Goldman Management – CTA performance commentary June 2014
In the first three weeks of May the S&P’s trading range was extremely compressed at roughly 1% with the previous 13 weeks having been limited to a 5% range, representing a measure of suppressed volatility that has not been seen in 8 years. In addition, numerous volatility measures also moved to the lowest levels in years, as is the case with VIX, which fell below 11 last month, the lowest since February 2007. Entering the month of June the S&P broke above this narrow range and advanced in the first three weeks despite the turmoil in Iraq. The S&P has rallied in the last two months without a single daily gain or loss +/- 1%, a rarity as well, with a prior occurrence in 1995. Furthermore, the S&P finished in the top 25% of the daily trading range (the S&P point change from the previous day/ the S&P daily range) in the first 20 trading days of the month, which is an unusual occurrence, having been seen less than a dozen times in the past 55 years. This trend continued into month end, driving the 40 day average of the formula into the top 31% of the daily range. This has occurred just one other time going back 55 years, having last manifested in the middle of May, 1995. The present backdrop is different than in May 1995 as the S&P then traded sideways the previous year and experienced a 10% correction induced by the Federal Reserve raising rates.
The calm in stock prices was not limited to the equity arena but was confirmed by the corporate bond risk premiums which continued to grind tighter. According to the Bank of America Merrill Lynch Index, the average junk bond premium paired against the comparable Treasury is down to under 3.4%, the lowest spread since July 2007. The spread between corporate BAA-AAA stands at roughly 50 basis points, a level last seen in January 2000. This is in stark contrast to the December 2008 level when the spread touched 350 basis points, the highest recorded since the depth of the Depression. Additionally, and related to business confidence, the amount of domestic commercial paper outstanding issued by nonfinancial corporations has continued to rise this year. Using a smoothed two month average the amount of paper outstanding has surged past the 2007 peak levels by more than 35%. From the top in this reading in 2008 to the summer of 2010 this measure contracted by a whopping 50%. There is typically a lag in the levels as the reading measures outstanding paper, which takes time to mature. Furthermore, the calm and confidence are reflected in the readings of several Federal Reserve reports on Financial Health (“FH”) based on a comprehensive update of U.S. financial conditions in money markets, debt and equity markets, as well as the traditional and “shadow” banking systems. This composite isolates components of financial conditions, uncorrelated with economic conditions to provide an update on financial conditions relative to current economic conditions. The measures range from debt issuance, to consumer surveys’, to credit conditions. This oscillator level recently reached the most favorable reading since early 1994.
There is a natural tendency to review the aforementioned paragraphs with a trace of concern, as the last time some of these milestones were reached was just before an ominous turn in the world’s economy took place. For instance, the prior time the composite on FH reached such a favorable condition was in early 1994, but soon thereafter in February 1994 Alan Greenspan surprised both the bond and stock markets and the sea of liquidity rapidly evaporated. In addition, as stated previously, VIX last month reached the lowest close since early 2007, and in July 2007 stock prices were etching out a market top just before the ensuing 10% market correction. A more accurate representation of these gauges is to isolate the times when these measures initially reached such extreme levels, not the last time. For instance the FH moved to very favorable levels in this cycle in January 2013 and has since steadfastly remained favorable, while in the previous economic cycle the reading improved in January 2003 and then remained in a favorable mode for years. Regarding VIX, in the previous economic cycle VIX initially touched 11 in February 2005 and excluding a few flare-ups averaged 11-12 using a 150 day moving average over the next couple of years as stocks continued to advance.