Some of your best writing, thanks! I think you might be being a bit harsh on yourself given you’re justifiably pissed off as one of the few facing into the storm, but even more credit to you for doing so with equanimity
I still struggle with the overall conclusion on how to react to the impacts of passive. I agree with the entirety of your thesis that it is occurring but the implicit view in your thoughts is that we will have lost true price discovery and that this ends with limit down after limit down when flows reverse.
You haven't spoken at this anywhere that I can find, have looked pretty far and wide and have been following your thoughts on this since 2018. The only thing I can find is that you believe vol (upside calls) are systemically underpriced.
But why would I not go levered long (say 1.2x) large caps and just monitor unemployment data for the next 10 years, and then unlever, sell calls, and buy OTM puts as unemployment data starts to show increases? Is that not a simple way of practically playing your thesis?
Can you please provide some color on this? It's too theoretical right now without any practical steps for how to action it / protect oneself.
Like at the same time, I'm a bit worried about buying SPY and QQQ with my retirement funds based on your overall thesis. But it's not clear if I should be concerned in doing so.
I don’t know, Michael. Barry Ritholz has been very mean-spirited towards those with whom he disagrees. In my experience ad hominem is his go-to. Hard to resist coming back with some. IMO, he’s very much an intellectual lightweight.
“There is nothing we can do. Vanguard and Blackrock OWN the regulatory apparatus. If we raised the alarm, all we’d do is get fired. We have to wait for the event”
Besides the conspiratorial being proven true in the first half of that quote;
The second half --"We have to wait for the event"-- is horrifying. This statement is policy, not exception. And sadly, if these folks are intelligent (assume they are) even they know the system cannot be bucked.
Making it a system that necessitates every man for himself in the end.
Reposting my comment that was originally provided on the March 24th version of this post.
I have much to learn about the world of volatility. This article helped me with that, and the various jargon used are terms that I will study on my own as part of my active learning process. Thank you, Mike.
"In general, this is a byproduct of countries reacting to the Fed’s interest rate hikes to try to maintain currency stability."
This makes sense in that when it comes to foreign exchange, central bankers believe in an idea that interest rate differentials dictates FX rates (conveniently this view places central banks at the, well, center). The central bank of Switzerland demonstrated that this past week through their target rate cutting, and implicitly stated that they believe the Fed and ECB will cut their interest rate targets in the near-future.
While there is evidence for the prominent influence of interest rate differentials in short-term periods, that's not the case for medium and longer-term periods.
These dynamics of currency exchange values have effectively nothing to do with the Fed, nor central banks more broadly. Counterexamples may be found by comparing interest rate policy targets of the Fed and ECB such as by plotting DXY (or alternatively the price of DX1 front-month futures contracts) trends with plots of the spreads of shorter-term sovereign debt yields, such as yield spreads of the 2-year UST note (denominated in USD) and the 2-year German schätz (denominated in Euros).
Likewise, make the same comparison but using the 2-year Italian note instead of the schätz.
Those durations' yields are rate-sensitive to their respective central banks (i.e., the Fed and ECB).
In these examples lies much more relevant factors in the monetary system. One can see DXY/DX1 trend upward during periods of tighter collateral conditions, such as when there are large divergences between German bunds and Italian bonds. Given market perceptions of higher quality in German sovereign debt compared to those of Italy, the debt of the former comes in higher demand by money dealers, and that often results in the selling of the latter debt; hence, the diverging yields. DXY/DX1 will trend higher as those German yields become lower (this isn't a perfect relationship, which highlights the elusive complexity of FX).
But even in shorter-term periods the idea of interest rate differentials is dubious. This past week, the Bank of Japan raised their target interest rate for the first time since 2007, and a bit comically JPY almost reached a near four decade low against USD. To be fair, that move might have been a short-run fluctuation. We will see.
As for China and USDCNY, the mostly sideways movement for the latter most surely was due to certain Chinese commercial banks being active in the swaps market (e.g., cross-currency basis swaps and FX swaps). Chinese commercial banks have been in these markets in order to borrow (euro)dollars and re-lend those (euro)dollars into local currency markets in China and in doing so helping to maintain the PBOC's central parity target range for USDCNY. This market action has been recurring throughout the current global trade recession and failed post-pandemic 'reopenings' in China. Something changed this past week, as CNY suffered a big drop against USD, and USDCNY may be converging back to approximate synchronization with USDJPY.
