There are many fundamental reasons stocks have behaved well lately. Earnings are strong and appear to be getting stronger. Economic growth is accelerating and in-sync globally for the first time since the post-financial crisis bounce. And of course, global monetary stimulus continues to be highly stimulative and supportive of higher asset prices.
The confluence of these positive factors has led to market calm. In fact, volatility has not been this low since 1966. While it’s true that most bull markets are accompanied by low volatility, never have investors been so able and willing to invest directly in this “long calm” trend. As seen below, shorting volatility (or the VIX index) through ETFs has been one of the most successful momentum trades of this bull market, up 1735% over the last six years – outperforming the ultimate momentum stock, Tesla, by 455%.
Investors chasing returns is not new but doing so in a short VIX vehicle is relatively new. The broad market implications of this large imbalance are uncertain. Many fear the trade has become overcrowded and could lead to an exaggerated reversal when fear re-emerges. A relatively small -3% to -5% sudden stock decline could force ETFs to unwind positions quickly, as investors move from “long calm” to “long vol” in order to hedge stocks in a declining market.
Our long-term view, and the optimistic factors listed above, keep us invested in equities. But, our concern that asset prices are fully valued while new leverage is being added to the system in novel and untested ways, keeps us vigilant and reaffirms our commitment to diversifying investments that reduce overall correlation to stock prices and market volatility.
Chief Investment Officer