It’s one prominent voice right after another these days.
Seemingly everyone is now concerned that the lull in markets (as evidenced by suppressed vol. across assets, record high stock prices, and still tighter tights in credit) will invariably end in tears.
Most of these warnings have two things in common: 1) they all flag reduced accommodation by central banks as a likely catalyst, and 2) they all suggest that the low vol. regime and the trades it’s supported (carry, levering up by systematic strats, etc.) will probably go from markets’ best friend to everyone’s worst enemy when things turn.
More specifically, because vol. is so low, a nominally/optically small spike will look very large in percentage terms, which could cause levered and inverse VIX ETPs to buy VIX futs into the spike, exacerbating the problem and potentially triggering deleveraging by the systematic crowd.
Well, speaking of the programmatic folks, JPMorgan’s head quant Marko Kolanovic (affectionately known as “Gandalf”) sent out the following “cheery” message on Thursday afternoon in an apparent effort to send everyone off to the weekend on a high note…
Positioning for Rise of Volatility and Tail Risk.
Risky assets have been rallying for years, and market volatility is near record lows. Valuations are high, arguably supported by low interest rates and the record pace of central bank monetary expansion.
However, this may change in the near future. In the US rates are rising and monetary accommodation from the ECB and BOJ will recede.
Medium term, this is likely to lead to market turmoil, and a rise in volatility and tail risks.
More on this when I get a minute…