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Noteworthy News – December 19, 2011

Economy:

Are we at the beginning of a 25-year recession? – The Week

A Financial Crisis Needn’t Be a Noose – New York Times

Snap analysis: Fed sees downside risks, over and yonder – Reuters

U.S. Retail Sales Rose at Slower Pace in November: Economy – SFGate

Unemployment claims at lowest in 3 1/2 years – SFGate

Markets:

Inflation Conspiracy Theories – New York Times (Krugman)

Wall Street Confounded as Volatility Extends Record Stretch – Bloomberg

France’s AAA Outlook Cut; Fitch Reviews Others – Bloomberg

Global markets cautious over economic gloom – Businessweek

China’s yuan jumps on signs of c.bank intervention – Reuters

Politics:

North Korean leader Kim Jong Il dead at age 69 – Associated Press

Obama aide: Republicans playing politics on taxes – Reuters

The politics of the top 0.01 percent – Washington Post

Banks:

The Size of the Bank Bailout: $29 Trillion – CNBC

Europe Crisis Drags On, Raising Concerns About U.S. Banks – Huffington Post

Morgan Stanley to Cut 1,600 Jobs – Wall Street Journal


Posted in Economics, Markets, Media, Politics.

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By SurlyTrader – December 18, 2011

The Great Divide

The media has played a tremendous part in describing the rich versus poor in the United States or the 99% versus the 1%.  There is a great truth to the fact that the elite make a disproportionate amount of money…but the elite are the business owners, the CEO’s, the individuals and families that earn most of their income from investment or business ownership and can deduct nearly all taxes away and shelter the rest…meaning a tax increase will probably only really impact the bottom 99.5%.

As an illustration of the dichotomy, two news stories that I just ran across:

Census Shows 1 in 2 People Are Poor or Low-Income

Squeezed by rising living costs, a record number of Americans — nearly 1 in 2 — have fallen into poverty or are scraping by on earnings that classify them as low income.

The latest census data depict a middle class that’s shrinking as unemployment stays high and the government’s safety net frays. The new numbers follow years of stagnating wages for the middle class that have hurt millions of workers and families.

CEO pay jumps 36.5%

After two years of lower pay packages, chief executives at the nation’s major companies enjoyed a 36.5% jump in pay last year, according to a leading survey of CEO compensation.

The most lucrative sector for CEO pay was health care, which included three of the nine top-paid executives, including the two most lucrative packages:

$145 million for John Hammergen of McKesson Corp. (MCK, Fortune 500), which distributes drugs and health and beauty care products to pharmacies; and

$98 million for Joel Gemunder, who retired in July 2010 as CEO of Omnicare (OCR, Fortune 500), which provides drugs to nursing homes and other long-term care facilities.

 

Two very different pictures of American prosperity.   An issue that will most likely end up being sold by politicians to the public as “taxes on the rich”, but will end up being realized as higher taxes paid by the 25th-99.5th percentiles.


 

 

Posted in Politics.

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By SurlyTrader – December 15, 2011

What is the New Normal for Volatility?

The 5 year implied volatility on the S&P 500 is currently 29%.  The math to take an annual standard deviation or volatility metric and convert it to a daily standard deviation is rather simple:

Number of trading days in a year = ~ 252

Daily Standard Deviation = Annual Standard Deviation/Sqrt(252)

In the case of a 5 year implied volatility of 29%, this translates into a daily standard deviation of 1.82%.   If we believe that the distribution of returns follows a normal distribution, this means that 33% of the trading days for the next five years will have returns that are greater than or less than +/- 1.82%. This is a whole lot of movement over the next 5 years.  To put this into perspective, we can look at the trailing 1 month, 1 year and 5 year realized volatilities since 1928:

 

One month realized volatility is….volatile.  One year is less so and five year could almost be described as smooth.  Take a look at the red line and find the periods where 5 year realized volatility traded above 20%.  During the great depression, a period after the internet bubble and the recent period since the global financial crisis.  What about 29%?  Great depression exclusively.

This is by no means proof that 29% five year implied volatility is expensive – merely that it is historically rare.  We could believe that the next ten years will be more volatile than the last ten and possibly more volatile than the great depression.  I do not currently believe in that outcome.  I personally believe that we happen to price risk with a very short memory.  When looking at the last 70 years since 1940, the 3rd quarter of 2011 had the 5th largest number of trading days that were +/-2.5% or more.  I believe that recent experience has a larger impact on the implied volatility term structure than a pure forecast of the next five years of market realized volatility.

As a quick reference for putting volatility into perspective, take a look at Bill Luby’s Rule of 16:

Using the rule of 16 and the 1/3 trading days time frame, the following translations should be committed to memory:

    • VIX of 16 – 1/3 of the time the SPX will have a daily change of at least 1%
    • VIX of 32 – 1/3 of the time the SPX will have a daily change of at least 2%
    • VIX of 48 – 1/3 of the time the SPX will have a daily change of at least 3%

 

Posted in Markets, Media.

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By SurlyTrader – December 14, 2011

Top Economic Graphs of 2011

The BBC released a series of graphs from the top economists that highlight and summarize 2011 from a visual standpoint.  My personal favorite shows the interest rates of the European Monetary Unit (EMU) members:

Did things really change in 1999?

There are a few things that this graph really brings to my mind.  The first is that markets can be horribly long for an extended period of time.  Do I really believe that 2008 and the bankruptcy of Lehman created the disparity between the countries’ default probabilities?  Likewise, do I really believe that the countries became equal in credit risk when they merged into the EMU in 1999?

In addition, if there was an improvement in certain fiscal optics in 1996-1999 before the currency merger, were they actually real?  I think it is rather obvious that the countries with the worst fiscal issues “cooked the books” so that they could join the Eurozone currency pact and ride on the backs of the more fiscally disciplined brothers.  Do I feel sorry for Germany and France?  Absolutely not.  In fact, they did not abide by their own fiscal rules in 7 of the 11 years while in the Eurozone.

Posted in Economics, Markets, Politics.

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By SurlyTrader – December 13, 2011

Is the Fear Subsiding?

With the equity markets down over 2% intra-day as the participants realized Friday’s European Summit did not provide a silver bullet to the Eurozone problems, you might expect the VIX to skyrocket.  In reality, the S&P ended the day down 1.5% and the VIX ended down 2.65%.

We can look at the last few months of range bound trading to compare the absolute levels of the two indices:

It is difficult to dissect the sawtooth market action

At the end of October the VIX traded near the 25 level while the S&P was trading at about 1275.  At the beginning of December we saw the S&P trading at about 1260 while the VIX was at 25.  It is also important to note that the VIX climbed through last week even as the S&P traded in a tight range.  In the past wee, we have watched the S&P fall from1260 to 1230 while the VIX tumbled from 31 to 25.67…

This observation of decoupling can be better shown by looking at the correlation between the VIX and the S&P 500 over the last few months.  From the beginning of August through the mid portion of November we saw a very strong negative correlation between the S&P 500 and the VIX.  Since then, there has been a significant decoupling between the two on a rolling basis:

Decoupling of the VIX?

This could be viewed as the lifting of a worry cloud, but I more likely attribute it to the fact that we are heading into the end of 2011 and light holiday trading.  Most traders and banks are relaying an expectation of a holiday rally with a return of the crisis in the early part of 2012.

Posted in Derivatives, Markets.

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By SurlyTrader – December 12, 2011

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