/From Low Volatility to No Volatility

From Low Volatility to No Volatility

Just when we thought that it couldn’t get any worse for traders, markets have almost come to a standstill. Simply put, unless price actually moves, traders cannot make any money. And so it is with some dismay that we look at the S&P 500 Index of the largest US companies, noting that daily closing prices over the last 13 trading days have been within an eight point range; or less than 0.3%. If this is what Summer has to offer, we’re off to the beach!

Yet, as we sit here sporadically rebooting our PC just to make sure that Bloomberg is actually updating prices, we have been reading reports that include some great anecdotal evidence that a major top in US equity prices may be close at hand. As explained last week (and quite a few times before), we continue to err on the bearish side of the ledger in US equities, and we simply could not help ourselves as we chose to implement a bearish S&P 500 trade this past week, which is reflected in the “Trade Ideas” section; covered at the end of this week’s commentary. As well as sharing some of the anecdotal equity stuff, we will have a very quick look at FX, which may be at an interesting juncture.

We are continuing to suffer from some flashbacks to previous bull market highs in equities. Chart 1 below shows the S&P 500 alongside the per cent of cash held by individual investors (according to the American Association of Individual Investors or AAII). These individual investors are holding the least amount of cash in their portfolios since January 2000 – at the height of the dot.com bubble.

Chart 1 – US equities and Cash weightings held by Individual Investors

Further evidence of the excitement emanating from individual investors comes from Schwab who have confirmed that they are opening the most number of new accounts since 2000 as well. As can be clearly seen in the chart, retail investors have a disconcerting history of being overly bullish at market highs (as measured by low a low cash allocation) and overly bearish at market lows (as measured by a high cash allocation). We would also note that although cash balances have been historically low for a few years now, even recent relatively  low cash weightings in 2011 and 2015 coincided with interim market highs which were followed by at least 10% corrections.

There has been many a pundit that has noted that the bull market evident since 2009 is the most hated bull market in history, and up until this year, we would probably have to agree.  However, chart 1 tells us that retail investors have fully embraced the bull market. And it’s not just the baby boomers who are desperately trying to save for their retirement (via taking on more equity risk than they should). All age cohorts are overweight equities according to the work of Fidelity shown in chart 2.

Chart 2 – All age cohorts are overweight equities as measured by Fidelity

Now, these bits of anecdotal evidence should not be used in isolation. However, when we add in the extreme market valuation metrics (see chart 3 below courtesy of Goldman Sachs showing most market valuation metrics close to their highest ever rating), we continue to believe that the US equity market is very near the forefront of a major topping process, if not a decent sized correction.

Chart 3 – Selected US equity market valuation metrics (courtesy of Goldman Sachs)

So as noted, we have taken the plunge, and bought a bearish option on the S&P 500. With volatility so low, we believe the cost of the option is relatively cheap at the moment. If we are wrong, and the S&P 500 does not go down, we have capped our loss at the cost of the option. If the S&P actually does decline, then hopefully we can make some money. We said last week that for the immediately bearish case to have a chance of working out, the equity market had to start falling within a matter of a couple of weeks or so. We stick to this narrative.

Moving onto the foreign exchange markets, as most of you will know, the US Dollar has had a torrid time of it since the start of the year. Unfortunately, we did not see this coming, and in hindsight, we feel more than a bit foolish about this. With that ‘mea culpa’ out of the way, we do look at the current condition of the US Dollar, and wonder aloud whether we could be near the start of a bottoming process.

First up, we note in the chart below how the US Dollar Index (which measures the performance of the Dollar against major developed economy currencies) has fallen to a major support level. We would not be surprised to see buyers emerge around current levels. Secondly, interest rate differentials generally support being positive the Dollar, and Friday’s decent US employment report will perhaps encourage the Fed to continue with both balance sheet reduction AND further interest rate increases. Thirdly, we note that as shown in the Commitment of Traders report, speculators generally hold short positions in the US Dollar, which could be seen as a contrarian signal that we should be looking to buy (see chart 5).

