Holiday Party Risk Management

For many, the Holiday season brings an equal measure of loathing and loving – especially when the subject of the office party or family gathering comes to mind.  Whether it’s the indignity of forced merriment, navigating around a weird uncle plus a few drinks on board, auntie’s marshmallow fruitcake concoction, to humiliating party games, holiday gatherings can often be an emotional minefield.

Annoying party attenders is a certainty, though they can be so in different ways. One of the more common spirit dampeners is the “investment windbag.” The person who you wind up seated next to or cornered by who, like a preacher from his pulpit,  feels quite free to hold court on his market gallantry and yet is unable to concede anything that may contradict their point of view.

When changing the subject won’t work, I have developed a general list to assist you in the identification, disarming, and coexisting with this charlatan.  You don’t need to believe them, react to them, or agree with them at all but won’t if be fun to be the person who actually has the facts.

Topic: The Federal Reserve and their Fed Funds rate forecast.

Keywords:  Federal Reserve, FOMC, Fed Funds Forecast, Janet Yellen.

Facts: It is true that the year-end 2016 median fed funds forecast by FOMC members is 1.3750%; a lifetime away from the current .375% and much higher than the .92% implied by Eurodollar futures.

• This is a median forecast by FOMC members and one that has been higher than the market consensus for eighteen months.
• The rate implied by both Fed Fund futures and Eurodollar futures has consistently been well beneath the market.  In fact, the odds of a December, 2015 hike dwindled below 50% after the mid-September meeting.
• It would be easier for the markets to digest the FOMC gently lowering their long-term interest rate projections than abruptly raising them.
• Energy and its disinflationary effect is masking a sturdy media CPI and non-financial credit growth.  Perhaps inflation is higher than consensus thinks?

Topic:   2016 commodity price projections.

Keywords/phrases: “I cannot think of any good reason why commodities will bounce in 2016” etc. etc.

Conceivable outliers to disagree otherwise:

• Faster than anticipated recovery in oil supply balance via. cataclysmic weather event, political disruption, civil war. 
• A large reversal in the U.S. dollar due to above consensus economic growth outside our borders.
• A new cartel to support prices and enforce supply cuts.  If it can be done with cocoa and rubber prices than it surely can be done with industrial metals.
• Creative economic growth stimulus measures through direct intervention (stockpiling) of commodities or the incentive for building massive infrastructure projects.

Topic:  Equity market volatility

Keywords: The VIX or “Fear Index”

Facts: Although the VIX is computed from liquid options prices on the S&P 500 index, it is neither in relation to implied volatility resulting from these option prices nor is it in relation to expected volatility of the S&P 500 stock index.

• The best way to decipher the VIX, which is connected to S&P 500 option prices across a substantial series of strikes, considers the level of volatility “smile” at any one given point in time. In a chart of volatility values, if the VIX goes up, the S&P 500 index appears to have a broader smile.
•  This is because options contracts that are in the- money and out-of-the-money will have a higher implied volatility than at-the-money contracts. Hence the smiley face curve. A lower VIX value makes the S&P 500 volatility values more somber, at least in the diagram.
• Bottom line: the VIX is a good indicator of the shape of the supply vs. demand of equidistant calls and puts of the S&P 500 index.

Topic: One-liner defense against the over reliance of “heady” mathematical terminology.

 Keywords: Probability, Back-tested, Algorithm, Value-at-risk (V@R).

Facts:

• Probability or odds – you cannot speak to distributions without also talking about processes within the distribution.  A process is a distribution that has time in it and things change with time.  Probability and odds need to be left with issues that have finite outcomes.
• Value-at-Risk: V@R  – Value-at-risk (V@R) is an attempt to predict the future using the past.  Perfect for card games but not so with predicting the economic debacles including the “Great Recession”, “Tech Bubble”, “Russian Ruble Crisis”, etc. etc.
• Correlation – with enough imagination one can imagine a relationship between any two items if you look hard enough – including the “January Effect”, “Super Bowl Indicator” and “Hemlines”.  A correlation is a correlation until it’s not.
• Back-testing - We know what happens from the events of the past – the future is unknowable.  We are quite good at unconsciously editing or extending past experiences in such a way that memories slowly morph to be in better agreement with what we believe to be true.

Topic: Portfolio diversification

Keywords: Diversified, volatility balanced, or market neutral.

Facts:

• A portfolio that is diversified within stocks and bonds is diversified some of the time but not all of the time and definitely not when you mean diversification most.
• Diversification is not effective when you are up against a clock or calendar. You are setting yourself up for large whipsaws as markets do not follow a calendar.
• Stocks and bonds are convergent strategies; history has shown that offsetting with divergent strategies (i.e. managed futures, global macro) has reduced return redundancy.

Topic:  Party-goer who creates any false sense of urgency by claiming a very limited opportunity, overly willing to offer a big cut in commission, claims of being with a reputable firm, or dangling any prospect of immediate wealth.

Keywords/phrases: “gas wells or mines are guaranteed…”, “this opportunity is only available until tomorrow...”, “I have my entire family and church invested…” etc. etc.

Facts:

• There is no free lunch.
• If it sounds too good to be true, it probably is.
• If this “party ham” is so certain, why is he offering it to you?
• Investing in knowledge pays the best interest.
• A fool and his money are soon parted.

Next Steps:  Run!