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Anchor 1


The China Call Option.

December 2022


  • Don't forget about China

  • Muted inflation in China

  • Korean Won risk reversal is a window into Chinese economic health

  • Inflation may continue outside the U.S.

Understandably, investors have been focused on the Fed and U.S. economic inflation data. We would like to draw attention to the impact of China’s zero-COVID policy resulting in unusually weak inflation in China. The chart below (“Chart 1”) shows that Chinese inflation has been loosely correlated to U.S. inflation until the onset of COVID. This is when U.S. inflation began to rise as Chinese inflation began to fall.

Source:  Tallbacken Capital Advisors L.L.C., Bloomberg L.P.

It is difficult to say whether the widespread protests or a weakening economy are the catalyst for change in China. Either way, it has raised important outcomes from supply chain shocks for U.S. companies/consumers to the risk of political upheaval. China has made the decision to loosen COVID restrictions and the Yuan has strengthened, and Chinese equities have rallied (“Chart 2”).

Source:  Tallbacken Capital Advisors L.L.C., Bloomberg L.P.

As we look across assets, specifically the options market, we identify an important relationship between the Chinese economy and Korean Won risk reversal, the spread between calls and puts. Korea has a sophisticated open capital markets system with substantial exposure to the Chinese economy. Historically, when the Won risk reversal surges (Won protection), it coincides with a downturn in the Chinese economy. This was never clearer in the Chinese Yuan devaluation in August of 2015. Today, the lower Won risk reversal spread points to less regional stress and a healthier economic outlook for China. In “Chart 3,” we observe a stable Won during the recent Chinese protest.

Source:  Tallbacken Capital Advisors L.L.C., Bloomberg L.P.

Finally, in “Chart 4,” we overlayed the dollar (DXY) with the Won. This chart shows periods of correlation with a spike at the dollar peak in late September 2022. Since that time, the weakening dollar has led to further Won spread compression. Said another way, the U.S. dollar has had a greater impact on Asian markets than China’s unrest. Take away: China growth coming back online could be a spark to reignite global growth. This could lead to improving EM equities and increasing commodity prices which could impact the Fed’s terminal rate. How fast will this all play out, patience my good friend.

Source:  Tallbacken Capital Advisors L.L.C., Bloomberg L.P.

Anchor 2


October 2022


The VIX reached a higher peak in October than it did in September. Interestingly, in the second half of October, the VIX then steadily decreased as the U.S. equity market rallied more than 8%. For its part, Treasury volatility also came in during the latter part of the month, but for all practical purposes, the MOVE index (a VIX for the Treasury curve) did not come in as much as the VIX (Chart 1).

Source:  Tallbacken Capital Advisors L.L.C., Bloomberg L.P.

If we look at the long-term relationship between Treasury volatility and equity volatility (Chart 2), we can see how unusual the last two and a half years have been. In the aftermath of the Fed’s emergency response in the spring of 2020, the MOVE index fell to record low levels and remained there throughout 2020. In 2021, the MOVE index normalized to pre-COVID ranges, and this year, the MOVE has surged to record high levels. The VIX, on the other hand, remained elevated throughout 2020 and 2021, and while it remained in the higher range this year, it has not exploded even higher with the bear market. The MOVE/VIX ratio, shown in the bottom panel of Chart 2, has oscillated between record lows to the current record highs.

Source:  Tallbacken Capital Advisors L.L.C., Bloomberg L.P.

Why is Treasury volatility expanding so quickly in 2022?  An obvious reason, the Fed has undergone an extreme pivot in monetary policy over the past year. Currently the futures market is pricing in eight more hikes (an incremental 125 basis points after the just announced 75 basis points) to a “terminal rate” of about 5% which is anticipated to be reached in May of next year.  If this plays out as currently priced, this hiking cycle will be the second most aggressive on record in terms of both the number of rate increases and the speed of those rate increases. The fact that this hiking cycle started at an incredibly accommodative level underscores how strong a policy shift this has been, and why the rate volatility has been so high.


