top of page
  • Writer's pictureVimal Gor

July 2023 Monthly Flash Report

Updated: Feb 15

Macro Overview


The MSCI World equity index was up 3.38% in July to finish just under its all-time high and has now rallied 31.2% since its October lows. All sectors in the index were up in July with strong earnings reports from the largest banks like JP Morgan and Bank of America leading the rally. The Fed raised the US benchmark cash rate 25bps at their July FOMC meeting and now, outside of the UK, most rate curves are pricing in no more hikes and cuts starting in mid to late 2024. Clearly market pricing is implying we are at peak rates now and as long as the economic data keeps confirming the lower trajectory of inflation, they should be correct. A stable rates outlook combined with low unemployment and rising corporate profits, S&P 500 Index aggregate earnings are forecast to increase by 10% in 2024, which should keep asset prices from falling too far even if valuations remain lofty. Many economists previously forecasted rate cuts would be needed soon after the aggressive rate hikes ended because the economy will have fallen into a recession (possibly a severe one). The hiking cycle that began in 2022 has been far less transparent and driven by the need for aggressive central bank actions not observed since the 1970’s period of rampant inflation. It is difficult to recall any predictions calling for, when at peak rates, risk assets to be near all-time highs and rate cut expectations perpetually twelve months in the future. The dire forecasts have not played out in the economy or in asset prices and the need for nearer term rate cuts is not yet apparent.


While hiking cycles over the last 25 years have had relatively transparent guidance by the Fed and more gradual interest rate increases, easing cycles have often occurred more abruptly and as part of an economic and/or market crisis response. In the current cycle, the switch from near zero rates in 2021 to aggressive hikes in 2022 was not transparent or gradual. Macro-economic data releases gained outsized significance because they often upended the current central bank guidance, forward interest rate expectations, and created greater multi-asset class volatility. The increased significance of data releases during the hiking cycle can be measured with S&P 500 zero day to expiry options.


Zero day to expiry (0DTE) equity index options in the S&P 500 were listed in May 2022 and as the daily expiring options trading volume has grown, their impact on everyday price moves has increased. 0DTE’s also provide data points to measure expectations and results of daily price moves through the 1-day VIX Index. The 1-day VIX index is a measure of the implied volatility surface for the 0DTE options and is like the VIX which calculates the value of the volatility surface of one-month SPX Index options. From the one-day VIX we can estimate the expected price move on any day, like on a CPI data release, compare expectations with days that have no scheduled data release, and see how cheap or expensive the risk premium compared to the actual market move on the data release day. The following chart shows the implied one-day price move in the S&P 500 compared to the actual move on that day.


Source: Bloomberg


The risk premium of index implied volatility surface over its’ daily actual variance is evident in the graph. The average implied volatility premium over the past year was nearly 6 volatility points each day, which means the index actual daily move was approximately 38bps less than was implied from the volatility surface. On US CPI release days, the 1-day VIX jumped as much as 25 points versus the previous day implying an 1.5% additional expected daily price move. On the CPI days in the second half of 2022 the actual price move in the S&P 500 Index was greater than the implied predicted, even after the jump in the 1D VIX was signalling much greater moves. The large outliers in September and November, where the daily price move was much greater than the implied move, were CPI data release days. In contrast, over 2023 the actual moves have underperformed the implied moves by 1% on CPI days as data releases are no longer surprising market participants.


The dampened market volatility on economic data releases exemplifies the lower variance versus consensus expectations in 2023. The unexpected outcome of inflation trending lower without a recession is also resulting in a return to a lower volatility regime for equity markets. Equity index implied and realized volatility has also decreased as corporate earnings reports come in line with expectations. The chart below shows the 1-day VIX and the average one month rolling risk premium in volatility points.


Source: Bloomberg


The volatility that was caused by the uncertainty and aggressiveness of the hiking cycle may be over. In a soft-landing scenario, an eventual easing cycle could be slow, gradual, and transparent; reminiscent of the methodical US rate hikes from 2004-06 when seventeen 25bp hikes occurred. The implied volatility risk premium is still observed on lower implied volatility levels but the asymmetric payoff of selling volatility at lower nominal levels becomes less appealing.


Declining volatility during the northern hemisphere summer rally is an indication of stabilization of risk assets. The low levels of equity index implied and realized correlation is another indication of that stability and the lesser impact of macro news dictating price moves in individual stocks. The technology stock surge driven by the AI thematic has been far greater than the financial and health care sectors’ more modest gains this year. Stocks and sectors moving independently of each other and in different directions further dampens index volatility. The below chart shows S&P 500 implied and realized correlation and 1-month realized volatility.


