Daily Agenda: Debt Concerns Hang over Improving Chinese Data

Economic data overshadowed by IMF warning; Microsoft to buy LinkedIn; Symantec to acquire Blue Coat; Blackstone raises long-term fund; MKM’s Strugger on volatility prospects.


Data released over the weekend provided evidence that the People’s Bank of China policy has helped China’s economy find its feet even as a painful transition away from debt-fueled investment continues. Industrial production rose by 6 percent year-over-year in May, while retail sales grew at a 10 percent pace versus the same month in 2015. Urban fixed investment levels were softer than consensus forecasts at an expansion of 9.6 percent—the lowest year-over-year expansion since 2000, helping to send equities in Shanghai lower even though many analysts view slowing investments into industrial sectors that are already operating at overcapacity as a net positive. Investors, however, wonder whether growth levels can be achieved that will support the massive private-sector debt load acquired during the prior credit cycle. In a speech in Shenzen on Saturday, David Lipton, a deputy managing director at the International Monetary Fund, reiterated his organization’s concern over high private-sector debt levels in China.

Cybersecurity merger. In a statement released over the weekend, Symantec Corp. announced it will acquire Blue Coat Systems for more than $4.6 billion in a cash deal. Blue Coat had previously filed for an initial public offering. Greg Clark, CEO of Blue Coat, will become head of the new combined entity as it refocuses on cybersecurity after Symantec spun off its data-storage division in January.

Microsoft to Buy LinkedIn. On Monday, Microsoft Corp. announced that LinkedIn Corp. has agreed to merge with the software giant in an all-cash deal valued at more than $26 billion. At $196 per share, the bid represents a nearly 50 percent premium to the closing price of LinkedIn’s shares on Friday. Management at LinkedIn will remain in place as the corporate networking platform retains its own separate brand and identity.

Peru presidential race ends by narrow margin. Pedro Pablo Kuczynski, a 77-year-old former central banker, won the Peruvian national election on Friday after rival Keiko Fujimori conceded defeat, despite some remaining ballot challenges. The race was one of the tightest in Peru’s history. Kuczynski won on a probusiness platform that linked private-sector job creation to government policy.

Blackstone raises $5 billion buyout fund. Bloomberg News reported today that Blackstone Group, currently believed to be the largest private equity manager by assets, has raised $5 billion for a new fund that will hold portfolio companies for much longer than usual within the industry. The new fund will focus on stable, deep-value plays in established industries and has accepted capital from long-term investors only, according to sources cited in the report.

Yahoo! asset sale hits end game. Multiple media outlets reported today that telecom rivals Verizon Communications and AT&T are expected to submit final bids for Yahoo!’s online assets in coming weeks. Multiple private equity firms and corporations have been rejected by the embattled firm’s board in earlier stages of the auction.


Major Korean IPO scrapped as investigation begins. An initial public offering for a hotel subsidiary that would have resulted in a flotation of more than $4.5 billion by South Korean firm Lotte Group has been indefinitely delayed. Last week South Korean officials widened their investigation into possible embezzlement within the Lotte empire, which is family controlled.

Portfolio Perspective: Shake Off the Hedging Fatigue — Jim Strugger, MKM Partners

We will take some blame for the hedging fatigue out there. Since late March, we have expected the next cyclical lift in U.S. equity volatility. A couple of different times over that period, we pushed hard on adding portfolio hedges and long volatility exposure. It is a premium that would have gone up in smoke with spot VIX now having remained below the 20 level since then and the Standard & Poor’s 500 index grinding for a 2 percent gain. Three and a half months marks the longest period of U.S. equity volatility suppression within a high-volatility regime, surpassing a three-month period in 2011.

Had VIX collapsed toward levels from the 2012-14 period, VVIX [a volatility of volatility measure] dropped below the 80 level that has been its floor since mid-2014 and volatility across asset classes and geographies similarly broken sharply lower, we would have written a mea culpa and worked to recalibrate our methodology. That has yet to happen.

With the U.S. economic expansion at 84 months versus the 95-month average of the last three cycles, it is still more likely than not that volatility broadly remains structurally elevated through an eventual recession and bear market. If so, then we can isolate the length of the recent VIX trough as a high sigma result, but one that cannot be sustained indefinitely.

So does that mean Friday’s lift in the VIX and VVIX and almost 1 percent drawdown in the SPX was the beginning of the next sustained volatility event? Path dependency of volatility suggests it is a higher probability now than any time over the last few months, but as always, we cannot be sure if it will intensify. That said, we believe investors are unprepared.

SPY options open interest is near 24 million and approaching the highs of the last couple years, but the ratio of puts to calls is near lows back to 2009. One of the most active hedging products isn’t signaling much demand for protection. VIX futures tell a similar story with net positioning having shifted from a small positive in March to short 103,000 contracts as of the last data point, just 13,000 shy of the record position in 2013.

While many see an equity market poised to break out to new all-time highs, our work warns of a dislocation. Even investors in the hedging-fatigue camp should appreciate that following this unusually long period of calm, every volatility impulse has an increasing probability of triggering a high-magnitude event.

Jim Strugger is a managing director and derivatives strategist for MKM Partners in Stamford, Connecticut.