There is another dimension to this sustained rate volatility. Chart 3 shows the market pricing of the terminal rate increasing steadily this year (the blue line) alongside the number of months that the terminal rate is expected to reach. Since June, the timing of the terminal rate keeps getting pushed back. With no clear end in sight to the end of the hiking cycle, we think it is intuitive that rate volatility will remain at these extremely elevated levels until the Fed sends a signal to the market as to when the rate hikes will end or at least be paused. 

Source:  Tallbacken Capital Advisors L.L.C., Bloomberg L.P.

Clearly, when the Fed decides to stop raising, we should see a reduction in both rates and rate volatility. There is another scenario to consider:  the Fed hikes toward market expectations and then “sits on” the terminal rate for a long period of time. That would presumably bring down inflation and rate volatility. Once we see lower rate volatility, then we believe the equity market will be able to sustain a less choppy condition. 

Anchor 3






The Fed will succeed.

October 2022



Dispersion abounds. While U.S. and European equity markets produced a strong recovery in October, Asian and the broader emerging markets lagged substantially. Similarly in the U.S., the Dow Jones Industrial Average was up just under 14% while the Nasdaq 100 was up less than 4%. Earnings in the old economy stocks, led by JP Morgan and Exxon Mobil, substantially outperformed the likes of Microsoft and Amazon. S&P 500 P/E has firmly established a low at ~15 with the “E” is moving markets higher. All of this good news for the equity markets occurred as the Fed reaffirmed its commitment to stomp out inflation and as the US Aggregate Bond index sunk lower to finish the month down 1.3%.

A lower CPI number and a meaningful number of lower real estate transactions showed that the Fed’s efforts are starting to have their desired impact. One metric that remains strong is employment. This will allow the Fed to continue to move terminal rates above 5%. We certainly didn’t expect equity markets to hold up this well given the speed and ferocity of the rate rise. Should a soft-landing not happen, we can all take comfort in the fact that rates above 5% will afford the Fed sufficient ammunition to fight a recession. So, we expect the Fed to speak softly while they continue to wield their big stick.

Another interesting phenomenon is the dollar weakness, largely driven by the Fed hinting at a terminal rate. The DXY was down 0.53% in October. We believe that dollar weakness and reevaluation of crypto will lead to a rally in the most hated asset in recent history, gold. Drop the mic!


Working toward stability.

  1. VIX continues to grind lower. Implied volatility is pointing to a more stable market environment for equities. Moreover, as the Fed’s hiking begins to subside, stabilizing the rates market, investors who have been underweight equities will likely become buyers who aid the VIX’s continuing decline.

  2. Downside is limited because the Fed’s ability (dry powder) and willingness to change direction. If the Fed believes that it has gone too far too fast, we believe it will make the appropriate adjustments. Reenter the Fed Put. Before that happens, we expect to see bad actors and unprofitable growth businesses exposed. We do not anticipate a V- or U-shaped equity market recovery, but rather a sideways market with an upward trend over the next 12-24 months. Aligning with above point, we anticipate that the VIX will migrate below 15 in 2023.

  3. Bad behavior in the options market. Currently, 40% of the SPX volume is in 1- and 2-day options. As longtime option practitioners, we view this as gambling, not investing. We do not believe that this is a sustainable investment strategy. As these temporary entrants go away, again, the VIX will continue lower.

  4. Tiptoeing backwards out the door. Having failed at a ground war, a draft, a reengagement, and drone attacks, Russia is shifting its attention to its only remaining leverage over the U.S., Brittany Griner. In thinking about possible tail events that could jolt the VIX, we do not expect Russia to engage with nuclear weapons, nor do we anticipate an invasion of Taiwan by China. If either of these happen, the shock to the VIX will be the least of our worries.






Stickier than any of us thought.

