Earlier today in the XLF trade (read here) I highlighted the dislocation of U.S. equities with that of credit (specifically high yield), fx and commodity markets. While U.S. equities remain a sort of “safe haven” trade given what appears to be solid economic data, there has been a stealthy emerging bid in equity linked volatility, most prominently displayed by the VIX’s 70% gains in just the last week as the S&P500 (SPX) declined a measly 3%.
The volatility in oil and related stocks has spooked some investors causing them to reach for protection in the High Yield market and U.S. Treasuries, driving Yields back towards 52 week lows.
I have no idea how this is going to shakeout. I have no idea where the bottom in oil is, I have no idea what the true effects are on our economy (that seems to be doing ok to this point) and I have no idea how significant the relief at the pump will be for the American consumer.
What I do know is everyone should be keeping a close eye on how investors are reaching for vol hedges. It’s really evident in crude oil over the past 5 months as the ramp in the CBOE Oil etf VIX Index (OVX) has been breathtaking. Crude is down 50%, OVX is up 250%:
To remain complacent about the effects of the broad commodity collapse on U.S. corporate earnings (with the backdrop of a strong dollar) could be foolish. The VIX is above 20 for the first time since mid October despite (or maybe because of?) the SPX being almost 100 points higher since then:
With that sort of set-up it makes sense to wonder what a VIX breakout would mean for the SPX. The VIX is above 20 and the SPX hasn’t even touched its 50 day moving average yet (it might today). If we see the VIX back at 30 like we did in October where’s the SPX then? 1900? And where’s the VIX if we revisit the Oct lows? 40?
That chart shows just how incredible the rally off the October lows was. And now with people realizing there’s some volatility in other asset classes and a U.S. stock market barely off the highs after an parabolic rally, it may be the time to grab some vol in equities.