No topic has received more attention recently than the disconnect between uncertainty (on every level) and volatility.
For obvious reasons, the VIX has gotten the most attention. Retail investors understand it (kinda, sorta), it has a cool nickname (the “fear gauge”) and it’s sitting near all-time lows.
But as we and others have noted, vol is suppressed across the board.
That begets all kinds of (probably) dangerous steamroller-penny-picking and as BofAML’s Barnaby Martin pointed out earlier this week, it’s been a veritable “bonanza” for credit traders.
But with everyone from Jeff Gundlach to Mohamed El-Erian chiming in with their own take on the now ubiquitous “THE VIX IS TOO DAMN LOW!” meme…
…everyone and their brother is hungry for more “uncertainty vs. volatility” juxtaposition analysis.
Well on Thursday, Goldman is happy to oblige.
What follows are excerpts from a piece that carries the rather ominous title “Worst Case Survival Guide To Uncertainty,” and as should be abundantly clear from the excerpted passages, Goldman thinks this is getting really – really – precarious.
A Worrisome Disconnect? Uncertainty but no Fear
The juxtaposition of rising policy uncertainty vis a vis declining fear in risk assets raises cause for pause in our view. With investors focused on the ‘Art of the Possible’ as it relates to Trump’s pro-cyclical agenda the market is giving a pass on the negative impact Policy Uncertainty has on corporate spending, M&A and by extension economic activity. Indeed with quarter-over-quarter annualized GDP growth of 0.7%, animal spirits failed to materialize into economic activity in Q1. With much of the optimism priced into the market today hinging on a more complete Washington agenda we note progress may be slow with the House in session for just 39 working days before the August recess. Further elements of the upcoming tax plan raise questions specifically as it relates to the deduction of State and Local taxes where the top 10 states most impacted yields not a single Republican senator but 46 members of the House. We note that is one more than the GOP’s current majority. Below we frame the history of Policy Uncertainty, its relationship with corporate spending and provide a deep dive on the state of (the lack of) volatility. Lastly we map factor and sector impact in the face of rising fear.
- Policy Uncertainty spiked around the US Election to levels last seen in 2013 and remains above the post-Lehman average. The recent decline in Small Business Future Business Conditions helps illustrate the potential linkage with activity. In its April release, NFIB President and CEO Juanita Duggan noted, “The tax system is a major burden …and an impediment to economic growth… Without clarity on future rules, it is likely difficult for business owners (of any size of company) to make spending decisions.”
- M&A activity, which has historically shown a strong correlation with policy uncertainty, is on pace to be down 25% YoY. In their 1Q17 calls, Lazard CEO Kenneth Jacobs commented, “The M&A market has been uneven this year as corporate decision makers cope with uncertainties regarding U.S. policy under the new administration,” and Evercore Chairman of the Board John S. Weinberg said, “You will see what I would call smaller transactions, there is no hesitation…I think large transactions will be influenced somewhat by tax policy.”
- Bank loan growth has also slowed materially since the Election (down from ~7% YoY to ~3.5%), with business (C&I) and CRE lending showing some of the sharpest declines. This could be indicative of a CapEx slowdown, which has also been correlated with Policy Uncertainty in the past (though with a lag). See Exhibit 13.
Despite elevated levels of Policy Uncertainty, the traditional market proxy of uncertainty – the VIX – is near all time lows. SPX 1M implied volatility hit its lowest level ever this week (note, index options started trading in 1983). This is not just an equity phenomenon as many fear gauges across most asset classes (e.g. US rates, G9 FX, US High Yield) are below average.
Furthermore, positioning suggest investors are positioning for volatility to move lower. AUM of inverse VIX Exchange Traded Products (such as the XIV) has grown ~$600 mn YTD while AUM in long VIX products have declined $460 mn.
In addition, short positions on the VXX, the largest ETP product, are currently in the 87th percentile vs. the last year.