September 2022


Inflation is stickier than any of us thought, and the Fed is determined to wipe it away. Traditional inflation-linked assets are not serving as a proper hedge. Last month, gold was down 3.14%, oil was down 11.23%, TIPs (ETF) were down 7.91%, and REITs (IYR ETF) were down 13.62%. U.S. equities (S&P 500) had the worse month of the year, down 9.34%. Bonds continued to provide no protection with 10-year note futures down 4.14% and 30-year bond futures down 6.95%. As noted in our April 2022 Commentary, and again in our May 2022 Commentary, a 4% 10-year treasury yield would make for a very interesting environment . . . and that is where we are. Since the GFC we have kept rates low, afraid of repeating the mistakes of the 1930s. Today, post the pandemic stimulus, we are raising rates to prevent the mistakes of the 1970s. We continue to believe that strategies that benefited from low to falling rates are going to have issues: growth tech in public equity and risk parity funds in fixed income. What is the next shoe drop? It is difficult to say. Who expected LDI issues in the UK pension fund market? The key question is, what is the driver of outperformance? If there is leverage, where does it come from and does it make sense to continue to invest that way? Will investors accomplish their investment goals with higher rates? One last thing, if Yellen is talking about liquidity of treasuries, please think about liquidity across all asset classes and investments. We believe that investors should trade when you can, not when you have to!


We are not big believers in equity tail hedges. If you are one of the select few that owned tail hedges on bonds and currencies in September, kudos! We are now seeing implied volatility in currencies and bonds in the top 10% of historic levels. The result of unwinding fifteen years of bullish Central Bank policy. Now, where do we stand? We are much more constructive on U.S. equities with the SPX at 3600, P/E of 15, 10-year yield at 4%, and the VIX at 32. Looking back at the 1994 through 1995 Fed actions, yields had dropped from 8% to 5%. In 1994 the Fed raised rates which brought the 10-year back to 8%. In 1995, the FED lowered rates to 6%. Why is this important? At that time, the SPX P/E was 15, granted we had just come out of a nasty recession prior to 1994 and things were looking up. What we find most interesting, is that during this time the VIX was 12-13 and skew was incredibly flat. Consider this in comparison to the current environment, VIX at 32! Said a different way, we are still committed to the theory that equities will remain in a range, at least for the short term. The economy is still cooking and while I write this, we are seeing good earnings in old economy stocks, not semi-conductors, but staples. If the E in P/E doesn’t come down, like many are expecting, equities will likely see significant upside because so many large pools are very underweight in public equites. I think that there is a good chance that this year may be followed by a 1995 style rally. In fact, it may have already started!






August 2022


This year continues to be demanding, with extreme moves across all markets. At its highest point in August, the SPX was up 4.5%. It sold off almost 9% from there, to finish the month down 4.2%. This followed a 9% up move in July and 8.4% down move in June. What is telling is that the SPX hasn’t really gone anywhere since the major sell-off in April. While the SPX has been volatile and it has been a challenge to manage risk, the SPX hasn’t really given up much in the way of level since the middle of the second quarter.

Following a big move in March and April, the 10-year note is hovering around 3%. We have seen yields as high as 3.5% in June and as low as 2.5% in August. Our view is that 2.75% - 3.25% is a reasonable range for the foreseeable future.

Commodities continue to struggle as gasoline futures dropped 25% in the month of August. Comparisons have been made to 2008, where a recession led to a commodity sell off. We don’t think that will be the case this time. In fact, we believe that it is simply the end of the summer travel season and don’t expect demand to pick up anytime soon, as folks are committed to working from home at least part time and limiting business travel as part of our new realty.

Lastly and most importantly, the dollar continues to go higher, up 2.64% against the DXY basket on the month. We continue to believe that the dollar strength comes from the U.S. exporting energy. We are sticking with view that the fourth quarter will continue to be a roller coaster across equity and fixed income markets, though we may end up in the exact same place that we start.


Everyone is asking, why doesn’t the VIX go higher?

First, this is a market about positioning and not fundamentals. In other words, we go higher when investors must buy, and we go lower when investors must sell. Investor’s positioning, both gross and net, continues to be light. We experienced this in 2009. If investors are light on positioning, they don’t need to buy insurance, since they have very little to insure.

Second, the realized correlation within the SPX is very low, i.e., energy vs tech. The way this works:  as the price of oil increases, oil stocks rise, bonds fall, and the dollar strengthens. This has been broadly negative for tech stocks. Conversely, as the price of oil decreases, oil stock falls, bonds rise, and the dollar weakens. This has been broadly positive for tech stocks.

