My natural reaction is twofold. Somebody should arbitrage this and if they can, I'd like a piece of the action. Some kind of options play coupled to the VIX, perhaps? (But of course, on a basic level, that's already in our toolkit. Question is, how generally rising rising volatility would influence such an approach).
Secondly, if the lessons of the past no longer apply to the previous level of safety, does that mean my index-applied backtests need to be revised?
A more important question is, what should we do if markets fall 40%. I am saving like a squirrel, hoping for a 50% fall and praying it will not last more than a year. That will be my making.
Good luck with that. Do you know the story of John Hussman. I think waiting for a major market drop is going to cost you more than riding the bull and selling when stop losses are triggered.
Definitely relevant. But the topic will only become a concern when it's too late, as you imply at the end of your post. If you haven't, listen to a podcast with Mike Green, the "passive investment" czar who works at Simplify Asset Management. This is only actionable int terms of preparedness for even higher tail risk and so highlights the importance of a good hedging strategy.
Why do the graphs stop at 2020? Of course everything is going to become more correlated when the global economy pauses. Has correlation remained up there or dropped back down to a historically normal level?
Because that's when the academic study ended. But I did a back of the envelope calculation and track the correlation in the UK and Europe. In each case, correlations have declined after the 2020 pandemic but remain at the elevated levels we see in the late 2010s before the pandemic.
what about a 'radical' strategy of avoiding s&p500 stocks altogether?
we know absolute flows into itn'l and midcap are 10-1000x smaller, but do we know whether relative flows into these other indicies are equally automated or reflexive to panic selling?
Important food for thought, thank you!
My natural reaction is twofold. Somebody should arbitrage this and if they can, I'd like a piece of the action. Some kind of options play coupled to the VIX, perhaps? (But of course, on a basic level, that's already in our toolkit. Question is, how generally rising rising volatility would influence such an approach).
Secondly, if the lessons of the past no longer apply to the previous level of safety, does that mean my index-applied backtests need to be revised?
Hypothetical: I would be curious to know how equal weighting would affect this risk. Is it a wash? Or does it compensate for it?
A more important question is, what should we do if markets fall 40%. I am saving like a squirrel, hoping for a 50% fall and praying it will not last more than a year. That will be my making.
Good luck with that. Do you know the story of John Hussman. I think waiting for a major market drop is going to cost you more than riding the bull and selling when stop losses are triggered.
A good point. What stop loss would you put for the S&P 500?
I always use 1.0 or 1.5 standard deviations. For the S&P 500 that means about 20% drawdown from the most recent high
Definitely relevant. But the topic will only become a concern when it's too late, as you imply at the end of your post. If you haven't, listen to a podcast with Mike Green, the "passive investment" czar who works at Simplify Asset Management. This is only actionable int terms of preparedness for even higher tail risk and so highlights the importance of a good hedging strategy.
Great piece, flows matter. Michael Green from Simplify in the US has done really great work on this topic, highly recommend!
Why do the graphs stop at 2020? Of course everything is going to become more correlated when the global economy pauses. Has correlation remained up there or dropped back down to a historically normal level?
Because that's when the academic study ended. But I did a back of the envelope calculation and track the correlation in the UK and Europe. In each case, correlations have declined after the 2020 pandemic but remain at the elevated levels we see in the late 2010s before the pandemic.
what about a 'radical' strategy of avoiding s&p500 stocks altogether?
we know absolute flows into itn'l and midcap are 10-1000x smaller, but do we know whether relative flows into these other indicies are equally automated or reflexive to panic selling?
We don't know.
Mike Green, as others have stated. "Professor Plum". On a lot of podcasts.
https://x.com/profplum99