May 2014: Richard 'Jerry' Haworth - Volatility has dropped to lows not seen since 2007

"There is a bubble … in complacency.” [attributed to Grant Williams, 2014]1

In a perverse way we at 36 South are happy. We have suffered the “slings and arrows of outrageous” calm extremely well and have enough dry powder to meaningfully add to the portfolio at these low levels.

Volatility is an expression of the market’s view of the uncertainty existing in the market at any one time, not its risk. Risk is discounted already in the price. Uncertainty is not something the market is good at ascertaining, it is unknown. But one thing that seems certain, the explicit price of future uncertainty as expressed in option prices, is counterintuitive. We humans, using stone-age hardwiring, accumulate belief based on time and recent experience. Thus in the face of a long secular cycle we are often the most complacent at the very time we should be fearful and vice versa.

The global credit/debt bubble has reached jaw-dropping proportions. The financial world is like a huge sugar coated balloon attached to an air compressor, pumping up the balloon at ever increasing rates. We are flies sitting on this balloon, marvelling at how over time the real estate in sugar coating just grows and grows! This is hardly a time for complacency.

Another interesting point to note is the seeming secular correlation between interest rates and volatility (albeit with the odd hiccup). Interest rates and volatility are trending lower together. This doesn’t seem right but when one looks through the lens of behavioural finance, it does. Central banks have dragged interest rates to zero which has basically taken away conservative investment options especially the older population. The hunt for yield has extended to volatility as financial product structurers do what they do, replace risks which you don’t see with yield which you do see, but not in the right proportion, thus more and more investors are effectively selling volatility in return for yield. This is akin to picking up pennies in front of oncoming freight trains but the freight train has not killed anyone yet so investors are emboldened.

Long volatility funds are now facing the best opportunity set seen since 2007, seven years later. Since 1987, black swan events have occurred almost like clockwork about every five years: 1987, 1994, 1997, 1998, 2000, 2001, 2008, …?

To sum it up:

What matter if I stand alone?
I wait with joy the coming years;
My heart shall reap where it hath sown,
And garner up its fruit of tears.
                John Burroughs (1837 - 1921)2



[1] Maudlin Economics 2014 Thoughts from the Frontline: A Bubble in Complacency [online] May 2014. Available at [Accessed on 11th June 2014].

2 Burroughs, John Waiting [online]. Available at [Accessed on 11th June 2014].