Third, realized volatility is not that high. The 100-day is 26.36, the 50-day is 19.60, the 30-day is 19.64, and the 10-day is 17.50.

Finally, we haven’t had any issues in the credit markets, to date. In our opinion, it is difficult to justify a VIX above 26, with relatively stable credit markets.

So, why all the equity volatility in the first place? In a word, trading. This is a trading market. The best performing funds this year are CTA, Macro, and multi-strategy trading funds. These strategies have attracted new money, which means more trading. Based on our experience as traders, and the current VIX, our belief is we are moving into a wide range. Yes, a range. The equity premium will not see the quick reset most market participants are expecting, SPX 3000, but more a range for longer than many anticipate. This will take equity risk premium down. The VIX will continue to fall as trading groups get chopped up trying to trade trends, buy highs and sell lows. One of the many things that we observed on the trading desk when our team was on the sell side was investment strategies that did the most future/ETFs trading volume in a one-year period struggled and even closed its doors the next year, without the sustained market volatility. That is where we are now.






Is there a better alternative?
Q3 2022


Mechanically, high-yield bonds have the same features as other types of bonds. They have a scheduled maintenance payment, a principal repayment at a specified maturity date, and in some but not all cases, maintain priority over other obligations in the capital structure. While the maintenance payment (or coupon) is typically fixed, the value of the bond is determined by the market’s assessment of the probability of repayment.

The Fed’s plan to tighten monetary policy and tighter regulation discouraging broker-dealers from taking risk, has led to less liquidity in the U.S. stock market and exacerbated daily moves.

Download PDF






Well That Fixes the June Problem
July 2022

The S&P closed the month of May at 4132.15 and the month of July at 4130.29, with plenty to see in between, and with the VIX hardly at zero! It’s been a wild ride. In the short-term, I believe we have reached a top in commodity prices and inflation. The 10-year Treasury has found a “happy place” between 2.75% and 3.25%, and as discussed last month, earnings have not been as bad as many anticipated. The last few months have been a trader’s market, and not an investor’s market – and certainly not for the faint of heart. I believe we will drift around here with an upward bias until we have better visibility into the fourth quarter. I also believe that the fourth quarter will be one direction, up or down. Funny thing, at this point, I am leaning more bullish and could easily be convinced of an S&P at 4600 at year end, largely due to the new mixture of growth and value in the S&P today. I am still negative on growth tech and poor cash flow companies >> that check has not been cashed.


Currently, the VIX remains above 20, which is understandable and reaffirms that there is sufficient uncertainty to once again say that we are in a trader’s market rather than an investor’s market.  

The MOVE index, fixed income’s version of the VIX, fell from 150 to 120 in July. This is a significant, as the market is telling us that it is comfortable with the current path of the Fed and sees more certainty in the rates market going forward. The most telling metric continues to be the CSFB Fear index, which measures the market for skew. It started the month of July at 16.65 and ended the month of July at 16.79. This means that investors are not buying downside protection. In my opinion, this is resulting from a combination of two things: Investors remain underweight in their equity exposure but are now buying upside calls to synthetically increase market exposure. My experience has shown that while bullish, this is a very low conviction trade. Nobody is convinced that this rally will continue! 






No Place to Hide
June 2022



Diversified portfolios had another horrible month, the S&P was down 8.25%, the Barclays [Bloomberg] Agg was down 1.73% and GSCI was down 7.64%.  The one major asset class that was positive on the month was the U.S. dollar. The DXY was up 2.88% on the month and, on the year, the DXY is up 9.42% with the Dollar/Euro moving towards par.  I think this is a meaningful development as folks seek to resurrect the 1970s-style stagflation conversation. In my view, there are two major differences between today and the 1970s. First, in the ‘70s, we had recently moved off the gold standard. Eliminating the peg drove the dollar much lower against other world currencies. Second, at that time, the U.S. was a net importer of commodities (especially oil) and was dealing with the newfound might of OPEC and thus weakness in the dollar had a major impact on inflation. Certain commodity prices are spiking again but this time, we are a net exporter, and the case can be made that the that the US dollar is benefiting from higher oil prices. Another important factor is that earnings are transitioning from New York and San Francisco to large oil-producing states like Texas and North Dakota. The pundits seem anxious to call a recession when, in fact for the time being, we are dealing with a war launched by a Petrostate and adjusting to a world of higher interest rates and more expensive capital. As for a recession, that remains to be seen.


