One of my least favorite charts was back in the news this week.

Plotting any version of the Baker, Bloom and Davis policy uncertainty gauges with the VIX is an asinine exercise.

For those unfamiliar, the Baker, Bloom and Davis gauges use newspapers to construct indexes measuring the volume of articles discussing economic policy uncertainty. The US version also incorporates a metric that tracks the number of federal tax code provisions set to expire and another component that captures dispersion among economic forecasts.

Those indexes, useful as they most assuredly are in all sorts of contexts, can’t be plotted with a measure of expected near-term S&P volatility calculated using bid/asks for index options. Obviously. Such a comparison isn’t apples to oranges, it’s apples to aircraft carriers.

Of course, saying the two “can’t” be plotted together is a statement about best practices, not about technical hurdles. As a Bloomie would tell you if Bloomies could talk, anything can be plotted with anything else. And this is a scenario where it’s very tempting to commit a chart crime: The VIX is the “fear gauge” and fear’s a second cousin of uncertainty, which the Baker, Bloom and Davis indexes try to measure.

There’s one version of the chart. I used monthly readings for both the VIX and the US Economic Policy Uncertainty Index, because the latter’s too erratic on a day-to-day basis to be useful.

The point of the visual is to suggest that equity investors aren’t especially fearful despite the rampant uncertainty engendered by a US president who believes being maniacally mercurial is a virtue when conducting domestic and, especially, foreign policy. (Donald Trump’s not completely wrong about that, but I think we can agree he’s taking the madman theory a little too far this term).

The drawback to using monthly readings when plotting implied equity vol with the policy uncertainty gauges is that you don’t capture the VIX peaks. Basically: If you want to see those, you have to resign yourself to the above-mentioned daily noise on the EPUs.

The figure above shows you the daily series plotted together. That’s the chart Bloomberg used this week to argue that volatility’s out of step with policy uncertainty. Note that if you use the daily series, you could’ve made the same argument at virtually any point during Trump’s second term.

The “problem,” if you want to call it that, with this comparison (beyond the above-mentioned “apples to aircraft carriers” issue) is that it fails to take account of what’s actually going on in the equity vol space, and just in equities more generally.

At the 30,000-foot level, it’s still all about high dispersion and, as a consequence, low correlation, as AI and Energy outperform and everything else bleeds, with the moves “offsetting” for the purposes of index-level optics.

The two figures below show you implied and realized correlation for the S&P and Nasdaq 100, which are both experiencing/exhibiting the performance dispersion dynamic as discussed here.

“The name of the game is ‘thematic bifurcation’ in a world where there’s basically just a small cluster of massive-magnitude AI winners, while everything else languishes on the crowding out of capital or a perception that the ‘others’ are [either] at risk of disruption from AI or ‘rates losers,'” Nomura’s Charlie McElligott said.

In the same note, Charlie reminded investors that vol supply “remains massive” due both to the impact of intraday VRP harvesting and, of course, the secular AUM growth story that is income products with embedded derivatives.

The figures below are updated versions of charts many readers have seen before. They give you a sense of what I mean when I say vol supply’s a “secular growth” story, with exotics contributing heavily this year.

Those flows, Charlie went on, “stuff dealers on gamma, insulating us from large moves, further perpetuating the low realized vol environment.”

The latter point speaks to the notion that, as ever, this is a self-fulfilling prophecy. The longer vol stays suppressed, the better/smoother the Sharpes look on vol-selling strats, which in turn encourages more of the same, keeping vol suppressed and around we go. The high dispersion/low correlation environment provides a fundamental underpinning for the trade(s).

The figure below shows you trailing realized. 10-day sports a nine handle, one-month a 10-handle and three-month an 11-handle. For reference, those were all at or near 30-handles in June of 2022 (when inflation peaked in the US) and they were ~65, ~50 and ~30 at the “Liberation Day” highs.

Low realized vol green-lights vol-control/target-vol strats to dial up their exposure and otherwise re-allocate into risk. On a Nomura metric that rolls up vol control, CTAs and risk parity, systematic strat exposure to US stocks is 86%ile and sits near the highest levels this year.

So, coming full circle, if you’re going to compare the options-derived “fear gauge” to a newspaper-based measure of policy uncertainty, be sure you’re prepared to offer a more nuanced explanation of any perceived disparity between the two.

Oh, and as McElligott noted, there is in fact evidence in the equity options space of fright. Have a look:

There’s some fear for you. Not fear of a meltdown, but rather fear of a melt-up. Call skew — which reflects demand for out-of-the-money upside exposure relative to closer-to-spot calls — is 100%ile.

As Charlie wrote, “the only fear is of the right-tail equities rally, with many institutional investors not owning enough of the narrow sleeve of AI stocks which are driving the index higher.”

It won’t surprise you to learn that put skew — which reflects demand for crash protection versus near-the-money puts — is 0%ile.

“Demand for downside hedges is weak,” McElligott said. “Skew just chokes daily, because you don’t need downside when nets are so low. Or you’re just sick of the theta bleed and paying-away the measly performance in your underlying book.”

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