The Fattening of the Tails Since 2018
If you know about tails skip to the next paragraph. For those who don't, they're just another word for extremes. The idea is most of the moves in the market will be within an average expected move and then sometimes there'll be extremes. Rare events where far bigger moves happen. Think of it like the height of people. Most people fall within the average hight and then there are extremes. The "Tails". A small amount of exceptional people. In this context, tails would be exceptional market moves.
During the run from 2012 to 2018 record lows were set in volatility. SPX was climbing but it wasn't like the big swings we have today when we can swing several percent in total on any given day. There was a slow and persistent grind up. The VIX was in a steady downtrend, prompting a lot of interest in betting against the VIX.
Short VIX funds were setup and they were doing really well. Looked like this.
2018 was a really bullish year with prices starting to clearly trend more aggressively.
Then one day SPX. This turned into a sharp correction in SPX.
And this happened.
Why I bring this up is many believe volatility is mean reverting. That it can have extremes to either side but will ultimately revert to the mean. Which makes a lot of sense to me and far smarter people than I think it's true. Empirical studies have been done on it. They're terribly confusing if you don't speak science, but a lot of people seem to agree.
Studies have also found volatility clusters. Low vol tends towards more low vol and high vol towards high vol. So vol isn't random. It has a couple known properties of coming in clusters and being mean reverting. Where this gets interesting is during the run into the 2018 high we set record lows in vol. Then clearly broke the low vol trend.
You'd not think it to look at the VIX, but since 2018 things have clearly gotten more and more volatile. The moves up have gotten more aggressive. There have been much more drops. The market can drop more on any given day in these conditions more than it dropped most months in 2013 - 2017.
Year after year we've seen markets more volatile than previously. A new trend in volatility. Which is interesting when considered inside the context that vol is mean reverting and we've recently come off record lows. What would that imply? Wouldn't seem to imply vol drops back to record lows.
Things that mean revert tend to overshoot. When coming off record lows we'd not expect to just go back to the mean, we'd expect to see some sort of overshoot of the mean. Which would imply we would have a massive volatility spike some time in the future. A fat tail event. Where we have something dramatically more volatile than the average move.
Note, I am talking about vol as in how much prices are moving. Not the VIX. The vol move could be a massive crash up in markets with them rapidly doubling from ATH. I'm not saying the fact we have reason to believe there can be unusually strong moves has to be immediately bearish (Although one would assume the final hoorah of a vol overshoot would be a bear move).
If volatility is mean reverting and we're coming off record lows, we might be in a vol cluster in which there's an upward trend in volatility.
Which means wild stuff could happen.
And it has been. The tails have been getting fatter since 2018. Really taking off in 2021. We have fattening tails ("More extreme stuff more often"). I feel we can almost say it's a trend at this point. Things have not been getting calmer. More and more we see things outside of the typical distribution of market moves.
The parabola
Indices are in parabolic curves. People say, "Use log" and I say, "No. It's less fun". The point is, these charts exist and they do not resolve sideways. Doesn't matter if they look different on log charts. These style of moves are prone to increased volatility. Parabolas do not resolve sideways. Which is not always a bearish statement.
Trends are progressive. If the uptrends continue, it's only reasonable to assume as per the norms of trends the trend will become stronger. Trends do not weaken. They get stronger and stronger and die in a blaze of glory. This is a really important concept to understand if fading trends. Crazy stuff can happen if big resistance levels break.
If we accept the premises that vol is mean reverting and clustering and that trends are -progressive and will either speed up or crash down - then we have a solid seeming case to think it's reasonable to expect that we have increased chances of seeing exceptional moves in the medium term future.
Basically - things might be extremely good or extremely bad.
If the parabola is to continue the angel has to steepen and if it's going to fail a crash is coming. If the two premises of vol and trend are accepted, this seems to be the only logical conclusion.
I think bears in this area are going to either be right or significantly wrong. Which I suppose isn't a very bold statement to make at any time. But I know my bias would likely switch from bear to hyper bullish on failure of bear levels. I feel like we're either in a situation like Nasdaq 1996 - where it's about to go into hyper performance. Or 1999, where a huge drop is setting up.
I think the case for fat tails in the years ahead is very good. It does not predict a direction, rather a style of move, but is very good. Currently, we trade at major resis levels with pending bear patterns. If these fail, case for upside shock is really good. At those levels, is the time to be most cautious.
People think calls for a big reversal are just hopeful ramblings of people who hate everyone. There's a very salient case to be made for it.
Leading this case, the following things;
-Rapid rising rates giving parabolic markets
-Interest rates over 5%
Have always resulted in a crash when rates were cut any time they happened in the last 40 yrs. This is a sell signal that almost never happens and has almost always worked. Granted, we're talking a small sample size but it's ... notable.
If vol is having an elastic band like effect, shooting from one extreme the other before finally settling in the middle, it would seem inevitable the grand finale of this would be a crash.
