Eric Peters On Tipping Points: “It All Worked Incredibly Well, Until It Blew Up”

Sunday, October 1, 2017
By Paul Martin

by Tyler Durden
Oct 1, 2017

Two years ago, long after we first suggested that the transformation of VIX from a measure of implied market volatility to a reflexive instrument that can be traded – and thus influence the underlying assets whose volatility it was supposed to measure – the VIX served as the “fulcrum security” for broad asset manipulation, first the FT, then the WSJ confirmed what we said, namely that pervasive market manipulation was not only possible, but took place on a regular basis, thanks to the VIX (see “Conspiracy “Fact” – VIX Manipulation Runs The Entire Market” and “Another Rigged Market: Scientific Study Finds Systemic VIX Auction Manipulation”).

Today, one of our favorite hedge fund commentators, One River Asset Mgmt CIO Eric Peters, discussed various market “tipping points” in his latest weekly notes, which emphasized why volatility is no longer a “measurement”, as much as a “target.” More his latest Sunday anecdote:

“When a measure becomes a target, it ceases to be a good measure,” said the Englishman, stepping outside of himself.

“That’s Goodhart’s Law.” Charles Goodhart observed that central banks measured money supply, and found certain M1 growth rates to be optimal. But once they targeted that optimal range, M1 lost its value as a measure.

Market and economic actors adjusted their behavior to game the M1 system. So central bankers shifted to M2, then M3, and M4.

“Investing is obviously not a science, but if it were, we would say that you can’t act on something and observe it at the same time.” French colonialists discovered this in rat infested Hanoi, when they offered a bounty for killing rodents. To receive the reward, the Vietnamese were required to produce severed tails. Soon thereafter, tail-less rats scurried throughout the city. The bounty hunters removed their tails and released them to the filthy sewers to breed. Boosting their bounty.

“Investors discover pricing anomalies from the past. And they pile into them, ensuring that for a time they persist.”

They mistake the distortions of their wall of money for the wisdom of their observations. They interact with the market as if they’re exogenous, when, in fact, they’ve become endogenous.
“Today’s greatest example of Goodhart’s Law in action can be found in volatility markets.”

The Rest…HERE

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