But the global trade recession may not be the only problem here. India has a robust and generally strong economy, but INR plummeted to a record low againat USD this past week. It may be too soon to tell, but that could suggest (euro)dollar funding problems related to collateral circulation impediments (something India has been grappling with since at least 2022).
Can I please ask you a question? I am not sure I missed it in the article or maybe you have this covered in some of your old posts. I'm preparing to re-read the 2024 articles though. I've been following and reading your work and podcast interviews for more than 5 years.
Say, take one or three of the 6 listed companies and show the active vs passive activity vs the available float? I would think the following periods would be interesting to observe and compare:
1. March - April 2020 and 2022: active's selling is greater relative to the passive' consistent buying (assumption of mine) ?
2. 2021 and 2023 - to date: passive is again net buyer vs active net buyer / seller /flat ?
3. All this compared to the available float to determine the realized elasticity for each of the tickers?
1) March-April we saw selling from both active and passive
2) Passive is almost ALWAYS a net buyer due to share gain
3) Float is less relevant now as the buying is adjusted to "float-adjusted market cap." The measure of price inelasticity I quote is from Bouchaud's "Market Impact" and is a function of volume and volatility.
This is a table I was thinking of when commenting the other day.
1. I don't think I am reading the table properly. The 2018 Q4 number as an example: ~ 13.5M of shares bought in total for three months? Is that correct or am I misreading it?
I am thinking some additional columns will help (myself)? The additional columns will allow me to better digest the correlation and causation (if any).
2. 10,601,702+2,835,896=13,437,598 (is this passive selling or combo some passive + some active selling to passive? or 10,6M is net passive buying and 2.8M net active buying?
Original columns: Period,NVDA Price Chg,Passive Buying,Active Buying
I am not sure if Daily Volume helps. I am thinking if I/we can see the dates of Passive Inflows and then when they buy (a few days later) NVDA (or other tickers),then we can better assess and get closer to the truth and the mechanics.
3. I'd like to be able to better grasp this :) because I am not sure why NVDA is
a. down in 2018 Q4 because I don't know who was selling relative to the ~13.5M of buying
b. up in 2019 Q2 because I see very little buying by passive and active's significant seller
c. nearly flat in 2021 Q1: both selling. who is buying?
Guess I’ll play devils advocate (again) and say that asset prices do eventually feed into the real economy and inflation. That’s starting to get reflected by energy and base commodities. Yea we can point to things like crypto and biotech for a barometer of speculation. Asset prices are already pricing in these upcoming cuts and the ordering does matter. In terms of the K shape recovery that’s unfortunately been a thing and has gotten worse. The only way to reverse it is to kill asset prices which in turn will kill more jobs. The end result might be deflation vs disinflation and it is a crude and sad answer. The other point is Feb represents the toughest base effect so we will be seeing higher inflation (not 6-8% but 3-4%) over the coming year with no tough comp and higher commodity inputs now going through the system. Only way to get asset prices down is through higher long end rates for a longer period. 2 of the 4 banks that failed btw were crypto related and one can argue that a lot of the troubled assets while contained should have never been underwritten in the first place. Higher rates just show that when the tide goes out. Sadly I don’t see good way out until we see real value destruction and materially higher unemployment. I’ll play the dumb game in front of me but make sure I’m hedged and not paying in frothy areas of the market. Or you could buy quality at a 2% entry FCF yield.
Some of your best writing, thanks! I think you might be being a bit harsh on yourself given you’re justifiably pissed off as one of the few facing into the storm, but even more credit to you for doing so with equanimity
I still struggle with the overall conclusion on how to react to the impacts of passive. I agree with the entirety of your thesis that it is occurring but the implicit view in your thoughts is that we will have lost true price discovery and that this ends with limit down after limit down when flows reverse.
You haven't spoken at this anywhere that I can find, have looked pretty far and wide and have been following your thoughts on this since 2018. The only thing I can find is that you believe vol (upside calls) are systemically underpriced.
But why would I not go levered long (say 1.2x) large caps and just monitor unemployment data for the next 10 years, and then unlever, sell calls, and buy OTM puts as unemployment data starts to show increases? Is that not a simple way of practically playing your thesis?
