Volatility is not (yet) your friend

Volatility is not (yet) your friend

• Currently, clients are asking us about the potential length of the current equity market down-trend? The short answer is that as we are yet not receiving ‘clear to go’ signs from our indicators, we maintain a defensive approach to risk-taking.

• Among indicators we are looking at is implied S&P500 volatility or VIX. In this TAD, we investigate the latter and conclude: “Volatility is not (yet) your friend.”

• On p.3,  key factors determinating equity market volatility are shown. Here, it becomes clear that Fixed Income volatility is the most critical factor behind the current high S&P500 market volatility. However, it is also clear that volatility in Macro Fundamentals is still low, which means that the latter may become a source of more volatility in equity markets in the coming weeks and months.

• On p.4, our volatility model is shown. The model suggests that traded volatility should be somewhat lower than realized. This could indicate a soon-to-come rally. Still, we do not think that volatility is yet our friend as an investor.

The reasons are: 1.Our VIX model suggests that the balancing volatility level should be above 25, too high for the market to start a new uptrend. 2.The volatility level may continue at a high level. For instance, Macro volatility is still too low compared to other input factors. 3.‘Investor capitulation’ has usually triggered a VIX spike to above 35. However, we have not yet seen VIX above this threshold level.

• Investment Conclusion: We have not yet received sufficient evidence from our VIX model that market volatility will trend lower, and without that, we stick to our underweight position in risk assets, including SPX. For other relevant notes, please look at https://c-a-p.dk/from-headwind-to-storm-rotate-further-into-defensives/)