Look, today is not yesterday.
That is, today is a new day and as we’ve noted before, the low vol. regime is the market’s perpetual topic du jour.
So, today’s hot topic is the same as yesterday’s hot topic and tomorrow’s hot topic will be the same as today’s and yesterday’s.
All of that can only mean one thing: there are more analyst notes out on Monday morning about the low vol. regime.
To be sure, Deutsche Bank’s Aleksandar Kocic relegated everyone else’s take on market complacency to also-ran status late last week. You can read his epic piece in “‘Turbo-Complacency’’ Fear Gets A ‘New Dimension’ In Kocic’s Latest Masterpiece.”
But just because topping Kocic is for all intents and purposes impossible, others will still be inclined to pen still more missives on the subject and I suppose “the more the merrier” applies.
So with that, here’s Goldman’s latest which finds the bank observing that the VIX call/put ratio is back to highs last seen in 2014 and 2007 – only to summarily dismiss that as a meaningful predictor of subsequent vol. moves.
Since mid-2016, markets have been stuck in a low vol regime – in particular, for S&P 500, vol has been low, with 1-month realised volatility at 7% in June (11th percentile since 1928). This has been supportive for risk appetite and valuations of risky assets. But in the past few days, in part owing to fears of central bank tightening, volatility has picked up. FX and rate volatility picked up first and spilled over to equities, which have corrected from all-time highs. On Thursday last week, the VIX reached an intra-day high of 15, a level last seen only briefly in mid-May 2017 on concerns over a possible impeachment of President Trump but it reversed quickly afterwards. If we are nearing the end of the current low vol regime, this has material implications for asset allocation and specifically volatility selling strategies, which have been increasingly popular.
Investors have recently started to position for higher volatility – the open interest in VIX calls has increased, inflows into the largest long VIX ETP (iPath S&P 500 ST future, VXX) have picked up and the net short on VIX futures has decreased. The VIX call/put ratio has spiked to one of the highest levels since the GFC, indicating investors anticipating a higher VIX. As shown in exhibit 1, the ratio between VIX call and put open interest is now back at 2007 and 2014 highs, where realised volatility was similarly low. However, a backtest shows that it has limited predictive power for vol spikes – although there is little history (see Exhibit 2). The largest vol spikes have usually occurred from average levels of the VIX call/put open interest ratio, i.e. have not seen material positioning ahead.
While in the near term, volatility could pick up as the ‘Goldilocks scenario’ fades, it might not drive a breakout from the current low vol regime unless recession risk picks up or uncertainty on central bank policies increases on a more sustained basis. Indeed, a more plausible risk is an increase in bond term-premia from current depressed levels, as reflected in our rate forecasts.
As we showed in our GOAL – Global Strategy Paper No. 23, when low vol regimes end, they tend to do so with a small ‘risk off’ initially; usually, larger equity drawdowns have occurred only after a transition into a higher vol regime.