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Stagnant Volatility and Investment Choices

The fear factor of the markets has existed since the end of April.  Greece was at the top of the headlines, May 6th Flash Crash, the crash of the Euro, a double dip US recession, bad S&P 500 earnings, a crash in Chinese real estate, overheating in China, treasury rates showing deflation…  I guess I am at the point of saying, “Go ahead and topple already”.  I do not really mind seeing crashes in markets, because crashes provide opportunities.  What I do mind is a chronic state of fear.  Volatility has remained elevated for over 4 months, and we have little more than a 14% correction while retail and institutional investors continue to sell out of equity funds.

The issue at question is whether we have a greater day of reckoning coming.  The treasury market would say that we truly do.  With a 10 year treasury yield of sub 2.5%, the bond market is prepared for terrible days ahead.  Stubbornly, equity markets remain dislocated versus their yield based compatriots.  At the same time, I have suggested that it is hard for me to believe that the dividend yields on blue chip S&P 500 companies would be cut, which would make them very cheap compared to their very own bond yields.

What does not help our cause is the election cycle during the fall, a persistently negative employment situation, and the notoriously volatile fall months.

Is 30% really much different than 34%? Three months of Fear.

The chart above only illustrates that the prediction level for volatility has remained elevated.  A 34% volatility level suggests a daily standard deviation of 2.14% whereas a 30% volatility level suggests a daily standard deviation of 1.89%.  In reality, the 10 day annualized volatility hit a high of 37.86% and the 30 day realized volatility hit a high of 32.53%.  That was in the height of the “European Crisis”.  Since then, realized volatility has faded while implied volatility has remained elevated.

A very slow decline in Vol

So if you would like to make a bet, I suggest five strategies:

  1. Sell Volatility under the premise that everyone has a heightened sense of fear since the terrible market action of 2008
  2. Go long equities because an 8% earnings yield or 5% dividend yield on the top 100 dividend payers certainly beats 10 year yields on corporate bonds
  3. Buy treasuries because a 2.5% 10 year treasury yield will look phenomenal under our deflationary Japanification
  4. Short equities and buy physical gold because the whole financial/fiat system is unraveling
  5. Hold onto your cash and watch all of the fools chase fool’s gold

To me, 3 seems ridiculous knowing Bernanke’s mindset, 4 makes it seem like I would be better off investing in a bunker with ammo, 5 exposes me to the Bernanke mindset, 2 exposes me to the mentality of 3-5, and 1 seems like a way to take advantage of 2-5.

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  1. Bill says

    Nice summary…or perhaps just a case of you and I thinking along the same lines.

    Cheers,

    -Bill



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