“If you don't watch the violence, you'll never get desensitized to it.” - Bart Simpson - Commentary July 2017
My daughter’s 9th birthday is fast approaching which, given that she is my youngest and only daughter, constantly keeps me reminiscing about how her life has evolved. As a “post-crisis” child (I may trademark that term – she was born in October 2008), she thinks interest rates don’t really exist because I show her savings account statement to her every quarter. She is getting taller by the day. She only watches videos of toys and baking on her iPad and TV shows on demand. She has zero need for live TV. She does not know what a landline is. She knows how to look up things to buy on Amazon and AliExpress (are you listening Chair Yellen). Despite her inability to complete a sentence longer than four words without adding “like” she managed to win her grade’s spelling bee. Ever since I explained to her what I do, how more volatile down markets help us buy stuffed animals, she often asks how my day went and I tell her stocks went up again and I then ask her to punch me in the face. Ok…that last part isn’t true but the disappointed look on her face is pretty similar.
As you can see, other than the generalities, the things I recall about my only daughter are all recent and other than her subtle disgust insinuated with her shoulder drop upon the market being up again, are all generally positive in nature (she has been a pretty great kid). I challenge each of you to quickly think of a few things about your child: you will likely succumb to what is called the availability heuristic as well, here’s why. According to Wikipedia the “availability heuristic is a mental shortcut that relies on immediate examples that come to a given person's mind when evaluating a specific topic, concept, method or decision. The availability heuristic operates on the notion that if something can be recalled, it must be important, or at least more important than alternative solutions which are not as readily recalled. Subsequently, under the availability heuristic, people tend to heavily weigh their judgments toward more recent information, making new opinions biased toward that latest news.”
So when a good friend sent over an article from the New York Times entitled, “Day Trading in Wall Street’s Complex ‘Fear Gauge’ Proliferates” I almost hurled; after all this is today’s recency focused environment. To summarize the article, there are a growing number of people that have become day traders on newly established investable volatility products. While a portion of the article was dedicated to buyers of these products the majority of the content was describing the “post-crisis” lucrative, seemingly riskless trade involving selling volatility. As an example they told the story of a guy who quit his job at Target, made $12 million and now has investors asking him to manage their money: all driven by selling volatility indexes that are hovering near historic lows on markets explicitly and implicitly supported by central bankers around the globe. This is anchoring to the availability heuristic to a tee.
The quote I liked best was this, “The nature of volatility is that it desensitizes over time.” In case you were unclear on what desensitize means here it is according to Merriam Webster, “to make (a sensitized or hypersensitive individual) insensitive or nonreactive to a sensitizing agent.” Or as Bart Simpson put so well to his sister Lisa, “If you don't watch the violence, you'll never get desensitized to it.” Clearly, Bart is right (he almost always is in the end) as time and inputs play a huge role in desensitization. So my daughter’s brief, eventless life up until now and the corresponding “post-crisis” markets with growing herds of short volatility traders are not surprising. After all, she doesn’t have a phone yet and markets have been devoid of stress or volatility.
That said, over time the reality of the cyclicality of markets and life in general rarely go without some angst. We are not half-empty or sky-is-falling here at all. Just cognizant of what has gone on in this idyllic environment for long-only investors and short-only volatility traders “post crisis”. Passive investing has trounced active investing: just turn on the television and they’ll show you the data “post crisis”. Buy-the-dip and shorting volatility regardless of implied levels is always the thing to do: just turn on the television or read the paper and they’ll show you the data “post crisis”. And so it goes. The media desensitizes everyone via the proliferation of fact, fiction and opinion. The central banks desensitize everyone by purchasing assets, dampening volatility and forcing investors to chase yield. The list goes on and on.
I have been trading volatility for 27 years and have seen traders come and go. Some focused on the sky-is-falling and others focused on blue skies forever. The reality is somewhere in between, especially from a longevity standpoint. I can say that with great conviction as 10 years from now I’m pretty sure my thoughts of my daughter will not be anything close to my list today. My guess is volatility desensitizing conviction over time while currently in vogue for now will likely not be the case 10 years from now either. Stay hedged.
