Marko Kolanovic Finds A Bubble – In The VIX

Marko Kolanovic says the VIX is “bound to decline.”

In a Wednesday note, Kolanovic blamed recent “turmoil” in markets on the rotation in equities, as cyclicals, value, and other reopening assets attempt to take the baton from secular growth favorites, frothy tech, and bond proxies, all of which have suffered amid rising rates tied to recovery optimism and fiscal stimulus expectations.

I’ve repeatedly argued that was never likely to be a smooth handoff. Equities expressions tethered to the yearsold “duration infatuation” in rates were entrenched in leadership roles and had proliferated, creating factor crowding and other dynamics that encouraged still more inflows. When taken in conjunction with pandemic realities favoring tech, we ended up with epic (and ultimately unsustainable) disconnects, like the one illustrated in the visual (below).

But despite recent rotation-related turbulence and stretched multiples, Kolanovic wrote Wednesday that it’s hard to suggest the broader market is a “bubble” or otherwise teetering precariously on the brink of something bad.

“A dominant group (FANGs) practically hasn’t moved for six months despite massive amount of stimulus and an expected economic recovery, Financials have barely recovered 2020 losses, and Energy is still down 25% from last year despite a commodity bull market,” he observed.

In an effort to be what he called “thorough” in the search for bubbles, Marko looked at the VIX which, regular readers will recall, is a semblance of “broken” (see here and here, for more). A supply/demand imbalance in implied vol has created what some argue is a perilous setup — an “accident” waiting to happen.

For Kolanovic, the situation should correct in benign fashion. “The VIX is now disconnected to underlying short-term S&P 500 realized volatility, indicating a demand from investors looking to hedge or profit from a hypothetical market selloff,” he said Wednesday.

The spread between the VIX and two-week realized sits in the 99.6th percentile going back three decades, he noted. In the past, such spreads usually followed VIX shocks and resolved relatively quickly. When the spread between the VIX and realized has been in the 95th percentile or higher, the VIX typically dropped by 11 points over the ensuing three months, Marko wrote, adding that the accompanying market rally averaged 12%.

The hit rates are very high, for those curious.

“Based on historical data of equities and the VIX, one should expect a decline in the VIX and rise in the S&P 500, which is consistent with our forecasts and price targets,” Kolanovic went on to remark.

What we’re witnessing currently in the elevated VIX-realized spread indicates “a bubble of fear,” he added.


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