Ok, well it looks like something snapped about an hour ago and notably has so far forgotten to “mean revert,” although rest-assured someone (or some Terminator) is looking to buy the dip already.
USDJPY is well off its highest, following Treasury yields lower…
S&P and Nasdaq futs are tumbling…
…and the VIX is eyeing 11 (believe it or not) after yesterday’s crash around the Fed decision…
And guess who appears to have caused it?
That’s right: Gandalf.
“The weakness occurred as traders circulated a note by JPMorgan quant strategist Marko Kolanovic that cautioned investors on the risks of record-low volatility in the equity market,” Bloomberg notes.
Here are some excerpts:
Volatility near or at record lows by a handful of measures should give pause to equity managers.
Low volatility would not be a problem if not for strategies that increase leverage when volatility declines.
The usual suspects are flagged, as Kolanovic mentions vol. targeting strats, CTAs and risk parity funds.
Many of these strategies (option hedging, Volatility targeting, CTAs, Risk Parity, etc.) share similar features with the dynamic ‘portfolio insurance’ of 1987. While these strategies include concepts like ‘risk control,’ ‘crisis alpha,’ etc., in various degrees they rely on selling into market weakness to cut losses.
Additionally, growth in short volatility strategies in a self-fulfilling manner suppresses both implied and realized volatility. This in turn prompts other investors to increase leverage, and those that hedge with options lose out and eventually throw in the towel. The fact that we had many volatility cycles since 1983, and are now at all-time lows in volatility, indicates that we may be very close to the turning point.
The risk is the same as ever: deleveraging into a falling market:
They rely on selling when markets are weak to cut losses, creating a selling order that gets bigger as volatility gets lower.
“It’s usually a quiet time of the day too so it doesn’t take much to move things at this hour,” Mark Kepner, an equity strategist at Themis Trading LLC in Chatham, New Jersey said, while Yousef Abbasi, global market strategist at Jonestrading Instiutional Services LLC added this: “If you poke it in the right place – this market will leak. Low volatility probably creates tighter stops when you try to manage risk — and when a headline, a story or a note hits and gives pause – you see these small unwind.”
Or maybe this is a better summary: