We're Now in a Higher Volatility Regime: 3-Minutes MLIV

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00:00Mark, the risk on force seems to be strong globally for stocks. You've been pretty impressed,

00:05I think, by some of the dip buying impulse. Where does that take us, do you think?

00:10Yeah, I think the price action's been incredibly positive over the past week. That seems a strange

00:15thing to say when we've had the biggest short-term kind of dips lower that we've seen in six months.

00:22And what I mean by that is the bounce backs have been very, very quick. Now,

00:25the underlying fundamentals are very impressive. We know that the AI bubble, if you want to call it,

00:30and I believe it is a bubble, but we're at the early stages of it is very strong. We're expecting

00:34a very strong earnings season. We're seeing that on both sides of the pond this morning,

00:38with ASML impressing, as well as the U.S. banks yesterday. So earnings expect to be good.

00:43We're seeing yields come lower. We're seeing growth still be resilient. We've got the positive news in

00:47France. So I think there's overall a very, very strong backdrop. And it's understandable to be

00:52expected in three weeks' time we'll have a U.S.-China detente, perhaps a progress in a trade deal,

00:58and stocks will be much higher. What I'm very, very concerned about is the path there. Game theory

01:03suggests that there won't be an immediate backdown from either side, particularly from China,

01:08has no reason to kind of offer concessions unilaterally until we get much closer to the deadline.

01:14So I worry we've got some very scary headlines in the next couple of weeks. And whenever you've got scary headlines,

01:19you've got a risk of things going wrong. So even though I understand the extreme bullishness,

01:23I am worried that the path is going to be more negative. We're going to have more sharp dips in

01:27the coming weeks. And I think people are maybe rushing to buy the dip a little bit too quickly.

01:32Okay. VIX is at 20. Does it stay elevated? Does it get more elevated? And if so, what does that do,

01:39particularly for the systematic trade, kind of what does that do in terms of kind of risk on territory?

01:44Yeah, that's a great question, because I actually think that's the key change.

01:50We've been in an extremely low vol rally over the last few months, exceptionally so,

01:54and we have seen a move up in the VIX. I think volatility will rise from here because of that expected

02:00headline risk out of the U.S.-China situation, and also because we're in earning season now as well.

02:06And as a result of those move higher volatility measures, we are going to have systematic reduction

02:11of positioning. We're going to have a cut in leverage.

02:15And that's why we're going to get some more whip around. And these things become self-feeding.

02:19We know that volatility spikes are autocorrelated. Volatility begets volatility.

02:24And it's from that simple process that as you get a spike in, well, as you get a decline in volatility,

02:30people have to take more leverage to get the upside. And then when you suddenly get a spike in volatility,

02:34they then have to further reduce positions, which causes more volatility.

02:38So that is the exact dynamic I'm worried about. And I think it's really important to emphasize,

02:42it depends probably on your time frame how you play this. But I think it's only people who have very deep pockets,

02:47have very high risk tolerance, and, you know, can afford to be buying the dip quite so aggressively

02:52because I think the path dependency is very, very important. And there's still a tail risk of it going materially wrong.

02:59If markets are completely complacent about U.S. trying to trade, there's no pressure on either side to make a compromise,

03:04and maybe we will not get a compromise.