VOLATILITY: Equity volatility has plunged to a post-covid low on both sides of the Atlantic. The VIX ‘fear gauge’ is down near 40% this year, well under its own long term average levels, and diverging from fixed income volatility (See chart). This reflects both the equity rally and less-bad macro environment. Many have seen it as a source of ‘cheap’ downside protection as global growth and inflation risks stay elevated. This has been consistently disappointing, making short VIX positions a ‘widowmaker’ trade all year as volatility continued to fall despite the US banks scare and debt ceiling showdown. We do expect some VIX reversal. The economic slowdown remains ahead of us, summer seasonality poor, and VIX futures at a record premium to spot.
VIX: The S&P 500 ‘fear gauge’ is the Chicago Board Options Exchange (CBOE) Volatility Index, introduced in 1993. It represents market expectations for S&P 500 volatility over the coming 30 days, calculated from options prices. It can be a contrarian sentiment indicator, and forms part of our own composite. It is negatively correlated with the S&P 500 and ‘convex’. Meaning it typically does not fall by as much as it gains when markets sell-off, making it useful for hedging. But it’s been hurt by the huge growth in short-dated options and in other hedging instruments.
‘WIDOWMAKERS’: These investments make sense on paper but have been consistently and significantly wrong in practice. Losing plenty of investors money and many of their jobs. The most famous of these is the two-decade temptation to short Japanese government bonds (JGBs), in expectation that the country’s soaring debt would lead to higher interest rates. It has seen the opposite. It has the world’s highest government debt/GDP at 221% but 10-year bonds yields of only 0.35%. US natural gas markets have picked up a similar moniker given their gut-wrenching volatility. Similarly, the more recent GBTC discount to net asset value in crypto.
All data, figures & charts are valid as of 27/06/2023.