Volatility has not been moving higher as the markets sell off. The CSFB index was trading below 16 just prior to month end, which means that investors are selling puts. Skew, the difference in implied volatility between out-of-money calls and out-of-the-money puts, as reflected in the CSFB index, has only been lower when we hit rock bottom in 2008 and 2020. The challenge with this “rock bottom” thesis is that the VIX was close to 80 during those times, not 30! Another meaningful observation is that the correlation between equity asset classes has been very low, with value and growth moving in different directions, Energy and Tech are the obvious example. This has been slightly different with Energy stocks selling-off with oil and credit is finally starting to show signs of weakness. If we continue to see follow through in these areas, we expect volatility to push higher. Said another way, we expect credit to take the lead of the near-term direction of the market.

Finally, I am genuinely concerned about the market pundits’ commitment to recession. While there are some unusual behaviors in the market, in my view, the bad news is largely reflected in the equity market pricing, and I am genuinely constructive if credit stands its ground. However, if credit weakens, I see the VIX escalating, and equity market exposed to further downside. The fourth quarter is going to be very interesting!






Protect your gains and stay in the game
Q2 2022


Buying outright puts to hedge equity downside can be costly and a constant drain on portfolio returns.

  • The Put-Spread Collar is the popular form of portfolio protection.

  • Passaic’s Hedged Equity strategy is a low-risk equity strategy that seeks to provide capital appreciation through equity market participation while limiting the downside.

  • Passaic’s approach to implementing a put-spread collar is driven by an informed understanding of option market dynamics which includes a proprietary view of implied volatility, term structure, and skew dynamics.

In this piece, we will briefly explain how various defensive options strategies and passive option indices work and why Passaic Partners’ tactical dynamic approach produces better risk-adjusted returns with transparency and liquidity.

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May, a Month to Remember
May 2022


May was a month to remember. The 20th marked the low in the S&P 500 futures at 3807, down almost 8%. The futures then rallied all the way back to finish the month unchanged. Nasdaq’s trough was significantly worse with a myriad of high flying Covid tech names getting destroyed. The recovery in the Nasdaq fell a little short of getting the index back to unchanged. Fixed income, which has seen incredibly high volatility this entire year, settled down with the Fed seemingly finding a ‘happy place’ with 10-year Treasury rates floating between 2.75% to 3.25%. Given the choppy equity markets, I suspect that we will see some very differentiated returns among managers this month.

What does this mean? If we hold here, shy of 4% in the 10-year, the market will maintain a downward range. 3800 to 4400 is a reasonable expected range with 4275 as single point of reference. If inflation continues higher, pushing the 10-year to 4%, all bets are off until we hit 3400, the pre-Covid high.

The one thing that is making the ole market maker nervous is liquidity. In their last meeting notes, the Fed expressed concerns about liquidity in Treasuries. As the saying goes, if the Treasury market catches a cold, the equity market could get pneumonia. 50- to 100-handle days in the S&P are not healthy for markets or investors. Electronic markets and regulation have significantly reduced the number of capital providers and market-makers. Market-makers will not provide the liquidity advertised during periods of high market volatility, particularly outside of the top fifty single-name stocks and when investors need it most. Should the summer prove to be less volatile, it may be the right time to think about improving the liquidity of your portfolio. Is there sufficient liquidity to add risk? In this type of market, Liquidity should trade at premium and Illiquidity should trade at a discount. But that is just one person’s opinion.






