Thread by @jam_croissant

1/x Alright, if you haven’t read @choffstein most recent piece, do it. & if you have, go read it again. It speaks to a concept that I‘ve been preaching for 4+ years now. & if you’re involved in fin markets, even tangentially, I don’t think there‘s a more important topic right now

https://twitter.com/ksidiii/status/1305281957627072515

2/x The main thrust of the piece points, rightfully so, to 1) Federal reserve liquidity & a) The moral hazard that it causes (due to the fed put) & b) the scarcity of opportunities that it creates.These 2 pressures drive massive market wide compression of risk premia by way of

3/x forcing participants to move up the risk curve, increasing carry trades & the leveraged selling of convexity. The net effect of this is to move all risk from local variance, to the tails. As Corey, is fond of saying , ‘risk cannot be destroyed, only transformed’.

4/x The net result is mismatched leverage/liquidity on the wings with less probable yet significantly more dramatic tail events... 2016 & 2017 were the first obvious signs that this had become the essential driving force in markets as 2017 RVol was 30% lower in the SPX than any

5/x other time in history. Not in 50 years, not in 100 years... EVER... but the important part to understand is that low idiosyncratic risk wasn’t the driver. Correlations were the lower than any other time in history. Not in 50 years, not in 100 years... EVER...

6/x this is no coincidence.Idiosyncratic risk was alive & well. But SPX was pinned, due to the lowest Ivols in history. & when the indexes are pinned & 1 stock reports a cure for a disease or a case of fraud, by definition, another stock has to move in the opposite direction.

7/x So with Risk Premia compressed & longterm liquidity guaranteed to companies otherwise incapable of surviving liquidity crises, the rise of the large growth name as winner is no surprise.Companies like Amazon, Tesla, and Uber (or any well healed SPAC) can easily access capital

8/x as they do not need to generate cash flow to support operations and can actually make long term growth investments & take loss leaders in order to disrupt & crowd out other players. This untethers them (& broadly the market) to short term market realities & allows them to

9/x diverge from reality for extended periods of time (WeWork).This momentum factor, as @choffstein points out, is a divergent strat & the secular move to passive as @profplum99 has pinpointed as another driver of this trend reinforces & institutionalizes these trends to extremes

10/X The end result is a market that is built on a strong liquidity bubble. An almost impermeable ballon, floating higher & higher, seemingly safe & protected by the watchful eye of the fed & its reinforced low risk premia liquidity casing...

11/11 But idiosyncratic risk doesn’t disappear. Viruses happen, wars happen, elections happen, inflation happens, & politics happen.... And it’s a long way down when they do....