on Treasuries at the end of last year.
Interestingly, Frontier Markets shrugged off last weeks sell off and outperformed other regional indices. They were up 0.8% for the week.
US Small Caps were down the most, declining over 2.5% for the week that was.
I discussed how this index was already declining for the third week in the row and technically breaking down — well before large caps started their sell off.
The rest of important global equity indices, from Europe to Asia, all declined by 1.8% or more.
Market Volatility Returns
Market participants were extremely complacent coming into August.
As I wrote in the last post, there was an abundance of warning signals that volatility shall return.
It did so.
Let us look at the volatility across asset classes.
The United States stock market volatility jumped to 15.5 by weeks end and was up over 60% at one point during the week.
At the time of writing this, VIX has quickly reversed back below 12.
All of these moves look and sound dramatic in percentage terms when volatility measures are rising from the single digit 9 handle.
Emerging market equities are more volatile by nature, so its respective volatility index never got as low as S&P 500’s.
The spike on Thursday pushed both of the VIX indicators towards their respective year to date highs.
Treasury Bond and Gold price swings are also starting to wake up from their summer doldrums.
For both of these safe haven assets, volatility has been at one of the lowest levels on record.
Considering how calm and quiet the first half of the year has been, I would expect volatility to pick up in across all major asset classes in the second half.
Dollar Attempting To Rebound
However, what I didn’t show — and what I think is worth showing — is the hedge fund positioning when we exclude the Japanese Yen.
When I add up all the positioning in major foreign exchange crosses, we can see market participants are holding over 20 billion dollars in net short bets.
That is a colossal bearish position.
The biggest since 2013, actually… and one of the biggest over the last decade.
Unless you’ve been living under a rock, you would obviously know that 2017 has been a fabulous year for asset allocators (so far, at least).
One of the causes has been the weakness in the global reserve currency.
Falling Dollar helps US companies with the top and bottom line.
Falling Dollar usually props up commodity prices, increasing margins for producers.
Falling Dollar gives a hand to various global equity indices, all of which are priced in USD.
Dollar Rally Would Pressure Some Assets
Since the weakness in the USD tends to be good for the global economy as a whole, a rebound from oversold levels would have some serious implications for the remainder of 2017.
Therefore, I am keeping a close eye on the DXY Index, which now sits on a major technical support.
Daily Sentiment Index survey recently showed only 7% bulls.
Contrarians take note.
When I look at the behavior of Crude Oil traders, it is as if they are already sniffing out potential Dollar strength.
Last weeks daily outside reversal right near an important trend line, coupled with excessive hedge fund positioning, might signal another leg down for the black commodity.
Another important asset to watch carefully is the Korean Won.
The Korean economy is highly cyclical and very much export oriented. It ebbs and flows like a risk barometer for the global economy.
Or better yet, the US Dollar tends to spike rather sharply against this cross whenever the global financial markets go through a period of risk.
We saw large spikes in 1998 and 2008.
Wouldn’t it be ironic if we saw another large one in 2018?
That would be like clockwork.
Interestingly, the price of the currency pair is now coiling into a major decision point.
Second Half of 2017
I’m sure you are just as surprised as I am to notice how complacent Korean Won has been despite the fact that geopolitical tensions have been escalating in recent weeks.
Stock markets and credit bonds seem to be in the same boat.
Turning on Bloomberg or CNBC clearly shows 2017 has been a very favorable for most investors. It has been especially favorable for my clients.
With risks rising, will the same strategy continue to work in the second half?
If you would like to know how I am positioning my client’s portfolios and how we are preparing for the potential correction ahead — get in contact by clicking below and filling out the brief survey.
I’ll get back to you within 24 hours.
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