Source: Bloomberg


The volatility that was caused by the uncertainty and aggressiveness of the hiking cycle may be over. In a soft-landing scenario, an eventual easing cycle could be slow, gradual, and transparent; reminiscent of the methodical US rate hikes from 2004-06 when seventeen 25bp hikes occurred. The implied volatility risk premium is still observed on lower implied volatility levels but the asymmetric payoff of selling volatility at lower nominal levels becomes less appealing.


Declining volatility during the northern hemisphere summer rally is an indication of stabilization of risk assets. The low levels of equity index implied and realized correlation is another indication of that stability and the lesser impact of macro news dictating price moves in individual stocks. The technology stock surge driven by the AI thematic has been far greater than the financial and health care sectors’ more modest gains this year. Stocks and sectors moving independently of each other and in different directions further dampens index volatility. The below chart shows S&P 500 implied and realized correlation and 1-month realized volatility.


Source: Bloomberg


Low realized correlation is helping push realized equity index volatility lower. Lower volatility provides technical support to equity markets as volatility control models increasingly become more bullish. Equity valuations are still historically very high and could limit further upside and thus equities could head into a narrower price range in the second half of 2023.


The economic data release volatility was certainly correlated with the large fiscal and monetary pandemic injections and then withdrawals. Economic data releases that are near expectations will remove some of the macro volatility from the past few years, similar to what has been observed this year. Stable asset prices will continue to make central banks more patient when deciding to cut rates. The improbable soft-landing outcome continues to unfold.


Digital Asset Overview


The total digital asset market cap finished July down 1.28%, largely driven by an end-of-month market fall on the back of further speculation or “FUD” regarding Binance US operations, as well as broader macro headwinds from weakening Chinese economic data and the BoJ’s change in monetary policy. Bitcoin, which has mostly outperformed the broader digital asset market this year, fell 4.06% for the month after the “BlackRock ETF” momentum from June faded. Many alt-tokens finished July higher following Ripple’s ruling in the US, which offset Bitcoin and Ethereum’s price declines on the overall market.


The favourable ruling in Ripple’s case with the SEC, which found the XRP token to not be a security, pushed many alt-tokens higher in July. The negative sentiment from the overhang of US regulatory actions towards the alt-sector eased following the news and provided optimism that the SEC actions will not hold up in court. Leading alt-layer ones such as Ripple, Solana, and Cardano, as well as Ethereum layer-2’s Optimism, Arbitrum, and Polygon, all finished higher, with Ripples XRP up near 50% for the month. Further US regulatory clarity could further support the bullish recovery of the alt-token market.


As outlined in our macro commentary, the biggest (unexciting) takeaway from July was record low levels of volatility and spot liquidity. Bitcoin’s realised volatility is currently at levels not seen since 2017, and a Goldman Sachs report found that spot volumes for Bitcoin and Ethereum were down near 25% MoM, and down 53% and 77% YoY, respectively. The below chart shows the downward compression of ATM option implied volatility, verified by the tight range of Bitcoins price since March this year.


Source: Glassnode


The Bitcoin “HODLers” accumulation trend continues, as supply held by long-term holders reaches all-time highs at above 75%. One cohort of this group we pay particular attention to are holders of between 10 to 1k BTC (aka the fish and sharks). These are generally HNW investors, institutions, or trading desks and together represents sophisticated investors. The below shows their continuing upward accumulation trend.


Source: Glassnode


In the stablecoin market, Tether and Circle, the companies behind the leading USDT and USDC stablecoins, announced record profits for the first half of the year, driven by higher returns from treasury and money market investments. Tether once again announced it would look to allocate more of its excess reserves into Bitcoin after it reported operating profits of over $1B for the period of April-June 2023. Meanwhile, PayPal announced it would launch its own stablecoin in early August, yet another move by traditional finance players into the decentralised finance space.


Bitcoin reserve accumulation can also be large methodical buyers of Bitcoin. The US-listed software company MicroStrategy announced it is looking to raise up to $750m by selling stock to buy more Bitcoin. As of the end of July, the company owned over 152K bitcoin and is one of the largest holders of the asset. Microstrategy, Tesla and now Tether, are pioneering the “Bitcoin on balance sheets” movement. Looking forward, with further regulatory clarity and spot ETF approvals, we believe these early adopters could pave the path for other corporates to allocate depreciating cash reserves to Bitcoin, which to paraphrase BlackRock CEO Larry Fink, is quickly becoming a globally accepted digital store of value.


If you’d like to speak with our team about any of the above market views or to discuss our Funds further, please reach out via investor.relations@trovio.io.


2 views0 comments

Recent Posts

See All

Comments


bottom of page