Just a week before the biggest spike in US equity market volatility ever – something ‘no one’ in the mainstream even thought possible – Universa’s Mark Spitznagel warned “a reckoning always follows…something really big is coming”
This is an age of massive artificial economic imbalances and systemic risks.
Repress change, and you repress all that it means. Repressing it is sheer hubris and, in Dylan’s words, “beyond your command.” You can only defer it, not stop it. (Juxtapose this view with outgoing U.S. Federal Reserve Chair Janet Yellen’s ambitious claim that there will not be another financial crisis “in our lifetimes.”) When we try enforcing stability by decree, a reckoning always follows. An unsustainable boom leads headlong to an inevitable bust. A hard rain falls.
Rather than fear it, we should “tell it and think it and speak it and breathe it.” This is Dylan’s resolve. Something really big is coming. Let the central bankers try to keep standing in its way, but as investors we need to recognize and accept its logical consequence of a return to the meaning of volatility. Change and volatility are good. “There is nothing perpetual but change”—according to Mises, who surely must have loved Dylan just as much as I do.
While this is a common theme from the guru of tail risks, his timing could not have been better. As some might say “nailed it,” and Spitznagel was asked to explain how to spot market crashes coming on Bloomberg TV this week…
Spitznagel begins by pointing out the obvious, and crushing the business models of 99% of the mainstream media’s guests:
“My job is not picking the top. My job has always been risk mitigation. Picking crashes is impossible… timing crashes is impossible. If you require a forecast in order for your investment thesis to do well, then I think you’re doing it wrong.“
The Universa CIO then reminds viewers that this is not over yet, explaining that markets do not crash in one big move but in an oscillatory drop and pop manner that “is meant to shake out the weak hands and get you short at the bottom.. really it’s an impressive thing what the market can do.”
“We are living in a reality distortion,” Spitznagel continues, “when it comes to what happened this week, and what will happen ahead, all roads lead to the central bankers at The Fed.”
“People feel we are in a benign investing environment… we are not!“
“We have been here before. Let’s remember The Great Moderation of the mid-2000s – we have seen this play out before and it will do the same thing again… It is so naive that people think they can put on trades like the short-volatility trade – I think people don’t really believe it but in the low-rate world, they are forced to chase and do crazy things…”
“It’s easy to snicker at how naive the short-volatility-trade was, but it is a short-gamma trade – which means there is feedback process where selling begets selling… There is no difference between that and people who are long the market – they are long the market because it went up; when it goes down people are not going to want to be long.”
And they are doing it again already!!
Bob Dylan put it best, Spitznagel said, “people don’t do what they believe, they do what is convenient.. and then they repent… I think what we saw in the last few days was repenting, and there is more to come.”
The bubble in passive investing is “a big problem,” warns the hedge fund manager, but there are bigger problems:
“…think of the landscape of problems we have – think of the over-valuations we have, look at where rates are, there’s no room for more monetary-easing… for us to focus on the derivatoive tail wagging the dog here is losing sight of the big picture – It’s easy not to worry about that but everything is distorted today – this is what happens when we have the type of historic monetary interventionism that we have had.“
Then Spitznagel dives into the uncomfortable reality for the Bloomberg TV anchor:
“The S&P is a risky thing to hold. It does not feel that way, but it is… I expect in the coming years we will take back a decade…“
“Everyone has this dogma of ‘diversification’,” he explains “they think it is the answer to the markets we are in today (and to risk in general).”
It’s not – “the reality is that diversification has not been a good risk strategy, because correlations tend to spike just when you least want them to…”
“After the fact they realize that when correlations spike, people who think they are diversified – the extreme case being risk-parity – get it wrong and it is too late at that point… we are going to see this negative feedback happen again – but it will not be driven by a small area of the derivatives market, it will be driven by actual sellers of stocks.“
Bloomberg’s Alix Steel finally asks for some advice for her viewers: “Is there a magic-hedge that would help you if you owned the S&P 500?”
Spitznagel simplifies things perfectly: “own less of it! … it’s a bad idea for the public to be looking at derivatives hedges in general… that was one of the problems of these VIX products. There are people in these things that have no business being in them in the first place (and frankly I would put some professionals in that category too).“
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