Mole’s Market Momentum Musings 3/2019

I was chatting with my quant buddy Tony a week or so ago and he asked me what ‘MOMO’ meant, which kind of had me stumped. In my mind it was an abbreviation for ‘market momentum’ but obviously this doesn’t make any sense. I was trying to figure out where and how I had absorbed that term and couldn’t figure it out. Nevertheless I have used ‘momo’ for many years now without thinking about it, which goes to show that we all fall prey to intrinsic habits and more often than not aren’t even aware of it.

That however doesn’t mean I have to keep doing it, so henceforth market momentum here at Evil Speculator shall be known as ‘mamo’. Alright, with that out of the way, let’s get to the good stuff – shall we?

As usual we are looking at implied volatility first as it presents us with a general assessment of market downside risk. Of course it’s a relative perspective, hence the term ‘implied’.

The take away here is that risk perception has dropped significantly after a relentless rally to the upside, one that has repeatedly rolled over valid bearish reversal signals.

As you can see the SKEW:VIX ratio (SKEW on its own is pretty useless, which is why I am using this one) has now pushed outside its upper Bollinger. So is it time to short the market?

Frankly I would be very hesitant to make that call. Since I started to track this ratio and even before that it seems to me that upper breaches during and shortly after a falling Bollinger have a tendency to be ignored.

However maybe this time it’s different, so let’s continue on and look at more evidence. Of which there is plenty.

If you are a purist then you may want to look at the VIX on its own and here it is against the SPX. What I’m also plotting below the price panel is the ROC relative to the VIX.

What do we see? Increasing complacency often produces dropping realized volatility in IV (yes, RV in IV – it’s a thing). When it bottoms out at around -25 bearish things can happen. But they don’t always do!

Like in January when perms-bears were licking their chops at an opportunity to exploit yet another big leg to the downside. Trolls were staging a siege on the evil lair but ended up being blown to pieces by bullish artillery.

Here we are looking at the VXV:VIX a.k.a. the inverted implied volatility term structure. The short signals it has offered us have been mixed and often delayed in the past few years, however starting in 2018 they became a lot more reliable, thus suggesting that a new market phase was in play.

More recently however, since the late 2018 lows, we have observed two failed bear signals. Again, this is not unusual and I concede the current one may actually still pan out in the near future.

Quite a lot more waiting below the fold – please grab your decoder ring (and perhaps a tall cup of java or your favorite tea) and then meet me in the lair:

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