It’s rational to ask if asset prices are destined to buckle under the weight of last month’s rally — to wonder if the path to “El Dorado” was paved with fool’s gold.

After all, the S&P’s now a mere 4% from its record highs, a remarkable feat given all that’s happened, recession odds are elevated (according to most) and the 2024 geopolitical agenda is “busy” (as Goldman recently put it).

Traders (including Bill Ackman and Bill Gross) are betting on Fed cuts. And Fed cuts there will almost surely be. But as JonesTrading’s Mike O’Rourke wrote this week, “financial markets themselves are making the case that there is no reason to rush rate cuts.” US equities, he pointed out, have returned in excess of 9% since the Fed started raising rates in March of 2022.

As the simple figure shows, it’s eminently possible that Wall Street can reclaim records by year-end. To some observers, that seems somehow inconsistent with macro-policy realities.

Although many on the sell-side begrudgingly came around, not everyone’s on board. JPMorgan sees the S&P falling in 2024. The bank’s year-end target is 4,200. “We expect a more challenging macro backdrop for stocks next year with softening consumer trends at a time when investor positioning and sentiment have mostly reversed,” Dubravko Lakos-Bujas said. “Equities are now richly valued with volatility near the historical low.”

Options-based measures of risk aversion betray no demand for protection (or no demand for downside protection, anyway) and realized vol fell away entirely in recent days.

Recall the discussion from “Adventures In The Vol-Scape“: The harvesting of vol risk premium (following the vol expansion witnessed from August through October) became self-fulfilling.

It’s “a function of incessant index vol-selling across the usual suspects,” Nomura’s Charlie McElligott wrote, mentioning income and yield enhancement strategies, systematic VRP harvesting, structured products as well as “crowded dispersion books” which, together, are “creating a dynamic where dealers are getting stuffed on bleeding gamma / vega, which forces them to ‘join the parade’ and short front-end vols themselves to stop the PNL bleed.”

To casual observers, all of this might sound perilous — an example of “stability breeding instability,” so to speak. But that’s not quite right here. Consider the figures and annotations below.

Why is there no demand for downside? It’s not all unbridled optimism and it’s not necessarily indicative of widespread complacency either. Rather, “there simply isn’t enough long / net equities exposure on,” McElligott said.

In addition (and Charlie has mentioned this repeatedly), cash can be conceptualized as a de facto ATM put. Cash currently yields 5% or better, and if you’re sitting on a lot of it, that’s your downside protection.

So, what does this mean in the context of crash odds? Well, as Charlie went on to explain, the dearth of demand for downside makes it hard for equities to selloff meaningfully. “In order to get a crash, you need clients grabbing at tails which then sees dealers immersed in the dreaded ‘short gamma’ feedback loop,” he wrote.

The takeaway: From the perspective of positioning and vol dynamics, the “‘mechanical’ conditions for a disorderly equities selloff are simply not yet in place,” McElligott said.

Of course, that doesn’t mean a selloff is impossible. A run of hot macro data that compels the Fed to lean against escalating rate cut bets (really lean against them, as opposed to just paying lip service to two-way policy risk), a disorderly spike in yields or, God forbid, some kind of disastrous exogenous shock, could change the game overnight. That goes without saying. Or at least I hope it does.

But, coming full circle, if the question is whether positioning and vol dynamics are themselves conducive to an “accident,” the answer is probably not. Yet.