Options Show Rare Polarization in Global Equity Outlook
Dr. Ashwin Alankar discusses with Bloomberg TV why signals from the options market show a distinct preference for U.S. stocks over emerging market, European and Asian equities, as only the U.S. government talks about fiscal stimulus as a means to offset a global policy shift to tighter monetary conditions.
Scarlet Fu: Let’s bring in Ash Alankar. He is head of Global Asset Allocation and Risk Management at Janus Henderson Investments, and he joins us now from Denver, Colorado. Ash, great to speak with you. Talk a little bit here about how trade tensions are playing into what’s already been kind of nervous equity markets, given the sell-off we saw in February.
Ash Alankar: Sure. Good afternoon. Well I think the trade tensions and the trade talk is more rhetoric than anything else. As you had mentioned earlier on, I think the anxiety over embarking on a trade war had definitely alleviated and mitigated. President Trump has made it very clear, a couple of days ago when he mentioned that the tariffs on aluminum, the tariffs on steel, they’re all part of this plan to try to negotiate better, a better NAFTA treaty. So whereas the worst fear was to rescind NAFTA, now those worst fears are unlikely to be realized and it’s more about renegotiating NAFTA. So the trade war, President Trump and his team, they know a trade war is not a zero sum game, it’s a negative sum game. Everyone loses. If there’s one part of the world which has a competitive advantage, it’s the benefit for the entire world to have access to that competitive advantage. So it’s something that we personally are not too concerned with.
Joe Weisenthal: Ash, let’s talk about the volatility regime which seems to be in a sort of (inaudible) February vault spike to now. We’re in a higher volatility regime. But in terms of the acute risks driven by short volatility trades, has a lot of that washed out of the market in your view or is it still there and could rear its ugly head again?
Alankar: I think it’s washed out of the market. There was one very significant structural difference between the short volatility crowded trades of 2018, of 2017, of 2016, versus the short volatility trades of say 2007 and 2008. And that structural difference is the short volatility traits today were not in the hands of banks. Banks were not short volatility. Whereas in 2008, banks were short volatility or banks were short correlation. So if a crowded trade suffers large losses, and those large losses are concentrated within the banking sector, the middleman is gone. Credit cannot flow anymore. And that poses a systemic risk. But if mark-to-market losses or even realized losses are suffered by the non-banking community, it’s not that systemic. It doesn’t really have a very large chance of being contagious. So we’re not, once again, so worried about the spike in volatility or subsequent spikes in volatility as long as those short volatility trades are not in the hands of the banking community.
Julia Chatterley: What is the option market telling you about potential positioning as far as upside or downside potential is concerned? Because you’re noticing, I see some anomalies and expectations as far as the U.S. markets are concerned, particularly versus EM in Europe, which arguably have been favored.
Alankar: This is an excellent question. One of the most interesting things that we’re seeing is coming out of the option market where the option market is pricing very good attractiveness for U.S. equities in terms of potential upside versus potential downside. But it’s telling us something completely opposite when it comes to European equities, when it comes to Japanese equities, when it comes to emerging market equities. And this type of dichotomy being priced by the option market is in fact very, very rare. Going back the past 15 years, this type of discrepancy has only come about a handful of times. So the option market is telling us something very interesting here and it’s something I think we should pay attention to.
Chatterley: Is there a fundamental basis for this if you look at what’s going on as far as monetary policy, fiscal policies concerned on a relative basis in these countries? To what extent do you have to watch the signal and react to it?
Alankar: I think you’re exactly right. One major difference between what’s happening here in the U.S. versus what’s happening outside of the U.S. is the U.S. is talking about fiscal stimulus. The U.S. is talking about fiscal spending and that will offset what everyone else is talking about and what the U.S. here has embarked on, which is monetary tightening. So it’s only in the U.S. that monetary tightening is being offset potentially by fiscal stimulus. That’s not happening in Europe. That’s not happening in Japan. It’s not happening in emerging markets. So I think you’re exactly right. That’s why the option markets are telling us this.
Fu: It’s certainly something we’ll be taking up with Robin Brooks shortly. Very quickly here, Ash, let me just ask you a final question as we get the jobs report. I know that you were saying that the February sell-off was catalyzed by a structural risk, which is a faster than expected rise in real weights. We’re going to get a sense of what inflation, wage inflation looks like on Friday. What would be a game changer for this kind of market that would prompt the options market to pricing something different?
Alankar: The wage numbers, which I think are more important than the payroll numbers, if those wage numbers show an unexpected, very high acceleration like they did last month, you could really move a bit faster, and a Fed that moves a bit faster is automatically going to imply real rates are going to move a bit faster upward and that real rate is what you have to pay attention to, not really the inflation number, but the real rate and how real rates move. That’s what’s important when it comes to the stability and fragility of the economy.
Chatterley: We’re going to pick up this conversation regarding the currency market. Ash Alankar, Head of Global Asset Allocation and Risk Management at Janus Henderson Investors, thank you so much for joining us.
To learn more, read Dr. Ashwin Alankar’s latest article, Volatility Spike Says Little About the Outlook for Stocks, from Bloomberg Prophets here.