Attempting to divine anything meaningful about sentiment from historically low levels of equity volatility has become an exercise in futility. Ditto for cross-asset vol.
The ongoing provision of trillions in liquidity from central banks and the communication feedback loop between policymakers and markets which makes it impossible for anyone to form a long-term view, ultimately creates a scenario where volatility simply can’t sustain a bid irrespective of how ostensibly dramatic any trigger event (e.g. missiles over Japan) seems.
Seen in this light, there’s an argument to be made that conventional measures of market angst have been neutered – rendered meaningless by central banks and held hostage by “innovations” in market microstructure (e.g. VIX ETPs).
Still we watch. And still we wait. And still we protest. And still we point to the record net short in the CFTC data. “It’s a sign of complacency!” we shout.
Here’s some quick Friday morning color from a new SocGen piece…
For a wide range of assets, current volatility levels have reached near historical lows (see chart below). In normal times, volatility is one of the most fundamental risk indicators that helps make a useful comparison between different asset classes. Current levels are so low though that they give falsely reassuring messages. Consequently, assets with vastly different risk profiles get treated basically in the same way, caught in the relentless hunt for the last remaining sources of yield as the only focus. Beware of complacency: reduce risk.
A fitting example of extreme positioning is the unusually strong level of net short positions on implied equity volatility, more than three standard deviations below the longterm average. Despite very low levels (spot VIX at 9.87 on 27 September) hedge funds continue to expect this very low volatility environment to continue. If it does, the strong skew in volatility futures results in attractive returns. Compare that with dancing on the rim of a volcano. If there is a sudden eruption (of volatility) you get badly burned.