Chart 4 – The US Dollar Index weekly chart

Now trying to buy the Dollar does have a bit of a feel of trying to catch a falling knife, and although we think that the odds for a Dollar rally are improving, we may be jumping the gun a bit in thinking bullishly. However, given all of the evidence, we think that it is far too late to be bearish, and given the internal risk controls that we exercise, we can limit the damage if we do buy Dollars and are ultimately proved wrong. So to be clear, we have not yet bought Dollars, but we think the time is fast approaching, and we will of course write about it when we pull the trigger.

Chart 5 – US Dollar Index with IMM Speculators net bullish positions

So to wrap up. Historically, retail investors give great contrarian signals in the equity market, as they pile in near the top and capitulate near the bottom. This has occurred over many cycles, and although we felt that it may not happen this time, it looks like it has. History may not repeat exactly, but it does rhyme, and so we take the message from recent retail investing behaviour at face value; they have piled into the market in recent months and are pretty much “all in”. This is a bearish signal and with developing caution in some of our technical work (discussed last week), we think that our long awaited topping process is close at hand. We are also on the lookout for signs of a bullish turn in the Dollar, and it could well be that the two turns we are looking for broadly coincide with each other. Despite no volatility in some assets in the last few weeks, Summer may not be as quiet as some think, or hope.

Summary of trade ideas highlighted in our weekly commentaries

As noted above, we have bought a PUT option on the S&P 500, investing about 1% of capital. As can be seen in the table below, we have exited all of the trades we made in the soft commodity complex. We sold the remaining long exposures to Cocoa, Coffee and Sugar as a) price had moved into zones of resistance and were showing short term signs of exhaustion, b) we detected signs that commercial traders have been reducing their bullish holdings, c) we are a little concerned that a rally in the US Dollar, if it were to occur, will present a headwind to commodities in general, and d) we were keen to protect profits, in line with our internal risk management policies.

We continue to broadly see the same bullish set up in the soft commodities as we saw three weeks ago when we first turned bullish, and we suspect that we will re-enter the market from the long side in the not too distant future.







Stop Loss Level







US Dollar P/(L) Last




14/07/17 Long 10 Contracts Sept Cocoa 1892 04/08/17 2047.7 8.2% 15570.00
14/07/17 Long 10 Contracts Sept Cocoa 1892 01/08/17 2068 9.3% 17600.00
14/07/17 Long 20 Contracts Oct Sugar 14.099 04/08/17 14.174 0.5% 1680.00
14/07/17 Long 10 Contracts Sept Coffee 132.10 04/08/17 139.4 5.5% 27375.00
19/07/17 Long 20 Contracts Sept Cocoa 1943.10 28/07/17 2035 4.7% 18380
19/07/17 Long 20 Contracts Oct Sugar 14.42 01/08/17 15.0245 4.2% 13540.80
20/07/17 Long 10 Contracts Sept Coffee 136.175 01/08/17 138.65 1.8% 9281.25
26/07/17 Short 100 Contracts  Sept Schatz 112.03 112.3 112.095 -0.06%
02/08/17 Long 40 SPX Sept 2400 Puts 12.70 0 11.35 -10.63%
Cumulative Closed Profit/(Loss) $103,427.05

This is not meant to be a model portfolio and it is not meant to constitute any investment advice. This is purely a way of keeping track of specific trade ideas that we highlight in our weekly investment commentaries. These ideas will consist of the more important or higher conviction ideas that we implement in our multi asset macro fund. We have chosen to have a notional starting portfolio value of US$5 million; the reason being that we can also illustrate how much risk we are taking on each trade as well as keeping a cumulative track of how our main trade ideas are performing. This is a notional portfolio only and does not represent any portfolios that we manage. However, for the sake of clarity and consistency, we do put these trades into our multi-asset macro portfolio alongside other trades that we do not make apparent here. The prices we show in the table above are the prices we transact at for our macro fund, not including any trading expenses.

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