Can you please provide some color on this? It's too theoretical right now without any practical steps for how to action it / protect oneself.
Like at the same time, I'm a bit worried about buying SPY and QQQ with my retirement funds based on your overall thesis. But it's not clear if I should be concerned in doing so.
DC, I generally think this is right. Unfortunately, the unemployment data IS showing increases, so it's been wrong.
There are lots of ways to play the events. Your analysis is not dissimilar to mine, but I was too early in rotating.
Thank you
Thanks for the continuing education, Mike. You've helped me (and countless others) see the world more clearly. Keep fighting the good fight.
It takes a big man who has a grip on his ego to walk back previous comments. Bravo, I commend you. If only more people could be so mature and humble
Bigger man would have avoided the situation in the first place! But thank you
I don’t know, Michael. Barry Ritholz has been very mean-spirited towards those with whom he disagrees. In my experience ad hominem is his go-to. Hard to resist coming back with some. IMO, he’s very much an intellectual lightweight.
“There is nothing we can do. Vanguard and Blackrock OWN the regulatory apparatus. If we raised the alarm, all we’d do is get fired. We have to wait for the event”
Besides the conspiratorial being proven true in the first half of that quote;
The second half --"We have to wait for the event"-- is horrifying. This statement is policy, not exception. And sadly, if these folks are intelligent (assume they are) even they know the system cannot be bucked.
Making it a system that necessitates every man for himself in the end.
Ben is a pompous douche and I don’t blame you.
Reposting my comment that was originally provided on the March 24th version of this post.
I have much to learn about the world of volatility. This article helped me with that, and the various jargon used are terms that I will study on my own as part of my active learning process. Thank you, Mike.
"In general, this is a byproduct of countries reacting to the Fed’s interest rate hikes to try to maintain currency stability."
This makes sense in that when it comes to foreign exchange, central bankers believe in an idea that interest rate differentials dictates FX rates (conveniently this view places central banks at the, well, center). The central bank of Switzerland demonstrated that this past week through their target rate cutting, and implicitly stated that they believe the Fed and ECB will cut their interest rate targets in the near-future.
While there is evidence for the prominent influence of interest rate differentials in short-term periods, that's not the case for medium and longer-term periods.
These dynamics of currency exchange values have effectively nothing to do with the Fed, nor central banks more broadly. Counterexamples may be found by comparing interest rate policy targets of the Fed and ECB such as by plotting DXY (or alternatively the price of DX1 front-month futures contracts) trends with plots of the spreads of shorter-term sovereign debt yields, such as yield spreads of the 2-year UST note (denominated in USD) and the 2-year German schätz (denominated in Euros).
Likewise, make the same comparison but using the 2-year Italian note instead of the schätz.
Those durations' yields are rate-sensitive to their respective central banks (i.e., the Fed and ECB).
In these examples lies much more relevant factors in the monetary system. One can see DXY/DX1 trend upward during periods of tighter collateral conditions, such as when there are large divergences between German bunds and Italian bonds. Given market perceptions of higher quality in German sovereign debt compared to those of Italy, the debt of the former comes in higher demand by money dealers, and that often results in the selling of the latter debt; hence, the diverging yields. DXY/DX1 will trend higher as those German yields become lower (this isn't a perfect relationship, which highlights the elusive complexity of FX).
But even in shorter-term periods the idea of interest rate differentials is dubious. This past week, the Bank of Japan raised their target interest rate for the first time since 2007, and a bit comically JPY almost reached a near four decade low against USD. To be fair, that move might have been a short-run fluctuation. We will see.
As for China and USDCNY, the mostly sideways movement for the latter most surely was due to certain Chinese commercial banks being active in the swaps market (e.g., cross-currency basis swaps and FX swaps). Chinese commercial banks have been in these markets in order to borrow (euro)dollars and re-lend those (euro)dollars into local currency markets in China and in doing so helping to maintain the PBOC's central parity target range for USDCNY. This market action has been recurring throughout the current global trade recession and failed post-pandemic 'reopenings' in China. Something changed this past week, as CNY suffered a big drop against USD, and USDCNY may be converging back to approximate synchronization with USDJPY.
But the global trade recession may not be the only problem here. India has a robust and generally strong economy, but INR plummeted to a record low againat USD this past week. It may be too soon to tell, but that could suggest (euro)dollar funding problems related to collateral circulation impediments (something India has been grappling with since at least 2022).
