#202: The Doctrine of the Mean

28 years today, the strongest man I ever knew ended his life. My dad was a man of integrity who taught me the value of doing the right thing. A few years ago I wrote a very personal note on LinkedIn about the struggles we all battle. On the anniversary of his death, I wanted to share this note again. You can read it here.

Aristotelian philosophy promotes the idea of moderation, as the great philosopher wrote about in his Doctrine of the Mean. I wish to spotlight 2 ideas where I see extreme behaviour that is presenting a high probability risk-adjusted return. I will start with the more abstract one.

The VIX index measures the expected volatility of the S&P 500 over the next 30 days. As you can see, it is low at 14.69%, “implying” that the market is not expecting anything dramatic. This is where things get interesting. The Skew Index measures the implied volatility for out-of-the-money options that are 2 standard deviations away from spot. The skew is trading near all-time highs, meaning that the market is anticipating a black swan-type of event. I added a ratio of SKEW vs. VIX, which is a way of looking at the cost of out-of-the-money options (SKEW) versus in-the-money (VIX).

There are a number of ways to trade this theme, which is beyond the scope of the newsletter.

Coming back to the spotlight theme of moderation, or lack thereof. Value is about to break to 30-year lows versus growth. Personally, I don’t think that ratio will hold, which means we are likely to get even more extreme. This is a trade idea I like, but it is one that is extremely difficult to time, and you will probably need to get some exposure and keep adding to it if it gets more extreme.

Another example of valuation extreme is Tesla’s forward PE is now 136.

Continuing the theme of moderation being an ideal, we are witnessing with Fart Coin one of the greatest extremes I have ever witnessed. In nearly months it is close to having a market cap of $1 billion.

I want this post by Saylor on my newsletter timeline as another textbook example of excess. This guy, in terms of his capital raise mandate, is gladly buying $1.5 billion of Bitcoin at all-time highs and quoting that nonsensical concept of BTC Yield of 72.4 YTD. Take note: for all the pain he has endured, he hasn’t even doubled his money in 10 years with an average cost of $61,725. He is far smarter than I am and richer, but I still believe this whole crypto thing has gone too far.

There is something brewing in China. All is not well there despite their 10-year bond yield strengthening. I don’t have more data than a year, but this is the biggest 5-day rally of the year. Remember bond yields move inversely to their price. Could we be witnessing the beginnings of deflation?? Looks like we have a new carry trade leg.

Finally, the reverse repo balances are at their lowest levels since 2021, down to $110 billion. The Fed has said for some time it wishes to bring it down to $0 to help stimulate the economy by getting banks to remove their excess deposits sitting at the Fed.

I bet you weren’t expecting to see that the famous Dow Index is down 8 days in a row for only the 12th time in 50 years. The last time this happened was 2370 trading days ago.

For those who are new to the letter, the shading is Z-Score adjusted so that only moves bigger than usual for the symbol are highlighted.

The post #202: The Doctrine of the Mean appeared first on Signal2Noise.