Sie sind auf Seite 1von 4

Dropping Acid in Disneyland: Thoughts on the New Normal TM JM April 30, 2010

The boom and bust cycles of the new normal (as it wishes to be called) can be characterized. This characterization provides clues about the nature of its endgame and progress toward that end.

Economic growth fueled by easy monetary policy leads to excessive investment in specific assets (bubbles), resulting in more extreme boom and bust cycles.

Government policies to regulate the cycles lead to further crises that impact higher levels of capital structure.

In particular, very steep yield curves result in a generalized carry trade.

Equity valuations always get smashed in a crash. However, in the new normal the top of the corporate capital structure is not as immunized as it has been.

The next to get smashed? Sovereign credit.

The Endgame? The United States lives within their means, or U.S. t-bills get hammered.

Remembrance of Meltdowns Past

   

Equities

 

Bonds

 

MSCI All-

MSCI

MSCI

       

World

Developed

Emerging

iBoxx HY

iBoxx IG

Sovereign

U.S. T-

 

Date

Index

Markets

Markets

Premium

Premium

Bonds

Bills

LTCM Stumblebum

Aug-98

-14.20%

-13.50%

-29.30%

-2.20%

-1.50%

2.50%

0.90%

Tech Bubble Screw-Job

Nov-00

-6.20%

-6.10%

-8.80%

-1.30%

-0.70%

2.00%

0.70%

September 11, 2001

Sep-01

-9.10%

-8.80%

-15.50%

-1.40%

-0.70%

0.80%

1.00%

Idiot Quant Crisis

Aug-07

-0.20%

0%

-2.10%

-0.80%

-0.90%

1.60%

0.70%

Lehman Clusterfluke

Oct-08

-19.80%

-18.90%

-27.40%

-7.40%

-6.30%

-1.90%

0.70%

Average Loss

-9.90%

-9.46%

-16.62%

-2.62%

-2.02%

1.00%

0.80%

Note: Red cells indicate losses greater than average over the listed crashes.

The typical stuff you often read is that “averaging these losses out, optimal return is obtained with the following ”

asset class allocation… blah, blah, blah

exhibit a tendency toward greater losses at the top the capital structure. This is not just in corporate names. If you permit the analogy, sovereigns were marginally affected in the latest bust (see above). You can see it written

all over SovX quotes. It will get worse until policymakers stop rewarding failure.

The real point is quite different. Observe that the boom-bust cycles

My conjecture is simple: more and more capital structure senior assets are synchronized to a measure of disruption in the subordinate capital structure: VIX. This instability is the new normal until another new normal comes along.

Focus on 2008

A closer look at those capital structure losses in the last bust gives a feel for the cloth. That Spoos vaporize is nothing new. CDX.IG is an index of big liquid CDS names. There was a tremendous amount of stress on cash markets, shown by the IG bond index blow-out, and that the term structure of SP500 vol was inverted for a good chunk of Q4 2009.

The Year the Music Died, selected quotes

         

5Y Swap

CDX.IG

iBoxx IG

Milestone Insolvencies

Date

VIX

ATM 5Y Vol

SP500

Rate

spread

Bond spread

 

1/2/2008

12.0%

18.7%

1,417

5.06%

0.33%

0.14%

Bear Sterns

3/17/2008

32.2%

27.0%

1,277

3.17%

1.85%

4.64%

Merrill Lynch

8/29/2008

20.7%

25.4%

1,283

4.03%

1.43%

3.43%

Freddie, Fannie

9/8/2008

22.6%

25.2%

1,268

3.91%

1.38%

3.41%

Lehman

9/15/2008

31.7%

25.3%

1,193

3.69%

1.94%

5.04%

AIG Failure

9/16/2008

30.3%

26.3%

1,214

3.45%

2.00%

5.07%

12/31/2008

40.0%

35.3%

903

2.10%

2.14%

8.13%

Data Porn: Piecewise Regression and Correlation Functions

Imagine a financial experiment across a spectrum. At one extreme are very solid senior credits, at the other extreme are residual securities, subordinate in terms of capital structure. Shocks to one extreme manifest in higher credit spreads to the “risk-free” reference rate; the other extreme results in selling. I use daily bond

spreads and VIX quotes for this. VIX is good for this purpose because it is traded and thus demonstrates extreme effects better. And yes… I too am stunned, benumbed, and burned by the hateful chasm between ratings and

reality. The agencies themselves engage in at best pro-cyclical cheerleading. At worst they are eyes, think of England.

pathetic. Close

The model: (Baa spreads) t = 0 + 1 (AAA spreads) t + 2 (Closing price of VIX) t = t

t = daily quotes

AAA, Baa spreads = ratings based on Moody’s seasoned bonds, daily quotes.

From 1990 to 1999, the fit was near perfection (R 2 ), and Baa spreads were dominated by AAA spreads (t-value).

 

Regression: Jan 1990- Dec 1999

 
   

Parameter

     

Variable

N

Estimate

t

Value

Pr > |t|

R

2

Intercept

 

-0.38698

 

-14.41

<.0001

0.9804

VIX

2620

0.01144

 

24.48

<.0001

 

AAA Spread

2625

1.12232

 

354.96

<.0001

From 2000 to 2005, the model says essentially the same thing, though the overall fit is marginally diminished.

 

Regression: Jan 2000 - Dec 2005

 
   

Parameter

     

Variable

N

Estimate

t

Value

Pr > |t|

R

2

Intercept

 

1.20161

 

33.24

<.0001

0.9546

VIX

1447

0.02261

 

26.24

<.0001

 

AAA Spread

1435

0.88106

 

134.28

<.0001

From 2006 to April 2009, the situation is different. The overall fit now admits specification issues (it’s still real good fit), but more to the point, VIX now has more explanatory power over Baa spreads than AAA spreads (bold t- value).

 

Regression: Jan 2006 - Apr 2010

 
   

Parameter

     

Variable

N

Estimate

t Value

Pr > |t|

R

2

Intercept

 

2.28122

11.96

<.0001

0.8183

VIX

1149

0.05061

66.36

<.0001

 

AAA Spread

1137

0.62153

17.81

<.0001

In these regressions I lagged VIX as well. There was no appreciable difference in fit are parameter estimates. This implies that either the relationship between VIX and Baa spreads is simultaneous or the effect in time is somewhat complex.

Physics or Technical Analysis of Cap Structure

The correlation function is a way to determine how the relationship of VIX and Baa spread evolves in time. The correlation function is a mapping that measures the correlation of changes in one time series to changes in the other time series.

The analysis below uses daily quotes; back-testing on intraday quotes shows evidence of a power-law relationship. Simulations haven’t performed as well on single reference entities as it has on indexes for a high-frequency cap structure trading strategy.

The chart below takes a given Baa spread in time and measures the strength of correlation to the closing price of VIX from 24 days before to 24 days after. The closer a line is 0 on the horizontal axis, the less relationship there is between Baa spreads and VIX. The more positive or negative the line becomes shows how positively or negatively correlated Baa spreads and VIX are to each other when looking at Baa spreads on, say, Jan 1 and at VIX 24 days in the past and 24 days in the future.

Changes in the Baa spread is negatively correlated to the closing price of VIX on the same day. However, Baa spread rises made VIX more likely to rise then next two days afterward. Note also that the correlation between Baa spreads and VIX has more extreme positive and negative correlations in the 2006-2010 period. These extremes seem to characterize the new normal.

There are other details you can determine on your own.