I'll stop here.
Sena, promise I'll come back with thoughts here.
Thank you. I look forward to it. 🙂
Thank you. Regarding Barry's tweet / question
https://substackcdn.com/image/fetch/f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1fe41864-9e07-41db-9dc2-b8788fd2ede4_1310x974.png
Can I please ask you a question? I am not sure I missed it in the article or maybe you have this covered in some of your old posts. I'm preparing to re-read the 2024 articles though. I've been following and reading your work and podcast interviews for more than 5 years.
Say, take one or three of the 6 listed companies and show the active vs passive activity vs the available float? I would think the following periods would be interesting to observe and compare:
1. March - April 2020 and 2022: active's selling is greater relative to the passive' consistent buying (assumption of mine) ?
2. 2021 and 2023 - to date: passive is again net buyer vs active net buyer / seller /flat ?
3. All this compared to the available float to determine the realized elasticity for each of the tickers?
Is the data available? Is it too much work? :)
1) March-April we saw selling from both active and passive
2) Passive is almost ALWAYS a net buyer due to share gain
3) Float is less relevant now as the buying is adjusted to "float-adjusted market cap." The measure of price inelasticity I quote is from Bouchaud's "Market Impact" and is a function of volume and volatility.
4) For a company specific example, I went through NVDA here https://www.yesigiveafig.com/p/signs-of-artificial-intelligence
I am catching up. :)
I read the last article of 2023 and most of the 2024. Lake Wobegon is next.
I found the below table useful from: https://www.yesigiveafig.com/p/no-david-no.
This is a table I was thinking of when commenting the other day.
1. I don't think I am reading the table properly. The 2018 Q4 number as an example: ~ 13.5M of shares bought in total for three months? Is that correct or am I misreading it?
https://substackcdn.com/image/fetch/f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa8c5f8c8-8ccb-4506-a67d-493c5c7895ea_743x885.png
I am thinking some additional columns will help (myself)? The additional columns will allow me to better digest the correlation and causation (if any).
2. 10,601,702+2,835,896=13,437,598 (is this passive selling or combo some passive + some active selling to passive? or 10,6M is net passive buying and 2.8M net active buying?
Original columns: Period,NVDA Price Chg,Passive Buying,Active Buying
Additional columns:
Passive Selling,Active Selling,Available Float,Float-Adjusted Market Cap,Quarterly Volume,Daily Volume,Volatility,Passive Funds Inflows
I am not sure if Daily Volume helps. I am thinking if I/we can see the dates of Passive Inflows and then when they buy (a few days later) NVDA (or other tickers),then we can better assess and get closer to the truth and the mechanics.
3. I'd like to be able to better grasp this :) because I am not sure why NVDA is
a. down in 2018 Q4 because I don't know who was selling relative to the ~13.5M of buying
b. up in 2019 Q2 because I see very little buying by passive and active's significant seller
c. nearly flat in 2021 Q1: both selling. who is buying?
d. etc.
I appreciate your quick response. Thank you.
Guess I’ll play devils advocate (again) and say that asset prices do eventually feed into the real economy and inflation. That’s starting to get reflected by energy and base commodities. Yea we can point to things like crypto and biotech for a barometer of speculation. Asset prices are already pricing in these upcoming cuts and the ordering does matter. In terms of the K shape recovery that’s unfortunately been a thing and has gotten worse. The only way to reverse it is to kill asset prices which in turn will kill more jobs. The end result might be deflation vs disinflation and it is a crude and sad answer. The other point is Feb represents the toughest base effect so we will be seeing higher inflation (not 6-8% but 3-4%) over the coming year with no tough comp and higher commodity inputs now going through the system. Only way to get asset prices down is through higher long end rates for a longer period. 2 of the 4 banks that failed btw were crypto related and one can argue that a lot of the troubled assets while contained should have never been underwritten in the first place. Higher rates just show that when the tide goes out. Sadly I don’t see good way out until we see real value destruction and materially higher unemployment. I’ll play the dumb game in front of me but make sure I’m hedged and not paying in frothy areas of the market. Or you could buy quality at a 2% entry FCF yield.
Thanks for making this public, Mike. It’s really helpful.