If you know about tails skip to the next paragraph. For those who don't, they're just another word for extremes. The idea is most of the moves in the market will be within an average expected move and then sometimes there'll be extremes. Rare events where far bigger moves happen. Think of it like the height of people. Most people fall within the average hight and then there are extremes. The "Tails". A small amount of exceptional people. In this context, tails would be exceptional market moves.
During the run from 2012 to 2018 record lows were set in volatility. SPX was climbing but it wasn't like the big swings we have today when we can swing several percent in total on any given day. There was a slow and persistent grind up. The VIX was in a steady downtrend, prompting a lot of interest in betting against the VIX.
Short VIX funds were setup and they were doing really well. Looked like this.
2018 was a really bullish year with prices starting to clearly trend more aggressively.
Then one day SPX. This turned into a sharp correction in SPX.
And this happened.
Why I bring this up is many believe volatility is mean reverting. That it can have extremes to either side but will ultimately revert to the mean. Which makes a lot of sense to me and far smarter people than I think it's true. Empirical studies have been done on it. They're terribly confusing if you don't speak science, but a lot of people seem to agree.
Studies have also found volatility clusters. Low vol tends towards more low vol and high vol towards high vol. So vol isn't random. It has a couple known properties of coming in clusters and being mean reverting. Where this gets interesting is during the run into the 2018 high we set record lows in vol. Then clearly broke the low vol trend.
You'd not think it to look at the VIX, but since 2018 things have clearly gotten more and more volatile. The moves up have gotten more aggressive. There have been much more drops. The market can drop more on any given day in these conditions more than it dropped most months in 2013 - 2017.
Year after year we've seen markets more volatile than previously. A new trend in volatility. Which is interesting when considered inside the context that vol is mean reverting and we've recently come off record lows. What would that imply? Wouldn't seem to imply vol drops back to record lows.
Things that mean revert tend to overshoot. When coming off record lows we'd not expect to just go back to the mean, we'd expect to see some sort of overshoot of the mean. Which would imply we would have a massive volatility spike some time in the future. A fat tail event. Where we have something dramatically more volatile than the average move.
Note, I am talking about vol as in how much prices are moving. Not the VIX. The vol move could be a massive crash up in markets with them rapidly doubling from ATH. I'm not saying the fact we have reason to believe there can be unusually strong moves has to be immediately bearish (Although one would assume the final hoorah of a vol overshoot would be a bear move).
If volatility is mean reverting and we're coming off record lows, we might be in a vol cluster in which there's an upward trend in volatility.
Which means wild stuff could happen.
And it has been. The tails have been getting fatter since 2018. Really taking off in 2021. We have fattening tails ("More extreme stuff more often"). I feel we can almost say it's a trend at this point. Things have not been getting calmer. More and more we see things outside of the typical distribution of market moves.
The parabola
Indices are in parabolic curves. People say, "Use log" and I say, "No. It's less fun". The point is, these charts exist and they do not resolve sideways. Doesn't matter if they look different on log charts. These style of moves are prone to increased volatility. Parabolas do not resolve sideways. Which is not always a bearish statement.
Trends are progressive. If the uptrends continue, it's only reasonable to assume as per the norms of trends the trend will become stronger. Trends do not weaken. They get stronger and stronger and die in a blaze of glory. This is a really important concept to understand if fading trends. Crazy stuff can happen if big resistance levels break.
If we accept the premises that vol is mean reverting and clustering and that trends are -progressive and will either speed up or crash down - then we have a solid seeming case to think it's reasonable to expect that we have increased chances of seeing exceptional moves in the medium term future.
Basically - things might be extremely good or extremely bad.
If the parabola is to continue the angel has to steepen and if it's going to fail a crash is coming. If the two premises of vol and trend are accepted, this seems to be the only logical conclusion.
I think bears in this area are going to either be right or significantly wrong. Which I suppose isn't a very bold statement to make at any time. But I know my bias would likely switch from bear to hyper bullish on failure of bear levels. I feel like we're either in a situation like Nasdaq 1996 - where it's about to go into hyper performance. Or 1999, where a huge drop is setting up.
I think the case for fat tails in the years ahead is very good. It does not predict a direction, rather a style of move, but is very good. Currently, we trade at major resis levels with pending bear patterns. If these fail, case for upside shock is really good. At those levels, is the time to be most cautious.
People think calls for a big reversal are just hopeful ramblings of people who hate everyone. There's a very salient case to be made for it.
Leading this case, the following things;
-Rapid rising rates giving parabolic markets
-Interest rates over 5%
Have always resulted in a crash when rates were cut any time they happened in the last 40 yrs. This is a sell signal that almost never happens and has almost always worked. Granted, we're talking a small sample size but it's ... notable.
If vol is having an elastic band like effect, shooting from one extreme the other before finally settling in the middle, it would seem inevitable the grand finale of this would be a crash.
