Headed into the final FOMC meeting of 2023, there was a bull market in allegations of dangerous investor complacency.
As is typical in such environments, the “evidence” was subdued vol.
On the eve of the December Fed decision (and the release of the new SEP and dots), the VIX hit a fresh post-COVID low.
The generic interpretation is that markets are fearless. The VIX is the “fear gauge,” after all.
I wouldn’t brave a categorical repudiation of that contention. Nor would I necessarily suggest “complacent” is an inaccurate description of the prevailing market mood.
What I would suggest, though, is that assessments which lean too heavily on a single measure to make sweeping claims invariably gloss over key nuance. This is no exception.
Current levels on the VIX are indicative of “smooth sailing,” Wells Fargo’s Chris Harvey told Bloomberg in a phone interview on Tuesday. “There’s nothing that really scares [the market] and there’s nothing that’s going to surprise it,” he went on, editorializing further around the supposed read-through of new post-COVID VIX lows. Harvey thinks markets will in fact be surprised. If past is precedent, he cautioned, equities may suffer a drawdown in early 2024. When the VIX starts the year below 14, it’s a bad omen, he suggested.
Again, I’m not arguing. But, as detailed on Monday in “Too Quiet?” (and on countless other occasions of late), there’s more to low vol (realized and implied) than generic “complacency.” In addition to oppressive short-vol flows, there’s an important under-positioning story right now.
“US equities index options are still cheap for a bunch of reasons, but an ironic one is simply [that] so few funds have the performance to spend the premium,” Nomura’s Charlie McElligott said Tuesday. “It feels like most convos I’m having with discretionary PMs are to the effect of ‘…just get me to year-end in one piece, please,’ which in my mind is at least part of the reason that equities keep grinding relentlessly higher.”
Keep that in mind when you look ahead to Q1, particularly in the context of a market that isn’t likely to give up on the idea of at least 100bps of Fed cuts in 2024 regardless of what Jerome Powell says this week or what the SEP looks like. As I put it a few days ago, I think ~100bps of expected cuts will be the baseline assumption for markets regardless of near-term oscillations in STIRS and irrespective of what the new dot plot shows.
Wells Fargo’s Harvey doesn’t disagree with that point. He told Bloomberg he personally doubts markets will be dissuaded from near-term rate cut bets even if Powell tries to push back. But he nevertheless suspects a rough patch for equities at some point in the first half.
That’s not necessarily inconsistent with the idea that January (or even the whole of Q1) could see “more melt-up” (more cowbell), but it certainly isn’t a ringing endorsement of any bullish views for the first few months of the new year. When you think about that, don’t forget that everyone who’s currently just trying to get out of 2023 will be starting fresh in just a few weeks, presumably prepared to go on offense.
“In light of the ongoing under-positioning dynamic discussed in broad assets coming out of Q3 into Q4, I still believe the market will cling to this dovishness on cooling inflation and labor into a new year with new PNL and loaded money market fund assets as the ‘source of funds’ to deploy further out on the risk curve,” McElligott said.
