The Great Short Vol Unwind has left a number of market participants and commentators wondering if this is a signal of a return to some “normal” level of volatility, a regime change that could perhaps fully remove the feeling of complacency in the market. Indeed, typing in “return of volatility” into
Is it so? I don’t think so. While equities are ridiculously overvalued I suspect they’ll become more overvalued before the reckoning. First, let’s put the vol spike in context of other asset classes. Here’s a Composite Volatility measure of implieds from equities (the VIX), along with the Ten Year Vix, Euro Vix, and Swap Rate Vix:
So, yes, a spike, but not a crazy spike. And note the calm after the previous spikes. Why am I so complacent? Look, there’s always tail risk-a crisis in China, war with North Korea, some unforeseen systemic issue, etc. But the fact is the US, EU, UK, Japan, EM-so yes, the whole world-is firing on all cylinders. The consumer is back, PMIs are at all time highs, unemployment is low, and the central banks are tightening at their characteristically slow pace. Will there be another recession? Sure! Probably sometime in 2019, if I’m pressed to guess. But until then a couple of scares isn’t going to be enough to stop real money allocations to US equities. What about a rise in rates causing managers to reallocate? 1) The Fed Model is a terrible predictor of equity returns (See Asness, Clifford (2003). “Fight the FED model” Journal of Portfolio Management), and 2) Managers, following longstanding tradition, won’t reallocate until equities are at their lows and bonds at their highs.
Am I telling you to JBTFD? No. I can’t in good conscience carry positive equity deltas at these levels. But I wouldn’t be short either. I would, however, sell small delta neutral vol on vix spikes above 75% IVR.