And The Hits Just Keep on Comin'
April 2022



In April, the S&P 500 Total Return index was down 8.72% and the AGG bond index was down 3.95%. Derivatively, a 60/40 portfolio is now down 11.61% on the year. While not news, it is the worst four months of performance for a 60/40 portfolio in decades. As we have forecast, we are now seeing bonds and equities with strong positive correlation. It is also safe to say that the bull market in bonds, which has existed since 1982, is now over. This is not going to change anytime soon as the Fed and the marketplace deal with negative real rates. This extreme circumstance is also prevalent in developed countries in Europe and Japan. I find one of the most interesting barometers has been the Yen. Dollar/Yen was up 6.57% in April, following a move of up 5.83% in March which is a massive move in a developed currency. For a country that imports all its commodities in dollars, that is going to create huge inflationary pressure. Point being, as bad as inflation is in the US, it is significantly worse in Europe (Ukraine war) and now Japan. The days of low inflation and interest rates are over and now we’ll see if central banks willing and capable to deal with it. More importantly, are investors’ portfolios ready for this significant change? Is the move in 60/40 and the high correlation of equities to bonds just the beginning of things to come?


We typically focus on what is happening with equity volatility and, to a lesser extent, other asset classes. 2022 is proving to be a year where focusing across asset classes and regions is becoming more relevant. For now, let’s look at interest rate volatility in the U.S. The “MOVE” is a volatility index created by B of A and ICE that tracks 1-month treasury volatility over a 2-, 5-, 10-, and 30-year treasury options. Above, we discussed how bonds are now in a bear market. The MOVE index confirms, like with equities, that as bond prices have gone down, the volatility of bonds has gone up substantially. The MOVE index was up 10.43% in Jan, up 17.92% in Feb, up 6.45% in March, and up 20.13% in April. While we are seeing uncertainty in equities with a higher sustained VIX, the increase in Treasury volatility is showing even more uncertainty in the rate market. With the 10-year hovering around 3%, market uncertainty, as seen through option volatility, has increased substantially. Our view, as stated last month, if we can hold 3%, the equity market will likely continue to trade in a downward trending range. If it looks like the 10-year is moving more towards 4%, the equity markets could get very ugly.






After Three Decades

March 2022



March was one of the more interesting months I have experienced in my three-decade career. The war in the Ukraine has created major supply issues in commodity markets, outside of just oil. While most investors were focused on oil, nickel was the real surprise. The London Metal Exchange shut down nickel futures trading due to a short squeeze caused by one large producer. This situation undoubtedly warrants more attention than a simple commentary. My view is that market oversight of the EV related commodities will have to be more stringent, particularly as their impact on global economies will eventually become as important as oil.


Market volatility remains high. Market participants do not want to be short volatility, with the war in Ukraine, despite the Fed’s ambition. The Fed has now formally introduced the “Fed Call,” as I described in my last piece. The Fed Call and the well marketed “Fed Put” are going to keep the market in a range. The Fed will continue to raise rates to lower inflation; they will also attempt to manage volatility to help to calm investors’ nerves. Unless the Fed loses control of this narrative and rates exceeds 3%, the market will remain in a range. I expect this range to be slightly downward trending, unless a more significant rate hike is required. We are not naive to the fact that there are many factors influencing this story, but the Fed, currently, is the most important factor when it comes to the VIX.






February 2022 - Monthly Update



It is difficult to talk about volatility markets with what is going on in the world today. My hope is the war comes to a peaceful solution quickly and we can look back at all of this and think it was just a bad dream. With that hope, it appears that the market dynamics have become more complicated. In addition to the war, we can now say that we are in a much higher inflation regime and that rates really have only one way to go, which is up. That doesn’t leave the Fed much of a put anymore. We can also say the peace dividend of the 1990s is now gone. This likely means the PE ratio of markets will have to go lower. We can see in gross and net numbers of hedge funds that managers are not just reducing net exposure, but also gross. This shows itself in the options market through the skew numbers or the CSFB. As I write this, the CSFB is in the mid-20s. In other words, as people take off risk, they are reducing hedges. You don’t need a hedge if you have less exposure or are in cash. My thinking is we are in a bear market with some violent bear market rallies. With the VIX already high, I think the selloff will be more drawn out than we are accustomed to in a typical bear market. And one school of thought is that we need a good case of fraud for any bear market to end, so I am waiting for that! 2022 is likely to prove to be a tough year.

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